If you want to go long using options to a position that is equivelent to a long spot position, then you would create a synthetic long (short put and buy call). Although I am not using options to mimic a spot position. I am selling premium, so I actually don’t want price to move outside of a certain range.
Cleaning House
I did some house cleaning this week in more ways than 1. First I removed a covered call in ABBV due to a low liquidity options market with huge spreads. The next thing I did was implement a few new strategy rules in my never ending conquest to reduce risk and improve performance. Finally I sold part of my ABBV buy-and-hold position because it was far too large for my account size.
The Week Behind
Overall my portfolio held out much better this week than I expected. Even through holding negative delta's all week and the markets constant rallying, I was able to end the week at 1% profit. This is not the blowout week I was hoping to have but it is not the massacre that a short premium portfolio like mine could/should have had.
Tough being a short premium trader this month
Many people over complexify options. At the end of the day options sellers are making money due to IV regularly overstating RV. This is similar to how insurance companies profit, because they regularly take in more in premium(IV) than they pay out in claims(RV).
The next article sums it all up pretty well. In 30 days time we had the worst December and worst Christmas Eve in history with the Nasdaq selling off over 20% from it's highs. Followed by the strongest comeback in 10 years.
Cleaning House
As I mentioned at the beginning of the article, this was a week of house cleaning. First let me remind everyone that this is my first attempt at this type of portfolio. One that implements buy-and-hold, options selling and price-action trading. This portfolio is rough around the edges but I am tiding things up as I go along.
One of the first things I want to do is to ensure going forward that all of my options are in a liquid market. Unfortunately ABBV does not fit that bill. The answer was simply to close my covered call and rely on short delta's from my QQQ's position to provide some covered call effect.
This was also a week where I looked at my strategy and thoughts about any new rules that might help moving forward. One of the rules I decided on was to ensure no single buy-and-hold position took up more than 10% of my account balance. I will be injecting my account with some more capital next month, so for right now this rule is being violated, but will naturally correct itself next month. Even after the added capital my ABBV position was still going too be to large so I cut it in half, from about $10,000 to around $5,000.
The Week Ahead
While I was able to stay green throughout the rallying this week, that will not be the case next week if the rallying continues. The delta's in the position are getting increasingly negative (-43 as of this post), my gamma is increasing, and a lot of volatility has been sucked out of these options, not giving me a lot of buffer from contracting vega.
I would like to believe that the market is due for at least a small pullback, but I also know the market will do whatever it wants. It may decide to rally another 12% next week, who knows. With that in mind I am going to simply stick to the rules and stay mechanical. That means my QQQ position will be rolled up(in strikes) and out(in time) if price reaches my break-even at around 166. If this does occur then my P&L will likely be a few percent red on the year.
On a final note, I am still glad to have negative delta's in place for now because I know how quickly markets change. All it would take is one materially down day and those negative delta's quickly become positive.
Portfolio Strategy Rules
Below is a summary of my portfolio strategy rules. The goal of my strategy is to find an appropriate balance between returns and risk. Rules will be added, removed, or modified as needed. In this post I will keep track of the strategy rules and any changes made over time.
Portfolio
- Maintain a delta neutral portfolio
- Allow up to +/- 50 delta's per $10,000 of account value
- Target a portfolio correlation of 0.5
- Generate returns through short options premium,
candlestick/price pattern trading, dividends, and stock appreciation - Use the following 3 high-level strategies: options selling, candlestick/price pattern trading, long term buy-and-hold.
Options Trading
- Target 0.3% of account value in positive theta
- No single correlation group of more than 1x account size
- Only selling premium in underlying's where the IVR exceeds 50%
- Sell 16-30 delta options in the 30-45 DTE range
- Roll positions up/down and out in time when they are tested
- Only roll a position that is being tested at its break-even
- When defensively rolling try to reduce delta's to at least 30
- Only sell options in highly liquid markets. Ideally 1 cent spread per $100 of underlying.
- Use options to adjust delta's in high IV environments and static delta's in low IV environments
Candlestick/Price Action Trading
- Trade daily candlesticks
- Risk no more than 0.5% of total account value per trade
- Only trade 1:2 R:R or greater setups
- Use split strike synthetic and vertical spread strategies to further reduce risk
Buy-and-Hold
- 3% or greater dividend yield
- PEG ratio lower than 1.5
- Trailing PE and forward PE lower than 20
- Average annual growth rate of 15% over the past 5 years
- Beta of 1 or less
- Stocks in sectors and industries that historically perform well during bear markets
- A single stock should not be greater than 10% of the total account value
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QQQ – Bearish Rising Wedge – Ready to Drop
Any day now would be nice 
In the Teeth of the Rising Wedge
Performance:
YTD P&L: -0.8%
MTD P&L: -0.8%
WTD P&L: -1.72%
Below are the key takeaways of my trading portfolio from last week
- Disappointed that my P&L is negative on the year with January almost finished
- Pleased to see how little of a loss I have taken so far given the monstrous price movements in the market
- Knowing my account has unnecessary risk due to low account capital
- The market's are grinding up within a very large bearish pattern, so what does that mean for next week?
To get started I want to talk about my overall P&L. I am generally disappointing that I am negative on the year (who wouldn't be?). The more important question is, what could I have done differently to start the year, that would have possibly increased my P&L. Looking back, and I have mentioned this in previous posts, but I poorly initiated and managed some short premium trades mid-December. Those are trades that I have carried into the new year and have continued to cause problems. Mid-December I had way to many positive delta's. I also was over-leveraged in both my buy-and-holds as well as my short QQQ and short XLE positions. I have vowed to let these positions naturally correct themselves as I roll them off, which is the plan I have continued to stick to. I imagine these will all be resolved by next month.
The next thing to note is how well my account has weathered this epic rise in the NASDAQ. This recent rally is now the fastest 50% retracement of a bear market in history. This came on the heels of the worst December in history. That means my portfolio is getting a very early trial-by-fire by having to face some pretty extreme movements, right out of the gate. The crash that occurred in December caused a 10% draw down in my account. The subsequent rally has put my down less then 1% year to date. How well my account has fared on the rally back is likely due to some risk reduction measures I took in early January.
https://www.nytimes.com/2019/01/20/business/stock-market-recovery-federal-reserve.html
My account also has a good amount of hedge built into it now with my delta's sitting at -92, I estimate that it would take a drop of over 20% within a 1 to 2 week period for my account to take a material loss. My upside is more risky right now, but a continued rise in the markets would trigger an automatic defensive roll which would subsequently cut my upside risk by about 1/2.
The next thing to note is that I am forced to have a more risky account due to lack of capital. This is because part of my strategy's risk reduction comes through diversification and I simply do not have enough capital to properly diversify. For example, a single short strangle in QQQ represents $16,500 of underlying. That 1 position alone puts my account at almost 1X leverage. There is only 1 solution to this problem which is adding more capital. I guesstimate a minimum of $50,000 in capital to be able to diversify properly. My goal is to at least have that much in my trading account by the end of February.
The final thing to look at is where the markets stand technically right now. The price action that occurred in Q4 of 2018 I believe caused some technical damage. While the past 3 weeks make it all seem like a distance memory, I don't believe it will be resolved that easily. My expectations is for volatility to re-enter with a vengeance and for the markets to be trapped in the 2400-2800 range for a while. I have been tracking a rising wedge, which is generally a bearish pattern. The market's have attempted to break out to the upside a number of times only to be pulled back in. If we see price break and hold below this rising wedge, there could be a swift selloff. While I don't believe we will see lower lows, I think we could certainly see a 50% retracement of this up-move. We shall all find out soon enough!
This is an interesting study on the short 25 delta put vs a short 16 delta strangle. Both strategies offer the same premium but behave much differently.
There it goes. A few more percent to hit the price target back, but this is a nice start.
I find it humorous when I hear “options are very risky”. These comments are usually from people who have never traded options, and of course never provide any empirical evidence to back up their statement.
What is up with people making bold claims and never providing any studies or empirical evidence of these claims? Well, that is another conversation for another day.
Anyways, my claim is that selling options are less risky, even significantly so, than a buy and hold strategy. The buy and hold is a good baseline to use because it requires very little knowledge to do and is a very common strategy many people use.
See exhibit A:
I hope this portends bearish things because my P&L really needs it. I caught this bearish little bugger forming on QQQ an hour ago.
Peter Mulmat, full-time commodities trader. This guy is the real deal. I will be curious how his double ratio spread plays out.
How to improve your trading game… add Nintendo dubstep.
You’re as cold as ice
Performance:
YTD P&L: Unch
MTD P&L: Unch
WTD P&L: Unch
My blog title mainly has to do with how cold it could get next week where I live.
Although, in a lot of ways, my portfolio was as cold as ice. In the sense that my P&L didn't move. In the sense that one of my buy and holds took the high honor of being the second worst performing stock on the S&P 500 today.
Even with those negative aspects of my portfolio this week, there is still plenty for me to be happy about and, to be honest, I ended this week feeling the best about my portfolio than I have any other time this year. I will get into the "why's" later, but let's look at the negatives first
Issue's this week
The biggest issue that plagued my this week was that one of my buy and holds ABBV tanked hard on Thursday and Friday. The total loss between these two days was somewhere in the 9-10% range. Ouch. The positive spin on this is that thanks to having a diversified portfolio and strategy, my portfolio completely absorbed the loss and was able to end the week unchanged.
Positives this week
Even though the market didn't give me quite the pullback I had hoped this week, it did allow me to keep my short premium positions open for another week and milk some decent premium out of them. My short QQQ's strangle swung from a large loss to a small profit, and my short XLE strangle went from a small profit to a decent profit. So the positive here is while the pullback wasn't deep enough to maximum profits on the strangles, it did buy me time and as a premium seller time is one of my most precious (and profitable) commodities.
I was able to sit on my positions all week until they were ready to roll to the next expiration today. My strategy involves automatically rolling positions to the next expiration once their DTE reaches the teens or low 20's. The reason I do this is to lower gamma and delta risk that start to exponentially pick up in the last few weeks before expiration.
I had recognized last week that I has violating one of my most important rules which is to not be over-leveraged, which is greater than 1x leverage on any group of positions. XLE and QQQ had become very highly correlated and my leverage was around 1.4x. When I rolled my positions to the next expiration it gave me an opportunity to let one of my XLE strangles roll off, and now my QQQ + XLE leverage is right at 1X. Perfect!
Another thing that I was able to do while rolling was to re-position my strangles. I have complained about this since starting my blog 3 weeks ago, but I had poorly initiated a number of positions in December, and that continued to haunt me all the way until now. The scheduled roll today gave me an opportunity to remedy this issue and get my positioning right.
My new positions are now a short strangle in XLE and a short strap strangle in QQQ (2 calls to 1 put). The reason I did a strap is to reduce delta's from my long stock positions. In my mind this position is a strangle with a short call as a proxy covered call to my long stock. My theta is sitting just below 0.1% of my portfolio. I have a lot of capital I haven't put to work, so I may initiate some new positions next week to get my theta closer to my 0.3% goal. My delta's are now slightly positive, but with a delta to theta ratio of 1:1 I consider my portfolio basically neutral.
Looking Ahead
After making slight adjustments to my portfolio over the past few weeks I now have resolved almost all of the issues and strategy violations I had started the year with. The only part of my strategy that my portfolio is currently violating is the size of my buy and holds. Right now each one of my buy and holds are close to 20% of my portfolio size. I am going to resolve this by simply injecting more capital into my portfolio. I plan on doubling or tripling my portfolio size next month which should bring those positions to around 6-10% of my total portfolio size (my strategy limit is 10%).
The other issue I am looking to resolve is not having enough diversified short premium positions and enough diversified buy and holds. This is simply an issue of low capital. Once I have more capital in the account I will be able to add in some more buy and holds and initiate some new, uncorrelated, short premium positions. This should go a long way to further reduce risk, and make it so no single position has too much affect on my portfolio.
I would like to put some more capital to work sometime in the next few weeks. I need to diversify with more non-correlated positions. I found this great chart that shows correlations of futures products. My core position is NASDAQ so I have a lot of choices such as wheat, corn, soybeans, bonds, gold, silver, and a few others.
I have initiated a bear put spread in GLD. Reward:Risk is around 3:1 with the theoretical profit curve(based on today) listed below.
Maximum loss is 0.65% of my account and maximum profit is 1.9%.
Commodities vs S&P500
Performance YTD P&L: -$350
Portfolio Overview
This past week saw options selling as profitable for my portfolio but my buy and hold positions continue to be a drag. MMP had earnings last week in which the stock promptly dropped by around 5%. This was following ABBV's earnings the week before where the stock had dropped by 15%. Even then my account has only experienced a draw down of less than 2% since the beginning of the year. I think my goal of reducing volatility through diversification and premium selling is working, and this past month has been proof of that.
This month I will be adding a decent amount of capital to my portfolio which will allow me to significantly reduce risk on my buy and hold's, and open the door for me to be able to sell options premium in more markets such as corn, soybeans, wheat, silver, etc.
Positions Changes
I made some changes to my short premium positions this past week. Firstly I bought back my XLE short strangle and replaced it with a short strangle in MU. The reasoning was simply that XLE's IV had dropped to a level that I felt it wasn't paying out enough premium for the risk involved. MU on the other hand has an IV that is about 2.5x that of XLE, and as an added bonus is less correlated to QQQ(0.8 vs 0.7). In addition to this change I also opened a bear put spread in GLD. I wanted to introduce a directional play that had low correlation with my core portfolio. GLD offered a great opportunity to do this as it is currently bumping into some major overhead resistance. The position itself offers a 1:3 risk:reward setup. Max profit occurs at 119 and break-even occurs at 122.75. This position has 40 DTE.
Looking Ahead
I want to look way ahead this time and decide what sort of portfolio composition I want over the next few years. Last year on my TradingView account I began discussing the GSCI Commodities index vs the S&P500. This ratio has showed how commodities to stocks have cycled back and fourth for the past 45 years. I'm a huge believer in cyclical and mean reversion, so I believe this ratio being at an extreme offers an opportunity to position for the next cycle.
I have been thinking about what the correct portfolio should look like to take advantage of this extreme. I have decided on making a few changes to my buy and hold rules. One is that I want to increase my portfolio stock holdings from 65-35 (65% stocks and 35% cash/options) to 75-25. With that 75% dedicated to long term buy and hold stock positions I have decided on the following weightings: When the commodities to stocks ratio is at a cyclical low I want 2/3 in commodities and 1/3 in stocks, and vice-versa when at a cyclical high. That means right now I need 50% of my portfolio in commodity exposed stocks.
After I properly capitalize my account this month my current buy and hold's will be about 25%. My plan is to research and choose holdings that are primarily in precious metals and oil industries. I am planning on adding in these positions over the next month.
Debunking Common Wisdom about Stop Losses
This is a great study by Dr. Russell Richards regarding stop losses and how they hurt short option strategies. In fact, in this study a stop loss resulted in a long term P&L loss and not having a stop loss resulted in long term profits.
This is another feather in the cap of those of us who believe that stop losses are harmful to short options trading.
I have also recently switched to not using stop losses with price action trading. I believe the results could be similar but the verdict is still out on that.
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I have been thinking about adjusting capital allocation based on implied volatility levels for my short premium positions. I found a study that backs up that idea. I am going to look into this more and see if it should find a place in my portfolio.
I am going to pin this right here for analysis later on when I have more time.
This goes along with my previous post where adjusting the strategy based on IVR can improve performance (increase profits/decrease risk). The previous post talks about adjusting capital deployment based on IVR. This study talks about adjusting delta’s based on IVR. In summary when IVR is less than 50% the preferred delta is 10-20. When the IVR is greater than 50% the preferred delta is 30. The 30 delta generates 4x profits compared to the 10 delta in high IVR(<50). The 30 delta generated less profits than the 10 when IVR was low (>50).
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Just remember that you have about 5 days until you can’t add to the post - I believe adding to posts or editing is time limited? Have the same issue on my own tread where i’m showing how to lose money off the bat.