"Tight spreads" (atm, itm, slightly otm) trading

C

conduit3030

Hi there,

i've been surfing this forum a while, found a little bit of it helpful occasionally. Anyways, I'm going to write a journal of every trade I make, including the ones since I started this options account (it will take several days for me to post them all and describe what I'm doing etc. for now I'm going to do an introduction before I go to bed lol).

About me: I'm 25, been trading about 6 years but options for only the past year. I traded at an equiites prop firm for a year after graduating college, did decent there, but not enough to make a living unfortunately. As fortune would have it, I have since moved to options trading and think it is infinitely superior to equities trading for my style(s).

My account: I opened a new options account in May 2014 with $1,700 in it (will post transactions history to verify account starting point, pnl as it goes on) and am at $3,400. I never plan to go back to equities as options are just too versatile IMO. I had prior had a $2,000 account exclusively trading iron condors and butterflies (for "income" lol!)...it didn't do so well. I had a good run up on that account, but it dropped out to $1k, I closed it out, saved up a smidgeon more and now as of May I am trading a new account.

Performance: Will post performance specifics in further posts, but essentially I've put on a lot of risk relative to my wee-baby account and steadily grown it to a baby account totaling $3400 (wohoo!) over the past 7-8 months.

My goals here: A few things.

a. I want to write out my thoughts live and find this fun to do
b. I want input on my trades and trade theory


Disclaimer 1: I want input, but if you're not willing to show your own results then I'm going to take it with a grain of salt. I've noticed there's a lot of people on here who think because they know the "nuances" of implied volatility they can go around telling people what to do. So input is more than welcome, but this disclaimer beware. (and I will take your posted results at face value regardless of whether or not I should)

Disclaimer 2: I'm going to be putting on a lot of risk (relative to my baby's size) over the coming months so you might all get a good laugh if this doesn't pan out well.

Next topic: A broad overview of my methodology coming soon to a theater near you.
 
Alright, so to understand my super coo' methodology one must understand my history.

A. I come from an equities background but since trading options, seeing how much I love them, I have read lots of books backtested stuff to death etc. in order to apply the options principles to an equities-style trading. No, this doesn't mean I just use options to get them deltas fast! On the contrary, I mostly spread and occasionally go outright calls/puts.

What I never, ever do anymore is begin a position with a butterfly or iron condor outright. The reasons will be explained more in depth soon but the gist of it is:

a. As Taleb (my personal god) emphasizes, there is too much uncertainty to try to predict where a price will roam, even within x range in most cases. Essentially, one can be directional but don't be arrogant to know "how much" the price will move, which is the essence of constructing flies/condors.

b. I got murked trading those on my original options account, and they just plain don't suit me

c. They are essentially (usually) income strategies which I believe are a farce of an idea, more in depth later.


However, note that I didn't say I won't ever be in an iron condor; rather I just won't start off in one. The common scenario here is I do a credit spread, the price goes in my anticipated direction but starts to stall. What do I do? I do the opposite spread above or below the current price and have just made a condor (hurray!!!!). But this is a credit spread trade with its own merit, the condor position is just a byfactor.



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B. I worship the God Taleb, he is my hero and I believe his ideas will be as revolutionary as Nietzsche someday. I was pretty much forced to start reading the Black Swan by a friend, but have never read a book that hit so close to home, in trading or w/ regards to my life in general. Then I read antifragile. If you haven't read these books then I highly recommend them lol...they are literally a bible, upon which if a cult were formed around their principles, I would happily join said cult.

Anyways, as you'll see the black swan concepts have hurt me a couple times on this account, I think I got too gung-ho about looking for black swans rather than being robust most of the time to potential black swans. My first trade, the SLV trade I rolled from my old account, highlights this. That'll be the first one I post actually. See below


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C. The reason I now do spreads (credit and debit) is that they are robust (see taleb's definition/google it). I am protected from black swans in individual spreads, and black swans will come in a trader's career. While I wish to capitalize on future black swan events to the fullest, I also want to be active and protected in the vast majority of the time when these events are not occurring.

Note: Someone who seems like a very knowledgeable trader on here pointed out that spreads aren't as robust as they seem when taken in the aggregate; ie as part of a broader portfolio. Hopefully someone brings this up at some point

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D. My primary trade is the credit spread. But it's not the 1-2 standard deviation spread that is for "income" (again I believe the whole concept there is a farce) because:

a. That doesn't suit my trading style. As an equities trader I was taught that you must take the most you can out of the market, and capitalize on your gains, ie you're seeking the higher risk reward trades. However, the incredible thing about options is you are much more primed to get lower RR, but higher probability plays than with equities. If you've traded equities and used stops before, you'll know what I mean.

b. If I have a slight directional edge developed over the years from trading equities (you can't profitably trade equities w/o developing this) and, though, it's a razor thing edge, I want to capitalize on it. Thus, I want to be making more than .6:1+ and preferably .8:1+ on what I risk. In the case of debit spreads, 1:1+ is more typical (around atm spreads)

c. Some people on here (seem) to be able to make those deep otm spreads work despite the fact one trade erases multiple gains, that's great. But it's not something i believe I have any edge in.

Thus, my credit spreads seek .8:1+ and are thus the strikes will be very close to the money.


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E. I'm a shorter term swing trader, ie I'll start positions 1-3 weeks out but am flexible in rolling, delegging etc. for bigger moves. This is called "options on options"

a. Standard rolls - spread didn't work, I think it's worth a roll

b. Capitalization rolls - spread worked, I want some more

c. Capitalization de-legs - from spread to outrights when the price is going my way and I am more confident in a continued move.

Note: (C) requires that i be in a debit spread to accomplish this de-legging, thus most my trades are going to be debit spreads but they function like your typical credit spread, i.e. the put strikes are below current price and the call strikes are above current price. But instead, I'll flip the calls to put positions (put call parity should about make them the same value and structure) so that i can get rid of the short position and find myself long the outright put/call if I want to be. Ask if confused here.

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F. Money Management - there's not much here (and now the "gurus" of this forum will come at me with all their cliches about money management being hte cornerstone of success) but that's simply because my account is so small. I will not risk more than 10-15% per trade, excluding adds to my positions. Were this a big account, rules would be much more stringent.

Note that there's significant risk in the coming months of me trashing this account as I'm going to be putting a lot of %wise risk on as I want to grow this account. So you guys might have a good time reading as you watch it crash and burn (but I think more likely I'll continue to do well, but that's cuz I'm Me)

Anyways, next up is the sad ol' silver trade
 
Alright, here's the silver trade.

1/3/2014: +2 SLV Jul 19 2014 calls @ 1.82

See pics below of price/iv charts, bid/ask quotes (roughly note that the time is about 30 seconds off I'm using TOS's ondemand to place these)

Ok, I was young, I was bold, and I had just come off the high of reading The Black Swan. I wanted to get busy pyramiding a position because "the market was high and prone to black swan events." So here's the rest of the rationale.

Note: A Check means I still agree with this rationale, Meh means partially agree, NO means this is dead wrong and stupid

1. IV is low, the calls are cheap. Check.

2. SLV is basing around 18-19, couldn't get lower prior, and the price has just gapped on volume the day before. Meh.

3. I want a position in Silver. I want to start a base and if the price moves up, just like I used to do w/ equities, I'm going to pyramid into a larger position. Thus, the trade has value in that alone ie the potential for future adds to it.

NO. This is not how you go about looking for black swans (are you even supposed to "look" for something so unpredictable?) Instead, give them the opportunity to grow. And whats more, don't focus so much on them but rather being robust against them. If the opportunity presents itself, take it.

The last 2 sentences above will be very important to my methodology over the coming months, most likely. What I have concluded I'm going to do is always start off in a debit spread if I have any potential inkling I might want to get to the outrights for a bigger move, I simply dump the short side of the spread and I am long calls/puts respectively.

4. I am slightly bearish on the market but do NOT want to short the spy.

Meh. I agree with using SLV as a proxy for said short, it's a much better trade, but the market remains strong, focus on other trades.

5. I want to keep my deltas of my portfolio in check, thus slv is a good way to get a little downside exposure.

NO. I would have to write paragraphs about this, which I will later, but suffice to say trading isn't about being delta neutral for the sake of being delta neutral. If you find yourself in that position, great, but I'm not going to intensely focus on my exposure in this regard.

Next post narrates the add I do to SLV
 

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Alright, it's 2 months later, SLV is going up at a reasonable, though choppy and uncertain pace. I decide to add as planned.

3/14/2014: +1 SLV Oct 18 2014 19.0 Call @ 3.05 (see pics)


Arrow 1: Original position

Arrow 2: New position.

1. SLV is grinding up, though nowhere near trending like I'd like it to be. I want to add to my position as is default and planned.

Check. The original trade isn't valid, as described above, but when playing out rights you have to treat them much like equities and capitalize on the trend.

2. Buy the 18 strike october. I want more time on this as I'm thinking, base on projecting historical moves relative to time, that it's going to take a while to really climb.

Check.

3. Buy the 18 strike, I want to break even a little better than say buying the 20 atm strike.

Meh. Yes I'll be more likely to break even but this play isn't about breaking even, it's about adding to a winning outright position.


4. IV remains low and more time means vol benefits me more - thus october calls

Check.



Next reply: what happens over the coming months up to october.
 

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Nice job,...from $1,700 to 3,400 in only several months....that's the power of Options...using leverage/risk -- Try doing that with stock...it's virtually an impossibility. :oops:

I laughed too...at the 'income' part of writing options, when i first learned about this stuff...you call that income -- you can make much more trading them, rather then selling them.
 
Alright, so now I narrate what happens. I didn't get a chance to add again ( thank god) and the move in SLV not only fizzled out, but slv trended down after about august:

Arrow 1 - that was my add, you can still see where I put it in (see above post)

Arrow 2 - Silver just couldn't climb, actually, it trended down in a nice move that would have been ideal for the credit spreads I now put on. For shame. The point is, I realized about 3-4 months into the trade that I was too hyped about catching black swans (bless Taleb's heart) but wanted to stick with my plan at the same time.

Arrow 3 - expiration friday...and I lose my whole $700-odd risked.

Summary: This was a classic case of not being robust. Note that I hadn't read antifragile or done much more than backtested spreads at this point. I was still trying to trade in the old fashioned equities way in essence. The key takeaway is that being robust (spreading) is what I'm going to be doing the majority of the time, rather than seeking the black swan moves.
 

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Alright, so the next thing I want to talk about is backtesting. This is critical as I want criticism of the way I do it. Please first read through my methodology though before replying.

1. I do manual backtesting, and lots of it. This is done through TOS's OnDemand function and I literally go through things that I try to have the least knowledge about (foreign etf's currencies etc.) over time frames where I have no clue what will happen. At least I try not to have any idea of what will happen, and usually succeed in that regard.

See the sample below for how I analyze my results in excel, essentially I have different trades and parameters, then I make pivots and analyze the data (if anyone knows how to attach the whole spreadsheet please just tell me).

2. As I trade live and do the backtesting, I write down casual notes in a word doc as I go. Then I consolidate those notes in a more organized manner (ideas, theory, practical, whatever) onto my "trade guide" (ask and you shall recieve...again I don't know how to attach it). This is the more extensive guide and outlines exactly my parameters for trades, ranging from standard risk rewards to more subjective content.


3. Unfortunately, I don't have a programming background but would like to be able to mechanically backtest too (although I think there's value in going through each trade manually.) That's one thing I'd like advice on here as I think that's a future step for me.
 

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So rather than dive into the spread trading that has done better for me, I have to first address butterflies and iron condors, and the inherent arrogance behind these trades. The best way to do that is an example from my old account:

TWTR
12/27/2013 15:30:12Bought 2 TWTR Jan 18 2014 85.0 Put @ 18.41




12/27/2013 15:30:12Sold 4 TWTR Jan 18 2014 72.5 Put @ 8.76




12/27/2013 15:30:12Bought 2 TWTR Jan 18 2014 60.0 Put @ 2.71






Ok see the attached image for a graphical description, a butterfly needs to stay between the strikes etc.

Rationales:

1. IV is through the roof. Check

2. Earnings are coming out - this is obviously going to be bad for an atm fly, I acknowledged this and decided the huge IV overrode that. Check. Agreed still...


3. The wings are outrageously wide given if it lands at 72.5 I'm making 3:1+ on my risk (and progressively less as it moves from the middle.

NO. This is "arrogant trading." I think you have to capitalize on volatility like this if you can find a way, but this is the wrong approach. Take the 1.5:1+ credit spread w/ puts (don't fight the up momentum) and be happy with that trade. Don't try to guess where the price is going to land exactly.

So I got 2 out of 3 right on this trade, but the third one is the one that was most important. Don't be arrogant; don't try to guess exactly where the price will go.

So what's my problem with butterflies and iron condors? Well besides the fact when I was exclusively doing them I was exclusively getting murked, I think they're inherently going to have a very small edge at best. There's very little margin of error (they are incredible "fragile" in Taleb's words), and they just seem too easy. And what's easy doesn't work in this competitive game, from iron condors over the long run to way out of the money credit spreads. Both are prone to disasters or even small hiccups that you are then forced to make multiple profitable trades to make up for one lost trade. And you WILL have losing trades, don't be arrogant.
 

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