I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Saturday Reflections, I take time out to reflect.
Last fall I took the overgrown clumps of yellow and burgundy irises from my backyard, divided them, and replanted them in my front bed in drifts, mixed in with daylilies and catmint (which I also divided and replanted). Not a single iris bloomed this year, probably because I planted them too deep, but also because a late season snowstorm hit and froze the emerging buds. The few irises I left in my backyard didn’t bloom either, despite having done so the prior two seasons.
There’s not really any good story to tell about the lack of iris blooms this year, at least taking that occurrence in isolation. It didn’t happen because my life needed to not have iris blooms for some reason this year — in that sense it didn’t happen for a reason other than the biology of irises. Ok, it did teach me something about irises, possibly that I need to be more careful when I plant them so I don’t bury them too deep. But mostly it was just the vagaries of life. Very few irises bloomed in my neighborhood this year, so it wasn’t just my planting technique.
If my life were literature, and I the complicated, flawed protagonist, the story of the irises can be told in a way that is meaningful though. All that work I put in to move them, and then the fans of leaves proclaiming the coming of spring, and finally the outcome: nothing at all. You could imagine this narrative going in at least two ways: one would be if I dig up the irises this fall and replant them, ensuring they’re not buried, and a triumph of yellow and burgundy blossoms next spring. Or another potential path: the irises don’t bloom next year, or the year after, or ever. Then they could symbolize the lack of blooming of my life. Or just the idea that life doesn’t always work out the way you hope. You don’t always get flowers. Sometimes you never get flowers.
A third story might be where I tear out the irises right now thinking, “I didn’t like that color scheme anyway!” showing both my lack of patience and my persnicketiness, and leaving gaping areas of my flower bed without greenery.
Another theme here, and something that I think Nietzsche’s ideas of amor fati and eternal recurrence seek to express, is that life doesn’t give you everything you want; it’s so often stingy with payoffs. Just because you divide and plant iris rhizomes doesn’t mean you get the delight of blooms, this year or ever.
Thus, it is important to celebrate the blooms you see.
Amor fati for a down day in the market, and in my portfolio
Yesterday I found it hard to practice amor fati — the love of my fate — as I watched my carefully planned options trades suffer more than simple long positions would have. That’s the thing with options — they’re leveraged bets and can move in wild swings up and down.
I told myself, “don’t worry, this is a good thing! Now you’re in a position to take advantage of opportunities as stock prices come down.”
But amor fati doesn’t say, “this is the best of all possible worlds,” “everything turns out for the best,” or even “everything happens for a reason.” Sometimes stuff goes wrong, and keeps going wrong, and there’s never some outcome that makes it right or even makes it a lesson to learn.
Nietzsche’s exhortation to affirm life as it is acknowledges that things don’t always work out. Life is a mixture of the good, the bad, and the neutral. It can be painful or joyous, profitable or financially ruinous. And, Nietzsche would say, it’s better to not just accept the ups and downs of life but to celebrate the downs with the ups, to wish for them again and again into eternity.
Yesterday’s stock market blood bath didn’t hit my income account, where I trade options, very hard. But it hit my psyche hard because I started catastrophizing about what was going to happen. Despite the fact that I knew semiconductor and tech stocks were way overvalued, I did place some important positions in a couple ETFs and a couple individual equities in that sector. But it was my metals and mining plays which did the worst! And my energy positions weren’t much better.
So I spent most of the day feeling sick to my stomach.
In the past, I would panic when something like this happened, and sell, not everything, but a lot. Now, my new trading guidelines for the option wheel say: “Just hold on. Roll positions if you can, for a net credit. Or take assignment if you can’t.”
“Taking assignment” means that the short puts I hold (put contracts I sold to other investors) could result in my having to buy 100 (or 200 or 300…) shares of the underlying stock or ETF, if the price is below my strike price at expiration. I could even get assigned early, if the option is deep “in the money” with strike price far below the price at which the underlying trades.
I could suddenly find myself having 30% of my income account in long positions rather than in short put contracts instead.
This is the big risk of the wheel, getting assigned far underwater. Short puts have an asymmetric risk/return profile and not really in the direction most experienced traders want (the risk is pretty large the potential return pretty low). But still, it’s an easy way to start making money with options, and I’m going to keep it as part of my options trading arsenal.
Getting assigned leads to the second half of the wheel: selling calls on the shares you bought to make income and to, eventually, say bye bye to those long positions. That leaves you with your cash again, ready to sell more short puts.
I’m kind of excited to do that. I have yet to be assigned on any short puts so I haven’t had a chance to see what the other half is like. However, many wheelers consider the selling of calls to be a recovery activity after things have gone wrong, not something you should seek out. That’s because you can generally make more money with less risk with short puts than with covered calls.
What I did right and wrong before this
Knowing the risks of the wheel, here are some risk mitigation steps I took in advance of a pullback, correction, or outright crash:
- I have limited the short put capital at risk (computed by multiplying the stock price by the number of contracts by 100 shares per contract) to less than 50% of the value of my account. That means I could at most end up with 50% of the account moving from cash to long positions in stocks or ETFs. More important, it means that as various assets decrease in price, I can either sell puts on them for better premiums at lower strikes to start new wheels, or invest otherwise, at better prices.
- I diversified across different sectors, though I didn’t do enough. Yesterday there were many green areas of the market, but only my $MCD (McDonald’s) short put was up. I had looked at $UNH (United Health) on Thursday but didn’t pull the trigger. I was also way overallocated to commodity plays (see below)
- In my main IRA, I had my advisor move 20% of every position into cash earlier this year. That was before the massive semiconductor rally that drove broad market gains that we’ve seen over the past two months. Right now, it’s not clear whether yesterday was a blip, the start of a mild pullback, or the beginning of something worse. I’ll be watching charts and indicators in various sectors to decide if and when to move that IRA cash back into stocks, etfs, fixed income, or other riskier investments.
Every successful trader says it’s important to analyze your trades. I’m planning to do that this weekend, but I can also see a number of mistakes I have made across the portfolio. Based simply on decision-making strength rather than actual outcomes, here are some mistakes I made:
- I have fallen too much in love with my commodities supercycle thesis, leaving me overweight in many sectors that did very poorly yesterday: metals and mining, precious metals, and energy. I feel generally alright about this because I don’t so much mind getting assigned on those positions, thinking as I do that they’ll come back strongly later on this year. But I’ve learned that conviction and theses really mean nothing compared to momentum and market sentiment. So I could be underwater on these positions for a very long time. Meanwhile, I’ll focus the capital I have available on whatever’s trending, regardless of my macro thoughts about it.
- A couple weeks ago I bought a hedge against the market going down but closed it when the market kept going up. Had I kept it, that hedge would have offered a slight bit of green yesterday. I need better practices around placing and holding hedges so they can actually do their job when things go south. This particular hedge I had wasn’t very well thought out, so the next time I do that I’ll be a little more disciplined and thoughtful about it.
- Ultimately the wheel needs to be complemented by additional strategies, whether around buying stocks and equities outright, shorting stocks, using put spreads or call spreads for bearish and bullish bets, and so forth. I’ve learned so much using the wheel about risk management, sizing positions, diversifying, and, most important, making explicit profit and loss taking plans ahead of time. I’m going to start developing equally explicit guidelines around other kinds of setups. I might go back to the swing trading idea and actually already put in place one such trade last week. But I also want to expand my trading into bearish bets like bear put spreads or bear call spreads. Although stocks generally go up over time, there are of course times when most stocks decline together, and also times when sectors or individual stocks are on a short- or long-term downtrend. I want to see good returns whether stocks are going up, going down, or staying right around the same area.
My most important task this weekend is to come up with rules and tracking spreadsheets for two new setups:
- Short- to medium-term long buys of stocks and ETFs (say one month to six months). This is not exactly swing trading because I would not decide up front when to get out of the position, but would stay in it until the trend reversed. The idea is to get in when the chart indicates a new uptrend starting (e.g., a reversal from a downtrend, or a breakout from a consolidation). Get in with a small position, and then add more if the trend proves itself. Stay in it with a trailing stop loss until the trend breaks down. I may do this with $UNH or other health care equity investment next week (e.g., $XLV, the S&P 500 health care sector ETF). However, the market decline yesterday could also take down health care stocks.
- Call and put debit spreads. These options trades require that you pay premium to enter a position with one long contract and one short to offset it. A call debit spread is bullish while a put debit spread is bearish. They are very similar to just outright buying a call or a put, but they add some protection in case the trend goes against you. They provide defined risk and reward. You can also do so-called “credit spreads” which give you a premium credit on entry. But their reward to potential payoff ratio is unattractive.
- Maybe even short selling stocks, which I’ve never done. Very scary and high risk which means I’ll probably do it soon!
I also need to refine my guidelines across the whole portfolio to ensure diversification across sectors and factors and control overall risk.
Trading’s like gardening
Trading and gardening are actually very similar. You take short-term action but only see results play out over months, seasons, and years. Sometimes you think a particular rhizome is a sure thing and instead it rots in the ground. Other times some seeds you planted without thought give rise to a bounty of blooms (my Chinese forget-me-nots are a good example, a great plant to start from seed).
Cheers to not just accepting the fact of no iris blooms, and the fact of my poorly risk-managed options account, but to affirmatively celebrating it!