Long-scalping equity options against time decay and market drift

[fullautotrading]

Today (Monday) and Friday the market has been going down hard and fast:

https://www.nytimes.com/live/2022/06/13/business/stocks-bear-market
"Stocks dropped around the world, investors dumped government bonds, and cryptocurrencies crashed as the U.S. stock market fell more than 20 percent from its January high."

ES FUT 20220617 GLOBEX 50 E-mini S&P 500 [ESM2, 477836957, mult: 50]

The large move has caused a significant DD, as funds are being invested in new positions.

Currently down to -56K with 11K in commissions.

A sharp move that so far has been bearable with the current funds and hedging action.

The 2 layers with the largest DD are:

ES FOP 20220819 2850 P GLOBEX 50 E-mini S&P 500 [EW3Q2 P2850, 509909241, mult: 50]

and

ES FOP 20221021 2900 P GLOBEX 50 E-mini S&P 500 [EW3V2 P2900, 510341141, mult: 50]

We can learn a couple of things from this sharp DD:

- To mitigate further the DD, one could invest, in the good times, some of the profits on some deep OTM PUTs which could alleviate further the DD in cases like this one.

- More graduality in opening new layers can be beneficial

This can take some time to recover and transform into new profits. We need to be patient.

 

[fullautotrading]

Today we have recovered a bit, returning to a green area. Quickly going from -56.2K to +28.3K (that's right, more than 84K). Well, that is the good part of trading FOPs (instead of FUTs), at least DD, even if sharp, is often short-lived, and decay is certainly a huge ally.

Also, that is the reason why we were keeping fund usage around 50%: just to be able to ride and trade on these occurrences. Clearly, if we were using something like 80%, now we would be out of the game, or at least in big trouble.

Let's follow the evolution of the 2 "worst" layers, we have identified in the previous post:

ES FOP 20220819 2850 P GLOBEX 50 E-mini S&P 500 [EW3Q2 P2850, 509909241, mult: 50]

ES FOP 20221021 2900 P GLOBEX 50 E-mini S&P 500 [EW3V2 P2900, 510341141, mult: 50]


Today, I have also transferred one layer:

Transfer: ES FOP 20220711 2700 P GLOBEX 50 → ES FOP 20220729 2700 P GLOBEX 50

which has allowed me to recover some stop orders that were on the previous layer:

here you can clearly see the hedging buy orders (blue circles with white border) which have been closed profitably after the "information transfer", thus removing their negative contribution to the PNL.

A current view of the market:

ES FUT 20220617 GLOBEX 50 E-mini S&P 500 [ESM2, 477836957, mult: 50]

 

[fullautotrading]

Very busy week for me. In the meantime, the market is recovering a bit after the large move downward we have seen last week, where I recorded a minimum of 3639. Currently about 3886:

We have recovered a good part of the DD and slowly transforming all the new positions into additional profits. Currently back to 98.6K and the large margin usage shows that we have "loaded up" to ride this fluctuation. At the first good chance, I will start closing the profitable layers to reduce the margins to "safer" levels.

As a curiosity, let's look at the 2 worst layers, that we have been following:

ES FOP 20220819 2850 P GLOBEX 50 E-mini S&P 500 [EW3Q2 P2850, 509909241, mult: 50]

ES FOP 20221021 2900 P GLOBEX 50 E-mini S&P 500 [EW3V2 P2900, 510341141, mult: 50]

And this is the one we "transferred":

Transfer: ES FOP 20220711 2700 P GLOBEX 50 → ES FOP 20220729 2700 P GLOBEX 50

So the first one has turned positive. And it could also be closed to recover margins.

 

[Overnight]

Very busy week for me. In the meantime, the market is recovering a bit after the large move downward we have seen last week, where I recorded a minimum of 3639. Currently about 3886...

So the first one has turned positive. And it could also be closed to recover margins....

Did you bank any profit or loss? Jesus, tell us already!

 

[fullautotrading]

Did you bank any profit or loss? ...

No, there has been no fund transfer, since we started.

 

[fullautotrading]

The current PNL situation is 109.2K, with a maximum reach of 122.1K, before the recent large move down. Commissions 12.2K:

Current margin usage is 79.9%. Still too high, but it's just the consequence of the large "load" on the large market move, to grab additional profits. And the reason we were using 50% before, was just that.

Some people express trading performances in terms of CAGR, but this is quite misleading imho in this context as there is no such thing as an automatic "compounding" mechanism when trading.

Something possibly similar to "compounding" happens only by taking more risk with the additional funds available, and this is why the variance of the PNL will increase in time (and the same will happen for the DD distribution). This means that at any time you must be ready to even see (periodically) all your profits return to negative territory ("load up" phase) in order to be able to ride the next price wave and increase your PNL.

The 45-degree equity lines you see on some charts presented by clueless wanna-be quant do not exist in the real world and only happen as a computational artifact created by "backtesting" and curve fitting.

 

[fullautotrading]

- Additional sources of hedging -

In this "public illustration", we have seen an example of algorithmic trading of options, where the main idea is to scalp long and recover hedging orders through "information transfer" (rollover) while continuously grabbing option decay.

The scalping action and "stop order recovery mechanism" provides an effective device for hedging and for grabbing additional profits. We have seen that there is no "prediction" involved and everything is fully "mechanical".

Clearly, to this strategic core, expert options traders can add at will any other "defensive mechanisms" they like, for instance, in order to smooth out the DD spikes caused by the larger vega of the far away options.

There would be innumerable ideas to achieve such further additional hedging actions and I will let the experts unleash their fantasy with new proposals. All these ideas can run simultaneously to the "core strategy", obviously on different layers, as the platform can "overlay" any simultaneous long-short position at will.

To provide a very basic example of that, without ambition to be the "best" one, let's for instance examine how we could use a spread for further protection. I will let the options experts come out with other more powerful ideas.

Clearly, the additional "protection", which in this case specifically is aimed to reduce the DD peaks, by using the larger vega of the "far away" options.

In this case, I have done the following:

BUY 10 of:
ES FOP 20221216 2750 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2750, 534471394, mult: 50]

SELL 10 of:
ES FOP 20221216 2250 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2250, 567386034, mult: 50]

ES FOP 20221216 2750 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2750, 534471394, mult: 50]

ES FOP 20221216 2250 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2250, 567386034, mult: 50]


For now, I will let think and figure out the "cost" and the meaning of this setup and in case let me know your ideas and motivations for other possible defensive mechanisms.

Current PNL situation: 116.2K (147 days elapsed). 12.4K commissions. 47.6% funds used.

Mkt situation:

ES FUT 20220916 GLOBEX 50 E-mini S&P 500 [ESU2, 495512566, mult: 50]

 

[fullautotrading]

Note, marginally, that this (bear put) spread also slightly reduces the overall margins used (about 65.8K in this case).

I made a (payoff) picture to help visualize the "logic" of the above simple example of a "protection" scheme, which can be interpreted as a form of defence against a "black swan" event:

total value of strike difference (50 is the multiplier, 10 our order size):
(2750 - 2250 ) * 50 * 10 = 250K
(buy) (sell)

total value of price difference:
(33.25 - 15.25) * 50 * 10 = 16625 - 7625 = 9K (cost of this single "protection", until Dec 16)
(buy) (sell)

max outcome of this spread alone: 250K - 9K = 241K

Clearly, the "protection zone", is "sliding" or "rolling" in the sense that, as the price moves (up or down), we can overlay more and more of these (for instance, every xx%).

The position and extension of the "protection zone" and the potential profit (proportional to the difference of strikes), in case of mkt crash, as well as the cost of the "protection" (proportional to the difference in prices), are user parameters.

In essence, the scalping-hedging engine will be doing its ordinary activity on the "rightmost side" of the (S&P) price axis, and in the (very unlikely) case of "black swan" (mkt crash), the put spreads gradually overlaid by the platform and currently active (which could be several, of course) kick in.

 

[fullautotrading]

The week ended without much excitement, with S&P slightly declining:

Current PNL 116.6K, with 6 layers waiting to go eventually in the green territory and about 50% of funds usage. 152 days elapsed so far, 12.5K gone in commissions:

In the previous post, we have seen a simple example of black swan event prevention.

Do we really need it? Well, if you agree with Nassim Taleb, certainly you need it. On the other hand, one might argue that the event is so rare that one prefers to save that "insurance" money because the amount it adds up could anyway be used (if kept as "reserve") to cope with DD.

Clearly, it is also a matter of personal preference. Personally, I would rather go with Nassim's suggestion, as anyway the bot would produce enough profits to cover and exceed those costs, and there is no need to be exceedingly greedy, to look like an idiot, in hindsight, if the event happens.

Let's take a look at what our protective spread is doing right now:

ES FOP 20221216 2250 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2250, 567386034, mult: 50]

ES FOP 20221216 2750 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2750, 534471394, mult: 50]

Most interesting would be the discussion on possible other ideas to protect against those black swan events. Feel free to contribute with your opinions and proposals.

 

[fullautotrading]

ES did not vary too much since the last check, currently around 3845:

ES FUT 20220916 GLOBEX 50 E-mini S&P 500 [ESU2, 495512566, mult: 50]

PNL situation is ok, with 125K profit (156 days elapsed so far), 12.6K commissions and 50.8% current fund usage. The negative layers are slowly coming home.

Let's take a look at the situation of our "life insurance" and how much it is costing so far:

ES FOP 20221216 2250 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2250, 567386034, mult: 50]

ES FOP 20221216 2750 P GLOBEX 50 E-mini S&P 500 [ESZ2 P2750, 534471394, mult: 50]