A beautiful theory struck down by annoying data

The million-dollar traderbot needs work:

ES,SLD,1,3364.75,11:51:57,20200218,GLOBEX,U354...,,
ES,BOT,1,3365.25,11:52:21,20200218,GLOBEX,U354...,,,
ES,SLD,1,3364.75,11:52:26,20200218,GLOBEX,U354...,,,
ES,BOT,1,3365.25,11:54:41,20200218,GLOBEX,U354...,,,
ES,SLD,1,3364.75,11:54:46,20200218,GLOBEX,U354...,,,
ES,BOT,1,3365.25,11:55:06,20200218,GLOBEX,U354...,,,
ES,SLD,1,3364.75,11:55:11,20200218,GLOBEX,U354...,,,
ES,BOT,1,3365.25,12:04:12,20200218,GLOBEX,U354...,,,
ES,SLD,1,3364.25,12:08:01,20200218,GLOBEX,U354...,,,
ES,BOT,1,3365.25,12:10:11,20200218,GLOBEX,U354...,,,
ES,SLD,1,3364.75,12:11:11,20200218,GLOBEX,U354...,,,

(just an excerpt)

I consider the opposite set of risks (gaps, blow-out moves) but not this one: grinding back and forth around the strike price.

I think there may still be a way to make this work but I need more data to test with. I'll report back when I have an answer on that.

In the meantime I put on two limited-risk trades:

/GC: short 1675 call, long 1680 call
         short 1555 put, long 1550 put

/ES: short 3380 call, short 3380 put
        long 3500 call, long 3095 put

Both of these should work; the /GC price has really spiked the past couple of days but still is 30 points below our short call.

And the /ES price is down to 3338.25, but that's still well within the space to turn this iron butterfly profitable as soon at the current volatility strike relaxes a bit.

Overall: down 9.9% for the week, about 7% on the traderbot problem and 2.9% on the temporary volatility spike. I'm expecting to be back close to breakeven by next Friday ...

Why this volatility all of a sudden? Maybe the centrist trauma over the election:

More next week!

A "new" trade: Dynamic Covered Strangle

First, this isn't new; I thought of a version of this a couple of years ago and it may well be standard practice by organizations who aren't publishing their trade ideas.

But it looks good enough to me that it reminded me of this guy:

This is Pele, the Brazilian soccer star, who came out of retirement in 1974 to play for the New York Cosmos for an amount of money that he described as "The Sun, The Moon and The Stars."

Now for the trade ... it requires these brokerages attributes:

• SPAN margining ... one could theoretically do it with equity options, but the margin requirements are so much greater it probably doesn't make sense in most cases
• trading of futures and futures options

This makes it challenging to work inside IRAs in many brokerages; some don't allow futures trading or futures options trading, inside IRAs. Make sure you know your brokerage's rules before getting excited about doing with your IRA.

Step 1: sell N contracts of any futures options strangle, 30-50 DTE. So far I've backtested this only with /CL (West Texas Intermediate), the only dataset I have, but I don't see a reason that it shouldn't work with any futures product that supports options.

Step 2: set a contingent order with a tight stop to buy N of the underlying futures only when reaching the short call strike. (If your brokerage doesn't support contingent orders you'll have to do this with alerts.)

Step 3: set a similar contingent order and stop to sell N contracts when reaching the short put strike.

Wait and watch ... 80% of the time (on a one-standard-deviation strangle, with strikes at the 16 delta), nothing will happen and you can just close the trade for a profit of 50% or 80% or even 100% of the credit received.

Another advantage: you are not worried about a huge move in either direction! I'd be fine doing any /CL trade with this setup with the war drums beating last week ...

Backtesting results!

Setup details:

• January 1 2016 to Dec 23 2019, /CL (West Texas Intermediate crude oil)
• Futures options prices, including 'delta' and underlying price
• End of day prices only
• Tests were run with just a 1-lot strangle (i.e. selling 1 call and 1 put)
• I used 30 to 50 days until expiration
• I set to take 85% of the credit we got on opening of the trade

I varied the delta of the options I sold:

.16 delta            + $28577               13 whipsaws

.30 delta             +$52997               15 whipsaws

.40 delta             +$70907               28 whipsaws

The "whipsaw" count is the number of times that the underlying price went through the strike price once and then came back once ... Clearly making sure that these whipsaws are handled optimally is key, and they will be a small drag on earnings nonetheless ... but selling the options closer to the money (.40 delta) pays enough extra to compensate you for this extra attention.

Also, you need to watch the extrinsic value left in your options to decide when to get out ... if you're getting whipsawed around a strike early on you need to hang in there as the option price will still be too high for you to close for a profit. Later on with the extrinsic value down to 50% or less of the opening credit, you can certainly get out and move on if getting whipsawed at that point.

Note that the option price will collapse to the amount it's in the money; for example, if you sell the 65 /CL call and /CL closes at 67 at the time your option expires, you are down $2000 on that option ... But: (1) you got credit when opening the position and (2) you bought the the /CL option contract at 65 that covers your option loss ... so you are just left with that opening credit!

Note also: there's no reason this couldn't work with shorter timeframes like those available in /ES and /GC ...

I'd suggest to start:

• Take 1/2 of your account's buying power and set up a variety of futures options trades as described above ... /CL, /GC, /NG are three you should definitely consider.
• Try the .30 delta to start and make sure you stay on top of the strike breaches going back and forth
• After you work with this for a couple of months, you can try the .40 delta ...

Have fun! More next week ...

Craziness continues; A.M. Triumvirate debuts; equities + futures = profit!

The market craziness continued this week, with equity prices whipsawing crazily all month so far:

S&P 500's wild August 2019

As I mentioned last month, I demoted the "fabulous NDX trade" and moved to use each of the three a.m. settled indices: SPX, NDX and RUT.

I am just trading small accounts right now (mea culpa) so can't do wider "wings" on the iron condors, and this week once again showed why that's a problem ...

The NDX trade was short the 7530 and long the 7540 call, and the a.m. settlement price was all the way up to 7564. That's 100% loss in the case: $737 per 1-lot ... if one had been doing 50-point-wide wings, that reduces the loss to about 65% ...

The other two trades worked ... and didn't. RUT was OK, being the least volatile of the three lately.
SPX closed at 2870, great for the account where I had the short strike at 2875 ... but I put one on later in the a.m. that had the short strike at 2865, long at 2870, so: 100% loss ($390 per one-lot) .... but less than 10% if doing 50-point-wide strikes.

So I think I'll mostly stop doing this trade in accounts that aren't big enough to widen the strikes ...

The two accounts I'm trading right now are both small enough that they can't handle futures trades, and that makes all the difference right now. While the equity positions I've been trading have held up better than I would have thought, they're just down slightly (about 8%) where futures positions would have taken up the slack.

I mentioned the 'short oil' trade last time. Natural gas is similar. But opposite these two is gold, which has been going up:

The thing is, selling calls against a long commodity position is very rich; volatility goes up (and prices go up) the higher you go. For example, the latest gold futures (/GCV9) price is 1517 ... and you can sell the 1525 call option expiring September 25 for $27.30 ... i.e. $2730 credit. This brings your breakeven price to the downside all the way to $1490 ... 

That together with your short oil and gas positions can keep your account humming while equities are going nowhere.

More next week!