This concept arose from the need to demonstrate my defense mechanics for a client during a coaching week in 2021 when there was little UVXY action to use for this purpose. The general idea was to open a trade that had a high probability of moving against me, forcing me to address the red ink. I had run this trading for over 3 dozen cycles before I experienced an actual loss. My edge is not reliant on an ability to always pick winning opens, but to fix the inevitable trades that go against me. I’ve found it very useful to keep this mechanic well practiced and apply variations of it to all of my opens.
Concept
Premium selling is a run out the clock game so initially these were always 0DTE trades, though I have since adapted this for weekly expirations. Premium is your ‘buffer’ and managing that with subsequent opens, adding more premium and avoiding uncovered intrinsic exposure is the key to making this work. This is an approach that rejects the idea of using a stop loss for protection. In fact, it rejects the idea that any trade might end in a loss.
The Open
You can use any method to choose a bias, so any edge that you can deploy here will reduce your need to defend. Almost any option strategy is fair game, ranging from a simple OTM naked Call or Put, to verticals, condors, or ratios. The amount of premium collected should be large enough to be a useful buffer if the underlying moves quickly and to handle bid/ask costs. The important idea is that no leg is ITM so as to produce immediate intrinsic exposure (delta values less than .50)
Gamma
A gamma flip is when spot price moves and changes your OTM option to ATM, then ITM, and represents the core risk to premium collection strategies. While theta is still decaying as the session wears on, non-decaying intrinsic increases are to be avoided at all costs. This gamma risk can be eliminated by expiration, relieved by a price reversal, or mitigated by selling another contract (defending) to ‘absorb’ further adverse price movement.
Defending
Swallowing the spider to catch the fly is the idea here as you layer on move after move, building a book that keeps you out of danger to your best ability. The basic defense mechanic is to sell an ITM contract to absorb further price movement against you. This will also give you more premium to defer intrinsic losses. You’ve now legged into an Inverted Strangle and can use the various defense strategies for that spread. You’ll most likely be looking at large losses when the defense is filled, as the premium on your initial contract has risen to its maximum near ATM, but still very profitable once expired at the end of the session. Your position can get very complex as the trade wears on and I’ve found it useful to track it with a P&L analyze screen.
Whipsaw
By far the biggest challenge is when price runs through strikes you have in your book over and over again. The best defense against this is to try to maintain larger zones of protection, though the moment you place a defensive trade, your risk is now in the other direction. Less trading is usually better in avoiding being whipsawed, but your premium buffer will dictate when a defense is required.
Sizing
Sizing is an important consideration as you may eventually need to increase to 3 or 4x your initial notional with your defenses. An open with a single /ES contract might grow with a second defending move and keep increasing to your pre-established limit. As the trade wears on through multiple defending moves, I’m always looking to reduce size as theta contracts.
Stress
If you want to experience how long a minute can be, try surviving a max size trade with a defended range of movement so small that there’s no way you’ll get to the end of the day without more management opens. Your style might reduce this from happening, but as your size and risk increase, stress management is crucial. While you can use platform alerts (if they are timely) to keep an eye on your underlying, realize that this is not a set it and forget it trade.
Final Thoughts
None of these points are absolute as the most important aspect is your confidence and execution. You could have a strong directional bias and sell a DITM contract, you could choose to lock the trade down to a scratch or small loss with the first touch, modify this as it suits you. Like all other trading, your methods and performance follow how you uniquely interface with the markets, so you have to make this your own and cannot simply copy another.
I will share trade by trade examples on my subscription site so that you can see how I implement this.