Credit Spreads for Consistent Profit in Small Accounts

Sorry for the delay on these. Look for them to post on Monday mornings at the latest in the future. This post will show two weeks of activity in order to catch up.

Let me clarify what we are doing here. We are selling vertical credit spreads in high volatility. The process is as follows

-Scan stocks for IV Rank over 50 and secondarily IV Percentile over 60

-Check option chain for sufficient open interest and a reasonable spread (20-30% reward to risk)

-Look at chart to determine direction and key support/resistance

-We select spreads that have the short strike at or close to the .16 to .24 delta (these are essentially a shortcut to determining probability ITM. The larger delta is more risky, but tends to pay more.

Being a seller puts option greeks to work in our favor. Gamma causes delta to fall faster than it rises, so when the market is choppy, it is good. Theta decays value over time, which we love. Vega determines value based on IV. We are shorting on high IV and utilizing a philosophy of mean reversion to our advantage.

https://vicmora.wordpress.com/2011/02/05/credit-spread-greeks/

Week ending 4/28

Awesome Monday with world news causing stocks to fly. We took advantage of the surge by taking profits off the table. IV ran down as a result so we slowed down trade monday afternoon to see what happens on Tuesday. We happened to get a miracle play on GOOGL!! WOW. Realised TD Ameritrade pricing is not good for small accounts. Next week I will start with Tastyworks pricing: $1 per contract and no closing commission. That will save a bundle. One dark spot was that we had one short position on which got destroyed and we took our first loss (one of the rules in this strategy is that if price touches the short strike, the trade immediately terminates). Losing is part of playing the game. You have to be able to accept that and move on. Ended net positive in spite of taking a loss. After Monday, trades were increasingly difficult to fill. When markets are thin it is difficult to get what you want, best to take it easy and wait for setups. Watch out for earnings. I had a couple sneak up on me. The fortunate thing is that the nature of our trades benefits from the flush in IV that comes after earnings announcements. The danger is that the IV is warranted, and large swings can wipe out your position. BWLD went against us, but we profited. AMZN went for us, luckily. Big earnings on thursday, mostly tech, mostly good, so our QQQ hedge will be dropped at around half loss. Generally we hedge around binary events. Wrapped up the week with no positions, which is a good idea when you don’t know what is going to happen.

Read an interesting article about the “dangers” of trading credit spreads. Apparently the author had blown up his account with the strategy. I discern that he was not managing trades. If you think that this is a set it and forget it proposition, then you will lose. This is how I manage trades…

-Stop loss is the short strike. If price touches short strike, exit immediately. No questions.

-Take profits if they clear 80% of credit taken. It is worth missing the other 20% to not have your good fortune reverse overnight. (consideration given to proximity to expiration)

I thought about giving daily updates, but you can see in the trade notes what is happening.

pic1pic 2pic3

Week ending 5/5

Monday started the new pricing on contracts. Now I am getting $1 per contract to open and no cost to close. In two weeks I had spent about $140 on commissions, which makes this far more challenging. All of this week’s trades cost me only $8.

Came in this week with nothing on the board. With the government funding on the line I did not want to have risk on. They decided to fund and markets continue up. Earnings are really the only IV catalyst for the week. It makes for some more risky trades, but they can be rewarding as well in a shorter time frame. You’ll notice that both of our earnings trades ran against us in a big way but stopped right at our short put. Need those to rally off of that low. Noticing some profit in AAPL while I am still under entry price. That is why I trade this way. Technically wrong, but not losing. Beautiful! And I have time working for me every day that passes. Oil happened to be down quite a bit. Took the opportunity to get long with XOP and some good duration to see it happen. A bit close to the money for normal setup, but I am calling a bottom. 65% chance of success is still better than buying calls. We had a very positive jobs report on Friday that boosted things a little. Great news since I had two decent moves against me.

This is an interesting article I found

http://www.optionpit.com/blog/fallacy-income-trading

It seems to go against our strategy, but he makes the real point right at the end. We aren’t just blindly selling premium and praying for a winner. Our “edge” is in our selection. The elements are high relative volatility and, through technical analysis, some directional bias. Also we gain advantage by managing trades effectively. I have said before that we want to take profits at 80% of credit, but I think we can actually reduce that to 50% in most cases. Also there may be some value in holding losers to expiration day and then selling them. I suppose that depends on how far in the money the contracts are. We’ll see what that looks like perhaps on the TSLA earnings trade.

Friday evening I made some decisions. I closed all but the short FXE position just because I am really uncomfortable carrying much risk into a big event like pivotal French elections.

pic4pic5

You can see the rules of trade are morphing. More on that in the next post!!

Guest Post: Credit Spreads for Consistent Profit in Small Accounts

The following is a guest post from a friend on trading. Give it a read and use the comments section for additional thoughts! As always, your risk and decisions are your own.


The individual retail investor has the ability to invest more aggressively than the average institution and with a greater security than the average hedge fund. There is a wave of retail investors, that’s you and me, who are coming to a realization that the investment firms are not necessary. There is a whole world of investment opportunities in the public markets that require no advice from the people that have always been the ones that “know what they are doing”. Rant complete!

 

With this weekly update, we are going to see if a regular Joe can create consistent positive returns with relatively small quantities of capital. How? Trading options… with a twist. This is a study of a person’s ability to remain profitable and control losses with an account size that really can’t afford to lose. The method selected for the task is the sale of credit spreads at or near one standard deviation from the at the money strike. This is not intended to be an education on option trading, so I won’t go over the basic concepts. If education is required I can link some YouTube videos that would do better justice than I. Every week I will update this page with open positions, updated PL and a breakout of returns per expiration week. I have had the strategy on for a little over a week already, so there is a some activity to look at right away. Before I post the details, here are some of the rules of the trade.

 

  1. Trade small and often
  2. Take credits that are between 20-30% of risk
  3. Always use limit orders, never use market orders
  4. All trades terminate if price touches short strike
  5. Trade strikes at 1 standard deviation from at the money (sometimes I bend this one a little to squeeze extra profit, but only when I am very sure about direction)

 

This study supposes an account size of 2000 dollars to start with. You will notice the importance of protecting capital with so little available. Credit spreads require more cash to put on the trade than simply buying options, but it is way less of a gamble when it comes to being directionally correct. I find that many people who are familiar with trading options are either unaware of this strategy or simply do not use it. We will see here whether it is the best strategy, or at worst something that should be in your tool belt.

 

This was the very first trade. Not the best but it worked.

graphic 2

Lessons learned. Use wider strikes instead of more contracts. The premium was not ideal and I should have been able to find a much better credit. You can see that risk was $840 which tied up my cash and inhibited my ability to trade often.

 

Here are the current open positions, with notes.

Graphic 1

Still ironing out the process, but getting there. This is the Profit and Loss per trade

Graphic 3

 

The AAPL position is closed for a profit(green), the others are open positions, closed losses will be highlighted in red.

 

There is a lot going into these trades that you do not see like technical analysis and scouring option chains to find the best spreads. This is not intended to be education. Merely a proof, maybe, of the efficiency of this method. Future updates may include more of the process of selection and execution.

 

If you are interested in knowing more of the details, or have questions, use the comment section to let me know.

Dean

More execution, less talk; or building a track record and things to read

When you are an unknown trying to break into the entrepreneurial world from the outside there are a few maxims that hold true:

  1. No one knows who you are; no one has reason to believe you’ll be able to execute
  2. Talk, talk, talk. Everyone talks about being their own boss, running a business, taking that risk, far fewer actually pull the trigger. I liken this to the military as well. “I was gonna be a SEAL/Green Beret/PJ/CCT/Superman, but I decided to pursue my dream of basket weaving instead.” Or really, “I was gonna join the military but decided that would be selling myself short, but that’s just as good as having actually served.” This is probably not dissimilar to a number of things. “I was going to be a US Senator, but decided that would be selling myself, and my calling, short.” And on and on. People like to talk about the cool things they are PLANNING to do, they are too good for, or that they could have done if they had wanted to. I think it is similar to why many people assign blame for their circumstance or failings to some other unspecified boogey man. It’s the governments fault. It’s that rich guys fault. It’s that poor guys fault. It’s the fault of (Insert ethnicity) people. Risk is scary. Talking is easier. Blaming something else is comforting.
  3. It doesn’t matter how much money you make on your first deal.This comes from a conversation I had on my networking efforts over the winter holidays back in Texas. That first deal gives you a success to point to, which gets you a second deal, and third deal, and fourth deal, and so on. Then hopefully you have a reputation for adding value and have solid trusting relationships with LP’s, business mentors, friends, confidantes, and partners.

The above is my opinion, and I reserve the right to be wrong.

With that, I am actively working my first deal. I hope to have news to share shortly.

Best to your investing!


Sectoral and Occupational Trends in the U.S. Labor Market

Why the 101 model doesn’t work for labor markets

Q1 GDP Forecasts Downgraded Again

Turkey’s President Declares Victory in Vote to Expand His Powers

HIGH TECH COWBOYS OF THE DEEP SEAS

 

Unsexy Businesses

Unsexy Businesses or “Acorns”

Acorns get it? (Unicorns)

Anyway…

I’ve spent over a year looking through Bizbuysell.com (BBS), signing NDA’s and, getting a wide array of financial data on various small businesses.

My thought has been, what is to stop someone from buying up profitable cash flowing small businesses and levering them up in their segment.

Find a cash flowing profitable small business, focus on growing the balance sheet and bonding capacity, and streamline, consolidate, and optimize like your life depended on it.

Basically a personal private equity strategy meets an industry rollup meets a dude running a small business.

Or something like that.

To get one thing out of the way…BBS is mostly full crap.

I’m talking big time crap.

Discovering this made me move my price threshold to >$1M.

Yes that cutoff is pretty dubious, but it helps eliminate most of the fly by night trash heaps that many have up for sale.

I’ve learned a few things about the sustainably profitable businesses I have come across.

  1. Most of these businesses could use massive help in the accounting and finance department, operations modernization, and general high level strategy.
  2. A lot of these owners view finance as the nerd stuff. There are pretty glaring holes that come out of due diligence calls and simply looking at whatever financial statement they provided.
  3. Very few millennials own a sewage processing company. I have no data to back that up, but I am fairly certain that among entrepreneurs in my age group, next Facebook startup trumps steel and piping fabricator all day every day.
  4. A lot of these owners started a business a couple decades ago by walking into the local bank, finding a loan officer and never looking for financial sources again.
  5. Unsexy businesses can be major money makers. Obscure niche industries with surprising market size, obscure locations, and quirky owners. Highly fragmented industries in general. There is opportunity everywhere.

The drawbacks to the strategy of levering up/acquisitive growth at the small business level is:

  1. Exit strategy. Eventually you would want to sell. You would have to reach a size that put you on the radar of specific large industry players or private equity.
  2. Acquisitive growth/segment consolidation requires capital and a whole lot of patience and trust unless you are already wealthy. There is no way around this one. In my eyes the biggest hurdle to acquiring the above fictional steel piping fabricator would be the down payment of the first sba loan/commercial loan/debt instrument to get into the deal in the first place. Thus you need a high net worth backer and their trust (and hopefully sage advice).
  3. Finding an LP that is patient enough to look past the next quarter or the next 4.
  4. Some of the owners stories are very circuitous…now ideally that wouldn’t happen, but if it does I would think you need some staying power with your LP otherwise the plug is pulled too early.

Industries that I have hit on profitable small businesses with varying degree of market (and expansion): Steel piping, guest ranch/inn, cattle ranching and Ag, sand mining, water treatment, and logistics (trucking).

Thoughts from the crowd?

Volatility Trade

Pros have been shorting volatility since late last spring and roll yield has rewarded them handsomely.

I’ve had a pair trade on for the last 3 months.

Spread SVXY

Spread UVXY

I put it on and left it to see what would happen.

So far SVXY is up 21.84% and UVXY is up 253%.

Now…

My UVXY position was up over 400% on a previous post. That means it took yesterdays spike in the VIX to put it back to 253% today.

SVXY on the other hand has been trucking regardless. The long side of the SVXY spread is up 63.2% and 46.14% respectively. The short side is down 53.61%.

In spite of the UVXY position being up several times over multiple times this year, I have to think that long volatility is a losing bet. I don’t pretend to be able to predict the future which is what going long volatility requires.

I am speaking in the sense that you would contemplate going long volatility as something beyond a hedge.

Public market design makes long volatility a guaranteed loser in the long run.

Of course products like UVXY aren’t designed for the long run, but that is for a different post.

Beyond the volatility trade I am crushing GMAT study time and reading through every Pitch posted on VIC. Time permitting I would like to post critiques of the VIC pitches. “Post mortems” if you will.

Best to your investing!

 

 

Things To Read

I spend most of my free time (…time in general) reading something.

Economics and Finance

   The Reclusive Hedge-Fund Tycoon Behind the Trump Presidency

“Mercer is the co-C.E.O. of Renaissance Technologies, which is among the most profitable hedge funds in the country. A brilliant computer scientist, he helped transform the financial industry through the innovative use of trading algorithms.”

RenTech is pretty fascinating in general so this may be of interest to you.


Recommend the Fall 2012 and Winter 2015 issues of Graham and Doddsville with Royce Associates and Corsair Capital


 

Not Guilty by Association: Why the Taint of Their Blank Check Predecessors Should Not Stunt the Growth of Modern Special Purpose Acquisition Companies  

Equitable Growth in Conversation: an interview with William A. Darity Jr. (“Sandy”) of Duke University

How to Give a Cool Appraisal to Hot Economics Studies

Mortgage Rates at 2 Week Lows Amid Political Uncertainty

Housing: Upside and Downside Risks


 


National Security

The Rise of the Autocrats

Few Observations on Wikileaks and Vault7: Hacking at the CIA

Why Strategies Disappoint—and How to Fix Them

Assessing the Third Offset Strategy

Tracking the Trends and Numbers: Islam, Terrorism, Stability, and Conflict in the Middle East

 

 

 

Economists View (Things To Read)

Can’t we all just get along?, Econometrics edition – Noahpinion Why the Trump Agenda Is Moving Slowly: Republican Wonk Gap – NYTimes Can Tight Labor Markets Inhibit Investment Growth? – macroblog GDP-linked bonds: A primer – VoxEU Machiavelli as an economist – globalinequality Does everybody prefer organic? – Jayson Lusk The Financial Fire Next Time…

via Links for 03-01-17 — Economist’s View