The Downfall of Success

After I saw my account increase by a much larger amount and at a much faster pace than I could really hope for trading stocks, I was hooked on options. Also, keep in mind that I am only 23, I am allowed to be more risky with my assets at this age than someone who is say 40. However, like I said I still feel like you can be very conservative with options and they can be a good replacement for stock if you stay diversified and know what you are doing.

So for the next month or so I traded Apple options, basically looking at what the sentiment was and how reasonable I thought a move was and I would choose an option out of the money at my price target hoping it would go over it. I had no real education on Technical analysis at this point, I would just go off of what I "felt" the stock would do. Obviously having a feeling about a stock is likely based on logic that is based on previous movement but like I said I didn't really think about that at the time. As I went on I started to notice that the stock price would get "pinned" at a fairly round number at options expiration so I would take this into account when picking a price target.

So, I was only trading Apple options, I then decided diversification would be good(which it is) and bought some other option positions in stocks I liked. All of these positions went against me and my only position making money at the time was Apple. This basically made me think "well why go away from a good thing if it is working".

Since it was so logical to me Apple was the easy money and going higher with all the pending news it would have I focused all my efforts on one stock and started to increase my position size.

This unfortunately worked. I basically got into the market at a very good time (remember the May-July run?) which was great for my account but not good for my skills. My account was more or less increasing steadily although fairly volatile being tied into one stock.

As I went along I had adapted a few rules:
1. Cut loser short
2. Don't trade in the first hour
3. Incrementally buy a position so you can cost average down.

While I was on vacation, I finally saw my account cross the 100% return mark. I had hit $75,000 in my account within 3 months of beginning my options trading career. Great! Right? No.

How did I get there? Basically stupidity that worked out for a short while. I was trading huge positions once I had gotten over 50,000 I would regularly be buying 100 contracts since that then became the new standard(up from my 10 just a couple months prior). I would put on a 15,000 dollar position and see it double. I had the timing and price movement mostly down but I was going about it the wrong way. Way too risky.

So, the wake up call came shortly after Apple's earnings in July. I went all in, literally my whole account into Jan 08 250 calls since they were 1.25 I could get almost 600. That means for every 10 cents the call increased I would make 6,000 dollars.

This was actually fairly logical in setup, I looked at what other comparable tech stocks that beat had done after earnings, most had gapped up. RIMM for example gapped up 50 dollars. I had actually done my own calculations and come up with my own estimate on apple, something like .95 cents EPS, which wasn't far off. I figured if they got close to that the stock would gap up 10-15 dollars. Well I couldn't have been more right, they got .92 EPS, after hours the stock gapped up 14 dollars. At this point I am thinking "ka-ching". I had basically thought I doubled my account on that move, given my Delta was like .10 and gamma was .003. So a rough guess was I gained about a 1.50 in my option value minus some small time decay.

The next day the market opens the price had held pretty much, it was still up +13 from the previous day so I was going to sell out right away and book my profit. Market opens, my option price doesn't move, in fact it has lost 10 cents in value. I am freaking out, going WTF happened. I end up getting out with a 20 cent loss so I lost 12k.

This was odd to me, I was actually lucky I was so right in retrospect because otherwise I would have lost way more at that point. What had happened and what I didn't know about the time was Implied Volatility decay. This basically happens after every earnings announcement, however I didnt see it happen to my last options over earnings because I was at the money and they became in the money and gained intrinsic value, these were all time value and volatility.

So this was partially bad luck and partially a rookie mistake because I didn't know about Vega, which I should have. However, when you lose 12k when you thought you were going to make 100k? You bet your ass I found out why.

The lesson learned here? Trade out of the money(OTM) options going into earnings as volatility will generally increase and increase your option value, then if you do not become In the money(ITM) then trade up to ITM. However, this is only if you are fairly certain of the outcome and its higher probability. I would now take profits and hold less contracts over earnings since you really don't know how the stock will react.

So we covered my earnings blunder, how did I give up my 100% gain and then more in the span of a week? I'll tell you.