Bobby, let me try to be constructive here. If you had to explain to a 7 year old why "you" believe this strategy works, what would you tell them? BTW, this is a common interview question in finance jobs because employers find that those who have the most understanding of complex subjects have the ability to explain them in the most simplest of terms.
Maverick, this is an excellent question! I have two children, 11 and 6, and two Foster babies. Here's how I would explain it to my six year old. Daddy is trying to make money by doing something that has a big chance of making a profit. This works most of the time. It's kind of like dad leaving in my car to go to work, working, and then coming home. You are very excited to see me come home every day. We hug. We play super power wrestling and we have a good time. That's the same way dad feels with trading. Most days everything works out fine and we get happy when we make money because dad can buy you an ice cream cone and take you to the movies. But there's that one day a few years ago when daddy didn't come home. You weren't born yet, but I was on my way to work and I had a bad car wreck and my car flipped over and I was thrown from the car. It was awful. I was blind in one eye, my back and pelvis were broken. My ribs and sternum were broken and I couldn't breathe because one lung collapsed and the other one was punctured. They took me to the hospital where I stayed for 51 days and then I came home and had to be in a wheel chair for 6 months. It was tough being out of work for 6 long months but your dad didn't give up. I went to rehab and learned to walk again. I exercised and I got better and today I'm brand new after having a little metal in my spine and pelvis. I'm like a robot. You see, most days trading is fun and good. Every now and then we are going to have rough days. Did my accident stop me from driving you to school? Heck no! We buckle up, look both ways, drive within the speed limit and stay focused on the road and our surroundings. I am a better driver today than I was before my accident. I am also a better trader.
Thanks Bobby. Let me re-phrase my question. Let's say you have a very bright 6 year old, top of his class and that might very well be the case, how would you explain the mechanics of your strategy in terms of why it works. For example a long only stock trader could tell little Johnny that the reason daddy makes money almost every year is because over the last 100 years, broad stock market indices like the S&P 500 have returned 7.5% annually which is a function of the risk free rate, the rate of inflation plus a risk premium.
How sure are you of the optimal theta decay curve for this time frame? Why 50%? Why not 60%? Why not 40%? Why losses at twice the credit received? Why not 1.5x? Why not 2.5x? So is this how you forecast volatility or do you not forecast at all? What sort of drawdown do you expect? How would you have fared during fall 2008? May 2010? August 2011? October 2014? August 2015?
Maverick, I am not sure that this will work. That is the reason for the experiment. I know absolutely nothing and don't claim to be an expert. With that said, I am selling options with a high probability of profit, often times with a 90%+ chance of success. I then look to manage the trade in a variety of ways. First, I close the trade at 50% profit. Why? Tastytrade research shows that this increases probability of success. Or, I close the trade at a loss equal to 2 times the credit received. Again, this is based on Tastytrade research. Finally, if neither of the above is triggered I exit the trade after being in it for 24 days. This is somewhat based on Tastytrade research combined with my own little twist. The above should help me to manage winners early and get out of losses before they become too big. Ina complete meltdown, I will be actively managing positions by closing and/or rolling. If all hell breaks loose and I have a 5%+ reduction in my net liq then I give myself permission to shut it down, run a Z, and stay out until things settle down. Why will this work? I'm not entirely sure but I do have a certain level of confidence that it will be successful. I am targeting an annual return of 25% - 36.5%. Each day I am attempting to move toward a delta of 1/2 of my vega. I would like to have a theta to vega ratio of greater than 0.2. I am often unsuccessful in these targets, but I am mindful of them each and every day and I try to adjust the account accordingly. I hope I have addressed your question. If I can be more specific in any area, please let me know. Bobby
. Members of our group traded similar styles through 2014 and 2015 and did very well. The key is size. You cannot get too big. Size kills.
Bobby, let me address just this statement: "Why will this work? I'm not entirely sure but I do have a certain level of confidence that it will be successful. I am targeting an annual return of 25% - 36.5%." Historically going back say 100 years (a lot of data here), there has only been two traders in all of the world over a period of 100 years that have made more then 30% annually over a period longer then 20 years and they are Soros and Simons. These people are held higher in regard then Michael Jordan, Tom Brady and Tiger Woods. In fact, there are only handful of guys (sorry women) that have even gone over 20%. One that comes to mind is Ed Thorp of Newport Partners. I believe Julian Roberstson is another. But we are talking about enough people to count using two hands. Even the high teens the list is fairly small. So here you are a guy stating that you have no idea if this will work or why it will work and at the same time saying you are expecting to earn returns in the echelon of the highest most exceptional human traders of all time. Have you thought about that? And you are throwing out this 25% to 36.5% return as if you are dialing it down, making a sacrifice to even except such low returns. I think this is a big problem on this forum, certainly not just with you. But the genesis of this logic comes from a deep lack of mathematical understanding. It's why you hear guys say things like all I want to do is make 30% a month. As if they could make much more but don't want to piss off the neighbors. The fact is, this industry attracts some of the most brilliant and intelligent people you will ever meet and I would say 99% of them do not get into double digits. Hell, even the criminals in this business, the guys who steal the money from widows and orphans can't even get into double digits. I just think you should think about that. I can throw a decent football, but there is no way on earth I would presume that I could have been Tom Brady if I really wanted to. That comes down to personal honesty with yourself. And Bobby this is not just directed at you but really everyone on ET.
Maverick, I first want to really thank you for your recent questions and comments. This is the engagement and debate that I so desired when I came to Elite Trader. Let's first go to my target of 25 - 36.5% returns. This is my target. I didn't say that I am going to hit that target. I'm a very confident guy. When I set a goal to be valedictorian of my class, I achieved that. When I set out to graduate summa cum laude, I achieved that. I'm in grad school right now and I have a goal to make all A's. Will I achieve that probably. When I started playing trumpet, I was horrible but I worked my tail off and got music scholarships to several colleges. I work at things until I figure them out. Trading is like playing a musical instrument. In that regard I can hardly play a scale. However, be sure of this, I will figure it out. This is an experiment and I learn each and every day. Tweaks will be made. Mistakes will be made. But, I have a high level of confidence in my abilities. I'm not cocky, I'm just confident. In setting goals, one must be specific. I want to beat the market - that's a dumb goal. I want to beat the S&P! That's not specific. Should I set my goal to making 7% a year? That doesn't excite me. I aim high. Now, is my goal unreasonable? I don't believe so and this is going to piss some people off. I use theta to help me calculate my expected returns. Is this going to work 100%? Not at all. I have a daily theta goal of between 102.74 (25%) and 150 (36.5%). I use this to help me establish my goals. I also utilize other formulas to help me determine the amount of premium that I should be selling in relationship to my expected returns, but I will leave that for a later post. Setting specific goals in life has served me well throughout the years. Why should trading be any different? At the end of this year, I will evaluate the returns and set new goals for next year. Will I hit my goals? Time will tell. I am curious? Do you set goals for your returns? Surely I'm not the only one. Keep the questions and comments coming. It helps me to think through my process. Happy trading! Bobby
No, I don't set any goals. I look for opportunities. They are either there or they are not. It's like anything else in life. I can't make opportunities suddenly appear just because I want them to be there. You can't impose your will on the market like you can on a trumpet or your GPA. The market is unique in that most of the variables you are working with are out of your control. If I wanted to learn how to play the trumpet, I can control how hard I want to practice. The market unfortunately does not work that way. With regards to only making 7.5% a year, most professionals are not trying to beat the market on an absolute basis but rather on a risk adjusted basis. To accept the 7.5% return in equities you have to put up with 15% annual standard deviations. So most fund managers are trying to minimize their sigma while targeting index like returns. It's actually really hard to do and 99% fail at it. There is nothing wrong with having big goals, but if the goals cause you to stretch your risk out, that is where the issue is. Pretend your 11 year old said dad, I want to move to Hollywood and become a star. Nice lofty goal and you never know right? But would you let them move out there with no money, no where to live, no friends, and no plan? Of course not. Most traders on ET only think in absolute terms, not in risk adjusted terms. And what most of them think of as alpha, is really just piling on leverage. You should have seen the outrage when US regulators limited FX margins to 50 to 1 from 300 to 1. They were burning cars and flags. LOL. The key here is not in making the most amount of money, but rather in making the most amount of money with the least amount of risk taking into account all your opportunity costs.