My Bread and Butter Trade

[ernsttanaka]

I executed the discussed adjustment around 10AM this morning. I did not expect a run away market to the upside, but I can only allow myself so much room when it comes to delaying my adjustments. The name of my game is not 'correctly predicting market direction', my game is called 'Manage Risk while Theta is doing its work'.

Hence I moved 2 call spreads from 790/840 to 840/890.

In the attached graph you will see the effect on the break evens and the Greeks.

The 2nd graph I attach today shows 4 P/L lines each for 2 days further. So the white line is today, the next one is for Friday, Sunday, Tuesday and Thursday. You can see that the distance between the line become bigger, that is the effect of the acceleration in the decay of the Extrinsic Value (theta).

Completely theoretically I am getting close to my goal next week Thursday.

[ernsttanaka]

The time spread / calendar part of the trade hit its profit target and I removed it for a nice 20% profit (not taken into account commissions).

In for 9.50, out for 11.40 * 3 times = $570 minus $8 commissions. Not bad for a trade which started of as a hedge for the increase in volatility.

I will give a general tally of P/L when we finish this month.

Below you see the position as it is currently without taken into account the profit from the calendar or from the first butterfly. As said we will add up later.

The plan is to sit on hands during the trading day, and when we have a close beyond 810 or 785'ish to adjust.

The planned upside adjustment is a buy back of the 790/840. Not sure if I will sell extra 840/890 since there is not much money to be made for a lot of risk.

[ernsttanaka]

Sorry for the hiatus - but I am in California on vacation - with my wife and little baby girl. After hours I try to stay away from this evil eye.

We are still in good condition, the plan is unchanged. I will wait for a close above 810 or under 780 before I will do an adjustment.

A rough tally I kept over all the RUT trades so far (first butterfly and calendar) set me at 3/8 of my $ goal. It is for sure taking a bit longer this month. Let's see how it ends.

[ernsttanaka]

This is becoming a struggle this month. Taking into account the prior butterlfy and the calendar I am slightly up for the month, but not yet half way my goal.

As always I have two choices; pull the trade and decide that this month was not a good month to play the "normal distribution" odds, or keep fighting.
It is 6:30 AM in California, I am going for a golf game. So I will make up my mind on the 18th hole :)

BTW I adjusted the trade Yesterday morning, by closing out 2 790/840 spreads.

[Ken]

Thanks for the daily update Ernst. These are really helpful. What are your thoughts on creating butterfly around the range where max pain would fall into since there's tendencies for price pinning near these price points ? This would have to be nailed up perhaps 2 weeks prior to expiration which also is where we have greatest option premium decay. Longer term butterfly/Iron condor appears to work best in slow grind up type market but seems to be a difficult strategy to maintain in volatile market.

Thanks,
Ken

[ernsttanaka]

Yesterday, I had to make another adjustment. Taking of again a 790/840 spread would have create a (for me) too big an imbalance between the put and the call side. Of course you can put you head in the sand and just keep removing 790/840's but a market which returns south would then really have the potential to hurt. So I preferred to remove a 790/840 in combination with a put spread 740/790. In effect removing a 2 lot Iron condor (see below).

Now I "waiting" for a couple of days of weakness. I am giving the market as much time as I can, expecting that window-dressing @ Q-end will follow by some selling into the long weekend.

To Ken's question - I have been toying in my analyze page with adding a new ATM butterfly on top of this trade. I have been playing that in combination with removing the last of the prior iron butterfly. For so far I have decided to sit and wait. Partly because I am on vacation and have less screen time.

By itself I have nothing against adding a fly here ATM, but I would not place the fly above the market. We already made a big move up, some consolidation would be very normal. The usual aspects come into the equation when you add to a trade; Risk and possible reward. Getting closer to expiration you have to appreciate the risk in Gamma. Gamma is becoming larger closer to expiration and is more factor the daily trade management. Due to gamma you will have bigger swings in daily P/L.

I attached three graphs;
1. my risk graph
2. my adjustment
3. my account page giving you an overview of what I have left in this small 5 lot account.

[ernsttanaka]

I am flat - I pulled the trade. I will write a wrap up post later this weekend or early next week. Going to enjoy a long weekend in CA before we return to NY on Monday.

Ernst

[so2c]

Thanks very much for daily updates, which have been very helpful. Volatile market is challenging for any type of trade style and looks like it does make easier for this one.

I'm wondering if more active manage/adjust would make results better (e.g, to maintain delta flat as possible?)

Wish you have a great vocation and Looking forward to your warp-up and more teaching on spread trade tricks (I'm always looking for a lazy man's trade :-).

PX

[ernsttanaka]

I am going to try to tie it all together.

First let's look at sequence of the trades and I will try to evaluate my decisions.

I started with the trade marked 7 and 8 (sorry for the sequence but that is TOS).
That is my normal monthly butterfly, as said before, I aim for a return of 20% on risk. Trade 7 is some extra long delta which I normally buy to compensate for the negative deltas from an ATM fly. I will try to cut my delta exposure in half by adding some OTM - longs. Quite early in the trade the market stepped down hard, without an enormous raise in the VIX. This allowed me to be profitable in the trade while getting close to the expiration BE's. Since width of the fly is calculated using a standard deviation move till Expiration, getting close to the BE so early in the trade is a red flag.

I first decided to defend the trade with a calendar @ the 790 (trade 9). Intraday the market and sentiment turn further south - So I decided to reduce my risk by taking the fly off (for a profit). In hindsight I have no 2nd thoughts on that decision. Taking a profit, reducing risk in that specific situation was prudent. The only question could be; did I overreact? I answer for myself with no.

The next trade was to re-enter a fly at the new ATM 790 (trade 1). Here I made an judgement error which came to bite me later. I entered that trade without reducing my delta with some extra long. I let myself be guided by an opinion that we would not revisit 840'ish so quickly. When we did, I had to make several adjustment (trade 2, 3 and 4).

In the meantime the calendar hit a 20% profit mark -- an alert fired to warn me -- I took it off @ target (trade 12). No comments on this decision.

Trade 5 and 6 gets me flat and returns a small profit of $150.00

So the question is why stop and why not fight longer. The answer lays in several (im)ponderable facets.
1. it had been a difficult month in comparison to a 'normal' month
2. I had been longer in the trade than normal, and had not much to show for
3. it was a difficult month but I had not burned my fingers.
4. In this 5-lot account I am up over 25% up for the year (25% over account value, not risk). In other accounts the numbers are even better, but there I take more risk (larger fly in comparison to the account size).
5. the closer you get to expiration the larger becomes Gamma and the daily swing in PL can become quite large even in a 5lot trade.

The sequence of my reason above, is the weight I gave to each argument. The first argument weighting the heaviest etc etc.

If and that is a big IF; I had added some extra long to the 2nd fly, that 2nd fly would have been in a better condition when we approached the expiration BE. Argument 2 in my why stop would have fallen away, and I could have given myself some extra time by adding a small new ATM fly or even a small fly a little bit above the market (as Ken suggested in his question). Without these longs I needed to choose between a potentially losing month, a scratch or a profit.

Commissions plays a big roll in this style of trading; my commission's bill is $75 for July.

Overall I am happy with my performance as non-directional trader. For me it is the only trade style which make sense. Of course considering my personality. I have deep respect for Billy and Pascal and the amount of research they do and their ability to stay objective while under pressure. Knowing myself, over time my research becomes sloppy and I will start to see profitable set ups in every bar. Non directional trading allows me to receive payment for market risk, while I don't need to second guess every bar on the chart.


Hope you enjoyed this series into the dark world of "risky" options.

Ernst

[EB]

Hope you enjoyed this series into the dark world of "risky" options.

Ernst

Indeed. Thanks.