A Trader’s Progress

What does it take to move from paper trading to using real money?

Paper trading serves a purpose. It give the trader a chance to go through the motions and to gain experience

    –Entering orders, including understanding what constitutes a suitable trade

    –Managing risk, including when to hold and when to exit

    –Making profitable exits, learning when it pays to leave money on the table and eliminate the risk of holding

    –Learning to use the broker’s trading platform

One objection to paper trading is that no real money is on the line and that the undisciplined trader may not treat the position as if it were real. When that happens the trader loses out on the opportunity to get a feel for risk management and the important decisions that are involved. I have to agree that this can be a problem for some traders. However, once you can handle the order-entry system and understand the strategy, it does not pay to remain in paper-trading mode much longer, unless you are making specific trade experiments (to learn from the experience).

The one-lot

I know that trading one-lots may seem to be a chicken’s way of trading. However, be assured that it is not. Whatever your bankroll, it is important to trade small position size when getting started. For many beginners, that size is a single-lot. If you have more money (say 6 figures) to deposit into an account, then it’s okay to begin trading with 2- or 3-lots. But there is no need to do any more until you have a feel for ‘real-world action.’


Suggestion: Until you know for a fact – because you have proven that you can take appropriate action when necessary (when real cash is at risk) – that you will not be stubborn and that you will reduce risk (or exit the position) when risk has moved beyond a level where you are comfortable taking that risk – do not increase position size.

If you decide that an appropriate number of contracts for a given strategy is 10 (for example), it is best to move from 1- to 2-lots for a month or two. Next move to 3- or 4-lots. Do not go all the way to your desired position size immediately. Some people who have trading experience (but who are new to options) will be able to move to full size quickly. However, new traders may not realize how frightened they can get (it truly depends on your own personality), and there is no reason to subject yourself to an uncomfortable risk just because you lack patience.

You have the rest of your lifetime to trade. My advice is to take steps to get where you are going. Try to get out of paper trading and move into the world where real money can be earned or lost. But have the patience to increase position size slowly.

Good trading.



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The competition


It is flag day in the US.

I cannot compete with the likes of:

Stock Options offer the opportunity to make some enormous returns. A simple $100-$200 trade is all it takes to turn hundreds into thousands of dollars.

Our goal is to utilize our experience trading stock options to help you secure those big gains.

Nor this

On Monday afternoon, XXXXXX closed out a trade in the Apple Weekly Calls, locking in over $330,000 in profits.

Sure it may be true, but numbers that large are for boasting only.

What I want to know is

    –Is this a smallish 9$165) gain on a 2000-lot?
    –Or was this a spectacular ($3,300 gain) with a 100-lot?
    –Was the trade a call or put purchase, a spread, or ‘lots of different trades.’
    –I’d want to see a track record and how often big trades go wrong.

I find it more important to talk about losses than gains in an attempt to instill the need for good risk management in every trader. That does not bring customers flocking to my doors.

There is the hidden implication that if you sign up for this trader’s service that, you too will make that much money.

If some trader tells you that he earns $1,000,000 per year, don’t be impressed until he tells you how much money he is trading. It could be a 1% return on a $100,000,000 bankroll.

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Investment Advice

Advice is cheap and bad advice is vastly over-priced at zero.
However, good advice is often available with no cost and no obligation. I’m sharing some of that advice today. I am not the source, but it is so useful that I feel obligated to pass it on.

There is a problem. Most people tend to shy away from good investment advice because they often believe that they can do better by taking their own course. And maybe you can. But not as a beginner. The earlier you begin, the better your chances of facing retirement with adequate funds.

Here are a few excerpts from rock-solid investment advice from R. P. Seawright who publishes an excellent blog (Above the Market).

I encourage younger traders to read the whole post. It is never too late, making it appropriate for traders of all ages.

Establishing Your Top 10 Investment Default Settings

Every investor — personal or professional — ought to have a clear investment plan based upon appropriate personal considerations, goals and outlooks and every investor ought to stick to that plan unless and until something significant changes. But there is a crucial component of the investment process that gets surprisingly little attention: our investment default settings. We can use them when we aren’t sure what to do, when we’re deciding what to do, when our circumstances have changed but our plan hasn’t (yet), or when we’re just starting out.

The idea here is that we all have default settings — known and unknown, acknowledged and unacknowledged — and that those defaults greatly influence how successful we are and become. Having the right default setting in defined contribution plans make a big difference.

What follows are my suggested default settings.

1. The most important thing you can do is save

2. Invest you must

3. Start Passive

4. 60/40 is a decent start. Asset allocation is a really big deal.

5. Be a cheapskate

6. Tax efficient is better

7. Don’t forget to re-balance

8. Keep it simple stupid (KISS)

9. Have a very good reason to change course

10. Haste makes waste

The details are worth your time.



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This ‘n That

Here’s some solid advice (with a link to a tale of trading horror) by Bob Lang.

I’ll conclude on this note: be in control of your account, know your risk tolerance and don’t believe you are in a casino. Options trading is not easy but can be done successfully with the right tools, mentality and outlook. Nothing I could do in trading could have made this client happy other than getting back to even, which was so far away it was nearly impossible to get there without wild bets.

You can stay in the game long enough by being respectful of your account and using your knowledge as a tool to grow it over time.

Tools: options provide the best hedging ability on the planet
Mentality: develop a winning Mindset
Outlook: it must be realistic

Looking for a new stockbroker or interested in how yours is rated?
Stockbrokers.com rates the brokers (2013 edition).

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What Other Bloggers are Saying

NOTE: The 2nd edition of The rookies Guide to Options is now available. The retail price is $27 and amazon.com is currently offering a discount. If any Options for Rookies Member wants a copy, I can send it to you at 1/3 off, or $18. Free shipping to addresses in the USA.

From Tadas as the excellent blog, Abnormal Returns.

Pay special attention to the last paragraph.

Asset allocation and the challenge of avoiding tunnel vision
June 7th, 2013

It’s really easy to get sidetracked when it comes to investing. Indeed investors can get tunnel vision focusing on some small matter to the exclusion of others. All that matters in the end for investors are the real, after-tax returns on their portfolio. However we spend most of our time obsessing about the latest economic release or the performance of the latest hot new stock.

Josh Brown at the Reformed Broker notes many examples of strategies that have captured investor’s attentions only to fall by the wayside. There is never a shortage of these strategies because there is always something working. For the vast majority of investors these strategies end up being a distraction from the things that matter most for their performance.

James Picerno at the Capital Spectator looks at this phenomena in relation to asset allocation. The purpose of any asset allocation program is to try and generate acceptable risk-adjusted returns. As we have seen investors like to get off track and focus on either the best (or worst) performing asset class. Picerno writes:

The allure of focusing on one asset class at a time, and obsessing over its outlook, keeps us from concentrating on those variables over which we have some limited influence, namely, asset allocation and rebalancing. In fact, most of your success (or failure) will be closely tied to how and when you rebalance across time…It’s easier, of course, to obsess over individual securities and asset classes, one day at a time, in isolation. But don’t confuse intellectually comforting preferences with strategic wisdom.

Which begs the question: how are you spending your time? Are you obsessing over some small matter or are you focused on the big picture of overall portfolio design? The honest answer to that that question might surprise you.

I’m as detail oriented as one can be. So I understand when readers ask about the details of how a specific number was calculated for one of the tables in The Rookies Guide to Options. Does it really matter? Isn’t it more important to understand the principle being discussed?

It is so easy for investors to lose focus. Maybe diversification is not an issue for you, but Tadas’ warning about losing focus on overall portfolio design is worth noting.

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Commentary on an Iron Condor Trade

An experienced stock trader is learning to use options to enhance his earnings. We are looking for conservative trades that have a good chance to earn a modest profit (12% per year).

in my paper trading account today I sold the September SPY 140/145/180/185 IC for a credit of $0.67.

It is approximately one week later, but let’s take a look at these numbers.

    SPY is 164.4
    140/145 put spread midpoint: 40 cents
    180/185 call spread midpoint: 16 cents.

    Delta of options sold:
    145P: 13
    180C: 6

Immediate comments

–This trade is not market neutral. I have no criticism of that because our trader has a bullish bias

–The 5-point SPY spread width is equivalent to an SPX trade with a 50-point spread width

–The 5-point iron condor is equivalent to owning 5-different one-point iron condors, and the 5-point call and put spreads are each equivalent to selling the five consecutive 1-point spreads

Why is this important? Isn’t this a ‘who cares’ moment?
No. Understanding how equivalent positions work can help a trader make better decisions.

The call spread is equivalent to selling each of these spreads

let’s look at the bid/ask quotes for each of the spreads included in that 16-cent, 5-point call spread.

  • 180/181C; 0.03 to 0.07
  • 181/182C; 0.02 to 0.06
  • 182/183C; 0.01 to 0.05
  • 183/184C; 0.00 to 0.05
  • 184/185C; 0.00 to 0.04

It is not clear how to break up the individual spreads to arrive at a total of 16 cents. However, it is extremely unlikely that the 184/185 call spread premium was any higher than one penny. But, even if it were as high as 2 cents. would you want to sell it? There is so little profit potential. If you were short this spread from a previous trade, wouldn’t you want to pay $0.01 to cover – especially when expiration is three months away?

Consider an investor who has a large stock portfolio and will do very well on a rally. Let’s assume that he wants to collect some cash premium and is willing to sacrifice a portion of his upside gains in return for that premium. From my perspective, no one, not even this bullish trader should accept $1 in cash for the 3-month 184/185 call spread when the potential loss is $99.

Thus, I suggest that selling the 180/184 call spread represents a smarter choice. The premium would be 0.15, or perhaps even the same 0.16. [Do remember that I did not get the real numbers at the time the trade was made.]

For anyone who accepts that premise, what about the 183/184 call spread? How much did that contribute to the 16-cent premium? Probably not more than 2 cents, if that. Would you prefer to sell the 180/183 spread at 13 or 14 cents? with this spread only 3-points wide, you could sell 5 call spreads for every 3 put spreads and still have the same money at risk. The premium collected would be higher: 5 * 13 compared with 3 * 16.

The point is that the 5-point spread premium may seem attractive to sell, but there is no reason to give your money away. When selling spreads that are wider than the most narrow possible spread width, it is almost always worth your time to look at the premium available from selling each of the individual spread. You may discover than one is so much more attractive that you prefer to sell more of that spread than one of each. Or in this instance, you may discover that one is not worth selling. NOTE: DO NOT TRADE THE INDIVIDUAL SPREADS, BUT LOOK AT EACH SPREAD SEPARATELY TO DECIDE WHICH TRADE YOU WANT TO MAKE.

Next, there is another point worthy of discussion. I understand being bullish and not wanting to take a loss on the upside. But, is there any reason to sell this call spread? Is $16 a good enough premium when the possible loss is $484? It is for some traders, but not for me. I firmly believe that selling cheap, far-out-of-the-money spreads, is not a viable strategy over the longer term. They are difficult to manage when things don’t go well because there is no price at which it is comfortable to exit and accept a loss.


I love that this trade was made in a paper-trading account because it demonstrates a willingness to lean and get some trading experience before making a real-money trade.

The main lesson here is to be certain that the trade makes sense. In this example, I would encourage the trader to choose a different 5-point spread. However, he chose strikes that suit his comfort zone – always a good plan. However, by looking at the synthetic components of a spread separately, there are times when you will not want to make the trade. This is one such case. Selling the embedded 184/185 call spread does not offer anything in return for the tiny risk.


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