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Chapter 35 says, “Our intention is to keep writing OTM ‘out-of-the-money’ shorter-term calls and keep collecting those lovely premiums.” This points to a keystone of truth: The spread strategist must also be a stock trend follower, positioning a spread with call options above a rising stock or with puts below a descending one. Those imaginary plaques on my wall include several four-word variations by W.D. Gann: “Go with the Trend,” “Don’t Buck the Trend” and “Trend Is Your Friend.”
One statement that flies off the wall and hovers before my eyes more than rarely was written by Nick Darvas: “There is no such thing as ‘can’t’ in the stock market. A stock can do anything.” That advice saved me more than once from the “It can’t happen!” quicksand. It can also protect a trader from risking too large a portion of capital on any one venture. This links up with Gann’s warning: “Never average a loss. This is one of worst mistakes a trader can make.” Averaging means “buying more” shares or options in anticipation of rebound -- while the stock is trending the wrong way!
Notice that many people buy the near-in-time options and markedly fewer the far in times. The fars are “the extra mile” that is “never crowded.” From the spread strategist’s vantage point, the Bowery Boys and horseplayers buy the near in times.
Brief mention was made earlier of the “naked option” seller. He sells calls on stock he does not own or sells puts which obligate him to buy shares for more than their market value. Usually the options expire worthless and the cash he received for them is pure profit. But the “occasionally” makes this as dangerous as lion’s fangs. One commodities man sold $100,000 in out-of-the-money calls on futures. While he waited for 100 grand in profit when they turned worthless at expiration, the underlying futures rose dramatically. “Buying back” to “pull out” cost him $500,000. GO yee not naked.
With spreads, the long-end increases in value along with the short-end. Spreading is not risk-free but it is risk-reduced and a situation similar to the one above often generates a profit. Another “there in spirit” plaque on the wall courtesy of Gann: “Handle speculation as a business, not as a gamble.” Gamble. Everybody knows about the horseplayer who has been losing for years but keeps betting. In simple arithmetic, he would have done far better putting that money in a bank over the years. Of course, it does not take much study of psychology to understand that a bankbook lacks the excitement of post time and the suspense of the horses rounding the far turn. He has many counterparts in stocks and futures and options. They keep losing but speculation electrifies and jazzes up their nervous systems. Like the wagerer who bets on the weather to “make it interesting,” this kind of “interesting” is pathological.
The problem can be pinpointed. Nothing thrills many people as much as trading. Rail tycoon and short-seller Daniel Drew in the late 1800s and “speculator king” Jesse Livermore in the early 1900s both amassed millions but both kept trading until they lost everything and died broke.
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