types of circumstances, it is important to be able to think outside of thebox  in  order  to  create  a  new  position  or  ﬁx  the  mistake  that  you  made.Let’s review how to ﬁx a trade when mistakes have been made and whererevisions will improve the risk/reward proﬁle. Let’s use an example of along synthetic straddle using Nortel Systems (NT). The price chart of thestock is shown in Figure 11.1.
My original assumption in 2000 was that NT was consolidating to gohigher, so the trade was placed in anticipation of making a proﬁt from theincrease but was hedged just in case things went differently. The originaltrade was composed of going long 1,000 shares of NT at $81.50 and long20 January 85 puts at $11. This long synthetic straddle was pretty close todelta neutral with an overall position delta of +50. The original risk proﬁlefor this position is shown in Figure 11.2.
Unfortunately,  the  market  assumptions  on  NT  were  completelywrong. In addition, some mistakes were made when adjusting this tradethat  turned  this  relatively  good  trade  into  somewhat  of  a  problem—thecause of great frustration.
A  couple  days  after  putting  this  position  on,  NT  began  to  fall  and  itstarted to fall hard. After the third day of the stock falling, it closed aboveits  low  from  the  day  before.  This  seemed  like  a  reversal  and  since  theshares seemed headed to go higher from that point, I reacted by selling offﬁve of my puts and taking some proﬁts. At that point in time, this seemedlike a great idea, because I was booking some proﬁts, increasing the deltaof my position, and setting myself up for the big run-up the shares weregoing to make. Unfortunately, the shares continued to fall and fall and fall!
Nortel Networks
Daily 0. 27.2000
1000 Oct 
Nov 
Dec 
2000Jan 
Feb 
Mar 
Apr 
May 
June 
July 
Aug 
Sep
90
80
70
60
50
40
30
20
40000350003200026000240002000010000800040000
Volcln 1000c/o
82000 Stockpoint.com
FIGURE 11.1 NT Price and Volume Chart (Source: Optionetics © 2004)
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Profit/Loss by Change in NT Common Price
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60,000
54,000
48,000
42,000
36,000
30,000
24,000
18,000
12,000
6,000
0
–6,000
–12,000
–18,000
19.50 
28.50 
37.50 
46.50 
55.50 
64.50 
73.50 
82.50 
91.50 
100.50  109.50 
118.50 
127.50  136.50  145.50
FIGURE 11.2 Original NT Risk Proﬁle
What a terrible decision it was to sell off part of my protection (the puts);but it wasn’t a complete disaster. I was still long 15 puts against the long1,000 shares; however, it would have been much more proﬁtable to haveheld on to the puts that I sold. This left me just about breakeven in a tradethat could have been far more proﬁtable. Figure 11.3 shows the risk pro-ﬁle after selling the ﬁve puts and the shares falling to $60.
After viewing the risk proﬁle in Figure 11.3, I decided that somethinghad to be done with this position. I simply didn’t feel comfortable with therisk proﬁle anymore. The shares would have to continue lower or reallyramp in order for this trade to turn green for me. Even though the optionsdidn’t expire until January, I was still ﬁghting with the issue of time decay.In reality, the shares could remain range-bound for a while. It was time toconsider my alternatives. I could exit the whole trade and continue to re-main  angry  for  making  a  costly  mistake,  or  I  could  think  creatively  andchange the whole proﬁle of my original position. I opted to do the latter.
My longer-term assumptions for this security had not changed. I stillthought  the  shares  would  eventually  go  higher.  Let’s  take  inventory  andsee what we have to work with. We have 1,000 shares of stock and 15 puts.The problem is that if the shares remain in a range from this point, I willlose the time value that I paid for in the options. There are a number of dif-ferent changes that can be made to this position; but I prefer to turn thesynthetic  straddle  into  a  collar.  This  is  accomplished  by  purchasing  500more shares of stock at $60 and selling 15 January 90 calls at $1.50. Theseadjustments  decrease  the  maximum  risk  on  the  entire  trade  and  relieve
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Profit/Loss by Change in NT Common Price
95,000
90,000
72,000
64,000
56,000
48,000
40,000
32,000
24,000
16,000
8,000
0
–8,000
–16,000
13.00 
25.00 
37.00 
49.00 
51.00 
73.00 
95.00 
97.00 
109.00  121.00 
133.00 
145.00 
151.00 
169.00  197.00
FIGURE 11.3 NT Risk Proﬁle after Selling Five Puts
my mind of the time decay problem. Additionally, I still have a nice proﬁtpotential if the shares do head higher. The risk proﬁle of the new position(collar) is shown in Figure 11.4.
The maximum risk on this trade has been reduced to $2,000. The maxi-mum reward is approximately $20,000, which is realized if the shares climbto the mid 90s by January expiration. As you can see, this position begins toreact immediately if the shares begin to climb; and even if I’m wrong again
Profit/Loss by Change in NT Common Price
22,000
20,000
19,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
–2,000
–4,000
13.00 
25.00 
37.00 
49.00 
51.00 
73.00 
95.00 
97.00 
109.00  121.00 
133.00 
145.00 
157.00 
169.00  191.00
FIGURE 11.4 NT Risk Proﬁle of Collar Position
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and the stock heads south, I am limited to a small loss at January expira-tion. If the stock does not move in my favor within the time frame needed,then I can readjust the positions and give myself more time to be right.
The process of adjusting positions is just as much an art as it is a sci-ence.  There  are  usually  many  different  courses  of  action  that  you  cantake. Sometimes you will be right on the ﬁrst try. Other times you will bewrong or maybe your market assumptions change while being in a trade,requiring you to change the proﬁle of the position. The key to successfultrading is to be able to creatively make changes that enable you to obtaina risk proﬁle that makes you feel comfortable.
911 STRATEGIES
Here’s a dose of reality to those who are reading this book! You can havethe  best  trading  system  in  the  world  that  works  90  percent  of  the  time,with low drawdowns and big gains; but if you don’t have an exit plan or anadjustment plan when things don’t go your way, that great system isn’t go-ing to help you at all. Optionetics 911 strategies are designed to teach youvarious techniques that focus on teaching you how to ﬁx losing positions.Seminar  students  frequently  ask,  “Is  there  any  possible  way  to  ﬁx  alosing stock or option trade?” Rest assured that our Optionetics team oftraders has found some viable answers. However, I want to ﬁrst point outa mistake made by many traders—a mistake I used to make myself until Igained some other tools that work in these types of situations.
We’ve all taken directional stock trades in which the particular stockhas gone 5 to10 points against us. Many traders assume that the only wayto ﬁx a losing position is to average up or down, depending on the direc-tional bias of the initial trade. Averaging down is put into practice by pur-chasing more of a stock at a lower price in order to reduce the averagecost  per  share.  Averaging  up  consists  of  selling  more  shares  at  a  higherprice. These types of approaches not only require more capital, but alsoincreases the risk of the trade.
For example, if you were to buy 100 shares of XYZ at $100, the costof the trade would be $10,000. If XYZ stock fell to $90, the trade wouldhave an open position loss of $1,000. Buying 100 more shares of XYZ at$90 would require another $9,000. Although it lowers the breakeven onthe trade to 95, you have doubled your risk if the stock continues to de-cline. This is a very dangerous strategy in some cases, especially whenmarkets are in a free-fall. Many traders have used this strategy only toﬁnd  that  they  regretted  averaging  down  later.  Just  imagine  if  you  haddone this with an Internet stock that was trading at $420 per share andnow trades at $5.
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Some traders may choose to buy an at-the-money (ATM) call on XYZ.This approach ties up less capital, reduces the breakeven to 95, and is lessrisky  than  averaging  down  on  the  stock.  However,  this  solution  still  re-quires additional trading capital for the cost of the option. If XYZ were tostay at 90 or below, the option expires worthless, meaning you lose the ad-ditional money paid to purchase the option. This is a more sophisticatedapproach but also has its perils.
Let’s say you get a hot tip on a stock, and you decide to position your-self for a big gain if the stock moves up. You place the order and wait, andwait, and wait! The stock does nothing. You may think the option is goingto  do  nothing  as  well,  but  unfortunately  the  option  loses  value  whileyou’re just sitting there like a deer in the headlights. The options drop tohalf their original value and you’re stuck wondering why you got into thisposition in the ﬁrst place. But there are ways to repair this position. Learn-ing what they are, and how they are applied is the key to reducing yourlosses and increasing your returns.
Our  Optionetics  team  has  researched  and  discovered  many  ways  toﬁx long and short positions, as well as spread positions on stock, options,and futures. Each Optionetics 911 strategy fulﬁlls three basic criteria thatmake up a good trade by:
1. Reducing the breakeven of the position.2. Tying up no additional capital.3. Allowing the trade to still have proﬁt potential without any additional
risk.
CONCLUSION
When I see people, including my colleagues, who make their living by navi-gating the markets, I feel very fortunate that options play such an integralrole in my trading process. The simple reason is that options are the mostﬂexible ﬁnancial instruments that exist in the markets today. They provideunique  investment  opportunities  and  advantages  to  the  knowledgeabletrader on a regular basis. Yes, the entire options arena can be a very com-plex and confusing place to venture—especially for the novice trader—butthe rewards far outweigh the sacriﬁces of getting there. One of those re-wards  is  that  you  never  have  to  be  stagnant.  There  is  always  somethingthat  you  can  do  to  make  the  risk/reward  characteristics  of  your  trade  ﬁtyour  objectives.  Remember  Legos,  those  building  toys  you  used  to  playwith  as  a  kid?  Well,  options  are  very  similar;  they  let  you  build  to  yourheart’s content.
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As we all know, this market can be one tough cookie to beat. Some-times  the  best  approaches  have  been  nondirectional  in  nature.  Add  thecritical levels we’re currently trading to this difﬁcult environment and youhave a recipe for some serious ﬁreworks, one way or the other. I’m a bigbeliever in protecting proﬁts by making adjustments.
This is where the major dilemma comes in and where the ﬂexibility ofoptions  provides  us  with  many  advantages  over  other  techniques.  Whentaking proﬁts, the major emotion that we have to deal with is greed. Haveyou ever caught yourself thinking, “Well, I’m just going to capture thoselast couple of points I’m entitled to on my bull call spread”? I used to thinkthis way all the time—until that time the stock came crashing down andmy proﬁts faded away in the blink of an eye.
There  are  a  couple  of  ways  to  protect  yourself  from  this  scenario.First, if you’ve already doubled your money in the trade, it may make senseto take half of the position off for a no-risk trade. It may also make sense totake the entire position off and make 100 percent! This is a great situationto be in, but not one in which we always ﬁnd ourselves. For example, posi-tions that are constructed with LEAPS take more time to mature (depend-ing  on  the  type  of  trade).  Therefore,  you  may  not  have  doubled  yourmoney, even though the security has moved big in your direction. Let’s sayyou’re up 15 percent in your trade, but it will be quite some time before theproﬁts really kick in. You don’t want to exit the entire trade because yourproﬁt potential is much higher; but at the same time, you don’t want to giveup the gains you’ve already earned. What can you do?
When I’m in this situation, I adjust the position so that I keep my orig-inal upside and protect my proﬁts on the downside or even make moneyon  the  downside.  One  way  to  achieve  this  is  to  simply  purchase  putsagainst  the  position.  You  want  to  minimize  the  time  value  you  pay  forthese puts, so going in-the-money is a good idea. The number of contractsthat you would purchase is subjective and dependent on the risk proﬁleyou want. The best thing to do is look at a number of different alternativesby checking out what the Optionetics.com Platinum site has to say. Theobjective here is to protect the proﬁts you’ve already made and not takethe upside (or downside) out of your position. If you adjust the trade cor-rectly, you lock in proﬁts, keep upside reward potential, and have the abil-ity  to  make  money  on  the  downside.  Talk  about  a  stress  reliever!Incorporating  these  types  of  adjustment  strategies  into  your  trading  ap-proach is vital to your success as a trader.
The more contracts you have to buy and sell (i.e., 2 × 3, 3 × 5, 5 × 10),the more proﬁtable adjustments you can make. It’s somewhat like being inAtlantic City or at the racetrack. If you are betting on a horse with 2-to-1odds, you know you have a pretty decent chance of winning. If you bet on
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a horse that has 100-to-1 odds, your chances of winning are slim, but thepayoff would be enormous.
Consistent returns on your investments lead to the gradual accumula-tion of wealth. The accounts I trade have increased dramatically over theyears because I take proﬁts on a consistent basis. You, too, will be able toincrease your account size dramatically. Did you ever lose everything youhad in the futures or stock market? I have, more than once. But I perse-vered in the face of what seemed impossible odds and bounced back intoprosperity. It can happen to anybody. With delta neutral trading, you havea much better chance of succeeding. I tell a lot of traders that if they can-not  trade  delta  neutral,  then  it’s  better  not  to  trade  at  all.  I  believe  thattrading without visualizing the risk and subsequently limiting that risk isakin to gambling at a Las Vegas craps table—the house eventually wins.
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CHAPTER 12
Choosingthe RightBroker
Selecting  the  right  broker  and  placing  orders  correctly  are  essential
elements  in  your  development  as  a  successful  trader.  In  the  begin-ning, the entire process may seem quite complex and perhaps morecomplicated than you thought. Don’t waste time worrying about all the dif-ferent issues involved. It all boils down to one intention: You contact yourbroker and explain to him or her what you want to do. That’s it.
However, it is important to realize that each step leaves room for errorto occur. You can’t control all the steps, because once you place your orderthe  rest  of  the  process  is  handled  by  your  brokerage  ﬁrm  and  the  ex-changes. At the same time, however, you can control which broker you’veselected to help you. Remember, a good broker is an asset and a bad bro-ker is a liability. It is vital to take the selection process very seriously be-cause you don’t want your broker to make you broker!
A major mistake many people make when they ﬁrst begin investing isto  listen  to  their  broker’s  advice  without  question.  Why  do  they  do  this?Perhaps because many people have been brainwashed to believe that justbecause a broker has a license, he or she must know how to make prof-itable investment decisions. As in any profession, there are top-notch pro-fessionals as well as others who have missed their calling and should notbe offering their services. The best advice I can give you is to be very se-lective  in  ﬁnding  your  broker.  The  ﬁrst  step  is  to  decide  what  kind  oftrader or investor you want to be.
No  two  investors  are  exactly  alike.  Some  prefer  to  trade  activelywhile  others  simply  want  to  buy  stocks  and  hold  them  for  many  years.
330
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Still others rely heavily on options. Trading and investing attracts all sortsof people, and each person has a unique approach to the market.
What type of investor are you? Answering that question is an impor-tant ﬁrst step when looking for a broker—someone who meets your spe-ciﬁc trading needs. After all, there are more than 200 different brokers tochoose from and each is unique in terms of commissions, choices of in-vestments, research, and so on. There are, however, only a handful of bro-kerage  ﬁrms  that  most  options  traders  choose  to  deal  with  regularly(check the Optionetics.com Broker Review section for a current list).
WHAT IS A BROKER?
A broker is an individual or entity who is licensed to buy and sell market-place  securities  and/or  derivatives  to  traders  and  investors.  In  addition,brokerage ﬁrms must also be licensed and insured to accept customer de-posits. A word of caution: It is a major misconception to believe that justbecause someone is licensed to take an order they have the knowledge toinvest your money wisely. Just like there are bad doctors out there prac-ticing  medicine,  there  are  many  brokers  who  are  not  good  at  making investment decisions.
If you’re reading this book, chances are that you don’t need the helpof a full-service broker, which is a type of broker that receives relativelyhigh  commissions  or  fees  for  offering  investment  advice.  Instead,  mostoptions traders use self-directed brokerage accounts, or brokerage ﬁrmsthat serve as order takers rather than investment advisers. Commissionsand fees will be greater at a full-service broker.
A reliable broker is worth a great deal whether he or she is offeringadvice  or  merely  executing  trades.  Finding  a  broker  who  understands  awide variety of markets and your trading strategies is relatively difﬁcult,but, when possible, the relationship between client and customer can de-velop into a long-term and successful one. Remember, successful tradersdevelop  proﬁtable  trading  strategies  that  require  a  broker  who  can  exe-cute  orders  with  precision.  Brokers  are  the  intermediaries  of  trading.Building  proﬁts  is  the  name  of  the  game.  The  broker  makes  moneywhether you win or lose—the brokerage commissions will always be paid.Many traders choose to trade with discount brokers; this can be prof-itable as long as they are getting good executions on their orders. Brokersget  paid  to  provide  this  service.  They  execute  your  orders  and  protectyour interests. Many investors, especially beginners, try to ﬁnd a brokerwith the lowest commission cost. However, an inexpensive broker can be-come an expensive broker overnight if mistakes are made each time the
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broker  places  your  trade.  It  is  imperative  to  balance  low-cost  commis-sions with prompt service and good execution.
Until  1975,  the  brokerage  business  was  dominated  by  a  relativelysmall  number  of  large  ﬁrms.  But  in  May  of  that  year,  deregulation  loos-ened  the  commission  fee  structures  and  discount  brokerages  began  set-ting up shop. Since then three main kinds of brokers have dominated theplaying ﬁeld: full-service, discount, and deep-discount.
All brokers get paid a commission each time you place a trade. Theamount of this commission depends on what kind of service they provide.Full-service brokers have higher commissions because they spend consid-erable time researching markets in order to advise their clients. Discountbrokers  have  lower  commissions  because  they  simply  act  as  an  agentplacing  the  trader’s  order  as  well  as  facilitating  the  exit.  Deep-discountbrokers primarily trade for investors who trade in large blocks. They offerthe lowest commission rates of the three. In the 1990s, online electronicbrokers burst upon the scene offering the lowest commission costs evervia easy computer access.
THE RISE OF ONLINE BROKERAGES
The way people use the Internet to make investment decisions continuesto evolve. It all started with the appearance of a handful of online discountbrokers in the late 1990s. Now a large number of online brokers are bat-tling for traders’ orders. Full-service ﬁrms, which have seen an increasingnumber  of  clients  gravitate  toward  do-it-yourself  investing  and  onlinetrading, have responded by launching their own web sites and recapturingsome of those lost accounts.
But the way people use the Internet to handle investments goes beyondthe battle of full-service and online brokers. A number of new and innovativeproducts  have  been  launched  and  more  are  expected  in  the  near  future.Some products are designed to help investors make better asset allocationdecisions and others are designed merely to simplify the investment process.Regardless of the speciﬁc purpose, the new Web-based ﬁnancial services areall designed to proﬁt from the increasing use of technology by the individualinvestor. The result has been a proliferation of new online products and anevolution in the way the Internet is used for investment decisions.
Online  brokerages  provide  a  number  of  advantages  over  traditionalfull-service  and  discount  brokerages.  First  and  foremost,  online  broker-ages have severely reduced their commission costs from the lofty levels setby traditional brokers. All brokers get paid a commission fee each time youplace an order (or exit an option position). The amount of this commission
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depends on what kind of service they provide. Each transaction is called around turn and costs as little as $10 (and the cost is getting lower) at anonline brokerage and more than $100 at a full-service brokerage.
Although  generally  much  lower  than  their  predecessors,  online  bro-kerage commissions and margin amounts vary. But don’t waste too muchtime fretting over a couple of dollars of commission when evaluating on-line brokers. Small difference in prices due to poor trade executions cancost you a great deal more, and an inexpensive broker can become an ex-pensive  broker  overnight  if  they  lose  money  each  time  they  place  yourtrade. Broker responsibilities may differ, but timely executions and goodﬁlls are still the most important part of a broker’s services. Bottom line: Itmay be desirable to match low cost with prompt service and good execu-tion; but it is not always proﬁtable to use the cheapest broker just to savea few bucks on commissions.
Another major improvement comes in the form of information. Onlinebrokerages  offer  real-time  quotes,  charts,  news,  and  analysis  as  well  asthe  ability  to  customize  this  information  to  ﬁt  your  portfolio.  Now  youhave the means to research stock tips immediately, read up-to-the-minutenews as it happens, monitor the mood of markets throughout the day, andaccess  option  premiums  for  price  ﬂuctuations.  The  marketplace  is  aliveand you’re right there with it. You no longer have to sit on hold waiting foryour broker to tell you he’ll get back to you on that.
Given the Internet revolution that has permeated almost every aspectof our lives, it is likely that you will consider using an online broker. To helpyou make the most of this decision, pay attention to the following points:
• Trade  online,  but  have  a  broker  on  standby. Some  investors  wantthe convenience of being able to make some trades online, but alsohave a speciﬁc broker to bounce ideas off. Full-service ﬁrms have an-swered their call. Responding to the increasing popularity of onlinetrading and its low commissions, many of Wall Street’s big names arerolling out services that let investors trade online for discount com-missions or a ﬂat fee, but at the same time offer the services of a livebroker for higher commissions. Similarly, many online ﬁrms provideclients with the ability to trade over the Internet or with a broker foran additional fee.
• Online  brokers  are  also  recognizing  the  importance  of  having  anonline  and  traditional  brick  and  mortar  presence. Some ﬁrms likeE*Trade  and  Charles  Schwab  have  developed  online  trading  plat-forms and physical locations that investors can visit and do business.If you’re the type of person who likes to go into the bank rather thanuse  the  ATM,  you  might  want  to  check  in  the  yellow  pages  to  seewhich brokers have branches in your area.
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• Options  specialists. Some  brokerage  ﬁrms  like  Thinkorswim,  WallStreet*E, and OptionsXpress specialize in dealing with options traders.These ﬁrms provide sophisticated trading platforms with the ability toexecute almost any conceivable options strategy on- or off-line.
• Screen  for  trades. Are  you  looking  for  a  site  that  will  help  you  ﬁ