Friday, September 08, 2006

Lessons Learned, Part I

First, some background.

My first experiment with options also turned out to be an experiment with futures. 2 for the price of 1. I received a cold call from a broker in late May. Although I didn't have the funds immediately available, I was able to assemble them by early - mid June. The plan was a bull call spread on options for October expiration on unleaded gasoline futures. The reasoning was solid, I think. Entering both summer and hurricane season. Expectations of a bad hurricane season. Instability in the mid east. Nationalization of the oil industry in Bolivia. So I went with it. In 3 weeks, I made 12.5%. (That's not annualized. That was the 3 week return.) After closing out those contracts, I was feeling emboldened. So when my broker came to me in July to do the same thing, I went with an even larger stake.

Mistake #1: Bad money management.

So things progressed fairly well. Until they didn't. The Israel/Hezbollah "war" ended w/o causing any problems between Iran and oil markets. The deadline for Iran to stop enriching uranium came and went. (Loved the "woosh" sound that one made as it went by.) Hurricane activity was so low that the estimates were lowered, and we still haven't seen a level of activity consistent with the lowered estimates. (Kinda like homebuilder stocks. *shrug*)

Mistake #2: Cut your losses.

I held on. Looking for an out. "Hope is a lousy defense." At the first sign of breaking 5% down, I should have been out. Instead, I made a worse mistake.

Mistake #3: Never average down.

I turned the puts in the bull call spread into calls, by buying them back, closing the contracts and sinking the money into more October calls. Now I'm long unleaded gasoline calls in a dropping market. I doubled down on a losing position, like a bad poker player. WTF was I thinking?!?!?!

So now I'm sitting on top of even more calls spiraling toward zero, and I refused to close out the position. Until this past Friday. When I tried calling my broker and couldn't reach him. And I continued watching my calls falling into the apartments beneath me. Glad I didn't need that money for my (future) kid's college tuition, because that 5K is sooooo gone.

And the moral of the story is - apply the same rules that you do for stocks, but even more strictly. Thankfully, knowing how volatile options can be, and futures as well, I went in with the expectation that it could all disappear. And thankfully, not all of it disappeared. I still have some money in some other positions, and a bit in cash. It was expensive tuition, but sometimes you learn the hard way (unfortunately).

Until next time, anyone got a recommendation on an online broker with good response times & order routing and that allows you to trade options and currencies? Stockdiva? I'm not ready for bonds yet, but I can do the options, currencies and futures still. I haven't completely lost my taste for them. Just gotta remember the rules.

2 comments:

Ben Evans said...

I trade options mainly on equities as opposed to commodities. I believe that they are similar, though.

There are many bad ways to trade options and a few good ways. I do like using spreads....I have done well over the years. If you trade equity options, I like optionsxpress. Keep up the good work on your blog it is an enjoyable read.

Good luck

Ben

Khyron said...

Ben,

Thanks. I was looking at OptionsXpress. They seemed to be ranked reasonably well by Barron's survey of browser based brokers, including good coverage of the markets I plan to trade in.