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If you were in the market during the last year, chances are you lost money. It seems most of us are bullish traders: if the market is up, we make money; if it's down, we lose. There are, of course, at least two other styles of trading: neutral and bearish. What is neutral trading? It's a trading method that enables traders to be profitable regardless of market direction. How can that be, you ask? Well, if you're a stock trader, it's certainly not easy. However, if you're an options trader, there is a multitude of possibilities for profiting from stagnant or vacillating markets.

My favorite is the calendar spread, whereby an option with both a long expiration limit and low volatility is purchased simultaneously with the offsetting sale of a nearer-term option with high volatility. The trade is directionally hedged, and the profit is made by purchasing back the short option after its time value and/or volatility erodes to the point where it has lost much of its worth. Meanwhile, the long-term option that was purchased as a hedge has not lost much value, so when the trade is closed (long option sold simultaneously with the repurchase of the short option), there is a net profit.

I have profited very nicely with this type of neutral trade in the last several months and have written articles about this strategy (and even some of my trades, all of which are available in the Optionetics.com archived articles section).

But this week's column is about lessons learned the hard way and what the bear taught me last year. So why am I telling you about neutral calendar trades? Quite simply, the number one lesson I learned last year is not to trade your entire account directionally anymore, that's why!

I entered the options game several years ago and rode, with the rest of us, the escalator up until it started backsliding in March of 2000. My board of choice has been the Nasdaq-the money is real and no one has ever given me two hundred dollars for passing Go. It was an easy game. I did it with stock and option plays that made lots of money and created a false sense of perpetuity and expertise. "I know how to play the game," I thought, and I wasn't alone-you probably thought so, too. And indeed, make money we did! Anyone can play the game and win when the market is going up, up, up. I remember a period in late December of 1999 when it seemed the market rose about 14 days in a row! I had placed a bunch of bullish vertical option trades in November, and my account was growing by several percentage points everyday.

It was a time of "buying the dips." Sure, there were days-even several in a row-when the market went down, all of which were capped off with a high volume up day as the buyers stepped in to pick up their favorite tech shares at "discount" rates. Amazingly, the prices that seemed such bargains were the prices the stocks had been trading at just a week or two prior! There was none of this "2-year low" stuff that's going on now in so many tech giants.

Let's jump ahead to the rest of 2000. My account, like many of yours, suffered a lot of damage. I was very heavily leveraged to the upside. By this I mean that if the upswing had continued, I would have profited wildly; and if the market stagnated or turned down, I'd be flat or start hemorrhaging my profits. Well, we all know what it did. I closed many positions in the spring and summer and saw many open positions annihilated. Why am I sharing this with you when I'm supposed to be an expert trader? Well, I'm trying to communicate a couple of points.

First, I learn better from real people who aren't afraid to can show me their mistakes so that I can learn the lesson and (hopefully) become a better trader. There's simply no need for false bravado-I got kicked, some (OK, most) of it by my own volition, and I learned from it. I'd like to teach you the lessons I learned so we don't go through it again.

Second, there will be markets like this again and again. The market giveth and the market taketh away! If you're serious about becoming a seasoned, successful trader, it's important to have more than simply bullish strategies in your arsenal. At the beginning of the game, that's all I had. But that was OK, since it was the time to be bullish. Now, through the expensive process of learning from my own experience, I've taught myself how to combine trades, take a bullish, neutral or bearish stance, and profit in any market.

If not for the bear market of the last year, I wouldn't have had the impetus to learn to trade neutrally and bearishly (although yes, I'd have been more than happy to keep winning with bullish trades). I took the opportunity to learn other alternatives rather than sit by and blame Alan Greenspan and the Fed for my fractured account. Pain is a great learning motivator, regardless of whether it's emotional, spiritual, physical pain (or in this case, financial pain).

I don't blame the Fed completely for what's happening in the markets right now. It's a confluence of factors: all-time high natural gas and heating oil prices sapping household budgets this winter, high costs at the fuel pumps, adjustable rate mortgages (which have gone up substantially with the six rate hikes of the last 18 months), erosion of the stock market wealth effect (which had given people the sense of security to spend more of their household recurring income) and, of course, six rate hikes imposed before the effects of the first two could be gauged.

Never has there been a time in our economy when all of these factors converged as they are now. People, as we saw during the Christmas season, are afraid to spend. PCs are piled to the rafters in the electronics stores. This will have a trickle (flood?) effect on the PC manufacturers in the first two quarters of this year as inventories must be cleared before new models can be moved. Next, this will ripple to the component suppliers for those PCs. You know the names. And on it goes.

Ever the optimist, however, I do know that the picture will eventually change-probably by the third quarter of 2001, when, coincidentally, the effects of the first few rate reductions by the Fed will be felt throughout the economy. Credit card rates and mortgage payments will come down, people will spend more freely, analysts will lift their earnings forecasts on companies, the market will resume its upward trend, and we'll enter a multi-year period of prosperity again. (OK, OK, maybe I'm wrong, but even so, by then you'll have forgotten who wrote this article anyway!)

Trading flexibility and the desire to learn more are just a few of the lessons the bear market taught me this year. In addition, I understand many more of the factors that go into the health of our economy than I did a year ago (when I could just look at a stock, choose a target price, put on a play... and be right).

How will I trade now? Neutral and hedged. Calendar spreads are my favorite type of play these days. I have spent hundreds of hours testing, back testing and forward testing the many ways of hedging one option against another, using the same strike price and different months while taking advantage of volatility skews. In some cases, for very long-term calendar spreads, I'll place a bullish bias in the trade, choosing strikes that are above the current market value of the underlying stock. For the shorter-term trades, I like to sell an option with a strike pretty close to the current market price on the stock and that way I can maximize the incoming premium and hedge it with a longer-term option.

Will I go back to vertical spreads? Yes, they are still a part of my trading arsenal, and in many cases I can combine them with calendar spreads on the same stock to create a profit curve with very little downside and plenty of upside. I'll also choose more reasonable expectations for total return in my portfolio than I had in the past. I realize now that staying in the game is the only way to get to the goalpost.

As this is my last column before the Superbowl, my final lesson and piece of advice to you is not to throw any "Hail Mary" passes on the trading field-just go for lots and lots of first downs with plenty of blocking protection, take the occasional end run if you see an opening, and maybe, just maybe-if you see a clear path-throw a 20-yard pass with a very small portion of your football.

Enjoy the game, keep learning, and happy trading!

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Recent Articles by Ed Hecht, Optionetics.com

• April 9, 2001
  Riding the (Elliott) Wave to Profits
• February 23, 2001
  Being Assigned is Not the End of the World
• February 14, 2001
  The Generalist vs. the Specialist
• January 31, 2001
  Activating a Game Plan for the New Year
• January 17, 2001
  Lessons Learned the Hard Way Thanks to Last Year's Bears