Last update: August 2021

When markets crash, tactics that used to work don’t and those that used to not work do. But before you go hog wild embracing these once-unfavorable-but-now-favorable techniques, you need to recognize something. Once the world turns right side up again (and it will) these seemingly smart ideas will become stupid once more.

Like Monday’s Tales of a Technician post, the inspiration for today’s musings come from the clubhouse. Ryan discussed his recent experience with a misbehaving credit spread. As with all bull-put-toting traders, October upended his 75/70 credit spread on WWE. Rather than scaling-in to more contracts or simply exiting when the short strike (75) was breached, he legged out.

That is, he bought back the short 75 put at a loss but kept the long 70 put in hopes that continued weakness in the stock would allow him to rack up additional gains on the long leg. In doing so, he flipped the trade from bullish to bearish. This was his rationale:

“Rather than buy back the long put, I let this ride for the following reasons: negative news affecting price, post earnings, and below 10, 20, 50 day MAs. My exit strategy could consist of a trailing stop or buying back above previous high.”

The idea of legging out is a legitimate one. When it works, it makes the wielder a wizard whose sorcery turns losses into gains. Such was the case with WWE this go around. Because the downside follow-through was swift this month, any traders who legged out of bull puts likely reclaimed their positions from the jaws of the defeat.

But here’s the rub. Just because legging out worked this time doesn’t mean it works most of the time. October was an outlier. It’s not common for the market to plunge as swiftly as it did. Almost every other market pullback this year recovered quickly. And if you legged out in those scenarios then the tactic would have added insult to injury. You would have peeled of your short put at a loss and then seen the market rebound over the ensuing days to steal the gains from your long put.

But wait! Ryan’s idea was to use a stop of some sort to protect the gains on the long leg if the market were to snap back. Would that not have helped minimize the damage on the long leg?

Sure. However, sometimes the market gaps up the next day. Even if it did trade higher in an orderly manner, you’re still likely giving back some of the profits you had in your long put even with a stop loss.

As with all adjustment ideas, whether or not legging out is a technique you should resort to comes down to your skillset and management. If for every October that makes you like look a genius there are five other instances where the market rips higher after you legged out, then it may not be worth it in the long run. Keep a journal to record the overall results. Then and only then would I decide if it’s worth using.

—

If you’re a new trader, stick to your rules and try to process these concepts as you go. You don’t have to know everything to be able to follow your rules and make a trade. Generally, playbooks—like our own Trading Playbook (for PRO Members only) —are invaluable resources for new traders so that you don’t get your head spinning too much on the definitions.

---

Financial freedom is a journey

Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.

---

Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.