2017 – The year of experimentation

This year has been a long year of experimenting and pushing the boundaries of complex option trading. I have come to realize that a good strategy has a triangle of requirements that need to be fulfilled to be a valid scalable trade. Namely, it has to satisfy 1) margin and margin expansion requirements 2) Slippage, fills and real life initiations of the trade 3)Good backtest results.

Pre 2017, backtests were generally good enough because everything was standard and because of this, generally, if it backtested well it would do well enough live. We used standard width PCS and PDS and combos therein, and generally putting those on were quite easy and can be done without much directional risks. IE putting on PCS then instantly putting on the PDS or even filling them as a condor or butterfly. Not a big deal.

This year, I got excited about a few strategies based solely on backtests,–> really good backtests. Almost ‘end game’ nothing else needed type of results. This specific trade required a high vol entry and I patiently waited for this entry in what ended up being the lowest volatility period on record, it didn’t come. Time was wasted from Sept-Nov. Then we had some red days and I licked my chops ready to get trades on, unfortunately, it was met with disappointment. Now, I did put on a few sample tests before but it was in relative low vol and the trade was OK to initiate in low vol as the market didn’t move much and I’ll get into why that ends up being important. Something I didn’t realize. The non-standard widths in the credit spreads were very very difficult to fill. It wasn’t low hanging fruit the market makers could understand and hedge. It was too exotic. Coupled with the PCS you had to initiate long puts that had some combos @ ATM and some OTM (the hedge portion). However, in a fast moving market these things move quickly. So there in lied the rub. IF you got filled on the long puts, there was no guarantee you could get filled on the PCS. Leaving you incredibly exposed. If you got filled on the PCS, it meant that the market was moving against your longs (the makers apparently called them STUPIDS) and you will pay a really bad price for the longs as they become high in demand. Filling this trade in size was a nightmare.

So some people had ideas about using ratios. I gave it a shot the next red day. Again, I had mega issues getting fills on this. It just was untenable. But I did manage to get on about 150 units of this trade through a lot of pain.

The backtests were great, it was the trade of all trades..but filling this live was a different story. It’s all easy when you just enter the trade and press commit in a backtest, not so easy in real life.

The next issue was margin, at first I didn’t have much margin issue at IB but as time went on, all of these seem to margin expand to abut 13-14k a unit! This made the trade almost untenable from a margin perspective. Gross use of capital. So not only did I have a nightmare fill situation but I had a nightmare margin situation. IB doesn’t take into account the full benefits of the longs below a certain delta (in this case our spread was so large that the margin hit from the short was not getting covered at all by the longs). This isn’t such an issue at Think or Swim but at IB it is.

So a dream trade from backtests became somewhat a nightmare trade from a margin and live slippage/initiation perspective. Lessons learned and 3 months of opportunity potentially wasted.

These things you just can’t know. And again, this year was a year of exploring every nuance of complex option trading and it ended my year at best break-even. But the year was the most successful year in growth as a trader and I feel there is not that many more stones to turn. We’re (my PMTT group) are approaching the apex of what’s possible with respect to the triangle of requirements in complex trades. Guess what? It’s gone pretty much full circle for me. I am actively trading STTs and variants of BSh factories and the last 1 month of doing this has produced great result. Now on to formalizing this as a base trade and putting capital to work with what is proven to work and not into nuanced complexities.

Here is the summary of how my year from memory:

1. Jan/Feb I still had on legacy Rhino structures that got smooshed from the incredible trump bull run. Remember these? They hate 4%+ up moves in a cycle. Love everything else. During this time I started testing the new STT/BSH stuff. I started off with BSH and waited as per the rules to finance with PCS on a down day. I think we had a 14 day bull run there with no opportunity to finance, this is extremely abnormal. Bad timing. So the BSHs put on lost money because they couldn’t be financed. Not a great start. The STTs obviously as they always do, did great.

2. March/April I start testing a combo trade I came up with called the PC2 and PC3. The PMTT group seems to like it as well. The tests were insane. Really good. But I miscalculated margin requirements and put the trade on the shelf. I documented this in the blog here even. Exciting stuff. Shelved due to miscalculating margin requirements (I entered each segment into IB and added the margin up). During this time, we used a method that tested very well but failed to deliver during this specific period as a way to finance the BSH. The BSH/STT combo broke even. During this time there was a cross expiration skew issue that kept the financing method from paying off the BSH costs. These are all legacy methods of financing that aren’t really used. Learning process. Backtests of the RC financing method did great. Just we had a bad period here…timing was poor.

3. May/June/July Extremely low volatility, RCs still not working, unable to really have opportunity to put on some good STT trades due to low vol. Start looking at PC2 again and do extreme testing and was aiming to present in September at the PMTT group. Basically broke even through this period. Poor pay off of the BSH. The PC2 had we started in April would have been hitting profit target every single month this year! The financing method is built into the PC2. Unfortunately, I calculated margin wrong and didn’t initiate, instead I used RCs which just did not pay off the cost of the BSH and we were slightly profitable but more or less break even during this period. Maybe up 7%?

4. Aug I entered some T5 (just about 40k worth). Along with most of the group. This was a juicer trade, a trade meant to pick up our returns. It is the most POSEV trade but its got variance. Variance I can accept though. We entered and experienced one of the worst skew issues you could imagine due to the NK missile issues. Vol sky rocketed in January options but not so much in earlier expirations. This caused massive draw down. Most of which was eventually recovered through October. But this was the highlight of August. Also during this time, I realized error of margin re PC2 and started heavy heavy testing and was ready to deploy a mastermind session in September.

5. Sep The HS3 and Fulcrum ideas come out. They tested so well. Dream like almost. Read the beginning of my blog post for more info. It needed high vol entries. Vol was extremely low and historical. We wait patiently for opportunities.

6. Oct Market runs up, I took off some Dec PCS in what was record low vol, with intent to get off PDS next day or so on any slow down. Again, the market gapped up like 1-2% and I destroyed my Dec STT profitability and actually went negative.

7. Nov I decide to enter moderate size of Rhinos thinking we’re apex’ing and unlikely to experience sustained and large up moves. That was wrong, Rhinos were exited at fairly big loss.

8. Dec I finally put live all the good core trades, they do great and recover a lot of the losses from before. STT, PC2 and BSH factory is producing great returns. Onward into 2018 this will be the core.

The interesting thing about all this is that the complexity of all these strategies is solely based on how to hedge them from risk. it’s not about seeking out max EV or anything like that. I say max EV because seeking out max hedge is equivalent to maximizing profit at least from a risk perspective. Max EV trades are trades that have the highest expectancy and this can be without regard to variance. The highest EV trade I know of is called the T5 which is taught in the PMTT Mastermind group.

Anyway. That’s a sum of the year. You can see it was a lot of experimenting and backtesting and trial. In the summer, I was backtesting an average of 4 hrs a day on 20 or so new variants of strategies. Though I may still be backtesting going forward, the core bulk of cash will be put to work in combos of STT and self financed BSh. The STT always produces, it did though 2017, it was the BSH not getting financed that caused the meh results. THat’s solved. Excited to see how this thing does through the year.

More to come.

Aug 8 Trade and Travel Update

I am on my very last 2 day leg with my family in Milan. On Aug 10, I’ll drive up to Munich to meet some friends and do a beer tour around Germany and probably Pilsen (Czech) and maybe Krakow, Poland. On the 19th, I’ll be in Barcelona to play a big poker tournament and then I’ll be heading home to resume normal life. I think this will be the last EU tour for a little while. We’re building a house in Canada next year and I think we’ll use that as our summer base and slow down the EU tours as I think I’ve seen most of it now. It’s not as exciting as it first was and it’s been more of a drain than a rejuvenation. As my account grows, I need to fully concentrate on trading and take only brief breaks on weekends etc.

As for the trades, well, the market is in a historic area right now. The DOW has made 9 all time highs in a row and the VIX (and thus option premium) is at all time lows. It’s a bad time (the worst) to be an option premium seller. It’s the worst time for strategies I used and the plan I had 🙂

I saw this graph of VIX futures and it really sings a song.

Anyways, I know a lot of people are being challenged right now. It’s been a rough 20 months for trading these types of strategies. Slow. I started trading the Rhino (which really likes any market other than a 5% up market in a 45 day period) and as soon as I initiated that trade at full volume, the market had like 15 months where 9 of them (RUT) went up 5% or more 🙂 I have terrible timing. I think the RUT moved up 50%+ in the last 15-20 months. The SPX went from 1828 to 2475 in what 16 months? Incredible move. So I had low’ish returns for that trade over the course of 2016 (I was positive just meh, I think 20%-25% overall). Then 2017 came along, and I had started the STT full on but still had Rhinos on from previous. The rhinos got decimated in the environment and is still affecting my overall return for 2017. This environment for the STT can still be done well I just wasn’t able to kill it this summer. As to do well, you really had to be perfect in timing for paying off the BSHs and for initiating the STT. It took a certain plan and without knowing how the market would have gone, it would be hard to do well in that environment sans Combo trades (the combos would have crushed). The vol has been so so so low that I’ve been dragging heels on initiating new STTs. I mean, you’re a net seller of vol and vol is at historic lows, you haven’t gotten a worse price on this ever. So I wasn’t excited about initiating new trades. I know it can be done if you arrange a + UEL and if you are very prudent at paying off those BSHs but that’s not easy. On big up moves, I’d initiate BSH and RC (RC pays off about half of the BSH) and I’d wait for some vol to enter in STTs. That vol never came (ever!, it’s so damn crazy how low the vol is..we haven’t had 0.3% daily moves in record times) and I was stuck putting on STTs in low vol(Crappy prices) and when my BSH/RC combo was down. Still it profited but just nothing much at all. Typically, the plan was this: Put on RC/BSH as the market has a big up day, wait for down day and enter an STT. In ANY normal market, or any market that’s not this market, you’d have that opportunity. Down days are fairly common…just not this year. That all said, poor (slightly profitable) results because of the management/plan I chose for the year. That’s got me a bit bummed out but at the same time I haven’t been more excited for what is coming in my trading career.

The combos that we are working in the group and the testing that we’ve done suggest very very consistent results. I’m showing a result of 8.75% on margin in 45 DIT. Thats 5.833% per month on margin used. We use only about 65% of balance, so total balance return would be 3.8%. Not that exciting when looked at as a single component. However, If we combine this with a T5 (TTT555) trade the margin reduces significantly. My goal is to get it to 5% a month on whole account for the STT combo alone. The T5 trade has gone from 1200 to 20k in 2.5 years in backtesting. That thing returns 100% 70% of the time within 10 days and loses equivalent 30% of time. You obviously can’t do too much of these as you’d wipe yourself out psychologically (and 30% of your balance) if you had 3 losing months in a row but the boost and the margin reduction makes it very attractive. My goal is to have the combo, the BSH factory and the T5 trade working together to provide a total account return of 100%. That’s exciting but it’ll be a lot of work, a lot of organisation and diligence in process. Further to that, we’ve got a T5 timer that helps immensely with entries and exits. Unfortunately, I went about 40 units in for the T5 before the timer exists and I entered at a shitty time, it’s down at them moment but the risk profile looks great. Like I said, I have the worst timing for everything and I have to create a life and trading plan that negates my awful cursed timing 🙂

I was asked to do a presentation on the PC2 trade but I am on my last two days with the family and I just can’t sacrifice the time w/ them without having a very angry wife so I am hoping I can just do it early September instead.