Watch HowardCohodas Trade Index Options Credit Spreads

[MrGecko]

Howard, incase you missed it, can I ask you if you have come across the following "option brainteaser", and what your answer is?

There is a stock that is currently trading at $100. You have a call option on that stock with a strike price of $100 that expires and the end of trading tomorrow. The stock will either go to $101 (with a 60% probability) or to $99 (with a 40% probability).

What is the value of the call option?

 

[HowardCohodas]

Howard, incase you missed it, can I ask you if you have come across the following "option brainteaser", and what your answer is?

I have not.

 

[MrGecko]

I have not.

What would you say that call option is worth?

 

[HowardCohodas]

What would you say that call option is worth?

I love puzzles. If I traded in that domain, I would put a higher priority on working on it just for the pleasure of gaining a deeper understanding of options. As my methods never start anywhere close to ATM and I bail before reaching ATM, I'm uncertain that the knowledge I would gain would be worth pushing other activities to a lower priority.

At the moment, I've been stretched sufficiently that I have fallen behind on posting my trading summary and trading plan in this thread.

 

[MrGecko]

I love puzzles. If I traded in that domain, I would put a higher priority on working on it just for the pleasure of gaining a deeper understanding of options. As my methods never start anywhere close to ATM and I bail before reaching ATM, I'm uncertain that the knowledge I would gain would be worth pushing other activities to a lower priority.

At the moment, I've been stretched sufficiently that I have fallen behind on posting my trading summary and trading plan in this thread.

You trade options, don't you? It's a worthwhile exercise, and shouldn't take you more than 10 mins with pencil and paper.

 

[HowardCohodas]

23 DEC 2010 Trading Plan

23 DEC 2010 Trading Plan

Opportunity
    Incomplete Iron Condors
        26

    Roll Candidates
        None

    New Spreads
        Weeklies become available

Jeopardy
    Probability of Touching
        25.C - Expires today; likely needs repurchase

    Days Until Expiration
        Weeklies

    At Risk P/L
        None

 

[HowardCohodas]

23 DEC 2010 Trading Summary

23 DEC 2010 Trading Summary

Iron Condor 25, SPX Weekly
    67 CALL 5.3%  Expired
    62 PUT  5.3%  Expired
    As an IC 11.1%

 

[HowardCohodas]

24 DEC 2010 Trading Plan

24 DEC 2010 Trading Plan

Opportunity
    Incomplete Iron Condors
        26

    Roll Candidates
        56

    New Spreads
        NDX Weeklies

Jeopardy
    Probability of Touching

    Days Until Expiration
        None

    At Risk P/L
        None

 

[HowardCohodas]

25 DEC 2010 Trading Plan

I've been waiting all weekend for someone to call me on the fact that the markets were not open on Friday.

Same plan for Monday.

 

[HowardCohodas]

27 DEC 2010 Trading Summary

27 DEC 2010 Trading Summary

No activity today.

But I was tempted. For some reason, I had it in my mind that I wanted my balance to reach a certain figure by year's end and a trade on the NDX weekly would have done it for me. But, at different times of the day, I would have had to violate my Probability of Touching rule, or my Minimum Credit rule or both.

Having to report this deviation here and the possibility of having it go bad and mess with my results so far deterred me from making this trade. I'm good with that.

 

[HowardCohodas]

28 DEC 2010 Trading Plan

28 DEC 2010 Trading Plan

Opportunity
    Incomplete Iron Condors
        26

    Roll Candidates
        56
        36

    New Spreads
        NDX Weeklies

Jeopardy
    Probability of Touching
        None

    Days Until Expiration
        None

    At Risk P/L
        None

Starting today the dashboard image I use for my planning reference will remain as it was for the day the plan was made. This will make reviews of earlier planning posts meaningful when referencing the dashboard.

If I get sufficiently ambitious, I might implement a "way-back machine" in the T2W version of my dashboard and eliminate the chore of creating an image for each planning day.

 

[Hotch]

I have a question Howard.
Your income is steady at 7-11%, and given the nature of your trading, this is to be expected. You have however had a major loss (>30%).

I am intrigued as to how the month ended with similar results to the others with such a loss. Did you up risk, trade more, or something else?

 

[robster970]

I'm interested in the 30% loss too Howard. I now understand that Iron Condor strategies tend to fail in the trade management of the big losers rather than the steady stream of smaller wins that have a high probability of success. I think your strat lives or dies based upon your trade/risk management of the losers.

How do you manage trades that are going offside? How do you deal with trading at the market when your strike price has been hit if nobody will take the other side of your trade especially if you're not in an IC? Do you always monitor activity (i.e. were you active when the flash crash on SP occurred at 7.15pm UK time on 6th May)?

I think it's these kind of situations that will cause the damage.

Interested to hear how you actively deal with these scenarios.

 

[MrGecko]

I think your strat lives or dies based upon your trade/risk management of the losers.

I don't think the results of this strategy would change because of the way he manages is "losers"; as his results are capped due to the payout profile of IC's, it shouldn't make a difference whether he closes a bad'un or lets it expire. Not to mention a damn sight easier in the time and effort stakes.

All Howard is doing here is selling volatility. He will have a positive reward/risk ratio when he sells volatility rich, and a negative reward/risk ratio when he sells it cheap. Unless options were systematically overpriced (as per MR), in the end his results will sum to nil. Until he finds a way to determine what rich vs. fair vs. cheap volatility looks like, he's paying commissions and spreads to trade a strategy with no edge.

P.S. the answer to the brainteaser is $0.50

 

[robster970]

Is that still true if he hasn't formed an IC Gecko? Do all Howard's trades result in an IC?

 

[MrGecko]

Is that still true if he hasn't formed an IC Gecko? Do all Howard's trades result in an IC?

Well if he's only half way in to forming an IC, he's still got a vertical spread on, which also have a limited maximum loss. And even if he was doing it with outrights, I can't see why it chould change anything.

As I understand it, Howard defines a "loser" as a trade that reaches 20% of maximum loss (and he includes another 10% to account for the spread etc).

So:
Entry conditions = probability of touching = f(distance to strike, volatility)
Exit Criteria = Marking to market

Sometimes Howard will be taking a 30% hit instead of a 100% hit at expiry, which is all good and well, but other times he will close out a winning trade (at expiry) prematurely for a 30% loss instead of an X% gain.

By my reckoning these two will cancel each other out.

 

[robster970]

Got it now. The edge is down to trade selection to sell rich volatility

 

[MrGecko]

I'll try and explain how I see Howard's strategy in another way; Let's suppose Howard isn't trading IC's, he's trading EUR/USD.

Howards strategy is to Go Short, and he sets a fixed target and a fixed stop (notwithstanding execution / liquidity risk) OCO. When one trade is stopped or closed, he might wait a few days, but he will always enter a new short position. The size of his stop vs. the size of his target doesn't matter, in the long run. What matters is that Howard has chosen always to go short Eur/Usd - which means he must think that EUR/USD is overpriced all of the time.

In this case, Howard is doing the same strategy, except not with EUR/USD but with the price of options, which in turn are a function of time, price, strike, volatility and interest rates. This is what Howard doesn't get - he's is always short this function, which only makes sense if markets always overprice options. Which, alas, they don't.

 

[MrGecko]

Got it now. The edge is down to trade selection to sell rich volatility

We're right up to the limit of my understanding now, but I reckon there are a few ways that this strategy could be used to make money:

i - Directionally, by putting the IC on with one leg at or near the money and one leg further out (under the expectation that spot will move towards the middle of the two legs).... (having just read the Skew one below, this sounds like a relative value Delta trade between the two vertical spreads)

ii - Volatility, by putting on an IC that has the middle of the strikes right ATM (under the expectation that volatility is overpriced)

iii - Skew (?), as a relative value of volatility between the two vertical spreads (under the expectation that one volatility will move more than the other)*

* this one I don't really know anything about, but MR mentioned it earlier on in the thread.

 

[DionysusToast]

P.S. the answer to the brainteaser is $0.50

OK - I'm interested. Can you explain? I know nothing of these things...