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You implied earlier that 10-20 contracts couldn't' be managed as it would depend on account size. Fair enough. So let's play an example:
I have various accounts. On the trading account I have with around $500k, tell me how the method you are advising is feasible ??
Shorting 200 contracts of let's just say /ES 2000 puts .
On a large down move , the ask price of the puts goes to 50, reasonable or not .. (remember in large down moves , you can't get your outs back quick enough and they can simply raise the prices to insane levels. ) in addition to the extra margin requirement that kicks in.
So that's it. Just one trade of the /ES puts and $500,000 blows up.
Now if I was selling 10 puts, you can easily see how the portfolio withstands the fall , even if the puts rise 50-fold....it would only lead to a 5% account drop.
For arguments sake, give an example of an account size and the size of the contracts you recommend within this strategy in order to pull off the 20-30% return that your back test suggests.
Or are you saying that when a person initiates this trade, they should evaluate the margin required and as long as you have the 5x IM in cash, then go with the maximum size , whatever that number is ? So one month it may be 300 contracts, another month it may be 250 , depending on margin and volatility , etc.
You can say this about anything in finance. Eventually systems stop working or take heavy drawdowns. Over the last 8 years selling vol has been extremely profitable - but what if this strat continues to be profitable for another 8 years if CB's continue to keep stocks supported? To this day it's an ongoing joke/meme in the finance community - 'sell vol and live in a mansion'.
One thing you should note - LTM took excessive positions due to greed and despite having smart people trading, their risk management was poor which would have been on the risk department to manage. Berkshire do sell ES puts as part of their strat. Also note that many funds are positioned to mitigate risk and so wouldn't be able to take on such strategies - many funds underperform in bull markets but outperform in bear markets or high vol. There are many ways to play the market and of course there will come a time when this strategy goes through some heavy drawdowns, but there are thousands of other strats that will too and so you need to prepare in your own way - there is no free lunch in the markets.
Finally, I believe @ron99 actually said "I don't understand why you think 10-20 contracts can be managed but hundreds not" which was more to suggest that - technically what is the difference between managing a position of 20 contracts and 100 (as long as liquidity is there and your account size is suitable)?
I don't understand something in your logic. The backtesting has proven and several volatile trading days have proven that the spread will prevent a massive draw-down up to a point. That point is beyond $50 and in some cases well over $100 for the ask. Given that how can you say the spread won't work? Of course there are modifications that can be made to your position to help buy time or mitigate the loss if the position continues to work against you. For example, buying puts NTM with 5 or even 10 days to expiration and taking a small loss rather than a big one.
The reason LTM and "Super Trader Karen" got into trouble is because they were over leveraged too close to the money, Karen for example went 1-STD deviation 45 days out. Keep the margin excess high also limits total size. This is why Ackman and others can't do this, the positions they would need to make any meaningful gain on their total capital are just too big. It's just easier to buy the company or a large portion of it and harass management. For example, it's easy to open or close 50-350 contracts when the OI is 1500.
Trading: Primarily Energy but also a little Equities, Fixed Income, Metals and Crypto.
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I've been wanting to make this point for a while, but haven't because I didn't want to be perceived as nit picking or being negative. An obvious flaw of the back test is that it uses EOD prices. Intra day prices can be very different. Also slippage is asymmetrical. You might get slight positive slippage on trades but you'll never get significant positive slippage. The opposite is not the case. When fear hits, the slippage is enormous. These will be even more pronounced if you don't have the ability to execute the trade as a spread, and are actually managing individual legs. While backtests may show the strategy survived Aug'2015 go back and read some of the posts from that period regarding the bid/asks etc especially on Sunday Night the 23rd.
Off topic I know, well at least not relelvant to the main conversation, but I think some of your understandings of what happened at LTCM may not be spot on.
Ron, you know I have huge respect for you (I nominated you for member of the year and nominated this thread for thread of the year). This is an amazing thread and you have done a lot of work. Saying that I think your being a little harsh towards @Adam82. I think he raises some interesting points that maybe deserve some discussion. Lets not let a couple of miss-quotes/understandings derail the topic.
This is the one point that keeps me wondering and up at night. The spread when the Chinese devaluation was well north of double digits, I think I recalled seeing one at over $30. I enter my trades one leg at a time and leave the same way. I have very little idea how to construct a proper exit and account for slippage given that each situation is different. TOS can exit a spread as a single trade, which I may do but I'm just not sure. It's something I'm still tooling around with.
I may just go with the strategy of selling puts on weeklies in stocks, the rational there is that you at least own the asset and can wait it out.
BTW, "When Genius Failed" is on my to read list for this month.
Trading: Primarily Energy but also a little Equities, Fixed Income, Metals and Crypto.
Frequency: Many times daily
Duration: Never
Posts: 5,049 since Dec 2013
Thanks Given: 4,388
Thanks Received: 10,207
I think @mattz posted something a while back about the savings you can achieve by using the spreads. If you think about the market makers should make tighter markets on spreads as there's less risk for them.. one leg partially hedges the other.
I am not sure what you referring to.
Spreads could be entered as one trade (the spread) but on the statements you can see the actual instruments that are building the spread. We are pretty transparent with trading commissions.
Thank you,
Matt Z
Optimus Futures
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