Here are the returns that I have (net after commissions): 2011 (1/2 year): 14.44% (28.88% yearly rate) 2012: 27.69% 2013: 7.15% 2014: (9.48%) 2015 (YTD): 46.51% The 22% compounded yearly is the total results assuming an even equity curve. Obviously, haven't experienced that given the last two years! But I was really pleased with the results because my ratios are around 5:1 calls : puts, so I am essentially selling a lot of naked calls. And there are times where it's acceptable to tighten strikes for more premium. And after a down draft, the market surged back up on a bounce in 2014, got caught in the money and was showing net losses. But all through this time, while deleveraging, moving up & out, i was adding more cash & time value. And when the market flat lined this year, and had some dips, a lot of those call options were able to be rolled out & high enough such that their expiration strikes are around 2050, whereas when I opened the initial positions, it was closer to 1950. It was never my goal to return 20% within the calendar year, just to develop a strategy that never had a margin call, and if given enough time to adjust out, that the cash position would increase, leverage decreased, and theta ultimately works such that every position will expire out of the money. I think of the market as a bit of a spring loaded affect. When I have to roll out and up, I am taking losses, but building cash. That is the spring. The force that the spring has is building up waiting for a market reversal. When the market reverses, the losses on the calls suddenly turn into huge gains (thus why 2015 is looking strong).
One other point on the returns. Starting three years ago, I started trading a variant on this in my IRA account. I have to essentially do ratio iron condors to meet the cash account requirements and to fix the risk size. In the same period, my results are about 75% in my IRA account vs. my portfolio margin account. Two big issues here: 1. The commission & cost of the long legs eats at commissions. 2. When you get caught ITM with a vertical call or put spread, it's harder to roll out. I can get into a lot of the mechanics, but essentially since your call and put legs must match each other on the expiration date, you have to roll them together. In order to collect cash while also deleveraging, I tended to have to roll out 3-5 weeks at a time, losing a lot of potential time premium that I could pick up if I was rolling weekly. Also, in a PM account, when your calls are under attack, there are times where I rolled out months at a time, but would keep the puts on the weekly expiration, turning it into a calendar split. You can't do this in the IRA account. The PM account ends up grabbing a lot more time premium for the position overall.
Why not just use ES futures as a hedge rather than continually rolling out down and up etc. You have a PM account and aside from that ES futures require about 1/20th the margin of an outright position.
It is due to lack of sophistication and knowledge of how futures can be used as a suitable hedge on my part. Though I did start reading ET threads for a number of months now with the primary purpose of evaluating whether there are better ways to hedge the positions other than position sizing. I've mostly focused on possible hedges that involve opening additional option positions, but every time I analyze the cost : benefit, conclude that smaller overall position sizes is better choice. I never got around to studying how futures could play in, when to put on the hedge, at what position, for what margin, and what ultimate outcome. If I opened 40 naked calls on SPX, 2% OTM, 7 days to expiration. And then 5 days later, the market is surging, and I need to roll them out, up and deleverage, it's not intuitively obvious to me which ES future to buy, when to buy it, and how much to purchase.
There's a lot of mysticism out there surrounding futures when they're brain dead simple. You go long or short and that's about it. Margin requirements vary by contract, but are typically quite liberal. There are some per-contract delta differences between ES and SPX, but it's just a matter of sizing until balanced. Thinking about it again I'm not sure if PM will actually consider ES futures as a suitable hedge for SPX options, but as a real world hedge there shouldn't be an issue. Read this: http://www.elitetrader.com/et/index.php?threads/how-market-makers-hedge-spx-options.229095/ http://www.elitetrader.com/et/index.php?threads/hedging-spx-options.234350/ http://www.elitetrader.com/et/index.php?threads/spx-hedging-with-es.210952/ http://www.elitetrader.com/et/index.php?threads/es-vs-spx.253337/ http://www.elitetrader.com/et/index...n-es-and-sp-s-p-futures-instead-of-spx.54216/ (older) You could also just side-step the SPX options and trade ES options specifically.
Thank you for providing the great links. This will turn into my weekend reading list. Last weekend was spent going through all of the old Karen the Supertrader threads looking for points of wisdom. Weekend before that was some of the option writer vs. option buyer threads, and there was incredible wisdom there about volatility & risk management, especially from some of the guys like maverick and yourself.
Thank you kind sir. Maverick and others are more experienced than I in options trading. I'm just a lowly futures trader who sometimes sells index options ATM and hedges with the underlying. I try to control my risk by being on the right side of gamma and not cranking up the OTM leverage.
My advice, and this is probably better than most will give without trolling you to death is to spend some money and back test this strategy. I’m not huge on back testing, however I find that if it failed in the past, it’s going to fail in the future. If it breaks even, it’s not worth it, and only if it provides decent profits should you move forward with it – and even then that doesn’t imply live trading. I say this only because I see issues with short (ratio) strangles at 2% OTM (you mean .48 delta?) with 7 DTE and the rolling strategy you posted. I’ve never done what you have, but I have done something previously with short strangles with 7-8 DTE in JPY FOPs – I concluded the short DTE is not worth it as an outright trade, they are really only good for short (as in time) hedges against larger option or future positions. Furthermore, your vega assessment is incorrect, I’ve personally witnessed otherwise. The end of last October and early November saw the Nikkei rally (hard) after unexpected BOJ stimulus. Volatility absolutely soared and it caught me and my position off guard, I had a significant drawdown, and the strategy your suggesting (if ever used previously yourself?) would not be possible. The lesson here, who says volatility can’t rise significantly while the market rises? It can, it did, and if you model your portfolio for what happened in Japan, will you be trading tomorrow? You need to say yes. Otherwise, back to the books my friend.
When I first came up with this strategy, I was terrified of naked calls because of two big concerns. The first was the unlimited loss potential that you hear with naked calls all of the time. The second was what would happen if the market rose and volatility rose with it, as you described? So, I went searching through all of the historical periods where there have been sharp rises in the markets that also came with huge spikes (or already elevated) levels of volatility. I did my best to rank the 50 largest 1 week moves that also was tied to (likely) high volatility. What I found was that about 90% of those moves were after a significant downward event. And the downward event was where the volatility spike occurred. In these scenarios, if the positions had already been opened, then the down followed by the up did not impact the overall position. If you opened the naked calls when the market was already down, then volatility was already high, and you should be in a position to go further out of the money for the same return. Either way, if the market is moving fast down, you have to be really careful about heavy swings in the other direction when opening up a new ratio strangle. I modeled a lot of this through 2008 and 2009 and found that any opened call positions that may have gone negative due to increasing volatility or spikes up from major down days were more than compensated from the likely loses of the smaller naked put position that was likely deep ITM and rolling out + down. So in situations where calls were taking loses due to increasing vega + bounces, the losses on the puts were diminishing, and overall portfolio position remained balanced. Where it got interesting were the few days in history where there was a dramatic increase in volatility, a big up day, and there was no previously strong down day. Kind of like the experience you described in Japan. One of these events happened recently - the announcement of QE 3 or maybe it was 4. I think with QE3, the market had already risen volatility because of the end of the previous QE, so was in a tialspin, and when QE3 announced it was a massive bounce. But QE4 was somewhat unexpected and off of no negative news, with a huge swing upward. Volatility did increase, but not above 20 if I recall. It was shortly after this a lot of my options went ITM and had to do the adjustment philosophy. I hear you on never betting on the idea that the market doens't have a volatility spike and a dramatic increase at the same time. It is this reason which is why I do not trade this strategy on anything other than SPX. The earnings forecasts of the S&P 500 are so well researched that it will be hard to have a volatility spike other than for a downward event. Macro factors like liquidity from the Fed are unknowns that can cause such things. But otherwise, with so much money in the S&P 500 to begin with, the overall volatility of the index as a whole is dimished a bit. There may be situations in the future that disprove the point, but this is the area where it's worth taking the risk. Again, I come back to position sizing - and making sure that I can absorb increasing vega + a big move against me without receiving a margin call. If I avoid the margin call, I have a library of adjustments to use that buy me time, deleverage, and add to my cash position. The beautiful thing about options is that time and volatility are infinite. It's about designing a system that can absorb whatever short terms shocks so that you can benefit from the long term infinity of time and market volatility.
Despite its known shortcomings, do you use any widely used risk metric like Value at Risk (VaR) or Expected Shortfall (ES) on your position (portfolio)? One could consider this a sort of back test, more so if you’re using the historical method of calculating it. If not, you should see its result. I would be interested to know if the number is higher than your liquidation value for 1-day, 5-day and 10-day 99.9% ES moves. If you’re with IB you can get the 1-day data using Risk Navigator. For the 5 and 10-day, just multiply the 1-day number by 2.24 and 3.16. Keep in mind volatility is not incorporated or considered at all with this calculation, which means in real life should you have a VaR or ES exceedance it will be worse (potentially considerably). Edit: What I really mean above with regards to vega (volatility) is that in short option portfolios the percentage positive (up) or negative (down) number used in the VaR and/or ES calculations gives you “the VaR/ES loss”. This loss is normally reached at a smaller percentage move because of vega effects. This is almost guaranteed true if the percentage was a negative number (so the larger risk was negative) and sometimes (as we have already discussed) if it was positive.