Wednesday, May 25, 2011

SPY Double Calendar

RMBS Update - May 17 Naked puts

Link to original RMBS trades:

Sunday, May 22, 2011

6-Month Review of My Trading Journey

Background: For those of you that haven’t followed this blog or don’t know my history, in mid November 2010 I started out on a 6-month journey to attempt to trade my own capital for a living. With the expiration of May options on 5/20/11 my six months is up and the results are contained within this post. Prior to this time the previous three months had been spent in Chicago trying to find an entry-level job in the options/futures industry, and the previous 18-months to that was spent as a full time MBA student. I didn’t think I was prepared to head out on my own just yet, although that was always the long-term goal. Ironically, most of the feedback I received was to do just keep doing what I’m doing. More than one person asked why I was looking for a job if I had my own capital and a positive track record. But I will be honest and say that after two failed interviews and lots of dead ends it was out of default that I chose to give this a shot. I applied to plenty of finance related jobs outside the options/futures industry as well and got nowhere. So much for the time and money I spent on an MBA and Level I of the CFA exam, to date it’s produced zero dividends.

Goals: The first goal was simply to breakeven for my living expenses so I could at least tread water and buy myself some time. I had a ten year history of bringing in about $1000 a month writing covered calls so making my breakeven number of about $2000 a month seemed reasonable. Based on my experience and capital levels I thought that a range of $2,000-$4,000 per month was about the high or lows I could probably achieve. If I couldn’t do better than $2,000 a month then I couldn’t justify trying to actively manage my account.

I didn’t have an asset allocation model in hand or specific strategies to employ. I felt I would stick with my comfort level of selling premium, mainly in the form of short puts on stocks I wouldn’t mind owning if put to me. In addition to this I wanted to try and actively trade futures while I waited for time to decay in my short options. I felt actively trading anything would at least keep my finger on the pulse and probably produce more premium selling opportunities for me. It turns out that’s exactly what happened. I thought I would use the ES to trade futures but it turned out to be ZB for me. As a rough framework I thought I would try and sell $2,000-3,000 of time premium per month and shoot for $1,000 in actively traded futures.

Questions: I needed to see how I acted psychologically when shifting from passively looking for small income trades to supplement a primary income, to actually trying to bring in enough to call a primary income, and also to warrant not pursuing a formal career. I also wanted to see how many more trading opportunities I could find by actively monitoring the markets versus passively watching them during the time I was busy with school or a formal employer. Was it possible for me to make more trading simply by being available more? Or was the amount I brought in over the last few years passively trading about the limit no matter what my availability is. I needed to see if I felt pressure to produce even if I didn’t see any opportunities I liked, or if I could just sit idle and be patient and only act when/if I saw something I liked. It was going to be a huge test of my psyche.

My Unique Situation:
  • Low Expenses (less than $2000 per month)
  • $80,000 capital loss carry forward from the tech bust in 2000 (so I pay no taxes on the next $80,000 in gains)
  • $200,000 in my portfolio margin account
  • Single, no kids, no debt
  • 10-yr experience trading my own account, profitably
  • Nothing to lose, no job alternatives readily available and the positives of success far outweigh the negatives of failure
  • An unbelievably strong desire (as in, at almost all cost) to stay self-employed and maintain the complete freedom I’ve enjoyed most of my life.

Pros/Cons: If I can make this work, I would greatly prefer to receive the benefits of the lifestyle that come with it. If I don’t want to work I don’t have to. If I need a day or week off I can take it. I enjoy watching every aspect of globalization unfold, the politics, economics, ethics, dilemmas, etc. The only aspect of attempting to trade for a living that I don’t like is just the uncertainty. But in this day and age of labor getting squeezed, pensions chronically underfunded, ever increasing cost of living, and no allegiance from corporate employers, I have to wonder if the path of uncertainty that I’ve chosen is truly any different in the long run than the alternatives. I view the main difference as being, with formal employment you get paid every month, until you get let go and the paychecks stop. Unless you are consistently employed with no gaps from layoffs, firings, transitions, or lower amounts from unemployment benefits, then your income stream will vary at times as well. With my path, sometimes I get paid, sometimes I lose, and I never know how much those amounts will be or when they will happen. There is no normal.

But I’m willing to accept the trade off of an unknown revenue stream in exchange for not having to get up to go some place I don’t want to go, to do something I don’t want to do, with people I really don’t want to be around. I tried that for a year, it didn’t work for me. I found out that so called financial security was close to worthless when it led to misery in every other aspect of my life. For those of you that enjoy your job, the money it provides, and the people you work with, consider yourself extremely lucky as you are in the minority. I also don’t want to spend the combined amount of time and money it takes to commute to a place I don’t really want to be. Between the depreciation on a car and gasoline, trading at home for a living puts over $10,000 a year back in my pocket, think about that. My car is paid for and I fill up about once per month. Add to that the amount of time I get back not commuting and we’re talking about a significant change in lifestyle. 

There are other intangibles that make this something worthy of the journey. If I can successfully derive an electronic income, then I can choose to live anywhere I want, preferably some place where the cost of living is affordable and the quality of life is high. If successful, I would also enjoy managing money for friends and family, many of whom have not properly planned for their future financially. I felt kind of guilty when I emerged from the financial crisis with my account balance back to par by May 2009 when many of my friends are still not back to their pre-crisis levels. Or worse, they sold what was left and are literally sitting in cash. I can do better than that for them.

But let me be honest, there are major cons. The older I get the less I think I'll be tolerant of an unknown income stream. Ideally I would need to increase my capital to a high enough level to compensate for that. I've already found out from past experience that being self-employed is a knock against you should you seek formal employment. The first question is always "what have you been doing?", then they inevitably say, "well why don't you just keep doing that." Other than one year of formal employment in 2007, I've been on my own since 1996. This journey is really a one way trip for if it's not successful, my options will most likely be even worse than what led me here to begin with. There are other cons such as no face time in an office, I'm not building a career network, what little networking I do is mainly done electronically through social media (so please follow my journey on Twitter and forward to anybody you think is interested!!)

Results: I had a great first five months, better than anything I would have expected. This was quickly followed by my worst trading month ever last month. The actual results and breakdown are below, I reduced the amount of realized gains by my current marked-to-market losses of -$6,000 to get a true view of where I stand. My starting capital was $200,000 so (19,372/200,000) = 9.68% for six months. I ended up having more than half my gains come in the form of actively managed bond futures. This would have surprised me if you showed me my results six months ago, but what really ended up happening was I got out of the chute on the right foot trading futures and didn't look back. This led to less time and energy available to look for short option premium trades. I expect going forward that this will reverse and I'll get back to more of my profits coming from income trades and not directional futures trades, we'll see. If anything this is encouraging as I have a long history making money with income trades. I thought it would be tougher for me to venture in to futures trading but so far so good.

Rational Next Steps:
  • Just keep doing what I’m doing (just like the guys in Chicago told me!) But seriously, just spend the rest of 2011 trying to refine my craft, learn more, get better. 
  • Scale my trades up. I currently usually have no more than 35% of the buying power available to me accounted for. I’m fine with staying small until/unless I get comfortable going larger. I enjoy sitting in mainly cash and if I can meet my desired monetary goal while primarily sitting in cash, then I view that as a win-win. I feel no pressure to try and max out potential gains.
  • Manage money for friends/family. I’ve already verbally accepted money and have about 8-10 clients. Total capital under control including mine will be just under $1M. That is a good enough number for me to get my feet wet at managing outside capital. I am currently in the process of deciding how to do this. I’m leaning towards starting with separately managed accounts and then upgrading to an aggregate funds type of entity if things go well. In the last few weeks it seems that every time I mention this I get offered more money, I haven't even officially recruited any yet. This tells me there is even more opportunity once I am up and running.
Findings/Conclusions: I think it’s too early to make a long-term judgment call on the viability of this venture, six monthly data points are not enough to do any meaningful reflection or projections of the future. It isn’t reasonable to say that since I’ve had a 9.6% return in six months that I could probably hit the 20% mark for a full year. However, after the third month I had already seen enough prospects for the future and progress in my trading that I decided to extend the trial period to all of 2011 no matter what the six-month trial period produced. It is worth noting that the SPX returned a better return during this time frame (11.7%). However, to achieve that rate of return on my capital would have meant the whole amount would have had to been invested long, I will never be in that position again, ever.

I will skip the conversation about alpha or sharpe ratios. The bottom line is that my return versus the risk I took is more attractive than the return of the most popular benchmark SPX. I'm also not sure that an actively managed futures and options portfolio such as mine should be compared to the SPX. That type of long only equity investment is an alternative, but certainly not consistent or comparable to the risk/reward characteristics on my portfolio. Perhaps a CTA index would be a more legitimate benchmark, through May 2011 that index is at 2.22%. At the moment it's also important to point out that I'm not holding myself out to be a professional money manager and not trying to benchmark myself. I'm simply trying to learn, get better, and make enough money to survive until I can draw some further conclusions.

From a monetary standpoint alone I feel my returns so far do warrant continuing the journey for all of 2011. Had I lost money overall or wasn't even able to meet my minimum living expenses then it would be difficult to argue continuing. So thankfully things have gone good so far. Also, I was able to answer a question I had about how many more trade opportunities I could find find if given the ability to watch the markets more actively, it turned out to be quite a bit.

If anybody has any questions or comments feel free to contact me below, I also would love to hear from anybody pursuing a similar path.



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Saturday, May 21, 2011

May 2011 Options Expiration Results

This is not the month I feel good about total transparency on the blog as it is a little embarrassing, but the bottom line numbers are that I have realized losses of (-$4,675), and head in to JUN expiration with MTM losses of (-$5,965). While last month was my best ever at $11,357, this was my worst ever and these results are directly related, and now I'm basically a complete wash for the last three months. Here is a shortened explanation of this month's results. I got myself in trouble on two separate trades on bond futures (ZB), and (RMBS). I got too comfortable with my past gains over the last few months in these names, which led to a false sense of security that enabled me to use larger size without having the appropriate associated risk management in place.

For the last five months on ZB I've been trading one contract at a time, this month I used two and three contracts at times, and when a particular OTM call trade ran against me I started trying to trade around it rather than just exit at my predetermined spot if we got there. I actually ended up exiting near my predetermined worse case scenario, but I panicked a bit when it got there and closed out prematurely. Because I had too much size in play I was no longer able to trade according to plan, I found myself now caught up psychologically in the amount of capital at stake. A very frustrating byproduct of this trade running against me was that since I was already too large, I had to use tight stops on future trades in order to keep my sanity. Every single one of these trades were stopped out for a loss, and every single one of them would have been winners had I traded according to plan. Once I got off tilt things got out of control in a hurry. I was left with a string of small losses and on winners, very disturbing to look back at the mayhem I induced.

With my (RMBS) marked-to-market losses I got stupid and sold JUN puts a week before the MAYs expired, that isn't part of my trading plan and thus shouldn't have been allowed. This came back to hit me hard as the stock dropped more than 20% on some old legal proceeding news. I do not view this trade as a mistake or error simply because the stock dropped, the error was that I doubled up on size by not waiting for MAY to expire first.

I typically try and sell a few thousand dollars of time premium a month ($3-4K) spread out over a few names, and then actively trade futures while I wait for time decay in the short options. So losing -$6,000 on a single short premium trade this month is not acceptable given my capital levels and monthly goals. I shouldn't be in the position to have several small winnings trades completely wiped out by one loser. However, when you're a short premium seller with no hedge then this sometimes comes with the territory. I prefer to use small size and no hedge instead of larger size and protection in the form of spreads and delta hedging. It is expected with this type of trading that you'll expire worthless most of the time but take large losses every now and then. But it is now time that I add spread trading to my arsenal. While I have a long track record of success with small size and no hedge, I need to be more nimble going forward.

I view my errors were not in omitting a hedge, but rather it was the size of my trades given the fact that I chose not to hedge. And I will admit that had I not lost any money I wouldn't have looked back and said I probably got away with using too much size, I would have just continued doing the same thing until/unless it didn't work. That's why I view this month as an inevitability and good for my future, so long as I learn from my mistakes and manage future risk accordingly.

The were two bright spots this month. One is that I did bring in $2,259 of short time premium on a myriad of names, which is part of the desired monthly goal. The second is that the losses I incurred are large enough to hurt and thus alter my future behavior of risk management, but not large enough to affect the operation in a meaningful way. For now I'm going back to where my success/comfort zone is in trading one bond futures contract at a time with no hedge, and trying to learn more about the nuances of spread trading. When you add a long option with a short then you've got to incorporate IV skew and strike price where as straight IV sells are a lot more intuitive for me.

Updated Historical Records


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Sunday, May 15, 2011

Interesting Week: Got Chopped Up, But was given a Gift, and a Reminder

This past week was one of those where I felt like the ping-pong ball and not the paddle. The pictures pretty much tell the story. The trades below were all similar in that I used OCO orders to set my entry, exit, and stop loss points. It's frustrating to see your stop loss trigger literally be the high or low tick of the day. When it happened three different times in 24 hours it started feeling conspiratorial in nature. The only person making money this week was my broker. The total money lost on these trades isn't large, that's the purpose of using stop losses, but the net result is I had a serious of small losses and no wins. I don't mind being wrong, but for some reason if I'm wrong I would rather be really wrong and not just barely. The first thing that goes through my mind after wondering why the market hates me is if my stop losses are too tight, then I question why I use them at all, for clearly on these trades they would have all made money had I not used a stop loss.

But then Friday morning I was given a little gift. The IV on one of the stocks I follow had slowly gotten to what I felt were ridiculously high levels so I put an order in on Thursday at midnight to sell some far OTM calls to hopefully produce an income trade for the next five weeks as these were JUN expiration calls. I used an even higher price than the previous close figuring if somebody wants to pay me this stupid price I will sell, not really thinking it would get filled. So when my text message trade alert goes off at 8am I decide to log on and see what the stock is doing and why this could possibly get filled, I log on just in time to watch it crash. Less than two hours after my fill I was able to close out for a nickel. Any time you can capture five weeks of time premium in two hours that is surely a gift and I will say thank you and get out. It feels just as wrong, but in a good way, as being stopped out multiple times only to watch your desired profit exit point hit later in the day. So you take the good with the bad, if you trade long enough you will experience both multiple times.

So the picture above was my gift trade that made up monetarily for all the trades I was stopped out on, and below is my reminder. Remember one of the trades above where I lost .06 and was pissy that it would have been a winner later in the day, well it also could have been a $3.00 loser, which it was just 48 hours later. So while I was questioning the stop loss points I chose or even my use of them in general, I was thankfully reminded just why to use them. I'm happy to be sitting on a $60 loss and not $3,000. So ironically enough the gift and reminder (or second gift) were actually the same trade. I was short the JUN 15/25 strangle. Full disclosure: while the short calls of the strangle were closed out for a .70 gain, I am still short puts on this ugly chart at a cost average of $16.10, so could be in for some pain here as they are also JUN expiration.