YOLOs are sweet and all, but diversification and position sizing can be a more profitable and consistent way to trade

You’ve heard it all before… blah blah blah… diversification. I’m not going to be talking about diversifying away from tech and into commodities, fuck that. There is a time when commodities will be a good play, times when energy sector is booming, and a time when the financial sector will be rotated back in.

Before I get started, I want to remind you guys that YOLO-ing is fine, but it should be at your “maximum risk tolerance” per play. Any time you YOLO you should expect that play to go to $0. Anything better than 0% return you consider it as a win. The idea of making 200% and turning $10k to $30k sounds so enticing to many new traders/investors. I mean that sounds FKn amazing to me too, but with that mentality you will VERY quickly go from wanting to turn $10k into $50k, to trying to get your $6k back to the break-even, to eventually (and most likely inevitably) saying “Man I wish I still had $10k in my account to do small trades and caterpillar my way back up.” We’ve all been there, we’ve all had sweet wins, and anxiety-inducing losses. It’s cliche, but if you can learn from those losses you will truly improve over time. The best way to grow your account is to inch it up, even 1% per week would be beating most funds.

Everyone has a different trading strategy that will be fine-tuned to their own needs. Bottom line is if you are making plays that require you to watch your phone and see every tick the stock moves up or down, then your position sizing is too big. If you are sweating every time the stock drops 1%, then your position sizing needs adjustment. You should be able to trade/invest comfortably without needing to check the market 25 times per day. If futures opening red gives you anxiety then your position sizing needs to get in check.

Now this is where I talk about diversification. If you only like investing in tech stocks, then got damn who am I to tell you not to? But diversify your portfolio and slowly build positions. Just because you want to YOLO AAPL calls doesn’t mean you also can’t invest in FB, AMZN, MSFT all at the same time. You are all free to do as you please, but what I mean by building your position is to slowly enter each trade with solid entry points that will give you confidence in holding your position for 6 months if you have to.

I used to YOLO and do all that too… When you put 50% of your account into one play that expires in two weeks you are setting yourself up for some anxiety attacks if the position goes against you. I enjoy watching the market just as much as anyone else and can do it all day, but you should have the ability to not check the market every hour if you don’t need to. The performance of the stock market (which is next thing closest to being random) should not have the ability to fuck up your account, mental state, or your relationships with family and friends. Losses are tough regardless of the situation, but I guarantee losses are much more difficult to deal with when deep down you know what you were doing was slightly crazy.

Going back to “diversifying”. Typically I do 60% shares in my account, about 20% theta gang selling spreads, and the other 20% I am either buying calls (2-6 months out) or selling a call AGAINST my share position (as a hedge). If you stick to your game-plan or a set of rules you must obey, which can be something as simple as “only buying stocks when it’s down 1% or more”, you can really start to build strong positions. When you have strong positions and have managed a good amount of entry points for them, then the reward is greater than the risk. Compound this with 6-10 stocks and you will find yourself panic selling much less frequently. If you are heavily invested in 2 stocks and they don’t go your way of course you will panic sell. If you have 6-10 strong positions and 1 goes down, but the other 5 are up, you will have the confidence to hold that losing position until it is eventually profitable or at least back to break-even. How many times have you panic-sold on a red day only for the stock go be big green on the next? How many times did you re-buy on that green day and restart that very same cycle over?

With trading options you really must know how each Greek is going to affect your price in the short-term. Im sure most of you know about options greek’s and such. Sometimes the right play is not to buy a call, but to sell a spread, collect on the stock going up AND collect on IV potentially going down. Here are two examples of plays for AAPL, current stock price $438.66 at the time I am writing this and looking at the option chain (Tuesday night):

  1. Buying the $460 strike September 18 call costs $12.75. At that price, AAPL needs to continue climbing and be over $472.75 at expiration just to get your money back and break-even. I understand you would most likely sell the option if AAPL ran up a couple days in a row, which is reasonable to expect. For this example, lets say AAPL shoots up $480 in a week. Your $12.75 option contract would most likely be worth double. Let’s even say triple for the sake of this example… But remember, anything less than AAPL shooting up right after you buy it will eat into your profits. You would probably say AAPL had an amazing run in one week to get to $480, no? So we can assume anything less than an “amazing run” would have you barely break even. After melting up so much after earnings it wouldn’t be unheard of if the stock just consolidated at $450 for a bit too, no?
  2. A second play to consider is this. Sell a vertical PUT spread first strike OTM 3 weeks away expiration. In this case, we are going to sell the $435/430 PUT spread. Cost for opening 5 credit spreads would net you $1,250 in premium (Max Reward) and have a Max Loss of ($1,300). This is the SAME max loss as purchasing the CALL option from example 1. We are limiting our gains with a spread, but in the previous example we NEEDED the stock to absolutely rocket up in order to make 100% gains. In this example, all we need AAPL to do is stay above $435 in 3 weeks time to collect max premium. Since stonks mostly only go up (* not financial advice), it’s less risky play for a similar reward.

From the above example, option 1 you need AAPL to rocket up to earn your $1275, option 2 you only need AAPL to not go down to receive the same reward. This is why I mix shares/covered calls, spreads, and YOLOs. Different reasons to execute each. Find a trading strategy that works for your style and sanity and create a set of rules. When do you buy? When do you exit at a loss? When do you roll out? When do you take some off the table/profit? Do you play earnings? How long do you intend on holding the position? When do you average down, if at all? You should know all these things before entering any trade. 100% gains on YOLOs are nice, but inching your account up 2-3% per week or even month is actually the greatest gift you can give yourself.

There are definitely different risks to selling spreads such as being assigned the shares and dividend risk, so do your research on that before getting into spreads. Those two things are very easily avoided if you know what you are doing. Know when earnings calls are, know when ex-dividend dates are, keep an eye on your spreads for the short leg going in the money. Personally, my rule of thumb is if the stock has a dividend coming up, roll out the strike prices to further OTM to always keep the short leg out of the money. If there is no dividend and my spread is already ITM, I will hold my position and see if I can get a bounce/reversal to get it out.

Why sell at-the-money spread and not go further out?

A lot of people prefer to sell spreads a bit further out the money, it really depends on preference. In my opinion, selling PUT spreads on fundamentally strong stocks (AAPL, MSFT, AMZN) who don’t stay red very long are good candidates for this strategy. Going further OTM is increasing the max loss if the position does go against you. Another popular play would be to run the wheel by selling PUTs on a stock, getting assigned the shares (at a good price that you would normally purchase at), and then selling calls against the stock until the shares get called away. This strategy requires more margin or a larger account size, but can be profitable. If you run the WHEEL, in my opinion, it is always wise to not actually sell naked puts, but to sell a spread with the long leg very far OTM at the cheapest price, which will cover you in a black swan event such as what happened to Hertz going bankrupt. There was a company/hedge fund called “Option Sellers” that would sell naked call options on a relatively stable commodity, natural gas. One day natural gas m00ned and completely bankrupted his $200m fund. His investors actually owed more money than they invested. Again, his strategy was not very risky until all of a sudden it was. SELLING NAKED OPTIONS CAN BANKRUPT YOU. You can protect yourself for a small percentage of your gains by opening a spread, so do it.

Here is a great Reddit post explaining the wheel method.

*This isn’t investment advice, just a summary on how I execute and order trades. Find a strategy that works for you and keep improving on it.

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