Hey gang, ex poker player. Made quite a bit of coin in my day playing poker that I reinvested into successful businesses. Lost a lot of it promptly YOLO'ing the market decades ago well before the days of WSB because I wanted to retire early and figured I could retire early or keep working anyways. Learned the hard lessons, stayed focused on business and away from the market.
So why on Earth would you listen to me? Precisely because I've been a dumbass in all my dealings (poker, business, stocks) but have stuck each one through long enough to learn from my silly mistakes. I feel that Thetagang has given me much more tools in the quiver and want to pay it forward by helping those with... ahem, degenerate tendencies, and even those without, to understand some proper risk management. So on with the show.
Rule #1: Always Assume the Worst Case CAN Happen
Lady luck loves nothing better to take her big dick and deflower your naive optimism at every opportunity. Have a bet that you think is a sure thing? Great, can you "define" what a sure thing is in numbers? Cause if you can't, it's undefined risk and that means you have no idea what you are dealing with. Selling naked call / put options is an undefined risk (unlimited loss). Selling vertical / calendars is a DEFINED risk (you know what you can lose/gain).
I know what you're saying, "Hey granto, XYZ will NEVER hit that strike or ABC could never go bankrupt, it's impossible!". And of course, I'll say, it's impossible like the chance of a country defaulting on their bonds right? Like Russia in 80s which blew apart LTCM, one of the fastest rising stars in the hedge fund world with the smartest dudes around?
See the thing is, once you start thinking "It can't happen" or "The chance is so small.." then that's when you're fucked because you're replacing analysis with hope (or worse, ego). See the thing is, 99% isn't impossible. And 90% sure as HELL isn't impossible. And if you can't understand how your trade can go sideways, you are not the smart shark that you think you are. You are the fish. That's why any veteran trader (and I hardly call myself one) rolls their eyes at someone saying they make 1% a week selling FDs.
Rule #2: Size Your Bets Accordingly (SEE Rule #1)
If you think you've got a 60% winning bet, do you go all-in? Fuck no. 80%? Nope. 90%? Still no!
This is where Kelly's criterion comes in (good Reddit thread here. In a nutshell, even when you are at a high probability of success, if you make that same bet multiple times with a outsized portion of your assets, you will go broke due to the law of large numbers.
Example: You sell 1 standard deviation SPY call options (approx 30 delta) which assumes your contact expires worthless 68% of the time. Well since you're smarto pants here, you realize 68% isn't THAT safe, but two standard deviations (~95% win rate) would be very safe. So you sell 7 delta calls each week jacked to the tits. You're playing it safe, right?
Well, math comes out that your 95% trade over 13 trades (0.9513) comes out to a 51% trade. That means if you max your bets for a mere 3 months, you're a coin flip chance of having an assignment. This is why they call it "picking up pennies before a bulldozer" and why everyone says "It works, until it doesn't".
So how much should you bet? Most people say never more than 5-10% of your portfolio on any one position; and I mean that any one position should only have risk exposure of said 5-10%. If you short GME/AMC/MEME using 10% of your margin, then god bless and pray to not meet your maker because your risk is once again, undefined (unlimited). The reason the 5-10% exists is because you need to assume that your position can/will move against you AGAINST ALL ODDS and you need to limit your damage and exposure.
There are MANY, MANY smart players out there that have gone bust simply because of poor bankroll management. Once you're wiped out, you're gone. No more bets, no more opportunities. Even a 50% loss sets you back YEARS. When the game is based around compounding numbers, any significant portfolio losses is incredibly damaging to your ability to play the game.
Rule #3: Set Loss Boundaries and Know When To Exit
This is really important. Unlike the top two, which are based on hedging against the unknown, Rule #3 is hedging against your dumb ass self. Why? Because every gambler has that moment when he says: "Fuck this, I'm doubling down!"
That's a GREAT sign? Why? Because it's your own personal stop loss indicator, so that you know you are no longer able to trade rationally. Once you're angry, bitter or trying to win back a loss, now you're in gambling territory my friend. Emotions are high, you want to prove to yourself, Mr. Market, your wife who rolls her eyes that "No no no, I am toooootally right!". Sure thing bud, but let's cool off first and exit your trade and put down your phone before someone gets hurt".
Creating pre-defined exit boundaries are a requirement because it takes the decision making process out of the equation when you are least capable of making a decision. Otherwise, when your short on AMC is going to the moon and your face is melting off, you're not screaming at the invisible buy-side action telling them how right you are and that you'll hold until your account implodes.
Closing gains from 50-80% seems pretty common here. Selling insurance means that losses can quickly escalate far beyond your basis so it's important to put in your stops before it gets away. Where is your own risk tolerance, but mine is is variable depending on the volatility and delta, but as a general rule, if you set your losses to match your gains or even at double, you've at least defined an exit point.
The all too common theme at a poker table is the solid player who loses a big hand that he should have won, then proceeds to go on tilt and proceeds to take a single loss into a whirlwind of loses trying to make ever riskier plays. So of course our next rule is...
Rule #4: Don't Risk What You Can't Afford
I know I'm going to get hell for this, but trading on margin (without well defined risk params) is an invitation for the reaper. Again, if you don't understand how your trade can go south, trading on margin is NOT FOR YOU. If you're hedged with delta all which ways with tight stops, then play big league ball all you want. If your thesis is that SPX goes up 7% per year annualized, margin interest is 4% and your bright play is piling into nothing but high beta SPX plays... then please god re-read rule #2.
I'm sure I'm clear on this already, but if you don't understand or have conviction in the bet you are making, then don't make the bet or make it manageable (small). Most disciplined investors either throw an allocation into a "safe" asset such as an indexed ETF or mutual fund, then put the rest aside for gambling and fun times. That way, if you get caught in the worse way, you're not panicking or on a bender trying to recover. There were dudes in here yelling the end was nigh with a 3% correction a few months ago and if they rode the major crashes like '08, I can't even imagine how jacked they would be. If you're going to gamble, do it responsibly.
When I was young, the worst thing that happened was getting a fuck ton of margin, having a big ego and making a rash of successful plays early. Idiots success is a hell of a drug. A margin call is a hell of a morning wake up. LUCKILY even my dumbass was smart enough to stash away a pile of money to protect it from myself. Which leads me to...
Rule #5: You're Not That Smart, So Don't Bet 100% On Yourself
The rule we all hate. I hate it with a passion. I really enjoy being smart. I'm great at a lot of things. I am not, however, smarter than the market. But, after much hard lessons, I do have enough self reflection to realize that I enjoy options exactly because of it's gambling like nature. And if I keep telling myself that my bets are because I am smart, I may eventually begin to delude myself into thinking so and not question my dumb ass decisions.
Let's face it, we all know (or SHOULD KNOW) that the majority of hedge funds don't beat the market. Holding index funds will beat just about any other strategy time and time again. Yet why do we do this? Because it's fun... and because we all think just mayyybe we'll continue to beat the market, because maybe you currently do or think you can.
So don't get ahead of yourself. You're not the next Buffet. A YOLO play with 2000% returns does not make you a smart investor. Getting away with selling insurance in a bull market doesn't make you an smart investor. It doesn't make you stupid either. But over 20 years, let's see how you do. And if you're a billionaire, fucking kudos to you and your big dick. To everyone else, stay humble, donate to your local ETF.
Rule #6: Don't Force Opportunities, Be Patient for High Probability Scenarios
I've often sat down at a game and realized that it's just not a good game for whatever reason (slow pace, grumpy players, bad cards, etc). The wrong thing is to sit down and try to grind out when there's nothing to be gained. This is where the Bogle / Buffet type investors have it right, because they just jam their meat into SPY and let it slow cook for a few decades while they enjoy the sunlight, outdoors and get shit done.
Thetagang is thetagang for a reason... it's great to just sit and let your thesis play out and hopefully take your winnings. But sometimes I've invested a lot of time into my current plays and just don't have a good one out there that I have conviction of. So I won't force it or concentrate my bet. I always know it's time to chill out when I think "Hmm... this is going slow, maybe I'll just sell a few more CSPs on the same ticker on another date/strike". Because when I do, that violates Rule #2 for bet sizing.
Each player/trader has their own set of signals they they go by. If I'm not getting most of my signals, then I'm just not going to play, because otherwise I'm gambling. It's like shorting/buying AMC. Do I have long term thesis that I'm willing to stick to? Or am I just hoping to run in and scalp? If I believe it will collapse, then I'm at least going to look for a number of entry point indicators to go in vs just willy nilly jumping in.
Rule #7: Never Forget You Are Trading Against a Headwind aka The House Always Wins
This isn't exactly risk, but don't ever forget this rule, especially since we're all trading options here. The bid/ask spreads will murder you if you are going in and out of them frequently. Many spreads hover around 10%. The terrible ones are over 20%. Plus you've got your brokerage commissions on top. If you're round tripping 200 options on a vertical call with a 10% spread, that's 20% + $260 (@ 0.65 per trade). That is a HUGE headwind. Now obviously as thetagang, the hope here is the value decreases so that you're closing the call at a much lower value so the spread at close is a much smaller % vs your basis.
That said, being a monkey trader that is maxing out margin, being forced to close trades when you don't want to, or playing too many highly volatile stocks that stop you out of a trade before your desired point is a big win for the house. Say your monkey thesis is that ZIM is going on a bull run, you sell a put, only to have it turn against you the next week, you're now in a difficult position of accepting your thesis is wrong and closing out, waiting it out until you hit your safety eject number, or stubbornly hold until the cows and margin call comes home.
Rule #: Be Aware That You Have Blind Spots
I should probably call this "Beware of Black Swans" or improbable events that are outside of what you think is probable. This concept was made famous by Nassim Taleb, an options trader who made hundreds of millions by "exploiting" the Black-Scholes options pricing model, which Taleb claims does not price options correctly (too cheap on the edges, too expensive near the money, due to the gaussian curve not representing risk properly... but I am not a mathematician, so please don't skewer me for my ad hoc summary). In English, this is rule #1 on steroids - it's not just the worst situation YOU can think of, but what's the worst case situation you CANNOT EVEN BEGIN TO THINK OF?
Many people think this is like a futile exercise because how can you hedge against say, an asteroid or nuke from North Korea that falls into "acts of god" realms of probability. But as we saw with BTC, China is moving against BTC in a major way and miners are moving to the US. Will the US ban Bitcoin? Obviously, I don't know but the probability exists. How you trade that is beyond my pay grade. But, if you aren't even cognizant to the fact that BTC could be banned then you are trading with a blind spot.
So, this goes closely with Rule #5. You're just not that smart or reflective enough to see your own shortcomings.
.. Anyhow, my dumbass thought this would be a pay it forward for those who may be on the path to making the same mistakes I once did. Thank you to everyone here that contributes and continues to have patience. I am still learning and appreciate you all.
TLDR: Risk is overrated. Concentration makes you rich. Losers exit out a trade early. Your gut knows what is right. Markets always go up. Markets price in everything perfectly. You're the fucking champ with 20/20.
No comments:
Post a Comment