Why enter on 6 July?
At the time, the thesis was China stock market has fallen a lot from the peak of $55.19 down to $42.42, or more than 23% fall. The technical definition of a "bear market" is 20% fall, although this clearly doesn't apply to China as prior to that, the run-up was very fast in too short a period to be sustainable.
Besides falling more then 23% then, it also appeared to be resting on one of several reasonable strong supports, which is around $42. It looked strong, because it was a confluence of the 150-day Moving Average, combined with the 38.2% Fibonacci Retracement support off a major Swing from $21.07 low to $55.19 high that spanned over 15 months.
In addition, oscillators indicators was oversold (suggesting a large fall too far too fast, which usually but not always lead to a snapback rally). In addition, the Options Implied Volatility had spiked up (which usually suggests a good time to sell options). In addition, the higher volume suggests possible capitulation.
The only thing missing was a very clear divergence in momentum. There was a tiny one, but not significant enough.
Going long was obviously highly risky, not something any reasonable person would recommend. This is because we can never know how low the market can fall in a panic. During extreme conditions, normal market rational behaviour does NOT apply.
My 6 July trade
In my book, this is a valid signal to enter the trade. The 200-day MA slope is still facing upwards, suggesting the bull market in China "should" still be intact. This was a very big dip. It rested on strong support. Momentum was oversold, suggesting a bounce. It is definitely a valid signal, and so, I entered, without knowing what will happen next, nor do I care.
This is my trade on 6 July:
As we are catching a falling knife (which Masters always tell their student NOT to do so for very good reasons), I decided to play it safe by selling a Bull Put Spread for $35/32 strikes expiring in 46 days at the time. I set the Margin to be approximately $3,000. For simplicity, let's assume for this article that $3,000 is equivalent to 1% of my capital. The gross credit I received was approximately $0.50. This implies a potential maximum return of capital (ROC) of $0.50/$3 = 16.7%. If the trade went my way, I would have earned nearly 16% return on the $3,000 margin over less than 43 days - it was not a bad trade.
I chose the $35 strike leg because $35 is quite far away from $42.42, nearly 17.5% "safety margin". In addition it was very near $34 strong support, and a part of me "hope" and "expect" that buyers will come in at $34. In other words, ASHR has to fall another 17.5%, before my strike was threatened.
As a small footnote, in hindsight, this was slightly too aggressive (driven by slight greed). The safer play, based on the charts purely, would be the $34 strike, but the ROC was smaller. Still, it wasn't a grossly huge error (but still an error because instead of earning say 10% ROC, now, after repair, it is only 5% ROC).
What transpired next 3 days
The past 3 days was unbelievable!
The 17.5% "buffer" that I had was sliced through like a hot knife cutting through butter. In just 3 days, ASHR fell and closed at $33.89, or another 20% fall in just 3 days!
Imagine that - after falling 23% from the peak, ASHR fell another 20% in just 3 days!
My "safe" trade that risked 1% capital is now losing substantially (relative to the credit). At the time I sold the Bull Put Spread, I received a credit of $0.50. Now, the Bull Put Spread was worth $1.55. In just 3 days, I sat at an unrealized loss greater than 2R!
Is this a real loss? When we sell Options, this is very common. Options volatility is a very hard topic to master, but once you have a lot of trading experience, it is very common to experience temporary loss of 2R, 3R, even 5R and a few minutes, hours or day or two later, experienced a profitable position as price stabilizes and Options Volatility contracts rapidly. Of course, we can never know for sure if the volatility would contract, but at all times, my loss could never exceed 1% capital - this was my safety Net, which allowed me to trade ASHR calmly, despite the 20% fall in the underlying in just 3 days.
My Trade Repair
As there is no longer any safety margin in my strikes, I had a decision to make.
Normally, Masters will teach you to cut loss. If you had done so, you would have been out of the trade at perhaps a loss slightly larger than 1R in practice, if you had keyed the trade into the system, allowing for spreads slippage. This is not necessarily a wrong thing to do, as you would just then move on to another trade.
However, when selling Spreads, what I have found is that the Options volatility is very, very high, that such an approach tend to lead to negative expectancy systems - it is almost certain, during the life of the options, that some spikes will happen that will execute the Stop Loss, and nearly all the time, this stop loss is unnecessary.
There are actually much safer ways to "repair" the trade than the simple cut loss that you are taught in courses, but they are all more complex to learn (and unlikely to be able to be taught fully in a single class setting). There are actually many methods. One of the method is to simply go to a lower strike, for extra safety, which is conceptually simpler for Options traders to understand. This is only possible with Options, and unfortunately, is not possible with Stocks (whilst keeping the same amount of maximum risk).
I decided to shift down $2, by closing the $35/32 strikes, to reopen at $33/30 strikes. I decided to do this yesterday, because the cost of doing so is actually not very expensive. Closing the $33/30 strike will cost me $1.55. Reopening the $33/30 strikes will give me a credit of $1.20 approximately. The net cost of the repair is $0.35 approximately. As my original credit was $0.50, this now means that my maximum profit is now only $0.15 for a $3 margin, or 5% approximately over the remaining 43 days. My philosophy is that a small gain is ALWAYS better than a big loss, so, I decided to do this repair so that I can sleep more soundly.
If you trade stocks, you will notice that despite being wrong by more than 20% (ASHR underlying fell from $42.42 down to close at $33.89, or $8.51 or more than 20%), my loss is only $0.35, or approximately $350 for this trade that risked $3,000. How is this possible?
A full explanation is beyond this article, as it is too complex - you will need to learn Options first, and perhaps make at least 10 to 100 credit spread trades before you can really understand the mathematics behind this. Suffice to say that sophisticated Options traders knows how to control their risk, which are not available to stock traders.
My Second System Kicks In
In trading, it is important to understand that we can rarely be always profitable when trading one system. Every system has its drawdown periods. It is important to trade more than 1 system, so that when market conditions changes, a second system can start to be profitable.
As I repaired the Credit Spread system trade following my system, the rapid fall triggered a second system, which is a straight Buy the Dip.
So, I bought a Debit Spread of $34/$44 which cost me $2.83, with a maximum profit potential of $10 if ASHR manage to close above $44 in 43 days time. The RRR is greater than 3 times, and meets my criteria. I bought 10 verticals for a total cost of $2.8k, which is nearly also 1% capital.
In other words, the dip to the second Strong Support was so fast, that it triggered this second trade costing another 1% capital. So, I now have nearly 2% capital committed to the ASHR trade.
I also spend another 0.3% capital in a slightly more aggressive trade to buy a Debit Spread with $36/$46 strikes for a cost of $2.45. The RRR is nearly 4 times if ASHR close above $46. This is also a good RRR.
Updates at the time of writing
I wanted to show you a screenshot earlier, but didn't manage to do so. As I write now, Shanghai stock market rebounded 6% today, and ASHR in pre-market has gained +$4.43. I don't quite understand why but my Options position has also been updated in one of the leg - this pricing might not be correct, but it states that I now have unrealized profit of $0.4k in my ASHR position.
Ignore the unrealized profit/loss reported here, because they will keep changing and be very, very volatile.
The point is to note are the trades. You will see that I now own the Safer Bull Put Spread for $33/$30 strike (i.e. if ASHR closes above $33, then, I keep all the premiums with 5% ROC for 43 days). In addition, I now own 10 Debit Spreads for $34/$44 strikes (a bullish position that risk 1% capital), as well as 3 Debit Spreads for $36/$46 strikes (a bullish position that risk 0.3% capital). The latter 2 trades have RRR of 3 to 4 times respectively, and are valid trades belonging to the second system that got kicked in when the first system lost monies fast.
Summary
My 10 reasons for sharing are as follows:
1. Options trading are not the same as Stock trading. If you approach Options trading like Stock trading, it's like utilizing just 1% of the capabilities. There are a lot more to Options that will take a very long time to master.
2. In Stock trading, ,you could be very wrong and suffer a huge loss of $8.51. But if you know what to do and be conservative, you could reduce the loss to only $0.35/share.
3. When a stock falls from $42.42 down to $33.89 and rebound back to $38, the stock trader will still lose monies, if he still doesn't cut loss (it is not recommended not to cut loss in stocks). However, as I've shown here, if you trade 2 different system, and know what to do, you could transform a losing position into a winning position without requiring the underlying price to go back to $42.42, and without necessarily increasing your risk to excessive levels. You don't need the stock to go back up to $42.42 to break even. In stock trading, you could "average down" and achieve similar break even points, but your capital at risk becomes even larger.
4. Timing is everything, just like stock trading. The strategy above applies only to conditions similar to ASHR above where there is a choice of 2 very strong support and there is a very rapid dip that you could not predict the bottom, but either is equally likely to be the bottom.
5. Support & Resistance and momentum considerations are everything, just like stock trading.
6. The ability to cut loss whilst it is still small, is critical, just like stock trading. If my second strong support does not hold, I would accept the 2.3% maximum loss in capital, and move on to another trade.
7. The ability to trade multiple uncorrelated systems, to fit different market conditions is important. Otherwise, we cannot take advantage of the varied market conditions that is sure to arise.
8. Position sizing is critical, just like stock trading. When I first entered into this trade, my maximum risk was 1% capital, and I ended up losing only 0.1% capital as I repaired the trade. If you don't take losses when it is small, it is sure to get bigger.
9. My second system triggered 1.3% capital to buy the dip. If this trade turns out to be wrong, the maximum amount I could lose in the worst case scenario is approximately 2.4% capital (1.3% + 1% maximum spread loss + 0.1% cost to repair). This is very acceptable for a trader. Very likely, I will not allow the 1% maximum spread loss to occur.
10. The odds of me being stopped out unnecessarily is almost zero, as I manually controlled my stop loss. This breaks the rules of what Masters teach their students to key in their Profit Targets and their Stops, as most traders cannot monitor their positions.
In short, there is a lot more to Options trading that you are taught, or can ever be taught by anyone. Much of my personal learnings are self-discovery, self-experimentation, learn very widely and thinking through the logic of everything you plan to do with trading and varied market conditions. Still, the 2 systems above are actually still considered "intermediate" level, and not really Advanced level yet for Options in the States. You can do much more with Options compared to the 2 simple strategies above.
Stay curious, stay hungry.
All the best.
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