For those of you who are movie buffs like me,  you’ll know that one of the truly greatest films of all time is Cool Hand Luke,  the titlecharacter having been played by Paul Newman in one of his  finest  roles.  If you haven’t seen it, see it. What a great flick.

The Paul Newman  character is a prisoner on a chain gang in the South. After a hard day of road work in the grueling hot sun, the prisoners would congregate to play poker after dinner. Luke was an excellent player, renowned for his bluffing skills. In the scene that explains the movie’s title,  he was able to bluff his way into collecting the pot with literally nothing in his hand.  As the rest of the prisoner’s laughed in amazement as his cards were turned up,  he explained, “Sometimes nothing’s a real cool hand.” Here’s a link to the scene:

http://www.youtube.com/watch?v=xVXKOb5EE7Y

Every great options  trader has, consciously or subconsciously, developed  a  “playbook”  of trades that fits his or her personal trading style and risk tolerance level and  each of those trades is employed  as the market conditions become ideal for that particular trade.  Once the strategy is executed, these traders then practice great patience and discipline during the course of the trade, trusting from experience that the trade will be successful most of the time if  the  trade  plan is followed

All newer options traders have trouble with trade discipline in strong market conditions–either rallies or sell-offs. They react viscerally to scary looking risk graphs and will often, in panic, throw on an adjustment which takes  alot of risk out of the trade  during that particular trading day   but in the long run kills the income potential of the trade.

A classic mistake for example is the tendency  to panic in a sell-off, when implied volatility has gone through the roof as it did earlier this week.  Many newer traders will panic, and buy put options to cut downside risk on the trade.  That will make you feel better for the moment and cut your downside risk if a further downside move occurs. However,  once the market settles down and reverses, that put price  will not only lose value as a result of market direction, but will take a beating as a result of the drop in the implied volatility embedded in its market price.   The loss on that put purchased in fear, can ruin a solid trade that would have been a big winner. I’ve seen it happen hundreds of times.

Instead, follow the old aphorism: “plan the trade and then trade the plan”.  If your plan is well designed, the plan  itself will contain a protocol for dealing with a big market move with an adjustment that will NOT kill the trade in the longer term. And there are lots of ways to cut risk while preserving your opportunity to make good money on an options income  trade. Those methods must be embedded in your plan and they must be employed at the right time. Don’t get ahead of the market to make yourself  feel  better.  That’s almost always a mistake.

So if your plan calls for you to do nothing on a “scary” day in the market, then the best thing to do is just that:  nothing.  Depending on your personality type,  that can be one of the hardest things that you have ever done–to restrain yourself from responding to your natural instinct to control risk in the short term, when doing so will hurt you badly in the long run.

So the  next time you are tempted to deviate from your trading plan on a scary day in the market, just think of Cool Hand  Luke and remember:  sometimes nothing’s a real cool hand.