Going long on short positions without getting burned

[Cuddles]

Since I blew up my account this last month or so, I've been reading up on how to use stop losses more effectively. I came across this article which I found insightful:

https://www.quant-investing.com/blo...bout-stop-losses-that-nobody-wants-to-believe

Of particular interest was Research study 3 - Taming Momentum Crashes: A Simple Stop-loss Strategy. Cliff notes & link to study below:
http://www.cicfconf.org/sites/default/files/paper_811.pdf

The researchers applied a simple momentum strategy of each month buying the 10% of companies with the largest price increase the past six months and selling short the 10% of companies with the largest price decline the past six months.

Once the stop-loss was triggered on any day the company was either sold (Winners) or bought (Losers) to close the position.Remember this was a long-short portfolio.

The proceeds were invested in the risk-free asset (T-bills) until the end of the month.


So I liked that the strategy reduced the risk associated with crashes, but something that still bothers me is that it relied on staying both long & short for long periods of time. I recall a story last year of a guy that went short on a company that was diving, only to get burned when it gapped up due to an acquisition. A short stop loss in this case won't help since it's a market order.

Perhaps the above strategy is not much different than hedging w/options, but it struck me as a bit simpler. Any input on how to address my concern when using the above?

 

[Robert Morse]

Perhaps the above strategy is not much different than hedging w/options, but it struck me as a bit simpler.

Yes, I would say using options as a stock replacement, if you do not lever up, is a good way to trade without having to set stops and limit losses. Easier to just buy a call or put vs stock and a hedge. You still need to have a process for entering and exit. You do not want all your options to expire at $0.00.

 

[tommcginnis]

This is a naive strategy -- put up just to illustrate a general principle to see how it performs. A strategy-wise Straw Man. *Tweaking* such strategies..... well now! That is a Joy Forever!

(Which is to say, if you think it begs for refinement, then by all means refine it! But keep track of the path you're traveling, because if the refined strategy begins to lose its performance, then taking it back to its naive beginnings and examining the market for another productive tweak might be *quite* the rewarding activity. )

Anyway, .

 

[Cuddles]

Yes, I would say using options as a stock replacement, if you do not lever up, is a good way to trade without having to set stops and limit losses. Easier to just buy a call or put vs stock and a hedge. You still need to have a process for entering and exit. You do not want all your options to expire at $0.00.

Any reading recommendations? I figure the best way to start in options is to hedge my portfolio

 

[Cuddles]

This is a naive strategy -- put up just to illustrate a general principle to see how it performs. A strategy-wise Straw Man. *Tweaking* such strategies..... well now! That is a Joy Forever!

(Which is to say, if you think it begs for refinement, then by all means refine it! But keep track of the path you're traveling, because if the refined strategy begins to lose its performance, then taking it back to its naive beginnings and examining the market for another productive tweak might be *quite* the rewarding activity. )

Anyway, .

Well, it was back tested 80+ yrs with all stocks available is my understanding of the paper

 

[drm7]

I remember reading this study a couple of years ago. Remember that these quant strategies rely on extreme diversification. Even if you limited the universe to the S&P 500, you would still be long 50 stocks and short 50 stocks every month. This would dilute any "gap risk" from buyouts/sudden news/etc.

The diverisification also helps to smooth your returns. Some people see "buy the best 10% winners," then choose 3 stocks from the list, thinking they will all get that magical 2% per month return. There is a HUGE variance of returns within deciles, so it is impossible to replicate this strategy by cherry-picking stocks. You really have to buy all of them, or have a very sound secondary screen.

As to your original gap risk question, the stop is roughly equivalent to an OTM put/call, with the strike equal to the stop price, so you could do that too.

 

[Cuddles]

I remember reading this study a couple of years ago. Remember that these quant strategies rely on extreme diversification. Even if you limited the universe to the S&P 500, you would still be long 50 stocks and short 50 stocks every month. This would dilute any "gap risk" from buyouts/sudden news/etc.

The diverisification also helps to smooth your returns. Some people see "buy the best 10% winners," then choose 3 stocks from the list, thinking they will all get that magical 2% per month return. There is a HUGE variance of returns within deciles, so it is impossible to replicate this strategy by cherry-picking stocks. You really have to buy all of them, or have a very sound secondary screen.

As to your original gap risk question, the stop is roughly equivalent to an OTM put/call, with the strike equal to the stop price, so you could do that too.

It wasn't clear to me if you had to buy the whole decile or would be alright picking say the top and bottom 5 from them. I suppose a similar approach would be to buy/sell ETFs that track the top winners and losers if that's the case.

 

[Robert Morse]

Any reading recommendations? I figure the best way to start in options is to hedge my portfolio

https://www.optionseducation.org/
1st, before you do your first option trade, get an understanding of what options are, how they trade and the risk involved. 2nd, do some paper trading to get a feel for how options change, then when you are ready, start very small.

 

[qlai]

Since I blew up my account this last month or so, I've been reading up on how to use stop losses more effectively.

Shouldn't you look into money management instead?

 

[Cuddles]

https://www.optionseducation.org/
1st, before you do your first option trade, get an understanding of what options are, how they trade and the risk involved. 2nd, do some paper trading to get a feel for how options change, then when you are ready, start very small.

Thank you. Are there automated features built into any platform that would let one have "trailing" collars and/or protective puts without having to do it manually or automate it?