Covered Calls and Cash Secured Puts (Part 37)

I devoted the last four posts to discussion of the Martingale betting system because martingaling is to gambling what dollar cost averaging (DCA) is to investing/trading.  Today I discuss incorporation of DCA to the CC/CSP trading plan.

The first step is to determine my maximum tolerance for loss.  This is critical because I will approach that limit twice or four times as fast after doubling down once or twice, respectively. If I don’t know my maximum tolerance for loss–and most traders who have never experienced a volatile market and/or substantial loss do not–then the safest advice is probably to assume my tolerance will be small and to avoid doubling down altogether.

For the more experienced trader who is willing to commit additional capital, the next step is deciding when to DCA.  The only recommendation MacDuff offers for this is “when a stock is on sale.”  He seems to DCA inconsistently in his archives of successful positions.

Unfortunately, determining when a stock is “on sale” can only be done in retrospect. Any stock that went bankrupt was first down 10%, 50%, or more. Any of those levels could be considered “on sale.” Such identification might later be revised with the classification “falling knife” and dire regret had I acted and committed additional capital at the higher stock price. This is the risk of DCA and we can never get around it.

When to DCA is therefore an individual decision that must be made in accordance with your risk tolerance. Perhaps you will elect to DCA when the stock falls 30% or 50% or more. Perhaps you will do some backtesting [with a survivorship-free database] and decide what best fits your sample. I don’t have an answer to this question and I don’t think a correct answer exists. Period.

I will continue with more DCA discussion in my next post.