First reply. I have only read to about page 95. First, computing returns on margin required is just useless, unless you are 100 invested. Not sure why you chose to do that. (And why you still do it.) If your short strike has a ~20% chance of being touched, why would anyone consider a 1-19 risk reward? I would think you would be much better buying with those odds than selling. I didn't go back to look find it, but at one point you talked about when you roll spreads, risk doesn't increase. That is wrong. If you have a spread with >80% profits, the POT must be lower than any spread you roll into. So while you might not be exceeding the risk you wanted when you started the spread/IC, you are increasing the risk from where you are before you roll. From what I understand, if the underlying moves violently towards a strike, you close the in danger spread at hopefully a <20% loss. You take profit on you other spread, because it is nearing profit potential, and roll it closer. Has the underlying reversed and caused a loss in the rolled spread yet? I imagine that will happen in higher vol, wide range bound markets. I think you are being naive in your ability to get out when adverse moves happen. I have never trusted stops. A lesson everyone needs to learn personally. Some food for thought from this thread. The POT is interesting, but I think I will use it differently.
This is what i said the worst you can happen to IC if you try to roll .. you actually will loss more than you can expected (initially), and it did happen before (and will happen again) F I think you are being naive in your ability to get out when adverse moves happen. I have never trusted stops. A lesson everyone needs to learn personally. [/QUOTE] A hard stop loss mean you give a bargain to market maker for your bid/ask spread.
Albatross I´d be curious how you trade futures. Been looking up the EMINI but havent really found anything much to do with it and it does not come up on my trading chart two programs I use. Got any suggestions where to go, to learn more? I do follow the 30 min. E Mini chart from the CBOE I think? But this chart does not lend itself to manipulation that I can see, like Big Charts.
My losses in March were mitigated by stops. Yes you are at the mercy of the market, but when you are getting out of the way of the steam roller, your time to negotiate is limited.
This is my reasoning: A trading method is made up of several elements including what you can expect from a given trade and money management tactics; how much to risk on each trade, how much cash reserve to maintain, etc. In order to give some insight into the strategy, I show the returns on each trade as a separate entity. Although I have not specified my money management strategy, I have shown month on month returns which includes these decisions as well as accounting for commissions. I have reconsidered my reluctance to disclose my money management strategy primarily because a mistake I made in March cost me a lot. Hopefully my folly will inform others. PoT is probability of touching, not probability of closing. It represents an estimate of the probability that I will close a spread before it expires rather than letting it expire. Therefore it is not r/r in the sense you are describing. I have found that my actual experience is about half of what PoT would indicate. Also, I would think that the credit received as well as the probability of the spread expiring itm should enter into r/r calculations. The roll part of the strategy is to roll if 1)the current spread exceeds 80% of potential yield and 2)there is a new spread available that meet the spread entry specifications. Although you are technically correct about the PoT being lower on the spread you buy back than the new spread you sell, you get a new credit. They are independent actions. And the r/r should take into account not only the probability of failure, but the credit received. When the underlying moves "violently" volatility increases. Volatility is a significant component in the calculation of PoT. Therefore, the new spread will have accommodated some of your concerns. I have not yet been overtaken in the reverse as PoT has thus far kept me far enough away. However I have seen mild reverses permit me to roll several times on both sides in the life of an option series. I once had a total of eight spreads over time in one series and netted 56% return on funds at risk. My stops worked perfectly in March, except when I ran out of reserve cash because my reserves were too low. More on that when I write my end of month report. I'm interested on how you might use it differently.
These last couple posts are well-considered and informative. Thanks for sharing your thoughts. Re "reserves were too low," I hear Myron Scholes and Robert Merton speak in NYC a couple years ago. (BTW, Merton is an excellent speaker -- charismatic and entertaining). Scholes made the point that the return on a strategy that sells tail-risk is best accounted for as the return on <i>maximum capital that might be required</i> to maintain the position. He points out that every bank prop-trader in '08 (and '01, and '98, and '87...) was begging for more bank capital to support his "good positions" that were "temporarily against" him. But as Scholes points out, at exactly those moments, capital is difficult or impossible to come by. The bank is already running aground because of other losses. The general point is that using worst-case capital as the denominator, returns are <i>much</i> lower -- possibly by a factor or 10 or more, depending on the details of the strategy -- for short tail-risk positions.
No attribution given. That's unethical and outright theft, but at least you're not a hypocrite! http://www.elitetrader.com/vb/showthread.php?s=&postid=3104432&highlight=maverick74#post3104432