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.
Questrade, My direct access discount broker.
Wednesday, May 11, 2011
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.
Sunday, April 24, 2011
CMC results to date
The posted CMC trades, just one of the stocks that I am tracking and trading, has produced a decent return on investment since September.
Five trades posted, 4 winners and 1 loser.
Using the typical "$1,000 invested could have been..." method of reference seems a little unrealistic as the price varies and percentages can be deceptive if spun the right way. Assume that a trade size of 100 shares (the typical lot size) the first trade (a short at $14.50) would have tied up $1450... so I will use that as the starting capital. All trades thereafter remain 100 shares and, but as it turns out, $50 would have had to have been added to keep this size as the price does rise into the last trade.
Total profit was $400 for a 27.6% return based on the first trade of $1450 (26.7% if you count in the extra $50 added at the end)
Not bad.
Doing the compounding thing based on the share prices for each trade turns this out to $406. Interesting as I thought that it might have been a bit higher. The loss early on and the larger share price at the end reduced the effectiveness of the compounding.... but an extra $6 is still $6.
I'll post my total record next time around. I have the data but just have not run it through the ringer yet, some I traded and some I did not so it's a little all over the place right now.
Jeff.
Five trades posted, 4 winners and 1 loser.
Using the typical "$1,000 invested could have been..." method of reference seems a little unrealistic as the price varies and percentages can be deceptive if spun the right way. Assume that a trade size of 100 shares (the typical lot size) the first trade (a short at $14.50) would have tied up $1450... so I will use that as the starting capital. All trades thereafter remain 100 shares and, but as it turns out, $50 would have had to have been added to keep this size as the price does rise into the last trade.
Total profit was $400 for a 27.6% return based on the first trade of $1450 (26.7% if you count in the extra $50 added at the end)
Not bad.
Doing the compounding thing based on the share prices for each trade turns this out to $406. Interesting as I thought that it might have been a bit higher. The loss early on and the larger share price at the end reduced the effectiveness of the compounding.... but an extra $6 is still $6.
I'll post my total record next time around. I have the data but just have not run it through the ringer yet, some I traded and some I did not so it's a little all over the place right now.
Jeff.
CMC and not so live trade blogging
I've been somewhat tied up in other projects (personal and work related and I have not taken the time to keep my blog updated. Some of the trades that I have been tracking I have not actually managed to get into, and some I have. I can only do so many things. So, I am updating my favourite stock following today.
My CMC trade posted active on November 23rd, 2010 didn't get entered. The way the price hovered around $15 then broke up just did not instil much confidence in a followup drop in price, basically the setup looked far more bullish than bearish. As a result I just decided to let it settle into the next groove. In the interest of not looking like I am fitting the trades to the hindsight circumstances I will keep it in the mix as if it were made anyway.
Book one loss of $1.50
As such the setup came for a long trade, a little more aggressive based on older support / resistance rather than new trend establishment, enter long at $15.50 following the mid-December high of $17.46. February 17th saw the $18.00 break which made the setup a little less aggressive but still active.
Mid-March saw the price spending most of it's time in the $15's so there was lots of time to get a decent price for this trade. Target exit at $17.00 met on March 29th.
Book one profit of $1.50
Of course a short is in order next, target entry was for $17.50 to allow a little space to wind up and make this a lower risk setup. Trade filled on April 1st and closed on April 18th at the target of $16.00.
Book another profit of $1.50.
All in all not a bad producer.
Jeff.
My CMC trade posted active on November 23rd, 2010 didn't get entered. The way the price hovered around $15 then broke up just did not instil much confidence in a followup drop in price, basically the setup looked far more bullish than bearish. As a result I just decided to let it settle into the next groove. In the interest of not looking like I am fitting the trades to the hindsight circumstances I will keep it in the mix as if it were made anyway.
Book one loss of $1.50
As such the setup came for a long trade, a little more aggressive based on older support / resistance rather than new trend establishment, enter long at $15.50 following the mid-December high of $17.46. February 17th saw the $18.00 break which made the setup a little less aggressive but still active.
Mid-March saw the price spending most of it's time in the $15's so there was lots of time to get a decent price for this trade. Target exit at $17.00 met on March 29th.
Book one profit of $1.50
Of course a short is in order next, target entry was for $17.50 to allow a little space to wind up and make this a lower risk setup. Trade filled on April 1st and closed on April 18th at the target of $16.00.
Book another profit of $1.50.
All in all not a bad producer.
Jeff.
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