Stock Market Adventures: Heat

Part of a series on Finance.
Previously: Stock Market Adventures: Options & The Wheel

Last time, I presented the wheel option strategy (and gave a whole bunch of background on options).

I also said that personally, I was mostly selling puts on growth stocks, using a wide margin of safety afforded by their high implied volatility. (You do not know what any of these words mean? Go read the last article.)

This did not work out too well. Or rather, it worked fantastically well, but I failed to execute a proper pivot.

Don't worry, I'm not ruined. In fact, I haven't even lost money compared to when I started trading with this strategy — a whopping 4 months ago. But I am also not up much, while I was up 30% at some point.

What happened? The market was bullish on growth, and the strategy was making bank. Then, at then end of February, there was unrest in the bond market, and that spilled over to the stock market. This hit tech stocks the hardest, with the Nasdaq 100 shedding more than 10% from its high, back to where it was last December.

It did hit growth stocks even harder. (Growth stock nice euphemism generally used for the stock of companies that do not yet make money and/or is very overvalued — speculative stocks, really). Not everything was affected — many people talked of "a rotation into value" (where a value stock is essentially the opposite of a growth stock).

My puts quickly dropped in value.

This is where I messed up. I should simply have taken my losses and liquidated my positions. Why? Things were outside expected parameters. They were dropping, but I did not understand why.

Now I have two new rules:

Exit out of your positions when your assumptions are violated in a way that puts your capital in danger.

If you do not understand what is happening and you're losing money, close your positions.

Of course, it's better to try to understand what is happening. I did, and I now know much more about the bond market than previously (expect an article on that topic soon). But I still did not really understand (or maybe believe) the causal link between the bond market and the stock market. I thought "certainly, it can't be that people are panicking over bond yields raising to a measly 1.5% (way below March 2020's already low 2.5%)". But apparently, it is possible — and of course selling begets more selling through deleveraging: as losses mount, those who trade on margin are forced to liquidate assets to maintain their margin ratio.

So instead, I thought this was a temporary spike down (albeit a particularly virulent one), as there had been a few, and the market would pick up again. #buythedip was trending on Twitter, so I wasn't the only clueless person out there.

It wasn't a temporary spike down, and so that's that. Add to that a dumb (but totally unrelated) trading mistake I made, and I'm back at square one.

This whole adventure reminded me of the titular sequence from the (awesome) movie Heat:

Neil McCauley: A guy told me one time, "Don't let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner."

Vincent Hanna : What are you, a monk?

Neil McCauley : I have a woman.

Vincent Hanna : What do you tell her?

Neil McCauley : I tell her I'm a salesman.

Vincent Hanna : So then, if you spot me coming around that corner... you just gonna walk out on this woman? Not say good bye?

Neil McCauley : That's the discipline.

The heat came around the corner, and I did not walk out. That was as much part of the strategy as everything else, but I realized it only too late.

It's not all that bad. I "lost money", but also I didn't lose anything I didn't gain in the market. And I learned a ton. How often do you get paid to learn? The only thing I regret is that it did bring a lot of stress into my life at a time where I could have done without it.

What's next? Interesting times for sure. With the market uncertain for growth stocks, the previous strategy is out of the question. I will probably retreat to running a wheel-like scheme on safer stocks. Time to put the theory to the test and see if I'm abel to beat the index. This should also be a bit easier on my blood pressure. And I'll keep learning and experimenting. Maybe some other system will prove superior in the current market conditions.