When discussing trading with friends this is the number one question that always comes up: “What’s the rate of return you’ve got?”
I usually had to reply “I have no idea! Because.. i don’t care!“. And then i have to explain (all over again) why it is absolutely wrong metric to focus on.
The shortest (and incomplete) explanation goes like this: when you are racing car/motorcycle should you be focusing on your gas mileage? Should a basketball player focus on his last year statistics. Or should he be focusing on training, skill development, team-play, physical and mental preparation, on the game itself?
I guess it all comes down to the fact that people with no(t enough) experience in trading cannot imagine themselves making decisions that will result in loss of capital. But they can very well imagine making large profits.. and all that stuff they could buy for those profits. So if the rate of return is bigger they can buy even more stuff even more quickly! More, more! Because more is better!
It’s not a loss if i don’t close that trade! I can just buy more and bring my avg. price down! I just have to wait a little longer to make up the losses! Right?
Of course not. Because outside uninformed mind (i.e. the real world) stuff happens! Losses do occur and they don’t go away. This is what you SHOULD be focusing:
- how big is the maximum risk.. i.e. how much i can i lose?
- is the maximum loss only tiny part of my capital so i could continue to trade another day?
- are the expected gains large enough compared to maximum loss- is this risk even worth taking?
- how quickly can the “risk” happen – do i have any options to change my positioning while the “risk” is happening? risk happens very slowly at first… and then all at once.
- what is my plan on mitigating timing errors? no matter what you are told, nobody can time the market perfectly.
- what is my exact exit strategy when i’m up money? and when i lose money?
- am i mentally prepared to execute the trade (take the loss or leave money on table)?
Those are the things i focus on. I built Your.Capital around those concepts so that my emotional and irrational mind couldn’t play tricks on me. Because i am 100.0% sure that i am unable to completely avoid trades that will result in loss. Most important thing is i preserve my capital and be able continue to keep my winners much bigger than my losers.
And that just isn’t possible if you don’t focus on risk management.
Profits are just the by-product of risk managed well!
Here are the final results of that election trade (rate of return on capital highlighted).
So what do you think – how well was that risk managed?
The presidential election trade became profitable literally overnight. 70% of short option premium vanished in 3 days. Now 11 days later 99% of premium has disappeared but we still have 28 days until expiration.
If you traded only stocks and no stock options then with regard to risk (little pun intended) you have no options. When the position was initiated the main trade idea was that UVXY is overextended and should fall shortly after next POTUS is elected. Since then UVXY has fallen about 25%. And with it your probabilities of ETF moving either up or down have become more or less 50/50. As a stock trader you should exit the trade. Because you don’t have any statistical edge left.
Option traders on the other hand are smiling. They could have been 43% wrong and still be in profit (against stock traders 43% loss of capital). They got profits from UVXY fall (delta component in option pricing). They also profited from implied volatility crush (IV component) and also 11 days worth of time decay (theta component). And since UVXY could now go up, down or sideways we can adjust the position to accommodate all those moves simultaneously.. for more profits (against stock traders closing out from further profits).
Your.Capital found nice adjustment for existing position on friday 18th of November.
Here’s the position (one lot) before adjustment:
It has negative 93 delta (which means it gains $93 for each UVXY 1 point down move) and no short option premium left (Total Air column is almost 0).
And here it is after adjustment:
We now have over $724 of new short option premium (which we could gain in 28 days) and also positive delta. If you look at only delta you would think i must now be betting for UVXY to rise. But i’m not. If all option price components are accounted for after 28 days the total risk has now shifted as follows:
Trade gains additional profits when UVXY stays between -16% and +77%. Considering existing profits the whole trade remains profitable for moves from -30% up to +92%.
Max gain to current profits is $919. So there is potential for doubling profits. UVXY needs to move higher 15% for those max gains.
UVXY tends to move sharply up when market falls. And this is exactly where the bulk of gains are. Last month of the year is usually very calm in markets. Which means contango effect in VIX futures term structure and that makes UVXY lose value. Slowly but very very surely (just look at it’s long term price chart).
If this should happen also this year UVXY can lose up 16% and i’m still not giving up any gains.
Downward move is now much slower than upward spikes. That gives me time to react if UVXY looks likely to lose even more than 16%. Then i could close out the position, adjust it one more time, roll it forward into January 2017 or even further etc. There are always ways to adjust position – how & when is conveniently taken care by Your.Capital.
Best of luck to you with your trading!
The election trade (Stock could go 43 percent against me and i’d still be making money) worked as perfectly as i’ve imagined it. 70% of short option premium came in just one day after the elections. One lot looks like this:
Per one lot: in three days $435 gained, only $184 premium left to gain.
And here are 4 key reasons any sane person would take those profits:
- There is simple truth with option selling: your gains are limited and losses are unlimited. Therefore when your profits reach over 50% of potential max gains you now have more to lose than to gain.
- If you decide to stay in the trade you expose yourself to unknown event that could spike option prices. Gains will be replaced by unlimited losses – how stupid is that?
- Managing winners by taking profits have been thoroughly studied by Tastytrade ™. Their research shows why it makes total sense to take off winners with 50% max gains reached. With those fast profits you can now open a next trade somewhere else.
- Historically UVXY loses value so damn fast that it is reverse split nearly every year! This reverse split creates stupid new options that are not 1 contract per 100 shares anymore. Rather 1 contract per 20 shares (in case on 5:1 split). Nobody knows anybody who would like to trade those piece of shhhhhhht option contracts. Hence they become completely illiquid and you’ll be stuck! Exposed to all risks, until options finally expire.
And.. I shall not take off this trade!
First of all i’m completely ok with UVXY spiking so i could short more of this P.O.S. ETF.
Secondly http://your.capital monitors position constantly so i can enhance (lower risk, increase gains) in any market situation. You don’t have to limit yourself to mediocre gains with typical risks.
Let the machine do the constant working part and i’ll do whatever-i-shall-fancy part!
Thirdly if your positions are correctly sized (small enough) then you don’t have to take them off because you’ll have enough capital for your next trades.
Hope you all did well with the latest market swings and best of luck!
A time has come to put money where the mouth is. The plan was first described a month ago here https://yourdotcapital.wordpress.com/2016/10/09/trade-presidential-election/
A lot has happened during past two weeks:
- VIX has nearly doubled from 12 to 23.
- VIX rose on 9 consecutive days in a row – something that is unprecedented in its short 24 year lifespan.
- Market expressed very clearly that it is “with HER” and does not want to make America great again.
Rising volatility was great for the plan. That is until the director of FBI announced on Sunday after examining 650 thousand emails (1 email per second) found on some wiener’s laptop that Hillary Clinton is exactly as dirty as before!
Which in America means she won’t have to run the country from jail cell. Which the market liked very much. And the volatility collapsed. Damn.
Still… on with the plan. I chose UVXY as the underlying for shorting volatility. Just because it’s the worst ever vehicle for going long on volatility. And this means it’s the best for shorting it for the short term. The reasons for that have been blogged thoroughly. For example here.
Your.Capital found the best risk:reward ratio for shorting UVXY for next 39 days (December 2016 monthlies) to be a very simple combo:
short 3 CALLs (strike 20)
long 1 PUT (strike 13)
(by the time you look at this link the market data has already changed and so has the best combination along with it)
Of course it is not a standard textbook option strategy – it almost never is. Custom combinations offer much better risk:reward than anything you can learn online (or from some book). Btw, at the time of taking the position UVXY had short sales restriction.
Why is Your.Capital’s position so much better than buying puts (or anything else for that matter) needs more explaining. I’ll link it somewhere here (after i have written a post).
So (the one lot of) the combination looks like this with the real prices i got orders filled with:
I kept the initial position small for three reasons:
- because money&risk management.
- volatility has already come down from lofty levels (thanks FBI).
- maybe, just maybe… if Trump wins… there will be some short term volatility spike and i could add to the position with much better prices.
Now it’s just waiting. There will be third post coming up during christmas holidays. A final checkup on profits and losses.
PS: that lizard had a really bad day – Run, Vix, run!
PPS: don’t watch if you are afraid of snakes.
US presidential election is on Tuesday, November 8. 2016.
This is known event at precise point in time with unknown result. We’ve had that type of tradable political events before – remember debt ceiling “drama” in August of 2011?
I think the election offers great trading opportunity as (implied) volatility tends to rise before the event. Only to be fading in a matter of days. We do not know who will be elected as next POTUS. Yes, seriously – nobody knows… oh wait, you still trust those polls after Brexit?
We also cannot predict how the stock market index will react. Some say it will crash if Trump wins… or it will rally if Clinton wins. I won’t be catching any of those trains.
I’ll bet my money (yes, real money) that VIX futures will come down because one of the greatest enemy of stock market – uncertainty about the future – will be reduced after event has happened. Even if the market drops the volatility will still be coming down from lofty levels.
You could trade it as short UVXY or long SVXY trade. Both ETFs have tradable options available. Hence http://your.capital/#analyze/SVXY finds the best possible option combination for you just before the election.
I’m planning to open the position one day before the event, on November 7. 2016 and hold it until options expire. Follow up to this post is coming!
And as always – it’s your money, always do your own homework.