Lately I've been tinkering with credit spreads and naked puts in SPY, more out of curiosity than anything else... that is until I did some extensive studying of the historical SPY data. More on that another time though.
I have dabbled in options before and made out very well.... and not so well in varied proportions. The one strategy that I did have a 100% success rate (albeit with not as many trades as would be needed to prove feasibility) with was the credit spread. It was short lived due to my need for continued testing of other strategies and styles of trading, which is now one of those hindsight stories.
The basic credit spread plan is to sell an out of the money option and buy a further out of the money option with the same expiry. The first is the profit and the second is the protection. The risk is fixed and is the difference in the strike prices less the premium collected. The trouble is getting enough premium difference between the two transactions to be profitable which made me consider the naked option.
Naked option selling looks much more lucrative up front as selling the option without the need for a protective leg purchase means that all of the premium collected is kept. This often allows the sold option to be farther out of the money and still be profitable. The trouble is that the risk is no longer defined.
With a naked put, if the price plummets the loss becomes the difference between the strike price of the put and the price of the underlying at expiry. Not that a stock is going to hit zero but a large down move could be a real problem. This is the point where my SPY study comes in to provide some historical context for the risk involved.
While the naked options look enticing for the reasons mentioned and the credit spreads look to be a safer bet, the upfront account management implications for both need to be considered and compared.
Account size.
A typical broker may have a $5,000 minimum account balance in order to trade credit spreads whereas $25,000 is required to sell naked options. This makes the credit spread more accessible to the small account holder or hobby trader. Anyone halfway serious can probably start with enough to choose either method but only if they are comfortable and confident in the plan and have at least $100,000 would they really be able to use naked option selling.
Margin requirements.
The credit spread requires the entire potential loss to be in the account... so, technically, margin is not even being used. With a spread that covers a $1 strike price range, this amounts to about $100 per contract and the margin does not change with the price of the underlying stock. This is also the entire amount risked, less the premium collected, on the trade. It will vary with how wide the spread is in increments of $100 per strike per contract. Because the protective put will be exercised to offset the naked put in a worst case scenario, there is no chance that there will be any assignment of the stock or ETF.
For a naked option this amount is more variable and is not the entire risk associated with the trade. For a $100 stock the margin required might be in the $1,500 range whereas a $200 stock could be around $3,000. It varies with how far out of the money the option is and how much premium was collected for it. The margin requirements also change with the stock price.
These differences make the credit spread a more viable trading method for those with small to medium accounts as naked option trades will tie up much more cash per transaction.
For example, a naked 140 put for November expiry sold for 19 cents on September 30th. 10 contracts would yield $170 after commissions but based on a margin requirement of $24,860 which is an ROI of 0.68%. That is one trade.
A credit spread between 141 and 135 strikes sold at the same time with the same expiry would yield 7 cents net. It would take 42 contracts in one trade to equal the cash return of the naked option using $25,000. The advantage is that four separate trades could be placed at varied times and dates which could be at different strikes based on the price movement and these can be staggered in a way to reduce the chance of a price move producing a loss. Four trades of 10 contracts each that I am currently tracking are from September 30th, October 3rd, 7th and 8th with 10 contracts per trade which can yield a combined $200 profit after commissions based on a margin requirement of $23,800 or an ROI of 0.84%.
A quick note, both the naked puts sold and the credit spreads that I track are set up such that they have a success rate of better than 98% over 20 years. Even then the few times that they were "losers" appear to have been easy to close before they were a total failure... which is more important with the naked options than the spreads.
(UPDATE: I am investigating strategies based on historical statistics and current data that will serve to increase the returns on risk and maybe even increase the probability of the trades being winners.)
Jeff.
Questrade, My direct access discount broker.
Showing posts with label option strategies. Show all posts
Showing posts with label option strategies. Show all posts
Wednesday, October 9, 2013
Saturday, May 14, 2011
Strangling 96 out of 100 and Online Spreadsheet Woes.
I usually use online spreadsheets to run my data when I am working on a new strategy and trying to see the future possibilities based on past performance. This time I have had to use a PC based system as there is just too much processing involved. The online services just cannot handle it. As a result I don't have my spreadsheets with me today, so my numbers are going to be rough generalizations. I also have some more adjusting that I need to do to my entry and exit criteria to get the accuracy that I would like.
Actually, on the entry and exit. This particular strategy does not conform to the typical style of back testing that you might see when trying to buy or sell a stock based on indicators. In those cases the indicators need to be overlaid and entry exit prices determined by using some complicated formula and a charting service that has some level of backtesting capabilities. While there area number they are not cheap and the results are not always exactly what would have actually been traded... for a number of reasons.
Due to that my backtesting has typically been done by hand so that I would see what had gone on and applied my rules accordingly, I got to see exactly where the plan worked and didn't rather than just getting a number at the end of the test. This was necessarily very time consuming and, if a plan did not pan out, it was often frustrating.
This is different. I am not concerned with entry and exit points. I am not overly concerned with the price movements that the underlying security exhibits. I really don't care if it goes up or down or nowhere after a trade entry, only if it goes past my set move allowance from trade initiation to completion. The test is a win or loss determination for each trade based on the particular opening price and the particular price at option expiry (could be Friday's opening or closing depending upon the style of option traded). Each week there are one or two trades made, the allowance is applied for the time period and the result is spit out and tabulated as a total number over whatever time period I am testing for.
Also, unlike many backtesting plans my window tested can go back as far as I have data available. I can easily get free data for about 18 years, run that through my spreadsheet and produce a win rate in moments... just not online. If I want to apply a normal loss allowance I can do that, or I can use the actual closing value of the stock at the expiry of the trade to determine what the un-stopped loss could have been, sort of a worst case let it all ride scenario. I expect to do both methods to see what would have happened.
At this point I am seeing a greater than 96% win rate over all traded timeframes (1, 2 and 3 days). Well above my estimated 80% requirement. This is without any adjustments, just applying an allowable move percentage and making a sweeping assumption that I would have to use that allowance each and every time. In more volatile markets I could use a much wider allowance so the percentage I started with is really a minimum. I would rather not try to guess where the allowance could have been greater so I will just consider this as a worst case scenario. I have always liked to skew the results against me in order to keep the expectations more realistic.
Given such a high win rate and using a loss allowance of 4 times my option value (I may change that for a number of reasons but it is a good place to start) and applying this over the past since 1993 produces some very large numbers. I tend to think that the numbers are large enough that they can be discounted as, more or less, unworkable in a single security option. I expect that, at some point splitting the account into multiple security options would be necessary to not be trading all of the available open interest... that and switching to or adding the larger and more expensive index futures. This would also serve to mitigate any potential single loss. Of course there is always the removing of cash from the plan to use for personal uses along the way. I am not letting these numbers get me too excited as this is a longer term income strategy and I have yet to see what premiums can be sold in various option chains after applying reasonable move allowances to their respective historical data. I also have not accounted for income taxes in any of my math yet.
Even though past results do not guarantee future results I can at least be certain that if a stock or index fund exhibited 96 winning trades for each 100 trades and held this average for 18 years using a single move allowance value I can be pretty sure that some similar result may be reasonably expected to continue, particularly if I can apply varying move allowances to suit the volatility of the market in real time.
Jeff.
Actually, on the entry and exit. This particular strategy does not conform to the typical style of back testing that you might see when trying to buy or sell a stock based on indicators. In those cases the indicators need to be overlaid and entry exit prices determined by using some complicated formula and a charting service that has some level of backtesting capabilities. While there area number they are not cheap and the results are not always exactly what would have actually been traded... for a number of reasons.
Due to that my backtesting has typically been done by hand so that I would see what had gone on and applied my rules accordingly, I got to see exactly where the plan worked and didn't rather than just getting a number at the end of the test. This was necessarily very time consuming and, if a plan did not pan out, it was often frustrating.
This is different. I am not concerned with entry and exit points. I am not overly concerned with the price movements that the underlying security exhibits. I really don't care if it goes up or down or nowhere after a trade entry, only if it goes past my set move allowance from trade initiation to completion. The test is a win or loss determination for each trade based on the particular opening price and the particular price at option expiry (could be Friday's opening or closing depending upon the style of option traded). Each week there are one or two trades made, the allowance is applied for the time period and the result is spit out and tabulated as a total number over whatever time period I am testing for.
Also, unlike many backtesting plans my window tested can go back as far as I have data available. I can easily get free data for about 18 years, run that through my spreadsheet and produce a win rate in moments... just not online. If I want to apply a normal loss allowance I can do that, or I can use the actual closing value of the stock at the expiry of the trade to determine what the un-stopped loss could have been, sort of a worst case let it all ride scenario. I expect to do both methods to see what would have happened.
At this point I am seeing a greater than 96% win rate over all traded timeframes (1, 2 and 3 days). Well above my estimated 80% requirement. This is without any adjustments, just applying an allowable move percentage and making a sweeping assumption that I would have to use that allowance each and every time. In more volatile markets I could use a much wider allowance so the percentage I started with is really a minimum. I would rather not try to guess where the allowance could have been greater so I will just consider this as a worst case scenario. I have always liked to skew the results against me in order to keep the expectations more realistic.
Given such a high win rate and using a loss allowance of 4 times my option value (I may change that for a number of reasons but it is a good place to start) and applying this over the past since 1993 produces some very large numbers. I tend to think that the numbers are large enough that they can be discounted as, more or less, unworkable in a single security option. I expect that, at some point splitting the account into multiple security options would be necessary to not be trading all of the available open interest... that and switching to or adding the larger and more expensive index futures. This would also serve to mitigate any potential single loss. Of course there is always the removing of cash from the plan to use for personal uses along the way. I am not letting these numbers get me too excited as this is a longer term income strategy and I have yet to see what premiums can be sold in various option chains after applying reasonable move allowances to their respective historical data. I also have not accounted for income taxes in any of my math yet.
Even though past results do not guarantee future results I can at least be certain that if a stock or index fund exhibited 96 winning trades for each 100 trades and held this average for 18 years using a single move allowance value I can be pretty sure that some similar result may be reasonably expected to continue, particularly if I can apply varying move allowances to suit the volatility of the market in real time.
Jeff.
Wednesday, May 11, 2011
Strangling, forecasting the required win rate
Before I get to the backtesting results I figured I should check what might be needed for a win rate in order to produce a profitable plan. If I assume that I use a stock/ETF option produces at least a 10 cent credit each week I was going to setup a spreadsheet to forecast this over a period of time, a few years anyway, but decided that if I applied a very basic ratio of loss allowance against the expectation of profits it is very simple to calculate.
I figured if a 10 cent credit trade provides a $100 profit (10 contracts per side of the strangle, ignoring commissions at this point as they are only worth about 2 cents of the trade and I figure that 10 should be a low enough expectation to accommodate that).
Given the nature of a strangle, limited gain for larger possible loss, I used 4:1 loss over gain on a per trade basis. The 10 cent trade could loose 40 cents (which is actually a 50 cent move but the 10 cent credit gets applied against the loss) or a losing trade would be $400 for a winning expectation of $100.
Given this simple math I would need to see 4 trades to cover the one loss which is actually an 80% win rate just to break even. That's tough in the world of trading in the normal sense of buying and selling based on charts, fundamentals or news.
Keeping this in mind I will run the numbers for trading based on SPY (any index ETF would suffice to see the trend over time). After applying the range of 4% from open to close of the trading period I decided that I should also allow this range to be variable to see how much of a difference it might make on the win rate.
I also noted that I had been using the numbers based on Friday's closing price. there are only a small handful of options that expire in the evening of Friday, most expire based on the opening price on Friday morning. this is calculated based on the first moments of the market so I also need to adjust my spreadsheet test to accommodate this as well. Doing so makes the results more accurate as Friday can move quite a bit from open to close.
Win rates over time coming up.
Jeff.
I figured if a 10 cent credit trade provides a $100 profit (10 contracts per side of the strangle, ignoring commissions at this point as they are only worth about 2 cents of the trade and I figure that 10 should be a low enough expectation to accommodate that).
Given the nature of a strangle, limited gain for larger possible loss, I used 4:1 loss over gain on a per trade basis. The 10 cent trade could loose 40 cents (which is actually a 50 cent move but the 10 cent credit gets applied against the loss) or a losing trade would be $400 for a winning expectation of $100.
Given this simple math I would need to see 4 trades to cover the one loss which is actually an 80% win rate just to break even. That's tough in the world of trading in the normal sense of buying and selling based on charts, fundamentals or news.
Keeping this in mind I will run the numbers for trading based on SPY (any index ETF would suffice to see the trend over time). After applying the range of 4% from open to close of the trading period I decided that I should also allow this range to be variable to see how much of a difference it might make on the win rate.
I also noted that I had been using the numbers based on Friday's closing price. there are only a small handful of options that expire in the evening of Friday, most expire based on the opening price on Friday morning. this is calculated based on the first moments of the market so I also need to adjust my spreadsheet test to accommodate this as well. Doing so makes the results more accurate as Friday can move quite a bit from open to close.
Win rates over time coming up.
Jeff.
Strangling the weekly options, back testing
I downloaded the historical data for SPY from about 1993 to date and ran three checks.
The first compared the opening price on Thursdays to the closing price on Fridays to represent the percentage move over those two days. The second compared the opening on Wednesday and the Third the opening on Tuesday, again to the close on Friday.
These tests would show the number of times that the price of SPY, in my first test, moved 4% over one of these periods. Now this does not reflect the trades being set at strikes that are greater than 4% away nor does it factor times that I might only make one side of a trade to reduce risk during particularly edgy times. I am assuming that I am trying to set this as a, more or less, automatic style of trading where I can place the trades according to strict rules. I would count all the trades, winners and losers, and use the lowest target trade entry price. For a full strangle my lowest acceptable credit would be 10 cents. That may change as I track the current weekly trade possibilities, but it is a good conservative number for now.
These tests would also count a cumulative profit and increase the trade size as the capital base grew. I know that weekly options were not available in 1993, not actually until fairly recently, so the exercise is for interest sake mainly. At least the testing covers the tech bubble and the latest bear market and the infamous flash crash.
More on the results tomorrow.
Jeff.
The first compared the opening price on Thursdays to the closing price on Fridays to represent the percentage move over those two days. The second compared the opening on Wednesday and the Third the opening on Tuesday, again to the close on Friday.
These tests would show the number of times that the price of SPY, in my first test, moved 4% over one of these periods. Now this does not reflect the trades being set at strikes that are greater than 4% away nor does it factor times that I might only make one side of a trade to reduce risk during particularly edgy times. I am assuming that I am trying to set this as a, more or less, automatic style of trading where I can place the trades according to strict rules. I would count all the trades, winners and losers, and use the lowest target trade entry price. For a full strangle my lowest acceptable credit would be 10 cents. That may change as I track the current weekly trade possibilities, but it is a good conservative number for now.
These tests would also count a cumulative profit and increase the trade size as the capital base grew. I know that weekly options were not available in 1993, not actually until fairly recently, so the exercise is for interest sake mainly. At least the testing covers the tech bubble and the latest bear market and the infamous flash crash.
More on the results tomorrow.
Jeff.
Tuesday, May 10, 2011
Strangling Risk Management
First note, weekly options expire every Friday which means they are very short term as the trade is closed as of Friday's closing price. If the price falls short of the call strike and doesn't drop as low as the put strike then I keep all the premium. If I sell options on Wednesday or Thursday I limit my exposure to one or two days, no positions held for a possible weekend move. With the short time to expiry there is not much premium left for time decay so the options are fairly cheap, probably less than 15 cents normally... depending on risk tolerance and volatility at the time.
All that the price needs to do is not go into the money in either direction so I need to set my risk levels wide enough to miss most of the large moves and close enough to still have some premium left to sell. For SPY I tried 4% first. Based on this, as long as the price does not move up or down 4% from the time of the trade then the trade is a winner.
On a stock with a price of $100, just to make the math simple, I would sell the $104 calls and the $96 puts. Calls are usually less risky than puts as a price is more liable to drop faster and farther than to rise far and fast so I wouldn't mind holding the strike a bit closer whereas a put I would sooner leave a little more room. So if the same stock was priced at $100.50 I would still sell the $104 call but if the price was $90.50 I would move the put down to $95 to have AT LEAST a 4% allowance.
4% is just a guideline though. As the market becomes more volatile premiums rise and I could just as easily go to 5, 6, or 7% as long as I meet my target weekly option price. I haven't set targets yet as I need to watch the options for a while to see which ones will be the best for premium vs risk.
Watching the stock for price moves into the money is one way to keep track of the trade. Another is to just set a stop loss. I am not as keen on stop losses on options as option prices can vary widely even though the option is still OTM. Perhaps a 4 or 5 times loss allowance would do it. For example, a 10 cent option sold would have to go to 50 cents to stop out. I am not as comfortable with this as it could lead to some whipsaws so I would prefer, when I can, to monitor the price activity when the option prices get that far out.
Actually, another method of loss mitigation could be to sell the next higher (for calls) or lower (for puts) strikes seeing as the prices are higher. Closing the first trade may not be required but can be part of the plan. While this might not eliminate a loss, selling another 10 cent option farther out can at least cut it by 20 or 25%. Adding the other side of the trade to make a new strangle using the new stock price and adjusted strikes could effectively cut the loss by as much as 50%. Obviously I have not worked this particular trade management out completely as there is only a day or two in the original trade anyway. The worst case would be that one week's loss needs to be recouped over the next three or four weeks. How often can a stock make statistically unlikely moves from week to week? Given the correct analysis and application of the risk management strategy I expect losses to be few and far between even if they are larger relative to the individual gains.
Jeff.
All that the price needs to do is not go into the money in either direction so I need to set my risk levels wide enough to miss most of the large moves and close enough to still have some premium left to sell. For SPY I tried 4% first. Based on this, as long as the price does not move up or down 4% from the time of the trade then the trade is a winner.
On a stock with a price of $100, just to make the math simple, I would sell the $104 calls and the $96 puts. Calls are usually less risky than puts as a price is more liable to drop faster and farther than to rise far and fast so I wouldn't mind holding the strike a bit closer whereas a put I would sooner leave a little more room. So if the same stock was priced at $100.50 I would still sell the $104 call but if the price was $90.50 I would move the put down to $95 to have AT LEAST a 4% allowance.
4% is just a guideline though. As the market becomes more volatile premiums rise and I could just as easily go to 5, 6, or 7% as long as I meet my target weekly option price. I haven't set targets yet as I need to watch the options for a while to see which ones will be the best for premium vs risk.
Watching the stock for price moves into the money is one way to keep track of the trade. Another is to just set a stop loss. I am not as keen on stop losses on options as option prices can vary widely even though the option is still OTM. Perhaps a 4 or 5 times loss allowance would do it. For example, a 10 cent option sold would have to go to 50 cents to stop out. I am not as comfortable with this as it could lead to some whipsaws so I would prefer, when I can, to monitor the price activity when the option prices get that far out.
Actually, another method of loss mitigation could be to sell the next higher (for calls) or lower (for puts) strikes seeing as the prices are higher. Closing the first trade may not be required but can be part of the plan. While this might not eliminate a loss, selling another 10 cent option farther out can at least cut it by 20 or 25%. Adding the other side of the trade to make a new strangle using the new stock price and adjusted strikes could effectively cut the loss by as much as 50%. Obviously I have not worked this particular trade management out completely as there is only a day or two in the original trade anyway. The worst case would be that one week's loss needs to be recouped over the next three or four weeks. How often can a stock make statistically unlikely moves from week to week? Given the correct analysis and application of the risk management strategy I expect losses to be few and far between even if they are larger relative to the individual gains.
Jeff.
Monday, May 9, 2011
Breaking down the naked option income strategy
Well, historical option pricing is a pain to acquire for regular options let alone weekly, so I will just do some tracking this week figuring that the current activity is more or less average.
I ran up a spreadsheet to compare trade sizing vs option pricing to get an idea of how much capital I would need to maximize my returns based on the commission rates that I currently have. The thing about this strategy is that the premium collected from selling an option that is far enough OTM to be relatively safe is relatively small. Selling 5 and 10 cent options means selling enough contracts to make it worth while. For example a 10 cent option selling 10 contracts returns a net profit of $83.05.
An easy method to increase the revenue without increasing the risk is to turn the trade into a strangle. If both sides (the higher strike call option and the lower strike put option, a naked strangle) are taken simultaneously the commissions are less than doubled (with Questrade anyway) whereas the potential profit can be as much as doubled.
Selling calls at $140 strike and puts at $130 strike for a stock priced at $135 might create a 15 cent credit or more (5 cents on the call and 10 cents of the put, but these prices depend on a lot of factors). This particular single contract trade would require a cash balance of $985 to cover the margin requirements, although a single contract is not really worth the effort due to the small credit acquired. Take it up to 10 contracts per side and the margin requirement is $9,850. Profit on this trade would be $123.05 or, based on cash allocated, 1.25% return.
The down side of this is that, in the rare case that a trade goes against me the loss far outweighs the profits. This only means that the trading record has to have a very high win/loss ratio... back to the spreadsheet to create some historical tracking.
Jeff.
I ran up a spreadsheet to compare trade sizing vs option pricing to get an idea of how much capital I would need to maximize my returns based on the commission rates that I currently have. The thing about this strategy is that the premium collected from selling an option that is far enough OTM to be relatively safe is relatively small. Selling 5 and 10 cent options means selling enough contracts to make it worth while. For example a 10 cent option selling 10 contracts returns a net profit of $83.05.
An easy method to increase the revenue without increasing the risk is to turn the trade into a strangle. If both sides (the higher strike call option and the lower strike put option, a naked strangle) are taken simultaneously the commissions are less than doubled (with Questrade anyway) whereas the potential profit can be as much as doubled.
Selling calls at $140 strike and puts at $130 strike for a stock priced at $135 might create a 15 cent credit or more (5 cents on the call and 10 cents of the put, but these prices depend on a lot of factors). This particular single contract trade would require a cash balance of $985 to cover the margin requirements, although a single contract is not really worth the effort due to the small credit acquired. Take it up to 10 contracts per side and the margin requirement is $9,850. Profit on this trade would be $123.05 or, based on cash allocated, 1.25% return.
The down side of this is that, in the rare case that a trade goes against me the loss far outweighs the profits. This only means that the trading record has to have a very high win/loss ratio... back to the spreadsheet to create some historical tracking.
Jeff.
Return to the basics in option trading
I almost called it "Return to Fundamentals" but I am not a fundamental trader, never have been and I don't see that changing. Oh, this involves naked options, not really basic but the strategy is easy and should prove consistently profitable and, overall, relatively low risk.
I still like my latest trading plan but I don't like the need to hold a bunch of stocks in the wings waiting for trade setups. I look at tweaking the system every once in a while in order to generate more trades but I realize that more trades does not equate to more profit, often it is quite the contrary.
So, I return to an option trading strategy that I started a while back and add a few incidental facts that I did not have available at the time. If any were following along then and are still here it was my iron condor option trade strategy. While it happened to produce 100% profitable trades while I worked it, I shut it down as the SPY ETF options were getting rather cheap. This only served to drive the risk up while trying to optimize the profitability as I have to take options that were further away from expiry and closer to the strike prices. Besides, I had another grand trading scheme in mind at the time.
The little fact that I did not have at the time was that weekly expiry options were becoming available for various index ETFs. I had determined that I would need to start trading futures in order to see enough premium in option selling to justify running iron condors but I had tried that using a service already, and it did not pan out very well. Losses were more frequent and larger than I would have figured, but that is sometimes what happens when you work with a service and have less control over the trades directly.
Now, rather than selling options then having to buy the corresponding protective options to look after loss control I can directly sell options and set stop orders to exit for protection.
This allows two things to happen. One, cost savings for the trade overall, no buying and Two, I can take cheaper options which means closer to expiry (days) and/or farther out of the money.
This is where the weekly options come into play. Each week I can place a trade that is one, two or maybe three days away from expiry and select options that are far enough out of the money that the chances of them closing in the money are very very slim, I'll work that one out next post. These options are using the European method where they cannot be assigned prior to expiry so there is zero change of getting stuck with stock pre-maturely and they are traded right through to Friday evening which means I don't have to just sit and wait to see what happens on Friday as the prices could go anywhere. I had that happen where a loss turned into a larger loss over the Thursday night. Not fun.
I know this is an all over the place post but I wanted to get some information down and out of my head so I could focus on the particulars that I need to work out before this actually can be deem ed a workable trading plan. 15 years of backtesting for starters... even though the weeklies have not been around for more than a few years this lets me track the underlying price activity in order to see historically significant moves which provides me some idea of the possible risk involved.
Jeff.
I still like my latest trading plan but I don't like the need to hold a bunch of stocks in the wings waiting for trade setups. I look at tweaking the system every once in a while in order to generate more trades but I realize that more trades does not equate to more profit, often it is quite the contrary.
So, I return to an option trading strategy that I started a while back and add a few incidental facts that I did not have available at the time. If any were following along then and are still here it was my iron condor option trade strategy. While it happened to produce 100% profitable trades while I worked it, I shut it down as the SPY ETF options were getting rather cheap. This only served to drive the risk up while trying to optimize the profitability as I have to take options that were further away from expiry and closer to the strike prices. Besides, I had another grand trading scheme in mind at the time.
The little fact that I did not have at the time was that weekly expiry options were becoming available for various index ETFs. I had determined that I would need to start trading futures in order to see enough premium in option selling to justify running iron condors but I had tried that using a service already, and it did not pan out very well. Losses were more frequent and larger than I would have figured, but that is sometimes what happens when you work with a service and have less control over the trades directly.
Now, rather than selling options then having to buy the corresponding protective options to look after loss control I can directly sell options and set stop orders to exit for protection.
This allows two things to happen. One, cost savings for the trade overall, no buying and Two, I can take cheaper options which means closer to expiry (days) and/or farther out of the money.
This is where the weekly options come into play. Each week I can place a trade that is one, two or maybe three days away from expiry and select options that are far enough out of the money that the chances of them closing in the money are very very slim, I'll work that one out next post. These options are using the European method where they cannot be assigned prior to expiry so there is zero change of getting stuck with stock pre-maturely and they are traded right through to Friday evening which means I don't have to just sit and wait to see what happens on Friday as the prices could go anywhere. I had that happen where a loss turned into a larger loss over the Thursday night. Not fun.
I know this is an all over the place post but I wanted to get some information down and out of my head so I could focus on the particulars that I need to work out before this actually can be deem ed a workable trading plan. 15 years of backtesting for starters... even though the weeklies have not been around for more than a few years this lets me track the underlying price activity in order to see historically significant moves which provides me some idea of the possible risk involved.
Jeff.
Wednesday, March 17, 2010
Crunch time on a couple of trades
The trouble with playing index futures option spreads is the same trouble that had me stop trading spreads on SPY a few months back, lack of volatility.
Initially, lack of volatility looks like a good thing when you just don't want the security or index that the spread is on to move against the spread... or to stay within the entire trade for an iron condor. Low volatility sounds like the levels are just not changing quickly so the moves, when they come, will generally be slow.
While that seems to be true on the surface, volatility is priced into the premiums of the options contracts. Higher volatility equals higher premiums... they just plain cost more. The reverse is also true, low V = lower premiums which leads to having to take either wider spreads or spread that are closer to the level at the time.
This is where things can get hairy.
To keep the absolute risk the same all the time, for instance 20 points on the S&P500 futures between short and long calls, means moving that much closer to the levels at the time. I placed two call spread trades last month with short durations. These were at the 1160/1180 and 1165/1185 levels. In order to make my profits the S&P500 would have to stay under these levels. For the sake of one day entering the trades I could have (and did try...but that is another story) to set 1170/1190.
One day made the difference between being profitable and taking a decent loss...had I closed my trades today. I decided to hold as the price of the trade to close is inflated due to the proximity of the S&P levels to the spread trades. So buying back my short 1160 call while the S&P is at 1165 would cost me $1250 in intrinsic value (5 points X $250) plus at least half that again in extrinsic value. That is close to a $2000 loss.
Waiting one more day drops the extrinsic value by a certain amount...waiting until Friday drops it to zero. So my dilemma is now to decide if I out wait the market and hope for a move lower and/or let the trades expire ITM and take only the real intrinsic value hit by not buying back the options. Last month my trades lost a bit as I closed them taking the extra hit...as it turned out I should have (famous last words, I know) held them to see 100% of my profit as the market did turn for me...too late though.
The trouble is for every point into my trade the S&P goes the tally against me goes up $250...per trade.
I still really like the iron condor trades, I just need to rethink my short term entries...at the very least when the market is low in volatility. Had I been doing these trades all on my own I would have sacrificed some gains to move the trade farther as I knew that these ones ended up inside the trend channel on the upside... but the odds were in my favour even then. The thing about odds is the math really doesn't matter... what happens is what matters. I have that argument the odd time with mathees though.
I did have some faith in the S&P not breaking the 1150s before Friday... but that was last week and 1150 is already past.
Jeff.
Initially, lack of volatility looks like a good thing when you just don't want the security or index that the spread is on to move against the spread... or to stay within the entire trade for an iron condor. Low volatility sounds like the levels are just not changing quickly so the moves, when they come, will generally be slow.
While that seems to be true on the surface, volatility is priced into the premiums of the options contracts. Higher volatility equals higher premiums... they just plain cost more. The reverse is also true, low V = lower premiums which leads to having to take either wider spreads or spread that are closer to the level at the time.
This is where things can get hairy.
To keep the absolute risk the same all the time, for instance 20 points on the S&P500 futures between short and long calls, means moving that much closer to the levels at the time. I placed two call spread trades last month with short durations. These were at the 1160/1180 and 1165/1185 levels. In order to make my profits the S&P500 would have to stay under these levels. For the sake of one day entering the trades I could have (and did try...but that is another story) to set 1170/1190.
One day made the difference between being profitable and taking a decent loss...had I closed my trades today. I decided to hold as the price of the trade to close is inflated due to the proximity of the S&P levels to the spread trades. So buying back my short 1160 call while the S&P is at 1165 would cost me $1250 in intrinsic value (5 points X $250) plus at least half that again in extrinsic value. That is close to a $2000 loss.
Waiting one more day drops the extrinsic value by a certain amount...waiting until Friday drops it to zero. So my dilemma is now to decide if I out wait the market and hope for a move lower and/or let the trades expire ITM and take only the real intrinsic value hit by not buying back the options. Last month my trades lost a bit as I closed them taking the extra hit...as it turned out I should have (famous last words, I know) held them to see 100% of my profit as the market did turn for me...too late though.
The trouble is for every point into my trade the S&P goes the tally against me goes up $250...per trade.
I still really like the iron condor trades, I just need to rethink my short term entries...at the very least when the market is low in volatility. Had I been doing these trades all on my own I would have sacrificed some gains to move the trade farther as I knew that these ones ended up inside the trend channel on the upside... but the odds were in my favour even then. The thing about odds is the math really doesn't matter... what happens is what matters. I have that argument the odd time with mathees though.
I did have some faith in the S&P not breaking the 1150s before Friday... but that was last week and 1150 is already past.
Jeff.
Thursday, March 11, 2010
Edgy Optioneering and the Next Idea
While I had two losing trades last month they were only losing trades because I closed them early.
I made a call earlier that the S&P500 would re-test 1150 this month which would have meant holding my February expiring trades would have been a good plan. I ended up closing them when the loss was near it's peak... due to the nature of spread trades and the late term volatility spike associated with near strike market levels I got spooked.
So, same thing is happening with my call spreads this month, even though calls are the most risk averse trades on the books they are mounting substantial paper loses.
Should I be concerned?
Probably.
My lowest calls are at the 1160 level and 1150 should produce enough resistance to carry these trades through to next Friday... but it doesn;t have to. The key is that as long as the market closes Friday (including afterhours trading) anywhere at or under 1160 all my spreads will be fine and I will see 100% of the target profits.
Seeing as there is a 20 point spread in the spreads and each point is worth $250 I will see a loss of $250 per point that the market closes above 1160 in one trade and per point that it closes over 1165 in two other trades.
I liked setting my own spreads in Questrade better as I could pick my own levels cleaner... having said that my levels were closer and therefore more risky. So perhaps I just need to back off on my aggressive stance on these trades at least until the market picks up some volatility to increase the spreads for better risk ratios.
I don;t have access to decent futures options quotes... yet... so I cannot judge whether I could produce better spreads or not. I think that I might be able to so I will setup a trial account with a US futures broker sometime to try out their platform and spin the numbers in my spread calculator. See if the same rules can be applied to futures contracts as I applied to regular options spreads.
Always something to keep my mind occupied.
I scanned through the charts that we have been trading in the trading room and I am picking up on some of the trade setups that are suggested. The key is to be able to recognize the setups pre-market and have the right stocks in front at the time. I think I could still do that on my own with a handful of stocks, maybe fifty, sprinkle in a couple of ETFs and trade with the general trend as it sets up in the market.
I could tie this into the bullish percent index charting by having a group of stocks in each represented index and trade among the index stocks while that particular index is doing well relative to the other indices.
Then there is the pivot point relevance, volume confirmations and order flow to know when to buy, where to stop and where to target.
Definitely a theory to pursue... sometime.
Jeff.
I made a call earlier that the S&P500 would re-test 1150 this month which would have meant holding my February expiring trades would have been a good plan. I ended up closing them when the loss was near it's peak... due to the nature of spread trades and the late term volatility spike associated with near strike market levels I got spooked.
So, same thing is happening with my call spreads this month, even though calls are the most risk averse trades on the books they are mounting substantial paper loses.
Should I be concerned?
Probably.
My lowest calls are at the 1160 level and 1150 should produce enough resistance to carry these trades through to next Friday... but it doesn;t have to. The key is that as long as the market closes Friday (including afterhours trading) anywhere at or under 1160 all my spreads will be fine and I will see 100% of the target profits.
Seeing as there is a 20 point spread in the spreads and each point is worth $250 I will see a loss of $250 per point that the market closes above 1160 in one trade and per point that it closes over 1165 in two other trades.
I liked setting my own spreads in Questrade better as I could pick my own levels cleaner... having said that my levels were closer and therefore more risky. So perhaps I just need to back off on my aggressive stance on these trades at least until the market picks up some volatility to increase the spreads for better risk ratios.
I don;t have access to decent futures options quotes... yet... so I cannot judge whether I could produce better spreads or not. I think that I might be able to so I will setup a trial account with a US futures broker sometime to try out their platform and spin the numbers in my spread calculator. See if the same rules can be applied to futures contracts as I applied to regular options spreads.
Always something to keep my mind occupied.
I scanned through the charts that we have been trading in the trading room and I am picking up on some of the trade setups that are suggested. The key is to be able to recognize the setups pre-market and have the right stocks in front at the time. I think I could still do that on my own with a handful of stocks, maybe fifty, sprinkle in a couple of ETFs and trade with the general trend as it sets up in the market.
I could tie this into the bullish percent index charting by having a group of stocks in each represented index and trade among the index stocks while that particular index is doing well relative to the other indices.
Then there is the pivot point relevance, volume confirmations and order flow to know when to buy, where to stop and where to target.
Definitely a theory to pursue... sometime.
Jeff.
Thursday, January 14, 2010
Comparing risk and margin policies...sort of.
As a result of my "edge of seat" spread trades in BBY and SPY I am getting to know the market activity based on various reports a lot better than I did. Although the market does not necessarily do what I might expect, or anyone else for that matter, but it certainly points to possible days of volatility.
I am not sure how much value there is in this information. Had I entered the trades that I was planning to I would not be presented with this issue at all.
I will be looking at changing my opening spreads in SPY in future. I want to get minimum risk by putting the short strike option as far as possible from the price. I have revamped my price targets to get away from the idea of the $10 day, as I may have mentioned before.
Due to my spreadsheet forecasting I figure that a $300 return on an iron condor spread with up to $5000 risked is a good return as it amounts to about 6% ROR, as long as the trade is in the range of a 30 day timeline. This is really the reason for leaving the $10 per day alone as it pushes me toward the edge between low and high risk trades. I figure if I can squeeze $300 for every $5000 trade each month I can turn a decent cashflow.
While this will work well in the Optioneer futures contract setup I will still run the numbers on the Questrade SPY trades and see where I get. The major difference between the two is how risk is calculated and therefore how cash allocation is figured.
Questrade.
A 25 contract call spread on SPY can be placed with a $5000 risk (less the sold call credit, but I will ignore that for this example)
A corresponding 25 contract put spread can also be placed with a $5000 risk.
As it stands I might be hard pressed to see $300 from each of these trades but definitely could by combining them.
These two trades combined create an iron condor with a total risk of $10,000 with Questrade's separate spread trade method... the call spread is completely separate from the put spread.
Optioneer/Strikepoint
The trades are a bit different here as futures contracts use $250 points unlike the SPY $1 points. The result is the important issue.
A call spread based on the S&P500 futures placed with a $5000 risk.
A corresponding put spread placed also with $5000 risk
Like the above example a low risk call or put spread alone may not generate $300 very often, combining them will.
With Optioneer/Strikepoint the combined trade is taken as one trade and, seeing as the price can only be at one point at a time, only one side is ever at risk on any trade. Therefore they consider the two $5000 risk trades as one trade risking the same $5000.
This allows me to basically produce double the cashflow based on capital in the account.
If I could talk Questrade into letting me use their margin account in a similar manner when trading options on the same underlying security I could produce at least the same results and I would definitely continue to use their account for these spread trades... for some reason I don't see that happening though.
Although I wil try.
Jeff.
I am not sure how much value there is in this information. Had I entered the trades that I was planning to I would not be presented with this issue at all.
I will be looking at changing my opening spreads in SPY in future. I want to get minimum risk by putting the short strike option as far as possible from the price. I have revamped my price targets to get away from the idea of the $10 day, as I may have mentioned before.
Due to my spreadsheet forecasting I figure that a $300 return on an iron condor spread with up to $5000 risked is a good return as it amounts to about 6% ROR, as long as the trade is in the range of a 30 day timeline. This is really the reason for leaving the $10 per day alone as it pushes me toward the edge between low and high risk trades. I figure if I can squeeze $300 for every $5000 trade each month I can turn a decent cashflow.
While this will work well in the Optioneer futures contract setup I will still run the numbers on the Questrade SPY trades and see where I get. The major difference between the two is how risk is calculated and therefore how cash allocation is figured.
Questrade.
A 25 contract call spread on SPY can be placed with a $5000 risk (less the sold call credit, but I will ignore that for this example)
A corresponding 25 contract put spread can also be placed with a $5000 risk.
As it stands I might be hard pressed to see $300 from each of these trades but definitely could by combining them.
These two trades combined create an iron condor with a total risk of $10,000 with Questrade's separate spread trade method... the call spread is completely separate from the put spread.
Optioneer/Strikepoint
The trades are a bit different here as futures contracts use $250 points unlike the SPY $1 points. The result is the important issue.
A call spread based on the S&P500 futures placed with a $5000 risk.
A corresponding put spread placed also with $5000 risk
Like the above example a low risk call or put spread alone may not generate $300 very often, combining them will.
With Optioneer/Strikepoint the combined trade is taken as one trade and, seeing as the price can only be at one point at a time, only one side is ever at risk on any trade. Therefore they consider the two $5000 risk trades as one trade risking the same $5000.
This allows me to basically produce double the cashflow based on capital in the account.
If I could talk Questrade into letting me use their margin account in a similar manner when trading options on the same underlying security I could produce at least the same results and I would definitely continue to use their account for these spread trades... for some reason I don't see that happening though.
Although I wil try.
Jeff.
Tuesday, January 5, 2010
Option Strategies, Collars and Ladders.
I was thinking about the maximum loss with spreads and that I need to monitor them, loosely, to be sure they do not go negative on me. Particularly the current 116-118 bear call spread seeing as SPY (the S&P 500) is climbing smartly into the new year.
If I let a 10 contract $2 spread trade go and it hits the bought call price I will lose close to $2000. If it passes the bought call there are no further losses as the trades cancel each other out at that maximum loss at expiration as they exercise and the long call covers the short call.
I got thinking about a method to fix this trade by adding another option to it should it look like it is going to start losing. Buying another set of call contracts will allow the entire trade to profit if the price continues up.
So the trade would be this:
Sell 116 calls
Buy 118 calls
Buy 120 calls
This creates a maximum loss point at the 118 strike. Ideally I would want a longer term trade to allow some intrinsic value to be left in the calls near expiry if the price was heading up...close the trade one month out. Should the price take off I might choose to close part of the trade by buying back the short 116 calls or tying them to the 120 long calls and let the better priced ITM 118 ride.
If the price headed down I make whatever credit was gained from the 116-118 spread less the cost of the cheap 120 call by just letting the trade expire.
Checking in my options book I find that this is called a bear call ladder and my idea is very close except that this is a longer term trade that is best setup completely together...but my idea of a fix is also workable, it just costs more to execute later.
The other one that I found in the book was the collar. I thought I knew what a collar was, or I had one version of it in mind. The collar is a long stock position with a covered call sold for premium gain and a long put bought for protection.
Profits are gained when the stock price plummets and the put becomes valuable due to being ITM and some extrinsic value is added due to volatility, the sold call premiums are kept as well adding to the profits. The stock is a loss but can be kept after expiration in order to resell calls and repurchase puts if desired.
Profits are also gained if the stock climbs to or past the call strike. The upside is capped at this point as the profit is the difference between the original stock price and the call strike, plus the call premium from the sale less the cost of the put that expires worthless.
Again, upside and downside profits. The best part about the collar is that it can be made to be a guaranteed profit or very small loss if the right options are traded for the stock.
The worst part is it is a longer term trade 6 months and up and the cost of the stock must be carried the whole time. Having said that, using a dividend paying stock can add more profits and this strategy can be used in a TFSA as it is really just a covered call and a long put.
I now know what I am likely to do with that account now...or perhaps the RRSP as it has an added advantage of US dividends not subject to the US with holding tax.
Jeff.
If I let a 10 contract $2 spread trade go and it hits the bought call price I will lose close to $2000. If it passes the bought call there are no further losses as the trades cancel each other out at that maximum loss at expiration as they exercise and the long call covers the short call.
I got thinking about a method to fix this trade by adding another option to it should it look like it is going to start losing. Buying another set of call contracts will allow the entire trade to profit if the price continues up.
So the trade would be this:
Sell 116 calls
Buy 118 calls
Buy 120 calls
This creates a maximum loss point at the 118 strike. Ideally I would want a longer term trade to allow some intrinsic value to be left in the calls near expiry if the price was heading up...close the trade one month out. Should the price take off I might choose to close part of the trade by buying back the short 116 calls or tying them to the 120 long calls and let the better priced ITM 118 ride.
If the price headed down I make whatever credit was gained from the 116-118 spread less the cost of the cheap 120 call by just letting the trade expire.
Checking in my options book I find that this is called a bear call ladder and my idea is very close except that this is a longer term trade that is best setup completely together...but my idea of a fix is also workable, it just costs more to execute later.
The other one that I found in the book was the collar. I thought I knew what a collar was, or I had one version of it in mind. The collar is a long stock position with a covered call sold for premium gain and a long put bought for protection.
Profits are gained when the stock price plummets and the put becomes valuable due to being ITM and some extrinsic value is added due to volatility, the sold call premiums are kept as well adding to the profits. The stock is a loss but can be kept after expiration in order to resell calls and repurchase puts if desired.
Profits are also gained if the stock climbs to or past the call strike. The upside is capped at this point as the profit is the difference between the original stock price and the call strike, plus the call premium from the sale less the cost of the put that expires worthless.
Again, upside and downside profits. The best part about the collar is that it can be made to be a guaranteed profit or very small loss if the right options are traded for the stock.
The worst part is it is a longer term trade 6 months and up and the cost of the stock must be carried the whole time. Having said that, using a dividend paying stock can add more profits and this strategy can be used in a TFSA as it is really just a covered call and a long put.
I now know what I am likely to do with that account now...or perhaps the RRSP as it has an added advantage of US dividends not subject to the US with holding tax.
Jeff.
Risk checking for spreads
In light of my small boffo yesterday I thought I might take a closer look as a sheet that I had setup a while back to try to determine risk and ideal spread strikes.
It involved using various Average True Range (ATR) periods with a weighting towards the more recent values to come up with a daily ATR value. This value is then just multiplied by the days to expiry for the potential trade to come up with a possible range to give me a target to look for.
I put in an adjustment for position from the current median value of the 80 day Linear Regression. This indicates a call spread strike higher when the price is near the top of the channel and a put strike lower when it is near the bottom.
The last item is a risk factor that widens the spread strikes depending on which spread (Call or Put) I am looking at based on the LR position again. Values are 1, 2 and 3. Call or Put spreads with the SPY price at the median use a 2, general risk. I might use these for an iron condor under certain circumstances. Call spreads with the price at the top of the channel get a 1 and at the bottom of the channel get a 3. Puts are reversed.
Puts are skewed farther with a built in factor as they are higher risk spreads in general.
Based on these numbers from today's chart I get a call strike to sell at 116.38. I would round up or down depending upon market conditions, it's only one dollar either way so it's not a big deal. The put comes up to 108.23.
Using my target pricing I get a decent call spread at 117-118...which was where I was trying to go yesterday around noon and goofed with another 116-118.
Where I was going with this was to look at the ATR for past 10 trading day periods to get a feel for what might happen over the next 10 days to the expiration of my spreads. I am almost $3 away now and the ATR for hte past 10 days is 1.09. Tha largest 10 day ATR I see in the past was around the $3 mark as SPY was coming off of the March lows... it has been higher but those were due to large drawdowns earlier than that...ATR for uptrends are more relevant right now as ATR peaks on down moves with a few exceptions.
Jeff.
It involved using various Average True Range (ATR) periods with a weighting towards the more recent values to come up with a daily ATR value. This value is then just multiplied by the days to expiry for the potential trade to come up with a possible range to give me a target to look for.
I put in an adjustment for position from the current median value of the 80 day Linear Regression. This indicates a call spread strike higher when the price is near the top of the channel and a put strike lower when it is near the bottom.
The last item is a risk factor that widens the spread strikes depending on which spread (Call or Put) I am looking at based on the LR position again. Values are 1, 2 and 3. Call or Put spreads with the SPY price at the median use a 2, general risk. I might use these for an iron condor under certain circumstances. Call spreads with the price at the top of the channel get a 1 and at the bottom of the channel get a 3. Puts are reversed.
Puts are skewed farther with a built in factor as they are higher risk spreads in general.
Based on these numbers from today's chart I get a call strike to sell at 116.38. I would round up or down depending upon market conditions, it's only one dollar either way so it's not a big deal. The put comes up to 108.23.
Using my target pricing I get a decent call spread at 117-118...which was where I was trying to go yesterday around noon and goofed with another 116-118.
Where I was going with this was to look at the ATR for past 10 trading day periods to get a feel for what might happen over the next 10 days to the expiration of my spreads. I am almost $3 away now and the ATR for hte past 10 days is 1.09. Tha largest 10 day ATR I see in the past was around the $3 mark as SPY was coming off of the March lows... it has been higher but those were due to large drawdowns earlier than that...ATR for uptrends are more relevant right now as ATR peaks on down moves with a few exceptions.
Jeff.
Sunday, January 3, 2010
Shifting fom Linear Regression entries.
Given my thoughts on timeframes and cashflow issues I may have inadvertently shifted my idea from Linear Regression spread entries to the wider margin iron condors placed as cash becomes available. Seeing as the LR optimized trades are to boost yield and reduce risk they will be time sensitive in that not always will they line up when I have freshly freed up cash to trade with.
Looking back on LR setups I can have cash in place all the time but can I have maximum cash in play constantly?
What is the reduction in cashflow as I average the daily trading over the entire capital base and total time period and include those days or weeks that I have some or all of my cash sitting idle?
What is the effect of applied savings to the account balance to enable larger positions in my trading rather than relying strictly on account growth? This is something that I completely overlook when I study returns and something that I should not overlook.
Re-visiting the cashflow vs yield issue...beating a dead horse yet?
There are a myriad of other issues and ideas that I could look at to apply toward my trading in future. I figure that, seeing as I am cashflow targeted now, I should consider at least these fresher ideas.
Applied savings is probably larger than I anticipate. I can easily setup automatic transfers to my Questrade trading account in what ever denomination I feel that I can manage. Use it in place of a savings account in the sense that I can also withdraw as easily...seeing as my trading is no longer registered account based.
Is this safe? Given the wider margin and lower accepted daily yield I believe that it is safe enough. I will need to apply some exit strategy rules to allow safety margins over and above the strike from price spacing. Also this savings is usually used to buy "extras" other than groceries, paying bills and the like so if I all of a sudden I lost it all it would not be sorely missed. Besides, the likelihood of that happening is really small.
Applying this additional capital on a regular basis allows me to up the trading base by a few contracts at a time with each transfer thus increasing the cashflow regularly. I have not done any forecasting to include this at all so I am unsure of the final effect overall, but it may offset the effect of using linear regression entries somewhat if that is not already offset by keeping total cash in play all the time.
Using sort timeframes, under 30 days, means that I could break my capital in two chunks and use half for the put side and half for the call side... riskier than I might like. For now I will remain with the idea of applying about $2000 per side and using the balance to apply as LR entries until I am more comfortable with the plan.
Back to cashflow again. Assuming that I apply savings, use wider margins with lower yields, keep all cash in play in one form or another and concentrate strictly on cashflow I can produce a different type of trading game. The larger base, using full capital on these trades, increases the yield due to lowering of the commission relative rate (increasing the size costs $1 per contract as opposed to another $9.95 plus $1 per contract for a new trade). Seeing at these small position sizes it makes a difference, enough that bumping up to maximum right now changes some for the strikes by $1 thus decreasing the risk factor.
This turns into a similar game as investing for dividends. "Slow and steady wins the race" as the saying goes. I still like the idea of hitting larger returns overall but I will be satisfied to see the cashflow progressively increase at a greater than the typical expectation for a dividend plan rate. That was a 30 year plan IF my timing and the stock market timing worked out perfectly... along with the company dividend plans continuing on track.
I still have three spreads tying up some capital now but they all expire on Jan 15th. Even with placing the January trade tomorrow it will expire at the same time freeing up all of my account...except for a small stock position. At that point I will review my ideas and goals and see what my next step might be.
Off to ceck out the Optioneer trade setups for tomorrow now.
Jeff.
Looking back on LR setups I can have cash in place all the time but can I have maximum cash in play constantly?
What is the reduction in cashflow as I average the daily trading over the entire capital base and total time period and include those days or weeks that I have some or all of my cash sitting idle?
What is the effect of applied savings to the account balance to enable larger positions in my trading rather than relying strictly on account growth? This is something that I completely overlook when I study returns and something that I should not overlook.
Re-visiting the cashflow vs yield issue...beating a dead horse yet?
There are a myriad of other issues and ideas that I could look at to apply toward my trading in future. I figure that, seeing as I am cashflow targeted now, I should consider at least these fresher ideas.
Applied savings is probably larger than I anticipate. I can easily setup automatic transfers to my Questrade trading account in what ever denomination I feel that I can manage. Use it in place of a savings account in the sense that I can also withdraw as easily...seeing as my trading is no longer registered account based.
Is this safe? Given the wider margin and lower accepted daily yield I believe that it is safe enough. I will need to apply some exit strategy rules to allow safety margins over and above the strike from price spacing. Also this savings is usually used to buy "extras" other than groceries, paying bills and the like so if I all of a sudden I lost it all it would not be sorely missed. Besides, the likelihood of that happening is really small.
Applying this additional capital on a regular basis allows me to up the trading base by a few contracts at a time with each transfer thus increasing the cashflow regularly. I have not done any forecasting to include this at all so I am unsure of the final effect overall, but it may offset the effect of using linear regression entries somewhat if that is not already offset by keeping total cash in play all the time.
Using sort timeframes, under 30 days, means that I could break my capital in two chunks and use half for the put side and half for the call side... riskier than I might like. For now I will remain with the idea of applying about $2000 per side and using the balance to apply as LR entries until I am more comfortable with the plan.
Back to cashflow again. Assuming that I apply savings, use wider margins with lower yields, keep all cash in play in one form or another and concentrate strictly on cashflow I can produce a different type of trading game. The larger base, using full capital on these trades, increases the yield due to lowering of the commission relative rate (increasing the size costs $1 per contract as opposed to another $9.95 plus $1 per contract for a new trade). Seeing at these small position sizes it makes a difference, enough that bumping up to maximum right now changes some for the strikes by $1 thus decreasing the risk factor.
This turns into a similar game as investing for dividends. "Slow and steady wins the race" as the saying goes. I still like the idea of hitting larger returns overall but I will be satisfied to see the cashflow progressively increase at a greater than the typical expectation for a dividend plan rate. That was a 30 year plan IF my timing and the stock market timing worked out perfectly... along with the company dividend plans continuing on track.
I still have three spreads tying up some capital now but they all expire on Jan 15th. Even with placing the January trade tomorrow it will expire at the same time freeing up all of my account...except for a small stock position. At that point I will review my ideas and goals and see what my next step might be.
Off to ceck out the Optioneer trade setups for tomorrow now.
Jeff.
Target Yield Adjustment?
The big question running about in my head right now is can I lower my target yield and still make money? While the short answer is yes, the long answer becomes am I willing to do so?
Due to the market circumstances and the end of year seeming top out the premiums are very low for SPY and sector ETF options right now. Even over in the futures arena I saw one of the lowest value trades in all of my research into the Optioneer setup last week.
I considered lowering my target yield, among some other ideas for option strategies, but found that I cannot do so in any but the SPY chain. SPY is liquid enough, and large enough that there is enough premium value to go outside of my target if only to keep money in play. Dropping from 0.2% per day to 0.1% per day drops the ROR from 10% to 5%, roughly.
Once again, I need to remind myself that ROR is not king, cashflow is.
In keeping with the theme I figured a mix might be in order and came up with these iron condor style trades for tomorrow. I compared the January 0.2% call and 0.1% put against the February versions. This gives me higher premiums for the call side, which is less likely to get hit in my mind and wider margins for the put side which is always in jeopardy. While I don't like the idea of being in a trade for 46 days I want to compare the ideas as my gut tells me to stay short... let's see if the numbers justify my feeling.
January expiry iron condor
Buy 10 Jan 118 calls and sell 10 Jan 116 calls for a credit of 11 cents
Buy 5 Jan 100 puts and sell 5 Jan 104 puts for a credit of 9 cents
Combined daily cashflow for the 11 day duration is $9.56 with a risk of less than $4000
That is just over the 0.2% per day with a total $105.10 return or 2.6% ROR.
Not that big but based on the timeframe not too shabby either...2.6% for two weeks.
February expiry iron condor
Buy 20 Feb 120 calls and sell 20 Feb 119 calls for a credit of 13 cents
Buy 7 Feb 97 puts and sell 7 Feb 100 puts for a credit of 19 cents
Combined daily cashflow for the 46 day duration is $6.94 with a risk of just more than $4000
That is just under the 0.2% per day with a total $319.10 return or 7.97% ROR.
The total numbers look better but in reality they are not. This trade is much longer, more can happen and the premiums are not as good on a pro-rated basis.
Comparing the same timeframes shows that the second trade returns 2.27% in the same timeframe as the first trade returning 2.6%. My best bet is to take the first trade tomorrow for January even with a small lenience and plan to place the February trade as it expires. This keeps my money in play while keeping to the shorter timeframes where the premium erodes faster and the risk is less.
I should note why the discrepancy between the two expiry trades exists. The call spread for January is yielding a 0.38% daily return. The next strike call spread is under 0.1% so there is a steep drop off in premiums. If I change the credit on the trade to be in line with the February daily return the cashflow is more comparable. This is the idea in trading options is sometimes to find the better prices where they are over and under priced. I set my spreadsheets up to take advantage of these as I check a $12 strike range for spreads of $1 to $4 and use the best single spread combo. That is also why my position sizing is all over the place as I try to compare similar risks. A $2000 risk will take between 5 and 20 contracts to match depending upon the spread.
What I am getting at here is not so much that the Shorter term is a higher yielding trade all the time, just that is is similar enough that it have better numbers due to the shorter timeframe involved while optimizing the spread ranges.
Now, if this trade can be filled with tomorrow's trading is another issue altogether.
Am I willing to take the shorter trade while reducing the yield from my original plan? You bet.
The other side of the coin is to only place the call side trades. Doing that and boosting my initial January trade to a full $4000 risk would yield a much higher cashflow of around $18 per day or 0.38% ...well over my 0.2% target.
Strategy for tomorrow will be to watch the pre-market and see what the sentiment is likely to be off of the bell. If everything is going to hold the drop of Thursday the the call side only might be in order. If it looks as though a surge and higher open then close is likely then use the full iron condor trade.
Jeff.
Due to the market circumstances and the end of year seeming top out the premiums are very low for SPY and sector ETF options right now. Even over in the futures arena I saw one of the lowest value trades in all of my research into the Optioneer setup last week.
I considered lowering my target yield, among some other ideas for option strategies, but found that I cannot do so in any but the SPY chain. SPY is liquid enough, and large enough that there is enough premium value to go outside of my target if only to keep money in play. Dropping from 0.2% per day to 0.1% per day drops the ROR from 10% to 5%, roughly.
Once again, I need to remind myself that ROR is not king, cashflow is.
In keeping with the theme I figured a mix might be in order and came up with these iron condor style trades for tomorrow. I compared the January 0.2% call and 0.1% put against the February versions. This gives me higher premiums for the call side, which is less likely to get hit in my mind and wider margins for the put side which is always in jeopardy. While I don't like the idea of being in a trade for 46 days I want to compare the ideas as my gut tells me to stay short... let's see if the numbers justify my feeling.
January expiry iron condor
Buy 10 Jan 118 calls and sell 10 Jan 116 calls for a credit of 11 cents
Buy 5 Jan 100 puts and sell 5 Jan 104 puts for a credit of 9 cents
Combined daily cashflow for the 11 day duration is $9.56 with a risk of less than $4000
That is just over the 0.2% per day with a total $105.10 return or 2.6% ROR.
Not that big but based on the timeframe not too shabby either...2.6% for two weeks.
February expiry iron condor
Buy 20 Feb 120 calls and sell 20 Feb 119 calls for a credit of 13 cents
Buy 7 Feb 97 puts and sell 7 Feb 100 puts for a credit of 19 cents
Combined daily cashflow for the 46 day duration is $6.94 with a risk of just more than $4000
That is just under the 0.2% per day with a total $319.10 return or 7.97% ROR.
The total numbers look better but in reality they are not. This trade is much longer, more can happen and the premiums are not as good on a pro-rated basis.
Comparing the same timeframes shows that the second trade returns 2.27% in the same timeframe as the first trade returning 2.6%. My best bet is to take the first trade tomorrow for January even with a small lenience and plan to place the February trade as it expires. This keeps my money in play while keeping to the shorter timeframes where the premium erodes faster and the risk is less.
I should note why the discrepancy between the two expiry trades exists. The call spread for January is yielding a 0.38% daily return. The next strike call spread is under 0.1% so there is a steep drop off in premiums. If I change the credit on the trade to be in line with the February daily return the cashflow is more comparable. This is the idea in trading options is sometimes to find the better prices where they are over and under priced. I set my spreadsheets up to take advantage of these as I check a $12 strike range for spreads of $1 to $4 and use the best single spread combo. That is also why my position sizing is all over the place as I try to compare similar risks. A $2000 risk will take between 5 and 20 contracts to match depending upon the spread.
What I am getting at here is not so much that the Shorter term is a higher yielding trade all the time, just that is is similar enough that it have better numbers due to the shorter timeframe involved while optimizing the spread ranges.
Now, if this trade can be filled with tomorrow's trading is another issue altogether.
Am I willing to take the shorter trade while reducing the yield from my original plan? You bet.
The other side of the coin is to only place the call side trades. Doing that and boosting my initial January trade to a full $4000 risk would yield a much higher cashflow of around $18 per day or 0.38% ...well over my 0.2% target.
Strategy for tomorrow will be to watch the pre-market and see what the sentiment is likely to be off of the bell. If everything is going to hold the drop of Thursday the the call side only might be in order. If it looks as though a surge and higher open then close is likely then use the full iron condor trade.
Jeff.
Monday, December 21, 2009
S&P 500 SPY spreads vs scaled trades.
I got lazy and just used the same chart here.
Last post I mentioned diversification in trade type, price levels and timeframes. It reminded me that I could scale into a trade to try to effect some sort of similar idea, not really DCAing as I am looking to grow a core position by adding to it at key times.
Last post I mentioned diversification in trade type, price levels and timeframes. It reminded me that I could scale into a trade to try to effect some sort of similar idea, not really DCAing as I am looking to grow a core position by adding to it at key times.
In order to fudge against me I will use my minimum $2.40 per day yield based on a $1200 risk trade. Even though I already see that a SPY spread even at today's low VIX numbers can be much higher than that I would choose the safe trade as $2.40 per day lets me run the spread strike farther away from the price. This is 0.2% per day ROR or 6% ROR based on a 30 day trade.
So a quick 22 trades at 30 days per trade calculation leaves 660 trade days at $2.40 is $1584. I would want to optimize my trading to allow for certain overlaps depending upon my capital so I might run $2400 trades here and there. Regardless, this is for a comparison only anyway.
At most, four overlapping trades which uses up my $5000 base. That is a 31.7% return on the account base and I can add one more trade capability into the mix to start the compounding effect.
Scaling into this through purchasing shares directly in SPY in 10 share chunks. Buy at the good bottoms and hold through the top.
Buy at $70, $80, $90, $90, $100 and 6 shares at $104. Average cost is $87.93 for 56 shares. Current price is about $110 so $22.07 per share gain for $1236....if sold now. With a tight stop during this uncertain period it might get sold... maybe not. I can only make money as the price goes up and can only compound if I sell and catch a drop...if the drop reverses when I think it ought.
Meanwhile I am trading spreads and seeing profits while the price wallows each month as expiry dates pass. This way there is a cashflow. Buying and holding has no cashflow...although there is a slight tax advantage when it comes to capital gains
Jeff.
Sunday, December 20, 2009
The Other Side of Diversity
I have read tons about having a diverse portfolio and I always wondered exactly what it would take to be diversified appropriately. I have never seen a clear and concise answer, nor have I ever come up with one myself.
Earlier I alluded to over diversification being a bad thing, at least stifling gains and possibly even creating it's own series of loss factors. I consider diversity to be a form of insurance, insurance is a cost. Rather than belabour the negative side I am looking at a positive way to diversify ...not in the typical sense.
In the interest of being accurate I figured I would pull a dictionary definition for diversity and found that there are many variations of the use of the word and it's derivatives. These from thefreedictionary.com
The definition that seems to apply to the typical idea of diversity as it applies to the stock market and investing or trading might be:
"the quality of being diverse and not comparable in kind"
This leads to buying different stocks within a sector to provide a moderating effect and in different sectors to provide a hedge or safety with a varied and dissimilar portfolio. Key words that I don't much like here are "moderating", "hedge" and "safety".
The one that I found to more accurately represent my idea was not even a primary definition:
"The relation that holds between two entities when and only when they are not identical; the property of being numerically distinct".
Earlier I alluded to over diversification being a bad thing, at least stifling gains and possibly even creating it's own series of loss factors. I consider diversity to be a form of insurance, insurance is a cost. Rather than belabour the negative side I am looking at a positive way to diversify ...not in the typical sense.
In the interest of being accurate I figured I would pull a dictionary definition for diversity and found that there are many variations of the use of the word and it's derivatives. These from thefreedictionary.com
The definition that seems to apply to the typical idea of diversity as it applies to the stock market and investing or trading might be:
"the quality of being diverse and not comparable in kind"
This leads to buying different stocks within a sector to provide a moderating effect and in different sectors to provide a hedge or safety with a varied and dissimilar portfolio. Key words that I don't much like here are "moderating", "hedge" and "safety".
The one that I found to more accurately represent my idea was not even a primary definition:
"The relation that holds between two entities when and only when they are not identical; the property of being numerically distinct".
This idea very seldom gets any screen time with the exception of the use of Dollar Cost Averaging (DCA) which is really a form of price diversification... buying a stock at numerically distinct prices to provide diversity within the same security.
The trouble with DCAing is that all trades become one trade as it averages the initial cost of the position. This makes the position still susceptible to volatility losses even if the DCA was lower on each successive trade. The other issue is that exiting the position in a profit provides a gain but buying back into the same position requires close to the same dollar figure unless timing is done well...which DCAing is supposed to eliminate. That makes this a buy and hold strategy only.
Here is a chart of SPY for the last 10 or so months:The red arrows indicate rough areas to sell spreads and the green lines are rough levels and duration to sell spreads. The indicator on the bottom is an ADX oscillator and has no real bearing on what I am doing here...yet. The black lines are trend lines that would have been established along the way. I would have had linear regression lines serving this purpose day by day.
The call spread strikes are 90, 95, 99, 102, 105, 107, 110,114, 117, 116
The put strikes are 73, 76, 83, 84, 85, 84, 83, 91, 94, 95, 96, 102
First, diversity by trade type. I run call spreads to bracket the upside and put spreads to bracket the down side. In this case no matter which way the SPX goes at least one direction of the trades will profit. Technically this does not make a true iron condor but it amounts tot he same thing, just with a greater yield due to the optimized entries.
Second, diversity by price level. The calls are all distinctly different even if only my a dollar or two. The puts tended to hover in the middle as the price moved sideways a bit. I expect that I could have gone wider as the put premiums likely headed up a bit due to the uncertainty as to the market direction. Some calls could have been put on along this point as well and given my thinking at the time I would have done so... I was bear minded.
Third, diversity by timeframes. All of the trades are of a short duration and due to that they will be staggered, overlapped and just expiring on 3rd Friday's and end of months depending upon when the price sets up. Longer term trades may be taken if the $2.40 target can be met and there is not too much volatility in the market. There is not one single trade for the whole duration or even a scaled in or scaled out trade. Many multiple profit takings.
Jeff.
Sunday, December 13, 2009
Selling Premiums vs Buying for Gains
In my last post I mentioned a bit about sector rotation, among other things, and it got me to thinking some more about relative sector performance among themselves and against the market in general.
Sticking with the S&P 500 as the index and the ten basic sectors.
Trading ETFs or stocks to take advantage of outperforming sectors was where I was headed with the Bullish Percent Index charts... trying to determine when to get into a sector security and when to switch. The trouble came in when I realized that I was splitting my efforts between two conflicting ways of thinking about making money in the market.
Selling premiums and buying for gains are pretty much opposing in there ideology. This goes against my plan to specialize and get to know one method and to be able to execute that method very well. This has been my greatest downfall over the last two years as I see potential in one system only to see potential in an alternative idea... skipping about until something felt right.
Enough already.
Selling premiums is where I am at and I will not lose sight of that plan now.
So, back to topic at hand, sector performance vs market performance.
Two plans, two methods of study
First, a basic premise. The market can do one of three things in varying degrees of amplitude.
1) the market can go up
2) the market can go down
3) the market can go sideways
All three are subject to duration and amplitude or volatility.
Buying for gains requires a sector to outperform the market toward the bias of the trade, up for long and down for short. In order for a plan to also outperform that market money needs to be in play on that sector or group of sectors for most of the period of out performance. Of the three basic premises one must be chosen and be relatively correct to beat the market. This does not necessarily mean it is profitable, just better than the underlying index.
Of all of the factors direction, duration and amplitude, there are 12 possible combinations. For buying, getting 1 in three of the major ones right is necessary. Profitability is determined by amplitude and duration which, if the first premise is correct, still have a huge affect.
Exit strategies are important as well as stop loss protection. While trading ETFs the whole trade is at stake but it is unlikely to be all lost in one trade. Capital needed may be large as some ETFs are expensive.
Trading options can skew the results in my favour and reduce cost and exposure as a down move may not be as damaging to the account. Even so, options become more sensitive to the duration even with the correct direction.
Choosing one of the three possibilities when only two can produce gains without range trading, which is pernickity.
Selling for premiums does not require any particular sector to outperform the market. This saves making the first selection the most important one. Amplitude is a factor but can be mitigated by a decent exit plan.
Unlike typical buying, selling can be right for two of the three basic premises and even all three if the amplitude is small. Duration is not really a factor if time to option expiry is kept short. The only case that can be wrong is if the amplitude is large and faster than the term of the trade and even then profit can be managed later into the trade. I would have to be really wrong and right off the bat by a large margin to lose a lot of quickly.
Of the 12 combinations any with duration are eliminated due to the short time to expiry, basically the trades are short enough that duration does not affect the profitability. This cuts it down to 3 major premises, up down and sideways and one other factor, amplitude. Choosing a correct combination is made much easier as only 1 of the remaining 6 combinations will work against the trade. Wrong direction with a large amplitude.
It boils down to comparing two basic methods
1) Making a buying decision where being correct is a 2 in 6 and profitability and complexity are issues. Exit strategies are often more important than entry strategies.
2) Making a selling decision where being correct is 5 in 6, profitability is known beforehand and complexity is no longer an issue. Also, being wrong that 1 in 6 time does not necessarily mean a loss unless the amplitude of the move occurs very early in the trade and the exit strategy is to just let the trade expire normally...easy as pie.
While this is an overly simplistic way to look at the issue and there are other factors that can affect trading plans of any style, this covers the major ones.
Keeping it simple is the best plan in any case.
Jeff.
Sticking with the S&P 500 as the index and the ten basic sectors.
Trading ETFs or stocks to take advantage of outperforming sectors was where I was headed with the Bullish Percent Index charts... trying to determine when to get into a sector security and when to switch. The trouble came in when I realized that I was splitting my efforts between two conflicting ways of thinking about making money in the market.
Selling premiums and buying for gains are pretty much opposing in there ideology. This goes against my plan to specialize and get to know one method and to be able to execute that method very well. This has been my greatest downfall over the last two years as I see potential in one system only to see potential in an alternative idea... skipping about until something felt right.
Enough already.
Selling premiums is where I am at and I will not lose sight of that plan now.
So, back to topic at hand, sector performance vs market performance.
Two plans, two methods of study
First, a basic premise. The market can do one of three things in varying degrees of amplitude.
1) the market can go up
2) the market can go down
3) the market can go sideways
All three are subject to duration and amplitude or volatility.
Buying for gains requires a sector to outperform the market toward the bias of the trade, up for long and down for short. In order for a plan to also outperform that market money needs to be in play on that sector or group of sectors for most of the period of out performance. Of the three basic premises one must be chosen and be relatively correct to beat the market. This does not necessarily mean it is profitable, just better than the underlying index.
Of all of the factors direction, duration and amplitude, there are 12 possible combinations. For buying, getting 1 in three of the major ones right is necessary. Profitability is determined by amplitude and duration which, if the first premise is correct, still have a huge affect.
Exit strategies are important as well as stop loss protection. While trading ETFs the whole trade is at stake but it is unlikely to be all lost in one trade. Capital needed may be large as some ETFs are expensive.
Trading options can skew the results in my favour and reduce cost and exposure as a down move may not be as damaging to the account. Even so, options become more sensitive to the duration even with the correct direction.
Choosing one of the three possibilities when only two can produce gains without range trading, which is pernickity.
Selling for premiums does not require any particular sector to outperform the market. This saves making the first selection the most important one. Amplitude is a factor but can be mitigated by a decent exit plan.
Unlike typical buying, selling can be right for two of the three basic premises and even all three if the amplitude is small. Duration is not really a factor if time to option expiry is kept short. The only case that can be wrong is if the amplitude is large and faster than the term of the trade and even then profit can be managed later into the trade. I would have to be really wrong and right off the bat by a large margin to lose a lot of quickly.
Of the 12 combinations any with duration are eliminated due to the short time to expiry, basically the trades are short enough that duration does not affect the profitability. This cuts it down to 3 major premises, up down and sideways and one other factor, amplitude. Choosing a correct combination is made much easier as only 1 of the remaining 6 combinations will work against the trade. Wrong direction with a large amplitude.
It boils down to comparing two basic methods
1) Making a buying decision where being correct is a 2 in 6 and profitability and complexity are issues. Exit strategies are often more important than entry strategies.
2) Making a selling decision where being correct is 5 in 6, profitability is known beforehand and complexity is no longer an issue. Also, being wrong that 1 in 6 time does not necessarily mean a loss unless the amplitude of the move occurs very early in the trade and the exit strategy is to just let the trade expire normally...easy as pie.
While this is an overly simplistic way to look at the issue and there are other factors that can affect trading plans of any style, this covers the major ones.
Keeping it simple is the best plan in any case.
Jeff.
Saturday, December 12, 2009
Credit Spreads vs Buy and Hold, a Comparison in Principle
BUY AND HOLD
The goals of buy and hold are long term appreciation and dividends taking advantage of the premise that stocks go up over the long run... blue chip large caps anyway. Perhaps some shorter term "investing" which is really longer term trading for some straight speculative gains plays.
Canadian and US registered accounts are a benefit in allowing these gains and dividends to grow tax free. Taxation only comes into play when the positions are sold and/or the resulting funds are removed from the registered account.
The idea that a long term holding does not have to be monitored and a that a drop in the portfolio will aways come back over time seems to be the mindset of most B&Hers...time frames not of the investors choosing though. Using stop loss orders or put buying, these positions can be protected. The issue becomes market timing to get back in at lower prices. Not many seem to be able to do this.
DRIPs alleviate some of the holding issues as dividends are re-invested in additional and partial shares. Over time this creates a compounding effect and the plan is to have the dividends produce an income stream sometime in the future. I find the time frame too long for my style.
The latest popular plan is to buy ETFs in place of stocks in order to provide some level of diversity. Some even promote buying index ETFs in order to gain the historical 11% per year of the general market. Fine if your time of capital needs lines up with the time of market strength. Sector rotation or sector relative strength are becoming know now as well. While decent strategies these are not strictly buy and hold plans as portfolios require re-balancing over time
CREDIT SPREADS
The goals of a credit spread strategy are income generation and risk aversion.
While not able to be executed in registered accounts the gains are realized monthly and taxed annually as income.
One major idea behind this style of plan is to take profits regularly thereby eliminating the chance of having a position drop below a predetermined loss allowance without having to set stop losses. Compounding is handled by increasing position sizing as profits accumulate to an additional contract size. Buying back into a position differs from stocks as each month a new set of options are available and buying back in is at the then price of the options given the strike prices chosen. Buy an option pair this month, letting it expire by month's end, turn it back into the next month's option pair at a similar price.
Selling high and buying low is, essentially, taken care of automatically.
Sector rotation or relative strength can be used to increase the already high probability of taking full profits from these trades with exposing the portfolio to undue risk. In fact, these additional strategy adjustments can allow a greater position sizing opportunity. Something that is not as easy to do with stocks unless using up margin.
COVERED CALLS?
Some would argue for a covered call strategy but it has it's downfall in that the underlying stock could drop substantially. While premiums collected by selling calls against the position can mitigate this problem it does not eliminate the issue altogether. It also requires more capital and risks having the stock called forcing the purchase of another position at a probably higher price.
While any strategy has it's benefits and drawbacks that must be taken into account I have found that credit spread trading fits my particular style and time requirements. I have run numbers to get a feel for what is needed to produce an annual money doubling strategy and they look very good and attainable while taking conservative risks and starting with small positions.
While I have gone on about various points and strategies in other posts I just felt a need to summarize to myself a few points drive the final nail in the coffin of buy and hold investing for me.
Jeff.
The goals of buy and hold are long term appreciation and dividends taking advantage of the premise that stocks go up over the long run... blue chip large caps anyway. Perhaps some shorter term "investing" which is really longer term trading for some straight speculative gains plays.
Canadian and US registered accounts are a benefit in allowing these gains and dividends to grow tax free. Taxation only comes into play when the positions are sold and/or the resulting funds are removed from the registered account.
The idea that a long term holding does not have to be monitored and a that a drop in the portfolio will aways come back over time seems to be the mindset of most B&Hers...time frames not of the investors choosing though. Using stop loss orders or put buying, these positions can be protected. The issue becomes market timing to get back in at lower prices. Not many seem to be able to do this.
DRIPs alleviate some of the holding issues as dividends are re-invested in additional and partial shares. Over time this creates a compounding effect and the plan is to have the dividends produce an income stream sometime in the future. I find the time frame too long for my style.
The latest popular plan is to buy ETFs in place of stocks in order to provide some level of diversity. Some even promote buying index ETFs in order to gain the historical 11% per year of the general market. Fine if your time of capital needs lines up with the time of market strength. Sector rotation or sector relative strength are becoming know now as well. While decent strategies these are not strictly buy and hold plans as portfolios require re-balancing over time
CREDIT SPREADS
The goals of a credit spread strategy are income generation and risk aversion.
While not able to be executed in registered accounts the gains are realized monthly and taxed annually as income.
One major idea behind this style of plan is to take profits regularly thereby eliminating the chance of having a position drop below a predetermined loss allowance without having to set stop losses. Compounding is handled by increasing position sizing as profits accumulate to an additional contract size. Buying back into a position differs from stocks as each month a new set of options are available and buying back in is at the then price of the options given the strike prices chosen. Buy an option pair this month, letting it expire by month's end, turn it back into the next month's option pair at a similar price.
Selling high and buying low is, essentially, taken care of automatically.
Sector rotation or relative strength can be used to increase the already high probability of taking full profits from these trades with exposing the portfolio to undue risk. In fact, these additional strategy adjustments can allow a greater position sizing opportunity. Something that is not as easy to do with stocks unless using up margin.
COVERED CALLS?
Some would argue for a covered call strategy but it has it's downfall in that the underlying stock could drop substantially. While premiums collected by selling calls against the position can mitigate this problem it does not eliminate the issue altogether. It also requires more capital and risks having the stock called forcing the purchase of another position at a probably higher price.
While any strategy has it's benefits and drawbacks that must be taken into account I have found that credit spread trading fits my particular style and time requirements. I have run numbers to get a feel for what is needed to produce an annual money doubling strategy and they look very good and attainable while taking conservative risks and starting with small positions.
While I have gone on about various points and strategies in other posts I just felt a need to summarize to myself a few points drive the final nail in the coffin of buy and hold investing for me.
Jeff.
Thursday, December 10, 2009
SPY and the Bull Put Credit Spread continued...
I did some more thinking about this last night and decided to check the historical odds of getting a 102 strike put hit from a $110 level...basically an $8 drop in 36 days as that is what my trade would be for the January puts.
Other factors include the fact that the price is already at the low end of the trend or linear regression channel, even using the price at a peak this happened once in June...very close anyway and in the steep drop earlier in the year. During the drops I would be putting my energy into calls spreads so puts would not make it to the table very often.
So, rather than go on about it here I will be placing some orders, one and maybe two, for either Dec EOM or January expiry.
Order placed for Dec EOM, 6 contracts meets my target for $1200 risk. I went as low as 13 cents or better as SPY is going to open up this morning, maybe 60 cents, which may depreciate the put options...15 cents was based on yesterday's close prices. So we'll see what happens this morning.
It would be nice to be able to sell naked puts and keep all of the premiums, I could go lower on the strike as well and still come out ahead. I know I take the risk of the trade really going against me but it is an ETF tied to the S&P 500, that in itself creates a ton of diversity. The only downside is an ETF valued at $110 needs to have $11,000 free cash to back it up.
Jeff.
Other factors include the fact that the price is already at the low end of the trend or linear regression channel, even using the price at a peak this happened once in June...very close anyway and in the steep drop earlier in the year. During the drops I would be putting my energy into calls spreads so puts would not make it to the table very often.
So, rather than go on about it here I will be placing some orders, one and maybe two, for either Dec EOM or January expiry.
Order placed for Dec EOM, 6 contracts meets my target for $1200 risk. I went as low as 13 cents or better as SPY is going to open up this morning, maybe 60 cents, which may depreciate the put options...15 cents was based on yesterday's close prices. So we'll see what happens this morning.
It would be nice to be able to sell naked puts and keep all of the premiums, I could go lower on the strike as well and still come out ahead. I know I take the risk of the trade really going against me but it is an ETF tied to the S&P 500, that in itself creates a ton of diversity. The only downside is an ETF valued at $110 needs to have $11,000 free cash to back it up.
Jeff.
Wednesday, December 9, 2009
SPY and the Bull Put Credit Spread
I modified my spreadsheet to include put calculations today. I was concentrating on the call spreads just because I needed to start somewhere.
Seeing that the call spreads would benefit from having the SPY price closer to the top of the current regression channel I figured that it would be a good time to check the puts...I was not disappointed.
I chose to check the January expiry's first but the timeline is too far out to be comfortable as I would like the trades to be in the 30 day range or shorter if I can manage it. So I also ran the December EOM.
Based on my range finder the calls at the SPY $110 level should be at 115 strikes sold for EOM and the puts 105 strike sold. For some reason I look at the chart and I don't like the call level still... perhaps I should add a trend factor in there. I did add an adjustment for the price position in the trend or regression channel. Time will tell how much I may have to adjust these factors.
Anyway, back to the puts.
I decided a while back that $10 days for trades risking $5,000 are my minimum target, (Optioneer), breaking that down to smaller trades puts me at $2.40 per day at the $1200 mark assuming that I can keep my money working for me regularly. This is roughly what I expect to use in my SPY trading as a risk allowance. This doesn't convert very well to an overall ROR as it depends upon the timeframe...as long as the daily dollar target is met the rest looks after itself. It is a 0.2% daily ROR though so a 30 day trade should return 6%.
Using that as a minimum guide I ran the various strikes at the various spread values and I can now just scan down the chart to see what the minimum credit trade would be to accommodate my minimum target. As of today's close prices a 104 strike put sold and a 102 put bought would provide $3.09 per day over the balance of the month...22 days. Seeing as the premium collected is based upon the difference in the prices of the two options a longer expiry should have provided a similar result.
Using the chart for minimum targets allows me to assign a better risk model as I can use the absolute farthest strike from the price and I don't really need the whole range calculation at all. Now trial and error can be very expensive in this so I will have to be nimble if this puts the spreads too close and they start coming under pressure form a larger price move than I anticipate. All I need to do to adjust is lower my daily minimum target and the trade moves farther away on it's own.
A quick comparison of the SPY puts.
December EOM
Sell to open Dec EOM 104 strike and buy to open the EOM 102 strike for a 15 cent credit.
21 days left, $3.24 per day, 6% overall.
January expiry, 3rd Friday
Sell to open Jan 104 strike and buy to open the Jan 102 strike for a 28 cent credit.
36 days left, $4.06 per day, 13.86% overall.
Sell to open Jan 103 strike and buy to open the Jan 101 strike for a 24 cent credit.
36 days left, $3.39 per day, 11.32% overall.
Sell to open Jan 102 strike and buy to open the Jan 100 strike for a 19 cent credit.
36 days left, $2.56 per day, 8.31% overall.
Jeff.
Seeing that the call spreads would benefit from having the SPY price closer to the top of the current regression channel I figured that it would be a good time to check the puts...I was not disappointed.
I chose to check the January expiry's first but the timeline is too far out to be comfortable as I would like the trades to be in the 30 day range or shorter if I can manage it. So I also ran the December EOM.
Based on my range finder the calls at the SPY $110 level should be at 115 strikes sold for EOM and the puts 105 strike sold. For some reason I look at the chart and I don't like the call level still... perhaps I should add a trend factor in there. I did add an adjustment for the price position in the trend or regression channel. Time will tell how much I may have to adjust these factors.
Anyway, back to the puts.
I decided a while back that $10 days for trades risking $5,000 are my minimum target, (Optioneer), breaking that down to smaller trades puts me at $2.40 per day at the $1200 mark assuming that I can keep my money working for me regularly. This is roughly what I expect to use in my SPY trading as a risk allowance. This doesn't convert very well to an overall ROR as it depends upon the timeframe...as long as the daily dollar target is met the rest looks after itself. It is a 0.2% daily ROR though so a 30 day trade should return 6%.
Using that as a minimum guide I ran the various strikes at the various spread values and I can now just scan down the chart to see what the minimum credit trade would be to accommodate my minimum target. As of today's close prices a 104 strike put sold and a 102 put bought would provide $3.09 per day over the balance of the month...22 days. Seeing as the premium collected is based upon the difference in the prices of the two options a longer expiry should have provided a similar result.
Using the chart for minimum targets allows me to assign a better risk model as I can use the absolute farthest strike from the price and I don't really need the whole range calculation at all. Now trial and error can be very expensive in this so I will have to be nimble if this puts the spreads too close and they start coming under pressure form a larger price move than I anticipate. All I need to do to adjust is lower my daily minimum target and the trade moves farther away on it's own.
A quick comparison of the SPY puts.
December EOM
Sell to open Dec EOM 104 strike and buy to open the EOM 102 strike for a 15 cent credit.
21 days left, $3.24 per day, 6% overall.
January expiry, 3rd Friday
Sell to open Jan 104 strike and buy to open the Jan 102 strike for a 28 cent credit.
36 days left, $4.06 per day, 13.86% overall.
Sell to open Jan 103 strike and buy to open the Jan 101 strike for a 24 cent credit.
36 days left, $3.39 per day, 11.32% overall.
Sell to open Jan 102 strike and buy to open the Jan 100 strike for a 19 cent credit.
36 days left, $2.56 per day, 8.31% overall.
Jeff.
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