Covered Calls and Cash Secured Puts (Part 36)

Today I want to get back to discussion of dollar cost averaging (DCA) as a position management technique and its implications for risk management.

In his book Systematic Covered Writing, Rich MacDuff writes:

> …the disadvantage of using the [DCA] strategy
> stems from the possibility of further price
> erosion of the stock after a second purchase.
> This sets up the possibility of [DCA]…
> a second time.

Just how much more capital should I be willing to commit to a position as it goes against me?

Without defining this number, I cannot know how much cash to keep on the sidelines in case I need to use it. If this is unknown and I am willing to repeat the DCA process then I am playing a game of unlimited risk. I may go months to years without ever realizing this or thinking this way because such a string of bad luck may come around once in a blue moon. Nevertheless, when that “blue moon” or “black swan” does show itself, I am a prime target for getting blown out of the water… maybe never to trade again.

Keeping money on the sidelines also complicates the matter of calculating returns. Recall the last post where I derived the possibility of having to make 3,432 trades in one year. That involved trading the whole account. The total return of the account drops proportionally to the percentage of cash I keep on the sidelines, though. The 15% annualized return MacDuff frequently writes about becomes 9-12% annualized if 20-40% of the account, respectively, sits on the sidelines in cash for use toward DCA when [or if] needed.

In my next post I will borrow from the world of gambling to further study the pros and cons of DCA.