Hedged options selling system sys14 (and the combo-system sys15)
AN OPTIONS SELLING SYSTEM THAT THEORETICALLY ALWAYS WINS THE FULL CREDIT
Author : botpro at [url]www.trade2win.com[/url] (previously botpro at [url]www.elitetrader.com[/url])
History:
2016-04-19-Tu v1.4a Added legal stuff
2016-04-18-Mo v1.4 It works also with American style options
2016-04-17-Su v1.3 Added optional Extension #1 (s. end of the text)
2016-04-17-Su v1.2 Fixed PnL to 201% p.a.
2016-04-17-Su v1.1 Fixed PnL to 218% p.a.
2016-04-17-Su v1.0 Initial version: PnL=187% p.a.
First things first: the legal stuff:
To be on the safe side, I as the author of these free systems make these statements:
1) The systems are the result of academic research.
2) The systems have not been tested yet in the real market.
3) Use the systems at your own risk. Test it first throughly in simulations and/or backtestings/forwardtestings.
Intro:
- This is an options selling system with a special hedging mechanism (called "entry-level hedging").
- A classic static or dynamic zero-delta-hedging is not used with these systems.
- One needs a near-24/7 market with ideally no overnight gaps in the underlying stock price.
Such a market can be emulated by using multiple markets around the globe where the stock trades.
- The hedging mechanism requires that the stock position gets monitored continuously.
- If applied correctly in the market, then it is a zero-risk system.
- It can be used for all options regardless of the option style (American or European).
- PnL is dependent on the ATM premium: the higher the ATM premium the higher the PnL.
- The basic system uses a short Call (can also be a short Put, but then hedging rules have to be reversed).
- The combo-system (sys15) uses a short Call and a short Put together (but uses just one stock position for both!).
- The example uses a 40% volatile stock; then the PnL is about 201% p.a. for sys14 and 658% p.a. for sys15.
- It is the special hedging mechanism that makes it all possible.
Beware:
- The example below uses for simplicity just the minimum 1 contract,
but in practice one would need a PDT-account with at least $25k.
- When testing this system use a cheap stock commission rate like that of the broker IB ($0.005 per share, minimum $1).
Rules of the options selling system sys14 with "entry-level hedging":
1) The system consist of 2 parts:
1.1) sell a call option, and
1.2) go long the stock
2) The option position is normally kept till expiration (but a possible early assignment is OK with this system)
3) Entry-level hedging for sys14:
3.1) if stockprice drops below the initial entry price then close the stock position immediately
3.2) if stockprice crosses over from below the initial entry price then re-open the stock position immediately
In practice one would use two bands (for example +10 cents and -10 cents) around the entry price to avoid too many hedging trades.
(FYI: the hedging mechanism for sys15 is a little bit complicated and tricky; in the next version it will be documented)
Example: assuming InitialStockPrice=100, HistoricalStockVolatility=40%, using monthly options (ie. Expiration=21 business days)
Selling 1 Call:
Spot=100.00 Strike=100.00 ExpDays=21 HoldDays=21 EarningsYield=0.00% DividendYield=0.00% StockVolatility=40.00% --> Call=4.60 Put=4.60
Going long 100 shares of the stock:
Spot=$100.00 --> CapitalNeeded=$10,000
At expiration date:
Regardless what the CurrentStockPrice or the CurrentVolatility is: we will keep the credit fully.
The stock position serves us only to hedge our option position; it is not intended for making additional profits.
Profit:
We use the usual 2:1 overnight margin of the broker. So we have a leverage factor of 2.
Meaning: of the $10,000 only half of it minus credit / 2 is our own investment (this is the basis for the PnL calcs).
CreditReceived = $4.60 * 100 = $460
StockPos = $100.00 * 100 = $10,000
UserPart = $10,000 / 2 - $460 / 2 = $4770 (this is the basis for the PnL calcs)
MonthlyPnL = $460 / $4770 * 100 = 9.64%
AnnualPnL = ((1 + 9.64/100)^12 - 1) * 100 = 201.73%
From these numbers the commissions paid and the interest for the margin has to be subtracted.
Remarks:
- It's up to you to apply this system in the market(s).
- To get the hedging correct, one would need to monitor and if necessary trade the stock nearly 24/7 by
using multiple exchanges around the globe. Ie. by this, one has to eliminate any overnight gaps in the stock price.
- If applied correctly then the given guarantee holds, ie. in this example 201% profit per year.
- Using more volatile stocks and/or a shorter timeframe than the above used 1 month will give even more profit.
- Regarding margin: you have to do the math to get the 2:1 margin. Ie. in this case you would initially
keep only $5000-$460/2=$4770 plus commission in your account. The broker grants you 2:1 overnight margin (or 4:1 intraday margin).
- The system is freely scalable to any investment amount. But the stock position should not be too big
because it must be easily closable and re-openable; I would say the stock position should not be more than $50k.
- For big money one would use multiples of such constructs, but then one should of course use different stocks.
The following extension(s) are optional:
--------------------------------------
Extension #1: Profit booster: How to make more than 8000% per year with this system:
The smaller your own part of the invested total money is, the more the profit% will make up:
Example:
- let's say your own money is $1000
- borrow the rest ($3770) cheaply from friends or take a 1 month loan
- let's assume you have to pay 1% interest for the 1 month loan, ie. $37.70
Now, your basis for the PnL calcs is your own $1000 plus the interest for the loan = $1037.70:
MonthlyPnL = 460 / 1037.70 * 100 = 44.3288%
AnnualPnL = ((1 + 44.3288/100)^12 - 1) * 100 = 8070.26%
Since compounding gets used, each month the above absolute numbers would of course change,
but the relations (ie. the percentages) would stay the same.
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