HowardCohodas Index Options Credit Spread Trading Journal

[HowardCohodas]

Quote from rew:

How well would your bull put spreads do if we had a flash crash like last May but the market *didn't* pop right back up? I was of course simplifying when I gave the toy example of a series of credit spreads that expire worthless followed by one that goes in the money so fast you can't stop out and wind up with the full, worst case loss. But what is more realistic is a drop so fast that you stop out with a 40% loss of capital. Remember that you're trying to buy back those spreads when the market is panicking, half the market makers have put up "Gone fishing" signs, and bid/ask spreads are a mile wide.

Nearly ALL of the credit spreads are paired with a companion to form an IC within a short amount of time. So if the PUT spread takes a serious hit, the CALL spread will be at or near its maximum return. The market "popping back up" is not part of the strategy. If the capital at risk is showing a 20% loss, I bail. I do not adjust. I do not pray. I do not hope. I bail.

A stop loss is still effective for those "gone fishing." There may be considerable slippage because this is a leveraged trade and moves faster than the market. Nonetheless, stops do work.

Quote from rew:

It is the nature of selling far OTM credit spreads that you have lots of little wins with occasional big losses, and that makes it very hard to do adequate statistics to determine if you really have an edge.

It is not necessarily so. There are techniques that make this scenario far less common as the so-called experts would have you believe.

 

[timbo]

Quote from HowardCohodas:

Are you still paper trading or is any of this commentary dealing with money at risk?

Regardless of your recent post(s). You haven't answered fundamental questions. Do we need a treadmill to get to your level?

 

[HowardCohodas]

Quote from timbo:

Regardless of your recent post(s). You haven't answered fundamental questions. Do we need a treadmill to get to your level?

I was not walking on the treadmill for an extended period because of an ankle injury (falling on ice). I still stood at my desk, but did not have the treadmill running. There was no detectable difference in trading results.

 

[trefoil]

Quote from rew:

Nothing in your post explains why trading iron condors requires Black Scholes to be correct. There are any number of other pricing models that assume fatter tails than lognormal, and if options are priced according to accurate assumptions an iron condor will have zero expectation. Yes, once in a while you will get wiped out. But in between you make enough to pay for the occasional blow up.

Typical iron conder statistics: win $500 19 times in a row, lose $9500, win $500 19 times in a row, lose $9500. The expected return is 0.

If you believe that far OTM options are still under priced, despite the volatility smirk, then buy them. If you are wrong and options are instead priced correctly your payoff will look like this: lose $500 19 times in a row, win $9500, lose $500 19 times in a row, win $9500, etc. Again, this is a 0 expectation strategy-- it doesn't have the dramatic drop offs on the P&L curve that iron condors do but it's just as lacking in positive expectation. (Of course, allowing for the bid/ask spreads and commissions both strategies will lose money in the long run.) Your one big win with the Lehman strangle no more shows that long strangles are a winning strategy than the fact that Howard has made a good deal of money selling hundreds of credit spreads shows that he has a winning strategy.

Atticus' gripe is that Howard has not demonstrated that he has an edge, i.e., positive expectation. It is in the nature of selling credit spreads that you can have a long string of wins that makes it look as though you have an edge, when in fact you just haven't rolled the snake eyes yet that wipe you out. But this has nothing to do with whether BS is correct. Even if the lognormal distribution of prices was correct and BS was used to price options iron condors would still blow up often enough to give you 0 expectation.

I never said they were a winning strategy per se. Only that that example and some others from real life, like pretty much all the action in the fall of '08, showed the dangers of IC's.
No options strategy by itself has a positive expectation, obviously.
Now, the reason I say that IC's depend on BS being correct is simple: it's a strategy that depends on a world where the risk and the reward move along a smooth curve. Any discontinuity upsets the strategy. Discontinuities are not allowed for in BS, or any mathematical model.
You need a model to generate the greeks, like I said, and that's useful info to have. Credit spreads use the model as the basis for a strategy though, without really understanding what is going on in the underlying beyond its volatility. That volatility determines the probabilities, which determine, for an IC trader, which strikes he uses. It's a direct line. You have to, because otherwise you won't collect enough premium to make it worth doing even for the months where it works well.

 

[trefoil]

BTW, just to explain the Lehman trade: I traded Lehman regularly. It was my bread and butter at the time. The week before earnings I looked at the options, and thought the IV was way too low given what was going on in Bear, and since Lehman was in the same industry, I figured there'd be some sort of big surprise on earnings day (given the pessimistic background, a good one would have been just as surprising as a really awful one), and that that surprise wasn't being priced in, for whatever reason. The Bear debacle over that weekend made the earnings report an anticlimax of course, but the reasoning was based on the idea that the vol was not matching the real world probabilities. That's a good reason to do a strangle, I think.
IC's assume, because they have to assume, that those vols are a reasonable reflection of reality. Most of the time they are, but sometimes they're not.

 

[rew]

Quote from trefoil:

I never said they were a winning strategy per se. Only that that example and some others from real life, like pretty much all the action in the fall of '08, showed the dangers of IC's.
No options strategy by itself has a positive expectation, obviously.
Now, the reason I say that IC's depend on BS being correct is simple: it's a strategy that depends on a world where the risk and the reward move along a smooth curve. Any discontinuity upsets the strategy. Discontinuities are not allowed for in BS, or any mathematical model.
You need a model to generate the greeks, like I said, and that's useful info to have. Credit spreads use the model as the basis for a strategy though, without really understanding what is going on in the underlying beyond its volatility. That volatility determines the probabilities, which determine, for an IC trader, which strikes he uses. It's a direct line. You have to, because otherwise you won't collect enough premium to make it worth doing even for the months where it works well.

So what you meant to say (and should have said) is that trading iron condors requires being able to quantify the probability of large moves in the underlying price. I agree with that, but obviously there are very many ways to model price action other than the lognormal distribution used by BS.

Sharp discontinuities in price can certainly wipe out iron condors, but they can wipe out most other types of leveraged trades as well -- many a futures trader has been blown up by such moves.

 

[trefoil]

Quote from rew:

So what you meant to say (and should have said) is that trading iron condors requires being able to quantify the probability of large moves in the underlying price. I agree with that, but obviously there are very many ways to model price action other than the lognormal distribution used by BS.

Sharp discontinuities in price can certainly wipe out iron condors, but they can wipe out most other types of leveraged trades as well -- many a futures trader has been blown up by such moves.

I've been thinking and thinking about this, and I don't think you get the point: what you're saying is kind of impossible. The number of outliers, let's call them, varies wildly over time. You would have had lots in the 72-74 bear, which was actually a peak from a series that started back in the mid-sixties, then suddenly for a long time only a very few. Starting in August 1982 lots of up action that would have killed you on the call side. Then nice and trending, mostly. Then in 1987, lots again. Then again in 1989 (United Air mini-crash) 1990 (Iraq invades Kuwait) then in the late nineties they start coming one after the other (the Tequila Mexican peso crisis, the Asian currency crisis, the Russian default and LTCM, and then the dot com bust), then a period of calm where the VIX practically goes to single digits, and then in 2007 the crisis starts (the VIX shot way up at the end of Feb, which looking back is when the fun started) and you continue with that until the spring of 2009, when, by the way, you would have gotten murdered on the call rather than the put side of your IC's.
The variation of these over a long period of market history is pretty severe. We're in a period of relative calm now. (and guess what? We've got someone boasting about his credit spread returns.) For how long? No one knows. Let's just say that the frequency and the severity of discontinuities is itself discontinuous. Therein lies the problem.

 

[atticus]

Garbage credit spread blowouts (peak to trough)

7/07... SPX loses 185 points in four weeks

10/07... SPX loses 170 points in six weeks

12/07... SPX loses 250+ points in six weeks

Less than six consecutive months in 2007. 2008 was absolutely CATASTROPHIC for sellers of credit spreads.

 

[Magic8]

I've lurked on here for a while. I've read the 2000 page thread OptionsCoach had, on credit spreads. That was quite a read.

Forget all the talk on negative expectancy, having 'no edge', the greeks, delta-neutral, gamma risk, risking $10 to make $1, horrible r/r... that '2008 was a horrible year for spreads' .... on and on.

How do you counter the RESULTS that these people were able to produce (as an example):

http://www.monthlycashthruoptions.com/ReturnOnInvestment.htm

Their results go back to 2006. They survived 2008. They've been net positive, year after year. Look at their trades.

Disclaimer: I'm not a member of their service... but you can't argue with their results, can you? There are other 'garbage' credit services out there... but not these people.

Howard may be an older man... and an easy target (I respect my elders)... but how do you argue with real results, real money, real risk management - from people who have actually traded credit spreads, successfully, in good and bad times?

 

[Rodney King]

Quote from atticus:

Garbage credit spread blowouts (peak to trough)

Less than six consecutive months in 2007. 2008 was absolutely CATASTROPHIC for sellers of credit spreads.

"Asked and answered, counselor"... Everyone on the thread has advised Howard about blowout risks. He's willing to take the chance, so G-d bless. He's not a young guy, and he may well dodge the black swan till his last days, and leave a nice sum to his heirs and assigns.