Practice Trades Cal 1.1

I’m going to apply my initial backtesting guidelines shown here with a few tweaks:

• Use 10-point strikes only and lean bullish (by < 10 points) as needed.
• Adjust only when TD shrinks to 1 or less.
• Profit target (PT) 10% and max loss (ML) -20%.
• No time stop.

Cal 1.1 begins 5/15/18 (66 DTE) with SPX = 2707.45 and 2710 puts down $168. MR is $2,778 (two contracts), TD = 11, IV 11.2, horizontal skew -0.44%, NPD = 0.9, and NPV = 177.3.

On 44 DTE, trade down $218 (7.9%) with TD = 1 with market up 0.83 SD over 22 DIT.

Adjustment increases margin requirement (MR) to $3,066 and puts trade down $302 (9.9%). TD increases to 3. Raising second strike any higher results in horrific sag in the expiration curve. Two of five T+x lines are profitable now.

On 42 DTE, trade down $347 (11.3%) with TD = 3.

Exit trade at 14 DTE (52 DIT) for 11.7% ROI ($358). Here is underlying price action during this trade:

Nothing to see here.

Practice Trades IC 1.2 – 1.6

More of the same, today: backtested trades per guidelines discussed here. All I’m trying to do is build muscle memory.

IC 1.2 begins 1/11/21 (67 DTE) down $336. MR is $18,136 (two contracts), PT is $1,864 * 0.8 = $1,492, and ML = $2,984. At trade inception, TD = 32, IV 17.7, NPD = -1.1, and NPV = -234.7.

MDD = -$596 (-3%) at 51 DTE.

On 3/2/21 (50 DIT), exit trade for 8.7% ROI ($1,569 profit) with market up 0.31 SD. IV increased 7.6% while in the trade. Not much going on here:

Let’s shift the start date one week (actually eight days because of MLK holiday) later to 1/19/21, which is 87 DTE. Again, trade starts down $336. MR is $17,876 (two contracts), PT is $2,124 * 0.8 = $1,700, and ML = $3,400. TD = 23, IV = 17.6, NPD = -1.2, and NPV = -263.9.

MDD = -$1,196 (-6.7%) at 79 DTE.

On 3/22/21 (62 DIT, 25 DTE), exit trade for 9.5% ROI ($1,704 profit) with market up 0.51 SD. IV decreased 21% while in the trade. Once again, not much drama here.

Let’s shift the start date six days later to 1/25/21 (81 DTE). Again, trade starts down $336. MR is $17,846 (two contracts), PT is $2,154 * 0.8 = $1,724, and ML = $3,448. TD = 23, IV = 16.8, NPD = -1.3, and NPV = -259.1.

MDD = -$1,096 (-6.1%) at 79 DTE.

On 3/22/21 (52 DIT, 29 DTE), exit trade for 9.7% ROI ($1,739 profit) with market up 0.25 SD. IV decreased 21% while in the trade. Not much to see here.

Let’s shift the start date two weeks later to 2/8/21 (67 DTE). Again, trade starts down $336. MR is $18,016 (two contracts), PT is $1,984 * 0.8 = $1,588, and ML = $3,176. TD = 25, IV = 12.6, NPD = -1.4, and NPV = -265.7.

MDD = -$346 (-1.9%) at 66 DTE.

On 3/22/21 (42 DIT, 25 DTE), exit trade for 9.5% ROI ($1,704 profit) with market up 0.18 SD. IV increased ~10% while in the trade. Again, not much to see here:

The market sold off a bit then recovered—all for net sideways trading, pretty much.

For my final example of the day (IC 1.6), let’s shift the start date three weeks later to 2/28/21 (67 DTE). Again, trade starts down $336. MR is $18,146 (two contracts), PT is $1,954 * 0.8 = $1,484, and ML = $2,968. TD = 41, IV = 17.7, NPD = -0.7, and NPV = -241.4.

MDD = -$746 (-1.9%) at 78 DTE.

On 5/12/21 (72 DIT, 9 DTE), exit trade for 8.9% ROI ($1,609 profit) with market up 0.5 SD. IV increased ~42% while in the trade. Interestingly, trade exit occurred on a 2.5-SD down day. Three trading days earlier, the position looked somewhat precarious with the market up 1.1 SD over the first 62 DIT:

PnL was only -$516 at this point, but TD = 3 and T+0 upside slope is scary. Also note the blue shaded region, which corresponds to a 1 SD move over the next three days. Such a move would put the trade down over $2,000 (although it may be exaggerated if ONE computes this as a 3-day SD due to the weekend when it actually represents a single trading day).

If numbers work out over a large sample size, though, then I would deem such temporary pain to be worth the effort.

Practice Trades BWB+Cal 1.3 (Part 2)

Today, I want to finish reviewing the backtrade discussed last time.

Were I to take the [farther OTM] prescribed adjustment at 11 DTE (fourth paragraph here):

Loss here is $960 here on consequent margin requirement (MR) of $15,735 (-6.1%).

Second adjustment point is hit with 7 DTE and trade down $1,285 (8.2%):

This puts me down $1,915, which is 7.2% of consequent MR $26,570. The T+x lines are more positive than negative, which is good. This is a somewhat directional trade with NPD 53, but TD is a robust 12.

I become profitable (+$209) the very next trading day.

Two days later at 4 DTE, I hit the profit target up $2,385 (+9%):

Whether done “right” or “wrong,” this seems like a challenging trade because of the need to stare big unrealized losses in the face (-$2,920 by ignoring first adjustment point and -$1,915 by following guidelines). The only way to avoid these big losses would be to monitor adjustment points continuously, which violates the once-daily monitoring concept of the strategy.

The losses may not be extraordinarily large on a percentage basis if I position size for a potential 2-3x capital expansion. I just don’t yet know how the numbers pan out over a large sample size of trades. Those reaching profit target without adjustment will earn 5% of a minimal MR. A % ROI profit target inversely proportional to current MR could make sense.

This is probably an age-old question that pertains to any strategy where adjustment significantly impacts MR.

Practice Trades BWB+Cal 1.3 (Part 1)

This trade begins 10/12/20 (14 DTE) down $840. MR is $7,140 (five contracts) and PT is $7,140 * 0.05 = $357. At inception, TD = 128, IV 17.9, NPD = -0.65, and NPV = -140.

PnL is -$940 at 1 DIT.

Three trading days later, I hit the first adjustment point with trade down $540 (7.6%):

This is 17 points into a 70-point width (between breakevens), which is just inside the 25-yard-line. Adjusting puts the calendar inside the BWB structure, which for some reason doesn’t feel right to me. Other options would be to place farther OTM (40 points) or to do nothing at all. The latter would be vulnerable to a big downside opening gap and/or being far beyond an adjustment point at next monitoring in 24 hours.

Since this isn’t even MDD and TD = 8, I’m going to be a rebel and do nothing at all.

Two trading days later, we get a -1.5 SD move:

I am now down $2,290 (-32%) and the prescribed adjustment (with lower wing calendarization) looks like this:

Three of five T+x lines are underwater, but facing a big loss I find it difficult to exit. The adjustment increases my loss to $2,920, which is [only] -10.8% of the [dramatically increased] $27,155 resultant margin requirement.

Blue skies lie ahead. Two trading days later I have a $130 profit. One trading day after that, I’m up $1,380 (5.1%). One trading day after that, I’m up $3,267 (12%):

If I didn’t exit for +$1,380, which was at the profit target, then this is certainly a must-exit being Friday and 3 DTE.

Things work out well by doing the trade “wrong.”

What if do the trade “right?” I will pick up here next time.

Practice Trades BWB+Cal 1.2 (Part 3)

Today I wrap up some ideas for—well, let’s call it what it is: curve fitting!

Backing up, instead of closing BWB + downside calendar and rolling 9 points above the money, I could roll farther above the money akin to the guidelines discussed here:

One day later, the market has gone against me even though the trade is now down a bit less ($1,275):

Although the directionality may appear risky, I had the same thing in place one day earlier.

MR is $9,235 here, and this version is profitable one day to expiration with a profit of 1% ($50):

If I were really gutsy and held to expiration, I could end up with the motherlode:

That’s a profit of 41% ($3,775).

Back to reality, though: in the absence of other validated variants, this trade meets unfortunate demise at 2 DIT with a hefty loss of 15.3% ($1,410).

Since each of these variants begin by closing the original BWB and added calendar, they are essentially new trades altogether. By linking them to the previous transactions, I ensure an overall exit for something ranging from small loss to windfall profit. To maintain consistency and repeat the same strategy every week, though, I should keep things separate: BWB + Cal on one hand and, if so desired, bullish calendar on another.

Practice Trades BWB+Cal 1.2 (Part 2)

Per the suggested guidelines, this trade was a loser. Surely we can always come up with tweaks to improve the outcome.

One alternative would be to close current positions and enter a calendar above the money at 2 DIT. This is making a blatant directional bet albeit one that coincides with the general tendency of stocks to go up more often than they go down:

This adjustment would put trade down $1,830 on $9,235 margin with TD = 4. Despite a subsequent down day, we see a nice recovery through 3/11/21:

Trade is now completely directional to the downside, which blatantly taunts the general tendency. We could exit for a loss of $955, which is lower than the 2 DIT loss of $1,410.

If we choose to press onward, then we could roll to first above-the-money [10-point] strike. This would take PnL back to -$1,375 since the adjustment involves 20 contracts. Be aware that each adjustment takes days from which to recover (unless I’m being far too aggressive in my TF assumptions).

One day before expiration, this trade is down $375. Given what we’ve been through, we should take this and consider it a huge moral victory.

Rolling the dice to expiration:

That’s a 10% return of $925. Lucky Charms!

But wait… there’s more?! Watch for it next time.

Practice Trades BWB+Cal 1.2 (Part 1)

This trade begins 3/3/21 (14 DTE) down $840 (max DD). MR is $6,065 (five contracts) and PT is $6,065 * 0.05 = $304. At inception, TD = 44, IV 21.9, NPD = 1.59, and NPV = -122.

After one day, market is down 1.3 SD to force adjustment. Trade now down $1,360 on margin of $9,235.

On very next day, market is up 1.6 SD to force adjustment with trade down $1,410. Second adjustment looks like this after calendar repositioning and rolling out upper wing:

Since most T+x lines are underwater, I would close the trade for a loss of 15.3%. The problem with T+x lines being underwater is that I would have to wait nearly to expiration to be profitable—and even at that, only if the market remains in a range. The market is 0/2 so far at remaining “within range,” which seems like a very ominous sign.

With trade opened near close of first bar, the underlying price chart looks like this:

Recovery from such a whipsaw is difficult in a short-term strategy. I would be fine without the first adjustment, which occurred with the market still under the profit tent. These guidelines dictate adjustment nevertheless.

I will continue next time with some potential alternatives to managing this trade.

Practice Trades BWB+Cal 1.1

Practice Trades BWB+Cal correspond to the following general guidelines:

• With 14 DTE, buy first above-the-money 40/60 BWB.
• Use 10-point strikes only and TF $21/contract.
• If underlying exceeds upper strike then buy calendar above the money.
• If underlying exceeds upside calendar strike then [close downside Cal if needed and] buy Cal above the money.
• If T+x lines underwater, then calendarize upper leg of BWB to raise (else close).
• If underlying falls below 25-yard line of BWB then [close upside Cal if necessary and] buy Cal below the money.
• If underlying falls below downside calendar strike then roll calendar below the money.
• If T+x lines underwater, then calendarize lower leg of BWB to raise (else close).
• PT 5%
• Monitor position once daily and adjust as needed.

The wings may be adjusted to 30/40, 50/60, 40/50, etc. in order to limit initial NPD, which should ideally be slightly negative. The short strike may also be split although this may make execution more complex.

This trade begins 3/18/21 (14 DTE) down $840 (max DD). MR is $7,015 (five contracts), PT is $7,015 * 0.05 = $351.
At trade inception, TD = 36, IV 17.1, NPD = -1.78, and NPV = -122.

First adjustment occurs very next trading day with max margin increasing to $11,285.

Second adjustment occurs on 3/26/21 (8 DIT) by rolling up calendar and calendarizing two of the five upside wing contracts. This increases margin to $14,238.

On 3/30/21 (2 DIT), exit trade for 7.2% on max margin with market up 0.32 SD in 12 days. IV decreased 18%.

I have two general comments.

First, I suspect $21/contract TF is much more than I should normally see in live trading (this amounts to ~12% initial margin with a PT of 5%, which seems preposterous). If this works out okay in backtesting or on paper, then it should work out well. As I do some of these live, I should get a good feel for what number to expect.

Finally, I’m a bit unclear as to whether I should use PT as a percentage of initial margin, current margin, or max margin. Until I see reason to change, I will use the latter. This does mean, however, that the trade should always be done with a limited portion to account for margin more than doubling upon adjustment.

Practice Trades: IC 1.1

Whether important or not, I’m not happy about my trade diversity last year. In an attempt to push the envelope and improve, I’m going to start spending more blog time posting practice trades.

A practice trade may be live, paper, or backtested. Live and paper trades are both followed in real-time. Backtested trades are done completely in hindsight.

My goal in doing this is to gain more familiarity. Period. I want to be able to place these trades as if they are second nature. My bread-and-butter strategy has been repeated daily for months. I want to feel equally comfortable with others.

As seen in the post title, I am calling these “Practice Trades.” The subsequent code describes type of trade, trade number of the methodology referenced, and methodology (seen after the dot). I may or may not go into detail about the specific trade plan since my goal is not to wax eloquently about the pros, cons, and potential strategy variants. You’re always welcome to post questions or comments below.

Today, I will include the following methodology:

• Place in SPX monthly cycle 60-90 DTE using 25-point strikes and include TF $21/contract.
• Sell NTM option < delta 12 and purchase 100 (50) points farther OTM for puts (calls).
• Exit at 80% capture, when down 2x that amount, or with 7 DTE: whichever comes first.
• Trade and monitor 15 minutes before regular market close every trading day.

This trade begins 1/4/21 (74 DTE) down $336. MR is $18,036 (two contracts), PT is 1964 * 0.8 = 1572, and ML = 3144.

At trade inception, TD = 46, IV 21.31, NPD = -0.69, and NPV = -239.72.

On 3/4/21 (59 DIT), this trade closed for ROI of 9.1% with market up 0.19 SD. IV increased 17.5% over the following:

Chalk up one for the good guys. Remember though, the focus here is on developing “muscle memory.” To that end, losses must be welcomed as they are a reality of trading.

Call Me Crazy (Part 8)

Last time, I discussed the risks of a multi-year down or flattish market on the long call (LC) strategy. Today I want to start wrapping up some loose ends in preparation to move on.

Many variants can be made to what is just one of many LC backtest permutations:

• Vary DTE from two years
• Vary DIT from one year
• Apply price-based (i.e. market up/down X%) rather than time-based roll
• Vary strike from ATM (i.e. ITM, OTM)

In Part 7, I discussed how the LC can realize serial losses by rolling down to the current ATM strike in a multi-period down/flattish market. Holding the strike avoids replenishment of juicy extrinsic value that dissipates quickly on a continued move lower. Some people would say the stock market’s long-term upward bias makes this a lower-probability trade. My gut reminds me this upward bias is not written in stone or guaranteed by law. The Nikkei has gone over 30 years since hitting all-time highs. Can you imagine this happening to US stocks? I feel the need to consider it in order to be prepared.

A trend-following (TF) technique could take advantage of a sustained move lower. Maybe I hold the strike and do not roll down when price is below the 200-MA. Although this seems logical, keep in mind we have no data to suggest it actually works. In fact, I have data to the contrary from testing a variant of this as a short entry for /ES:

As much as it twists my innards, sticking with the long bias and is probably best until and unless I have reason to someday think otherwise (and if this happens, then hopefully I’ll have capital left when I finally make the decision to switch). Did someone say hope is not a strategy?

Thinking about the damage from a long-term bear market is to say the LC strategy has no built-in TF downside component. Oh well. One of two resilient [expectancy, not necessarily risk-adjusted] edges I have found is the upside for equities.

A volatility filter to add or substitute more downside protection sounds logical to monetize a down market. In this case, maybe something OTM would work better because despite the built-in insurance, the LC cost can really hurt. Maybe even selling the stock and going put-only would help—or some sort of put spread to offset the higher volatility and time decay.

Similar to the TF filter explored above, the problem with this idea is that going long on VIX spikes historically performs well. While a volatility filter might keep me alive should equities not bounce back, I think (versus my gut) I’d rather play the percentages than bet on something never-before experienced. Much of investing seems to come down to this.

I will continue next time.