Wednesday, March 15, 2006

Married To Money

Anyone experienced in premium short selling is familiar with the curse of "marrying money". And, if you're not, here is the story:

At the risk of sounding trivial, when an option is sold short, the proceeds are applied to the seller's account. Now, assuming the seller's strategy is to collect the proceeds (via the option expiring worthless), a normal, human tendency is to treat these proceeds as unrealized profits.

Of course that's wrong, but consider the context:
  • You're selling "worthless" options and you watch your account increase in equity from $20,000 to $22,000.
  • This selling has impacted your margin and you have much fewer bullets to fire.
  • You now can only sit and wait for the expiration bell to ring. Besides selling some (increasinly smaller portions of) additional premium before the time runs out, that's the only way you'll make money.
The time is ticking and the clock is grinding away at options prices. The closer to expiration the less opportunity you have to make trades to increase your equity. And as the time squeeze curves your portfolio's theta into an exponential drop you realize that what you see is the most you're going to get as far as account equity is concerned.

And this is when you experience the moment of fear. That's when you start to pray that your option deltas don't increase and put your positions in the money and wipe you "profits" out.

You become married to money.

The funny thing is that being married to money is at least just as bad as being married to a position. Actually it's much worse. A position that you're married to is already losing you money and you are experiencing pain. Pain is good because you have a threshold and once it's reached you are going to act.

However, the money you married is there in your account. It isn't painful to have it. But it is scary to lose it. And therein lies the problem: fear is the mindkiller. You do nothing when things go wrong. You do nothing because you are afraid.

I prefer pain to fear. The former gets you to act. The latter gets you killed.

Cheers,
/Dmitry

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