Exiting a Non-Seasonal Early—When the Real World Meets the Trading World

As an ordinary thing, when we write options in the non-seasonal strategy, we’d like to sit on them until expiration and avoid the trading costs of exiting the trade via repurchasing the option. That’s fine when we can conveniently
do so, and I support this policy completely, with exactly one exception.There’s such a thing as making money too quickly.Suppose we undertake a longer-dated non-seasonal trade having 14 weeks until option expiration, and we write some number of WOOM options we select, with full discipline, for 140 points each.

Suppose also that the market tendency operates perfectly and vigorously right from the get-go.The premium of the options we’ve written falls all the way down to 9 points or even 5 or 2, within 6 weeks. Repurchase these options now if you can possibly do so. (Side note: a lot of times, WOOM options will show a settlement price of 2 or 3 points, but when you try to repurchase them there, you’ll find the market quoted at something like 2 bid/14 offered.

Nonetheless, try to repurchase them for just a few points if expiration is a more than a month away.) Why do this? Because the risk/reward picture of the trade has changed,and this change is radical. In the case just described, we’d be sitting in our trade and waiting six, seven, eight weeks to collect 6 whole points. If our trade is in, for example, heating oil, 6 points is a big, bad, bold $25.20 per lot.“Well, what can happen?” you’re asking. “Geez, if I wrote

November heating oil puts (ticker: HOX) in July to take advantage of strong demand going into the fall, and they were 10 cents OOM then, and heating oil has moved sharply higher, say 9 more cents, why am I worried? They’re 19 cents out of the money, 1900 points! Hey, I’m better off risk-wise than I was when I got into the trade. Thanks, but I’ll just sit and wait for expiration.”Good luck. You are now in roughly the same tactical position as the folks at LTCM

were, attempting to “pick up nickels in front of a bulldozer,” as Nicholas Dunbar quotes one of LTCM’s principals in his book Inventing Money (Wiley, 2000), (wonderful book by the way, great reading). If somebody starts up the bulldozer, if the one-off event, the impossible-to-predict catastrophe occurs, you’ll rue this decision very rapidly. Why did I choose heating oil in July–October for this example? Easy.

I was in that exact trade, in that exact circumstance, and thought exactly as you do . . . in 2001. I had written the November 62.00 puts for 140 points in July, straight non-seasonal trade, actually anticipating a typical seasonal rise in heating oil. Here’s a snapshot of what happened when those jerks played kamikaze with the World Trade Center (my apologies: my editor doesn’t want me to use a much stronger and far more appropriate term for those alleged humans).

The markets closed for the next few days, very honorably so in light of such a fantastic atrocity. Upon reopening, the energy markets went up, presumably on war fears, for precisely one day, with HOX closing at 82.00 (!) on Monday, September 17. The short HOX puts settled at 6 points on September 14 and at 5 points on the 17th. And then the energy markets just collapsed. One week, just five trading days later, HOX settled at 62.52, having made an intraday low of 61.50.

I’d blundered into one of the sharpest moves in the history of the heating oil market—event risk at its most virulent.I had protected the position somewhat by selling futures (which I hate doing) in the overnight NYMEX ACCESS session on Sunday the 23rd. I’d sold one future at 67.00 for every four 62.00-strike put options I’d written, and another at 63.30 (dumb and dumber, sigh) on Monday the 24th.

The whole mess was not an outright disaster, but I still had brilliantly transformed a profit into a loss by simply not accepting the lovely profit available, which represented 90 or 95% of the absolute maximum profit that I could ever have made. And, no rest for the wicked, if I wanted to try to let the trade return to profitability,I was now faced with trying to keep up a defensive position for a month or so, while heating oil prices would probably be gyrating furiously.

Ultimately, with HOX trading at 64.90 or so some trading days later and margin requirement going through the roof, I exited the whole position,losing about $1,380 on each 4-lot of options written, and pocketing a small profit, $300 on average on each short futures. There’s a term for trading in this fashion: rank stupidity. Trading genius at work . . . ri-i-i-ight.Usually, I add very well. Occasionally, somebody should grab me by the collar and yank my stupid butt off to remedial math class. By not wanting to spend perhaps 10 or 12 points plus a commission, call it $65.00 per lot, I gave away about $480 profit per option and oh so cleverly (choke, wheeze. . .), turned it into a $300+ loss to boot.