After you watch this video, you’re going to discover details on how to hedge an option premium selling portfolio. If you don’t already know, my name is Karl Domm and I’ve been trading stocks and options online since the mid-1990s. I’ve been able to extract an edge from the markets. At this point, I probably sound like all the other instructors on Youtube, but I’m the only stock or options trading instructor that is proven to be consistently profitable by actually sharing my portfolio P&L and my daily portfolio balance on Youtube every month. I’ve been sharing my P&L on my Youtube channel called Real P&L since August of 2019, and I’ve turned $110,000 into $202,000 by only trading options, and I use them to make returns with lower risk.
Why hedge? The main purpose of a hedge is to protect capital in the down market, particularly, in a market that is crashing. When a market is crashing, a few things are going on.
#1: all stocks and commodities become correlated. They all go down together because traders are being margin called, and these margin calls create a strong demand for cash or liquidity. When a trader needs capital to prevent taking a large loss, they sell other assets that are not being margin called. In essence, everybody is looking for the exit at the same time so all assets become affected and lose value. All assets lose value except for one, and I’ll get into that one winner when the market crashes later in the video.
[#2]: During a crash, it’s too late to hedge. You may think you want to go short some stocks or short the market, but how do you know where the bottom is? As soon as you get short, the market could violently turn back up and you could make your original losses even worse. And this is called getting whipsawed. Traders typically sell option premium because they edge to selling options because implied volatility is higher than real volatility about 83% of the time. And volatility is a key variable that can inflate or deflate the price of options. Now, properly mining this edge needs to be better understood in order to prevent your account from being blown up. In a normal downturn, which I would call a grind-down, a premium seller may be just fine. But in a crash, they can get absolutely crushed.
The difference between a grind-down and a crash can be explained like this. Let’s take an $SPX put worth $1. Now when the market grinds-down, that put can go up in value to around $5 to $10. But in a crash, I’ve seen it go as high as $90. Imagine you’re a premium seller and your net short puts in order to collect premium. You’re trading along, kicking ass and taking names. You’re on top of the world. You’re just making a killing like 50% to 100% a year. And you think this stuff is easy money. I call this the 95% trap because 95% of the time, this works like a charm.
What happens to your portfolio when you sold a bunch of out of the money puts to collect premium and the market crashes? Let’s say you sold a 45 DTE 5 Delta $SPX put for $10. You collect $1,000 and you’ve been collecting this $1,000. And when it reaches $500five in value, you take it off and make $500 every couple weeks, and this has gone on for a year now and you’ve made around $1200 with this strategy. Out of nowhere, in one day, the market crashes. What happens to your open positions? Well, the puts you sold are now worth $90,000. you owe $90,000 in your account. You have two choices. You can either add money to the account and continue to carry that risk or close the position, because you don’t have enough money to put into your account. And when you close the position, your accounts blown out. You’ve just lost well over five years worth of trading profits in one day.
The key is to be on the right side of the trade when the market crashes. Remember, the one asset that always rises when all the others fall in a crash. That asset is volatility. And you want to be long volatility. Notice, I did not say you want to get long volatility. I said you want to be long volatility. During a crash, it’s much too late to get long volatility because it’s too expensive and you could easily get whipsawed. Being long volatility already means that you were hedged proactively which is a key to maintaining your capital. The problem is that being long volatility all the time costs a lot of money. It’s like wasting money waiting for a crash.
To preserve capital and not blow out an account in a crash, the key is to be proactively hedged. But at the same time, when the market is not crashing, the options portfolio needs to be making money. In other words, the long volatility cost that will save your account when the crash comes need to be overcome during the non-crash market scenarios. And this is a tough balance to maintain and most cannot do it. The options trade structure needs to be very specific and the trade plan needs to be very specific.
One of the ways you can do a quick check to see if a positive Theta portfolio is at risk is to count how many short puts versus long puts. If a portfolio has more short puts than long puts this could be a sign of high risk when the crash comes, and this is not considering any calls in the portfolio but it’s just a quick test to see if a further look should be done with some urgency. When trading a positive data portfolio, the risk of a crash should always be considered. The goal should be to be positive Theta along with crash protection that does not drag down the portfolio. Nnow, this can be accomplished through a course I developed called The Premier Level 5 Alerts.
And in this alert program, I also teach a trade structure which is long volatility without a drag. And I highly recommend this trading system and I’ll continue to share my P&L and my P&L daily balance to prove that this trade system works. If you have at least $30,000 and you’re interested in this course, the course is called The Premier Level 5 and you can see the link in the description.