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Selling Options on Futures?
Started: by ron99 Views / Replies:599,866 / 5,838
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Selling Options on Futures?

  #4931 (permalink)
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Dudetooth View Post
@Kevalo,

I may have the terminology mixed up, but in post #4925 I believe I have two examples of how a ratio credit spread with the same and with different DTEs would have faired last week.

#3 is a 1:3 credit ratio spread both legs ~90 DTE

#2 is a 1:2 credit ratio spread with the short leg at ~90 DTE and the long leg ~60 DTE.

My understanding of your example 3 was that you sell 1 ESX5 P1700 and buy 3 ESX5 P1400. I may be wrong but to me the "classic" ratio credit spread in this example would be to buy 1 ESX5 P1700 and sell 3 ESX5 P1400. Although I don't know if this combination still leaves a credit. The strikes of both legs should possibly be closer together.


Last edited by Kevalo; August 29th, 2015 at 03:15 PM.
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  #4932 (permalink)
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Kevalo View Post
My understanding of your example 3 was that you sell 1 ESX5 P1700 and buy 3 ESX5 P1400. I may be wrong but to me the "classic" ratio credit spread in this example would be to buy 1 ESX5 P1700 and sell 3 ESX5 P1400. Although I don't know if this combination still leaves a credit. The strikes of both legs should possibly be closer together.

Sorry about that ... are these more in line with what you were thinking of?

#11: 1 ESX5 P1750, -2 ESX5 P 1700 with an initial credit of $115
#12: 1 ESX5 P1700, -3 ESX5 P 1650 with an initial credit of $233
#13: 1 ESV5 P1775, -2 ESX5 P 1700 with an initial credit of $273

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Previous examples of #2 would have had an initial credit of $133 and #3 would have been $120.

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  #4933 (permalink)
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ron99 View Post
There are different definitions of a ratio credit spread.

Cordier has this definition


Quoting 
A ratio credit spread is really just selling a group of out of the money naked options, and then adding one final twist: After selling the naked options, the trader takes part of the premium collected and buys a close to, or at the money option.

Using the Cordier definition for a ratio credit spread of buying 1 option ATM and selling 3, to do that on 8/17 for ES, you would have bought a 2100 and sold 3 1950s for a credit of $370.

I'll give you one guess what happens when your multiple short options go well in the money. (Draw down 78% and on margin call on 8/24)

Edit: Buying one 1800 and selling three 1700s for a credit of 203 does even worse.


Last edited by ron99; August 29th, 2015 at 04:39 PM.
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  #4934 (permalink)
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Dudetooth View Post
Sorry about that ... are these more in line with what you were thinking of?

#11: 1 ESX5 P1750, -2 ESX5 P 1700 with an initial credit of $115
#12: 1 ESX5 P1700, -3 ESX5 P 1650 with an initial credit of $233
#13: 1 ESV5 P1775, -2 ESX5 P 1700 with an initial credit of $273

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Previous examples of #2 would have had an initial credit of $133 and #3 would have been $120.

Thanks a lot. According to this a ratio credit spread can offer a little hedge but will not fully compensate the loss of a naked put.

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  #4935 (permalink)
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ron99 View Post
Using the Cordier definition for a ratio credit spread of buying 1 option ATM and selling 3, to do that on 8/17 for ES, you would have bought a 2100 and sold 3 1950s for a credit of $370.

I'll give you one guess what happens when your multiple short options go well in the money. (Draw down 78% and on margin call on 8/24)

Edit: Buying one 1800 and selling three 1700s for a credit of 203 does even worse.

Right. I wasn't thinking of options at or near the money but FOTM for both legs. Dudetooth showed some good examples.

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  #4936 (permalink)
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@ron99

I hope you're recovering well. I've been giving a lot of thought to your comments and the comments of a lot of other people on this thread after last week and I've been wondering if were all just overthinking this problem. You made a fantastic discovery regarding the addition of 2 long puts for every 1 sold. What if, instead of continuing down this road of trying to preserve a near perfect win rate we do something a little bit more pragmatic. Combine your method of buying 2 long puts with a hard exit at say 3x the premium. I'm just pulling the 3x out of my ass by the way....it may be something different.

One of my biggest challenges with this style of trading is that it has a very nebulous exit point. Everything that I have ever read about trading says to have a strict, known exit point with a clearly defined loss before you enter a trade. Given that perhaps we try the following...

1. Sell 1 Nov 1700 with 3xIM
2. Buy 2 Oct 1600
3. Have a stop loss at 3x premium not IM.

Using this methodology you would simply have to determine how many times the market exceeded 3x premium keeping in mind that the long puts would add to the value of your overall position as the market moves down and let you stay in the position longer. I'd also include Black Monday and last weeks rout in the research afterall that's the even we're all weary of right. If this reduces the overall win rate to something like 88% vs 98% then we'd be silly to not take that deal.

Thoughts? I would try to run these numbers but as I mentioned in an earlier post I just don't have the expertise or the tools in order to do anything like this. If this idea actually holds water would love to find out what the results would be from a back test.

/rsm005/

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  #4937 (permalink)
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rsm005 View Post
One of my biggest challenges with this style of trading is that it has a very nebulous exit point. Everything that I have ever read about trading says to have a strict, known exit point with a clearly defined loss before you enter a trade. Given that perhaps we try the following...

1. Sell 1 Nov 1700 with 3xIM
2. Buy 2 Oct 1600
3. Have a stop loss at 3x premium not IM.

Using this methodology you would simply have to determine how many times the market exceeded 3x premium keeping in mind that the long puts would add to the value of your overall position as the market moves down and let you stay in the position longer. I'd also include Black Monday and last weeks rout in the research afterall that's the even we're all weary of right. If this reduces the overall win rate to something like 88% vs 98% then we'd be silly to not take that deal.

Using the example above entering the trade on 8/17 that would be a 28% loss if you got out exactly at 3X. It has not hit that number yet. It is at 20% right now.

I need time to see about how often it hits 3X.

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  #4938 (permalink)
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ron99 View Post
Using the example above entering the trade on 8/17 that would be a 28% loss if you got out exactly at 3X. It has not hit that number yet. It is at 20% right now.

I need time to see about how often it hits 3X.

Sorry, I didn't follow your second sentence there. You're saying that if I entered a trade on 8/17 a 3x exit would cost me 28% of my account but that point still hasn't been reached even with the market turmoil in the past week? Wow.


/rsm005/

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  #4939 (permalink)
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My Two Cents

I thought I'd share with you my experience with past week plus trading. Maybe it will give you some ideas for your own trading, and maybe how to prevent a catastrophic blowup like a few people probably had this past week.

First off, I sell options naked, sometimes with spreads, most of time just naked. I have been a seller of ES Put options, along with most of you. All together, my option selling accounts lost about 15% this month, mostly due to ES options (I had to buy back some options at more than 50x what I originally sold them for!).

Overall though, in all my trading, I actually was up about +9% the past week plus, during all this turmoil. Why? Probably because I have a ton of strategies (78 at last count) - different methods, different markets, etc. The option selling hurt, but it did not kill me, because it is a small part of what I do.

But since this thread is on selling options, let's just focus on that. Why did I only lose 15%, when many others went tapioca? One word: diversification. I normally aim for using approximately 40-50% of my margin to sell options (the 3x rule would say you allocate 33% max for margin). BUT - and this is the key - I try to limit my risk in any one market to 8-10% (for "big" markets like ES, CL, NG, currencies) and 5% or less for smaller markets (cattle, hogs, cocoa, etc).

Right now, for example, I am allocated like this:

Cattle 4.5%
Cocoa: 3.7%
Milk: 3.2%
Nat Gas: 10%
ES: 2.4%
Currencies: 7%

You can see I am under allocated right now, but I have not been able to find any more good markets at this time. That's OK, though - one thing I won't do is increase above my limits (it was tempting a few weeks ago to go above 10% for ES, but I [wisely] resisted that urge)...

So, maybe diversifying across multiple markets is an alternative solution to what has been presented earlier. It certainly helped limit my risk and my loss.

I still expect to end up the year up 25-30% in my options accounts. I guess we'll see how that works out...

If you have any questions please send me a Private Message or use the futures.io "Ask Me Anything" thread

Last edited by kevinkdog; August 29th, 2015 at 07:21 PM. Reason: fixed typo
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  #4940 (permalink)
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This strategy makes money when selling puts if futures:
1. Rise
2. fall slowly
3. fall moderately over long time
4. Black Swan (yes a huge drop in price makes money)

It loses money if there is a medium speed drop in price that falls a good amount. Long term down. The question is how many of those will happen and is there a way to avoid 28% losses on them. Here is the drop from 9/19/14. 3X premium happened on 10/13/14.

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Here are same contracts and time frame but using IMx4. It did not hit margin call but did pass 3X premium. Possible ROI drops from 3.3% to 2.5% when switching to IMx4.

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I am liking this strategy enough that I feel I can use it in other commodities that I was avoiding because of their volatility. You will still need to be somewhat right on direction of futures.

It still needs more research. This is very preliminary.

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