One of the ultimate thrills for a trader is arguably turning a losing trade into a winner. There’s nothing better than following a trade into the depths and emerging victorious. Humans hate being wrong. It’s annoying. It wounds the ego.
This is the reason why trading techniques that have the potential to turn losing trades into winners are so darn attractive. Sadly, there isn’t a cure-all for trades run amok but there are a few things you can try to salvage a loser.
…and a little luck never hurts.
To illustrate, allow me to share one such trade I experienced this past month on Disney (DIS). Over the past few years, the stock has been on a rocket ship to the moon. Every time I look at it, I curse the market gods for not having bought it at some earlier date. So I was quite happy to see the magical company finally get its comeuppance following August’s earnings announcement. The stock plummeted 9% on holy-freakin’-cow volume. I looked on with glee thinking my golden opportunity had finally arrived.
The stock started rebounding the morning of the down gap, so, not wanting to miss my chance, I sold September bull put spreads. With DIS trading around $111, I was able to sell the 105/100 Sep put spread for roughly 50 cents (number 1 in the chart below). For those otherwise unfamiliar with the bull put spread, I was essentially betting DIS would remain above $105 by Sep expiration. If it did, I would pocket the 50 cents. Since my risk was $4.50, the potential return on investment was 11%; typical for a high probability spread.
All went well for about 30 minutes, then Mickey Mouse came at me with a machete.
Disney tumbled over the rest of the day, then plunged the next morning; tagging my short strike ($105) in short order. There’s nothing more insulting than selling a low delta, way out-of-the-money put a month from expiration and having the stock smack it one day later.
Not wanting to abandon my beloved put spread, I promptly sold a Sep 110/115 bear call spread for 93 cents (number 2 in the chart). The additional credit received helped to hedge my downside exposure and effectively turned the trade into an iron condor. Now, I say promptly, but I mustn’t lie. I didn’t sell the call spread until DIS was already down at $105. …and since I didn’t feel like enough of a moron already, Mr. Market decided to carry Disney stock right back up by day’s end. So, naturally, my timing on shorting the call spread was horrible.
But don’t give up on me yet. I’m not completely inept. I hung with the trade, reasoning DIS would probably settle down and time decay would chip in to reduce the loss. Unfortunately, Disney took another dive on August 20, so I added yet another bear call – the Sep 105/110 for $1.03 (number 3 in chart).
By the time September rolled around, I was able to buy back the Sep 110/115 call spread for 10 cents; locking in an 83 cent gain per contract. Then, on 9/3 and 9/10, I added a 106/110 bear call AND a 105/110 bear call for about 50 cents apiece (number 4 and 5 in chart).
Basically, I’m short put verticals and call verticals with the short strikes at $105. This means the best case scenario is for DIS to drift back toward $105 near expiration.
Well, it’s expiration! Almost, anyways. And look at that, DIS is perched right at $104. Here’s the risk graph of my position:
The white line is the trade today while the red line is what the trade will be at expiration (end of day Friday). In case you can’t tell the trade is back to break-even. Huzzah!
Despite all the drama, harmony has been restored, the money has been returned to its rightful owner and all is well in the world.
Suck it, Mickey.
Financial freedom is a journey
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