Tag: john locke rock trade

Risk, back-testing and drawdowns

When I first started out in options a decade ago, there were only basic backtesting systems, namely Option Vue (which, actually just recently went out of business due to lack of adapting and other reasons). It was not only cumbersome and slow to test but the datasets were very limited, we didn’t have the option data in a variety of market types to really test out strategies. We basically had EOD data pre 2011 and I believe 30 min data after that. That gave us what? Like 3 years of good testing ability. Further to that we had less expirations.

This is an era where trades like the Modified Iron condor were popular. These sets of strategies were borne from the limited data set I mentioned above. They had produced consistent unchallenged small gains for a handful of years only to be dinosaured when the inevitable bulldozer came while picking up these pennies (ie Aug 24, 2015). With this new data set and many more to come (Bear 2016, Low vol 2017, Feb 2018), many other trade types started to be developed, using a much more varied market data set. It was also when the first inklings of the pre-PMTT group came about when I started a skype group to talk about the Rhino trade. From the ashes of these previous trade systems, our group was born when Ron took the reigns and created PMTT.

There’s been a lot of talk in my group about curvefitting and having OOS periods now that we have access to automated tools where we can essentially backtest loads of iterations in very quick time. It’s true, when I backtested the HS3EZ, 488 and 484+2LP it took 100+ hours to properly do. I had one set of parameters and if I changed them, that’s another 100 hours :). I am certain I’ve spent 2000 hours+ backtesting in the last decade, if not more. We can now test that AND any changes in a few minutes. This creates a problem of fitting data by removing losing trades by filtering w/ new parameters etc etc. I am betwixt between the two camps of thought when speaking about the PMTT type trades only. When I am looking at the algo trading or TAA, I am firmly and obviously very focused on OOS testing and curve fitting. The edges are less and the variables much more variant. You’re searching for small edges that need a LOT of data to confirm because the edges can be or can come from something much more ambigious as is the case in algorithmic trading. It’s a definite concern for PMTT types of trades, but just not as much.

The PMTT type of trades are not the same thing as algo trading or trading futures or utilizing parameters like the TAA guys use which have less pronounced and even ambiguous edge with much more variables and variability in those variables. Our edge comes from the very robust premium inherent in the market of which acts like insurance and the pricing of this insurance is less variant and affected by less variables than other non-option trade types. The pricing of an option is via the corresponding greeks which I view as almost like a device of rubber bands which can only stretch and pull so far. We don’t need 1000 samples of bear markets and 1000 samples of low vol periods. There’s only so much that can happen in our structures. With that said and related to my betwixt comment I believe that any strategy created from a limited data set needs OOS testing before going full hog, especially if you’re only testing from 2020+. Which I am currently seeing a lot of. I firmly believe we should be using all data available to us to create these strategies (that means 2014+ at very minimum). This gives us the 2014 Oct crash and unrelenting V-Rally, the 2015 crash, the 2016 prolonged slower bear, the 2017 low vol run up, the 2018 crash, the Oct-Dec 2018 bear, the 2020 crash and subsequent huge 2021 rally and so on. I think a strategy can show returns in a full test in those markets as well as random sampling within AND it has a solid hypothesis and theory of why it should work, then it is robust enough for me to slowly add in.

In regard to risk and draw down, I also believe you can appropriately reduce overall risk with solid well thought out and well tested diversification and trade development and you can in fact limit max draw down on the portfolio of trades by doing this. By limiting draw down you increase geometric returns.

I don’t think drawdown equals risk.. It is just not that simple. You can diversify, you can mitigate, and you will have better geometric returns because of that. Risk mitigation=return. My life is just focused on this aspect, reduce risk and draw down for better geometric returns. There is volatility tax and it’s much more attractive to limit your draw down to allow for better compounding. I always say this, but its the time series of returns, the pathway we take in our bets, that is the most important.

Updates for the Quarter

Finished the quarter at 8.5% which was a good look given the S&P was down about 5% but I felt like things could have been managed better especially the initial response and the adjustment to the huge bearish rallies we had. I have two accounts (EDF w/ a seat in Chicago to trade futures) and IB. The EDF account I purposely left on as totally systematic and had traded the IB account more discretionary. The systematic account did beat the discretionary account. Now some caveats there, when we have a large market event like this quarter, we often pause new entries of OTM trades, allow convexity to play out in our tail structures and move to more defined risk structures like ATM trades but only until we get an all clear, this is usually days to weeks max. 99% of the time we’re in our systems. Some learning nuggets in there but mostly nothing we didn’t already know. Interestingly, the account would have published >20% result if the market closed anywhere near 4350 or below but alas, we had a bullish run into EOQ. A little lotto almost. The good news is that this quarter (Q2) is almost up the same as Q1 and it’s only 18 days in. The expectation based on models is that Peak will end up around 25% for H1 2022.

We officially Just finished the first two years for the fund which did awesome. An average of 40% a year which matches the arithmetic backtests we’ve done. I had about 2 years before that with personal trading, so I now have 4 years out of sample matching the available back-testing. All in all, couldn’t ask for anything more. What a successful start. The fund setup was as legit as you could setup and was pretty interesting, it requires 2 independent directors as oversight, a 3rd party fund administration company, that has access to the platform back-end and reviews all trade logs daily, an auditor (Grant Thornton) and loads of administrative tasks by the government. Literally have 10+ people reviewing our trade logs for accounting/oversight. I don’t even have access to the bank account. How neat. Who would have thought. At first, I thought it was a lot of pressure especially given short term swings/dynamics, but I am quite used to it now. As it grows, so does the need for very robust systems, checklists and daily verifications of models/trades. It’s been an interesting experience and I’m loving that our results are published and audited. It’s opening up a lot of pathways and keeping me to task. I am not living my semi-retired life I was on the path to living a few years back but I love what I do so it’s not work.

As I always harp on about my focus being on risk reduction as a way to increase geometric returns, it’s really taking in the point of ergodicity vs non-ergodicity and an example I really liked that Spitznagel used in his book (safe haven) was that of a merchant company who had ships going back and forth in Europe which were prone to pirate attacks. They determined that 1/20 ships would sink and they’d lose 10k (just an example) but had been offered insurance at the price of $600 per ship. Seems like a bad bet right? $12k is more than the 10k they’d lose every 20x on average. But it isn’t when looked at geometrically. The stable cost of $600 per sailing and not having that 10k draw down actually generates more $ over time. It’s a win win for both the merchant and the insurance company. A paradox! But it has one assumption, that the merchant is actioning his money to increase business. If so, then having less cash draw down allows for better compounding in the number of ships he can send. Having that 10k drawdown and having to recover from that drawdown is more of a cost than paying 12k to insure the 20 ships. Go figure. On paper, it’s -2k worse but geometrically it’s better. Here’s another example, if you flip a coin and heads you gain 50% of your worth and tails you lose 40% of your worth, most professional gamblers would all agree that you’ve got POSEV of 5% and it’s a great bet. But geometrically it is a terrible bet. Given enough trials, all participants will go bust. Having been a professional gambler in my university days (only with edges!) I’ve witnessed people through out the years, taking insane $ bets for small edges, I guess if their bankroll is enough, it’s fine but else, it’s eventually a bust. It’s not just about POSEV situations but also bankroll management and risk mitigation via volatility reduction. Most bets aren’t an ergodic process. There’s mathematical equations you can use to figure out how to size bets like these, but rarely do professionals or gamblers alike do that. It’s like Russian roulette (where the 1/6 will end the game forever). Sure, if you had 1000 of you spinning that revolver (picture a multi-verse), you’ll obtain the arithmetic average, but as an independent single trial, it’s an assured total loss. We don’t care that we on average beat the game but what happens if we KEEP playing the game! It’s the life pathway in investing/trading that we care about most not the EV of a specific trade. Large draw-downs along the way are inhibitive to growth more so than the EV itself (for the most part and being reasonable). Everyone says (I stole this) that “Man I wish I invested in Amazon in 1999, I’d be Rich” But that’s pretty stupid, because during that time amazon had 90% draw downs. Imagine following the trajectory of that persons investments.

Volatility tax is such an important concept in finance and one that many ignore. It’s my focus and it’s why I have such positive exposure to tail events and work to have mid-way hedges to reduce drawdown in a campaign setting. I went from being a professional risk taker (I’d define myself this before up until a few years ago) to becoming a professional risk reducer. The entire premise of my trading style is risk reduction (volatility reduction) by way of diversification (as best as I can within the framework I work in) to provide better geometric returns. Just having a risk focused mindset is a win. I don’t focus on returns so much anymore, but rather, smart defined ways to reduce risk via diversification so that my edges are better compounded.

Jul 30 2020 BWB+Fly Aug Trade Update

A nice pop in the p/l given the US is contemplating giving up on those pesky elections. Who needs them 🙂 Delta sitting comfortably at -800 and given the DTE, any moves towards -200 delta and I’ll just start peeling off the trade piece by piece removing risk as I go.

Sep BWBs are currently going for about 95c credit and Oct BWBs are going for about 2.25c. I’ve got loads of flies up in Sep so I can purchase BWBs against those but I didn’t get any in Oct yet so I’d have some exposure to downside if I get some of the Octs on. Not terrible given the deltas I’ve got built up in Sep so I’ll probably put some on today. Usually I like to start with the flies. It’s no different than just entering a rhino/bwb though which loads of people do without the fly hedge/combo.

It’d be a huge milestone to close the Aug at 500k P/L. It’ll call for some real nice champagne. But I won’t fixate on it, I’ll just manage that risk. Huge month so far and I think July is sitting at just over 7% P/L and Aug will likely be similar. Cannot complain and thankful the market keeps on giving.

Had a 30% year last year and I gather I’ll get towards 50-60% this year solely from the opportunities. The last few months, I’ve just been concentrating solely on building that long vol BSH up and trading these Rhino/BWB combos but it rarely takes much more than 30min a day, things are boring when they are producing. Many traders say you’ve made it and are barking up the right tree when you’re trading a system thus eliminating human factors and bias and subsequently the actual act of trading becomes boring. The latter part is true right now, the former isn’t based on a system per say but it will be once this environment ends.

Jul 27, 2020 – August BWB/FLY Trade Update

We ended Friday at a delta of -900 after adjustments and now sit around -1700. That shows you just how quickly negative delta you get with time even just the weekend. The position is hovering around 285k P/L so it’s seen an increase of 35k over the weekend. I’ll have to adjust the upside today and by Thursday this will be done with removals from the structure rather than additions to it. There is 25 days to expiration and I’ll aim to remove risks as we go from here until it’s a benign structure that can be expired.

Jul 24 2020 – The Big ATM trade update

Here’s an update on my big August trade that has about two weeks left in it. It’s starting to actually look like an old school ATM trade given the reduction in VIX and the lack of credits in 30 DTE or earlier trades. From March till June, credits were huge and upside risk NIL. Now as opposed to then, I actually have to use some upside adjustments aggressively.

I started adjusting for upside exposure during this little fall towards 3200. My overall deltas are sitting at -900 and I’ll close out the day at that.

Delta: -939

Theta: 21,956

Vega: -10,567

The position represents 5MM in planned capital and is sitting at 251k profit. I’ll dance this thing into Aug 7/8th and continuously remove risk and adjust. There’s a small chance for an extremely large payoff (the biggest I’ve ever seen) @ 1MM in 1 month. Reminds me of that show 2months 2million. Ridiculous but it is the environment and the opportunities. These types of trades won’t last. For now, I’ll happily let it beef up the account. I’ve got BS protection in case we have some sort of massive gap down.

Here’s the trade looking forward 7 days

Here it is where I expect to close it. It won’t look like this later as I’ll be constantly adjusting back and forth between now and then and the negative deltas will continue to build up as time passes

For a bit there, the VIX hit around 24 and it looked like the ebb and flow trade was about to get a lot harder but today we can now get a Sep BWB for $1.00 credit. So we’re still going for now 🙂 I got some on to offset the Sep position which I started with symmetric flies back at 3260-3270. I’ll be very happy if we can keep getting these conditions for the next 6 months.

In a large fall, and if we approach -400 delta, I’ll start to adjust for the downside and I’ll offset with some way OTM calendars in case of a bounce. I have two trading weeks left for Aug position which will get more and more negative delta and have more and more protection to the downside. If I am forced to adjust for downside next week, it means we went through 3150 area and to offset the nuance of continuously increasing negative deltas, I’ll use some way OTM calendars for upside protection while adjusting for the asymmetric risks on the downside.

I gotta say, I feel kinda lucky that I was also able to start the September position, I wasn’t sure I’d be getting the same opportunities with BWB pricing. Perhaps this continues on for the rest of the year re elections in Nov. Eventually I will move on to a 488 campaign, BSH factory, TAA and ATM at lower PC.

Post Covid Crash update – May 5

Been a while, I should have kept posting through the whole event. I am up about 20% on the year which is decent given the events and given several mistakes I made. I’ve since revised how and what I do in my process and can only be thankful I ended up positive through-out.

Bizarrely, I was super in-tune with the whole virus thing back in late January as the first reports were coming out of China. By early Feb, I had got out of my entire standard equities portfolio (TAA –Tactical Asset Portfolio blend) and purchased 400 long puts ~ $1.00-$2.00 in anticipation of some volatility thinking I caught it earlier than the market. The market just kept going up and up and up until Feb 24. I had no real OTM trades on and had built up some long-vol portions but the nuances of en-cashing was where my regret lies.

On Feb 28th, I started cashing out of those 400 long puts which took a beating through the mid part of February. Had I kept them on till March 24th they’d have been worth millions. Just before that, on the 27th, with the VVIX spiking the highest since Feb 2018, I also started opportunistic OTM trades that got annihilated despite being hedged with Black swan hedges. A poorly timed entry, every indicator was flashing off so I should have waited for a bottom signal before entering but at the time I figured that the virus news would cause a more lengthy decline with several bounces in-between so I figured I could get in and out using vol relief on the bounces to capture profits. I was wrong. The mess lasted till Mid March and lost a bundle but was offset by my long-vol and BSHs. Though, I did take a pretty big temporary hit on mark-to-market throughout. Anyways, to go back a bit, on the bounce in early March, I picked up another 450 long puts at 1800 for $3.00 and I was going to convert into a BSH factory but the market collapsed almost immediately after I bought them (lucky). So I followed the trend down converting slowly into fully formed BSH and used them to hedge off the OTM trades. I was keeping that left tail popped up. By the end of it all, the combo was green and all was fine.

In Mid March, I started using OTM calendars on bounces as an income capture. As well, to offset the long vol hedge that was incredibly negative theta positive vega until I got a signal to encash, I started selling 5-7 DTE puts in ES after-hours at ridiculous prices whenever they came up and used that against my long-vol (calenderizing the long vol hedge that was 90 DTE). This all worked out really well and I was able to capture some really ridiculous pricing. I saw 1000 SPX puts going for like $10 I am pretty sure.

By April, I started doing BWB ATM trades on dips for large credit (usually they are $4 debit!) with 40 DTE. On bounces, I’d add symmetric flies. I’d rinse repeat this in a nice ratio to maintain decent profile and am still doing this now.

I’ve become a fan of using trend indicators for risk management and that’s where my interests lie right now. In this environment, I’m setting my portfolio to be mostly locally concave with respect to selling premium (ATM income trades) yet my overall portfolio will be global convexity (long vol). I won’t sell asymmetric risk rather I’ll own it by using some BSH type factories and some usage of OTM strangles and I’ll sell more defined risk upfront with ATM type strategies. It’s the environment we’re in and with the credits (removing upside risks) in the BWBs, it makes management much easier.

Since I am doing my own blend of things I can probably start posting more risk profiles and trades so I’ll start doing that.

May 6 2019 – Trade review (STT+BSH)

Nice little vol pop there. When I saw the tweet yesterday I knew to expect a very rocky futures open and when it got to about -2% I almost thought we could have a repeat of Aug 24 with a -5% open only because of the swiftness of the fall and the potential reaction when Europe opened. Alas, we swiftly found footing and the market rebounded and sits currently at 2920.

Funny enough, I had a portfolio on for my base via AllocateSmartly but didn’t love my entries and sold all of it Friday along with all my other longs. Good timing 🙂 I also harvested all my older STT and BSH last week and removed a ton of risk. I mean I have 600 net long puts in May 31 expiration and my Aug/Sep STTs were harvested. I wasn’t breaking a sweat last night even if we did open 5% down. Even today, I am neutral delta without a single adjustment.

Today, I am using the bounce and increased volatility to add some bearish toned STT. The bounce gives me better delta and the increased vol allows me to have a longer upside runway. Pretty much all I’ll be doing today.

My newest Oct STTs are taking a bit of heat, down about 300 a shot x 40. They were quite positive upper expiration line and roughly +50 delta but I have -delta older ones and I am adding some bearish toned ones now. Within a week or two they’ll be positive if all things remain equal. As time goes on, the trades get more and more -ve delta.

I gather I’ll get the account up to about 20% for end of June for the year. Which is roughly the target. I am hoping for 25% but we’ll see how this plays out. If we have more downside, then I gather I can get even more as we enter the tents of matured trades but if we runaway upwards, it’ll just be the standard lower profit. My goal is to consistently hit a yearly 50% with STT+BSH on total account value w/ compounding and opportunistic over-leveraging on significant down moves up to 1.2x. I won’t be deviating strategies or diverting any funds away to other trades. This is a year long real money test of real market conditions and actual trade results for the STT+BSH combo.

I’ve been researching T5 a lot lately but it’ll be far separated from my main account. There’s a lot of opportunity with that trade and its juicy AF but it’s more fitting of my older previous life as a professional gambler. You have to look at it like a weighted coin flip in your favor but with regular total losses. I have to analyze Kelly criteria and risk of ruin as well as all the trade mechanics and market environment entry type stuff. Big project. Re what I mean : if you have a 55/45 edge in a coin flip, and you have 50k total, how much do you bet per hand to eliminate risk of total ruin so that you can infinitely take advantage of that significant edge? Is it 5k a flip? 2k? etc. You have to analyze this differently then something where you put all your equity in every trade and try to eliminate max draw down. Rather you accept the 100% win or loss and determine the edge and calculate the bet size. Should be interesting.

Oct 16 – Update (#2)

Nice pop there. Pretty much bringing account back to normal now. Through the event I did have some vol related draw downs, nothing that stressed me out or anything but I didn’t love how I entered the event re trades/hedges and sizing which is prompting me to create a much more concise trading plan which I am really excited about. I feel really good about how things went and where they will go from here. I am basically shaking off some pests and revising some of the plan to be even more robust. Right now, I am developing a concise and mandatory trade plan that’ll be printed and bound and at my desk. As I mentioned before, I am taking my optimistic honey badger mentality and focusing it on entirely on risk management instead of out-sized returns and I am super relieved and kinda super excited about it. I am going at it hard. It’ll be epic to create any sort of trade plan that can handle large money that does 30-40% returns but doesn’t flinch in events. Ideally, it’s going to be a lotto as well. That’s an amazing feat. Thanks to the PMTT Group. Once developed, I’ll probably be looking forward to the next crash event 🙂

This plan, it’ll have all sorts of idiosyncratic rules and requirements that I am going to force myself to follow. It’ll also contain journals of my thoughts related to how I felt during crashes, what I did, tools etc. I’m accepting the returns that I calculated (more modest) and I am putting risk at the first priority. Take care of risk and the returns will come (compounded or otherwise). That’s the key I think.

Update on account and management:

ES:

By EOD, I have removed most of my PCS that I had on for the HS3s and am sitting at about even on an account level for the EDF/ES account from start of crash till now, all said. Not bad. I closed off all the Dec including the ATM PCS today (maybe a bit premature as I closed them around 2795 rather than the 2815 its trading at now).

Jan HS3s are locked and loaded in a really nice zone for quick profits in the next 14 days. Could add 40k in profit by end of Oct.

The Mar HS3 is down about 59k while the hedge is locked in at 30k profit so the combo is still down 29k total. Could recover quickly but EDf did force me to liquidate and lock in some loses last week. Not bad still. I also had initiated a 100 wide PDS at 2775 last week which hurts the UEL (upper expiration line) a bit.

The BSh factory is now profitable. I will use the next few days to start forming the BSHs and should be ready to rock soon as a hedge.

SPX

March CC campaign is at even now (wow!) and I have some bearish STT covering it which are down about 6k. So all in all about -6k to 10k on the whole thing.

Jan CC campaign is doing fantastic. It’s got so much theta that it could swiftly make a lot of cash in the next 14 days

Dec CC campaign. About even now (from pre-crash—but was at target anyways before) but has no real juice or risk. Will slowly turn into a hedge.

BSH Factory. Is profitable now. I was a bit too aggro on the short puts so I might use the opportunity to start forming on any signs of a down turn. Not really worried as it’s december shorts and they are deteriorating quickly.

X4: Removed for loss of 15k

Rhino: About even.

KH recovering some of the draw down.

All in all, I am about about 1.5-2% on the account and a week sets that even in theta and a month should be aces in profit.

If I get a few weeks to a month to rejig my plans, form factories and work on sizing then any further vol should be easily deflected if not profitable from here on in.

Dec 16 – March Rhino M3 Trade Entry

Not much going on. Trades gained some value today. Nice little down day in the SPX and flat for the RUT.

I entered some March Rhinos

50 x RUT:1290/1340/380 @ 2.19
75 x SPX 2120/2200/2260 @ 4.00

A bit far out but I do like to enter around 88DTE anyways.

I’ve converted most of my Jan trades into more M3 like structures today with the drop. I worry about a slow grind up for the rest of the holidays so figured I’d jump in front of that with some calls and futures hedge. Low volume rarely gets sold into. I do expect some January weakness though.

Oct 10 – Rhino M3 Trade plan

Not much to report. All the trades are sitting comfortably, we’re in a range that isn’t affecting much per say. I’ve got Dec and Nov expiries on and profits are rolling in. Great few months.

NOV:
For RUT I have 1150/1200/1240s

For SPX I have 2040/2120/2180s

DEC:
For RUT I have a mix of 1140/1190/1230, 1150/1200/1240 and 1160/1210/1250s

For SPX I have 2020/2100/2160s

I am approaching the need to RH the upper longs for both trades but I will wait till tomorrow since its reduced volume today re Columbus day.

I’ve been backtesting a longer variant of the SPX Rhino (80/60 wings) where I start 88 DTE and end before 31 DTE. I reduce the planned capital by half or in other words, accept a 5% return on the original planned capital of 25k for 3 units. The results were very good so far. The trade is easier to manage both on the upside and downside though quite boring 🙂

I’ve also been looking at uneven condors as adjustments (sell and buy volatility when skew is favourable for either). I like how Jim Riggio approaches this. When volatility is low, and skew steep, I might enter a symmetrical butterfly with a long call (buying cheap iv) and convert it to BWB when vol gets higher on a large down move.

As for the market, I have not the foggiest where things will go but bonds should be putting some pressure on the SPX especially if we clear 1.75. I still see a small correction to the 2040 area before making ATHs for end of year baring no surprises re Trump.