25.9%

Honest reporting on shorter-term trading activity and ideas
moorfield
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25.9%

Postby moorfield » January 1st, 2017, 5:03 pm

Hello All

Last year I started an Options trading project inspired by a slightly flippant reply I posted(*) to ajc5001 on the old TMF version of this board:
http://boards.fool.co.uk/163100000-turned-into-a-million-in-10-years-13308950.aspx

As there is no Options & Spread Bets board available I thought I would return here to post an update. I will be brief and to the point as possible for the weary eyes ploughing through all these end of year updates!

Happy New Year 2017
M


Objective

I am pursuing a strategy of selling deep out of money and time value put ratio spreads on the S&P 500 index, for net credit at expiry, using a spread betting account and conservative margin level; and aiming to achieve an XIRR of 25.9% on capital (measured as cashflow inputs since Jan 16 vs. net equity), ie. the same rate that will turn ajc5001's notional £100,000 into a million in 10 years.

This table records actual vs. target xirr at year end. The "forward xirr" column assumes current open positions expire otm without adding cash or opening new positions (I am now finding this a better indicator of long term progress than "actual xirr" which is more sensitive to short term market volatility). The "notional value" column I hope is self-explanatory, but my real account value is much smaller than that!




Position

This table shows my end of year open positions. I don't intend to publish a trading history - quite frankly it has been chaotic in the first year - but those familar with option spreads may see the routine I have settled into. The "normsdist" column is an approximate risk measure of the position failing ie. expiring itm.











(*) Under a different username which I was trying to standardize across different forums I was using at the time. I have given up on that idea and reverted to moorfield here. Apologies for any unintended confusion.

Lootman
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Re: 25.9%

Postby Lootman » January 1st, 2017, 6:55 pm

moorfield wrote:S&P 500 Jan 19000/20200 3.1x

Two questions:

1) Those numbers look like levels on the DJIA to me; not the S&P 500. As an aside, have you considered options on SPY - the most liquid ETF that follows the S&P 500, rather than options on the index futures?

2) When you say 3.1x, do you mean you are selling 31 lower-strike puts and buying 10 higher-strike puts? Or are you selling 31 higher strike puts and buying 10 lower-strike puts?

Either way, how do you manage the downside risk implied by those unless you also buy 21 lower-strike puts that are further out of the money? Otherwise it seems to me your strategy relies on the market continually grinding higher for the full 10 years.

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 2nd, 2017, 1:17 am

Lootman wrote:
moorfield wrote:S&P 500 Jan 19000/20200 3.1x

Two questions:

1) Those numbers look like levels on the DJIA to me; not the S&P 500. As an aside, have you considered options on SPY - the most liquid ETF that follows the S&P 500, rather than options on the index futures?

2) When you say 3.1x, do you mean you are selling 31 lower-strike puts and buying 10 higher-strike puts? Or are you selling 31 higher strike puts and buying 10 lower-strike puts?

Either way, how do you manage the downside risk implied by those unless you also buy 21 lower-strike puts that are further out of the money? Otherwise it seems to me your strategy relies on the market continually grinding higher for the full 10 years.


I am guessing this is SPX and he is quoting 10 times the actual strike. So 19000/20200 3.1x means short 31 put contracts at 1900 per long 10 at 2020. He could be taking the other side of course and be long 1900, short 2020, but I doubt it as doing that side would unlikely to have been profitable last year (unless seriously geared up and very lucky with timing!). My guess as well is that he is fully aware of the large downside risk below 1900 and is prepared to take that risk. I have been following a similar strategy since Sep 2015, but based on naked puts and it has been very profitable as well (and just as risky).

Hopefully moorfield understands the considerable risk he is taking here and with positions like this he will be very lucky not to suffer losses at some point over the next 10 years, potentially considerable losses. However, the strategy does not require the market to continually grind higher for 10 years in order to succeed. To reach his £1m goal he just has to not end up too far ITM on the lower strikes too often. He must be using a fair amount of leverage as well, so he must also be able to stay sufficiently solvent to make the margin calls when the market heads South and implied vol heads North.

Not a strategy for those with weak stomachs.

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 2nd, 2017, 1:28 am

Just realised who you are now moorfield. Glad to hear that last year worked out so well for you and best of luck for this year.

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 2nd, 2017, 11:12 am

Moorfield, you may find the last 2 weeks of August 2015 interesting. From what you have written, it looks as though you were not in the market at that time. Here is what the VIX and SPX did:

VIX

SPX


If you take the 4 days following the 18th, maximum upward movements in the VIX from 18 close were +2%, +5%, +14%, +37%. Maximum downward movements in the SPX from the 18 close were -26, -61, -126, -230. If you take these shifts and apply them to your March spread, you get the following spread price for 10 times 2130 premium minus 28 times 2030 premium:



Following the 24 August, the market stabilised and slowly recovered, but if that scenario were to play out this week, how would you cope? Would you have sufficient margin to make it past 5 Jan? Even if you did, would you want to? I was on holiday on 24 August, but from what I read there was major market disruption on that day. Trading was difficult and spreads widened. Many brokers considerably increased margin requirements.

I am not trying to put you off, but something like this could happen again at some point and it is worthwhile considering what you would do if/when it happens.

moorfield
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Re: 25.9%

Postby moorfield » January 2nd, 2017, 3:08 pm

hiriskpaul wrote:I am guessing this is SPX and he is quoting 10 times the actual strike. So 19000/20200 3.1x means short 31 put contracts at 1900 per long 10 at 2020.


Correct hiriskpaul. If there is better convention to use to describe these spreads I am happy to stand corrected ...

Hopefully moorfield understands the considerable risk he is taking here and with positions like this he will be very lucky not to suffer losses at some point over the next 10 years, potentially considerable losses.


Yes I do - I've watched two very volatile periods in the market last year, Brexit & Trump - which have helped me enormously in figuring out a minimum margin level I want to operate above - well above the 100% my s/b provider recommends ;-) ! I'm expecting losses which is why I'm trying to think and measure in terms of XIRR - I've no idea if 25.9% is reasonable but I wanted to start somewhere... I'm operating further otm than others probably and if the market blows up my account that spectacularly then it will be the least of my problems quite frankly.

moorfield
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Re: 25.9%

Postby moorfield » January 2nd, 2017, 3:30 pm

hiriskpaul wrote:Moorfield, you may find the last 2 weeks of August 2015 interesting. From what you have written, it looks as though you were not in the market at that time.


I was actually, I was in France away from my PC when all that kicked off, and I blew myself up. What did me in then was cr*p margin management and too narrow/too high ratio construction. I very nearly gave up after that but it was the start of a complete rethink of what I was doing.

If I was doing then what I am now, my August position would have expired before that week freeing up margin. Probably I would then have just had a September position open (since the beginning of July), and it might not have been too unreasonable to expect the P&L on September to move above the net credit during that week, which would have prompted an immediate close. I also would have been monitoring my margin level on my phone app, which I wasn't doing at the time.

Lootman
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Re: 25.9%

Postby Lootman » January 2nd, 2017, 6:25 pm

moorfield wrote: I've watched two very volatile periods in the market last year, Brexit & Trump - which have helped me enormously in figuring out a minimum margin level I want to operate above - well above the 100% my s/b provider recommends ;-) ! I'm expecting losses which is why I'm trying to think and measure in terms of XIRR - I've no idea if 25.9% is reasonable but I wanted to start somewhere... I'm operating further otm than others probably and if the market blows up my account that spectacularly then it will be the least of my problems quite frankly.

How do you account for the impact that your margin requirements have on your returns? Having cash held captive in order to maintain those short puts implies that there is an opportunity cost that perhaps should be factored into the returns?

Being short index puts provides a regular stream of premium income but you are in effect selling insurance, and it would be an unusual decade where you don't have to pay out some claims.

I periodically do a simpler version of your strategy - either selling puts or put spreads on shares I'm happy to own anyway. But with the market high and volatility low, I consider the conditions right now to be the opposite of when I would most want to engage this strategy. Opportunistically it can work. But continually?

And as a general rule I expect to collect about 1% a month (whether selling puts or calls). You're aiming for more like 2% a month, which is aggressive, and that presumably explains why you are using ratio spreads. Good luck to you - I'd be nervous given that we've seen 20% declines at least twice in the last decade.

GoSeigen
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Re: 25.9%

Postby GoSeigen » January 3rd, 2017, 12:37 am

moorfield wrote:I've no idea if 25.9% is reasonable


Well, I shoot for 3%pa after tax, commissions and inflation.


How do you account for the impact that your margin requirements have on your returns? Having cash held captive in order to maintain those short puts implies that there is an opportunity cost that perhaps should be factored into the returns?

Yes, and if you're clever enough to earn 25.9%pa from options then the opportunity cost of that idle cash is also close to 25%pa, right? Or the cash needs to be factored into the XIRR calculation at least...


GS

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 4th, 2017, 5:28 pm

moorfield wrote:
hiriskpaul wrote:Moorfield, you may find the last 2 weeks of August 2015 interesting. From what you have written, it looks as though you were not in the market at that time.


I was actually, I was in France away from my PC when all that kicked off, and I blew myself up. What did me in then was cr*p margin management and too narrow/too high ratio construction. I very nearly gave up after that but it was the start of a complete rethink of what I was doing.

If I was doing then what I am now, my August position would have expired before that week freeing up margin. Probably I would then have just had a September position open (since the beginning of July), and it might not have been too unreasonable to expect the P&L on September to move above the net credit during that week, which would have prompted an immediate close. I also would have been monitoring my margin level on my phone app, which I wasn't doing at the time.


Ouch!

If that bring on the stomach ulcers then you clearly have the temperament for this. I am short June puts on the SPX (1800), DOW (16000), DAX (8600) and FTSE (5750). All of which I took out last week. So far the markets have been very kind to us, but if we get a repeat of last January it will be very uncomfortable. If all my puts expire worthless, I will make just over 10% on allocated margin, which I consider aggressive.

Lootman
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Re: 25.9%

Postby Lootman » January 4th, 2017, 6:18 pm

hiriskpaul wrote:I am short June puts on the SPX (1800), DOW (16000), DAX (8600) and FTSE (5750). All of which I took out last week. So far the markets have been very kind to us, but if we get a repeat of last January it will be very uncomfortable. If all my puts expire worthless, I will make just over 10% on allocated margin, which I consider aggressive.

Those strikes look like they are about 20% out of the money. I'm surprised that you can get 10% in premia for them, even out to June. For instance the June SPY 180 puts cost a little over a dollar, or less than 1% of face value, reflecting how far out of the money it is.

You say its 10% of allocated margin, but that isn't how I would measure returns, since the margin is only a fraction of the face value. Which comes back to the question I asked earlier about how to correctly compute returns where margin is involved even when, as in this case, you are not borrowing and so have no interest cost. You still have opportunity cost.

I assumed that Moorfield is using ratio spreads to boost the return, with the elevation of risk that was noted.

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 4th, 2017, 8:48 pm

Lootman wrote:
hiriskpaul wrote:I am short June puts on the SPX (1800), DOW (16000), DAX (8600) and FTSE (5750). All of which I took out last week. So far the markets have been very kind to us, but if we get a repeat of last January it will be very uncomfortable. If all my puts expire worthless, I will make just over 10% on allocated margin, which I consider aggressive.

Those strikes look like they are about 20% out of the money. I'm surprised that you can get 10% in premia for them, even out to June. For instance the June SPY 180 puts cost a little over a dollar, or less than 1% of face value, reflecting how far out of the money it is.

You say its 10% of allocated margin, but that isn't how I would measure returns, since the margin is only a fraction of the face value. Which comes back to the question I asked earlier about how to correctly compute returns where margin is involved even when, as in this case, you are not borrowing and so have no interest cost. You still have opportunity cost.

I assumed that Moorfield is using ratio spreads to boost the return, with the elevation of risk that was noted.


I was not being very clear here. In this case, what I meant by margin was the total amount of capital I allocate for option trading. About 15% of that is in investments that are acceptable as initial margin to my broker, with a haircut to market value. These are mostly VCTs I used to hold as certificates and some Lloyds preference shares. The other 85% is in cash and is used to cover variation margin as required. Some cash is kept with my broker, but most is scattered around banks and NS&I, all available with instant access. My brokers margin requirements are a small fraction of the value of the assets I set aside for option trading, but of course vary with the market.

You are right about the premia for my puts, they are small. To get a decent return I am heavily geared up. To give an idea of the gearing, one metric I use as part of risk management is the amount of gearing I would have in the underlying if I held it at the strike price. As an example, I currently have about 25% of my capital allocated to my SPX 1800 puts. If instead of shorting puts, I went long the future at 1800, I would be 6.75 times geared. In other words, the futures position would be wiped out at 1533, about 32% down on where we are now. If the SPX dropped to that I would be in serious trouble and would likely need to allocate resources from outside the capital I set aside for that position. In reality I would likely be out of this position long before the market got to 1533 as I have a set of scenarios that would force me to close. For example, if I have insufficient margin available to cope with a 15% drop in the underlying accompanied by +5% on the implied vol, I would be likely to close out. It is not impossible of course for the market to plummet to 1533 before I have a chance to close.

One other point. My rate of return is about 10%, assuming I hold to maturity, but I often do not. Theta at present is about 1.5% per month rather than the linear 0.83%, so it is often advantageous to close out early. I closed out the March puts I shorted in September just before Christmas.

Lootman
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Re: 25.9%

Postby Lootman » January 4th, 2017, 9:25 pm

hiriskpaul wrote:
You are right about the premia for my puts, they are small. To get a decent return I am heavily geared up. To give an idea of the gearing, one metric I use as part of risk management is the amount of gearing I would have in the underlying if I held it at the strike price. As an example, I currently have about 25% of my capital allocated to my SPX 1800 puts. If instead of shorting puts, I went long the future at 1800, I would be 6.75 times geared. In other words, the futures position would be wiped out at 1533, about 32% down on where we are now. If the SPX dropped to that I would be in serious trouble and would likely need to allocate resources from outside the capital I set aside for that position. In reality I would likely be out of this position long before the market got to 1533 as I have a set of scenarios that would force me to close. For example, if I have insufficient margin available to cope with a 15% drop in the underlying accompanied by +5% on the implied vol, I would be likely to close out. It is not impossible of course for the market to plummet to 1533 before I have a chance to close.

OK, I didn't mean my question as a criticism, but more that I struggle myself with how to compute returns for when I employ this strategy, given the collateral I have to hypothecate for margin. If it is merely a matter of custodying assets with the broker that you would in any event have to hold somewhere, there is an argument that the margin doesn't cost you anything, absent borrowing. But in reality I take a much more conservative view, not least because I would hate to take on capital gains taxes to meet a margin call.

In your situation I'd be very tempted to also buy a "doomsday" put at 1600 or so. It would be very cheap to buy that protection and it would bail you out before the 1533 level. That's the principle behind butterfly and spread strategies, for instance, to hedge the tail risk of a black swan downside mega-move in the markets.

hiriskpaul wrote:One other point. My rate of return is about 10%, assuming I hold to maturity, but I often do not. Theta at present is about 1.5% per month rather than the linear 0.83%, so it is often advantageous to close out early. I closed out the March puts I shorted in September just before Christmas.

Yes, and in fact given how premium decays in a non-linear manner as the expiry approaches, it makes sense to recapture that or spread it out.

I should add that I only commit 10% to 20% to this strategy. I see the collection of premium as a different asset class rather than as a main method of building wealth. And I sell calls and call spreads as well to immunise myself more from market moves and downside risk. I'm selling time value, not predicting market moves.

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 4th, 2017, 10:52 pm

Lootman wrote:OK, I didn't mean my question as a criticism, but more that I struggle myself with how to compute returns for when I employ this strategy, given the collateral I have to hypothecate for margin. If it is merely a matter of custodying assets with the broker that you would in any event have to hold somewhere, there is an argument that the margin doesn't cost you anything, absent borrowing. But in reality I take a much more conservative view, not least because I would hate to take on capital gains taxes to meet a margin call.

In your situation I'd be very tempted to also buy a "doomsday" put at 1600 or so. It would be very cheap to buy that protection and it would bail you out before the 1533 level. That's the principle behind butterfly and spread strategies, for instance, to hedge the tail risk of a black swan downside mega-move in the markets.


One thing I forgot to mention is that I have been using spread bets for options for a couple of years. That saves on the CGT (and calculation of), and needs much less initial margin for naked puts, but it does make downside hedges a lot more expensive. So my preference is to go a bit more OTM than I did when I was trading spreads and forego the long puts. I do appreciate the doomsday risk here though. I could buy far OTM puts through a conventional broker, but it is highly likely to be ineffective if we get a major market dislocation. It would in principal cap the downside. but I would still end up being on margin call at IG, with a long position elsewhere that would take time to liquidate. I will consider this though if I stick with IG.

The primary benefit of using the VCTs and the Lloyds prefs is that they are not cash and so outside the £50k FSCS broker limit. Although I use VCTs for initial margin ("deposit"), I would not actually sell them on a margin call as I would have to repay the 30% tax rebate. I would instead find resources elsewhere. In extremis, it would be better to sell something from an ISA than one of the VCTs.

I should add that I only commit 10% to 20% to this strategy. I see the collection of premium as a different asset class rather than as a main method of building wealth. And I sell calls and call spreads as well to immunise myself more from market moves and downside risk. I'm selling time value, not predicting market moves.


I commit 20% of my assets (excluding property) to option trading and my gearing calculations refer to this 20%, so overall I am far less geared but I prefer not to think of it that way. I trade within the portfolio capital as if that is all there was. These days I consider option trading very much the way you do. Volatility/time value provide a useful source of return, quite distinct from other sources of return. I did use a lot more gearing in September 2015, following the mini crash. It was very profitable, but also very scary. I don't think I want to take that level of risk again. My current positions are at the top end of how far I am prepared to go now.

hiriskpaul
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Re: 25.9%

Postby hiriskpaul » January 20th, 2017, 11:56 am

You must be very pleased with progress Moorfield. Have you rolled to April yet? Or are you going to wait and see whether the VIX ticks higher first?

My June puts are well in profit. An excellent start to the year.


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