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Kim

CMLviz Trade Machine

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1 hour ago, Kim said:

This doesn't make sense, especially considering that the long options expire after earnings. The gains might be reduced if the stock rallies too much, but I don't think loss is possible.

Maybe he his referring to the fact that there will be an inversion of the delta difference (DD) between the long and short. When the trade starts out, the DD is +30 (50 Delta - 30 Delta). Since the short is closer to expiration and is on the steeper part of its gamma curve (since it is OTM its gamma increases faster until it gets to ATM whereas the ATM long which will show a slower gamma increase as it is moving ITM), the short option will see its Delta increasing faster than that of the long option. At some point the short's Delta will exceed that of the long option, and there will be a negative DD. At that point further up movement of the stock causes the trade to start losing. It is conceivable on a very big move prior to the expiration of the short, the trade will lose just due to this DD inversion.

Edited by Alan

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13 minutes ago, Alan said:

Maybe he his referring to the fact that there will be an inversion of the delta difference (DD) between the long and short. When the trade starts out, the DD is +30 (50 Delta - 30 Delta). Since the short is closer to expiration and is on the steeper part of its gamma curve (since it is OTM its gamma increases faster until it gets to ATM whereas the ATM long which will show a slower gamma increase as it is moving ITM), the short option will see its Delta increasing faster than that of the long option. At some point the short's Delta will exceed that of the long option, and there will be a negative DD. At that point further up movement of the stock causes the trade to start losing. It is conceivable on a very big move prior to the expiration of the short, the trade will lose just due to this DD inversion.

Just as with our NEHS trades (assuming a 1:1 short to long ratio) if the entry price is less than the distance between the strikes then you cannot have a loss on the upside.   However, if the entry price is greater than the distance between the strikes then you could have a loss if the stock price rises too much.

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I had one today with MU. 50 delta long at 71 exp. Jan 8th, 30 delta short at 71.5 exp. today Dec. 31st. Stock went from slightly over 70 to 75 in a few days. The initial cost was $202 but today it was worth only $150 because the short position went up so much. Rare, but it happens when your initial deltas are slightly off from the 50/30 backtest, in this case closer to 48/32 when I opened the position. 

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16 hours ago, Fractalfriend said:

I had one today with MU. 50 delta long at 71 exp. Jan 8th, 30 delta short at 71.5 exp. today Dec. 31st. Stock went from slightly over 70 to 75 in a few days. The initial cost was $202 but today it was worth only $150 because the short position went up so much. Rare, but it happens when your initial deltas are slightly off from the 50/30 backtest, in this case closer to 48/32 when I opened the position. 

Yes, you are correct. As @Yowster mentioned, you need to make sure that the initial debit is less than the distance between the strikes and the P/L chart looks good.

Your initial P/L chart probably looked something like this:

 

image.png


Instead you could do something like this:

image.png

So your longs would be deeper ITM and the short calls further OTM. I'm not sure if this setup gets enough credit, so maybe in case of MU it would be better just to skip the trade.

In case of IBM for example the setup looks better:

image.png

But you also have to enter 2 weeks before shorts expiration to get a decent credit. We can watch it and see how does it look a week from now.

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Re the recent discussions of trading results of TM strategies.

I have been trading pre earnings momentum calls for the past 6 months. Mostly 14 days pre earnings (with some 7 and 3 days). The strategy involved buying a 30 or 40 delta call for 14 or 30 day expiry and exiting just pre earnings.

I have restricted transactions to cases showing better than 6/2 winning records for the past 2 years with better than 20% average returns. As well, I set exit criteria acording to best results in backtesting, although not always following through-usually to my regret.

There were 90 trades during this period, of which 58 were profitable and 32 loses. The average return was about 35% with a large variance . Several trades generated over 200% in profit and almost 100% losses.  Because of the risk, positions were relatively small, particularly as market movements lead to positively correlated results between trades  over any short period.

In total ,over the past 6 months the profitable trades generated $21,400 profit and the losing trades generated $6500 in losses on a total of $43,200 at risk.

I am very happy with the performance of the strategy. HOWEVER, the period covered was clearly a bull market, so may not be very repreresentative  of the longer term results and risks.

Edited by ykotowitz
typo for loses count

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6 hours ago, Kim said:

Yes, you are correct. As @Yowster mentioned, you need to make sure that the initial debit is less than the distance between the strikes and the P/L chart looks good.

Your initial P/L chart probably looked something like this:

 

image.png


Instead you could do something like this:

image.png

So your longs would be deeper ITM and the short calls further OTM. I'm not sure if this setup gets enough credit, so maybe in case of MU it would be better just to skip the trade.

In case of IBM for example the setup looks better:

image.png

But you also have to enter 2 weeks before shorts expiration to get a decent credit. We can watch it and see how does it look a week from now.

Thanks Kim and Yowster, that’s very helpful and will part of my calculations for this type of trade going forward. 

Edited by Fractalfriend

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20 hours ago, ykotowitz said:

Re the recent discussions of trading results of TM strategies.

I have been trading pre earnings momentum calls for the past 6 months. Mostly 14 days pre earnings (with some 7 and 3 days). The strategy involved buying a 30 or 40 delta call for 14 or 30 day expiry and exiting just pre earnings.

I have restricted transactions to cases showing better than 6/2 winning records for the past 2 years with better than 20% average returns. As well, I set exit criteria acording to best results in backtesting, although not always following through-usually to my regret.

There were 90 trades during this period, of which 58 were profitable and 38 loses. The average return was about 35% with a large variance . Several trades generated over 200% in profit and almost 100% losses.  Because of the risk, positions were relatively small, particularly as market movements lead to positively correlated results between trades  over any short period.

In total ,over the past 6 months the profitable trades generated $21,400 profit and the losing trades generated $6500 in losses on a total of $43,200 at risk.

I am very happy with the performance of the strategy. HOWEVER, the period covered was clearly a bull market, so may not be very repreresentative  of the longer term results and risks.

Thank you for sharing this.   I was hoping to find the time to backtest some of these "naked" long calls over the winter break but got side tracked with some research on calendar trades.

Have you done any of the call ratio trades?   My hypothesis is that when you normalize for risk just dong the long naked call will be more profitable then messing around with the call ratios. 

 

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On 12/31/2020 at 12:39 PM, Fractalfriend said:

Frank, here are my TM trades just for 14-day Pre-Earnings Diagonals since March 2019. TradeMachine shows these if the stock is over its 50-day moving average. The backtester sells a 30-delta 7-day call and buys a 50-delta 14-day call. In some cases where weeklies don't exist it does this with monthly positions instead. I didn't take every trade suggested by TM, only where the stock hadn't started to rocket up yet before earnings and options liquidity looked good. So the chart had to look close to flat for the prior trading days. Since this was a test, positions are on the small side, that is a few hundred dollars per diagonal.

 

Total trades were 88 of which 64 were winners, or roughly 3 out of 4. Total invested for the 88 trades was $28,505 with a total profit of $1,846. Average position cost was $324 with an average return per trade of 6.5%, or $21, holding the trade for around a week before the position is closed. Biggest loss was $-403 and biggest winner was $327.

 

My conclusion is that, so far, this type of trade is consistently profitable. It's tempting to hold the long 14-day call past the expiration of the 7-day short call if the latter expired worthless and the stock has gone down a bit, but this doesn't tend to help you. If the position isn't profitable after a week, just close the whole thing.

 

Can you share what your largest equity drawdown was?   For example, what was the worst string of losers and how much did those pull down your account? 

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2 hours ago, FrankTheTank said:

Thank you for sharing this.   I was hoping to find the time to backtest some of these "naked" long calls over the winter break but got side tracked with some research on calendar trades.

Have you done any of the call ratio trades?   My hypothesis is that when you normalize for risk just dong the long naked call will be more profitable then messing around with the call ratios. 

  

I have not done many call ratios. Backtesting suggests that naked calls  generally generate superior average (not risk adjusted)  profit rates. I am not too concerned about the individual trade risks due to the small investment in each trade and the large number of temporally independent trades.  I did a few call ratios where the costs of a naked call were too large. These were not included in the report. I shall try to dig into these trades and report the results.

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On 1/2/2021 at 12:59 PM, FrankTheTank said:

Can you share what your largest equity drawdown was?   For example, what was the worst string of losers and how much did those pull down your account? 

The largest drawdown for me with this type of trade, 14-day earnings diagonals was in early 2019: 4 trades lost in a row for a total of $835. I think this might have been before TM put in the technical condition of the stock being over its 50-day MA to open this trade. Just eye balling my data, typically I've had a few winners in a row followed by one loser. And again, I'm not taking this type of trade where the stock has already made any sort of significant move upwards in the previous few days or where the price of the whole position is above $600.

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