The Effective, Winning Pattern in the S&P 500 and Russell 2000 Using Options Date Published: 2018-08-13 Disclaimer The results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation. LEDE We spend a lot of time researching individual stocks, but let us never forget that option trading is volatility trading, whether we mean it to be or not. In fact, we have a seminal webinar that covers this reality and dates back to the Great Recession for back-test results. Today we turn back to volatility trading -- and this time it's in the S&P 500 and Russell 2000. We present back-test results of a clever, risk controlled strategy that can built in Trade Machine using the custom strategy feature, and the results are staggering. Unlike most of our prior posts, this is not conditional entry -- this has nothing to do with earnings or technical charting. Building the Strategy Before We See the Results We constructed a multi-leg strategy, but that is not code for complicated -- it has just a few steps. Here is the entire image, and then we will break it down, leg by leg. Now, let's review each leg. Rules The first leg of this trade is simply a long, out of the money (40 delta) put. That's it. * Buy a 40 delta monthly put. The second leg of this trade sells two further out of the money (30 delta) puts. * Sell two 30 delta monthly puts. The third leg of this trade sells an even further out of the money (22 delta) put. * Sell a 22 delta monthly put. The fourth and final leg of this trade purchases two even yet further out of the money (15 delta) puts, leaving the entire strategy long 3 options and short 3 options -- the risk is well defined. * Buy two 15 delta monthly puts. What Does This Mean? This is casually called a ratio spread, and specifically this is a 1 x 2 x 1 x 2 (read out loud as "1 by 2 by 1 by 2") put spread. The idea is to create an option position that creates a credit, has no upside risk (if the ETF rises it's a winning strategy), has some downside bias (if the ETF goes down "a little" it profits at the maximum level), and finally covers the short positions with a final out of the money put purchase to limit total downside. But, words do us little good, let's just look at one trade, and the profit and loss graph exactly. Here is the first set of trades for a 5-year back-test in SPY, the top four lines are the opening trades, the bottom four lines are the resulting closing profit and losses. So, to be clear the opening trades resulted in a $0.70 credit, calculated as: Credit = -$1.6 + 2*$1.04 + $0.69 - 2*0.47 Those "2*" represent the fact that two of the legs have 2 options. Remember, it is a 1 x 2 x 1 x 2 ratio (buy 1, sell 2, sell 1, buy 2). And here is how all of that looks in a profit and loss chart: This strategy is profitable in the green shaded area, and shows a loss in the red shaded area. To get your bearings: * The maximum loss starts at the lowest strike price, in this case, $162. Any stock price there or lower shows a capped loss at its maximum. * The maximum gain occurs right at the second-strike price (the first short strike price), in this case $166. * The profit occurs when the stock price hits the high strike price ($168) or higher goes higher. That profit is the credit received to open the trade, after commissions. In English This strategy does well in a bull market but does best in a slightly bearish market. It does worst when there is a large stock drop, but that loss is capped. Finally, The Results Here are the results of this strategy over the last three-years in the S&P 500 ETF, ticker SPY, and the Russell 2000 (small cap stocks) ETF, ticker IWM: Tap here to See the Back-test And here are the results over the last year: Tap here to See the Back-test And finally, for completeness, over the last six-months: Tap here to See the Back-test How to Try This Yourself We simply used the Trade Machine® Custom Strategy builder. You can create it yourself immediately as a Trade Machine member, by simply clicking on any of the back-test links above. You can become an expert at custom strategy building, by watching our video which can be accessed in the link directly below the custom strategy button: A few clicks of the mouse buttons gave us the results that were presented above. What Do We have We now have one, of nearly infinite, custom strategy to back-test the index ETFs. In this case we looked at the S&P 500 proxy, PY, and the Russell 2000 proxy, IWM. This back-test can be run on individual stocks as well -- once the strategy is built, you can use it to test anything you like. But the broader point is, we now have a tool to create back-tests that don't depend on momentum ,technicals, or have anything to do with pre- or post-earnings dates. MOVING FORWARD There's a lot less luck to successful option trading than many people realize. Take a reasonable idea, test it, and apply lessons learned. Tap Here, See for Yourself Risk Disclosure You should read the Characteristics and Risks of Standardized Options. Past performance is not an indication of future results. Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment. Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition. Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.
Actually it works well in a bullish market , works better in a slightly bearish market, and does not work well in a bear market.
Yes it is a neutral to bullish strategy. I only raise that point because you call it a volatility strategy and say that it has nothing to do with earnings or technical charting. I agree because it is basically taking a monthly bullish position on the market and I wonder if you would achieve better results at the beginning of each expiration cycle buying a OTM bull call spread.
It's a trade that does better if the market goes down a little. At the top is a standard 1x2 Long Put Spread for a credit. This works during a bull market but better in a slightly down market. The goal was to elucidate two things: 1. We can position a little more conservatively and still have a winner if the market rises. But most importantly,... 2. You build and test any strategy or idea with the platform, and not doing so, in my opinion, is not giving a trader the best view of what ideas can be used. And, of course, I an the CEO if the company that created it (see my footer), but it's still the truth.
First time I've seen a % return (highlighted, no less) quoted on multiple profitable trades stacked onto the risk of one trade, multiplying it many folds.