Risk Management from a Fighter Cockpit to the Trading Pit

Welcome aboard! We’re going to cover a topic that top professional traders utilize to make extremely

large profits in the market, no matter which direction the market is moving – up, down, or sideways.

This is a critical aspect to trading that many retails investors simply do not do, but MUST be doing every

day, every trade, especially in this extremely volatile market where world and domestic events can move

the market in seconds.

At Top Gun Options, a Wealth Creation Investing (WCI) company, we say that Trading is Combat. Why?

It’s simple. In both of my worlds, fighter aviation and trading, there’s a winner and a loser… and at WCI,

you can bet which side we’re on.

In this report I’m going to provide you with not only a strategic way to look at risk, but a step by step

checklist that you can use right now to help you even the odds and

make you a more successful, confident, and ultimately potentially

profitable trader. This proprietary risk management process was

forged in combat conditions over Iraq and proven on the front lines

of Wall Street. It works. Period.

My name is Matthew Buckley and my call sign is ‘Whiz’. I flew the

F/A-18 Hornet for 15 years for the United States Navy. I have close

to 400 landings aboard almost every aircraft carrier in the fleet, on

almost every ocean on the face of the earth. I graduated from the

Navy Fighter Weapons School, also known as TOPGUN, and I flew 44

combat sorties over southern Iraq.

I serve on the trading battlefield as well. I was the Managing

Director of Strategy at PEAK6 Investments, L.P. one of the largest

volatility arbitrage options trading firms in the world. I was

promoted after one year and became the founder and CEO of a

financial media company, PEAK6 Media LLC, the parent of Options

News Network (ONN.tv), headquartered on the floors of the

Chicago Board of Trade (CBOT) and Chicago Board Options

Exchange (CBOE:. I’m currently CEO of the exclusive financial

training and trading firm called Top Gun Options LLC and I’m a

Managing Partner and Chief Investment Strategist at Wealth

Creation Investing LLC, headquartered in Fort Lauderdale, Florida.

I’ve literally gone from the cockpit to the trading pit, with no formal training, from the front lines to the

front office on Wall Street, while consistently outperforming the market year over year.

I’m also an author and recently completed a book focusing on the discipline and risk management methodologies required to successfully execute on the front lines of trading and in corporate America.

You’re probably wondering how did this guy go from the cockpit of a $40M fighter jet to the C level suite of a multibillion dollar trading firm? I spent 10 yrs on active duty in the Navy, and a lot of that time at sea, forward deployed to the Arabian Gulf. In any down time I had between studying my threats and preparing for missions, I took the time to teach myself how to trade stocks and options. Back in the mid to early 90’s there really wasn’t any financial training available for retail traders and I wasn’t going to let someone I didn’t know manage my money, so I attacked learning how to trade with the same drive and vigor as flying and fighting the Hornet. And reading a book about options back then was a lot easier then reading the manual of the F/A-18 flight control system! But I noticed something pretty cool…when I applied the same discipline and risk management methodologies, the same contingency planning, planning, eject criteria, and mindset to my

trading that I did to flying fighters, I outperformed the market…Significantly. 50-70% returns year over year in my personal portfolio were common, with not a lot of initial capital, maybe $30,000 max. Unfortunately I followed the crowd of military aviators out the door like a lemming in 2000, where I got caught up in a bubble. Not the internet trading bubble, I was making a lot of money trading options and stayed safe while others got wiped out, but the airline hiring bubble. I headed off to the airlines, where I was going to be a ‘rich airline pilot’ working 1 day a month, making a nice comfy 6 figures. Didn’t happen. I finished my training as a pilot for American Airlines and I was scheduled for my first flight on September 11th, 2001. We were living in the Dallas/Fort Worth area, which is where American Airlines (AA) and the reserve F/A-18 squadron I had been picked up by were both headquartered. I was awakened by a call from my mother in law in Florida. She told me that an airplane had flown into the World Trade Center. I immediately thought that it was some idiot in a small plane, maybe lost in bad weather. Whatever…it didn’t sound important but my wife went out to turn on the TV. As I took my new AA uniform out of the plastic, my wife came in to the bedroom and told me that I needed to take a look at the TV. The couple first things I noticed were that the weather in New York was beautiful and the impact hole in

the World Trade Center’s north tower was too large for a small plane. As I stood there in silence, going

through my mental aviation checklist of how such a thing could have happened, I saw an airliner streak

in from the right side of the screen and explode in a hail of fire and debris into the side of the second

tower. I immediately knew we were under attack.

I ran into the bedroom, reached past my brand-new American Airlines uniform, and grasped for the

familiar feel of my well-worn green Navy flight suit. I zipped it up as fast as I could, pulled my flight boots

up, and ran out the door, nearly tripping on laces I hadn’t tied yet.

I broke the land speed record in my Porsche getting out to Naval Air Station Fort Worth, and got out to

the base just as they locked it down and went to a combat status.

A squadron mate of mine had also made it onboard as

well. Our Commanding Officer was also an airline pilot

and was flying a trip for Delta that fateful day, so I

couldn’t reach him. But it didn’t matter. This was one of

those moments when you just have to take the initiative

and execute based on your training and the trust

bestowed upon you by your nation.

I called down to our Maintenance Control and the Chief

told me we had 4 Hornets that were ‘FMC’, or Fully

Mission Capable. I ordered them prepped for flight

immediately as my buddy worked the other phone line

ordering weapons to be loaded on the aircraft as fast as they could.

We coordinated with the Air Force Reserve F-16 squadron next door who was tied into NORAD, the

North American Air Defense Command, and we stood up an alert and we ending up flying combat air

patrol over the southwest United States.

I went from flying an airliner that day to possibly shooting one down.

A couple of days after the attack I scrambled on alert and forced down an a/c that was flying near

Presidential airspace.

Since I was one of the newest hires at AA, I was immediately “furloughed”, airline speak for laid off,

along with ten of thousands of others in the airline industry.

I lost everything – my job, my healthcare, my retirement.

We had just bought our first house – we had lived in military

housing for 10 years - and we had used up what little money

we saved in the Navy for a down payment. We lost it all…

But I still had my family.

Even at this low point, I kept things in perspective. I knew

there were folks out there who had it a lot worse than me.

The scenes flashing across the television of families posting

pictures of missing sons and daughters, husbands and wives, and mothers and fathers on a wall at

Ground Zero and looking for loved ones in acres upon acres of rubble brought tears to my eyes.

Time to stop feeling sorry for yourself, Whiz. Never again. And from that moment on, I was filled with

determination.

Over the next couple of years I did whatever I had to do to provide for my family. At one point I was

working 5 jobs and my wife was waiting tables in an Italian restaurant in Southlake, Texas. We did what

we had to do.

Never again would I put all my eggs in one basket.

I was hired by a consulting firm and I applied my leadership experience, planning expertise, and risk

management processes I used in the military and applied them to each new business endeavor. And it

worked.

I also turned what used to be a part time venture, my personal trading, into a full time job by applying

the same discipline and risk management methodologies we’re about to cover with incredible success as

you saw a little while ago. Eventually I popped up on the radar of a leading Chicago volatility arbitrage

options trading firm headquartered in the CBOT and I became a Managing Director.

I didn’t know a ton about Wall Street or the markets, but it didn’t matter – what this firm needed, like

just about every other trading or financial firm was Discipline and Risk Management. When combined,

these 2 powerful traits result in Superior Execution.

I’d be lying if I didn’t tell ya that I felt like Eddie Murphy inTrading Places…I

felt like 2 people were betting a dollar on me. I still believe that to this day.

God knows I didn’t think this role was for me. This would be a huge leap. I’d

be taking a big risk. And I’ve got news for you…contrary to popular belief -

fighter pilots don’t like taking risks…

Yeah right Whiz…a fighter pilot and risk. Risk is your middle name. Not true.

Fighter pilots are probably the most risk-averse people you will ever meet.

And of course, Hollywood hasn’t helped us out much, so let me eliminate the “Top Gun” stereotype

once and for all.

If a Naval Aviator pulled a stunt similar to any of those portrayed in

that movie, it would be his or her last flight. They’d lose the gold

wings on their chest, and maybe even their lives or potentially kill

or injure others. Those stunts in the movie were dangerous, they

were risky. Absolutely unacceptable.

Believe me when I tell you that flying fighters is not that

dangerous, it’s not that risky.

It’s actually pretty safe.

If you don’t believe me, see for yourself. Let’s take a look at a day

at work in my office as I fight one of my squadronmates over the Republic of TX. Take a moment to

check out this video: http://youtu.be/46Y2DbDdZNg

Just another day at the office right? Did that look dangerous to you? Well here are some reasons why it wasn’t. For an hour and a

half before the flight, my wingman and I briefed for this mission.

We covered everything from the weather to potential

emergencies. We covered the rules of engagement – what we

could and could not do during the fight. The

aircraft was readied for flight by expert

maintenance personnel, utilizing strict checklists

and procedures starting the night before.

You probably heard a bunch of beeps and radio

calls. Most of the radio calls were my wingman and

I deconflicting our flight paths so we wouldn’t

collide. At one point, I called “High” and he called

“Low”, indicating where our jets were going. While the engagement started at a high airspeed, you

could probably tell that we were maneuvering the jets as hard as we could to gain an advantage over

the other and when jets get slow they sometimes don’t go where you want them to. So we were

warning each other.

The tones you heard were indications from the flight control system that I was fighting the jet right on

the edge of controllability. The jet was warning me and letting me know exactly what flight regime I was

operating in.

You also heard a voice caution that called out “Bingo, Bingo”. This let me know that I had a couple

hundred pounds of gas to play with before I had to head home. There’s a couple smoking holes in the

ground from guys who didn’t manage their fuel properly so this backup system alerts me to a low fuel

situation.

So this 1 versus 1 air combat engagement wasn’t too dangerous was it? No.

But there was also one big risk missing. Were we shooting real missiles or bullets at

each other? No! This was training. But you saw we treat training with the same

intensity that we do as combat.

One of the mottos at Top Gun is ‘You train like you fight and fight like you train”.

We apply this motto to our trading here at WCI.

During combat, we talk about something called the “fog of war”, where the ‘unknown unknowns’ reside.

But even in combat that’s ok, because I’m going to eliminate all known risks – if I’m gonna get smoked

in combat or in trading, it’s going to be because of something I couldn't control, or in trading parlance, a

“Black Swan” event. Something I could not have seen coming.

I’m going to manage risk or die trying. It does my country, my wife and kids no good, to go out and get

killed by something I could’ve prevented. This may sound harsh – but in fighter aviation we obviously

mourn brothers and sisters we lose, but if it’s because of something they should’ve known or done

differently, we view their loss as expected and unacceptable.

So I approach the subject of risk management with a unique perspective. I spent years in what many see

as the most dangerous profession on the planet: flying fighters off the pointy end of aircraft carriers, in

bad weather and at night – over 400 times – while carrying out 40-plus missions over enemy territory.

Since then, I have taken up a career in what would appear to be one of the riskiest businesses around –

options trading . But like the fighter pilot profession, perception is not reality. Options traders also want

to avoid risk. And trading options, when done properly, is less risky than trading stocks.

This unique and unparalleled experience has allowed me to meld the best of both worlds into a

proprietary risk management system I’m certain can help you in your trading.

Now a lot of attention has been paid recently to risk management

or more to the point, the lack thereof on Wall Street. People got

complacent. Banks got complacent, we got complacent, even

countries got complacent! With cheap credit, many people forgot

about risk.

Wall Street and Main Street believed only in upside. Housing

prices can only go up, right? So the smartest people in the room

created exotic derivatives based on mortgages and when the housing market

collapsed, these securities crashed. And these

securities were interrelated to other financial

instruments like Collateralized Debt Obligations –

or CDOs. A house of cards…

All of these products being tied together created

a vicious spiral. Now WE bailed out institutions

that were ‘too big to fail’ with billions upon

billions of OUR money and our children are going to pay for it. And

still Wall Street firms are paying out record bonuses…with our money…

What is the main lesson you should’ve learned from the financial tsunami of 2007/2008?

No one cares more about your money than YOU!

No one, I repeat, no one cares more about your money than you. Period. If you do not believe or understand this, please go find something else to do, and hide your money under your bed… And the riskier the markets become the more important it is for you to actively manage your personal risk.

Risk Management in Your Trading

So let’s get into it. How to manage risk in your portfolio day in and day out. After spending time trading with the best in the options capital of the world, I was shocked to learn one very important thing. And I’m glad it confirmed how I was already trading… While most retail traders go into a trade and immediately think about how much money they stand to make, the pros do the EXACT OPPOSITE. They ask ‘How much can I LOSE!’ and this is critical to your trading mindset and becoming a more profitable trader.

The pros first rule? Don’t lose money. The 2nd

rule? See the first rule. Professional traders look to win 51% of the time, not 100% of the time. You heard me. I know you’re

sitting there saying I want to win on every trade…of course you do…but you won’t. And you gotta know when to fold ‘em, before it ever comes to that. Professional options traders focus on hitting solid base hits, not swinging for the fences and trying for a home run with every trade. A couple big strikeouts and you’re done. A brilliant woman I worked with once said ‘We

don’t make the most money, but we make money consistently’. That’s a winning game plan and makes you sleep well at night. Professional traders manage risk and live to fight another day, just like a fighter pilot – and are a lot more successful than you are because of it. Is it too late for you to get started? Negative. Wealth Creation Investing will help fix that. I’m going to teach you our proprietary risk management methodology forged in combat and proven on Wall Street.

Why you have as an individual have to manage risks?

Lehman Brothers. Bear Stearns. AIG. Merrill Lynch. MF Global. Some supposedly smart people ran these organizations…and now they’re out of businesses or they owe the United States (meaning us taxpayers) billions upon billions of dollars in bailout money with more on the way. Risk management allows us to deploy our precious assets

and capital more effectively. It allows us to identify and focus our resources, so we can minimize loss. Do you think these companies ever thought they would go bankrupt or out of business? Nope. Never in a million years. How about hedge funds? The term hedge means essentially a riskless trade – Hedge Funds try to make money no matter which way the market moves. How about you? Do you worry about the direction of the market or could you care less? At Wealth Creation Investing, most of the time we couldn’t care less – we often make money in our model portfolios in all market conditions and our traders sleep well at night. And finally risk management helps us keep our portfolios safe and potentially profitable. Let’s take at recent huge lapse in discipline and risk management. “…too extreme…likely impossible MF Global, skippered by CEO Jon Corzine, on the job for 20 months ignored his Chief Risk Officer’s dire warnings - Corzine’s bet that there wouldn’t be a European debt crisis swelled from $1.5B in late 2010 to $6.3B in October before flaming out and crashing under massive losses.

The Chief Risk Offcer – doing his job, informed the skipper, that there wasn’t enough cash to cover worst case scenarios with PIIBS (Portugal, Italy, Ireland, Belgium, Spain). Corzine’s response? I’m smarter than you are. Corzine said the “CROs scenarios are too extreme and likely impossible”. Corzine who only joined MFG in March of 2010 threatened the Board of Directors that he was going to take his ball and go home if they didn’t risk more and trust his judgment. After all he ran Goldman Sachs, was a US Senator, and Governor of the Great State of New jersey. He has to be brilliant right?? Wrong. The guy now admits that he has no clue where $1.2B of MFG’s clients money is…many of the customers are ranchers and farmers who used various MFG products to manage and hedge their financial operations. Was this guy born yesterday? Did he not go through the financial tsunami that has left our country in a ditch? Where legions of “smart men and women” on Wall Street decided managing risk was for chumps? Please tell me he’s not one of the smartest guys on Wall Street. He has no clue where $1.2B went and may have illegally used these funds to cover a margin call from J.P. Morgan. My wife and I freak out when I don’t know where $12 of our money went. Oh and by the way, his golden parachute for doing such a great job was $20M for bankrupting this firm and destroying thousands of employee’s lives… What’s your parachute if you don’t manage risk and your portfolio blows up? If you’re not managing risk on EVERY TRADE like we do at Wealth Creation Investing, you’re going to get smoked… it’s not a matter of if…but when… And in the Navy my parachutes weren’t golden…are yours? So now that we know why we should manage risk, who should manage risk?

You Should! I hope you answered that yourself. Simple answer you. Don’t think that risk management is a big term reserved for professional traders or hedge funds.

Alan Greenspan, former head of the Federal Reserve, said this in front of Congress when they asked him what went wrong, what caused this financial crisis:

"I made a mistake in presuming that the self-interests of organizations, specifically banks and

others, were such as that they were best capable of protecting their own shareholders and their equity

in the firms."

He thought companies, CEO’s, and professional traders were smart enough to police themselves and manage risk. But now the drunks are blaming the bartender for their hangovers. There was no personal responsibility, no risk management, no accountability. So who is responsible for risk management of your portfolio? Who is your CRO? You are! And if you’re not If you’re not you may end up occupying wall street.

When exactly should we risk manage? Or, to ask this another way, when is the worst time? Exactly! When you have to, because it’s usually too late. The melt down in the financial markets is a perfect example. It’s hard to buy homeowners insurance when your house is on fire. You need to be prepared and set up to profit just when everyone else is running out the door… With a solid risk management process built into your formal trade plan that you adhere to religiously in your personal trading, you can win. But the key point is you must adhere to it. The best risk management process in the world isn't worth the paper it’s printed on if it’s not followed. Just as Jon Corzine did… whose CRO resigned in disgust back in March? I wonder if Madoff has an extra bunk ready?

Four High Level Strategies In my experience from the cockpit to the trading pit, there are only 4 high level strategies that can be applied to address risk in the markets and your trading. After we take a strategic look at risk we’ll take a deep dive into our proprietary Risk Management checklist so I recommend you grab a pen and paper so you can take some notes.

Let’s take a strategic look at the Wealth Creation Investing RM process. We call it:

ARSA

Avoid the risk When looking strategically at a potentially trade, the first strategy we could adopt in our investing is avoidance. We could simply avoid the trade and the risk all together. But this is easier said then done. It has significant consequences. Let me give you an example from the front lines. I’m airborne in my F/A-18 Hornet. My

Reduce

Spread Accept

Avoid

RISK

mission is to destroy an Al Qaeda terrorist camp deep in enemy territory. On my way to the target, my sensors alert me that there’s a hazard ahead. Does you know what this is to the right? That’s right, a SAM or surface to air missile. You see this coming up at you and you’re about to have a really bad day at work…If I discover a SAM site on the route to my target and no other assets are available to take out this threat, I’ll alter my flight path to avoid the SAM site. And I’ll have to avoid this threat by a certain distance and altitude. In doing so, however, my mission will be impacted significantly. For one, I will need additional fuel. I will have to request support from the Air Force (God help me…) or a sister squadron to get some more fuel airborne. Now these airborne fuel tanker assets are usually pretty busy to begin with and there aren’t a lot of them, so someone at a higher pay grade than mine is going to have to make the call – is this target important enough to move tankers around so I can get fuel on the way back to the ship so I can land safely? In addition, avoiding the risk by changing my strike route will add time to the mission and the aircraft carrier. The aircraft carrier will have to change its planned course and speed to be in the proper location for me to land. Having 5,000 sailors and a multi billion asset move around for you isn’t as simple as it sounds. But if the mission is important enough, it’ll happen. So as you can see, avoiding a risk causes serious ripple effects. So for example avoiding a trade with significant risk will have consequences, but the risk of being shot down (in my humble opinion) outweighs those other factors. What about in your trading? What if you choose to avoid a trade because it’s too risky? Yes you might save some money but you’ll potentially miss out on a lot of upside. That’s why I trade options. More risk = more volatility, which potentially based on the tactic = more money. But I’m always hedged so I’m never fully at risk and often never have to avoid a trade. But based on your personal portfolios and risk levels, this may be a strategy you employ sometimes. But you’ll only know to do this if you mapped your trade out properly like we do at Wealth Creation Investing every single time. If for whatever reason we cannot avoid a risk, we could try to minimize. Reduce the risk. As a trader you need to be constantly evaluating whether the risk you’re about to take is worth the return. If it is, you then need to reduce the risk as much as possible so you can potentially make money. One of the best ways to reduce risk is by establishing, or adhering to, standard trading procedures. In the squadron and in my personal trading and at Wealth Creation Investing, we have SOP’s, or standard operating procedures or checklists. And we often said that these procedures were “written in blood.” Why? Because someone messed up pretty bad in the past and we’re going to avoid a similar situation in the future by following procedures and learning from these past mistakes. We improve our future execution and update our SOPs as needed based on previous lessons learned. Let’s look at a final example from the frontlines.

On February 9th, 2001, the Commanding Officer (CO), the CEO if you will, of the USS Greenville, a fast attack submarine, based in Pearl Harbor, HI, would learn this lesson the hard way.

He caused a tragic international incident because he didn’t do what he was supposed to do - reduce risk by following established procedures.

The Greenville had sailed from Pearl Harbor that morning for a day-long “distinguished visitor” cruise. DVs, as we call them, are part of an ongoing public relations campaign conducted by the Navy to curry favor with the business community, civic groups, and politicians. This particular group of DVs hailed from the Commanding Officer’s home state, so he took an elevated interest in their visit. The Chief of Staff of the Pacific Submarine Forces, a high ranking officer, was also onboard; so this got the adrenaline pumping even more.

Once at sea, the Greenville submerged. The DVs were invited to the control room to watch a demonstration of high-speed maneuvers, making it a very crowded control room. Think of a typical college dorm room packed with wall-to-wall high tech equipment and people. When the CO arrived in the control room with the DVs, he immediately began issuing orders to the crew. That may sound normal, but it’s not. In fact, the Officer of the Deck (OOD) is the one normally controlling the ship at any particular moment. And if the CO wanted to take control of the sub, he would have to formally announce this to the crew in the control room. But with the tour running late and the CO wanting to make an impression, procedure was set aside. The maneuvers commenced. Not risk free. Strike one.

As a grand finale, the CO wanted to do an Emergency Main Ballast Tank blow, also known as an “emergency surface.” High-pressure air forces water out of the ballast tanks that made the submarine submerge, sending the vessel on an elevator ride up to the surface. Not overly dangerous, but certainly not risk free.

During the exercise, the sub’s sonar technicians had been tracking two to three surface contacts, but during the aggressive maneuvering, they lost contact with the surface vessels and their systems needed a couple of minutes of non-maneuvering to regain a clear picture of the surface. But instead of taking the required time to allow his team to do this, the CO ordered the OOD to get the sub to periscope depth “within five minutes.” Strike two. They were required to visually check the area where they were going to surface and taking the sub to periscope depth involves a 16-step checklist, and some of the checklist involves multiple sub steps. Five minutes was an extraordinary demand. The OOD was known for being methodical, but that afternoon he felt pressured by the presence of the CO, XO (executive Officer), DVs, and the Chief of Staff. So he deviated from the checklist. Strike two.

When they reached periscope depth, the OOD began to conduct the required visual sweep through the periscope, but the CO stepped in, took a rushed look around, and failed to see the contacts the sonar team had identified earlier. Strike three.

They dove back down to depth to prepare for the maneuver.

The Greenville rammed a Japanese fishery training ship called the Ehime Maru with its steel rudder, and the 40-ton vessel immediately began to take on water. The crew, including a group of

Japanese high school students, scrambled to abandon ship. Five minutes later, the vessel slid beneath the deep blue Pacific, taking five sailors and four HS students to an early grave. All in the name of impressing a couple of DVs.

When all was said and done, the CO was charged with a felony, negligent homicide, as well as dereliction of duty and hazarding a vessel. The Navy faulted the skipper for not following the Navy’s established procedures. Had the skipper followed procedures, the tragedy would very likely have been avoided. At the very least, by following established procedures, the risks would have been greatly reduced. No, most of you traders do not face the same life-and-death situations, but reducing risk and following established procedures in your trading is just as critical. But if you cannot avoid or reduce the risk, you should look for ways to transfer the risk, hedge the position, or spread.

Spread the risk

This is how the smart people make money trading options every single day…they hedge, or spread their risk around. Unless of course…they don’t. Take a look at this stock,InterMune Inc. (ITMN)…

An FDA advisory committee didn’t approve their drug IPF which sent the stock down a staggering 80% in one morning. Back in March of that year the same committee approved a phase of the drug 9 to 3 so chances were high that it would recv final approval.

It didn’t. I had a buddy who was long the stock, “no way it will go down”, “already approved”, blah, blah, blah. Whenever I hear words in like that from a trader the hair on the back of my neck stands up and I immediately think what happens if what they believe doesn’t happen. I instantly become my own CRO. I decided to place bull call spread, a bullish options trade that is also a hedged position. My loss, if there was going to be any, was limited. My buddy’s risk however, was enormous. I held the same belief as my buddy, but we had completely different risk profiles. My buddy got wiped out. I didn't. Oh it hurt, but I lived to fight another day. He didn't. If he had bought what is called a put, basically a type of financial insurance that would protect against a huge loss, he wouldn’t have lost as much money and done correctly he could have paid for that put so this protection wouldn’t have cost him a dime. He may have even profitted. I told him this beforehand and of course he scoffed at having to pay money for the puts. ‘They’ll eat into my profits!’ he said. To this day he still tells me he wished he’d listened to me… His new call sign? Corzine The goal on Wall Street and for professional options traders is to win 51% of time. Retail traders who want to win all the time, who swing for the fence, end up blowing up. I have to shake my head and wonder why many people simply don’t hedge. It’s sad…it doesn’t have to be this way. I may not make the most money, but I make money consistently. And our final strategic look at risk before jumping into our checklist. Acceptance Even when you map out and identify all of the risks, you still can’t eliminate them all. You will have to execute the mission with these risks in mind; you will have to accept them. But we need to think through avoiding, reducing, and spreading risk first and exhaust all these others before deciding to accept risk. Why? Because acceptance is potentially the most dangerous RM strategy to adopt. By accepting risk, you’re saying that the benefits outweigh the possible risks. That’s a big gut check. This is a ‘take the hill’ moment. You’re ordered to take the hill…you’re outnumbered, you know you’re might get slaughtered – you tell yourself all of this but you nod and say, “noted…we’re gonna take the hill.” You over rule your own CRO – you. You’ve done your job if you’ve pointed out the hazards and risks to a potential trade. Accepting risk is when a trader finds out that it's lonely on the tip of the trading spear. That’s a powerful responsibility… Accepting risk means you’re accountable, you made the call and said “I got it.” Accepting too much risk was the root cause of the world financial crisis. Don’t let it be

the cause of your personal financial crisis…you’re either going to be a hero or a goat. -s

Risk is there every time you squeeze the trigger on a trade and launch capital downrange. It’s waiting to take you out and blow up your portfolio. But by looking at risk strategically, by employing one of these 4 strategies, ARSA, we can contain risk and trade more successfully.

Risk Management

WIN!

Reduce

Spread Accept

Avoid

Now let’s look at WCIs 7 Step Risk Management Process and how can employ it today in our portfolios.

TGO Trade Risk Management Process

1. Determine Trade Objective

What are you trying to achieve?

By when?

What are the measures of success?

Without knowing EXACTLY what the trade objective is, you will not be able to effectively manage the risks, and you will fail. The answer to the questions above are easy if you’re employing risk management as part of a dedicated trade planning process like we do at WCI. If these answers aren’t readily available, I’d strongly recommend going back to the drawing board and getting a tighter plan together.

After we have a clear trade objective, we need to -

2. Identify Threats

Internal – Company events, earnings, new product launches, disasters, employee/union issues.

External – FDA rulings, legal issues, market forces, oil prices, unemployment, housing, etc.

Identify all of the threats to the trade. What is going to keep us from hitting our trade objective? At Wealth Creation Inesting we identify these threats as internal and external. What threats internal to the underlying position could hurt me; what threats external to the underlying position might keep me up at night. Once we have identified the threats and have a clear picture of the things that could knock us down, we need to assess them, or decide how big a risk they are to our portfolio.

3. Conduct Risk Assessment

We need to know the potential impact of each threat to our trade objective. In the Navy we used a matrix to measure these hazards, and at TGO we use a similar system in our

trading to assign a numeric value to the risk so we can measure and quantify it.

With risk in our trading – we need to know 2 things – how severe it is, and what’s the probability of it occurring. Severity is pretty self-explanatory and probability is the likelihood that a hazard will result in a mishap or loss. This methodology provides a common framework and language for you to use in your everyday trading.

A trade you identify as a “1” is the most dangerous. It’ll get you killed or wipe out your portfolio if you’re wrong. But if you’re right, you could make a lot of money. A trade ranked “5” is low risk, but also low return. Put your individual capital amounts in the Severity column. At WCI a standard risk management rule of engagement in our Wealth Creation With Options Model Portfolio is we will not risk more than 5% on any one trade. At WCI each model portfolio that’s managed by a professional trader uses this ranking system.

Once you determine your own ‘severity’ dollar amount, you can throw them in there where you see the Roman numerals I-IV.

Let’s take a look at how we’d apply this to a trade.

Sticking with the recent crash of MF G Global, here’s how I would’ve mapped out risk on a potential bullish trade on European debt.

MF Global Trade Risk Assessment

Risk Rank 1. Large exposure to European debt 1 2. No EU bailout, Greece default 2 3. Euro zone countries elect anti-austerity leaders 4

So as you get more comfortable with this process you'll be able to map these threats out quickly and rank them. Now that we have assessed and ranked the risks and assigned it a numerical value, you can make an informed decision and take action.

4. Make Risk Decision

We can now make an informed risk decision and develop an action plan. Earlier we discussed four possible strategies you can take when faced with a risk: Avoid, Reduce, Spread, or Accept (ARSA). You can obviously avoid a trade, even if doing so jeopardizes making a lot of money (or possibly blowing up). You can take actions to reduce risk in the trade. You can spread the risk or hedge with various tactics. Or you can accept the risk in a trade and proceed with the execution of your plan knowing the possible outcome. Once you’ve determined the numerical value assigned to each risk factor, then we can determine what strategy we’re going to employ against it. If you judge a certain risk as a “1” or critical, does it make sense to Avoid it, or should you Spread the risk by employing a hedged options tactic? The point is that every risk in your portfolio deserves this type of assessment. It can mean the difference between making a lot of money or seeing your

portfolio crash and burn.

5. Determine Trade Control Activities

Now all we have to do at this point is execute one of the control activities we selected.

Action items:

Weekly position risk debrief

Employ stop loss

Limit order

Other WCi tactics We need to develop specific control activities, or action items that must be carried out during the life of the trade. For those familiar with WCI trading, we call this our ‘mid course guidance’. Implement the action items you have determined will aid in avoiding, reducing, or spreading the risk. Once you have completed your risk planning, it is imperative to -

6. Manage, Monitor, and Exit the Trade

Manage, Monitor and Exit for max profit and min loss.

Max profit

Min loss/Eject Level

Breakeven

Reduce

Spread Accept

Avoid

Follow the WCI Trade Plan If you follow this systematic and proven trade risk management process, you’re going to win more often than other retail traders struggling with what to do in this volatile market.

Trade Risk Management

1. Determine Trade Objective 2. Identify Threats 3. Conduct Risk Assessment 4. Make Risk Decision 5. Develop Control Activities 6. Manage, Monitor, and Exit 7. Win!

The Wealth Creation Investing Risk Management Process will help you overcome trading risks

and you will potentially win.

It’s a dangerous world out there folks. The trader or institution on the other side of your trade wants to knock you out of the sky. They could care less about you, your family, your savings, you name it. Remember, that’s why trading is combat. And with WCI you’re gonna be on the winning side. Happy hunting and make sure you hedge!

RISK