Had another productive weekend delving into some of the nuances of option strategies. As a result, my option strategy matrix is being revised. My primary trading objective it to take a small amount of money and reliably turn it into a large amount of money. To do this, I need to find a trading methodology that has a consistent edge over time and does not place undue risk on my trading capital. Once consistent and competitive risk-adjusted returns are established, say after two years of proven results, I can look to manage other people’s money for fee income on a much larger capital base. I am now going to substantially increase my account utilization for option strategies and hedge the various potentially unwanted risks that my account would now be significantly exposed to. Part of my risk management strategy is to diversify my trading instruments to include low correlation plays versus my otherwise primary hedging vehicle, MES. However, correlation can be subject to wide variance over my typical trade holding periods. I may be able mitigate this variance through an hedging adjustment based on my read of money flows and focusing on the lower correlated sector or industry ETFs rather than single named instruments. The following are risks that are subject to management: Directional Risk (Delta) - All of my positions in my portfolio will receive a correlation or beta adjusted delta exposure value, basis ES. My current overnight net directional exposure allowance is 30 delta maximum. Leverage / Daily Performance Risk (Gamma) - I wish to avoid a significant net negative gamma because of the potential of a large negative daily return and increased difficulty in maintaining a tight hedge on delta exposure. Therefore, this risk will be managed by using a multiple strategy approach. Volatility Risk (Vega) - Risk here can go either way. In overall high volatility environments, the risk is volatility declining and resulting in lower potential future returns. In a generally low volatility environment, the risk is increasing volatility, thus likely stressing theta capturing positions. Therefore, in a high volatility environment, I will look to lengthen the holding period of the theta capturing part of my portfolio. In a low volatility environment, I will look to increase my use of calendar spreads, vertical debit spreads, and will more actively consider long option strategies. Option Premium Decay Risk (Theta) - My net theta will generally be somewhat positive by forgoing potential additional gains on outlier moves in the underlying. There appears to be considerable opportunity in single names, but I will limit exposure of any one equity as well as total single name exposure as a percentage of my overall portfolio. The following are trading setups I will primarily be looking for: 1. Long calendar spreads of various duration depending on volatility levels and term structure. Primary metrics I will be looking for are net debit as a percentage of front month price and an inverted or at least flat term structure. Depending on my directional outlook, I will look to enter this trade at .25 to .50 delta basis the front month and prefer my debit is less than 33% of front month premium. This is a positive theta trade when placed in the delta range I have indicated. 2. Long Butterfly or Iron Condor Spread for Basis Reduction: I may use this strategy where a strong fundamental case may be made, but price may be “overextended” in the short term. This wide butterfly or iron condor will have the body near the current price of the underlying and wings at about the .024 / (.976) delta levels. As this wide trade entails more risk than others, I will adjust my trade size to account for it. Theta on this trade type is positive. 3. Long Butterfly Spread for Synthetic Position: I will have a well defined directional outlook here and want to benefit from higher leverage, tight defined risk, and a payoff profile that is more favorable than the underlying under a significant portion of the probability curve. This trade is to be structured so the one of the breakeven points nearly matches the current price of the underlying. The tradeoff to consider is when an extended move in the anticipated direction results in a loss instead of a outsized profit the underlying would enjoy. Generally, I will look to place this trade with one wing at about .65 delta, the body at roughly .40 delta, and the other wing at about .024 delta, or at about the two standard deviation level. Where there is a favorable term structure and I have reasonable confidence the chances of an extended move in the anticipated direction are low, a 1x3x2 structure will allow a potentially significant overall increase in probability of profit and improvement of other metrics. 4. Soft Overwrite (Hedged) or Covered Strangle: This strategy has a very high probability of profit and great flexibility in precisely dialing in one’s outlook. Issues to be aware of are potentially larger losses either to the upside or downside on extended moves. I will hedge unwanted deltas using MES. For capital efficiency and depending on other trade variables I could also buy a(an) .024 delta option(s). The key consideration is my net delta exposure and how much of it I want to keep. This strategy is mainly intended for ETFs. 5. Long Option: In a low volatility environment and a apparent change in the status quo in some metric, indicator, correlation, or Governmental policy, where a 2 standard deviation range expansion type move may be a reasonable target, I may take a shot, appropriately sized from a risk management standpoint, with a 1/42 chance of success based on static statistics. This type of trade will normally have a one day or intra week time stop associated with it. I would tend to go for very high positive gamma as would be seen with a Friday expiring option and thus would be subject to high theta decay, but a very favorable short term risk to reward ratio. My actual chance of success and potential for outsized returns may be much better than indicated by static statistics. Another consideration is workflow efficiency and data visualization. I feel too much time is spent on looking for trading opportunities. Practice and a multiple monitor setup should go a long way to improve efficiency. For data visualization, I will set up a Black Scholes utilizing spreadsheet that will simultaneously compute and chart the metrics of interest under a range of time to expiration, moneyness, and volatility considerations for my various strategies. In addition, I will be able to more easily and effectively account for future term structure and skew assumptions in my trading decisions than what is currently offered on my trading platform.
Closed one of my ES calendar spreads and my long MES as a hedge: Sold ES June 05 / 12 2860 put calendar spread for 3.25; sold 1 MESU2019 @ 2969.75. I have 1 remaining ES calendar spread and will make a decision tomorrow on whether to keep it. I will be looking for a larger bearish position on ES today and tomorrow. Watching bonds price action for clues on how loose the Fed is going to be. Other than NQ being stronger than ES and YM, it does not look like risk appetite is at all high, especially considering the so called good “news” on trade. I still have the gold calendar and will have to close it tomorrow if I want to salvage any possible value from it. I am considering adding a long term mini gold position or two because of my concerns over long term global monetary policy. Traveling right now, but I decided to go for a quick short on MES at 2976.25. I closed it at 2957.75.
Closed my gold calendar spread at $1.10 because the position was negative theta and the front option was at .022 delta, or more than two standard deviations away. Will look to establish another calendar spread with the front option set for next Friday’s expiration to take advantage of term structure inversion. Part of the challenge in choosing an appropriate strike is gold could test it’s recent high very quickly, but the .25 delta strike is at 1420, or about $25.00 below it’s recent high. Perhaps I will look at a mini gold contract or vertical spread. Closed my ES calendar spread at 2.80 for basically the same reasons as my gold spread. On a post mortem of my gold trade, I only now realize that certain metrics such as options skew was at extreme levels. Levels that are associated with a 95% chance or so of correction. I allowed a personal bias to be a significant criteria in my trading decision to buy the gold calendar. Never mind the vertical chart. I mentioned before I would be creating a trading checklist to help to avoid these situations. Just as pilots have their preflight and pre-landing checklists to help avoid “doh” moments, I feel I could have avoided entering this short term trade with odds so stacked against me. Even pilots with their checklists have forgotten to fuel the plane or put the landing gear or flaps down. In other words, a checklist should be followed. I am now completely flat and in the next few days I will create my checklist and a model portfolio for practice. I will post the checklist and model portfolio. In addition, I will post additional decision points or considerations on future trade ideas to help me be more rigorous in my trade selection.
Bought a VXX bullspread on ideas ES volatility is priced too low given persistent weakness in economically sensitive commodities such as crude and copper in spite of trade talks and easy Fed policy. Taking advantage of selling higher implied volatility of 62.4% and buying lower implied volatility of 51.9% in VXX options, I bought 8 VXX June 12, 2019 24 calls / Sold 8 VXX June 12, 2019 26 calls at a debit of $.55. The June 19 and June 12 volatility curves on ES look interesting and I will be looking for a trade there, especially if ES makes another new high this week.
Sold my 8 VVX bull spread at $.529 on stronger that expected jobs report that also saw growth in manufacturing jobs. If jobs start weakening in the future, I would look to get very aggressive shorting the market in spite of the Fed cutting rates. As it stands now, I will take a neutral to slightly bullish assumption with my option strategies. As usual, any intraday trades will be on either side of the market. Should have the model options portfolio with hedging strategy done this weekend.
My account is finally green on a ES calendar spread, now closed. I Have open profits on a short NQ at 2905. Took a lot of heat on this position as 8000 was tested. This heat was 7 times my standard stop loss levels. It was hard for me to exit because of ever widening divergence between US equities, global equities, and commodity futures. For example, at one point the Nikkei hit 11 day lows while US equities were hitting all time highs. Global economic and select US indicators are weakening. Historically, when the Fed first cuts interest rates, the equities markets experience a drop. Perhaps this is caused by a realization by traders the Fed, by action, is becoming concerned over economic prospects and thus validates market concerns. Personally, even with weakening economic numbers, I would like to see the Fed hold rates where they are for better monetary credibility. Hopefully the US starts seeing improvements with the budget deficit as a consolation for global economy draining tariffs.
Edit previous post: Short NQ at 7905.00, not 2905. Covered short today at 7868.00. My target last week was 7840.00. Was given two chances to exit at that price level, but I held off because Nikkei was down over 1% and nearing a 1 month low. Crude was getting hit hard as well. However, NQ stayed strong relative to my expectations and appeared to put a potential intraday bottom in. I have seen this situation play out before and am glad I covered when I did. If I had a pair, I would have gone long. US equities: Only game in town (World) from long side? Buy the dip forever? I need to get with the program and join God in worshipping the Fed!
Looking at the Australian Dollar because of its very low IV 52 week percentage rank and the upcoming Fed rate decision on July 31st. I’m thinking of several ways to play this. I’m looking at a long Aug 2 / Aug 9 call calendar spread or maybe even a outright call buy If the Fed drops rates a quarter point and indicates continuing accommodation going forward, perhaps AUD may test .7050 to .7100, the high of the last few weeks. This move may even be a part of a longer term move if China and the US can put together a trade agreement and eliminate tariffs as risk taking outside of US equities markets may be encouraged. However, the Australian Central Bank may be emboldened to ease even more after the Fed makes its move. Attached below is a profit table based on days to expiration and moneyness of a partially covered strangle from optionsprofitcalculator.com. This free website also has charts of this and other strategies. Eventually, I want to create a spreadsheet that will also include volatility assumptions based on price changes and time remaining for more accurate pricing projections. In addition, I could use this data to simultaneously calculate probability of profit and other metrics for various predefined option strategies for comparison purposes.
Will be posting my trading results with equity curve since inception ending July 31st next weekend. Since I have a little extra time today and my account value will not likely change much before end of this accounting period, I can safely go over my trading performance now. In the last three months I did not regularly trade due to other commitments. This made it challenging for me with my multiple strategy and time frame trading approach. Although I currently have a small, 2% profit overall, my trading performance was adversely affected because I did not consistently follow my trading plan, generally vastly underutilized my account buying power when I did trade, poorly managed many of my option positions, and was inefficient in applying the best strategy according to my outlook. Like in my previous journal, I made money in outright equities futures positions and lost money in either overnight stock trades or in this journal, option trades. I also still have yet to create my trade checklist to be used before entering a trade. Doing this will help me make sure I am choosing the best strategy and not leave a lot of money on the table again. This absolutely will be done by next weekend. One of the keys for improving my trading consistency is for me to gain the feedback of completing many trades and adjusting accordingly. Another key is for me to narrow down my trading strategies. That is not going realistically going to happen given certain aspects of my personality, though. I accept the greater challenge to my trading performance this entails. I will be able to dedicate more time to trading in the next month. As mentioned in a earlier post, I will use various option trading strategies such as 45 to 60 day wide iron condors that have both high absolute IV and high IVP. 10 to 45 day directional butterflies that have both high absolute IV, high IVP, anticipated move in direction of decreasing volatility, and offer basis improvement when compared to a outright position will see fairly heavy use as well. For low IVP environments with anticipated move in direction of increasing volatility, I will look to buy short term, slightly positive theta, 1 to 2 week duration calendar spreads that preferably has a favorable term structure. I love time symmetrical calendars that have a debit less than 1/3 of the short option. For reversal plays, such as a expansion bar in a well established trend in a low IV environment, I will look to buy 40 delta or so options that expire by the end of the week. For consolidation breakout plays where there is modest price action against the underlying trend, I will also look to buy options in direction of underlying trend that expire by end of week. Long option trade durations will be 1 to 3 days. Position management will revolve around addressing accumulated deltas, ongoing risk to reward calculations, and overall correlated exposure. My target account buying power utilization will exceed 50% in the upcoming period, instead of the previous 5% or so average in the prior period. My buying power utilization objective is to be ultimately based to avoid frequent daily equity fluctuations exceeding 3%.
Bought a Eur call calendar spread on ideas a Fed rate cut could change market sentiment on currencies. The Euro has several features that speculatively lend support for it as a backup reserve currency, especially for those countries who are increasingly looking to avoid the US dollar. I sold 5 Eur Aug 02, 2019 1.1300 calls, bought 5 August 09, 2019 calls at a debit of .06. Yes, I paid the full spread for this initial position to guarantee execution. Total theoretical delta for this position is .38. I sold 1 M6EU19 for a .10 delta partial hedge. Between today and tomorrow before the Fed announcement, I plan to buy more calendar spreads and will scalp around and adjust my hedging according to price action. My target overall delta net of hedging is .30.