buy or sell question - 28 months analysis

[riskfreetrading]

Quote from jwcapital:

As of 11:40AM ET, the total premium of the Mar 1350 Call and Put is 77.50. So, since your initial total premium was 82, your profit is 4.50 per straddle of one contract. In ES terms, this is a $225.00 profit. While it isn't enough to live on, it is still better than a loss in this market. When the market dropped to 1255, your loss would have been about 50%, and you would have been stopped out based on your 10-30% stop loss limit. I think in this environment, you need to give the short straddle some room to breath--that is why I suggested 60%. If I traded the Mar08 1350 put and call short straddle, the total premium would be 82.00 per single-contract straddle. Based on your data, my profit expectation would be 41.00 per single-contract straddle ($2,050.00). My loss would be 60% (based on my stop-loss suggestion) or about a 48 point loss ($2,400.00). That translates to a risk:reward expectation of about 1:0.85. A number of traders would not approve of this ratio. You gotta believe your expectation for success is higher for this to be a good trade. A 60% loss eliminated your three biggest losses over the 28-month period (losses were 71%, 107%, and 153%). Your next highest low was 54%; that is why I choose 60%; to give the trade room to breath. Please continue expressing your thoughts in this thread.

I think that one should also address the probabilities of win/loss. The more room to breath, the high erthe prob. The probability is time-dependent. One should then give more room to breath at the beginning, and less to breath later on.

Let us say the time period is 50 days. The first 5 days, I would give it 90% to beath (one fifth), then I will give it 80% for days 5 to 9. Etc. I would decrease the breathing space in a law which is function of time (square root of time or log of time, or something like that).

 

[jwcapital]

I want to share a real-life trade for the April ES Options. I placed a short straddle, using only one contract per side. I am short 1 C1325 @39.25. I am short 1 P1325 @36.00. My initial margin for the trade was $6,508.00 and my maintenance margin is $5,955.00. My online platform doesn't allow me to simultaneously execute the legs, so I had to do one at a time. In addition, I placed the trades around 4:00 PM ET. The problem with placing trades near the close if that everyone and their mother are also placing trades, so the execution is slower. Interestingly, I usually get my fills where I want them or better. Since I knew I couldn't place both trades simultaneously, I entered the trade for the lowest premium first, which in this case was the put. Once the put order was filled, I entered the call trade. Since the market was moving up rapidly, I got a higher fill on the call than I expected. Anyway, my total premium came out to 75.25. Multiply that by 50 to get my max profit of $3762.50. I will use as my initial stop loss 60%, which means I will exit the trade when the total premiums equal between 120-120.50. I like the idea of tightening up the stop loss as time goes on. Another thought: since the average profit was about 50% of the total premium received, perhaps the trade should be exited when that goal is reached. I am going to try to keep an eye on the daily swings. Any feedback is appreciated, and I will try report weekly on the trade's progress.

 

[theta636]

JW - I was backtesting on thinkorswim last night and selling straddles has been a profitable strategy recently, especially with the increased IV.

I plan on going the iron condor or iron butterfly route myself, using fairly cheap wings 8-10% OTM. The insurance will cut into profits a bit but I will sleep better not having to worry about a fat tail event gapping through a stop-loss.

Looking forward to your weekly updates.

Does anyone have a suggestion for a mathematical analysis of comparing, for example, a SPY 122 -132-142 iron butterfly; a 122-130-134-142 iron condor, or a 122-128-136-142 iron condor (using Thursdays closing price of 132)?

Any thoughts on whether the expected returns should be the same, assuming no edge in forecasting the expiration date closing price, ie. like betting in roulette - the house odds are the same no matter how one bets, or is this more like craps where the house odds differ dramatically depending on what bets one places?

 

[jwcapital]

I have been studying Markg's spreadsheet a great deal. Some other observations: the biggest losers occurred when volatility moved upward-or should I say leaped upward. Yes, it is tough to predict when this happens, but with the use of stop losses, the damage is really minimal. I also notice that when volatility is high and the total premiums are greater than 60, the short straddle doesn't seem to lose money. I keep my eye, on a daily basis, on the VIX, and I chart it with Bollinger bands only. I look at the range encompassed by the channel as well as the directional movement. When volatility was between 8-12, selling OTM puts worked about 10 out of 12 months. Once volatility got up to the 12-15 range, I began to hedge my naked puts with short futures. That worked until the volatility really spiked for the Aug07 options. The futures do not completely cover the loss of the options. My stop loss on the options was double the premium received. I was also rolling down and out at the time. Unfortunately, September had high volatility as well. I ended up getting whacked by my hedge, having to keep putting it on and off. Anyway, my point was to recognize where the VIX is and change the strategy. I actually sat out the MAR07 period, not by choice, but it would have been a loser. I also sat out the NOV07 period, and that would have been a loser. If I put on short straddles during these periods, I would have lost, but the losses would have been less than my previous strategy and the short straddle still had a much better chance of profiting. So, to conclude, I like the short straddles during high volatility periods; naked puts hedged with futures during moderate volatility periods, and naked puts with no or minimal hedging during low volatility periods. 20-30's+ appear to be the high volatility; 15-20 appear to be moderate and <15 is low. Any comments are appreciated.

 

[jwcapital]

More thoughts on short straddles on ES futres options. I noticed that there may be a liquidity problem when trying to exit a serial future option on the last day of trading. What I will probably do is: allow the OTM option to expire, and cover the ITM option, ie sell an appropriate number of ES contracts to cover an ITM put and buy an appropriate number of ES contracts to cover an ITM call. For quarterly expiration, I don't ahve to offset either position. The OTM option is not assigned and expires worthless. Since the expiring ES contract is cash-settled, I have a choice. I can cover the ITM option on the last trading day (Thursday) or allow assignment and cash settlement on Friday. Commissions are negligable in either case.

 

[jwcapital]

More Observations based on presented spreadsheet: When VIX was greater than 18, the short straddle consistently profited. Also, when total premium was above 56, it showed consistent profit. When VIX is near hsitorical highs, the short straddle consistently profits. Interestingly, when VIX was between 10.27 and 12.31, and the tota premium was between 25 and 28.50, the trade consistently profited. The worst loss occured when VIX rapidly increased. The second worst loss occurred when VIX was flat; so, I think that direction is not as important as relative high or low values of the vix and total premium. Keeping max losses to 60% vastly improved the 28-month outcome. In terms of using the ES future options, one would have needed to trade seven to eight contracts per side per short straddle to make a decent living for the time period given. To be safe, this would require a $70,000.00 futures account. Return on margin would be high as well as return on equity. This method would have outperformed my method of shorting puts with or without hedges.