There is only one issue with the Holy Grail: it does not come with an instruction manual.
I finally got my wish and the market pulled back by more than 5% since a week ago, allowing me to feel the heat and test the resilience of my system.
Well, I'm now down to 30% profit since July, from the peak of 55% profit on September 2nd.
So the system turned out to have limited resiliency, while keeping in mind it is a prototype and not meant to be a market making or delta-hedging system.
I take risk, while the system helps me reduce and balance that risk, mostly through buying index & stock puts, and VIX related hedging (or high Vega if looking at the Greeks).
The high volatility of my sytstem so far came mainly from me reverse Martingaling into ever-growing profits, somewhat by accident. This initially started in July with me trying a trade recommended by my system, which was profitable the next day so I tried another, than another, and another, each one quickly generating profits. Obviously it was an extreme bull market, but at least I knew how to hedge to a decent degree. Or so I thought.
It turns out that my hedges worked very well, but only during the first day or even first hours of the market dropping, when VIX was spiking. Otherwise hedges don't work too well when everyone is concerned with the market bubble and VIX is already high, which was going even higher during the earlier bull run together with SPX & NDX. So when stocks started falling on September 3rd, VIX initially jumped up by 30% and it was amazing to see my hedges working, but that's where they reached their limit because VIX quickly stopped climbing, even falling later together with the subsequent falling of the stock market.
What was most interesting to me, is that during the first day of the pullback the market lost about 7 days worth of gains, while I've lost only about 2-3 days worth of profits, and that's while increasing my positions (buying new stuff) every previous day. Later after analyzing my positions, I found some combinations that during the 1st day of pullback haven't even lost the previous day's value. Most importantly, not many of my positions lost more value than I originally paid, basically losing some profit but not losing the original investment.
Though that's where I needed an instruction manual. Because after the market pulled back I simply waited, wanting to see how my hedges will work and not sure when to exit. The profits started to evaporate throughout the next couple days, as the market continued downward while VIX reached its hedging limits. I started to liquidate some of my positions, one time even hitting margin limit at IB and they "helped me" by auto-liquidating couple of my sold SPX puts, buying them back for me. This actually wasn't too bad as it seemed to balance me out and my P&L stopped dropping. But it also threw my own accounting of my positions off-balance, and I decided to start closing all my positions, and lost quite a few more % due to slippage and slow time of closing the positions manually. Basically a fast automated exit of my positions would allow me to preserve much higher profit.
Generally this was a good test, but now I do see I have more work to do to prepare for the next bull or bear run. The current slowly down-trending market is the most difficult because that's where most of my risk is, which seems more difficult to hedge.
Here are some conclusions and plan forward:
1. I'm now doing some experimental trading in this slow and slightly bearish market environment to test my system at the current medium level of VIX/volatility. Hedges don't work in this environment while most of my bets are slightly bullish, so I'll be manouvering around, collecting a little premiums/theta, and testing some ideas. I do expect additional potential losses if the market keeps grinding down, but smaller than if I'd held stocks. If the market pulls back too much, some of my (new) hedges should kick-in again.
2. I'm thinking that I need to wait for VIX to stabilize at some relatively low level before entering more bullish positions, so that any new market pullbacks would have strong effect on VIX. Basically my previous bullish strategy requires strong VIX hedging power, whith market pullbacks being unexpected.
3. I may need to work on a proper options backtesting system, as currently I only have medium-quality historical EOD data (in addition to limited intraday data I capture) that for now I mainly use to validate some ideas, ratios and relations between options.
4. I definitely have a lot more coding to do now, automating parts of my system, implementing GUI, and an option combos entry & exit handling.
I may not be able to fully automate this system due to some decisions that need to be made manually for both trade entries and exits. Though some automation ideas will come out of that process.
5. I'm spending a lot of time analyzing historical charts of my option combos/positions, how they performed, how well they were hedged, and how can they be improved.
And I still see the Holy Grail in front of me because I feel that I have certain quantifiable and quantitive advantage. And I fully understand how it may be possible to generate in profits 50%+ per year, regardless of whether I'd be able to do this myself.
6. Finalize my system to the point where I can feel comfortable regularly showing my account balance/P&L, especially hoping to tame the current market environment and improve the system overall.
7. Figure out how to do all of the above while still spending most of my time staring at option chains and graphs and charts, and analyzing data.
8. Find out whether I'm the only conscious being in the Universe.
https://www.scientificamerican.com/...not-the-only-conscious-being-in-the-universe/
