When I first started trading options a number of years ago, I\u00a0 became very friendly with a\u00a0 great options trader, and an even greater human being by the name of Dan Harvey.\u00a0 Dan, \u00a0 a retired medical doctor,\u00a0 is one of the finest options traders I have ever met. He is very analytical, very calm\u00a0 and a very flexible thinker. When the market changes, Dan changes with it. He makes his living trading options– so he has to be adaptable to market changes. In fact one of the first things that Mike Bellafiore\u00a0 told me when I\u00a0 met him last summer was that one of the keys to his personal trading success was his recognition that you must\u00a0 constantly adapt to the marketplace in order to be successful long term as\u00a0 a trader.\u00a0 Any kind of trader.<\/p>\n
I learned many valuable lessons from my good friend Dan Harvey, but one of the earliest points\u00a0 that he made to me also happened to be one of the most important. In my earliest days of corresponding with him,\u00a0 he made the following statement (and yes I’m paraphrasing a little bit):\u00a0 “The market will do whatever the heck it wants, whenever the heck it wants to”.<\/p>\n
There is no rule that says an upward\u00a0 trend must continue and there is no rule that says a sell-off can not abruptly stop and turn into a raging rally.\u00a0 There is no rule that says that the market will not make a big move on a sleepy summer afternoon and there is no rule that says the market has to respond in a positive way to positive news. There are just NO rules at all around what the market will do next.<\/p>\n
The importance of this lesson is very simple–you absolutely must \u00a0 assume that something dramatically negative\u00a0 COULD conceivably happen to your options positions at any time, particularly overnight. And therefore there is no getting around taking\u00a0 the\u00a0 proper precautions against such an eventuality.<\/p>\n
This means that if you are going out to lunch on a slow market day, you MUST have contingent orders in\u00a0 for all of\u00a0\u00a0 your positions.\u00a0 The chances are that nothing will happen. But the implications of your\u00a0 being wrong are\u00a0 way too\u00a0 disproportionate to the effort needed to guard against it.<\/p>\n
It means that if a big sell off overnight would be devastating to an options spread, even though every technical indicator is pointing to a rally the next day, the position must <\/strong> be modified to deal with that possibility the day before . The same goes for a golf match on a beautiful spring day, when everyone is in a great mood and the market is slowly, gently drifting upwards. On the first tee,\u00a0 a small European country could announce that it is going into default on its sovereign debt, and all hell could<\/strong> break loose.<\/p>\n I could go on and on but I think my point has been made. Assume you know what is going to happen next in the market at your own peril. You won’t live too long as an options trader if you do–I can virtually guarantee that.<\/p>\n