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If we saw this, and we knew that prices had broken a key support level here, going back for a week, week and a half, or even farther – if we saw it break that support level, with the potential for the market to be trading down 300 or 400 points… What would we do?
We don’t know what the price is going to do. We can’t predict price ahead of time. The only thing we can do is manage our risk. Our risk, at this point, if we have a hurricane coming toward us, is to prepare for a hurricane – and then wait and see if it happens. Maybe it will veer off course, and it will completely miss us. We hope it does.
However, we need to prepare ahead of time for that. If we take a look at our Analyze tab here, if we do get hit by a hurricane in our trading position, and we don’t prepare for it… This is not necessarily the case, early in the position. I’m only talking about this type of risk management, going into expiration week. You’re trying to extract every potential piece of profit out of this position.
What we want to do, is we want to take a look at ways at which we can manage our risk. At this case, to the down-side. We also have risks to the upside, but we have plenty of room. Actually, if we moved up 50 cents, or $1. $1 on the IWM – let’s take a look and see if it compares to the Diamonds, here.
Let’s use the Dow, because we have our Dow up here. Let’s take a look at the exact levels that we are at. If we’re at 127.50, what is that on the Dow? That’s 12,750, which is just about where we are, give or take five points.
What happens if we move up to 128.50, which is 12,850 on the Dow? 12,850 is right at the top of this red bar. In order for us to be back in the middle of our position, we would have to have a complete reversal, and the market would have to go up 150 points. Or, at least, 105 points to get back up to the top of this. Even if it went up to 12,900, what does that do to our position? We are looking very good, because now, we are almost at our maximum profit potential here.
We have risk to the upside, but it’s good risk. It’s the kind of risk that we want. We want it to go up. What if it goes down? Let’s say it goes down to 12,600, which is 126 on the Diamonds. Now, we are not doing so well.
Let’s see where that is, 12,600. Do you think it’s possible that the market could trade down to that level? That’s 12,650, right there. Let’s bring it down even more. Let’s bring it down to 12,600. Do you think it’s possible that Monday morning, we could hit that 12,600 level?
It’s very possible. In fact, we could even move it down further. Do you think it would hit 12,500? It is possible. It’s only 245 points from where we are. What happens under this scenario, if we go back to the major support level of 12,300? Do you think that is possible? Yes, it’s very possible. Look at the move on some of these bars here.
This up-day – we had a couple of up days here that were up 500 points. Here is one that is 400. Here’s one that was 300. If we go back even further, we’ll see some down days. The high was 12,580. The low was 12,023. That’s a 240-point move.
We don’t know what’s going to happen, do we? We have no clue. The only thing that we can do is manage our risk. Now, for managing our risk – we’re going to manage it to the upside by keeping our position stable. We have quite a bit of room to move, and we would still make money.
On the downside, we don’t have as much room, do we? We’re already below center. You might be thinking, why didn’t I adjust the position here, by putting on more contracts? Because we’re already so close to expiration. There’s no more premium. Nobody wants to be buying those options in the front month anymore. We’re selling the premium in the Mays. Everybody wants June now. There’s not enough time before expiration.
How do we manage this, then? How do we manage the downside? Our upside is managed by the current position we have. We don’t have to worry so much about that, until we go even 350 or 400 points. Then we’re in a different situation. Then we manage it again.
However, what we’re trying to do is extract as much potential profit out of this position as possible. That’s all we’re doing. In order to do that, what I’ve done, is I’ve taken a position in the QQQs.
This is closed over the weekend, but you can take a look at this. This is $1.10 bid, $1.11 ask. That’s a penny spread, for the at the money option. Those are cheap. That’s a very inexpensive spread there.
I’m not saying the option is cheap, but the spread is cheap. The difference between the bid and ask is very inexpensive. It’s only a penny. Not only that, but they’re incredibly liquid. Let’s take a look at the open interest for a second. 60,000. 45,000. 80,000. 60,000 contracts over here. That’s incredible. That’s incredibly liquid.
In other words, we can buy and sell these at any time we want, as long as the market is open. Now, I want you to take a look at this picture. I’m going to add the position I had on the QQQs. What does that do? Not only does it bring our position right back into the center, we have a huge amount that we can go down and still be profitable.
What did it do for us? Let’s take a look at it without it. That’s what we looked like. We still had a nice profit. The picture is not really too bad. However, like I said, taking a look at the price action – we have more price risk just prior to expiration, than we have other risks. We managed that risk by adding a position that gives us an outstanding downside risk profile.
We can also go up. Actually, we can go up another 300-400 points, and we’re still in very good shape here. There are things that you can do. You have to really think about yourself as a manager of risk.
I don’t know how this is going to open on Monday, because this is Saturday. I’ll do a video of the follow-up part 2 to this, that will show you exactly what happens on Monday, when we open.
Is this going to be a long-term trade? No. The only reason that we took this additional position… Let me take these off for a second, so you can see where we are. We are down here. We want to go back up here. If the market goes up on Monday, we’re going to sell our little insurance policy. All we’re doing with these QQQs is managing the risk we have over the weekend.
Friday, we dropped dramatically here, through a key support level. If it continues to drop, we will make an additional profit here. Actually, this graph does not tell you, but the profits could be significant, just on the QQQ position.
This is only the current date and expiration, but it could actually go up much higher than this. What we’ve done is, because we were very close to expiration, and because we have weekend risk – we don’t know what is going to happen on Monday morning.