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Selling put options is definitely a good return on capital and it cannot outperform buy and hold. That’s been proven, so I’m not going to rehash all of that, but there’s a lot of caveats or as my old branch manager would pronounce as, “Kaveet,” which was hard not to laugh in his face – he’s a sweet guy. You got to be careful because these things, when the trades go against you, they can get ugly real quick. Let me tell you a little quick story. When we were in 1995 to 2000 and all those internet names you VerticalNet, Siebel Systems, Global Crossing, CMGI, JDSUniphase, right? You all remember the darlings, then you’re like the NVIDIA’s of today. They couldn’t go wrong if it had four or five letters in the ticker it was going up. That was the buying criteria. What’s the ticker of the symbol? JDSU?
Yeah, absolutely buy it. It’s a buy signal. Four letters in the ticker was a buy signal and so you could make money.

People were just buying stuff. Revenues and net income didn’t matter anymore. It was all about the eyeballs. And so people just got used to doing these things. Again, we talk about trading with an underfunded account, they started getting a little careless and so what you find out, I’ll have to find the study, but I think it goes a little bit like this. It takes only about a 10th of the time to see a correction of a certain magnitude than the time it takes to get there. That’s a big mouthful. So say it takes like 10 days for the security to appreciate, say 5%. The way people hit the sell button indiscriminately typically means that you could see that happen in one day.
And that’s what kind of happened with those stocks is what we were coming into March 10th, 2000, which was the high near term high for the NASDAQ Composite. And people had been selling a lot of these puts because the premiums were juicy. I mean implied vol was like 400% or something. It was really high. So you were selling like $15 to $35…$40 premiums for things that were right under the market and they were all going up $20 a day for no particular reason that it was just related to the internet. So people were like, man, this is great. I’m just going to sell these out of the money puts, I’m going to bring in all this premium and everything’s going to be great. And of course that selling puts is bullish buying calls, same side of the market. But in this case the premium was so large and because folks didn’t have a great trading strategy and thinking on how they could take $15, $20 out of a trade, especially if they were day trading, they could sell these premiums and make monster gains Whenever you sell, I’m sure you know this, whenever you sell a credit or a net credit, that’s your max gain.
So what ended up happening was, and I was there, I was in management, you had all these options that were all of a sudden out of the money

And money and then there was this cataclysmic fall where things were getting blasted and they would go from being pretty far out of the money to damn in the money and these little old ladies in Pasadena were getting delivered against because someone else owns the option. They have the right to put it to you. So people were selling these puts and they didn’t have any type of risk management going on whatsoever. All they knew is they had enough money in margin to meet the margin requirement to sell the naked put. Now there are ways to hedge. You could short the stock. Typically that’s considered a covered position, but I don’t want to get into that here. One thing that you can do is if you’re going to sell a put with say a $700 strike is you could buy something underneath it like $680 or something, and then this way if there is a massive correction, you are at least hedge to the downside.
That would be like, because selling a put is bullish and you’re bullish if you’re along the lowest strike. So that would be a “net credit vertical bull put spread,” holy macro, that’s a mouthful. Net credit selling the higher put that’s going to have a higher premium. You buy the lower one, so you still get a net. So it’s a net credit, it’s vertical because you’re just changing the strikes. And net credit, vertical bull put spread right along the lower strike. So that’s a mouthful. That’s one way to do it and to be hedged, obviously whatever you could make and lose is going to happen between the strikes. So you have to kind of figure that out. What’s your winning percentages and this and that because it’s going to be hard to find stuff that you’re risking for to make six kind of a deal, at least on paper.
You’ll have to see what the damn thing looks like as far as the deltas are concerned and this and that. Anyway, just be careful when you do these because when the market’s unwind and when everything is looking rosy, you do it once and you have enough on, you’re like, man, I didn’t have a big enough position on let me sell two or three more. So then you start selling next thing you know, got your whole account in this damn thing. And I can remember people calling up saying, I own VerticalNet, Siebel Systems, I don’t even know what they do. I’m in Global Crossing. It’s like the backbone of the internet. And so the last thing you want to do is be in those positions, and that’s one thing I don’t like about selling options is you’re not in control. So granted, you can get paid first because you got the credit of the net credit, but you still have to be super careful and not because man, these things can blow right through the strike and be down a lot. So even if you’re selling a 15 or $20 premium, I’ve seen things move so quickly in my life, especially in futures where you could be 20 cents in the money to all of a sudden be 40 cents. I mean 20 cents out of the money to 40 cents in the money and it happens so damn fast. I also know I get a lot of emails from folks on the QT saying, Hey, I want to tell you this story, please help me out, but don’t mention my name.

They’re not trading options with stops, right? Because the spreads are wide. So they sit and watch ’em and they figure the thing’s not going to move. The delta’s like 50, so there’s a big swing in the stock. It doesn’t necessarily translate to what’s happening with the option. And so they kind of let it go and that’s with or without putting their maximum amount of risk unit on. So you got to be super careful with these things just because you might’ve been making money with them ongoing. It doesn’t mean that one. Look what happened to Victor Niederhoffer, right? This guy was selling naked S&P Puts on S&P 500 futures, and if I read the book correctly, he was selling silverware and artwork to have to make up the margin call and he was trading for George Soros at the time.
So really, really smart people can take it up the wazoo. What does he need insurance for? He’s got money coming up the wazoo. So you have to be very, very careful. Although the strategy, and again, options admittedly are very hard. It’s hard to get the data, so it’s very, very hard to backtest option strategies. You also have to contend with the spreads being pretty wide. So be very, very careful with what you do. If you haven’t sold stock short, I don’t think I want to be the guy to help you do that. You could also just buy a lower strike on the puts and to create that bull put spread might be better risk reward for you, right? You might not make as much, but you got to remember your goal is longevity here. Everyone likes those grand slam trades, myself included, but I got to be able to come back and play tomorrow and I don’t want to take such a loss that it’s going to hurt me both financially and also destabilize me emotionally because then I lost my confidence.
I’ve lost my nerve and I can’t come back and play in the sandbox if I’ve lost all my marbles or a good chunk of it. That’s very, very painful. I’m sure there’s a lot of comments, you might be doing it a certain way. I appreciate everybody’s success, whereas we might all be traitors, but the way we do things can be as unique to one another as is our fingerprint. So it’s not a judgment call to say you’re doing it right or wrong. I’m just trying to be the voice of reason to say yes, the strategy is proven out over time to be very, very successful and to work, give you good return on capital. But just be careful because you could be in a really good name. They might be able to report, I don’t know, earnings tonight after the close. But suppose the market takes a dump when the tide goes out. A lot of times all the boats can go with it. So it doesn’t matter if you have a good earnings report, if the stock gets blasted right in the middle of your good earnings report, you might get hit too. That sucks. It’s bad luck, bad timing, but it’s going to happen anyway.

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For my experience, I’m going to recommend that you have at least $10,000 in your account in order to day trade, swing trade, or maybe even position trade Now, before you get all crazy and start writing snarky stuff, which I’m just going to delete anyway, hear me out. I’ve been there. I started with an underfunded account and it was really, really hard. So this is coming from experience, not saying anything to put a stick in your eye. When I had an underfunded account and I started, it was a few thousand dollars. I was adding to it every paycheck. Got it up to 5K. And if you remember in an earlier episode I talked about this, how I was willing to put up to 50% of my cash into one particular name at a time. This included futures and stocks in the same account at the time.
The problem was, is that my timing had to be absolutely impeccable, but even though I was at a wirehouse as far as trading was concerned, I didn’t know my ass from hole in the ground. So when you’re underfunded like that, you really need to have an amazing sense of selection and a really, really good sense of timing, which you don’t have. You can certainly develop it and I’ll give you that. And I know there’s stories of people out there who started with a few hundred bucks. Richard Dennis is one of ’em, and there’s some penny stockers out there that have done very, very, very well. And my hat’s off to you. We’re all celebrating the wins here. It’s just that I get the emails from the other 19 out of the 20 people who don’t make it and they’re like, man, wish I get this at least once a day.
I wish I saw your channel sooner. And that it really makes me sad. It’s not something I click my heels about because it’s not like I’m trying to save lives here. But what ends up happening is when I had an underfunded account, I had to be highly selective as to, because I didn’t have enough money. You don’t have any flexibility. And the last thing you want to do is start to cope and say, I got a thousand bucks. I’m just going to trade the MQs. That’s the worst thing you could do. My hat’s off to you for getting in the game, but there’s so much more opportunity out there than you are just looking at one particular instrument. And with the $2 tick value, not tick value, but point value, what’s your goal? Is it just to learn the craft? Okay, perfect. Forget what I said then because the best way to learn is to trade. I’ve said that. So I don’t mean to speak out of both sides of my mouth, but I wouldn’t recommend coming to the market and saying, just be a sugar trader. You’d look at me and say, Mike, you’re an idiot. So I wouldn’t recommend coming in and trying to trade the MQs, the Nqs or the EINs, the ess either. There’s too much opportunity in thousands of other names, but when you’re underfunded, you’re forced to cope, and the last thing you want to do is make your trading strategy a coping mechanism.
Now you’re going to force trades. You have to find something. So then what do you do? You start to downtime with no training. You’re looking at one minute bars. What looking for divergences? Well, that’s great for all your hard work. Then what are you doing taking your gains at two

To one, three to one? So I see those accounts, they end up churning themselves. So you can disagree with me, but I’ve been there and that’s what happens. Two, your count is so small. Small moves in the underlying instrument can really hurt you. So I had to be hyper. And again, don’t forget, I started a time when stocks traded in eighths and I would have to pay at least 25 to 50%, not 50, at least 25 to 50 cents commission round turn. It was usually 25 cents to buy it long and then another 25 to sell it long. So 50 cents, if I bought a $20 stock, I would need to go to 2050, $20, 50 cents just to get out of the trade flat and whatever gains I had, were going to go to pay the commissions, I still get a tax bill. So I couldn’t focus on these little spurts of activity in the marketplace here.
It wasn’t going to work for me and move the needle. So that’s why I had to grow my account fast. That kind of shaped me. The fact that I was underfunded shaped me to develop really good habits, like add more money to the account, take my losers quickly, add to my winners, take the risk home overnight. Obviously I’m looking at strongly trended things. I’m not looking for pullbacks. Scalping was stupid. I still think it’s not enough money, and I know there’s a few people that do it, but if I’m going to put the work in, I want to get paid. I don’t care about scalping and being cute with all that. There wasn’t enough money in it, right? Because the way I look, scalp units are a fraction of what your normal risk unit would be. So if my normal risk unit’s a hundred contracts, a scalp unit is 10 contracts for me, what do I care about making nickels and dimes on 10 contracts?
It’s not worth the work. Plus in futures, I have unlimited lost potential whether I’m long or short. So it doesn’t pay for me. The expected value is too small for it to make sense further, not at that time, but now even if there was a big three a TR move in my favor with a scalp position, it doesn’t move the needle enough for it to mean anything. It’s a rounding error. It’s not even right. It’s really small. So I don’t want to be in the risk. I don’t want to do the work for no money. The key part is the flexibility. Some of you might also be getting alerts or be part of discords or telegrams and this and that. I’ve seen a lot of these things and they’re like, every day we’re going to send you 15 of our top names. The trading engine’s going to generate these things and we’re going to send you text messages for these alerts. Well, that’s great. And you’ve heard me say nothing against these people because they’re doing hard work. They’re trying to provide a valuable service, but without a plan, how do you know which one of those to take? Do you take the first one or do you ham and haw?
How do you do that? And then if you’re losing money and you get another signal, do you take

That one or do you blow out the one that you’re losing in? If you have more money in your account, you could at least put two or three names on. Pull the weeds, let the flowers go. Let the flowers bloom. So this is why I think if you have an underfunded account, you put yourself in a tough spot. Again, I’ll give it to you that you will definitely learn the craft of trading by being in the game and learning how to trade. Absolutely, absolutely. And if that’s the goal, then by all means do it. But just realize that when you’re underfunded, you start to develop what I consider bad habits. Now, a handful of people have gone on, started the same way and eventually figured it out. But I’m going to also venture to guess that the way they’re trading now with a million dollars or even 500 K under management is a hell of a lot different than when they did it with a couple of thousand dollars.
And so I just want to have a little straight talk with you. That’s really what I think I do in many ways is be the voice of reason. It might not be what you want hear, but I’m not putting a stick in your eye. I’m just telling you, what are the realities of what are you going to face once you’re in that space? Again, my hat’s off to you trying to trade, but you want to have the flexibility. You don’t want to have to be like, well, I have to force this trade. I only have enough money to afford the margin for the MQs. Right? Again, that’s great, but you’re going to be watching every tick, which is a no-no, you’re going to be probably trading your p and l, which is also a no-no. And to me, you start developing bad habits. God knows I’ve had ’em, right?
I used to smoke. So again, if you develop bad habits, they’re awfully difficult to break. So I would say save your money. Give yourself some flexibility, have your own set of rules and not take indicators or alerts from other people. There’s a couple of different types of alerts. I’ll talk about that this week as well. But you need to have a plan and say, okay, here’s where I get in. Here’s where I get out. Here’s the inventory that I’m going to carry. In my case, when I was underfunded, I used to say, okay, if I was in a $20 stock and it went to 22 and I was risking a dollar, I will add that other, what did I say? I had 5K, and I would take my money and say 2,500 to futures, 2,500 to stocks, and of that 25 hundreds, I would put 1250 to work right away.
Whatever amount of shares I could buy, I’d put the 1250 to work. If it went up five or 10%, I would double down and increase my position by a hundred percent. I’d double my position. I would adjust my protective stop to where I’m risking still $1 maybe to break even, and sometimes I get knocked out. You know what I mean? Because in the short run, things are volatile and things are very, very random. So it was very, very aggravating as well. So then I have to fight the feeling of not coming back to the market all pissed off. It’s one thing to be an athlete and to be motivated this way, but when you get aggravated

Trading and you try to take that feeling and come back and seek revenge against the market, you’re going to lose once in a while. You might get lucky from a timing standpoint, but you need to be in optimal mental shape in order to trade. So don’t take this the wrong way, just understand that I’m giving you what the flashing yellow lights are going to be once you fund your account. Some of you I know are already going through this, so I’m kind of preaching to the choir. The majority of my viewers are new people by a big number every episode. So that’s why I speak. I’ve never met them before because the majority of people I haven’t. I have a lot of regular viewers, thanks for being here. But if you’re new to the show, we talk about the mental and the psychological aspects of trading, which is 80% of it.
And if you’ve been around the block enough times, you probably know that where you’ve had to look yourself in the mirror and say, what the hell am I doing? Why I shouldn’t even be in this trade. I’m losing money if no business being in the trade in the first place. I have countless conversations with people who are just in that spot where they’re dying to trade. They’re like, Mike, yeah, but Mike, I want to get involved now. And I’m like, yeah, I get it. But just understand that especially in futures are built for institutions, the rules are built. They’re hedging vehicles, right? They’re not a capital asset. It’s a risk transference device. So it’s for hedgers. The fact that as investors or the archaic term, a speculator you can jump in is really incidental. You just provide liquidity, but the rules aren’t built for you Institutions, they have lower margins, they get better fills, they got much more services and that we can participate when the rules are definitely lopsided for the home team, if you will. We got to really be careful about that. So think about this and mind your capital, find ways to add. If you’re working a salary job and you’re making money, think about ways to add into your account to build it up, because the more money you have, the more flexible you can be, the more trade opportunities. You don’t have to worry about like, okay, I’m in a winning trade, but I got another signal. How do I know I still don’t suffer? Opportunity cost, you see?

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Should you let a trade become an investment? Well, the answer is yes and no. I think that whenever you hear that statement, you should never let a trade become. An investment is really on the downside. If something’s losing your money, you got to puke it out. You have to know where you’re getting out beforehand, but if you have a winning trade, why not let the thing run? In my book, the Inner Voice of Trading, I described a situation very, very early on for a newer trader who doesn’t really necessarily know if he or she has any skill or if they’re just lucky and you have five equally weighted positions. One’s up 25, one’s up 10, one’s flat, one is down 10, the other one’s down 25. So you can see the symmetry here despite putting on five equally weighted trades, the account balance is zero.
Despite having some decent growth, at least in the first two names, plus 25, plus 10, it’s not until you employ a little money management technique where you say, cauterize the number five position at down 10. Now you’re up something like 3% and you don’t even know if you’re good or you’re lucky. So I think that statement is true, but only kind of half the time, right? It only makes sense to cut your losers if you have winning trades. You might as well let them run, even if you trade index futures because those things can run too. What I try to teach is to make sure that you’re not creating more work for yourself. In other words, I don’t want you to have to reinvent yourself every morning. If you have winning trades, which to me are hard enough to find in the first place, you might as well stick with them.
And if you’re scared about overnight risk, you can always position size, right? That’s where we make and lose our money. Now, of you written in about how many trades do you make, all this and that, it’s nearly not important. It’s not going to help you trade better just to have it for instance, and two, I don’t really care for voyeuristic kind of stuff, but I will say this, that for the systematized rules we put on all of those trades for the discretionary trades, those setups are harder to find. Plus, for my taste and preference where I am in my career, I’m not working for two to one type of payoff ratio. I’m really looking for three to one minimum, better yet even five or better, because for the risk that I’m willing to take, I really want to get paid. I’m not in it for the action.
So there are days that go by where I don’t have trades. Just to give you a for instance, I have access to simulators. I don’t necessarily use them because I know my rules off the top of my head, and after several decades I can kind of see the trades that would show up in the system. Does that make sense? I programmed the system anyway, so there’s a couple of good systems out there that can help you with the money management and help you backtest your ideas if you want to see what the worst case scenarios are overnight, I would say that over my career there have been three or four instances

Where I took big hits overnight, but by big hits, I’m talking like 2%, maybe 3% to my overall equity. I feel like people have, I don’t want to say irrational because that means something specific in the world of psychology, and I’m not a psychologist, but it does seem a little irrational that people have this fear about taking risk home overnight or over the weekends when it’s really not that bad at all. If you’re trading too large, then yes, by all means, but you should also know when you study the data that the biggest, worst days if you’re long are also really close to the better up days, at least when I look at the data. So you can get the data for free. If you go to Yahoo Finance and you click, excuse me, you click on the ticker that you’re looking at, you can look in the lefthand column and I think it’ll say historical data.
You could put in a date range. I would look at 10 years. You’ll get the data in a CSV file and you could put that in your Google Sheets or Excel, whatever you’re using, and look at the data and see what the results were overnight versus what happens intraday. I’ve done studies on that. It’s very surprising how much money you can make just by being in winning trades and holding them overnight over the weekend. So how did I come to understand this? Well, you can imagine, idiot, Mike, I’ve done this for 36 years now, and I had to learn the hard way. I found out because I came from the wirehouse background, the wirehouse coached you to use the firm’s research. That’s your first misstep. Now, these are really bright people. I’ve taught CFAs. I’ve got nothing against them, but the reason they do that is because of compliance.
If you’re going to have a client lodge a complaint, you better have documentation. So the firm basically said, if we have this research department and those folks who are smarter than you in terms of analysis are going to kick the tires and we have buy recommendations on these things, you’re never going to lose because it’s not a crime to lose money. What you don’t want to go doing is picking names that no one’s ever heard of, go to the pink sheets, this and that, because then we can’t support you if it ever comes down to arbitration. So rely on the firm’s research, especially if you’re going to make solicited calls, right? We talked about that. So you find yourself in the situation where you have five names of equally weights of equal weights, plus 25 plus 10, flat minus 10, minus 25, and then you’re in a situation where you know all the names because they’re all brand recognized. They’re all blue chip names. So now you’ve become emotionally attached to the name beforehand because you can see the good or services that exist in the world.
For me, that was a tough one to have to come over is that I had to be, the word I use is promiscuous or very disloyal. You can’t fall in love with the ticker because you think you know the company or you want it to win like it’s your favorite sports team. You have to dissociate from that and be promiscuous enough to know that if this thing ticks against you, that’s a form of cheating. That’s like your partner cheating on you, and it’s betrayal, so therefore it has to go. There can’t be any loyalty to it. I don’t care if it’s Disney, Coke, Nvidia, Bitcoin, it doesn’t matter if you’re starting to take on water and lose money, it has to trade. One of the smartest things I ever heard was from Alan “Ace” Greenberg, who was chairman of Bear Stearns back in the day, in case you don’t know, had very, very strong proprietary trading, and one of the rules that he had for his traders when he actually was on the floor was that if you bought a name on Tuesday, come to Friday’s close, if you still had it and it was down, it doesn’t matter where your protective stop was, meaning the stop wasn’t hit, but you were still down.
He didn’t take losers home over the weekend, everything traded. It could be at and t, could have been General Electric. It did not matter if it was down coming into Friday’s, close four o’clock eastern time, they puked it out and he would really put people through the ringers as to why they would try to justify taking losing trades home. So that much I understand that’s when you don’t want an investment to become a trade, to become an investment because you’re emotionally attached, like, Hey, what happens? You’re down. You start losing a little bit of money, but you’re like, man, it’s Nvidia. It’s never going to go out of business. But you have to remember, there’s like a 75% chance at any given time that the name could go through a 50% drawdown. You don’t know where it’s going to start. You can use reversals for sure, and there’s probably support and resistance that you can use before it would ever get that bad, but that’s when I think people run into trouble.
And the statement would be true. It’s like if you buy the thing long, don’t become emotionally attached to the ticker despite what you can see in the media. The truth is you probably don’t know anything about the fundamentals if you’re not a CFA, you can only see what you’re seeing on the internet. And to me, that’s information. I don’t know that it’s really research. So I’ve learned to train my mind to not look into stuff that amateurs are coming up with because it makes me feel good to see another person. Hey, Yankee fan, you’re walking down the street, you got a Munson jersey on. That’s all great, but at the end of the day, it’s up for you and it’s your responsibility to manage the risk. And man, I learned the hard way because I’d have Wendy’s or McDonald’s, I’d have ge, I’d have anything in the Dow 30, like how could it go wrong?
It’s in the stock index. Obviously other people really smart. It wouldn’t be in the index if it wasn’t a great name, but you find out that you can lose money with McDonald’s, you can lose money with Walmart, you can lose money with these big blue chip names. And so this exercise throws into sharp relief that you have to remain objective, right? You’re looking for candidates who are going to step up and if you buy them long are going to immediately start to perform for you. And if you don’t, it’s the double Bye-Bye, get out of my portfolio. There’s no time for that. And if it ticks down, you could make an argument to get out of it before your protective stop has even hit. Or if it stalls, and it’s not really plus or minus anything material after a day or two, you employ a times stop and get out because whatever you thought was going to happen, either you’re really early or the momentum is stalled and it’s time to go.
But I don’t think that statement, don’t let a trade become an investment is an absolute rule. I think if you have winners, and as long as you know how to manage the risk, then you’re putting on an appropriate amount at the beginning and you might have rules to scale out. You obviously have rules to adjust your protective stop so that if it does reverse against you, I just see too many people doing too much work for too little money and having to reinvent themselves every day. Where if you can find a strongly trending name and go to school on yourself, if you were short Tesla, how much did you take out of that trade? Because if it’s less than 10%, you left the majority of the money on the table. If you even took 25 or $50 out of the Nvidia move recently, you left the majority of the money on the table.
And yes, you can celebrate the wins all you want, but your goal is to maximize your behavior. You want to optimize your behavior. So for me, I would say when you hear people say that they’re not really sure about managing risk, because there’s nothing to fear about keeping good risks in your portfolio, good risks are the trades that you have that have unrealized gains.

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If you’re in a trading drawdown, man, it feels like it’s the end of the world. You don’t know when it’s going to end. You don’t know if it’s going to get worse and there’s nobody there to help you. Hi everybody, I’m Michael Martin. I’m a futures and equities trader, sometimes options trader in Los Angeles and I’ve been there. I’ve done that. Man. What’s even worse about this is that if you don’t know what the expected value of a trade is, you don’t really know a whole bunch of stuff. You don’t know what the probability is of a eight in a row losing streak. You don’t know what the probability is of your coming back and when you probably don’t have a plan as to what to do to dig yourself out. I’m going to talk to you about that today in this video. Give you a little bit of a bro hug and help you work through it.
Why? Well, because I’ve been there. I’ve been there and I’ve done that and drawdowns are really, really horrible. In fact, I’ll be honest with you, I coach and mentor traders who are both institutional and retail, do it yourselfers about the mental part of trading, and I use a case study from my own trading back in like 2005 / 2006, where I had a rollover account with about $50k at the time, and at that time it was after I had done and worked in the inline village trading tribe. It was after I was already pro. I had probably 15, 16 something years of experience in the markets. I was registered with the NFA as a commodity trading advisor at approximately $27 million in client assets at the time, and that account went into a rather large drawdown.
It went to at least 20% drawdown. Now, I was trading it aggressively and I stuck to my knitting. I didn’t change my trading style and over that period of time I was losing money. I kept my winners and I dug out of it and the account was up several fold. By the next nine months, it went to almost $300k in nine months, and I’ve got the charts and the trading confirmations and I walk everybody through it to show when you’re in the drawdown you can’t panic, and I caught the move in sugar, which was a substantial part of my open trade equity at the time, even though the account was still down between 15 and 20%. So it could have been very, very nerve wracking. I think what might make things worse for you is that if you’re trying to trade several different setups, you don’t know necessarily at the beginning which one is causing the hemorrhaging. You see, so sticking to one setup, which is what I advocate at the beginning anyway, and really knowing that and owning it is the key to your salvation. The other thing is consistent

Sizing. A lot of places and some popular proprietary trading firms advocate saying like, well, if you’ve never been down, say 10 times in a row, pick a number, call it whatever, five or 10%, and then divide 10 trades into that and that would become like your risk unit. I don’t really manage risk that way. That’s certainly one way to do it. I really always think about risk management as a percentage of my overall capital. What am I comfortable losing out of my account balance because I know things can happen at the position level and the tail can wag the dog, if you will. That’s a part of trading, and I learned that the hard way and if you listen to yesterday’s episode about my biggest mental error, you can see how these things shape who you are, your temperament, your personality when you’re managing risk, and I didn’t like those feelings.
I always thought I should have known better, but the worst thing that you can do is to stop trading. If you stop trading, you can’t dig out even a little bit. So I would say if you have and you’re coming into the thing and you haven’t been using consistent position sizing, you need to adopt a consistent position sizing methodology. Like right now, you can’t say, well, I have a strong bias on this or I have a conviction on this. In all due respect, you don’t know what that word means. You don’t have enough experience even with two years of experience to say you’re all hopped up and you’ve got this and that or the other thing in terms of conviction. To me that speaks of bias and you might be looking into things. You see what I’m saying? Intuition, as it’s kind of slang referred to.
Now some of you might take umbrage with that, but the point is it’s that you’re in the drawdown. You’re looking to get out. So these are, in my opinion, best practices. This is what I’ve used myself is I never really waver from constant risk management and position sizing anyway. I never can look and say, well, I’m down all this money because I decided to trade this thing bigger, it let me down, or I did this one smaller and it actually worked out, but I didn’t have enough those conversations with myself because I have constant risk in terms of my position sizing. So say you’re down X, Y, Z percent, but your trading is not in tune with the market either the market’s not amenable to your style or you’re just developing your style, and in all due respect, you don’t even really know what you’re doing. The thing you want to do is now cut your position size maybe by half because at this point the goal is to get back in tune with the market. It’s not to win the money right back, and it’s like being in a relationship and you’re not getting along. See what I’m saying? So you have to take a time out and reorganize things and try to make tomorrow a different day. If you continue to lose money by being all over the place,

That’s just going to make things worse and that can cause you to trade on tilt or just go for broke and just say, forget it, I’m buying everything in Nvidia or whatever your favorite ticker is. You have to remember what I’ve said before that bees and dogs can smell fear, but so can ticker symbols. So you need to cut your risk management substantially. In fact, even traders who trade mechanical systems have algorithms built into their rules that suggest, I’ll pick a number off the top of my head. If they come down and they’re in a 10% drawdown so that they have 90 cent dollars, they’ll cut their position sizes by three quarters, I mean not three quarters by say a third to a quarter, and then if it continues and they find themselves down 20%, they really start cutting down to half of what they had been trading so that this way, if they’re trading is out of tune with the market or if something’s going on in their world, they’ll lose money, but the decrements will be so much smaller that it won’t ruin them and cause them to hijack their system, adopt new trading rules, new setups, or they’re going to start selling options to bring the credits into the, I mean, I’ve heard everything that goes on.
There’s nothing that’s escaped me, but that doesn’t really serve you. Now you’re acting out emotionally, which is the last place that you want to be. You want to take every trade, and that’s no differently than you’re trying to hang 10 or catch a wave and surf it. So if your rules have worked in the past and you know what the expected value of a trade is, you have to remember that’s a weighted average, and you might just be in the window of like if you have 30% win ratio and you’re putting on 1,000 trades, you have 700 trades, so you might be just in this window where five to 10 of them are going to go into that 70% of the time that you lose. The key to that or the key to losing more frequently than when you win is to make sure that those losses are very, very small.
You see, so stick to your knitting. If you’ve made money in the past with the model that you’re running or the setups that you’re doing, stay with those because they’ll come back in season when I don’t have a damn clue. This is probabilistic for me too. What do you think? The rules are special for me. Thank you for that nod, but it’s not so cut your position, size and focus on just getting back in tune with the market Sometimes it’s the market, it’s not me, it’s you. It’s the way it works. And so it’s tricky. It’s tricky. The key though is to stay placated. You can’t spin out of control and start acting out of emotion. If you do that, you goose is already cooked. You might as well take the money out and go give it to your favorite church or charity, and at least you’ll direct it to a place where it’s going to go. But don’t be the person who’s going to be a philanthropist in the market through giving away your money

From your trading losses. If it’s so bad and you have lost your confidence, then take a week off. Do wonders for you. Don’t even look at the market. Get away. Just remember, what are you doing this for? Go back to step number one and think about your goals. What do you want trading to do for you? I don’t think it’s to have you in the emotional state that you’re in right now. This was something that happened and now you’re all caught up and you’re all twisted up in the game. So taking some time off can work wonders, and I used to do that. If I started off the week like Monday, Tuesday and it wasn’t working for me and I was already down, I would start cutting positions right away and then I would literally go hang out in Central Park. I knew that this was a marathon and I knew that any one particular day doesn’t really mean a whole lot.
In the grand scheme of things, it seems like it means a lot when you’re in the moment because you’re aggravated, you’re banging the mouse, who knows? You’ve seen the videos of people throwing their machines and doing this. I never felt that there was a big emotional payoff to ruin thousands of dollars worth of technology already down the money in my account. So I don’t want to amplify that by starting to destroy the physical aspects of my trading. So I would just take time off and say, okay, here’s what I thought about. Here’s the promise that I’ve shown so far. Here’s where I know where I’m at. Here’s what I know I’m good at. But the market is omniscient and omnipotent, and so if the market’s saying that no matter what you’ve done in the past to make money, we’re not going to oblige you this week, then take time off. There’s no reason to sit in front of the screen. If you’re in a bad spot, go do something to clear your head. Go travel, go visit somebody. Take a day off in the middle of the week. Don’t even look at the markets that might seem like it’s blasphemy to some of you because you’re so engaged, but getting some detachment, loving it with detachment right now can be a healthy thing.

Watch this video on YouTube

Michael (00:00):
Hey everybody, it’s Michael Martin. Thanks for being here. Really excited because I get to chat for an hour with one of my really, really good buddies for a long time, probably 20 years. Sean McLaughlin, you probably know him as Chicago Sean. He works with all-star charts. How you doing today, buddy?

Sean (00:15):
I’m doing great man. The market is winding down for the day. It’s been a wild week here in my house. My wife just celebrated a big round number birthday. I threw a surprise party for her this weekend. We had people coming in from out of town. They finally just left yesterday, so the week is winding down.

Michael (00:34):
That’s right. When the party’s over, everyone has to go at the same time as I like to say, get out of my house. I want my space back.

Sean (00:43):
Yeah, exactly.

Michael (00:44):
Well, happy birthday to Mrs. Chicago. I hope she has a good many more big round numbers on her way. We like theta in this case, right?

Sean (00:57):
That’s right, that’s right.

Michael (01:00):
So speaking of the reason I don’t do interviews all the time is because I really like to think about the emotional and the psychological aspect of trading. But what happens is if you say one or two things about options, you get a thousand responses from people and although I can speak from my own experience, I thought what I would do today is bring in Sean, who’s a real options pro, get a different opinion. You can hear it from another angle and if that helps you, that helps you, it’s all for free. Sean, one of the things that I get, and I kind of razz people about it so they feel antagonized, but I want to have a little fun with people is this whole zero DTE thing. My take on it is that it’s a real trap for small retail traders and that they’re better off paying more money for time value, give themselves a chance to win. I know there’s training programs out there where you got a bunch of teachers and they can I’m sure help you if you’re lucky enough to have access to that, but the majority of people are doing it at home. They do it your DIYers, right? Do it yourself. So when you think about it and your rolling in all star charts, what’s your take on zero DTE? Call me an idiot if I’m wrong. I mean I don’t care. No, you’re

Sean (02:11):
Not an idiot. Look, it’s right that you’re asking about it because the volumes in zero DTE options are exploding. In fact, options expiring today and tomorrow, so like zero DT E and 1D TE are almost equal to all the rest of the options volume out there. So yeah, we should be talking about it. Now I take issue with people who think that the zero DTE options are a new way to make money. In my experience, and I can only speak from my experience, right Michael, but I’ve dabbled with them, I’ve dabbled with them a lot and I’ve had some success, but I have not come up with anything that’s unique or different in zero DTE. That’s certainly anything repeatable that I know I can rely on to make money every day. My thought on what’s going on with zero DTE options is they are great instruments for people and institutions I should say, who want to hedge event specific risks.

(03:15):
Something that’s very binary, very short term. They know there’s a big government report coming out the next morning or something like that. I think they’re great instruments for affordable hedging, but for people who are trading them purely as speculative instruments, they’re very challenging because if you’re buying them right then that means the clock is working so quickly against you. Your timing has got to be nearly impeccable if you’re buying these options. On the flip side, if you’re selling them, you’re taking on a lot of risk for very little reward. If a big move happens, if we have a big rip that you weren’t expecting for, even if you just stepped away to go make yourself a sandwich or something and you come back and the market ripped 20 points in your face, you’re taking on a lot of gamma risk for very little relative rewards. So for people who are coming at zero DTE options with a speculative mind, I don’t know, I haven’t found a way to make money with that consistently yet. But for people who want to use ’em for hedging, I think they’re fantastic. You can get very specific, very dialed in on these specific day you want that risk hedged for and you could do it, especially if it’s very short term, you could do it very relatively cheaply. So there’s my take.

Michael (04:43):
Yeah, I like what you said about hedging these binary events. Don’t forget if there are non-binary options, we have to refer to them as they them.

Sean (04:53):
That’s the environment we live in now. Yes, that’s

Michael (04:55):
The environment we live in. We have to refer to non-binary options as they them. So I admit I’ve tried them to just because I like to speak from an experiential standpoint because theories, who cares? It’s like belly buttons. Everyone’s got one and I don’t really mean belly button, but this is a rated PG show. I think my guess is that there are people who have smaller accounts and for some reason they have this enormous fear about the, but if they’re day trading and swing trading, my take is who cares about data at that point? If you think the instrument’s going to move sharply in the direction, if you’re long calls, you think the thing’s going to move up. What do you care about theta if the underlying is going to move 10 bucks? You know what I’m saying? To me it’s kind of irrelevant. You’re overthinking stuff.

Sean (05:42):
I get it. There’s an entire cottage industry of options practitioners who swear by only selling premium, and I have no problem with that selling premium. If that’s your bag, I know plenty of people who are very successful doing that. The issue is they’re doing it on longer timeframes. They’re selling premium in options that have six months or six weeks expiration, eight weeks expiration. They’re not doing it on an option that expires tomorrow, at least not the ones that are making any money consistently.

Michael (06:16):
And I speak to timing, I admit there’s probably like three dozen people out there who can do this, but for the shorter term stuff, man, your timing has to really be impeccable. So that’s my gripe about everyone trying to sell you swing trading and day trading programs is you can look over the shoulder and see what they’re doing and understand it intellectually, but in order to have the sense of timing that they have, that to me is a whole other skill and it almost has nothing to do with the puts in the calls part. You know what I’m saying? There are just people out there who have a really good sense of how things unfold and options can certainly be a way to capture that while minimizing the risk. And let’s not forget if some of the high flyers out there, everyone has an opinion now about Nvidia and how AI is going to change the world. You’re looking at 700 bucks a share. So yeah, you can buy a call as a surrogate I suppose, but to buy it for two days because the premium’s eight as opposed to 30 for one month’s expiration. I feel like people are kind of misled. And then what happens is you get this kind of, I call it Johnny Cochrane logic, right? If it doesn’t fit, you must have quit, right? Hey man, the glove never fit oj. He didn’t kill the girl. You know what I’m saying?

Sean (07:38):
Allegedly, he allegedly was involved in that.

Michael (07:42):
That’s right.

Sean (07:43):
Speaking as a Buffalo Bills fan, sorry, that’s a little close to home. The juice.

Michael (07:46):
I remember the juice when I was growing up, that was his nickname. So you hear someone say something over and over and over again and then you lose your critical thought and you just accept it as being God’s honest truth. So my whole thing is not only are the better traitors that I know, really contrarian, but they also question everything, especially in their own behavior. They don’t fall in love with their own reflection like narcissists and you really have to see the data, not necessarily the chart pattern. So thank you for that. It’s just look, so if you’re out there and you’re trading things that expire within the week, I hope you kill it, right? I’m not trying to call your girlfriend ugly, but you need to have a voice of reason. And that’s part of what I do here too because after 36 years I’ve seen and heard it all.

(08:33):
I am not saying that these people are snake oil salesmen, but when I scroll through my Instagram reels, I’m seeing and hearing stuff that is just laughable. It’s like a skit out of Saturday Night Live, and we’re going to see that because it’s an unregulated market, there’s no one to say, Hey, you have to have data to back up what you’re saying. People can say what they want. It doesn’t mean that it’s true. Right on. Let’s talk about risk management. So I tend to be a debit buyer myself. I’m like long calls, long calls, long puts. So I have an idea of what the worst case is. I almost never stick around if the thing is moving against me to let the whole thing go to zero, I’m kind of trading out of it. So what do you think someone who’s just starting out in options to do, should they take their risk unit and make that like a hundred percent of the premium or should they buy several multiples of that? So in other words, if they have a million dollars account or a hundred k, they want to risk 1000, do they put a thousand dollars in debit balance or can they put as much as 3, 4, 5 and then get stopped out at say 80% after they’ve risked their thousand? How do you look at that? Probably with respect to leverage, the

Sean (09:47):
Way I look at it is I like to always plan for the worst case scenario, and I have a perfect recent example of this, and this is in Snapchat. I had a position in Snapchat coming into the debacle that happened this week where the stock lost 30% overnight. I had a calendar spread on which we won’t get lost in the nuts and bolts of it, but just know that it’s a defined risks position. The debit that I paid when I put the spread on a month ago is the absolute most I could lose in a worst case scenario. And you know, after what happened this week, I was very happy knowing that my risk was defined and so I lost, I didn’t lose a hundred percent of my trade, but I lost probably 90%. But that’s fine because the position was sized in a way that had I suffered the full loss, it was a loss just like any other loss, totally acceptable within the realm of realm of what’s acceptable for my size account.

(10:45):
So I always approach risk management from the worst case scenario. When I’m doing option trades with defined risk, I want to know what that worst case is. And yes, to your point, I do use stops. I do get out with if a chart pattern is broken that I was leaning against, or if the spread or the option that I’m in loses a certain percentage of its value typically, but not always. Let’s just keep it simple. Let’s say I’m long a call if the chart isn’t necessarily broken, but it’s just going nowhere and my call that I bought for $5 is now trading at two 50, it’s lost half of its value. Generally I’ll cut my losses at that point, even if the chart still agrees with me. But again, I know what the worst case scenario is, it could be a zero and I’m fine with that. So that’s how I think about it. Mike, yeah, try to keep the worst case scenario in mind at all times.

Michael (11:43):
Okay, that’s a good answer. So I think the same way I think for certain positions where I try to have constant risk, I do know markets can gap when I’m trading well, I tend to trade more aggressively. That’s a discretionary element to my own practice, but the thing that I wrestle with is if you take in the series seven, they’ll say if you buy a thousand shares of an instrument, don’t buy more than 10 contracts and it looks good on paper. You don’t want to over-leverage your account. The thing is, is that you’re given away a lot with that type of model and what am I talking about? We’re talking about delta. Delta of any underlying is one, but if I’m buying something at the money, your delta’s going to be about 50. Obviously gamma’s going to be super high, but I think in terms of position sizing, I try to balance both the premium with also the delta because I know if I’ve got the calls and there’s a gigantic move, I’m not really going to participate in it all that much.

(12:53):
Although you can get, I’m sure the numbers, the delta’s going to increase the more in the money it goes, but that’s still a bit of a haircut that you have to take. So I always try to think, okay, balance, how much premium do I have at risk in terms of debit or net debit? I’m really not a net debit guy, meaning spreader or broken wings. But then I think about what am I getting? What is the bang for the buck that I’m getting? Do you look at deltas too when you are looking to establish whatever structure you’re going to put on?

Sean (13:24):
Yeah, certainly If there is a trade that I like, and again, let’s keep it simple with just simple long calls. If I look at that trade from the perspective of a stock trader and let’s say a thousand shares is my trade size, but I don’t want to tie up that much capital that would be required to buy a thousand shares of the stock, what I would often do is I would go into the options market and buy enough calls to target that delta. So in this case, if I wanted to have a thousand deltas, which is what a thousand shares would be, if I was long a thousand shares, that’s equivalent to a thousand deltas, I would buy, what is that 200 calls to target that same size? Am I doing my math or 20 calls?

Michael (14:17):
Trust

Sean (14:17):
It. At the end of the day, Michael, I’m fried. I can’t do the math in my head.

Michael (14:21):
I know you just had the birthday party and all those pain in the ass people at the house. I understand.

Sean (14:25):
But anyway, I would size my call position so that the delta would equal a similar sized stock position, but the benefit being I’m tying up less capital, I’m tying up less buying power so that I can maybe diversify my risk in another trade that is uncorrelated, right? People do that all the time. It’s something I will do from time to time, but what I’ll be mindful of is if I do that, I know that whatever premium I pay for those calls, that’s my max risk. So

(14:58):
If I’m putting myself in a situation where the max risk is larger than what I’m comfortable with and I have a decision to make, the decision is do I want this much leverage with calls? Can I maybe take a smaller position and I’ll get to that target delta eventually if the trade moves my way or do I get a little creative and maybe buy some hedges, maybe buy some out of the money puts just in case. I mean, there’s a lot of different ways, and you kind of hinted at the top of this call about how with options trading, there’s lots of different ways to skin the cat, and that’s both challenging and frustrating to people, but also a great opportunity. It’s challenging because a lot of people, especially people who come from the binary world of futures where you buy or sell and that’s it.

(15:48):
People don’t like that the answers are black and white, that they aren’t black and white. If X happens, you do Y in options. There’s different, there’s no right answer and people want right answers. People crave right answers, right? They want to do it right. Well, I’m sorry to tell you that if you’re bullish and I’m bullish on the same instrument, you and I could trade it with options in two completely different ways and we could both make money, we could both lose money or one could make and you lose. It’s like that frustrates people, but I like it.

Michael (16:20):
I like them because you can really carve out your risk and that to me is the nature of trading. It’s so not about entries. To me it’s all about position sizing more than anything. If you looked at my, I’m like the Jimmy Page of trade entries. I have really good licks, but I’m sloppy as hell. Whereas there’s other guitar players who can hit every note all the time, but Jimmy Page is all balls, and that’s kind of more my style of trading. So what I try to do is I try to carve out where’s the risk, where’s the upside? Unlike a lot of folks, I don’t really get out of bed if I can’t find something where at least looking on the chart I can see a five to one type of ratio. This way when it works out, my winners can pay for a whole bunch of losers, and like you said, sometimes they stall, so I do use time stops as well.

Sean (17:09):
Yeah, that’s actually something, I mean I’ve always been aware of time stops, but certainly in the past year I’ve made a much more concerted effort to focus on getting out of the trades that just aren’t working quickly. Now, I’m not being greedy, but I look back at my trades over the past, I dunno, four or five years that we’ve done stuff with all star charts and I’ve noticed Michael, that all of my biggest winners, the trades that really made my year every year those trades, not every time, but almost every time they started ripping right away, maybe not the minute I got into it, but within a day or two or certainly within a week, it started going my direction and never looked back.

(17:58):
And certainly I had trades that I sat in for six months and then finally worked for me and that’s great, but I adopted the mindset of if all my biggest trades that make my year are all trades that start working right away, then what am I doing sitting in all these trades that are tying up capital for weeks at a time, months at a time doing nothing? I would rather get out of those things a lot quicker at the risk of maybe getting out of a trade that would’ve worked eventually, but the numbers work in your favor when you do that.

Michael (18:29):
God has spoken these words, and I do that with futures, which allows me to trade with bigger size. I don’t look at myself as a day trader. I’m more position trading, but if I do put on a trade, I don’t want to see red and sometimes I’ll be like in, out, in, out, out just because I’d rather trade with the size, not that I’m trying to sit here, double click in my mouse all day, but I want to get in on the trade with the right timing, then have the thing move in my favor, I can then adjust my stops and it really helps me live in a very placated lifestyle in that regard. It looks sloppy as hell, a lot of false starts, but the key is to get the right amount of risk on at the exact right time, and I don’t have time, like you were saying, I don’t have time to sit there to wait.

(19:15):
I had some puts on Disney a while back and I literally got paid the last day and I was like, this is bullshit. I’m not doing this anymore and I made 20% on the actual trade, so whatever, if my risk unit was 1%, I cleared out 1.2 net of commissions. So it wasn’t even anything really to write home about, so it was more of an emotional win or like a theoretical win. It’s not win-win, certainly not one that I want to get involved in and replicate no money in it, but I think the key here is position sizing. Just to take an aside, I wrote about in the inner voice about the inner invoice of trading being long live cattle, feeder cattle. When mad cow hit the tape, hey,

Sean (19:59):
I don’t know, he was over my shoulder, but right on my bookshelf over there, I’ve got the inner voice of trading right there on my bookshelf.

Michael (20:06):
Thank you. Thank you, Sean. That’s very sweetie to say, but man, that was painful because obviously commodity futures are not options and you have unlimited loss potential regardless of whether you’re long or short. The key was position sizing and the thing was limit move against me like five days and that’s 1500 bucks a contract. You’re getting blasted, but the problem is is that people see that and now they extrapolate it and they see that’s why I’m not trading futures now. I’ve been trading futures for 36 years and I can think maybe including that one, maybe two or three total times where I had limit moves against me.

(20:50):
I think options provide a good vehicle for folks who are learning how to take risk home and take risk home overnight over the weekend. It gives you a little staying power. You already can define what your max loss is, right? So I think there is a bit of a misconception and a fundamental misunderstanding of risk. Risk in and of itself is not bad. It’s how you handle it. To be honest with you, and I make this joke when I speak publicly, I trade futures more conservatively than people buy and hold their 10 year treasury notes. You know what I mean? Those things are all over the place. They look like my uncle Vinny’s, EKG, after a big meatball parm and three liters of Coke. My future’s equity account when you trade your equity curve, so you can take and trade it a very aggressive or risky instrument, but trade it conservatively. I think that’s what Sean was saying. So do you ever find yourself, Sean, where you’re in a long call and a long put and you’re like, Hmm, the financing of this thing is a little rich for my account size, let me sell away some of the upside and create a spread or do you ever do that, like ratio spreads or back spreads? Oh,

Sean (22:04):
Absolutely. Once I’ve determined whether or not I’m bullish on a position or bearish on a stock or neutral on stock, once I’ve decided my directional bias, then the first thing I look at is where is the implied volatility in the options? Now for newbies out there who have no idea what I’m talking about, implied volatility is just a measure of the expensiveness of the options premium. When implied volatility is high, that means that you’re paying a lot more to say buy an at the money call versus when volatility is low, the premiums will be much cheaper, and so I want to know where the implied volatility is. I don’t care so much about the actual number that will pop up on my screen. The volatility is 0.8294. No, I don’t care about that. I just care about where is it now compared to where it’s been over the past six to 12 months. If it’s in the upper third of the range, then I know that volatility is high. In that case, I want to be putting on some kind of spread trade in most cases, or maybe I want to be selling premium just being naked puts or maybe a strangle.

(23:16):
On the flip side, if volatility is cheap, then that gives me a little bit more comfort to maybe just buy a straight call if I’m bullish or buy a straight put if I’m bearish. But implied volatility is number one A in the steps for me in determining what I’m going to do to express my thesis.

Michael (23:35):
Thanks for saying that. I mean with options, man, it’s like to me, futures are so clean. You have supply and demand. There’s no Abby, Joseph Cohen, there’s no fed banker, central banker. There’s no ax that can really tell you where beans or cocoa or sugar are going to go, and that to me is kind of disruptive because if you’re in those positions overnight over the weekend, I don’t any more than any type of trader who’s, whether it’s day trading one minute bars or position trading and holding things overnight like I do, no one likes surprises. I don’t want to wake up and find that somebody just upgraded or downgraded or that there’s even just bad news coming in and out of the company like Refco halted auditor, resigns, CFO was arrested. Man, that Refco thing hit me hard. They had actually allocated money to me, so once I saw that, I knew the gig was over.

Sean (24:41):
So let’s talk about, I ran a small commodities fund back in oh three to oh five, and I cleared through MF Global and I moved to another firm. Luckily, maybe six months before that whole thing blew up, I could have been ensnared in that as well.

Michael (24:59):
That was the John Carine bond trade thing.

Sean (25:01):
Yep, yep.

Michael (25:03):
Yeah, yeah. I was affected by both because when I started out and I went out on my own, I cleared EDNF man basically my whole career. So yeah, he ruined that company. I mean, that company went back to 1794 something. Yeah,

(25:20):
So let’s talk about when you are making money, right? There’s so many things to measure. You talked about implied volatility, you have historical volatility, and then you have a whole slew of Greeks, you have charm, you have all of this. If someone’s just starting out, this is overwhelming. There’s so many things to know, so many things like, Hey, my car won’t start. Well, what is it? Is the battery not charged? Do you not have enough fuel? Are the two battery connectors corroded? Where do you start to go through your checklist of what’s material or not? My take on things for any asset class is to really keep things simple. The simpler models are easiest to run. They can be profitable, and then when they start to break, you could at least see what the hell’s wrong with it and take a time out. What do you advise for the newer folks two years or so of experience who are looking at options and they overwhelmed with just the vocabulary of the damn things?

Sean (26:28):
That’s a good question, and I meet people who are new to trading all the time. I run a traders meetup group here in Colorado. We get together a couple times a month and we get new people all the time. And one of the things that’s always said, options when they hear that I tried options, it’s like, oh man, that’s complicated. And look, here’s the thing about options. Options can be very complicated. In fact, there are a lot of people, a lot of successful traders out there who run very complicated volatility skew strategies that you need like a PhD in math that even scratch the surface of what they’re doing that exists and it’s out there certainly, however, that is not how I trade. I don’t know if I’m smart because I keep it simple or if I’m stupid because I keep it simple, but either way, I like to keep it simple. And option trading can be very simple. If you’re willing to learn a couple terms that maybe you’re a little unfamiliar with, and you mentioned the Greeks. The Greeks, all they really do is they’re just measures that tell you how the speed of things are likely to change in the event that X, Y or Z happens.

(27:35):
I always tell people, if you’re new to options, don’t start getting into multi legged spreads and don’t be selling naked risks. These are things that you don’t understand and you don’t want to learn the hard way. What you want to do is kind of wade in either just be a straight buyer of calls when you’re bullish or be a straight buyer of puts when you’re bearish or a very common way, and I call this the gateway drug to options Trading is be a covered call writer. If you own stocks, sell covered calls against your stock and just see how that plays, see how that affects your return streams. See how those short options play against your long stock. That’s the easy way to get your feet wet covered call writing and just buying calls and buying puts. That’s it.

Michael (28:22):
I would concur, and I’ll say this out loud, I’m a guy who looks at the data. I started creating my own trading models using Lotus 1, 2, 3 and kind of writing macros around it, and it’s awfully difficult even to get good data on options to back test, right? I mean, so it’s very, very difficult. So paper trading, it’s not the same as long as there’s no real risk. You really need to feel the burn of making and losing money in order to get the education that you want. And I’ve said it as a guy who teaches traders of all levels, beginners through institutional people and family offices. The best teacher of trading is the actual trading itself. Absolutely. Because so much of you is part of your trading process, right? Sean just said before that he could be in a spread. I could be in a directional trade on the same underlying instrument, and we could both be right and make money. There’s really not only one good way, there’s the best way for you. That’s probably going to be a reflection of your personality. That’s typically how it goes.

Sean (29:25):
I’m glad you brought up back testing, if you don’t mind. I’d like to riff on that for a second. I riff

Michael (29:29):
Baby riff.

Sean (29:30):
I’m a big fan of back testing. I’m a big fan. When I traded commodities, like U trade commodities, I used to run back tests and I used to do trend following strategies and I wanted to run back tests as far back as I could go to see if what I’m doing has an edge that I can rely on. Big fan of it. However, in options trading as much as we want to backtest it is really problematic because even in the most liquid options markets like say like s and p options or TLT options, SPX options, things like that, even the most liquid options markets, you’re still looking at bid ask spreads that are very material. If you’re looking at an option that’s a fair value of two bucks, for example, yeah, the fair value, the option might be two bucks, but the bid might be a dollar 75 and the offer might be 2 25. That is a spread. You could drive a truck through and when you’re trying to backtest and say, oh, I would’ve gotten filled at $2, the fair value, that’s not how the real world works. If it’s a fast market and you need to get out, you’re hitting that bid and you’re getting out at a dollar 75, and that’s a big difference from $2 in percentage terms,

(30:43):
And you combine that over hundreds of thousands of trades, those differences are just going to put your numbers way out of whack. I mean, if someone out there has a good way of backtest options, I’m all ears. I would love to see it, but yeah, I don’t know how it works.

Michael (31:01):
Yeah, it’s got to be something that’s custom made because it’s just too difficult. But backtesting can reveal at least so you miss, right? Because two payoffs to every trade. There’s certainly the financial part, but then there’s the emotional and the psychological. When you’re trading with paper money or using a demo account, you might be frustrated, you can’t get the thing to work, but you’re not despondent. You lost actual money that you worked hard to get in the first place, right? So there’s a really big difference.

Sean (31:32):
Absolutely.

Michael (31:33):
Sean, how do you go about, if you have a bullish opinion on a certain thing and it’s showing up on the chart, how do you kind of determine what’s the best, right? Because you have futures, you have all these different expiration months, which we call the strip and term structure and options. You have $5, sometimes $10 increments in strikes. So is there a Greek or is there just a methodology? Is it a gut feel? What should someone look to if they were bullish on some underlying instrument, what call strikes should they look at if they were going to buy it?

Sean (32:11):
I am afraid I might give you an unsatisfactory answer here, Michael, but it’s all of the above. Remember earlier I mentioned how after I’ve decided my opinion on the stock or the underlying my bullish or my bearish, my neutral, after I’ve decided that, then very next thing I do is determine where the implied volatility is. When I’ve determined that implied volatility, that’s going to steer me into the direction of what strategy I’m going to use. So let’s just use some examples here. If volatility is low and I’m bullish, I tend to to really just keep it simple and buy calls, I mean I don’t need to get any more complicated than that. If calls are cheap, then just buy the calls so much easier. And generally speaking, if volatility is cheap and therefore calls are cheap, I will try to go further out in time because it’s more affordable to go further out in time.

(33:06):
I get more bang for the buck if I get it right. And a really big trend develops, so we’re in February right now as we’re talking, if volatility is scraping the lowest levels it’s been in for a year in a certain name, I might look out nine months, 12 months option strike just to give myself as much time for my thesis to play to work out and the strike that I select. Generally speaking, if I’m buying calls, I like to buy the 25 delta strike, so that’s going to be an out of the money call. It’s going to be above the current price level. There’s no magic in 25 delta. Michael, I get this question all the time. Why 25 delta? What back test tells you that that’s the best one? No, back test tells me it’s the best one. I like it because at 25 delta, to me, it’s the right mix of affordability and leverage. If I get it right,

(34:05):
Meanwhile cheap enough that if I get it wrong, it doesn’t hurt that much. I didn’t risk a whole lot of my capital. So that’s why I like the 25 delta love. If you like to buy the 30 delta, if you like to buy the 40 delta, fine, there’s no right answer. Everything in options trading is a trade off. If you want to make more money, you have a lower probability of success. If you want to have a high probability of success and win more often than you lose, you can do that too, but you’re not going to make as much money. There’s always a balance.

Michael (34:37):
I appreciate that. I appreciate the honest answer. I’ve vacillated between 25 and fifties in recent times. I’ve been buying a lot of at the money stuff just because the moves are so strong, which really kind of brings me to the next question is if you see a move, let’s take a move that a lot of folks probably would know in some of these AI stocks, Nvidia broke out over whatever it was 5 0 5 and at this time, what last night, it was up 7 0 8. So you’re in calls that are going either at the money, in the money very, very quickly or like you with 25 deltas, they’re eventually getting to be at the money. Then in the money, is there a best practice for know and when to roll, right? Because sometimes these moves, you have $30 move overnight, you can’t roll to the next strike. You’re oftentimes the rolling, you’re dealing, you might have 30, 40, $50 in between strikes. So do you enter spreads or do you attempt to offset the winner and then immediately go back to your next 25 delta? How does that work? Because also the volatility might’ve changed.

Sean (35:46):
Yeah, that’s a good question. And what I tend to do, and I’m not saying this is the best way or the only way, but what I tend to do in a situation like that where I’ve got a big winner, it’s going my way. Generally speaking, when I get into a trade, I have a plan. I know where I’m getting out, I know where my stop loss is. That’s the easier part. I also have a plan for if things go my way, I have a upside price target. It’s not a firm target. It’s more like an area usually. But in my mind, what I do is if I get to that price target where I’m sitting in a nice profit, a best practice that I will do often is I will sell or get out of a portion of my position that pays me back my original risk capital. So whatever I initially invested in dollar terms, I’ll sell enough to get that money back and then I’ll hold the rest. I like to call it a free ride, right? Hashtag free ride, I got a free ride on the rest. No matter what happens, I’ve got no risk in it. Trade, yes, I’m risking open profits, but I’ll risk open profits all day long, but I don’t want to risk my original capital.

Michael (36:58):
Yeah, I got you. I kind of borrow from my future trading strategy, which is I tend to be very stingy at the beginning and use lots of times stops, but then once I start making money, I quickly actually scale and buy more. It’s called the moron strategy.

Sean (37:12):
Just kidding. I like that.

(37:16):
Well, Michael, I’ve actually come around on this. I’ve changed my thinking in recent over really the past year, up until about a year ago, my best practice, and I was pretty firm on this, was if I had a position on and the spread or if it’s just a long call or a long put, if it doubled in money, then I would always sell half of my position and again, taking my original risk capital out and then let the rest ride and that’s fine and that works. But after reviewing a lot of my trades, I said, man, Sean, you’re really leaving a lot of money on the table. Why not let these things go to that price target you have in mind and then sell a little bit, maybe just 20% of your position or 10% of your position get paid back your original risk capital and you still got a large position to potentially go to the moon as the kids like to say, it only takes a couple moonshots to make your ear

Michael (38:16):
Trading is great. The outside of Jiujitsu, I don’t know of any other thing that could completely humble you. So I did a similar study and people like to say systems remove emotion or whatever. I mean they don’t know what they’re talking about. Bill Dunn who when he’s retired now, but he would talk about the emotions running through his body and that guy was purely systematic because I kind of journal everything When I think of where I’m emotionally, okay in I bought, say I bought with in the Nvidia stuff, those calls, the at the monies were like 20, $30 with 50 delta, but they go in the money so fast, you’re looking at five times your capital. And so emotionally you’re like, well, I got to protect my capital. I have to put in a stop. If the market’s going parabolic sooner or later it’s going to fall apart.

(39:07):
Parais don’t end all that well, and I don’t know exactly when, but there will be a mean reversion even if the move kind of continues. So you’re dealing with all this stuff in your head. It’s insanely difficult to backtest with options. So I looked and I found that when I feel emotionally I better take some money off the table. If I actually bought the underlying at that point, I would’ve made more money. Kind of like to your point, so your emotions can betray you and stop you from making more money, not just get you into bad trades. The emotional part can hijack your behavior every step of the way in your preparation to your order tickets, to your morning prep, to the execution, to what I call managing the trade. What do you do when you’re in the trade? To me, I immediately put in a protective stop and then I set alerts as it’s making me money. Sometimes I add more, but then I adjust my stops higher. So I like to keep the position might be bigger, but I like to keep as the saying in baseball is I want to steal second without taking my foot off first base. I try to keep a constant risk. I don’t want 10% of my capital going directionally, that’s not 10% of the premium. That’s the distance between where we are and where my stop is. You know what I’m saying? So it’s a little different, but it’s important. Go ahead.

Sean (40:33):
Oh, sorry. I had the good fortune when I first moved to Colorado a little over 11 years ago to strike up a friendship with someone that you may know. Peter Brandt commodity trade has been around a long time. He was featured in the most recent Market Wizards book that came out from Jack Schwager a couple of years ago. Peter lived here in Colorado. He’s since moved, but we got together a few times and one of the things that I learned from Peter the first time we hung out, which has always stuck with me because he’s been trading now for 50 years or something like that, and he’s done fantastically well. He is made many millions of dollars throughout his career, although you would never know, he is the most humble guy in person you would never know. But one of the things he said to me, Michael, he’s like, Sean, in all my years of trading, getting out of losing trades has never been hard for me.

(41:30):
I always have a plan. I always have a stop in. I take small losses all the damn time. He’s like, the hardest trades in the world for me are the trades that immediately go in my favor because every bone in my body has seen this movie before where the thing rips in my favor and then immediately rolls back over and stops me out. He’s like, so every bone in my body wants to take that profit and get out of that trade because I know it’s going to come back on me. But those trades, and this goes back to what I was saying before, those trades that start ripping immediately, those are always my biggest winners. That’s what my biggest winners look like. So I actually learned that from Peter. I’ve only finally started to implement that thinking into my trading. It only took 10 years after he first told me to finally let that sink in. But yeah, man, it’s the emotions you battle and it’s counterintuitive to somebody who’s new to trading or considering trading and has never traded before. It’s counterintuitive to be like, oh, a winning trade that’s hard and losers are easy. But yeah, the winning trades are the hardest trades to hold and certainly been my experience.

Michael (42:38):
Yeah, I feel the same way. And we teach to that too. You have to have a plan for when it doesn’t work. You have to have a plan. Like the old saying on the street is if the market gives you a gift, you have to take it. And there is partial wisdom in that. But I’ve gotten comments via email and comments on the blog on some of the videos where you could tell the guy has no experience or their armchair quarterback and they’re like, dude, every breakout has a pullback. And I’m like, no, it doesn’t grow some hair on your nuts before you start talking and telling me about trading. Sometimes these things go and they don’t stop. So to just say nine times out of 10, it’s like you need to do your history, you need to do your research and know what the hell you’re talking about. The most expensive trade to a person could be taking a winner too soon.

Sean (43:34):
Absolutely,

Michael (43:35):
Absolutely. Times. Have

Sean (43:36):
You seen that, Michael? We’ve seen that so many times,

Michael (43:39):
More times than I care to. I’ve had my share of gigantic winners. I tend to trade aggressively when things are going very well, but the ones that bother you are the moves that take off that you’re not participating in or the ones that you don’t have enough on and it’s like your trade. So you say, okay, well then how can you learn from that? How can I screen better? What was the catalyst that made this thing move? It wasn’t just a breakout to a new hive. Maybe there was a news event, which is kind of hard to predict. So you look at that, but you’re constantly evolving. You never stop learning. You’re always looking at your behavior and trying to ascertain, am I marrying my beliefs with my behavior? For me, behavior predicts where you end up in life. I don’t care what anyone really knows about a certain commodity or an asset class.

(44:31):
If you have trouble sleeping, trust me, I could tell you everything you need to know about the sugar market or yellow soybeans number two, but that doesn’t help me make money, right? That’s not a trading tactic. That’s a data point. Now, 30 years ago when the internet didn’t exist, if you had that type of information, it would mean something, but the whole encyclopedic knowledge now of any type of thing is always a Google search away. So I tend to look at behavior and what is it that I know how to do that I could execute, that I could kind of quantify or journal, and that might even be certain sensations or feelings that I get or hunches. I actually write that down, okay, where’s the hunch? Where did it come from? Was it a news thing? I’m not really big on tv. Did I notice something in the chart? Did really, really bearish news come out on the name or what people would think would be bearish news, but yet the price didn’t budge and it’s still inched a little higher. All that kind of information tells you a lot about what’s going on in the marketplace. So

Sean (45:32):
I think

Michael (45:33):
It’s

Sean (45:33):
Just listening to yourself and listening to your body. One thing I’ve learned about myself, Michael, over the years is, and I don’t know how it happens, but I’ll have a trade on or a position on or just overall portfolio positioning, and I’ll start noticing as I’m looking at my positions that I’m starting to get a little cold sweat going, and I can’t explain. I’m like, I’m not cold and I haven’t been exercising, but all of a sudden I get this cold sweat, and more often than not, that’s my subconscious telling me, Sean, you need to make a change here. You need to get this position off the books or something. It’s kind of amazing how that happens, and it took me a while to figure that out, but that’s one thing that I get. I mean, what was it? George Soros used to say that if his back started hurting, it was time to get out of a position.

Michael (46:15):
I was just thinking about that. Yeah,

Sean (46:16):
Kind of the same thing.

Michael (46:17):
Yeah, I mean, at first I thought you were talking about that Austin Cuban food that we had in Venice the last time you were in la. Oh, yeah,

Sean (46:24):
We got to go back to that because that was great.

Michael (46:27):
Yeah, name was, I think I actually interviewed, her name was, I want to say Flavia Simsa, who would talk about that. I think she was like George’s coach and Victor. When Victor was working at Quantum Fund with Jim Rogers and George, he would say the same kind of a thing. He would feel his body would get a sensation and his back would start to hurt, and that would like to be an entry point to his system.

Sean (46:58):
Speaking of Jim Rogers, by the way, Michael, shout out to Jim Rogers. I had the very, very good pleasure of getting to meet him in person this past summer. I did a trip to Southeast Asia. Me and my partner Steve Strasse, I went to Singapore and we just kind of cold emailed it. Jim Rogers, he didn’t know me, I didn’t know we’ve never met before. I cold emailed him and told him we were in town. We were interviewing traders for a documentary, and to his credit, he’s like, yeah, sure. Come on over. I’d love to meet you. And we ended up spending two days with Jim, had some coffee, had some great conversation, man, what a gem of a guy.

Michael (47:32):
Oh, a hundred percent. Actually, he used to live near Columbia in that big house in Morningside Heights, so I would see him occasionally in New York City when I was in school, and then later on I would catch up with him for lunch or something, coffee in Santa Monica, talk about the old times, talk about managing risk, and I’ve had some really good interviews with him. I probably should have him back on the show. I noticed one thing in my own behavior that he and I shared was that when we were wrong, we were oftentimes early. So we started talking about, well, how could I better position size? And that conversation actually led me to instead of going risk on risk off, why don’t I trade a smaller piece getting involved maybe one fifth my optimum size so that this way if I’m my accuracy is 40%, it’ll be paper cuts as opposed to something that’s more ego-driven, like a plunging.

(48:31):
I buy 150 New York gold contracts. Maybe you don’t have to buy them all at once. Buy three lots of 50, get a feel for the market, see if it’s going to move in your favor this way. Like you were saying, if the market moves against you, I don’t want to get nailed on my first piece, I mean on my entire or my optimal risk unit. I’ll just take a small paper cut on the first entry. So again, so that’s an emotional development for trading that we’re talking about. Anything you want to say about the movie now that you opened your big mouth, the documentary? When is it going to be out? When can we see it?

Sean (49:13):
We expect at least the first couple episodes to be out by April. I hesitate to make any promises. It’s out of my hands. It’s in the hands of the producers and the editors and the people that make movie magic, but I know we’re getting close. It’s slated to be eight episodes. We went to seven cities throughout Southeast Asia, interviewed all kinds of traders, and we visited some of the exchanges in these countries and it was a wonderful experience and hopefully we’ve got some great content out of it. We’ll see.

Michael (49:49):
Dude, I have no doubt it’s going to be great just who you are. You’re one of the good guys. So I have one question in closing before I also want to thank you. I know you’re not a guy who’s just sitting around watching reruns of baseball games like I do. You are very busy in everything that we’ve spoken about today. Are there any other misconceptions or things that many people misunderstand about options, especially if they’re kind of starting out?

Sean (50:20):
I think the biggest misconception about options is people who have no experience trading options just automatically assume that options are incredibly risky. Now I know where that comes from. I know that people see that you could buy a call option and be wrong and lose 100% of the premium, and that sounds scary, and that makes for a great headline and certainly a good tool to scare people. Yes,

Michael (50:47):
It’s a total loss.

Sean (50:50):
Or you hear about the people who sell naked options, naked calls on something that gaps a hundred percent against them or something like that. Yeah, those things happen, but those things also happen in the equity markets and they also happen in the futures markets, and they certainly happen in crypto. It’s not unique to options, but if people are willing to do the work and just do a little bit of reading or just ask the right questions of the right people, you can find out that options trading actually could be very conservative. We talked about the defined risk. You could define your risk to be however much is comfortable for you, right? Maybe you’re only comfortable risking a hundred dollars per trade, fine in the options market. You can craft trades that give you a possibility of winning, perhaps winning incredibly while still managing your downside and knowing how much you’re going to lose no matter what stock could go to zero. You could still know what your maximum risk is. So yes, I understand why people can think that options can be very risky and certainly if you’re doing it in certain ways it can be, but that’s not a blanket truth, right? Options definitely give you a much better ability to be more conservative. I know that sounds crazy to some people.

Michael (52:13):
Well, I think in the context, I don’t want to put words in your mouth, but I look at the same thing too. People say, you’re a commodity trader. It’s legalized gambling. You’re a risk lover. You love gambling. I was like, no, I really don’t Myself. I’ve played games of skill at casinos, poker games and blackjack and this and that. So when I think about losing your total investment, if I break up my money in 1 25 basis point increments, I have 400 chances to be wrong. So if I put down $2,500 for every million and I lose it, sure it’s a total loss, but I still have 99.75% of my starting capital. So for me, it’s the same thing. I don’t really have a loss. Even if I have 99% of my capital, I would still figuratively say I still have all my money. You know what I mean? Yes, for sure. It’s a loss, but we make and lose our money from our account balance, from our position sizing, and that to me is like where the best traders really have an exceptional understanding of risk and they know how to position size the entries and the exits, they can be super sloppy. Obviously you’re trading a tiny account, slippage and skid probably is more meaningful for you, but once you start making some money, that stuff becomes incidental.

(53:33):
It doesn’t mean anything.

Sean (53:35):
As much as everybody would love to just rid themselves of the scourge of losing trades, the fact of the matter is losing is a course of business. It’s an essential part of what we do. You will lose, and depending on what type of strategy you’re employing, you might lose frequently. I mean, you and I both know traders who are fantastically successful, who have a win rate of 30%, right.

Michael (54:00):
Make a huge living with 30% accuracy.

Sean (54:03):
Absolutely. Absolutely. So losing is a part of the game. We’re not going to get rid of it, but it’s how you lose that separates the winners from the losers.

Michael (54:13):
Well, you’re a winner man. I appreciate you being here and taking the time. We’re coming up on an hour. I definitely want to know more about the movie, when the time, make sure to help you promote it, and then we’ll have you back on the show in a couple months. Talk more about options. Maybe we’ll do a little something or it would be great if we did a live stream, we did a demo or a live stream on something. I’ve been kind of toying with that idea. You certainly would be at the top of the list for doing that thing. Thank you, Sean. I appreciate you being here. I appreciate all your wisdom.