For those of you that have had to exit out of your trades based off of the exit strategy of if your current option premium plus 3 x current margin is greater than 3 x initial margin, what percent of your initial margin did you lose?
Im in the process of adopting this strategy, but I wanted an idea of what the actual worst case loss in terms of percentage of intial margin is.
In @mu2pilot example, he states when you have a losing trade, you lose the entire amount at risk (IMx3). So I wanted to see if this is anyway possible with above stated exit strategy
Here's an example scenario:
Today I have $20K to sell ES puts. Based on today's settlement price, this is what is available:
ESJ4 put at 1100 strike (with 73DTE and delta0.78), the Premium is $45 for an IM of $212.2
So total margin is 3xIM = $636.6, So i can put on 31 contracts for total premium of $1413 (given 20K total risk)
Now worst case loss would be to exit if the current IM + premium difference > 3 times margin at trade initiation. So just to get an idea of how much I would lose in that exit scenario, I can look at today's strikes where the IM +PremiumDifference is more than my 3xIM. This would be at ESJ4 put strike of 1280 (delta of 2.43) - the IM is 574 with a premium of 127.5. So, the premium difference is 82.5. $82.5 + the IM of 574 = $659 (just above exit mark of $636.6).
The total amount loss in this case would be premium difference = $82.5. This multiplied by the contracts (31) and divided by the $20,000 = $2557 or 12.7% loss on initial.
This of course would vary based on DTE when exiting, but this at least gives me an idea of what the maximum loss would be.
So as mu2pilot infers in his post - that you could lose 100% of the amount at risk - this is impossible with this exit strategy.
Last edited by Mo111; February 3rd, 2014 at 10:25 PM.
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THANK YOU for pointing this out. When I originally did my calculations, I didn't realize that I was supposed to be including the change in IM + change in premium to get to 3x Original IM. I exchanged a couple emails with Kevinkdog and he helped put me on the right track.
I should have come back to the thread and corrected my error. So again, THANK YOU, for pointing out this very important point.
So, repeating what Ron said, when your (CURRENT IM + CURRENT PREMIUM - OPENING PREMIUM) > (3 * OPENING IM), you exit your trade. I'm 99% sure I got this right, but please correct me if I don't.
The bigger question/issue is how much are we truly risking when we put on a trade? As Ron pointed out, we really don't know because of the changes in IM, volatility, etc., etc. Your example was one way to get a feel for what we truly have at risk.
To help with that, I have a real world example to share. I am currently short 3 different ES puts and here is a spreadsheet that shows my stop loss calculations:
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Notice that my 1480 Put is the closest to hitting the 3X stop and is currently showing a 4.13% loss on the amount risked.
The 1600 Put has more cushion left [than the 1480 Put], but it is showing a slightly bigger loss, 4.94%, on the amount risked.
Pointing this out and actually figuring loss percentages makes me feel a lot better about this trading method. I liked it before and was confident that I could make money with it, but the reward:risk ratio concerned me. Turns out some of my assumptions were in error.
Thanks everyone for helping me in my education!
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MU2PILOT - In your trade log, you might consider adding columns for underlying price, option delta and IV at trade entry and exit. You're selling so far out of the money that you don't need to watch these elements every day, although you may want to keep an eye on aggregate delta to see if your position is getting lopsided.
It's extra work but I think you will find it helpful in learning about how option prices respond to changes in time, underlying price and IV. An adverse move in the underlying may not hurt you if you're close to expiration or if IV is flat or declining; conversely, you might be break-even or lose money on a day the underlying rises and you expected to make money on your short puts (IV shot up). Call it a trade post-mortem; you'll probably learn something whether you won or lost.