Anatomy of a (Not Good) Trade

Thursday August 19th, 2012

With the earnings season coming into full swing and going a bit better than most expected, I thought it would be a good time to dissect a trade we did at Option Pit that did not work out quite as we thought it would. Usually, when I lose money on a trade, I like to go back and see if there is anything I missed. For the example below, it was relatively simple, but it is a good exercise to figure out what went wrong.  

The original trade two weeks ago was with the AAPL 620/635/650 July fly (long call butterfly) for $2.7, with AAPL trading around $615 (circle 1).  That is the first circle in the chart below. I have used this strategy in prior pre-earnings runs in AAPL, and it is a good way to game positive theta with lower deltas. The trick of course is to not keep the trade on if the name goes south. Usually, about 20% down on these little Flies, I would bail. Well, then AAPL faded to circle #2, to about $600, and the fly was cut near in half. The name drifted down so fast I thought it would do an AAPL and pop right back in a day or two, since the market overall was picking up a bit (slowly).

Well it did, 6 days later, which is not great on a two week to expiration trade.  We closed half the July position that week (for .51 ouch) and let balance hang for tomorrow.  Even if AAPL does break out above $620, it is a time to review some exit rules, no matter what name a trader has a position in.

Some rules to keep in mind-

Keep a tight exit routine regardless of the name.  If the trade is down 20%, that is the stop bail out or adjust if possible.

Exiting with a small loss gives you the ability to enter again at a better time, if conditions allow.  I kept the trade on because I thought AAPL was going back up, but the bounce was way too slow for an OTM Fly of this duration.  I missed the opportunity to put on a better fitted position on the $600 strike, because I was waiting for the quick rally on the $620 Fly.  I rolled down to the 620/630/640 to generate some more theta though, which added a little P/L but not near enough.

The priority of the trade swung once AAPL fell out of bed early.  The Fly went from long theta to short theta, so that the slow move up could never recover the lost deltas.   Decay crushed the delta recovery, even with the adjustment.  The end of week move happened  Monday, and the position would have been close to ITM again.

The only saving thing here is the trade was right sized for the other trades I have on.  I try to keep the max loss in one about the same as a medium gain in another to keep some consistency.

The thing I missed most was the bad sentiment in general around this earnings cycle.  Until some good earnings started coming out, the market went nowhere, and AAPL really underperformed (it being so earnings dependent).  Some good results last  week made some AAPL upside more possible again.  Either way, on to the next one.