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Selling Options on Futures?
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Selling Options on Futures?

  #5471 (permalink)
Market Wizard
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Many years ago, I was tasked with building a "cash flow at risk" model to predict 'potential' margin requirements for a trading desks NYMEX positions. At first glance it seemed like this would quite easy, it's just a "value at risk" calculation that also takes into consideration what your current clearing account excess liquidity is. I was a little surprised when my first attempt was woefully inaccurate on a couple of very significant days of the year. Further analysis showed that these days were all days where the margin requirements for contracts where changed. Hence in order to correctly have a "cash flow at risk" estimate I first needed to estimate the potential for an exchange margin increase. After further analysis I found that the best model for exchange margin requirements was heavily influenced by the X day average true range. (Sorry can't remember what X was). Admittedly this was a long time ago, and only applied to Natural Gas and Crude Oil, but hopefully an interesting story related to the current discussion.

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  #5472 (permalink)
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All,

I wanted to share how things are going on my open positions using the 1:2 ratio spread. Things are going well overall but as has been mentioned at other points in this thread getting out of the position may take longer because the longs are losing money faster than the shorts. This means that I'll be in the position longer than expected, as you can see on the with the first positon. This does suck and exposes me to more risk as the position stays open longer...but not as much as a naked position in my opinion.

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I've run through a lot of spread combinations and found that although a 1 to 1 spread works with moves like the brexit you'll get screwed for a move like August. I'm still trying to see what happens on a prolonged move down like December/January of last year. For now I'm just sticking to the strategy of 1 to 2 and smaller positions.

/rsm005/

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  #5473 (permalink)
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Delta instead of 20%short and 100 points long



ron99 View Post
I added one more example to my ES 8/24/15 research. I compared using a short 20% OTM (1675) and a long 100 below the short (1575). I did it for both the Nov contract which was 95 DTE on 8/17/15 and the Dec contract which was 123 DTE on 8/17/15.

Two things stand out. One is you can make a higher ROI on the 123 DTE Dec position. Using 5X gives you 3.3% monthly ROI if you had a 50% drop in premium in 30 days vs 2.2% for the Nov contract.

Second is that the Dec position withstood the crash better than the Nov contract. Using 5x margin factor the Nov 95 DTE positions hit 85% of account for IM with a 48% draw down. The Dec 123 DTE position only hit 60% of account balance for IM and 40% draw down.

The only downside difference for the Dec 123 DTE positions was you had to wait 7 days extra for the premium to drop by 50%. But the monthly ROI was still higher than the Nov 95 DTE positions at exit.

Also on the spreadsheet are 3 back tests of various positions starting 1/2/13. The 80% 100 sheet is short 80% of futures and a long 100 below short. The other 2 are naked puts either 300 OTM or a 3.00 delta.

I am going to run a back test of using a short 80% of futures but make it 110+ DTE when entered and see the difference. I will post it later.

Thanks, Ron for your generosity in sharing the excellent analysis.
I was thinking will delta values of i) short instead of 20% below current ES and ii) long 100 points below short strikr be a better guide? With changing volatility, percentage value and absolute value of 100 may not give correct values for strikes. Will be grateful for your views.
What are starting delta values of short and long options?
Regards,

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  #5474 (permalink)
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dvbattul View Post
Thanks, Ron for your generosity in sharing the excellent analysis.
I was thinking will delta values of i) short instead of 20% below current ES and ii) long 100 points below short strikr be a better guide? With changing volatility, percentage value and absolute value of 100 may not give correct values for strikes.

If I am understanding your question correctly are you wondering if using delta instead of 20% lower for short and then 100 down from that for long would be better?

I went with 20% down because the largest drop in futures since 2008 in a 90 time frame was 19%. I am wondering if I need to move to 25% for less risk. But ROI drops lower with that move.

I went with the long being 100 below the short because less than that decreased the ROI too low. More than that increased the possible loss.


Will be grateful for your views.
What are starting delta values of short and long options?
Regards,

For my 82415 example starting on 8/17/15 the Nov 1675 short put was 3.27 delta. The 1575 was 1.05.

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  #5475 (permalink)
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rsm005 View Post
I've run through a lot of spread combinations and found that although a 1 to 1 spread works with moves like the brexit you'll get screwed for a move like August.

/rsm005/

You need to move your long closer to the short when you do 1 to 1.

Here are examples using 5X margin factor and they made it through 8/24/15 OK. The one on the left used options 123 DTE and the one on the right used options 95 DTE. I would use a higher margin factor for the 95 DTE spread if doing it in real life.

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  #5476 (permalink)
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@ron99

I'm working through various models now. One set of tests is to use the same aggregate delta as a 1:2 but with 1:1. For example sell 1 at a 6 delta and buy 1 at 3 delta. So far, it's worked amazingly well for the drop in December and the Brexit but the drawdown during August was almost 21%, whereas a 1:2 spread would have been basically break even. I'm still running different combos and will try what you've said, 100 points rather than focus on delta. I'll put up the results shortly but here's a quick preview of the 1:1 with 9x extra margin hold. The biggest thing I'm looking at is the ROI, it's very low and I'm trying to come up with different options, thoughts are welcome.


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/rsm005/

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  #5477 (permalink)
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Here's what you would see if you ran the same trades with the 1:2 ratio spread

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I didn't get a chance to run the backtest against the brexit but Ron already did that. I hope this helps and gives me a lot of food for thought. I'll do more tweaking, the deltas don't line up 100% for all the trades as you can see. The reason, I chose strikes that I would normally go for when I trade strikes that would most likely have good volume or good open interest.

/rsm005/

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  #5478 (permalink)
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rsm005 View Post
@ron99

I'm working through various models now. One set of tests is to use the same aggregate delta as a 1:2 but with 1:1. For example sell 1 at a 6 delta and buy 1 at 3 delta. So far, it's worked amazingly well for the drop in December and the Brexit but the drawdown during August was almost 21%, whereas a 1:2 spread would have been basically break even.
/rsm005/

The 1:2 did have a low drawdown on 8/24/15 but on 9/29/15 it was almost 20%.

The problem with the 1:2 is that after 30 days the longs give less coverage because the longs are so far OTM. The delta was 4.00 on 8/24/15 but it was 8.63 on 9/29/15.

I'm not sure there is a "right" way to do this. What ever you feel comfortable with.

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  #5479 (permalink)
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80% short+ 100 long Vs short 5 delta+2 long 1.5 delta


ron99 View Post
For my 82415 example starting on 8/17/15 the Nov 1675 short put was 3.27 delta. The 1575 was 1.05.

Thanks, Ron for your clarification. I have observed the following when comparing "short 5 delta+2 long 1.5 delta" strategy with "80% short+ 100 long" strategy.
1. "short 5 delta+2 long 1.5 delta" strategy met margin call with 3XIM but with 6xIM, it will not meet margin call in Aug 2015 but with double the cash, ROI/year will decrease from 24.6% to 12.3% approx. for 2013-215.

2. "80% short+ 100 long 110 DTE or 80 DTE" strategies have ROI/year of around 28-29% approx. for the same period due to only one long.

3. Premium for Long in the item 1 above erodes faster after 30 days due to far OTM which doesn't happen for that in item 2 above.

4. So "80% short+ 100 long 110 DTE or 80 DTE" strategy seems to be better than the one based on deltas with two longs.

Is my observation correct?

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  #5480 (permalink)
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dvbattul View Post
Thanks, Ron for your clarification. I have observed the following when comparing "short 5 delta+2 long 1.5 delta" strategy with "80% short+ 100 long" strategy.
1. "short 5 delta+2 long 1.5 delta" strategy met margin call with 3XIM but with 6xIM, it will not meet margin call in Aug 2015 but with double the cash, ROI/year will decrease from 24.6% to 12.3% approx. for 2013-215.

2. "80% short+ 100 long 110 DTE or 80 DTE" strategies have ROI/year of around 28-29% approx. for the same period due to only one long.

Actually it is due to the strikes being closer causing the IM to be lower.

3. Premium for Long in the item 1 above erodes faster after 30 days due to far OTM which doesn't happen for that in item 2 above.

4. So "80% short+ 100 long 110 DTE or 80 DTE" strategy seems to be better than the one based on deltas with two longs.

Is my observation correct?

Mostly. If you do have flash crash within 30 days held, the 2 longs strategy will have less draw down than the 1 long strategy. But after around 30 days held the 2 longs strategy will do same or worse.

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