August Option Investing – Money Management Revisited

Late July and early August were ugly from the perspective of a covered call strategy.  My underlying positions were hammered.  At this point, I could switch to a bearish strategy such as buying long puts or creating a synthetic put, but neither of those are income strategies.  Since I am trying to generate cashflow, regardless of market conditions, I will have to mitigate further price declines in other ways.  The captain goes down with the ship, I guess.

Based on the information I have collected, I think the US has entered another major economic downtrend within the current secular bear market.  That said, it is time to review money management rules again.

To date, I’ve used risk percentages based on future portfolio size and max loss per ETF to determine my position size.  Given the massive price swings in August (volatility), I am adding a volatility-based factor to further limit position size based on a max volatility over the past 20 days or so. Some of you might recognize this equation from the Turtle Trader Rules:

True Range = Max(High-Low, High-Prev.Close, Prev.Close-Low)
N                     = ((19 * Previous N) + True Range))/20

“N” represents the average range in price movement that a particular instruments makes in a single day, accounting for opening gaps.

Don’t get me wrong; Volatility is great because it leads to higher option premiums. After a quick peak at the premiums for September calls (~10%), I see that I could go all in and smash my income goal for August!

Not so fast…

10% premiums are nice, but going all in right now is WAY to risky. I am more excited about the massive decrease in prices across asset classes.  Rather than deploying more capital, I can sit tight and wait for the markets to turn around (and they will).  When that time comes, I will be in an excellent position to deploy a larger portion of my account and meet even higher monthly income targets (6k through 10k).

The plan now is to meet my August income goal with as little capital in the market as possible. This may mean taking a loss by decreasing position sizes, but better large loss now than an even larger loss later in the year.  With my trades over the past two weeks, I only need ~1.6k in premiums to meet my August goal.

I’ve been asked why I am not 100% cash. Believe me, that is a question I struggled with earlier this month. All my trading systems were saying to get out, from a technical perspective. The simple answer is that in order to generate cashflow with a covered call strategy, I have to be in the market. I don’t have over 100,000 in my trading account, so I can’t trade naked options (brokerage rules).

When I reach a 100,000 account balance, my strategy, money management and position sizing rules will be updated to take advantage of the new capabilities. If the market tanks, I can sell naked calls and just sit on the cash (effectively a covered call, just without owning an underlying position). In early August, I would have sold my shares, and sat on the options until they expired.

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About T. Knight
Blogging about my journey to financial independence via investing for cashflow.

3 Responses to August Option Investing – Money Management Revisited

  1. Pingback: August Option Investing – EDC Covered Calls « Investing for Cashflow

  2. Pingback: Cashflow Report – Paper Income during August 2011 « Investing for Cashflow

  3. Pingback: Year End Cashflow Report – Paper Income during 2011 « Investing for Cashflow

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