Covered Calls and Cash Secured Puts (Part 40)
Posted by Mark on May 5, 2014 at 03:48 | Last modified: March 25, 2014 15:09To implement DCA in a market crash, spare cash would be required. The 15% annualized return MacDuff advertises with the Math Exercise would no longer apply because the deleveraged portfolio would be making less. How does this add up?
More recently, MacDuff has advised being fully invested. This eliminates the possibility of DCA and potentially resolves the discrepancy described above.
What happens when stocks tank?
On the call side I can sell premium at near-the-money strikes, which will enable me to continue generating cash.
What happens when a V-bottom prints (e.g. March 10, 2009) and stocks catapult higher through my lowered strikes?
MacDuff argues we are now better prepared for this situation thanks to narrower strike availability and weekly options that offer the potential for supercharged annualized returns.
What happens when I have to look months to years out in time to roll for a credit? Neither weeklies nor narrower strikes are going to save me.
In some cases, no available options will provide for a credit roll. I cannot take assignment at the [substantially] lowered strike because that would lock in a big loss. In 2009, I suspect this might have described most [if not all] of my positions.
My only other option would be to roll for a debit and hope the market cooperates and allows me to escape whole. “Hope is not a trading strategy” and I cannot begin to imagine my degree of insomnia if most of my positions were in that boat.
Until and unless MacDuff can give me some response to these difficult issues, I will have significant doubts about SysCW. One may argue “no trading system is perfect and losses are a part of the game” but MacDuff never shows any losses in his book nor in his tutorials.
How Madoff-esque is that?
Furthermore, what I have described here is more than “occasional losses.” What I have described is catastrophic loss running rampant across most of the portfolio. This is a risk that deserves a response and a remedy before SysCW qualifies as a viable trading system.
Categories: Option Trading, System Development | Comments (2) | PermalinkCovered Calls and Cash Secured Puts (Part 39)
Posted by Mark on May 2, 2014 at 06:49 | Last modified: March 25, 2014 14:03Once upon a time (one month ago), this space focused specifically about CCs and CSPs. My last post waxed eloquent about some optionScam.com aspects of the industry. Next I want to combine these two branches of inquiry and focus specifically on Rich MacDuff’s SysCW.
One of the biggest problems I have with SysCW is the exclusion of portfolio considerations. The SysCW tutorials and book include tens to hundreds of examples of successful positions.
Some were easy.
Some required more management.
Some involved dollar cost averaging (DCA).
Taken one at a time, MacDuff found a way to make every single position go back to cash profitably. For me, this was the primary appeal of SysCW: management strategies exist to handle most any situation imaginable.
Indeed, SysCW does offer tools to successfully manage most any situation… when looking at positions one at a time.
This is not the case when full attention is paid to portfolio considerations and that, in my opinion, is where SysCW begins to break down. What happens when another 2008-like crash occurs and all positions lose significant value? MacDuff has argued I can close profitable positions and use that money to aid losing ones. By definition, though, correlation goes to one in a severe market crash. No profitable positions are likely to exist in a violent bear market.
In Systematic Covered Writing (2011), MacDuff introduces DCA as a position management tool. Perhaps a market crash will require DCA and to do this I need significant cash on the sidelines. If I have significant cash on the sidelines then I will not realize 15%+ on my entire portfolio, which is what MacDuff repeatedly insists to be possible with the SysCW.
Something just doesn’t add up [yet].
I will continue this discussion in the next post.
Categories: Money Management, Option Trading, System Development | Comments (1) | PermalinkPortfolio Considerations of a Trading Strategy (Part 7)
Posted by Mark on April 24, 2014 at 07:34 | Last modified: March 19, 2014 03:53I concluded the last post by claiming portfolio considerations are often overlooked because discussion of trading strategies is much “sexier.”
To evaluate this claim, I should first address whether it is even true. Ryan Jones writes in The Trading Game (1999):
> Money management is thought by many to rival only accounting in its boredom.
At least I am not the only one who perceives traders to preferentially enjoy discussion of other topics like trading strategy. Jones continues on to say money management is misunderstood. Money management is truly exciting.
In most contexts, “money management” can be substituted for what I have been calling “portfolio considerations.” Some believe that strategy (e.g. position setups, adjustment guidelines, and stop-losses) and money management (e.g. position sizing, portfolio risk management) are two different components of trading.
This traditional, almost intuitive division between trading strategy and money management enables commercial interests and fellow traders to focus on the former while overlooking the latter. While they may be separate, a successful business plan cannot exist without both!
Jones argues that $1,000,000 in profit may be generated using a conservative money management approach by earning $100,000 trading a single unit, contract, or option. This can be done in five years by:
–Making $20,000 profit per year
–Making $1,667 profit/month
–Making $384 profit/week
–Making $75 profit/day
What would it take to make seventy five bucks per day?
–Three ticks in the S&P 500
–Less than three ticks in bonds
–Seventy five cents on 100 shares
–Six pips in a currency market
None of these seem to be altogether too much, do they?
Ryan Jones has presented an example where “money management” is responsible for $900,000 of $1,000,000 total profit.
What is dull and boring about that?
Could the true power of money management just be misunderstood and/or unknown?
Categories: Money Management | Comments (1) | PermalinkPortfolio Considerations of a Trading Strategy (Part 6)
Posted by Mark on April 21, 2014 at 07:07 | Last modified: March 12, 2014 11:23In the last post I left off by planning for the cash position ($12,000) along with the iron condor position ($8,000). This makes for multiple simultaneous positions. I can imagine a trading group discussing this. However, other portfolio considerations must be made to evaluate this trading strategy that probably are not appropriate for public discussion.
For example, I may not feel comfortable discussing the need to pay a $1,500 mortgage every month on top of $5,000 in living expenses. Suppose the backtest showed this position to average $150 profit per week, which is $7,800 per year. Am I comfortable increasing this position 10-fold to potentially make $78,000 per year? I would need $200,000 in the account for this purpose. This is a portfolio consideration.
Rather than scale up this particular position, perhaps I seek other trading strategies for diversification or hedging. How much can I expect to make from those strategies? How much cash do I need on the sidelines for those strategies? Am I able to fund all of them? These are portfolio considerations.
Zooming out even further, how much of my total net worth do I feel comfortable having in my trading account? Perhaps I only feel comfortable allocating 70% of my net worth to trading and the other 30% to bonds, real estate, etc. I should also probably have a small checking account readily liquid in case of emergency.
All the portfolio considerations described in the last three paragraphs are probably not appropriate for public disclosure because they involve matters of wealth. They certainly should be carefully thought through, however. Just how beneficial can a trading group be for the most-involved participants who trade for a living?
If all group members make a concerted effort then I think portfolio considerations can be discussed to some extent. If the common goal is trading for a living then these details affect everyone. One problem is that despite being the “elephant in the room,” in many instances portfolio considerations are not even acknowledged. Part of this is probably due to a second problem: discussion of trading strategies is much sexier than discussion of portfolio management.
I don’t know why. It just is.
Categories: Money Management, Option Trading | Comments (1) | PermalinkPortfolio Considerations of a Trading Strategy (Part 5)
Posted by Mark on April 17, 2014 at 07:30 | Last modified: March 12, 2014 10:23Recent discussion has labeled investment newsletters, trader education firms, and even informal conversation with other traders as different venues where portfolio considerations are overlooked. Today I begin to illustrate exactly where these portfolio considerations might apply when evaluating a trading strategy.
Suppose we participate in a weekly trading group and today is my turn to present. I show a 10-contract weekly iron condor position with a margin requirement of $8,000. My profit target is 10% or $800. I detail the trading strategy with position setup and risk management [adjustment] guidelines. I show last month’s successful trade and everyone is all smiles. Right?
Because one trade never makes a trading system, I need to zoom out to determine whether this trading strategy is for me.
Suppose I show three years of backtesting results and the worst year-to-date drawdown is $8,000. Does this suggest I need $8,000 to implement this strategy?
No!
First, I would likely bankrupt the account or come pretty close. People generally become concerned once drawdown exceeds 10%. In 2008-2009, the stock market fell 50-60% and people were completely devastated from that. I can hardly imagine a drawdown approaching 100%
Second, some trading guru once said “your worst drawdown is ahead of you.” In general, the longer the time interval the greater the variety of market environments available to test a strategy. Three years is a very limited backtest. In some future year, this trading strategy is very likely to post a drawdown [much?] greater than $8,000. I will arbitrarily deem $20,000 (2.5 times) as necessary to implement this trade: $8,000 for the iron condor and $12,000 as supplemental cash in the account.
If I am being entirely honest when discussing this trade then I should also realize my weekly profit target is now 4% rather than 10%. The margin requirement of the trade might be $8,000 but I have now set $20,000 aside for the trade.
Further calculations will be more about gross dollars. I will continue with these details in the next post.
Categories: Money Management, Option Trading | Comments (1) | Permalink