The HAPI: The Hope and Pray
Index
So you bought a call spread. At the opening bell the next morning, you find
that the market for the underlying has moved lower—a lot lower. You have
a loss on your hands. What do you do? Keep a positive attitude? Wear your
lucky shirt? Pray to the options gods? When traders finds themselves
hoping and praying—I swear I’ll never do that again if I can just get out of
this position!—it is probably time for them to take their losses and move on
to the next trade. The Hope and Pray Index is a contraindicator. Typically,
the higher it is, the worse the trade.
There are two numbers a trader can control: the entry price and the exit
price. All of the other flashing green and red numbers on the screen are out
of the trader’s control. Savvy traders observe what the market does and
make decisions on whether and when to enter a position and when to exit.
Traders who think about their positions in terms of probability make better
decisions at both of these critical moments.
In entering a trade, traders must consider their forecast, their assessment
of the statistical likelihood of success, the potential payout and loss, and
their own tolerance for risk. Having considered these criteria helps the
traders stay the course and avoid knee-jerk reactions when the market
moves in the wrong direction. Trading is easy when positions make money.
It is how traders deal with adverse positions that separates good traders
from bad.
Good traders are good at losing money. They take losses quickly and let
profits run. Accepting, before entering the trade, the statistical nature of
trading can help traders trade their positions with less emotion. It then
becomes a matter of competent management of those positions based on
their knowledge of the factors affecting option values: the greeks. Learning
to think in terms of probability is among the most difficult challenges for a
new options trader.