Warren Buffet stated that the two most important rules of investing are
- Not to lose money &
- Never to forget rule No 1.
We believe that it is essential to adopt the same mindset in our trading exploits. One must hate losing in this game. Paul Tudor Jones (one of the best short-term traders in the world) has stated that his focus is predominantely on never letting the “market” get into his pockets.
So how do we set up a “no lose”mentality for our short-term trading exploits? Our short-term strategy at present in this market is to trade low-prices socks which are trading with high levels of implied volatility. We then either sell puts or covered calls in these underlyings. Ratio spreads are also an excellent option if one wants to use more capital (hence, less time) in each position but that strategy is for another post. The next obvious quetion is why do we cap our potential gains with these types of strategies. For two reasons.
- Selling covered calls or naked puts enables us reduce our risk
- Secondly and probably more importantly, it gives us the opportunity to defend if the respective position were to go against us
Take Auris Medical Holding Ltd. (EARS) for example. As we can see in the chart below, shares have once more spiked to the upside on strong volume in March. This volume spike has spiked implied volatility to much higher levels than we usually see in this stock. This means “Fear” is elevated in this company at present which means a big move is expected shortly. However, given the price of the company ($4.40) and the liquidity of the options as well as the high level of implied volatility, we believe we are in a very good position here to defend if needs be. If the volume trend is correct though, we should have have to defend here as the chart has a bullish bias. Next week will tell us a lot about the future directions of this stock.