Saturday, January 29, 2011




I´m still trying to figure out your methodology. I´m looking at my IC. Calculating from the BUY BACK costs, different than the credit you receive. On the credits I got .60 cents a side for the IC.
Sunday morning and I´m fresh so I can think about this a bit.
The buy back cost was $1.00 a side, so to buy back when the IC is new, there is of course an immediate loss and you hope a combination of market action and time decay will reduce that $1.00 buy back cost below what credit you collected, thus ensuring a profit.
Right now after an 8 OEX point move downward, the PUTS are worth $1.50, a bigger loss by half. The calls are okay and have shrunk from a $1.00 to .85 cents. The market action by deviation method is 2% and I´m 6% out the money, so the IC is okay.
So what I´m looking at now is the losing PUTS for buy back costs. I believe you said you closed, if it reached 20% of capital in the trade? Since the trade is put on by a spread premium, is that 20% of the credit received, or do we figure on the margin required to cover the trade? Let me see ( thinking out loud ). 20% of $60 per contract would be to cover at a loss of $12. I´m already over that if you figure versus credit with a $150 loss on the PUTS with this downward swing. But let me see, if you figure margin at 10 to 1, we are looking at a $1000 at risk, so we need to cover if the trade loses $200? Okay so far - assuming that, then the current IC and the losing side PUT is okay at $150 loss so far, with a permissable $200 loss based on the margin requirement. I guess I will go with the margin at risk qualification. Would you confirm that is right?
Now I´m very curious about this POT, or probability of touching figure. The POT I find out was 51%, not so good at all. Obviously the spread was put on at the wrong time by your criteria. Comparing the POT to my usual deviation method and other people who use Delta. I´m going to look at weeklies, because if we are selling time decay it makes more sense to me to sell weeklies than two monthlies. Lot more trades. Bigger monthly returns. I want to check the option chain in TOS and see how the POT figures in those are and see what we get?
The trouble as I see it, is in safety versus reward for a credit spread trading method. That said, I can see that safety dictates you split your credit spread trading account into numerous small trade sizes. So if you close by forced market action in the two monthly method, your losses don´t become so large as to wipe out the gains from such small rewards of 3% or 5% credits. The more tiny trades you have the better you are. Of course over a two month period I can see you would be able to do this more often and by mixing up as many different indexes as possible, you would be able to do more Iron Condors, which in turn boost returns, because of the savings by not using margin for the second half of an Iron Condor. The complication being in one account, the computer doesn´t necessarily recognize multiple Iron condors when doing the accounting. So more indexes are required to spead Iron Condors. Either that or more accounts.
Indexes tend to move together, the charts are more or less the same. So putting on multiple Iron Condors depends on your finding favorable POT figures. I believe you use less than 20% POT.
The trick is to safely use credit spreads to make 90% better annual returns. Ordinarily that would be done by compounding, or increasing bet size as your account grows throughout the year. It is trying to keep your account fully invested in your methodology, but safely protected from losses. In your method losses are inevitable, and to protect against that you must go to smallest possible trade sizes and as many of them as possible, which in turn means using as many indexes as possible, or more seperated accounts.
I guess I´ll take a look at weeklies and their POT numbers and see how accurate the POT is for entering on the weeklies. Ordinarily I use deviation. If you can get a 5% deviation on a weekly trade, your chances of winning are roughly 97%. If you enter as the week progresses, the deviation reduces. by Wednesday a 4% deviation is usually successful and by Thursday a 3% upper and 4% lower deviation for a spread is successful. How that compares to POT calculations I do not yet know. Will be interesting to research the equivalency. While the premiums are much smaller in weeklies, whether some other index or the OEX, I found that the profit was the same, or better in the OEX, even using .15 cent to .30 cent credits. I traded the OEX last year exclusively and found the percentages were the same with the other indexes, if I had traded them. The only advantage I found in some of the other indexes was that you could get an extra 1% deviation, out the money, when looking for a suitable premium. In the OEX the premiums get very small and it is hard to get out as farther than 3% deviation. The winning profits though were the same percentage wise. So I stuck with the OEX. The only new factor here is the POT number and how good it is in forecasting for the week market action. I found the delta useless. The trouble with weeklies and using one index is that you cannot take a loss. One loss compounded to increase bet size wiped you out pretty much. The system I used was either win steadily, or lose it all. I ended up losing it all, on average once every four months trading weeklies. Though the compounding effect of credit spreads and iron condors was very impressive while it occured. But to get to 90% annual return or better, you had to compound your bet size.
The crux as I see it in your two monthly method is how effective your method using POT is, and particularly your method at taking a loss at the 20% of margin is. That is roughly a $60 win bet, versus a $200 loss on the bet when it occurs. At that rate you are looking at the need to win four times more often than you lose, if you want a profit at the end of the year. What size profit would appear to be the ability to make small bets. Since indexes move in tandem, you wouldn´t gain anything if you placed the same bets on different indexes, when you got a loss it would occur across the board. I suppose using the POT and maybe the VIX to control credit spread bets entries might be the answer? To what extent is unknown.

Credit Spread trading vernacular:

Credit spread, to sell premium in options on cash derivatives

Iron Condor, to bracket the fluctuation of an index market action using an upper and lower credit spread.

VIX, means the volatility of market action. A measurement that dictates index swings due to mob pyschology. Gives approximate average daily, or weekly true ranges of high and low swings.

POT, means an analysis of PROBABILITY OF INDEX movement touching a credit spread when you incur a total loss.

Delta, gives a rough figure of probability of the index swinging to hit your credit spread.

Deviation, the amount of swing, or fluctuation in market action as a percentage.


**** The Private Auxillou Family Hedge Fund switched from credit spreads to straight buying and selling of options on indexes as of Dec. 1st, 2010. As of this date Feb. 2nd., 2011 the Fund balance has grown 73%.