Covered Calls and Cash Secured Puts (Part 38)

My last post identified when to dollar cost average (DCA) as an issue to clarify for those who plan on doing it.  Today I will cover two other DCA issues that should be clarified prior to trading live.

How much additional capital to commit is a second issue requiring attention.  Doubling the position size is not the same as doubling the capital allocation. A stock that has fallen 50% will only require half as much capital to DCA.  If I actually double the capital then I will more than double the position size. The latter will benefit me if the stock reverses higher because my position breakeven will be even lower. If the stock continues lower, however, then I will lose money at a faster rate. 

What I wrote in the last post also applies here: 

> Perhaps you will do some backtesting and see what best
> fits your sample. I don’t have an answer to this question
> and I don’t think a correct answer exists. 

In other words, no specific approach will work for all situations. 

Besides how to DCA, a third issue to define is size of the cash position. Capital on the sidelines will dilute overall returns.  Without this spare buying power, DCA cannot be implemented.  In a worst-case scenario, DCA’ing all positions might require 50% of my capital on the sidelines ready for deployment.  Although individual positions are selected by the Math Exercise to achieve 15-18% annualized returns, this only represents 7.5-9% annualized if half my capital is on the sidelines.

If this decreased return is not enough for me then I have some decisions to make. Do I incorporate an alternative exit strategy if the market moves against me? Do I leave position size constant? How will either approach affect returns?

Of utmost importance is a need to completely define the trading plan and to understand what I can likely expect before going live. This will minimize the probability of becoming disenchanted when capital hangs in the balance. As always, the worst possible ending is a forced psychological exit when things get ugly that leaves me licking the wounds of a catastrophic loss.