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An Options Trader's Philosophy, Part 2


It's more than just mechanics.

It's your money. Protect It.

This topic is one I take very seriously, and I admit that I have difficulty convincing people of the truth of the following statement: When you own a position, unless there is something very unusual about the current option prices (that will be resolved shortly), the current value of the position represents your current stake. In other words, the price at which you could exit the trade right now (even if you don't want to exit), represents your money.

If you have a profit, that profit is yours. It does not belong to "the house." If the investment turns against you, and your $1,000 profit becomes a $600 profit, you lost $400.

I can hear the disbelief now: "How can I have lost $400 when I earned a $600 profit?"

Here's how I look at this situation, and I hope to convince you to look at it: You have a position or a bunch of positions. Every time you sit in front of your computer (or telephone or blackberry) and look at the position, if the market is open, you have a choice. You can hold the position, you can add to the trade, or you can exit and accept the current price -- regardless of whether it represents a profit or loss. If the market is closed, you can submit an order (to be executed when the market next opens), in an attempt to take any one of those actions (holding requires no such order).

Holding is a decision. It's a decision not to act. Because you can exit the trade at its current price, that price represents the value of your trade. This is marking to the market. No other accounting method makes sense; that's why I believe so many banks are insolvent -- a few accountants excused them from being forced to mark to the market. That's the way your broker values your account when it provides the current net liquidation value. It's also the value they use when determining whether to issue a margin call. Telling the broker that the position is worth more and asking that a margin call be postponed will have no effect.

When you make the investment decision not to close the trade, as will happen almost every time you look at your portfolio, that's equivalent to closing the old position and re-opening it at the same prices -- commission free. in other words, it's a decision to own the position at the current price. Thus, if your position declines in value from this point, you lose money. Your money.

If you earn profits from this point, you make money. And that's true even when a larger loss becomes a smaller loss.
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