It was late in the middle of the night on August 9th, 2011, the whole Mallory clan had been fast asleep, except for me of course. I was up pacing across the living room of my house. Tired and weary, but unable to get my mind off the markets, and more importantly the risks that I had take over the past month, and what it would ultimately mean for me and my ability to trade the market. I was finally able, at 3:30am, to drag myself to sleep, after finding some relief in the European markets pop into their open. But I would wake up 3 hours later, to reach for my iPhone as I do every morning, only to find the market had reversed course hard and fast. It had the makings of a Lehman's type market reaction, or worse. Rumors were running rampant on French banks. My wife asked me, "What's Wrong?" and I would tell her, "I think I'm literally, watching our world economy crumble from from the palm of my hand." I thought that I might be forced to throw in the towel, for what might be the most humbling and humiliating trading experience of my entire life.
Capitulation was at hand, and there was nothing that I could do about it at this point.
I had read over the years, that most famous traders have always experienced that awful feeling of capitulation, where they blow up account, feel the reality of an unforgiving market, only to come back and become one of history's greatest traders. I also had experienced capitulation before as a college freshman, when I had taken $5k that I inherited as a 11-year old who convinced his dad to teach him how to trade, and subsequently turned that money into $30,000 over the course of his middle and high school years. But when 2001 hit and the dot-com bubble had finally come home to roost, I saw my capital cut in half. To me, I felt like I had experienced capitulation.
But what I ended up experiencing throughout August, would put that theory to test, because I was standing on the brink of ruining my portfolio. The lessons that I had prided myself in trading and communicating to the traders at SharePlanner, about not doubling down, adhering to stop-losses, and having a plan, and trading that plan - position sizing, risk assessment, had fallen on deaf ears with me and my current predicament.
It all started on July 29th, as the market was dropping like a rock over the past five days, and I was essentially unaffected by the market action we were seeing from a portfolio standpoint. The S&P had just five days ago hit 1346, and now it was trading at 1282. There was fear in the markets, no doubt about it, but I relished the opportunities.
I had just started trading options over the course of the past year, and I was doing pretty well with them, in fact extremely well. Up until this past year, I always stuck to trading stocks and ETF's and nothing more. But this year I had decided to venture out into the wild and exciting world of options.
When I saw the market drop to 1282, three weeks from expiration, I decided to pick up some SPY August $136 calls at $0.33/contract, which in total accounted for about 1.7% of my portfolio value. So I put my order in and I got my fill. I wasn't so sure it would see $136 by expiration, but that didn't matter, I was confident that a dead-cat bounce was right around the corner, and I'd be the beneficiary of it as all the bears dashed for the exits in the days to come.
But while the S&P opened up much higher the next trading session on 8/1, the S&P took a pretty hard hit, and even more so did those calls I had just bought the day before. I began having doubts about whether those calls would really play out like I had originally thought. But instead of doing what the 'prudent' thing would have been, and cut my losses in the August SPY calls, I tried to makeup for those losses, recognizing that the August expiration was too aggressive, and thereby choosing to buy the September SPY 136 calls. And as the market dropped that day, I continued to add more and more to my SPY position. First at $0.71, then $0.70, and $0.63, and again at $0.59. I was getting these calls on the cheap and I was thrilled. I had dumped 5% of my portfolio value in those calls, and combined with the August calls I had about 6.7% of my capital committed to these call options.
The market was now closed, the S&P had dropped from 1346 all the way down to 8/1 lows of 1274. The market was unbelievably oversold and I was ready to benefit from the bounce that was due the market.
I had, at this point, risked more on these option plays than I ever had before on a single options play, but hey, I figured, that this was either one incredible buying opportunity, and we'd recover from this quickly, or truly the global economy was going to Hell-in-a-hand-basket, and it wouldn't matter what my cash assets would look like because fiat money as we knew it would have zero confidence backing it, rendering is worth substantially less.
So little did I know, that the choices that I made over the previous two days, would snowball, into a set of decisions that would create for me many sleepless nights and worry beyond anything I had ever experienced.
It's worth noting as well, that I'm not choosing to share this story for the thrill of it, but instead to give you a recent real-life example of how an accomplished trader, and someone, who has made a living out of trading the markets, allowed for discipline to be subverted and the consequences of which quickly spiral out of control.
I'll be making this a 3 to 4 part series over the coming week, as this may be one of the best educational articles I have ever written. I'll be detailing the events, the mental framework, and the decisions that I made in each post as well as the final outcome, so be sure to check in during the afternoon for the latest edition to the saga that I'm documenting for the benefit of you and I both.