SPY Ratio Diagonal

[cwelsh 1,551]

In the same vein of the GLD diagonal I opened last week, I just opened the following :

 

Buy to open  SPY Dec 2013 157 Put @ 8.53

Sell to open  SPY June4 160 Put @ 2.69 (0.54 extrinsic at the time)

 

 

So if you buy 100 contracts of the December puts, sell only 75 -- this is a partial delta hedge

 

There are 26 weeks (including this one) before the December expiration.  With only selling off 75% each week, that really means the "cost" to pay off is 11.37.  With 26 weeks left, we need $0.43 extrinsic each week to break even. 

 

I'm begin aggressive and aiming for a 5% weekly profit, which equals to $0.4265 a week for 26 weeks, or $11.09.  Add that to the current $8,53, for a total of 19.62.  That's needing .75/week, which should be doable.

 

We can sell less/extra contracts per week to account for delta if we need too.

 

I sold a lower extrinsic this week because I'm already three days in (F,Sat,Sun, end of day Mon)

 

If you think that "per week" value is too high, you can lower your profit target to 2.5%, which lowers your cost to $14.07, or $0.54 per week.

Edited June 24, 2013 by cwelsh

[cwelsh 1,551]

And I forgot the Ratio part , if you're worried about the deltas, just sell less puts (such as .80), which slightly increases the cost per week, but takes care of delta problems in the event SPY continues down.

[Saud 5]

Chris I don't understand what you mean by the June 4 Put

[tjlocke99 18]

Chris I don't understand what you mean by the June 4 Put

Its the last weekly put option on GLD.  It will say June4 (Think or swim) or 28Jun in some systems for options expiring the last week in June.

[Saud 5]

Thanks, I saw only the Jun 28 in IB. I figured out how to set up a ratio combo in there so I'm in

[cwelsh 1,551]

Due to some margin issues on the account I had  this in, I had to close out the trade yesterday (and did so for a handsome profit).

 

I just re-opened it today at the following (and the numbers of contracts are just the ratios I'm using):

 

Buy to open 5 Jan 161 SPY Put@ 8.95

Sell to open 4 July 12 162 SPY PUt @ 2.19

 

To hit a 5% per week profit, we need 0.87/week.  If SPY goes down, particularly if it goes down significantly, I'll stop the Ratio trade and just go to a straight diagonal -- right now this provides some delta hedging.

 

If you're still in the original trade I would:

 

1) Buy back the June 28 160 Put at apprx 0.19

2) Sell to open the July 12, 2013 162 Put at apprx 2.02 (with $1.74 in extrinsic value, needing $1.40 over two weeks without the ratio, or $1.75 on the 5/4 ratio). 

[Micahjw 3]

I don't think I'm fully understanding - can you explain further this: "With only selling off 75% each week, that really means the "cost" to pay off is 11.37.  With 26 weeks left, we need $0.43 extrinsic each week to break even."

 

I understand the basic of buying the far out puts and then selling nearer puts against that position...

[tjlocke99 18]

Due to some margin issues on the account I had  this in, I had to close out the trade yesterday (and did so for a handsome profit).

 

I just re-opened it today at the following (and the numbers of contracts are just the ratios I'm using):

 

Buy to open 5 Jan 161 SPY Put@ 8.95

Sell to open 4 July 12 162 SPY PUt @ 2.19

 

To hit a 5% per week profit, we need 0.87/week.  If SPY goes down, particularly if it goes down significantly, I'll stop the Ratio trade and just go to a straight diagonal -- right now this provides some delta hedging.

 

If you're still in the original trade I would:

 

1) Buy back the June 28 160 Put at apprx 0.19

2) Sell to open the July 12, 2013 162 Put at apprx 2.02 (with $1.74 in extrinsic value, needing $1.40 over two weeks without the ratio, or $1.75 on the 5/4 ratio). 

why did it end up being a "handsome profit"?

[chenthilan 0]

how do you enter a ratio trade? I use TOS, it does not allow to do a ratio on a single order. Do you leg in your positions?

[Maxtodorov 19]

I am in the new trade....

 

 

I assume you meant 162... (or I got lucky on the price)

Edited June 27, 2013 by Maxtodorov

[Stephen 4]

I am in the new trade....

 

diagonal6-27.jpg

 

I assume you meant 162... (or I got lucky on the price)

Hey Maxtodorov how does that work out with your trade of 5 BOT and 4 SLD when I thought this trade is looking for a 75% ratio sold.  Thanks

[Maxtodorov 19]

Hey Maxtodorov how does that work out with your trade of 5 BOT and 4 SLD when I thought this trade is looking for a 75% ratio sold.  Thanks

 

75% is NOT a hard requirement.  if you want to take on 5 PUTs Long, you only could sell 3,4,5. Neither is 75%. So, I picked 4.... 

 

 

Chris did the same in his second trade.... 

Edited June 27, 2013 by Maxtodorov

[tjlocke99 18]

Due to some margin issues on the account I had  this in, I had to close out the trade yesterday (and did so for a handsome profit).

 

I just re-opened it today at the following (and the numbers of contracts are just the ratios I'm using):

 

Buy to open 5 Jan 161 SPY Put@ 8.95

Sell to open 4 July 12 162 SPY PUt @ 2.19

 

To hit a 5% per week profit, we need 0.87/week.  If SPY goes down, particularly if it goes down significantly, I'll stop the Ratio trade and just go to a straight diagonal -- right now this provides some delta hedging.

 

If you're still in the original trade I would:

 

1) Buy back the June 28 160 Put at apprx 0.19

2) Sell to open the July 12, 2013 162 Put at apprx 2.02 (with $1.74 in extrinsic value, needing $1.40 over two weeks without the ratio, or $1.75 on the 5/4 ratio). 

 

Are you selling the 4th week July weekly or the July that expires next week (5 July)?

[Maxtodorov 19]

Are you selling the 4th week July weekly or the July that expires next week (5 July)?

In this context it mean 4 PUTs not 4 July. 

 

Its July 12th PUT, which is 2 weeks out.

[Marau 4]

Are you guys sure that Chris calculations of the weekly value we need to capture are right? We bought 2 long puts for each short, so we need the double, isn`t it?

[cwelsh 1,551]

Due to some margin issues on the account I had  this in, I had to close out the trade yesterday (and did so for a handsome profit).

 

I just re-opened it today at the following (and the numbers of contracts are just the ratios I'm using):

 

Buy to open 5 Jan 161 SPY Put@ 8.95

Sell to open 4 July 12 162 SPY PUt @ 2.19

 

To hit a 5% per week profit, we need 0.87/week.  If SPY goes down, particularly if it goes down significantly, I'll stop the Ratio trade and just go to a straight diagonal -- right now this provides some delta hedging.

 

If you're still in the original trade I would:

 

1) Buy back the June 28 160 Put at apprx 0.19

2) Sell to open the July 12, 2013 162 Put at apprx 2.02 (with $1.74 in extrinsic value, needing $1.40 over two weeks without the ratio, or $1.75 on the 5/4 ratio). 

 

Here's the calculation breakdown:

 

Between now and January there are 29 weeks, AFTER this week.

 

5 Puts @ 8.95 = $4,475

5% per week for 29 weeks = $6,488.75

Sold 4 this week @ 2.19 = 876.00

Total: $10,87.75

 

how much per week?

 

$10,087.75 /  4 contracts / 100/ 29 weeks = 0.87/week

[Saud 5]

Is the original trade with the Dec 157 put still ok? That's a five point spread versus one point in the new one...

 

This is my first such trade and I'm just going to follow it through for the duration. I understand the basic concepts but I think that things will become more clear by actually executing the trades and seeing it in action. I did find the P/L change in the position (in IB) after the roll today a bit hard to make sense of. I get that the credit I received for the new short puts doesn't show now in the portfolio P/L and it just shows a big unbalanced loss for the Dec put, but my cost basis for the Dec put was a little over 8.00, now it shows a last price for that of 6.50. How is this possible?

[tjlocke99 18]

Here's the calculation breakdown:

 

Between now and January there are 29 weeks, AFTER this week.

 

5 Puts @ 8.95 = $4,475

5% per week for 29 weeks = $6,488.75

Sold 4 this week @ 2.19 = 876.00

Total: $10,87.75

 

how much per week?

 

$10,087.75 /  4 contracts / 100/ 29 weeks = 0.87/week

 

Wy are you subtracting out the "Sold 4 this week @ . . ."?  You only realize that $2.19 on each short if SPY goes up to the short strike of 162 and you hold to expiration?  You need .87 / week in gains, but any week where the short gains exceed the extrinsic of the ITM short, you'll lose money and need to collect more the following week.

 

Right?

 

Thanks.

[cwelsh 1,551]

Wy are you subtracting out the "Sold 4 this week @ . . ."?  You only realize that $2.19 on each short if SPY goes up to the short strike of 162 and you hold to expiration?  You need .87 / week in gains, but any week where the short gains exceed the extrinsic of the ITM short, you'll lose money and need to collect more the following week.

 

Right?

 

Thanks.

 

Because that's the calculation as of today.  If you want to estimate what you'll buy that particular short position back for next week, and base it off that you can, but as of entering the trade, that's what was accurate.  Let's say next week nothing has changed , and I collect about .90 in value (so buy back the 2.19 for $1.29.  If NOTHING changes, I'd then roll to the same strike for another $2.19.  At that point we add back into the cost $516.00 ($1.29 x 4 x 100) and  subtract out the $876.00 from selling the next week at $2.19 again.  One less week, leaves us still needing right at 0.87.

 

Well what if SPY drops and we lose money on the shorts?  Well then the cost needed per week goes up.  Inverse is true if the price goes up. 

 

Because of that variability and not being able to predict WHAT price I'll be buying the short back for next week, I just keep a current account. 

 

If you prefer to build in some extra safety and NOT include the first round of credit, I have no critique of that at all -- it just builds in more safety for you.

[tjlocke99 18]

I am in the new trade....

 

diagonal6-27.jpg

 

I assume you meant 162... (or I got lucky on the price)

Max,

 

This looks like IB.  When you build a ratio spread the bid/ask spread is huge.  If you don't me asking, how did you structure and execute this in IB?

 

Thanks!

[Maxtodorov 19]

Max,

 

This looks like IB.  When you build a ratio spread the bid/ask spread is huge.  If you don't me asking, how did you structure and execute this in IB?

 

Thanks!

 

 

On many positions that are low volume I may have to leg in. In this case, BID/ASK is bad on the far out option Jan 14 LONG PUT. So I put in an order slightly above the bid, and essentially become the BID. I continue to sit and wait for execution or change my order, to continuously remain the highest BID. IB does charge cancellation/order change fees, but they are minimal when you compare BID and ASK Spread. At some point the order executes. At that point, I immediately go and put in an order for the leg that is high volume, and I put limit at MID or even above the MID. [but remember high volume items have small BID/ASK spread].

 

Bottom line, get the hard to fill LEG first, follow with easy to fill leg. This is the strategy you could/should also employ on RUT trades. Those almost always have to be filled that way to get best possible fill. 

[geneg 1]

This looks like a similar strategy to the Anchor trades, except with less downside hedging, and aimed at producing more income. Is this correct? 

I'm also wondering about the feasibility of a 5% weekly profit target over time, considering that the longer term return on just selling SPY puts (albeit monthly) alone is reported to be only a few percentage points above the return on owning SPY. How do you figure such great potential returns?

is there any backtesting on this strategy?

[geneg 1]

Just to clarify my question, it looks like the proposed trade is similar to one side of the Anchor trades with with an attempt to increase income. I don't understand why you would expect a 5% weekly return on hedged SPY put selling when selling naked ATM SPY puts (PUT) alone  brings less than 4% excess annual return over holding SPY? Please explain.

[K. Miller 3]

Risk/Margin requirements?

[cwelsh 1,551]

As opposed to the GLD strategy, I am NOT rolling this one right now, as I cannot get the extrinsic value I need by rolling up.

[cwelsh 1,551]

This looks like a similar strategy to the Anchor trades, except with less downside hedging, and aimed at producing more income. Is this correct? 

I'm also wondering about the feasibility of a 5% weekly profit target over time, considering that the longer term return on just selling SPY puts (albeit monthly) alone is reported to be only a few percentage points above the return on owning SPY. How do you figure such great potential returns?

is there any backtesting on this strategy?

 

The profit returns are a goal, they are not what are rationally expected.  Back testing indicates that, if handled properly, we can expect just over a 2% return. 

 

It is similar to the anchor strategy.  As far as downside protection -- there's the same absolute amount, but you'll see the weekly delta swings more.

 

Margin requirements vary by broker, and by type of margin you are on (portfolio vs. Reg T).  On a PM account, your margin requirement is whatever the lowest your broker sets, as technically it is fully hedged.

 

Here's the basics to the management:

 

1.  If you are at or above your long strike position,  you keep it as a ratio trade (Selling less than your longs.  For instance sell 4 puts while you own 5).  That way if the price goes down, the delta difference between the longs and shorts isn't as bad.

 

2.  If you are below the long strikes, particularly a significant amount, you MUST sell 1:1, so you don't get whipsawed on the price back up.  Once you're long is fairly ITM, the delta issue does not impact things as much.

 

So how do we lose money?  Well you still can get whipsawed some, even using ratio trades, or you could have a rapid rise that we have issues rolling in front of.

[geneg 1]

Do you also roll the long on the upside at 5-10%  as with the Anchor Trades strategy?

[cwelsh 1,551]

Do you also roll the long on the upside at 5-10%  as with the Anchor Trades strategy?

 

Most likely, yes, though I would prefer not too, so I might wait for higher gains (so 7.5%-12.5%) -- it really depends on the pricing and delta relationships.  At some point you HAVE to as you are no longer properly hedged and your margin requirements will significantly change and the delta difference between the longs and shorts will crush you.

 

However, since I don't have to protect a long stock portfolio, I have more flexibility in when to roll.  The best news would be if the price came BACK down to the long position -- whereas if that happens in a hedging stock portfolio (like the Anchor strategy) -- well that's horrible news as you just suffered a loss you wouldn't have had you moved the hedge up.

[cwelsh 1,551]

Rolling today:

 

Buy to close july 12 162  1.50

Sell to open July 19 163  2.50

 

If you're not doing the ratio trade, that's a credit of $1, if you are, then $0.80 once adjusted

[Micahjw 3]

Still trying to understand the in and outs of this type of trade. It makes sense, but I'm wondering what you do to adjust if the market goes down hard between now and July 19 and your July 19 163 that you are short is a major loss to roll. If this occurs, do you just close out the whole position and start over? Take the loss?

[cwelsh 1,551]

With the market continuing to rise, I did a VERTICAL roll: 

 

Buy July 19 163 to close

Sell to open July 19 164

 

Net credit .57

[cwelsh 1,551]

Still trying to understand the in and outs of this type of trade. It makes sense, but I'm wondering what you do to adjust if the market goes down hard between now and July 19 and your July 19 163 that you are short is a major loss to roll. If this occurs, do you just close out the whole position and start over? Take the loss?

That's why we're in the ratio at the start and when our short strikes are near the long strikes -- the ratio helps offset some of the delta difference in the longs and shorts.

 

And if there's a MAJOR downturn, as you're discussing, the loss is actually likely to be less, as the deltas of the long and shorts are closer together at that point.  At some point, on a big enough downturn, if you have the ratio on, you'll actually make money as your longs will have lost less than the short position.

 

BUT after a small downturn (so taking a small loss in a week), we need to take off the ratio so as to participate in any up trending markets.

Edited July 5, 2013 by cwelsh

[Maxtodorov 19]

 At some point, on a big enough downturn, if you have the ratio on, you'll actually make money as your longs will have lost more than the short position.

 

BUT after a small downturn (so taking a small loss in a week), we need to take off the ratio so as to participate in any up trending markets.

 

I think you meant to say, your longs have GAINED more than your shorts LOST. 

[cwelsh 1,551]

I think you meant to say, your longs have GAINED more than your shorts LOST. 

Corrected, thanks (its hard to type with a one year old in your lap)_

[Saud 5]

With the market continuing to rise, I did a VERTICAL roll: 

 

Buy July 19 163 to close

Sell to open July 19 164

 

Net credit .57

 

I didn't see this until later, and by then the credit was significantly less, so I didn't take it

Edited July 6, 2013 by Saud

[Marau 4]

Our short July19/164Put is currently OTM. Should we roll It?

[cwelsh 1,551]

I am rolling:

 

SPY Currently at: 164.15

 

Buy to close July 19 164@  1.46

Sell to open July 19 165 @  1.92

 

Net credit of: 0.46

 

And I am still in the 80% ratio (so am long 5 puts for every 4 I sell short).

[Saud 5]

Thanks for the updates Chris. I rolled from the 163 to the 165, not sure about the math   but I missed the roll to 164 and I've still got the original 157 put. I think this one was a bit too advanced for me at this stage but trying to follow along and learn as I go too.

[cwelsh 1,551]

You should have made out better on the 163 -165 roll (as opposed to 164-165), but what do you mean that you still have the 157 put?

 

If so, I would certainly roll that position today as well -- up and out (so sell to close the Dec 157 @ 5.30 or so and sell to open the Jan 164 around $8.30).  This does increase your cost $300 per contract, but you're gaining 4 weeks as well -- just adjust your sheets accordingly.  (So add the cost in and increase the weeks remaining by 4).

[Saud 5]

Thanks I've done that, now have the Jan 164/Jul 165 ratio. I knew I had to roll that 157 put as it was getting unbalanced, but I got caught off guard by the rapid rise and wasn't sure when to do that.

[fradav 1]

Chris (or any other knowledgeable people here  )

 

I've a few questions that I'd very much appreciate an answer to.

 

I understand there's a lot of variations here based on buy/sell ratio, OTM, ATM, ITM and each will have advantages based on whether it's a bear, bull or flat market. But is there any specific combo that's been backtested and produces the best average annualised results in all markets without guessing market direction? I know the results of selling ATM puts on SPX is well documented and performs best in a flat/bull market but not sure about how it compares to put diagonal spreads with the various combos. As it stands, using an approx 5:4 ratio with ITM shorts it's almost a SPY portfolio replacement strategy if I'm not mistaken.

 

Otherwise it becomes a bit of a guessing game, e.g., "down this week so I'll sell ITM 1:1 ratio as there might be a bounce next week"

 

Secondly, since the downside risk can be relatively accurately predicted, what's the max portfolio % you'd allocate to such a strategy? Would you only sell short what you could cover with cash, even with the longs as protection? Otherwise one could use a lot of leverage without too much risk since shorts are covered.

 

Finally, would SPX be a good alternative to decrease commission fees and remove worry of assignment of DITM puts, no matter how small that risk is?

 

Thanks for any thoughts on the above.

Edited July 9, 2013 by fradav

[cwelsh 1,551]

Thanks I've done that, now have the Jan 164/Jul 165 ratio. I knew I had to roll that 157 put as it was getting unbalanced, but I got caught off guard by the rapid rise and wasn't sure when to do that.

It's not a problem, and actually worked out quite well for you./

[cwelsh 1,551]

Chris (or any other knowledgeable people here  )

 

I've a few questions that I'd very much appreciate an answer to.

 

I understand there's a lot of variations here based on buy/sell ratio, OTM, ATM, ITM and each will have advantages based on whether it's a bear, bull or flat market. But is there any specific combo that's been backtested and produces the best average annualised results in all markets without guessing market direction? I know the results of selling ATM puts on SPX is well documented and performs best in a flat/bull market but not sure about how it compares to put diagonal spreads with the various combos. As it stands, using an approx 5:4 ratio with ITM shorts it's almost a SPY portfolio replacement strategy if I'm not mistaken.

 

Otherwise it becomes a bit of a guessing game, e.g., "down this week so I'll sell ITM 1:1 ratio as there might be a bounce next week"

 

Secondly, since the downside risk can be relatively accurately predicted, what's the max portfolio % you'd allocate to such a strategy? Would you only sell short what you could cover with cash, even with the longs as protection? Otherwise one could use a lot of leverage without too much risk since shorts are covered.

 

Finally, would SPX be a good alternative to decrease commission fees and remove worry of assignment of DITM puts, no matter how small that risk is?

 

Thanks for any thoughts on the above.

I'll try to answer these in alternative order:

 

1.  It is impossible to remove all assignment risk on any American Style option.  I have actually been assigned on an option that was FAR OTM, that I was just going to let expire worthless -- with less than 2 days left on it.  I'm sure some idiot just exercised his options for an unknown reason or an accident.  While this is unusual, you can be assigned on an American Style Option at anytime.  However, as long as there is extrinsic value left in the option, the chance of assignment is small.  I never open an option position without knowing (a) if the option is European style or American style and ( what to do if it is an American style and I get assigned.  Again the risk is normally small, but it is always there unless you trade a European style option.

 

2.  The downside risk, if you're using leverage, in a ratio trade like this is if the market quickly spikes.  A ratio trade like this is directionally biased.  Take the last two days for instance, while my shorts have done GREAT, and I am earning extrinsic plus intrinsic value, the longs are getting hammered.  Yesterday wasn't as bad as this morning, but right now my longs are down 22% more than my shorts are up.  I'm not concerned with this right now, as I still am receiving more than enough credit to pay for things over time.  But if this happened 2-3 weeks in a row, that would really hurt.  If I was levered up 5x or 6x, it would destroy me.  I would not use high leverage on this type of trade -- or any trade that is directionally biased unless I was prepared to lose 100% of my capital (I do have a high risk high reward portion of my portfolio that I do take naked long option or naked short option positions in, or other similar positions, but that makes up a small portion of the portfolio and I can stomach the risk and wild swings in it).

 

3.  I wouldn't say it's a guessing game.  I use a ratio trade if the current short strikes are OTM, ATM, or barely ITM.  Once we get deeper in the money, I go 1:1 -- but that's because I'm neutral to downward biased right now, for a whole host of reasons.  If I am wrong and the market goes up 5-10%, I'll roll up and out once or twice, but at some point I'd have to accept my market theory was wrong and just take my losses and move on.  This strategy will work best in downward or neutral markets (or VERY slowly rising markets).  As some readers have noted, the inverse trade can be done on the call side to accept the other side of the risk.  I have not modeled what the effect of doing both in conjunction will do -- it might perform better overall, or it might perform less because the two perfectly cancel each other out -- don't know without actual back testing.

 

4.  And yes there is -- it's called the Anchor Strategy (or an investment in the Anchor Fund).  It's a variation of this strategy that's meant to have positive annual returns in all market conditions.  That said, the cost of such a strategy is sacrificing the opportunity to write yourself checks at a rate of 2-5% per week.  I personally do both. 

 

I would NEVER recommend on a board like this an allocation or investment plan (as everyone's goals, situations, and risk tolerances are different) -- that's why I have an actual investment firm (Lorintine Capital) to provide such advice to clients.  My personal blend, and please note that I am young, very open and tolerant of risk (which the general investing public never understands), and can accept some losses.  My current personal allocations and investments are:

 

A.  Six months of living expenses (all expenses, including house payments, car payments, bills, food, gas, etc), in six month rolling CDs paying a whopping .25% interest right now (so each month one CD comes up and I buy another one six months out) -- this is my safety cushion.  Now that I have a kiddo, I have another account building up as I would like this to get up to one year worth, but at six months, I'm still comfortable;

 

B.  Fully fund IRAs -- in the US in particular, not doing this simply makes no sense, the benefits over time are just too large.  My wife's IRA uses the Anchor Strategy while my IRA 50% Anchor strategy and 50% speculative strategies;

 

C.  Rest of my investments/savings are broken down as follows:

 

-- 50% Anchor Strategy (actually in the Anchor Fund that I run)

-- 15% in the LC Fund (a highly volatile hedge fund I run that uses many of the trades discussed on here, plus several others)

-- 10% Option income strategies (some of which are the ones on here)

-- 5% in Oil and Gas and Pipeline MMLPs and MMLP funds, partially hedged against dropping oil prices

-- 5% REITs

-- 5% Gold & Silver (some hard bullion some various funds, sometimes ETFs, it moves around)

-- 5% tax exempt bonds

-- 2.5% unrestrained bonds

-- 2.5% bond funds hedged against changing interest rates

 

AGAIN -- this is my division and should not be yours.  The percentages aren't exact either as the markets move daily and I haven't done my quarterly adjustments -- right now I'm probably under weighted in bonds and precious metals, and over weighted in other areas.

 

Hope that helps.,

[cwelsh 1,551]

Ok I AM rolling up to the 165 today:

 

Buy to close the July 20 165 Put @

Sell to open the July 20 166 Put @

 

Net Credit of .40

 

Note that this is being done on the RATIO trade, not necessarily the anchor strategy if you are following that as well (though I might roll it too -- it will be for different reasons). 

Edited July 9, 2013 by cwelsh

[Marau 4]

Ok I AM rolling up to the 165 today:

 

Buy to close the July 20 164 Put @ 1.02

Sell to open the July 20 165 Put @ 1.42

 

Net Credit of .40

 

Note that this is being done on the RATIO trade, not necessarily the anchor strategy if you are following that as well (though I might roll it too -- it will be for different reasons). 

That was done yesterday. Do you mean roling to the 166Put?

[cwelsh 1,551]

That was done yesterday. Do you mean roling to the 166Put?

Yes

[cwelsh 1,551]

Yes though I would not do it now if you haven't as the extrinsic value difference doesn't make it worthwhile

[fradav 1]

Chris, thanks so much for taking the time to write such a comprehensive reply, very much appreciated.

 

I'm still working out what to with my portfolio with respect to allocation. My logic would tell me that until my portfolio is a certain size, the annualised returns from an option income strategy should be superior to anchor trades (AT), but once you get above a certain amount (due to inherent limitations trading large accounts with former and esp. tax advantages with latter), the AT strategy would be superior. Of course if you're patient enough compounding returns would be a large advantage with AT, but I'd think there's a threshold account size above which AT is the smart way to go.

 

I can see you do both, and you've obviously thought it well through for your situation. I'll need to sit down and do some calculations based on past performance to find something that's ideal for me.

 

Re. the SPY diagonal, I've been trading various combos of these both on paper and live. I did actually try it with both calls and puts, went very well on paper but first week live didn't work due to QE volatility. In short when SPY spiked, I had 2 legs working against me (long puts and short call) and only 1 for (the long calls) after the value of the short puts was used up. It left me having to guess where it was going next, and I took the wrong decision (to protect being crushed with further up move), bought back half the short calls at a loss, and rolled up 50% of puts. Then Bernanke spoke and I got badly whipsawed. Lesson was (1) with only one side open, i.e., calls or puts, it's easier to manage and of course to be careful placing the trade on volatile weeks. 

 

I'm paper trading combos now to get more experience (also on SPX which I like for this trade) and look fwd to following your trades here. Hope you continue to place your trades here on SO!

 

Best regards 

Edited July 10, 2013 by fradav

[luxmon 233]

Chris,

 

I'm starting to get a grasp of this concept but I'm confused by your answer to #3 in bold below.  Are you saying we should remove the ratio when we are selling shorts ITM?  Did you mean to say long strikes?

 

Thanks,

Tim

 

I'll try to answer these in alternative order:

 

1.  It is impossible to remove all assignment risk on any American Style option.  I have actually been assigned on an option that was FAR OTM, that I was just going to let expire worthless -- with less than 2 days left on it.  I'm sure some idiot just exercised his options for an unknown reason or an accident.  While this is unusual, you can be assigned on an American Style Option at anytime.  However, as long as there is extrinsic value left in the option, the chance of assignment is small.  I never open an option position without knowing (a) if the option is European style or American style and ( what to do if it is an American style and I get assigned.  Again the risk is normally small, but it is always there unless you trade a European style option.

 

2.  The downside risk, if you're using leverage, in a ratio trade like this is if the market quickly spikes.  A ratio trade like this is directionally biased.  Take the last two days for instance, while my shorts have done GREAT, and I am earning extrinsic plus intrinsic value, the longs are getting hammered.  Yesterday wasn't as bad as this morning, but right now my longs are down 22% more than my shorts are up.  I'm not concerned with this right now, as I still am receiving more than enough credit to pay for things over time.  But if this happened 2-3 weeks in a row, that would really hurt.  If I was levered up 5x or 6x, it would destroy me.  I would not use high leverage on this type of trade -- or any trade that is directionally biased unless I was prepared to lose 100% of my capital (I do have a high risk high reward portion of my portfolio that I do take naked long option or naked short option positions in, or other similar positions, but that makes up a small portion of the portfolio and I can stomach the risk and wild swings in it).

 

3.  I wouldn't say it's a guessing game.  I use a ratio trade if the current short strikes are OTM, ATM, or barely ITM.  Once we get deeper in the money, I go 1:1 -- but that's because I'm neutral to downward biased right now, for a whole host of reasons.  If I am wrong and the market goes up 5-10%, I'll roll up and out once or twice, but at some point I'd have to accept my market theory was wrong and just take my losses and move on.  This strategy will work best in downward or neutral markets (or VERY slowly rising markets).  As some readers have noted, the inverse trade can be done on the call side to accept the other side of the risk.  I have not modeled what the effect of doing both in conjunction will do -- it might perform better overall, or it might perform less because the two perfectly cancel each other out -- don't know without actual back testing.

 

4.  And yes there is -- it's called the Anchor Strategy (or an investment in the Anchor Fund).  It's a variation of this strategy that's meant to have positive annual returns in all market conditions.  That said, the cost of such a strategy is sacrificing the opportunity to write yourself checks at a rate of 2-5% per week.  I personally do both. 

 

I would NEVER recommend on a board like this an allocation or investment plan (as everyone's goals, situations, and risk tolerances are different) -- that's why I have an actual investment firm (Lorintine Capital) to provide such advice to clients.  My personal blend, and please note that I am young, very open and tolerant of risk (which the general investing public never understands), and can accept some losses.  My current personal allocations and investments are:

 

A.  Six months of living expenses (all expenses, including house payments, car payments, bills, food, gas, etc), in six month rolling CDs paying a whopping .25% interest right now (so each month one CD comes up and I buy another one six months out) -- this is my safety cushion.  Now that I have a kiddo, I have another account building up as I would like this to get up to one year worth, but at six months, I'm still comfortable;

 

B.  Fully fund IRAs -- in the US in particular, not doing this simply makes no sense, the benefits over time are just too large.  My wife's IRA uses the Anchor Strategy while my IRA 50% Anchor strategy and 50% speculative strategies;

 

C.  Rest of my investments/savings are broken down as follows:

 

-- 50% Anchor Strategy (actually in the Anchor Fund that I run)

-- 15% in the LC Fund (a highly volatile hedge fund I run that uses many of the trades discussed on here, plus several others)

-- 10% Option income strategies (some of which are the ones on here)

-- 5% in Oil and Gas and Pipeline MMLPs and MMLP funds, partially hedged against dropping oil prices

-- 5% REITs

-- 5% Gold & Silver (some hard bullion some various funds, sometimes ETFs, it moves around)

-- 5% tax exempt bonds

-- 2.5% unrestrained bonds

-- 2.5% bond funds hedged against changing interest rates

 

AGAIN -- this is my division and should not be yours.  The percentages aren't exact either as the markets move daily and I haven't done my quarterly adjustments -- right now I'm probably under weighted in bonds and precious metals, and over weighted in other areas.

 

Hope that helps.,

[cwelsh 1,551]

Tim:

 

As the long puts become more and more in the money, the delta on the position gets closer and closer to 1.  That means when the market drops further, then the long puts will gain value at a rate very close to the short puts.

 

Right now, if the market drops, the short puts will lose money faster than the longs, so we are in a ratio of about 80% short/long.  Once we are more in the money on the long puts, we remove that ratio because if the market keeps going down, the risk of losing more is going away, whereas if there is a rebound we want to capture more intrinsic value.

 

Remember this is a negatively biased trade, if the market keeps going up, let's say to 175 or so, over the next month, we'll have to roll the long puts "up and out"