Option income strategies

anonsTrader · Dec 13, 2009

Why worry about beating the market when it is rising at 30+% APR? It is during a bear market that a trader earns his keep.

Here is what successful trading should look like (capturing bull market gains, and continuing them through bear markets):

http://www.crystalbull.com/stock-market-timing/CrystalBull-Trading-Indicator-History-chart

spindr0 · Dec 13, 2009

Quote from akivak:

The problem begins when bear market comes â and in bear markers, very few newsletters deliver decent results.

Your iron condor is an indicator of market direction. Ignoring the 9/11 type of whacking, your iron condor is an indicator of market direction. If you see one side increasing in value and the other side idecreasing, isn't it obvious where your focus should be (management of existing positions and addition of new positions)?

My conclusion is very simple: itâs very hard to beat the market. So many experts say: just buy the index and hold. Well, we know what happened to those who just bought an index 10 years ago.

How can you beat the market if you buy and hold a broad based index? You just match the results, up or down. If you want to beat buy and hold, you have to have an edge (timing, selection, TA, FA, whatever) or trade from both sides (long and short).

So what's the solution? When buying stocks, indexes etc., the mathematical probability of success in general is 50%. Why not to put the probability to our favor by implementing options income strategies like iron condor, calendars etc.? Stocks and indexes do trade in narrow range 80% of the time. Why not to use this fact in our favor? If you trade Iron Condor for example, the probability of success (depending on the strikes) can be 80-90%, with 4-8% monthly return. Of course those trades require adjustments and constant management in order to limit losses, but so are stocks. We already saw the most âsafeâ stocks tank by 40-60%. So instead of buying stock/index, watch it to go up 20% only to come back, why not to put time to work for us?

Your risk comparison conclusion is fine if buy and hold is all you compare IC's to. The key to your IC success will be your risk control. In one of your other replies you mentioned buying some "black swan insurance." Good idea. Give up a small amount of potential in order to lop off a large amount of risk.

If I implement market neutral strategies with options, 80% of the time I can just sit tight and make 7-10% per month. If I control risk and cut my losses at those 20% period when indexes move more than 10-12% per month, I should do much better than directional strategies.

You'll do much better with IC's than with directional strategies if you're directionally handicapped. One replier hit the nail on the head with his comment that: "It is during a bear market that a trader earns his keep."

To reduce vega risk, I started using multiple calendars, in addition to iron condors. Iron Condor is vega negative (loses money when volatility increases), while calendars are vega positive. So Iâm trying to open iron condors on down days when volatility increases, and calendars on up days when volatility is lower. Combination of those two strategies reduces vega risk.

My experience with trading is that you run with whatever works for you. You bang out as many trades as you can handle for as long as you can but always remember that sooner or later it's going to bite you. Keeping that bite small is the key to it all.

More...

heiasafari · Dec 13, 2009

Quote from spindr0:
You'll do much better with IC's than with directional strategies if you're directionally handicapped. One replier hit the nail on the head with his comment that: "It is during a bear market that a trader earns his keep''

More...

I agree with most of what you say but I'd like to pinch in on that part... It would only be true when you target absolute return (obviously thats the case with us both not with most money managers). If you benchmark yourself to the s&p500, then any fool can beat it when its down, you just need to hold some cash (cause the benchmark doesn't). In my job when I evaluate a manager, I always want to know what cash he has and what he actually does when the market's up, for a "standard" fund manager, beating the market when its UP is more valuable. When its down, I can always have us pull some cash out.

For the record, that is the difference between relative and absolute returns. If you target absolute return, beating the S&P500 now, now that says something about what you can do.

spindr0 · Dec 13, 2009

Quote from heiasafari:

It would only be true when you target absolute return (obviously thats the case with us both not with most money managers). If you benchmark yourself to the s&p500, then any fool can beat it when its down, you just need to hold some cash (cause the benchmark doesn't). In my job when I evaluate a manager, I always want to know what cash he has and what he actually does when the market's up, for a "standard" fund manager, beating the market when its UP is more valuable. When its down, I can always have us pull some cash out.
More...

I have no disagreement whatsoever with your clarification. Your explanation of holding cash to beat a down market made me realize that I mstakenly spoke in broad terms while thinking of my metrics which really aren't applicable to the concept of buy and hold. For me, if the market is down 10% for the year, beating the market means that I am up more than 10%. Oddly, up markets give me more grief than down. As a result, I'd sooner trade from the short side (equities) than the long. Maybe I should be a Black Swan specialist?

jj90 · Dec 13, 2009

Quote from spindr0:

Oddly, up markets give me more grief than down. As a result, I'd sooner trade from the short side (equities) than the long. Maybe I should be a Black Swan specialist?
More...

It's my belief that many independent traders are trading a long vol biased system: their system does significantly better in high vol periods. Wherelse, buy and holders have a short vol biased system, where most of the variance is made in jumps. My terminology might be inaccurate, but anyways I too have been finding it hard since late AUG 09 in equities.

heiasafari · Dec 13, 2009

Quote from jj90:

It's my belief that many independent traders are trading a long vol biased system: their system does significantly better in high vol periods. Wherelse, buy and holders have a short vol biased system, where most of the variance is made in jumps. My terminology might be inaccurate, but anyways I too have been finding it hard since late AUG 09 in equities.
More...

I actually think this makes sense, I tend to do better in higher vol market conditions. I don't think it actually has to be the case but I just can't seem to "force" myself to adapt my trading (even though I know what I could do). Like sprindr0 said, I think we stick to what we do best even if its not optimal all the time. Better not optimal than bust though...

spindr0 · Dec 13, 2009

--------------------------------------------------------------
Quote from spindr0:

Oddly, up markets give me more grief than down. As a result,
I'd sooner trade from the short side (equities) than the long.
--------------------------------------------------------------

Quote from jj90:

It's my belief that many independent traders are trading a long vol biased system: their system does significantly better in high vol periods. Wherelse, buy and holders have a short vol biased system, where most of the variance is made in jumps. My terminology might be inaccurate, but anyways I too have been finding it hard since late AUG 09 in equities.
More...

Just for clarification, I meant shorting equities during periods of higher volatility not shorting options with high IV.

Taking a non technical guess at why I do much better in down markets may simply be that markets don't melt up. In good times, excluding special news like FDA approvals, EA's, etc., I think that people tend to buy some of this, some of that and everything rises somewhat evenly. In a fear based environment, people act irrationally and can inexplicably dump a lot of X or Y to keep Z. Things go down unevenly, some sharply. Opportunities are very different than during optimistic complacency.

Or maybe I just think negatively

mgmaggie · Dec 13, 2009

I believe this week will offer us some good premiums in the options even though it is a quadruple witching options expiry.

I was looking at the nasdaq and european economic calendar and with the Fed on Tuesday and Wednesday little news tomorrow we could see some big moves.

I am looking at selling some ITM Calls on any break out on the retail, metals and some of the food sectors or if we get a 30 percent or more retracement ITM Puts.

I don't play any specific strategy other than I will look to sell depending on above and worse case I will immediately sell part of my assigned position with new calls or puts and scale in as the market moves to hedge myself for the month as December and January should be lighter in volume.

akivak · Dec 13, 2009

Quote from spindr0:

Your iron condor is an indicator of market direction. Ignoring the 9/11 type of whacking, your iron condor is an indicator of market direction. If you see one side increasing in value and the other side idecreasing, isn't it obvious where your focus should be (management of existing positions and addition of new positions)?

I don't care about the market direction, that's the whole point. As long as the market moves in any direction but not too strong, I'm okay.

How can you beat the market if you buy and hold a broad based index? You just match the results, up or down. If you want to beat buy and hold, you have to have an edge (timing, selection, TA, FA, whatever) or trade from both sides (long and short).

The "experts" say that you cannot beat the market by picking stocks, so just join the market by "buy and hold the index" and you do better than 80% of fund managers. The purpose of non-directional option strategies is to beat both stock picking and index holding strategies.

Your risk comparison conclusion is fine if buy and hold is all you compare IC's to. The key to your IC success will be your risk control. In one of your other replies you mentioned buying some "black swan insurance." Good idea. Give up a small amount of potential in order to lop off a large amount of risk.

Risk control is the key, you are absolutely correct.

You'll do much better with IC's than with directional strategies if you're directionally handicapped. One replier hit the nail on the head with his comment that: "It is during a bear market that a trader earns his keep."

I AM directionally handicapped. If you can predict market direction and do it consistently, obviously you don't need non-directional strategies. Just buy SSO, QLD or UWM when the market is up, sell them short when the market is down, and you can make 30-50% a year no matter what the market is doing. No stock picking is necessary.

My experience with trading is that you run with whatever works for you. You bang out as many trades as you can handle for as long as you can but always remember that sooner or later it's going to bite you. Keeping that bite small is the key to it all.

This is probably true for every strategy. But if you think the market will go up and it goes down by 10%, you lose 10%. Period. With ICs, my margin of error is bigger. The market can go down 10% and I still make money.

More...

drcha · Dec 13, 2009

Quote from akivak:

This is irrelevant to margin calculation. If I make $2, it's 25% profit (2/8). If I lose $2, it's 25% loss. If I lose $4, it's 50% loss. If I lose the whole $8, it's 100% loss.

Lets take as an example IC with $2 creadit.
In order to lose 50%, the spread in money should be worth about $6 (the opposite one can be bought back for about $0.2 at that time). With proper risk management, you should never let this happen.
More...

You will not be able to stop this from happening in another 1987-style debacle. Your money will be gone at the open. Just another argument for insurance, but mostly, an argument for staying small.