protector alpha – Page 2 – Travels and Trades

Sep 17 – Fed Day

Today’s the big day. I am positioned with very little upside risk and about 5% room on the downside via a series of M3s. Though, one of the 1120 M3s are now vega positive and if volatility decreases it’ll sag the T+0 line a bit which will cause me some issues. Nothing too risky at all. I plan to up my risk going into October and have been waiting for the market to settle down. I added a few 1150 M3s today since the volatility is still high and we can get them at a nice cheap price given the time till expiry. Again it’ll handle all upside moves well and has a good 5% to the downside before any issues.

The RUT has moved up quite substantially in the last few days (up nearly 50 points! which is near 4%-5%).

5 min to go. Can’t wait for this meeting to be over with and for some normalcy to return to the markets.

The alpha protector is down on the recent rise as volatility flew out of the long puts. I was somewhat expecting that. As it gets passed 204-205 we’ll see profits return. I rolled up the shorts today from 201 to 203 to give more upside room.

Sep 14 -Trade Plan

I removed most of the September trades today. I have a little left but not much. Somewhat a small recovery these past few weeks enough to get back some confidence. The losses now are more stomach-able. Having realized how drastic the moves where and how little they occur in history has relieved me. I’ve lost a summers worth of profits on an event about as rare as 1 in 10 years. Not bad. Soon come, I am ready to get back on the horse. I have a renewed focus on proper risk management and diligence in preplanning and back-testing. I’ve been spending most of my free time doing due diligence and backtests galore.

I’ve got just a little risk on for October trades as I await the Fed meeting on Thursday. I want things to kind of settle down (which it is starting to!) before going back full risk-on. I needed a small break from the stress of it all as well.

Obviously the recent events were somewhat traumatic. The drop of 10% in four trading days is quite rare. It’s only occurred 9 times since the Great Depression. The other times it occurred was of course Aug 2011, Oct 2008 (Financial Crisis), Aug 1998 (Long term capital hedge fund explodes), Oct 1987 (Black Monday!), 1962 (Kennedy intro’s steel tariffs), 1940 (WW2), 1938 (Fed policy error). Source: Doug Kass

The neat thing is that every single one of those had a retest of the lows within a few months. Only two of the above occurred in bull markets (which we are pretty much in now). They eventually went on to new highs (one took 5 months and the other took four months). Again, source: Doug Kass

If we retest the lows at 1875, I’ll be putting some risk on. In the meantime, I’ll be adding M3s and Bearish butterflies periodically and ramping things up. The high volatility environment should be quite lucrative in the months to come. We’re finally getting paid for our risk!

The protector is just about break-even (maybe slightly profitable). Pretty damn good since we put the thing on at SPY 205 and SPY is at 195 (5% down ish). But I am worried that the next few years, the environment may not be good for a long based portfolio even when hedged. I don’t know what to do. I think its probably prudent to just keep it on and let it run its course over the next few years. The mechanical stock picking should keep things profitable as it has to date. Eventually, it’ll do quite well. It’s a long term portfolio.

Sep 12 – Trade Plan

This month has been the third most volatile month for the markets in history only being beat out by the 2008 financial crisis and the 1929 great depression. The overnight moves were extreme and made for the toughest markets for market neutral trading. Overnight gaps in each direction in the 1-4% range were regular and intense and quick reversals came at the drop of a dime. Going from an extreme low volatility environment to an incredibly high one is always going to be very challenging period for market neutral traders. Once in a high volatility period, it’ll be much easier to manage and probably a lot more profitable but the transition can permanently take out a lot of traders 🙂

I struggled immensely the past few weeks but finally had a decent week with some recovery. The MICs do not trade well in this environment and can be devastating in unexpected overnight crashes. The RUT moved from all time highs to about 17% down in the period of a few weeks. Crashes like what happened on Aug 24 will wipe out most iron condor traders. Luckily, those events are quite rare. If it happened during trading hours, it’d be a lot easier to manage. A study was done and it was found that 50% of the markets movement occurs in the futures between 3-4am during the past 7 years I believe. The market is more efficient and swift than in the past and I believe that it’ll make MIC trading a lot more difficult to manage than back-testing would suggest. In contrast, all the M3 traders I know are mostly positive (one is up 7%) and, remember, it’s still a market neutral trade that really doesn’t like movement. Yet it survived one of the most volatile months on record. That’s incredible. I’ve had a bunch of M3s on but not enough to even make a dent in the MIC losses. It’s a very resilient trade as you can see with the below risk profile.

M3’s can handle market movements a lot better. Here is an example of an M3 risk profile:

The beauty of an M3 is how it compliments human factors. When I say human factors, I mean psychology and the things that challenge us within when trading. Things like taking losses with adjustments, or the opposite, adjusting to quickly out of fear etc etc. If you notice, you have no real upside risk and on the downside, you’re falling into profit being under the tent. So when you make an adjustment on the downside, you’re up money AND you’re usually taking money off the table. That’s a very nice adjustment in terms of human factors. As well, look at the room you have before you start losing money (almost what 5%?). Again, the beauty of managing this trade is its conservative risk profile, the fact that adjustments are mostly welcomed, and that a trader who’s keeping their T+0 line balanced will usually never have a problem with deviating from the plans so greatly that it affects the trade overtime.

Here is an MIC risk profile.

You can see that on a quick fall (overnight) without the ability to protect yourself, you can have extremely large draw downs. This is especially pronounced as you get closer into expiry. Plus, this risk profile is taken in a high volatility environment, having put this on during Aug before the correction, it’d be even worse. That said, if you had the ability to adjust (moves happen DURING the day instead of overnight), then this trade is easy to manage. Overall, I mean, I loved the MIC trade until this month. I had a really rough month in the melt up in October of last year and I had a real rough month this month with the extreme overnight movements. For me, I just don’t know if its a trade that I can justify having seen how the M3, Rock and Bearish butterflies react. I mean, the MIC is a great trade for the most part, as you have quite a high theta and being in the green each month had a 93% success rate. It’s the extreme moves that occur overnight that really hurt and excessive whip saw. Both of those causes are what hurt me in the MIC trades recently. In hindsight, I should have closed the MIC straight away instead of trying to manage it through the week after crash. Hindsight is 20/20.

Sep 4 – Trade Plan

I had to take a break from posting. Those two weeks were probably the worst two weeks I’ve ever experienced. Managing the trades in this transitionary environment (extreme low volatility to extreme high volatility) has taken me to task and almost made me quit. We did terribly these past few weeks. Our MICs were utterly destroyed in the Monday correction and further the adjustments made (a mistake in hindsight) as the market moved 5% consistently over night in each direction several times.

We’ve got a few things hanging over the market right now and that is the fact that Chinese markets are open 2 full days before the US markets re labour day and the likely Fed rate hike on Sept 17th. Those two things are keeping options pricing very expensive. Being a market neutral theta decay based trader having originally been paid shit in a low volatility environment has been the biggest challenge. We’re experiencing 3-5% moves overnight and we’re getting no time decay. You literally cannot get a worse time for these trades and I have regrets in the management of the trades during the period. Though, I do realize most of these regrets are regrets in hindsight. I couldn’t have known the market would go green nor could I have let things ride the way we were positioned. All in all what an epic learning experience. I have weeks of data and thoughts to go over. I need to take this experience and learn everything I can from it.

As market neutral traders, we try to manage risk by making adjustments, but if we are constantly adjusting in each direction, we get killed. This means that we usually have to change the way we make adjustments (less frequently) but that exposes us to gamma risk if the market runs in one specific direction. My plan is to sideline the majority of my risk until after the 17th and wait for the market to calm down a bit then enter good solid trades and start the recovery process. As well, if we get a crash, I WILL enter some trades to take advantage of that (with great risk reward). This gives us the best odds for a smooth recovery. A few good months should get us back to where we were.

I tried to do the best I could at the time but I would do things differently. I opted to adjust pretty much when it was too late. I should have exited the MIC trades and took the loss. Instead, I adjusted and those adjustments cost me more than my planned loss as the market whip-sawed up and down in very large amounts. Each one taking more and more $. Taking a max loss isn’t just taking it for the sake of not having more, but the fact that you are at a max loss also means that the market is doing things it doesn’t usually do –> it’s not behaving rational or within normal parameters. That in and of itself is the main reason to just exit and wait. Given the conditions and what I saw in option pricing and market behaviours and how each strategy reacted (PUTS didn’t even have an ASK price during the morning!!) I learned so much and have so much to study about what happened, that it’ll make me a much better trader. I’ve now got an extreme melt up and an extreme melt down under my belt 🙂

So yeah, the transitionary period is the absolute worst thing we could have experienced (going from extreme low volatility to extreme high volatility) because we simply never got paid for the risk before the high volatility period. It’s no problem once we’re in high volatility and we get paid appropriately. However, that said, any EXTREME volatility market that was preceded by some sort of black swan (Yuan devaluation) will always be somewhat catastrophic for these types of trades. The event that we experienced is a 1 in 7 to 10 year event. We are still in an extreme volatility period while we navigate the devaluation issues and the potential fed rate hike on Sept 17th. This exposes our trades and I’ve reduced risk going into the weekend though not completely.

I felt so often to just quit but I’ve realized that I just went through a crash period that will be so invaluable to my experience in the future that I have to buck up and approach this as an opportunity to learn from direct experience in something that is such a risk but are experienced quite rarely and sometimes only once in someones options trading career.

Oh by the way, something super cool –> The protector alpha did not actually lose any capital throughout the crash or days following. We entered it at around SPY 205-206 and it was insured for that level. SPY went up to 213 and of course we had profits wiped out but we never lost capital. Now that is insane. We are at SPY 192 and we’re break-even. The market corrected 10% and our basket of equities were in fact 100% hedged. We participate in upside but not downside. Had we rolled our insurance, we’d actually be profitable.

Aug 23- Trade Update

That was a week for the history books. Oil had its largest weekly fall since ’86. Vix went up 47% in a week which is the highest in all history. The speed of the decline was also extremely unusual. I’ve read that perhaps the market cycles will be more square like rather than Sine like due to the efficiencies in this age (information hits markets instantly). Anyways, this decline reminds me of the up movement in October. These things are happening over night and giving no-one time to adjust. It makes for managing time decay based strategies quite difficult.

The protector portfolio is actually still up just shy of 1% while the SPY is down 4%. The equities were actually still up 2.5% but the hedge is down about 1.5%. So its outperforming SPY by about 5%. Nice. However, this last very swift correction has told me that I have have too much downside exposure. The MIC does not like increased volatility and sharp down moves nor does the protector. These were my leading strategies up until about a few months ago when I added the M3 and Bearish butterflies. Both of these have held up and are still mostly profitable though bruised from their specific highs. I’m leaning too much re risk to the downside and I need to adjust the ratios of the strategies. I’ll probably reduce the Protector to about 15%, the MIC to about 15% and the M3 to 50% and do the Rock trade and opportunistic Bearish Butterflies with the rest.

Like I said above, though, I know exactly how the protector would perform in a sharp down move, I’ve decided I am not comfortable with the downside exposure when coupled with everything else and how it affects my downside risks. Having two strategies go sharply down at the same time is not a great feeling and adds unnecessary stress. So I’ve decided to start working on lessening the ratio of these strategies within my own portfolio. I won’t be doing this reduction willy nilly but timed appropriately. The strategy does well, I mean it’s still up it’s just doesn’t fit well within all the other trades.

The RUT trades are down about 4-5% during that last fall. I imagine at least half of that is stuck in the prices of the options re volatility. Remember, the RVX/VIX are at extreme levels. That means that the options are priced with a lot of premium. The same options we sold. So the trades appear quite down. As time gets closer to expiry this volatility has to flow out and we’ll continue to maintain appropriate risk. Ideally, we don’t correct much more than a few more % before a strong bounce.

The SPX MIC trades are down 9%! This is expected as the SPX was the most dramatic collapse of the two. It fell 3% on Friday while the RUT only fell 1.1%. Any bounce should recover the trade to at least 4% down and we’ll do a larger adjustment then while maintaining appropriate deltas if we should have more down Monday. As we close in on expiry, I’ll be doing my best to get these things back to break-even. I’ve done it 2 times before during a correction. It just takes appropriate risk management and a level unemotional head 🙂

Overall, as of right now, with the options volatility at extremes and thus the option pricing also at extremes, when we look at all Aug (already posted results) and Sep trades, we are down about 2-2.5% overall. Not bad considering the events and also not bad since it is quite likely we will recoup a lot in the Sept trades. The trades weren’t designed really to withstand a furious drop with 80% of the downside happening after hours. Unfortunately, you can’t design a trade to weather all storms.

As I am following market news right now, I see that the bank of China has indicated that they are lessening reserve requirements, S. Korea and N.Korea have de-escalated the skirmish and Iran has requested an emergency OPEC meeting to combat the falling oil prices. This might be the bullish catalyst to spur a furious bounce. We shall see. A bounce would certainly be nice for the protector and also to adjust the MICs.
Update: In an effort to curb the fall in the markets, China is going to allow pension funds to invest 30 % of its assets(546 Bln) in the financial markets and that includes all sorts of financial instruments. Let’s see if the Shanghai composite holds that 3500 level and we see a bounce.

Aug 13 – Trade plan

These past few weeks have been interesting. On the 6th, the market fell quite a bit but we were only 3% from all time highs. There were no new headlines just the same old bearish stories (rate hikes, Puerto Rico default, Greece etc etc). I didn’t expect a full out correction because the people scared of those specific head lines had already sold long ago and we were only 3% from ATH. Obviously, the current holders weren’t too worried about those specific issues and aren’t going to sell on most news coming out of those regions. However, on Monday we had a new headline which wasn’t present before, the devaluing of the Yuan and the implications of a weakening China. These types of unexpected headlines are the ones that have the power to cause selling. It takes time to quantify the effects of a devalued Yuan and brings an unknown into the market for most participants and unknowns can cause panicked selling. I didn’t expect as strong a bounce we had yesterday and the strength of the down move usually suggests more to come. I waited for a smallish bounce to reposition and ended the day with a negative delta upside risk! Go figure! Anyways, this is a very whippy market and normally I’d be moving my delta limits on the upside a bit higher to accommodate for the volatility. However, this market refuses to correct. It had the opportunity yesterday and it decided to close green. Yesterdays action suggests more upside ahead barring no new headlines from China. It was definitely a bullish move and I’ll be taking that into consideration alongside my current thought to allow more upside room before adjusting. Confusing market no doubts.

The devaluing Yuan should help the US economy as it is a net importer so maybe this was a washout opportunity to shake out the confused and fearful weak hands for a big bullish move to all time highs?

Aug 13 – Back in Action

It was a rough go the past 2 weeks with more sporadic travel, driving and hotel stays. This put me in a constant catch up mode with both work and the market and I had little time to update the blog. I ~~should~~ will be back to regular posts and updates from here on in, probably every day.

We’re now finished the “road trip” part of the “sabbatical” and are in London, UK where we will trade in our Tesla for an american version for use in the Cayman. Tesla HQ is accommodating me in this respect and I’ll end up with a new P85D (a 3s 0-60 car) for not a whole lot more when considering the differences in the price of the Tesla in UK vs USA. It all worked out.

The market was nuts yesterday. That was a tough tough go but I am confident and proud in how it was handled. The market fell 1.6% only to rebound into the green for a 3% round trip in one single day all the while the entire market has moved 5% in the entire year! Not an easy environment for a theta based market neutral group of strategies. In fact, it was or should have been one of the toughest days a trade like that could experience.

For the M3s I added 1170 butterflies to hedge the downside and on the bounce (around RUT 1195 – an area I expected the bounce to stall) I took off some 1230s. Of course, the market did something I haven’t seen and the SPY ended up closing green on a <1.5% red day and the RUT just slightly red sitting around 1210 after touching the 1180s. Ah well, my entire account balance didn’t move to much by the end of the day (down maybe 0.5%) but the adjustments surely cost me. The size and intensity of the adjustments were nominal and probably the best case we could have expected if a rebound this size should have occurred. Can’t help but wish you were psychic and could have waited 🙂 With a fall that intense, you have to manage your risk and it is what it is.

The AUG MICs were mostly closed on Monday (thankfully). Some straggling parts to close out today. Will post the results soon. All positive.

The SEP MICs had debit spreads and bearish butterflies added to them on the down move yesterday and are probably around break even so far for the month.

Come Sept 1, I’ll start posting all my trades and adjustments as they occur.

Aug 1 – Trade Plan

I’ve officially added the M3 trade into my larger portfolio. I find it a much more conservative trade than the MIC in terms of risks, but strangely it should produce slightly better results, which is quite interesting. It’s also a lot less stringent on timing of adjustments and more forgiving in general. From a direct comparison to just the mechanics of the trade vs the MIC, it is a better trade overall. The edge for the MIC is my experience managing it. Either way, it’s a nice strong compliment to the MIC. The M3 is a trade John Locke developed when he was at the Sheridan mentor program. He’s since branched out on his own. It’s 10 bearish butterflies coupled with 1 long call thats DITM as to have no time value. It’s a market neutral time decay based trade. It’s got very little upside risk, and the downside adjustments usually occur when the trade is already up money and when the butterfly is close to its max value for that specific time in the trade. That’s neat.

Theoretical backtesting of the MIC in a strictly mechanical way produced an average of 3.3% a month since 2008, where the M3 produces an average of about 5% per month. However, with active management of the MIC and use of several indicators, I gather I am closer to 4%-4.5% over time.

For a neat look as to how well the M3 handles any market environment, in 2011 if you had put the trade on at the top of the market and had it on through the huge 63 point down day (what was that 8% down day?) and all the way to the bottom (~200 points??) and its subsequent rebound, the trade still came out at a win of the target 10%. That’s a resilient trade. This was managing the trade by checking only once per day at 3pm. That’s it. No intra-day adjustments besides that. Even during that 63 point down day, it was still up money.

Come September, I’ll start posting my trades and adjustments.

Jul 29 – Trade Plan

The protector Alpha is up 3% for the year vs SPY ~1.3%. We got hurt a bit on the last whipsaw. I had reluctantly rolled my 211 short puts to 213.5 when the market was at around 213 for a loss having missed the big upswing and thus losing on intrinsic value. The market moved very quickly and I just couldn’t stay up on it (overnight gaps etc). THEN the market decided to suddenly reverse falling to 206 leaving our 213s with no extrinsic value. Talk about whipsaw. I then rolled to 211 to get a bit of extrinsic now it’s on its way up again. I do believe this is a bounce into fed Wednesday and that we may stall or reverse hard but I’ll be sure to quickly roll if we come near 210.5. Not a great environment for rolling the shorts. That and the big loss NEM had (was actually -15%) has put our PA account at just about 3% for the year. Leveraged 7x = 21% or just about 3.5% a month for the year. This is better than expected given the market this year. This is a bullish strategy and has its place in our portfolio. It does well when the market does well yet is completely hedged on the downside. It’s not the big returns you’ll see in the market neutral options strategies but it’ll help in big bullish years. Maybe those years are behind us in the next 5 year time span? I don’t know.

My balance moved up 5% yesterday after the fall in volatility. Again, it shows how the mids and stated option pricing moves around so much in high volatility environments. It’s like the volatility was just sucked out of my accounts yesterday. It wasn’t delta losses or actual losses, it’s just that when the volatility floods out the MID pricing gets tighter and more accurate especially in the SPX. This can affect your stated balance (AND margin calculations quite a bit). Any new traders utilizing portfolio margin should be aware of this. You can go to bed with PM stating 100k liquid only to wake up having it show -100k and be forced into liquidations. It’s happened to me in my early days running MICs. You end up buying back risk at a premium during the first 15 min of market open. Not pleasant. There are tricks to reduce margin during these 15 min but that’s a subject of another post.

Some early results:

Aug Bearish butterfly: Up about 15%

Aug M3: Up about 8%

Rock Trades: up about 4%

Jul 22 – Trade Plan

We had another RUT down day yesterday so I entered some more Aug MIC since the prices were good enough. It’s pretty damn close, and I don’t usually enter the trade this close (32 DTE) but the prices were decent and I am going to keep my profit targets on that part of the trade a bit lower. The futures are down again and I might enter a final part today bringing our allocation to 50% for the month.

I closed about 75% of the SPX MIC put credit spreads when it touched 213. It appears it was great timing as the market just fell a bunch since then. Yesterday I sold more to get the delta’s in line and to replace the ones I bought back. Trade is looking great.

The RUT MIC is doing fine as well. I think it’s up 3-4%.

All in all, we are just holding our ground. The protector alpha shorts got a bit over-run and I had to adjust a few days ago – Only to have the market reverse 🙂

My bearish butterfly for Aug is up about 20% (the return is calculated a bit differently than the MIC returns).

Aug Kevlar trade is up nicely

Aug M3 trade is up 5-10%

All in all, sitting at all time highs and getting ready to enter the next trades.