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5 REASONS TRADES GO

WRONG …and how to fix them.

Written By: Jeffry Dunyon, CEO Safe Option Strategies

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Forward: “Why are my trades going wrong?” Have you ever asked yourself this question? Maybe you have

asked it to your broker or money manager. Maybe you have asked it to your spouse who handles all

the investing. I have traded stocks and options for over two decades. I also have taught complex

option strategies to hundreds of investors in the United States and around the world. This question,

“why are my trades going wrong”, may be the one I have heard more than any other from my students

and potential students. It is often accompanied by, “and how do I fix it?” In fact, the “how do I fix it”

part of the question is what ultimately led you to this publication. The same question has probably led

you to look at online education in some form or other, and has maybe even led to you purchasing

someone’s education program.

In an attempt to help identify what might be causing the struggles with the individual I am talking to at

the time, I found that I was always starting the conversation with the same five questions. In most of

these conversations, we would never make it past the first question. If we did, it would often be the

second or third question that would end the conversation. In the rare case that we got to the last

question, the result was often the same answer…. It was just not a good trade to be in.

Based on these many conversations, and with a sound understanding of what makes up a good trade, I

decided to define the answers to these five questions by tying them into the 5 Reasons Trades Go

Wrong. I did it this way because not every person will ask the questions in exactly the same way, but

however they word the questions, they ultimately lead to the 5 reasons.

It is also important as you read this to know that I completely understand that no two investors are

alike; that trading styles and methodologies vary greatly; that risk tolerance is high for some people

and extremely low for others; that short term and long term financial goals are rarely alike for any two

people. If your trading style is significantly different from mine, and therefor different from what I

teach students at Safe Option Strategies, you can still take valuable information from this. You may be

persuaded to try a different method of trading, or you may simply apply these principles to your

current style. Regardless of style or methodology, I believe that these reasons trades go wrong must

be addressed for any investor/trader, before they can begin to fix what is plaguing them, and become

as profitable as the markets will allow.

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It is also important to note that there are no perfect answers to all of the questions that plague us

when it comes to trading the US markets. No technical indicators or chart patterns are perfect in

predicting the direction a stock may move. No amount of fundamental soundness guarantees the

price of a company’s stock will rise. Bad news is not always perceived as a reason to sell, and good

news is not always seen as a reason to buy. Stocks go up and stocks go down. It is a fact of life as sure

as knowing that being born will lead to your eventual death. In the market, we act on the very best

information we have, and do so knowing that whatever we do is based on an educated guess.

Any time you put together a trade you have to ask yourself five hard questions, because how you

answer these questions will lead directly to whether or not you fall victim to one of the 5 reasons the

trades go wrong. The questions are:

1) Did I do my homework on this trade? 2) Did I define an exit strategy?

3) Can I adjust the trade if I’m wrong? 4) Can I live with the worst case scenario?

5) Is it a good trade?

This may seem an oversimplification, but these questions you must ask lead directly to the reasons the

trade goes wrong and loses money for you:

1) You did not do your homework. 2) You did not define, and stick to, an exit

strategy.

3) You do not know how to adjust trades. 4) You set up a trade with too much risk.

5) You placed a bad trade.

As we explore each of these reasons in detail, and come up with the all-important “fix” to them,

consider the trades you have on now, or have placed in the past, and how these things would have, or

could now change them. Consider that using a trading methodology different from what you are

currently doing now could show you different, and perhaps, better results than what you have been

getting in the past. Consider that if you can successfully address these five things, you could sleep

better at night, knowing that you are not subjecting yourself to as much risk in the markets.

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Contents 5 Reasons Trades Go Wrong

Forward: .....................................................................................................................................................................2

Reason 1: You did not do your homework. ................................................................................................................5

Know the companies you trade: .........................................................................................................................6

Know their competitors: .....................................................................................................................................8

Know their history: .............................................................................................................................................9

Know what is happening right now: ................................................................................................................ 12

Reason 2: You did not define an exit strategy. ........................................................................................................ 14

Setting up your exit strategy. .......................................................................................................................... 15

Reason 3: You do not know how to adjust trades................................................................................................... 22

Why Adjustments are So Important. ............................................................................................................... 24

What Exactly is an Adjustment? ...................................................................................................................... 26

Reason 4: You set up a trade with too much risk. ................................................................................................... 31

What can you afford to lose? .......................................................................................................................... 31

The most common mistake on calculating losses. .......................................................................................... 32

Risk vs Reward ................................................................................................................................................. 33

Trade with Little or No Risk. ............................................................................................................................ 35

Reason 5: You were not willing to walk away from a bad trade. ............................................................................ 38

A Little Bit About Safe Option Strategies ................................................................................................................ 42

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Fortunes are won and lost every day and every year in the US Equities Markets. Brokers make money

for their clients and they lose money for their clients. Individuals, often disgruntled with their broker

or money advisor, take over their own portfolios and manage thousands to millions of dollars within

cash accounts or self-directed IRA’s. Online trading has made buying and selling stocks and options as

easy as checking the balance of your bank or credit card balances.

Online education and live seminars abound with techniques and methodologies for trading stocks,

options, futures, foreign currencies, and commodities. The notion that it takes years of college,

specializing in economics or finance, to manage large sums of money has mostly faded. Brokers and

registered investment advisors are fighting to keep clients, not from one another, but from branching

out on their own.

There is a great feeling of satisfaction and joy when a well-placed trade makes a profit. There can be

feelings ranging from anger, to depression, to outright despair when a trade causes a loss of significant

amounts of money.

No one has been in the markets for long without experiencing the losses. The difference between the

winners and losers in the market can be as simple as one in ten trades that wipe out the profits of the

other nine. In order to be on the side of the winners, it is important to know why the losing trades go

wrong and what can be done to prevent, or at least lessen, the impact of the bad trades. The reality of

trading stocks and options is that some trades are going to lose money. Losing money on an occasional

trade does not however, have to ruin your overall results. If losing trades can be managed, and in

some cases reversed, the profits that can be enjoyed are vast.

With this premise, we dive in to the 5 reasons trades go wrong, and more importantly, how to fix, or

keep these things from happening.

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Reason 1: You did not do your homework.

This question speaks specifically to fundamental, technical, and sentiment analysis. Too many

people trade without being as thorough as they need to be in their analysis of the company

they are trading. They take a cursory glance at a chart, remember that they are trading a

company that makes a lot of money or is a common household name and WHAM….they’re in

the trade. What could they possibly have missed?

a. Often times they forget to look up when the next earnings report is.

b. They forget or simply do not care to read current news and events surrounding that

company. They see a bullish or bearish trend forming but do not look farther back on a

chart to see what past trends could teach about how the stock price moves around

certain seasons or events.

c. They do not know how or they do not bother to look at put/call ratios – short, medium,

and long term – as a means of gauging investor sentiment.

In short, they just do not do enough homework before they enter the trade and then scratch

their heads and wonder why, when things do not work out. Our suggestion is to:

Know the companies you trade

Know their competitors

Know their history and

Know what’s happening right now- today- that could affect the companies

Let us look at these items one at a time and make sure we are understanding what needs

to be considered:

Know the companies you trade:

There is a lot more to knowing a company than just know the product or service they

provide. A great example of this is The Boeing Company (BA). Most people think Boeing,

and they automatically think Jet Airplanes. While that is certainly true, it barely scratches

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the surface of what The Boeing Company does. From the website finance.yahoo.com, this

is what The Boeing Company describes itself as doing:

The Boeing Company, together with its subsidiaries, designs, develops,

manufactures, sells, services, and supports commercial jetliners, military aircraft,

satellites, missile defense, human space flight, and launch systems and services

worldwide. The company operates in five segments: Commercial Airplanes, Boeing

Military Aircraft, Network & Space Systems, Global Services & Support, and Boeing

Capital. The Commercial Airplanes segment develops, produces, and markets

commercial jet aircraft for various passenger and cargo requirements, as well as

provides related support services to the commercial airline industry. This segment

also provides aviation services support, aircraft modifications, spares, training,

maintenance documents, and technical advice to commercial and government

customers. The Boeing Military Aircraft segment is involved in the research,

development, production, and modification of manned and unmanned military

aircraft and weapons systems for the global strike and vertical lift, mobility,

surveillance, and engagement. The Network & Space Systems segment is engaged

in the research, development, production, and modification of electronics and

information solutions; strategic missile and defense systems; space and intelligence

systems; and space exploration products. The Global Services and Support

segment offers a range of products and services comprising integrated logistics,

including supply chain management and engineering support; maintenance,

modification, and upgrades for aircraft; and training systems and government

services, such as pilot and maintenance training. The Boeing Capital segment

facilitates, arranges, structures, and provides financing solutions, such as equipment

under operating leases, finance leases, notes and other receivables, assets held for

sale or re-lease, and investments for its commercial airplanes customers. The

Boeing Company was founded in 1916 and is based in Chicago, Illinois.

That is impressive to say the least. It also demonstrates that The Boeing Company does a

lot more than commercial jet airplanes. It also tells us that there is much more that could

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affect the price of the company’s stock than just what a competitor like Airbus does with

their next announcement. What if BA loses a big government contract for military aircraft

or missile defense to Airbus or Northrup Grumman? What happens if NASA loses

government funding and has to cut back on the number of private contract employees it

uses? If you thought all Boeing did was produce commercial aircraft, the dismal release of

the 787 Dreamliner would have put the company under instead of just causing the stock

price to mildly suffer for a short period of time. There is often more to a company, and I

would suggest much more, than what the average investor takes time to know about.

Know their competitors:

Now that you know more about what The Boeing Company does, who would their

competitors be? And, why would that be important? What market share are they fighting

for, and with whom? Do you know what happens to the price of their stock when one of

their competitors does something good, or what happens to their stock price when their

competitor does something bad? You should.

Let’s answer the second question first. In a highly competitive global economy, good or bad

news from a competitor could spell good or bad news for the company you are trading. If

Airbus announces it has perfected a lithium ion battery that doesn’t overheat, and can

operate for longer periods of time, while at the same time BA is having test flights of its 787

catch fire due to overheating lithium ion batteries, wouldn’t it be logical that BA could see a

deeper hit to their stock price.

Maybe a better, or at least more widely known, example would be Apple, Inc. (AAPL) and

Samsung Electronics Co. Ltd. (SSNFL). Apple news affects Samsung and Samsung news

affects Apple. Due to the rivalry of their respective leading cell phone handsets, the two

companies are inseparable, like it or not. In a recent search of news headlines, the

following information came up:

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Want to take a guess as to which of the two companies the search was done on? Does it

matter? It illustrates our point. The news of one company can affect the stock price of the

other and vice versa.

Know their history:

What does a company’s history really tell us about the company? After all, don’t we

overuse the cliché “past performance is never a guarantee of future performance.”? We

are going to dispel a myth in the markets right here and right now. History is a very good

indicator of how a stock could perform in the future; it is just not a guarantee.

It is crucial to differentiate between indicator, and guarantee. History is always one of the

best indicators we have on what could happen in the future. It is never a guarantee. It is an

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indicator, because, (are you ready for this?), there is ample history to show that history

repeats itself.

Let’s look at a different stock to illustrate this. The following is a three-year stock chart of

Caterpillar, Inc. (CAT). As you look at this chart, notice that at the bottom we have circled

the largest volume spikes in the day to day trading of the stock. Notice also that the volume

spikes we are circling are very evenly spaced apart. That is because each of those volume

spikes takes place on the day following an earnings report for Caterpillar, Inc.

If you look closer at this chart, something else might manifest itself to you as well: More often

than not the directions changes in the stock price come after those same earnings reports that

cause the volume spikes.

Consider another chart that shows us how history has the tendency to repeat. Below is a stock

chart of Apple, Inc. from December 2004 to July 2007. Circled on the chart are the respective

runs up in the price of the stock in January of each of the years represented. In each case, AAPL

saw a big move up just before their Mac World conference they held each year (they have since

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stopped holding this conference). As you can see, history repeated itself as the investment

community drove the price of the stock up in anticipation of a new product or service. In early

2007, if an investor had used history as part of their equation in determining a good play on

AAPL, they would have done great in early January 2007 with any strong bullish play on the

stock.

There are literally thousands of examples that could be added to drive this point home. And it

must be emphasized yet again that history does not guarantee anything. But, since we have

already established that any trade we place is based on an educated guess, wouldn’t it only

make sense to use history as part of that educated guess?

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Know what is happening right now:

What is the current political climate like right now? Is there a heated presidential election

going on? How about other world events? Is Russia invading Crimea? Is Italy or Greece

filing bankruptcy? More important than any of these questions would be this one: “Is there

anything going on right now in the world that could have a significant impact on the

markets, and more specifically, on the stocks I am trading?”

Take a glance at some recent news headlines: If you were trading Toyota (TM) or Amazon

(AMZN) would it not make sense to at least be aware of what is going on in the news and

how it could affect the price of your stock? On the day of these headlines, Toyota Motors

was trading down, and Amazon was trading up. Did the news of the day affect the price of

the stock? Could the most recent news possibly affect the long-term price of the stock?

Why would you trade any kind of position on these companies without paying attention to

the news surrounding them? Since we have already established that any trade is based on

an educated guess of what we hope the stock price will do, than it would be logical to have

as much education as what is readily available. In this modern, instant information age, all

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we need to know is right at our fingertips. Trading with less emotion and with more logic is

simply a better, smarter, and more effective way. It begins with doing your

homework….before you open a trade!

DO YOUR HOMEWORK!

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Reason 2: You did not define an exit strategy.

This has to be said in very simple English here, so there is no possibility of

misunderstanding: If you are not defining and following a very specific exit

strategy you are being greedy and will lose money in the markets.

Have you ever watched a trade you are in make money and then wish you had gotten out? Do

you wish you had booked the profit before the stock price turns and the potential profit is

gone? If you are reading this, the odds are that you have experienced this, and probably more

than once.

Early in my trading, I was up 90% on a bull call spread on AAPL. Every time the stock price went

up another day, I got greedy and stayed in. When the stock price started to drop, I was sure it

would be a short-lived pull back and would eventually rise. I watched and watched as the stock

price dropped day after day. By the time I actually got out of the trade I had made a scant 10%

over 2 months. I had a loosely defined exit strategy (I wanted to get 100% net return), but did

not have a time frame on it, and was not really willing to stick with it. I had several thousand

dollars in this trade, and at this time, doubling that would have been fantastic for my portfolio.

A 50%, or a 30% gain have would have done that for me as well, but I was not satisfied with

that. I wanted more. I was greedy, and it cost me!

While a lot of potential profit was lost due to my greed and lack of discipline, I did learn some

things that have made me a lot of money since:

1. Greedy traders seldom do well in the end.

2. Defined exits - that are strictly adhered to - will serve you well repeatedly.

3. Well-defined exits are realistic exits.

Setting up realistic exit strategies is the easier part of the process. Disciplining yourself to

follow your exit strategies can be somewhat more difficult. Let’s deal with setting them up

first.

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Setting up your exit strategy.

To successfully set up the right kind of exit strategies there are several things you need to

understand: 1) the rule of 72; 2) the concept of reverse engineering; 3) realistic expectations.

The Rule of 72

The rule of 72 is a way to figure out how long it will take to double your money, if compounding it

monthly. Investopedia.com describes it this way:

Definition of 'Rule of 72'

A rule stating that in order to find the number of years required to double your money at a given

interest rate, you divide the compound return into 72. The result is the approximate number of

years that it will take for your investment to double. (Investopedia, n.d.)

Another way to understand it is by stating that an annual return of 72% (if compounded

monthly) would double your money in one year. A return of 36% annually would double your

money in two years; 18% would double your money in 3 years and so on. To further illustrate

it, we put together a simple Excel spreadsheet:

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In this illustration, we put in an annual interest rate of 72% (row 3, column D) and divided it by

12 months giving us 6% monthly return (row 4, column D). Row 8 shows our starting balance in

January of $10,000 (column D) and the growth of $10,000 at 6% for $600 return (column E).

Our starting balance for February (row 9) shows the $600 return, added to the $10,000 starting

balance for a February starting balance of $10,600. We then repeated this process through

each month of the year. As you can see, we had a starting balance one year later in January of

just over double what we started with the January before (row 20, column D). There you have

it. Doubling our starting balance in one year with 72% annual return. To further illustrate (but

without all the explanation) here is what 36% annual return looks like:

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In this case, we grew the portfolio by almost 50% in 12 months with only a 36% annual return

(because of compounding the interest). Look at one more example of the same return rate

over the two full years, which the rule says will double our money:

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In January of the second year, while we were a little short of 50%, because of the continued

compounding, we were just over 100% return by the start of January of the third year. You will

apply this concept as you set up your goal for your portfolio, but through reverse engineering,

you will also use it to define your exit strategies.

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Reverse Engineering

Have you ever heard of reverse engineering? For our purposes, it means working backward

from your end goal, to set up each individual trade, or more specifically, your exit strategy for

each trade.

Suppose you have a portfolio which you would like to grow 36% annually (if you want to start

one step farther back, you would ask yourself how much money you need to retire on, and at

what age you want to retire, and then determine how much you need to grow your portfolio

annually in order to reach that goal). According to the rule of 72 this would double your

portfolio in two years. If you reverse engineer this, you could say that you want to get 3% each

month (36% divided by 12 months). You would then calculate how long each trade is open and

how much of your portfolio the trade is going to represent. This would give you an idea, if not

an exact dollar amount the trade needs to make. Then you would be able to determine how

realistic it is for the trade to make that amount of money, and in what time, and thereby set up

an exit strategy.

Here is a step by step way to reverse engineer the target return you need for your average

trade, and therefore a great way to establish your exit strategy (for easy math, we will use a

$25,000 portfolio):

1. Determine the timeframe in which you want to double your portfolio (2 years)

2. Apply the rule of 72 – 72% divided by 2 years = 36% divided by 12 months = 3%

per month return.

3. Multiply your starting balance by your desired monthly return ($25,000 X 3% =

$750) and this is the sum total you need your trading to produce each month.

4. Now divide your needed monthly return ($750) by the number of open trade

you are comfortable managing in a month (this could be a number of trades

running simultaneously, or one trade a week for 4 weeks in a row, or some

combination). If you chose 5 trades, for example, each one of your trades only

needs to make $150 profit. Now you can structure a trade that has as realistic

chance of gaining $150 in profit.

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5. Knowing you need only gain $150 in profit for each trade you manage,

calculate a risk to reward ratio you are comfortable with (we strongly

recommend a risk it reward number of at least 2:1) and make certain that the

$150, or whatever the number you came up with, is no more than half the max

profit in the trade.

This perfectly segues into our last part of setting up exit strategies: being realistic.

Realistic Expectations

I started this chapter with a true story about a trade I blew on greed. Remember the trade I

was up 90% on, and then watched all my profit melt away because I had such an unrealistic

expectation? I really let greed get a hold of me. However, I also blew it by not having a well-

defined and realistic exit strategy. It taught me a lesson for sure, but it still bothers me when I

think about it. It bothers me because while I have always been ambitious, and have always had

a desire to succeed, I never thought of myself as greedy. It also bothers me because, more than

the money I felt like I lost, I just felt plain foolish. And this after I had already been in the

market of over 10 years. I should have known better.

It happens to us all. We get greedy. We fly too close to the sun, and often times we get

burned. Greed is one of the biggest killers of consistent profits in the markets.

Greed is controlled by setting realistic expectations, and those expectations can vary greatly

from one type of trade to another. For example, if you had a spread trade like a bull call

spread, with a maximum possible profit of 80% return, a realistic expectation would be 30-35%

ROI. If you owned stock and knew how to collar trade it over time, 100% return in a year may

not be an unrealistic expectation.

The subject of what is realistic and what is not, in terms of setting up target exits, can be very

difficult because so many people have different risk tolerance. Having a higher risk tolerance in

your trading does not however mean you should not define and stick to exit strategies. Over

time, you may adjust your risk tolerance and find yourself setting more conservative target

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profit levels. But, whatever your personal risk tolerance is, you have to get in the habit of

setting attainable target exit points, and sticking with them.

Safe Option Strategies puts out a weekly subscription newsletter. Follow it and see us

repeatedly set conservative exits and then often exit early when we have gained half or more of

the original targeted profit. This is because more than anything, we have learned that the only

way to control greed is to define a reachable target ROI (primary exit) and then stick to it OR be

more conservative and get out early.

Never enter a trade without knowing exactly how and when you will exit.

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Reason 3: You do not know how to adjust trades.

No matter how good our due diligence (homework) may be; no matter how good we are at

reading technical indicators; and no matter how good we are at deciphering current events

locally and around the world as they may pertain to the stocks we choose to trade around; we

have already established that when we decide to place a trade, we are doing so on our best,

most educated guess, and at the end of the day - it is still a guess. This means, among other

things, that we could be wrong just as easily as we could be right. In fact, when we pick the

price direction we believe a stock might move, we actually have a much greater chance of being

wrong than right if you think in terms of everything the stock price might do. Have you ever

heard someone say that stock prices can move one of three ways, up, down, or sideways?

While this statement is certainly not untrue, it only tells part of the story. Stock prices can

move up very fast, or they can move up very slowly. They can drop like a rock, or they can

meander their way down a little at a time.

FIGURE 1 THIS C HART ON FSLR SHOWS NOT JUST A BEARISH MOVE, BUT A VERY STRONG BEARISH MOVE.

They can move in a somewhat stagnant or flat trend over a period of time, but have many ups

and downs within that range, which are not insignificant. This can be much more difficult to

trade with accuracy than a straight bearish trend.

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FIGURE 2 THIS CHART ON CAT SHOWS A VERY STAGNANT TREND FOR NEARLY 9 MONTHS.

The point here is that stock prices are at best unpredictable, and at worse downright difficult to

predict.

It would be appropriate to move forward from the premise that you do not know what a trade

adjustment is (whether you do or do not know about trade adjustments, keep reading. This

could well be what changes forever the way your trade. And do so for the better.). In order to

explain what a trade adjustment is, you must first understand a little about the way we teach

people to trade at Safe Option Strategies, because adjusting trades can be very specific to

certain methodologies. Put simply, we spread trade. We use options to create trades which

are hedged, and which can be adjusted.

If you are new to the idea of spread trading, or even new to using options in any part of your

trading, do not let that stop you from reading to the end of this report. You need the

information contained in the last two chapters no matter your style of trading. You can learn

more about options and spread trading, and more specifically about trade adjustments at

www.safeoptionstrategies.com . There is free class we teach online several times each week to

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introduce this concept. We also sell an education package that teaches from a very beginning

level, all the way to advanced strategies and adjustments.

Why Adjustments are So Important.

How many times have you had four or five, or maybe even as many as a dozen trades go your way, and

then one bad trade not only took away your profit, but cost you some of the starting principal you went

in to those dozen trades with? If you have experienced it once, or if it happens to you repeatedly, you

know too well the pain and frustration it can cause. The following illustration is taken from the free

class we reference in the paragraph above:

It is a simplified representation of how one bad trade can cost you profit, and part of your principal. The

illustration depicts four consecutive trades following a bullish trend on a stock (as stated previously, Safe

Option Strategies teaches spread trading, so these are representative of bullish spread trades). The first

three trades do very well, and the profit from each of these trades is added to the amount of money

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invested in the next trade. After only three trades, the beginning balance is up nearly 75%. Following

our desire to compound our returns into greater profits, we invest the profit and principal into the

fourth trade, and that is when the wheels come off the wagon. Through no fault of ours (because we

did our homework and made an educated guess that the stock price would continue to move up) the

stock price moves bearish. At this time, maybe we kept hoping it would go back up, or because we were

using options and the loss was so sudden we didn’t have time to react. Worse yet, we had a stop loss in

place and it was blown through, leaving us with a 50% loss. It does not really matter why, because the

end result is that we gave up a very nice profit, and were even down 13% from our starting principal.

In the years I have taught option spread trading and adjusting trades, this is without a doubt the most

common story I have heard from the traders who are researching my company. It happens to most

people in the markets, and for most of them, it is repeated again, and again, and again!

Now contrast this last scenario with this next illustration, also taken from our free class, which shows

the difference in results by one having the ability to adjust a trade:

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The same four trades are placed with some minor differences. The trades themselves may be

slightly more conservative in order to give us the ability to make an adjustment. In this

scenario, the beginning balance is only up 59% instead of 75%. However, it is that fourth trade

that is the real difference maker. The ability to adjust a trade resulted in not taking any loss on

the fourth trade even when the stock price turned unexpectedly bearish as in the first scenario.

More important, is the result of these four trades. By not taking a loss on the fourth trade the

result is keeping a 59% profit vs. being down 13%. That is net difference of over 70% and that is

why trade adjusting is so important.

To drive this point home in a different way, ask yourself this question: “what if adjusting trades

never helped me gain more profit in any of the winning trades I am experiencing right now, but

eliminated the losing trades from my track record of trades?” What kind of a difference would

your portfolio show in a year? What about in two years? Trade adjusting will not keep you

from every taking a loss on a trade, but it can lessen the number of losses you experience

greatly.

This book was not intended to teach options or spread trading from a beginning level, but we

firmly believe that this knowledge is needed to be able to trade more safely and therefore more

profitably in the markets. You owe it to yourself to find out more about option trading and

spread trading if you really want to survive the roller coaster our US markets have become over

the past decade.

What Exactly is an Adjustment? For those whom are familiar with spread trading, or at least familiar with options, an

adjustment to a trade is often accomplished by rolling a short option in one of the eight

different ways it can be moved.

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For example, a bull call spread (a trade using a long call and a short call with the same starting

expiration date but different strike prices) takes advantage of a strong bullish trend in the price

of the stock you are trading around.

If however, the stock price suddenly moved against your expectations and started trending

bearish, you could find yourself in a losing trade very quickly.

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In order to adjust a bull call spread if the stock you chose suddenly moves bearish, you could

roll your short option to a nearer term expiration, and down in strike price, and if done

correctly, give yourself a chance of still being profitable on a trade which has moved against

you. You have literally change the original direction of your trade to match the new direction of

the movement of the stock price.

This is a very simple example of one of many different spread trades and one of several

different ways this trade can be adjusted. For example, an adjustment for a strong bearish

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move on the stock price would be different than the adjustment on a slight bearish move. The

adjustment could be different still if the expiration date of the original trade were already near

term (in the current month or week of expiration), vs a longer term expiration, say three to six

months out. Adjustment strategies can be very simple, involving rolling one short option, or

they can be very complex, such as adding a ratio of long options to two different sides of a

trade, all with different expiration dates and different strike prices.

Regardless of how complex or simple, an adjustment strategy is, it is needed to go into any

trade with confidence beyond having belief that you made a correct guess.

Anytime you open a trade you could be wrong about the direction you hope the stock will

move. We have stated that numerous times and in numerous ways already. Imagine the

difference between just knowing you made a well educated guess, and knowing you made a

well educated guess, along with a great adjustment strategy, in case you are wrong. That

difference in peace of mind alone can be worth its weight in gold. Now imagine that the trade

actually goes against you. No panic; no heartburn; no loss of sleep, because you know your

adjustment strategy will work to either eliminate your loss, or even get you to profitability.

Trading without the knowledge and ability to adjust is like going on vacation without some cash

or your credit card. Maybe you did a great job of picking a hotel, and the rental car is already

paid for. Maybe you have an all-inclusive meal package so that you do not need extra money

for food. You may have done everything right in setting up your vacation and now what do you

do if something goes wrong? You have no backup because you left your money at home,

assuming everything was all taken care of. It is absurd of course, to think you would go on

vacation without your money. So, why is it not absurd to trade the markets without a good

backup in place?

Anyone who has traded has found himself or herself on the losing end of a trade with utter

disbelief that the trade went against them. You did your homework, right? You read the charts

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correctly, right? You listened to the most knowledgeable people, right? Then why is this darn

thing not going the way you thought it should?

Instead of being in this spot again, take some time to learn about spread trading and

adjustments, so you never have to venture in without a backup plan again.

The whole reason we do what we do at Safe Option Strategies is so that even if we are wrong,

we could still be right (and still profit) … that’s what adjustments are all about!

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Reason 4: You set up a trade with too much risk.

We all know, stuff happens! Stock prices can turn on a dime, for reasons we will

sometimes never fully understand, and even the best planning will not always protect us from

losses. Every time you enter a trade, you have to ask yourself, “Can I live with the worst

possible loss this trade could produce?”

As long as you are not setting up trades with too much risk, you will be able to answer this

question in a way that will make you happy. If, conversely, you are setting up trades with too

much risk to begin with, you are not going to get warm fuzzy feelings over your answer.

What can you afford to lose?

Far too often we hear the famous disclaimer on trading – “do not trade with money you

cannot afford to lose.” Companies use this disclaimer to make sure they are not sued by

someone who thinks they can place a trade and not lose money. As hard as it should be to

believe those people are out there, they really are. The people who would do that are either

the ones who know better, but would sue anyway because they are dishonest in their dealings

with others as a matter of habit, or they are the people who are dishonest with themselves

about the risk associated with trading. Either way, companies are advised by their lawyers all

the time to warn their clients or customers that they should not trade with money they cannot

afford to lose. So, I have a few questions for the people who would ask this question, and for

you: What money can you afford to lose? Your retirement money? Your kids’ college money?

Gas or food money? Your emergency “rainy day” funds? What part of your money can you

actually afford to lose? Even people who have enough money for all of their needs, and some

of their wants, would rarely if ever tell you they could afford to lose any of it. NO ONE LIKES TO

LOSE MONEY!

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Sadly, taking losses in the stock market is a reality of being in the market. Even if you know how

to adjust a trade, you cannot always do it in time to save some loss. In fact, even with a very

well planned adjustment strategy, sometimes a turn in the direction a stock has been trending

can have a devastating effect on a trade, and no adjustment strategy will save you from taking

the full loss of that trade. While it may be silly to say, “Don’t trade money you can’t afford to

lose”, it is not silly at all to ask yourself on any one given trade, “Can I live with losing on this

one as long as I know I will not lose on every one?”

Taking a loss on a trade from time to time will not devastate your portfolio, if you are only

experiencing this occasionally, and if you are confident that only the most extreme scenario

could cost you a full loss on a given trade. If the full loss on a given trade will not have such a

great impact on your portfolio as to put you in a desperate position to make it back, your

psyche can survive and you can think logically instead of emotionally when you put together

your next trade.

The most common mistake on calculating losses.

People who are new to the markets sometimes make the mistake of thinking a 20% loss could

be replaced by a 20% gain. The problem with this is that the math just does not work. If you

have $100 and you lose 20% of it, you now have $80. To gain $20 on an $80 investment, you

actually need 25% return because $20 is 25% of $80.

This might seem very elementary to you, but have you considered what at 25% or 30% loss to

your whole portfolio really means in terms of getting ahead in the market? One big loss cannot

only cause you to be out the money you put on the trade, but it can also make it much harder

to get back to a breakeven such that you can then move forward in your profits.

If you are not brand new to trading the markets, you probably remember 2008 and the losses

the markets suffered (and if you loss big, I promise I am not trying to rub salt into what could be

a still open wound). The DOW Jones Industrial Average was down from May of 2008 to March

of 2009, a period of 10 months almost 50%.

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To see your portfolio go down 50% is devastating enough, but when you consider that now you

need a 100% gain just to get back to break even, that makes it even harder.

Hopefully you are not still scratching your head about a 100% gain being needed to get back to

breakeven. It is worth stating once more so there is no room for mistake here: If you lose 50%,

gaining 50% on what is left only gets you half way back to where you started. You have to gain

100% to get back to breakeven, and that is not easy to do in a market that averages 12-15%

annual growth historically. Even the best stock pickers in the market have a hard time getting

100% growth in a year.

Risk vs Reward

When you are deciding what a realistic risk tolerance is for you and your trading style, you have

to look at the net effect on your portfolio as well. You cannot get into a position that would

have one bad trade devastate your portfolio. It is one thing to determine that you are willing to

risk a certain amount of money in a trade in exchange for the amount of money you stand to

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gain, but you must train yourself to look a step farther. What will the net effect to your

portfolio be? A good rule of thumb is to never allow one single trade to affect your portfolio by

more than 7-10% in a worst case scenario. And do not ever fool yourself into thinking you

cannot take a maximum loss on any given trade.

A good test to determine if you are putting too much risk in a single trade is how you would

answer these questions: Will the maximum loss on this trade devastate my portfolio? Will it

affect my confidence going into my next trade?

Your answers to these questions had better be in line with your risk tolerance, or you are

putting too much at risk in the trade you are considering.

You also need to consider the reward associated with the risk you are willing to take. Would

you be willing to risk 10% of your entire portfolio for a trade you could only profit 2% on (2%

relative to your portfolio, not to the trade itself)? You should be willing to do that, because in

order to succeed in the markets consistently you are going to have to.

Risk to reward ratios are set to determine the payoff on the money at risk, not necessarily the

effect on your whole portfolio. The question in the last paragraph was a trick one. If you have

10% of a $100k portfolio in a trade you are working with $10,000 risk on that trade. If you then

saw a 2% gain to your portfolio, that would be a 20% gain against the $10,000 you had at risk,

ad that is not a bad risk to reward ratio. If you only gained 2% monthly in your whole portfolio,

you could actually see a 26% annual return (if you are compounding the 2% monthly), and

according to the rule of 72 covered in an earlier chapter, you would double your portfolio in

about 3 years.

A good risk to reward ratio on a given trade is 25 - 30%. This means that you should be in a

position to gain at least a quarter to a third of what you could lose.

Put this into context with the previous chapter about adjusting trades and use this format:

Consistently run 4-6 open trades.

Never have more than 7-10% of your portfolio at risk in any one given trade.

Target a risk to reward ratio of 25% or more.

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Know you can adjust that one in four or one in five trades that go against you.

Trade confidently and make more money consistently.

Trade with Little or No Risk.

You did not read that wrong. You can actually trade the US Markets with little or no risk. In fact, it is not

that difficult to set up your entire portfolio with zero risk trades that still have a tremendous upside

potential. A large part of what we teach at Safe Option Strategies deals with collar trading, and more

importantly, ratio collar trading. We will give you an example after quickly explaining the two option

instruments used with stock ownership to create a collar trade.

The Long Put Option The long put is an option contract which allows a person to sell stock at a fixed price (the strike price) for

a predetermined period of time (from the time it is purchased to the expiration date). Regardless of

how far a stock drops in price, the holder of the long put option can still exercise his or her right to sell

the stock at the strike price they purchase the option for. If used correctly, the long put option works

much the same as an insurance policy for your car or your home.

Say you purchased a $100,000 sports car. Without giving it a second thought, you would insure the car

for $100,000. It would likely cost you $1000 or more to have this insurance in place for a year, and if

you chose to pay quarterly or monthly, you would likely pay a little bit more for the ability to spread out

your payments. During the time your insurance was in effect, you would have the right to have the car

repaired or replaced if something happened to the car. If nothing happened during the time you had

the car insured, you would of course be out the insurance premium, but you would have had the peace

of mind that you would not lose your valuable asset.

Now imagine you had $100,000 invested in a stock. You could likewise buy insurance in the form of long

put options. Depending on the time of expiration you chose, you would have the right to sell your stock

for the $100,000 no matter what happened to the price of the stock. Just like with your car, if nothing

happened (meaning the stock price did not go down) you would simply be out the insurance premium

(the cost of the long put options) but have traded that for the piece of mined that you would not lose

your investment.

The illustration below shows a long put option for the company Netflix when the stock was trading at

$436.36 per share. For a price of $49.65 per share, the buyer of this long put option would have the

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right to sell their shares of Netflix for $435 per share (the strike price) for a period of 206 days (the

expiration of the long put option).

While $49.65 per share may seem like an expensive insurance policy, consider owning stock in Netflix

and having all $436.36 at risk vs. having only $386.71 at risk (the price of the stock minus the cost of the

long put option). Less risk = more piece of mind.

The Short Call Option The short call option is a contract that pays the investor a premium in return for giving someone else

(the person willing to pay the premium) the right to buy stock from them at a fixed price (the strike

price) for a predetermined period of time (from the time the premium is accepted, or the option is sold,

to the expiration date). Most investors use this option in conjunction with stock they already own and it

is known as a ‘covered call’. If the price of the stock never moves above the strike price of the option,

the premium is kept by the seller of the option (you) and the stock ownership is maintained. If however,

the price of the stock moves above the strike price of the short call option, the person who paid the

premium has the right to buy the stock away from you for the strike price of the short call option, but

the premium accepted by the seller is still kept as profit.

In the above illustration, the person selling the short call would receive a premium of $48.45 per share,

but in taking that premium, the person who paid them would have the right to buy their shares of

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Netflix away from them for a period of 206 days. The $48.45 per share would be kept by the seller of

the option no matter what the price of the stock did during those 206 days.

The Collar Trade

Taking what you have just learned about the long put option and the short call option, think now about

combining them along with ownership in stock. You now have a collar trade.

This is very close to a risk free trade, for a period of time (87 days in this case). The stock is worth

$436.36. It is protected with a long put option (our insurance policy that gives us the right to sell our

stock between now and the option expiration for $435/share). We are also taking in a credit of $31.75

to lower our overall investment. Remember, in exchange for taking this money, someone has the right

to buy our stock from us for $440/share. Add and subtract your money in, and money out and you end

up with this:

Stock $436.36 (money out) plus -

Long Put $33.20 (money out) minus -

Short Call $31.75 (money in) equals –

Total Cost Basis of $437.81 per share with the right to sell your stock for $435/share for the next 87

days. Your risk is only $2.81/share for the next 3 months. How much better will you sleep at night

knowing you have only $2.81 at risk in a stock you have $436/share invested?

The worst-case scenario will eventually get you. Know you can survive it or do not place the

trade.

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Reason 5: You were not willing to walk away from a bad trade.

Of the 5 reasons trades go wrong, this is the one that might seem overly obvious. But, this may

also be the one that causes more heartache and loss than the others do.

You do not always need to be in a trade. It is perfectly ok to sit on the sidelines for short

periods of time.

No one has spent much time in the markets without regretting a trade they placed. Some of us

have regretted many trades we have been in. For me, the worst one was an iron condor (a type

of multi-option spread trade) on an oil stock. For the trade to profit, I had to see the stock price

stay between $21 and $23 per share for about a month.

The stock price had been moving in a stagnant trend for about six weeks, and it did not seem

unreasonable to me that it would continue that way. There was good short-term support at

$21 and good short-term resistance at $23. There was no earnings report coming up in that

particular month. I was unaware of any other news that might affect the price of the stock

significantly. I had done some homework, and I felt good about my “educated guess”.

However, I made several mistakes. The first was to sell way too many contracts in the trade. I

literally maxed out my available cash in my portfolio, and I had way more than 10% of my

overall portfolio at risk for the worst-case scenario, should it come.

The next mistake I made was in not having the ability to adjust the trade. Knowing how to

make an adjustment and leaving yourself with the ability to make the adjustment can be two

entirely different things. Some adjustments require some free cash in your portfolio, and I had

left myself without any.

The last mistake I made was placing this trade and then not paying close enough attention to it.

I fell asleep at the wheel until it was too late.

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While any one of these mistakes could have been costly, the biggest mistake of all was simply

not walking away from the trade. I should not have placed it at all. I did not listen to the little

warning bells going off in my head, because I wanted my money at work for me. If you have

not already guessed what happened, just look at the next picture:

Had I left myself the ability to adjust the trade, I could have done so in early August before the

real move up at the end of that same month. The move up in late August and early September

wiped me out. I took the maximum possible loss on the trade, and learned a valuable lesson: IT

WAS A BAD TRADE AND I SHOULD HAVE WALKED AWAY.

As a child of the 1970’s and 1980’s, I remembered well the song by Kenny Rogers called “The

Gambler”. I really liked the song, and actually still do to this day. But for the second half of

2005, having suffered one of the worst losses in my portfolio, anytime that song came on the

oldies station (because, let’s face it, by 2005 it was an oldie) I would turn it off. The words of

the song echoed in my head and all I could think of was the loss on this trade. The words of the

chorus go like this:

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You've got to know when to hold 'em

Know when to fold 'em

Know when to walk away

And know when to run

You never count your money

When you're sittin' at the table

There'll be time enough for countin'

When the dealin's done

Kenny was writing about a card player, but the lesson applies to traders as well. You have to

know when to walk away. If you do not, the markets will eat you alive.

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We are big believers in the cliché that you miss 100% of the shots you do not take. However,

when it comes to being a smart, profitable trader, we are also into the cliché that you will never

lose money on a trade you do not place.

If you have not done your homework, such that your ‘educated guess’ can be the most

educated possible guess, walk away from the trade.

If you do not have a well-defined exit strategy that you are committed to following, walk away

from the trade.

If you do not have a good risk to reward ratio, walk away from the trade.

If you do not have the money and the knowledge to adjust a trade, walk away from the trade.

If you cannot live with the worst-case scenario, walk away from the trade.

If you hear any sirens going off in your head, WALK AWAY FROM THE TRADE!

We do not want any investor to spend too much time on the sidelines. If you are constantly

afraid to be in the game, maybe you should play a different game. The US Equities Markets are

not for everyone. You may be better off letting someone you trust trade your money for you,

or you may want to invest in real estate, or open a fast food franchise, or get into multi-level

marketing. Do not torture yourself if you are constantly frustrated and you do not have a

commitment to fix things.

I am convinced after years of trading and teaching others to trade, that you can be immensely

successful in the markets. It takes a willingness to admit you need to make some changes,

learn things you do not know, and stay disciplined to methodologies that are proven to work.

There is too much evidence that people make great money in the markets to walk away from it

if you really want to succeed.

Take the steps needed to improve your results starting right now. Knowing the reasons trades

go bad is the first step. Fixing them is the next step. Take that step!

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A Little Bit About Safe Option Strategies

By early 2008, Jeffry Dunyon, the founder and CEO of Safe Option Strategies, had been through nearly

$50,000 worth of investment education in his attempt to conquer the US Equities Markets. His last

experience was in teaching trade adjusting classes for a start-up company, based near his home in the

suburbs of Salt Lake City, UT. There, he found he had a great passion for teaching the strategies that

were proving successful, not only for the students of the education company, but in growing his

personal portfolio as well. When the company shut their doors, Jeffry continued growing his portfolio

and expanded what he had learned. He created methodologies with a greater safety net and created

within himself a desire to deliver an amazing experience to pupils, seeking to trade more safely in the

markets.

Jeffry knew he could provide an investment education that was more effective, offered greater profits,

and would not have to cost a small fortune, as other programs he had tried did.

“You should invest and grow your fortune, not spend it on education!”

Jeffry started Safe Option Strategies wanting to offer a better way to learn complex strategies, without

requiring a lot of money to buy the education.

“I believe the best way to really learn this methodology is to allow the student to trade WITH the

teacher, as he is learning to trade better himself.”

“Similarly, if you are left alone in the water while you are learning to swim, you just might drown… At

Safe Option Strategies, we want to get into the water with you, support you, and help you stay afloat

while you learn a better, more profitable way to trade.”

Safe Option Strategies is now an international company with students studying its methodologies in a

dozen countries outside the United States. As a small business, Safe Option Strategies is still able to

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offer each new student the experience of working closely with those who know how to make money in

any market conditions. Perhaps the best way to understand the real goal of this company is through

Jeffry’s own words: “I firmly believe the success of Safe Option Strategies as a company is measured

only in the success of our students. If they succeed, we succeed.”

Jeffry Dunyon, CEO Safe Option Strategies

To learn more about the methodologies taught by Safe Option Strategies, explore our web site at

www.safeoptionstrategies.com Take the time to register for a free, no obligation, online class at

http://safeoptionstrategies.com/register_for_free_class . Class times vary, and seating is limited, so

reserve a spot now.