Options only portfolio money management and diversification

[ironchef]

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Ironchef, may I ask if you don't mind:
1: what percentage of your total trading account do you use for each trade?
2: do you use a Sell Limit Profit at least Equal to your Stop? Reward to Risk 1/1 ?
3: And finally, are you winning at least a little more than half your trades?

Thank you,
Jeff

You have to be mindful that I am an amateur small mom and pop retail trader with no formal financial training and not a professional:

1. 20% of tradable assets is in options and I am using < 1/4 Kelly for each trade and lately I am actually down to 1/10 Kelly for I am fearful.
2. I "hope" to get a reward risk of ~2:1.
3. I win <50% of the time.

I am a pure "Seeking Beta" (as oppose to Seeking Alpha) trader so I don't really have any edge.

Not a good strategy when the market tanks (or in a volatile market) like today.

Regards,

 

[jeffalvinson]

You have to be mindful that I am an amateur small mom and pop retail trader with no formal financial training and not a professional:

1. 20% of tradable assets is in options and I am using < 1/4 Kelly for each trade and lately I am actually down to 1/10 Kelly for I am fearful.
2. I "hope" to get a reward risk of ~2:1.
3. I win <50% of the time.

I am a pure "Seeking Beta" (as oppose to Seeking Alpha) trader so I don't really have any edge.

Not a good strategy when the market tanks (or in a volatile market) like today.

Regards,

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Thank you, that's very interesting and honest answers.
One more question if you don't mind:
You say that you don't have an edge, so what then triggers a buy signal?

 

[stockmarketbeginner]

As I dont trade for a living nor do I exclusively trade options hence I avoided responding to your thread. However options are the instrument I trade most frequently. As someone averred above trading is 98% psychology and 2% luck, I try and play to both. As you mention its hard to sit and watch your portfolio if you trade options, learning to let your winners run is even harder than learning to cut your losses.

My main strategy is to trade in what I understand and avoid what I do not. I dont touch futures for this reason, I dont get them and cant be bothered to learn. This is my current approach:

• leveraging directional trade, the largest chunk of my portfolio are directional trades using option leverage. The stocks are chosen based on momentum - crudely put its the assumption that last year's winner is on average also this year's winner, the actual basis of my choices is a little more sophisticated but you get the idea. Key elements to manage risk:

1. at the start no position is more than 2.5% usually less of the portfolio. I hold about 40 positions at any one time;
2. the options are running fairly long between 6 months to a year give or take a little depending on the stock. An AMZN option for JAN19 for example would exceed the 1) criterion for example so I would choose a shorter one;
   
3. the strike is chosen based on a simple equation: I add the ATM premium to the ATM strike and choose that strike. Hence if XYZ trades at 100$ and the Jan19 call is trading at $5, I would purchase the 105$ strike;
4. Options will be rolled 2-3 months before they expire to avoid excessive theta losses;
5. Positions are closed/rolled if the momentum of the stock is broken or when the value >5% of portfolio.

• In the current bull market this has been a huge winner - in a bear market I stay out altogether. Managing the losers is not so hard - managing the winners is. Deciding when to reduce exposure is pretty tough - when you start out your downside isnt so bad as the delta is 0.3/0.4 but once you get to 1 delta a downswing is painful. At the moment I am struggling with this as I foresee that should the Nasdaq drop 10% I might lose 75% on my positions. Thats the effect of leveraging and the fact I do have a bias to industries I understand mainly tech and classic industrial companies.

• As I admit its hard to sit and watch your portfolio - one gets the urge to trade when the above positions are up day 15% but the point is to wait and use the option time left to get 200% on a position. So to satisfy my trading urges I trade volatility on events, mainly:

1. using event driven volatility increases in option prices - mainly ahead of earning or other announcements - but sometimes just probability driven (when is Elon Musk tweeting again?)
2. trading volatility collapse on expiration day - generally with ratio trades or similar strategies;
3. some TA driven positions - MA crossings mainly

• These positions are short term usually a week or two no more. Trading costs actually are rather high in my opinion but the returns are reasonable. This is no more than 10% of the portfolio usually much less. I try to learn about other event driven volatility increases such as FDA announcements but my knowledge is still lacking to do this in real. It certainly occupies the mind
• The final batch in the options portfolio is some non-directional trades, Mainly monthly Iron Condors on the index and some strangles, straddles or ICs on individual stocks. Its a straight out probability bet and I adjust positions or close out if the downside is being challenged too much. Returns are about 20% a year on this. The added advantage is that these strategies lock up cash that cannot otherwise be traded and therefore limit potential overleveraging of myself by letting position size and underlying value expand beyond my comfort zone.

The above is matched by a conservative 5 sector index tracker portfolio and a bunch of equities chosen on value investing criteria. No matter how hard I try - the options portfolio will usually balloon to be 2/3 of the grand total.

The different strategies counterbalance each other somewhat and my human weaknesses are no doubt apparent to the hard core traders here. It works for me is all I can say, I have good enough results and sleep soundly.

Could you tell us more about your five sector index tracker portfolio? Do you stay with the same ones for years, or do you rotate around a lot?

Also, do you do options 100% for a living? I am having very good success with options, but I am hesitant to risk more than a small fraction of my portfolio value.

 

[ironchef]

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Thank you, that's very interesting and honest answers.
One more question if you don't mind:
You say that you don't have an edge, so what then triggers a buy signal?

I prefer not to go there. But here are some thoughts for you:

CAPM (Capital Asset Pricing Model) -
E = R + Beta(Rm - R)
E = expected return
R = risk free rate
Rm=market return
Beta = volatility over market volatility

The higher the Beta, the higher your expected return, but the risk adjusted return is no different from the market so you really have no edge. In a raging bull market, on average you will be richly rewarded. Of course, once the market turns, you will ride the down side faster than the market and the risk of ruin is quite high.

Bottom line: I always said I would rather be lucky (seeking beta) than be good (seeking alpha).

This is a lay person's view, probably nonsense. If I don't make any sense, you folks please correct me.

 

[TrustyJules]

Could you tell us more about your five sector index tracker portfolio? Do you stay with the same ones for years, or do you rotate around a lot?

Also, do you do options 100% for a living? I am having very good success with options, but I am hesitant to risk more than a small fraction of my portfolio value.

Like I posted I do not trade for a living, but I do trade mostly options. The ETF section of my portfolio is chosen on the same basis as I choose stocks. The sectors are simply the DJS/STOXX 600 sectors with the STXe 600 Real Estate sector added in. The ETFs are pure trackers of those sectors - most of the ones I choose are Comstage ones simply because their offering is very broad but a few are DB ones.

Basically the 5 sectors that show the most momentum are chosen at the start. A sector is sold if:

• it drops below position 12 on the list of sectors;
• it hits a trailing stop loss that is 15% off from the market at entry.
  
• if a position is sold the highest ranked non-held position is purchased.

The trailing stop loss was hit once during the last three years. Otherwise I have about one transaction every two months - in 2017: 7 mutations. The returns are pretty good - last year it was over 10.5% which (in EUROS) better than the return of the DOW (9.7% in EUROS) or the EUROSTOXX100 (5.85% in EUROS) - the return is also distorted by the fact I added substantially to my portfolio funds 2/3 into the year due to vesting some bonuses.

 

[jeffalvinson]

I prefer not to go there. But here are some thoughts for you:

CAPM (Capital Asset Pricing Model) -
E = R + Beta(Rm - R)
E = expected return
R = risk free rate
Rm=market return
Beta = volatility over market volatility

The higher the Beta, the higher your expected return, but the risk adjusted return is no different from the market so you really have no edge. In a raging bull market, on average you will be richly rewarded. Of course, once the market turns, you will ride the down side faster than the market and the risk of ruin is quite high.

Bottom line: I always said I would rather be lucky (seeking beta) than be good (seeking alpha).
This is a lay person's view, probably nonsense. If I don't make any sense, you folks please correct me.

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Ironchef,
Thank you for the response, it does make sense to me and I even think it presents a "slight" edge because it leads one to only trade vehicles with at least a slight mathematical edge.
I somewhat understand math based systems.
You told me a little about your methodology, so here's a little about mine.
I have a 3 tiered Step System of Deck-Stacking:
Step 1: Using a convoluted form of Algorithms that get Chained, broken down into Multiple Time Frames and run through a Multisystem Comparator, everything I trade has a Back and Forward Historical Mathematical Edge of 70% minimum based on many years of Historical Data and at least 1 year of Forward Testing, or I don't trade.
(Note: All data in Step 1 has been programmed because it take too many hours manually).

Step 2: Then I further stack the deck in my favor by requiring every trade get a discounted entry from its closing price, ranging from -15% to -40% below its closing price, depending on Signal Strength; Frequency = Sequence....i.e....Call Seq-1....Call seq-2...Call seq-3...etc..); and Overbought Levels based on the Mathematical Size plus Sequence of the Signal.
(Note: All the data in Step 2 has been programmed.)

Step 3: The final phase of Deck Stacking a trade in my favor is creating Gap Intervention,
based on all same Market scenario's dating back many years (sometimes a decade depending on the index). Gap Intervention are rules not programmed but are manual rules in case of Extreme market conditions that create massive gap openings down or up.
This prevents me from entering the market at the program output entry prices, because often times in these scenarios, the opening price is below both programmed Buy # 1 and Buy # 2.
In these cases I manually interject the next lowest set of programmed entry parameters from the program [----PARAMETER SCALE FOR BRACKET ORDERS----] (Buy Limit,Sell Limit,Stop).