Wednesday, February 26, 2014

A summary of Karen, the super trader's option selling strategy in 2013

More than one year ago, I was intrigued by the Interviews on Karen, the supertrader and posted an outline of her strategy discussed in the video. Since then, there were many reader comments. So I studied the portfolio margin that she used to achieve high return on margin, and wrote a few other posts related to the strategy. Besides, I also started working on back-testing Karen's strategy and set up a Karen Study Group.

On Feb 11, 2014, Karen was interviewed by Tasty Trade again to provide an update of her trading in 2013 and some of her general trading guidelines. Here, I'd like to share my understanding from the interview on this naked option selling strategy. Please note Karen will adapt her strategy according to market conditions such as the volatility VIX. She highly recommended traders to come up with strategies that work for themselves.

2013 Fund Performances & Goal
  • Two funds totaling 196 Million USD, yearly return after expense
    • 27%, 24% (over 50M USD profits)
  • No losing month on 2013 (13 straight months, incl. Jan 2014)
    • Close out every month. No rolling out to the next month, closed current month positions.
  • Goal
    • At least to beat SPX gains yearly (but there were no specifics discussed on what rules were used to ensure beating SPX)

Strategy of Selling Naked Options
  • A strategy to profit on Theta (time decay) and volatility
  • Rules may be changed depending on market trend and volatility
  • Sell calls or puts independently
    • Never sell options as spreads (i.e. strangles)
  • Sell more puts depending on market trends
    • In 2013, maxed out on the put side to sell twice as many puts as calls
  • Sell calls with greater risks as market does not crash up
    • In 2013, stayed light on call side to sell calls with shorter period of time
  • The variable ratio of put to call contract sizes allows the strategy to adapt to market trend
    • In 2013, the 2 to 1 put to call ratio kept the portfolio Delta from negative
    • Most premium selling option portfolio have negative Delta (but not Karen's)

Trading Vehicles
  • Traded SPX options mainly, used options of SPX e-mini futures /ES sometimes
  • Main reason not trading SPY is commission costs, plus tax advantage 1256.
  • No problems with SPX option liquidity
  • Can potentially go to RUT if need other positions to put on
  • Disciplined to avoid trading individual stocks even though they have high volatility

Option Strike Price Selection

Sell far out-of-the-money, high probability options depending on market volatility
  • In 2011 & 2012 when volatility was higher (VIX >= 15), sold puts with 2 SD (5% ITM Probability)
  • In 2013 when volatility was low (VIX around 11 to 13), sold puts with 1 SD (15% ITM Probability) to 1.5 SD (7% ITM Probability)
  • Sell calls with 10% ITM probability

Option Cycle Selection
  • 14 days to expiration for calls in general for 2013
  • 56 days to expiration for calls if price can be projected and good premium can be obtained from far above the projected price
    • Use trend analysis including 2 SD Bollinger bands, resistance, and FIB retracements
  • 56 days to expiration for puts

Trade Entry (Always legging in trades)
  • Sell calls when market rises
  • Sell puts when market falls
    • In 2013, sold more puts when VIX jumped
  • Trades are entered in multiple days around predetermined option expiration days

Trade Exits
  • Actively take profits and risks off the table
  • For options (puts) starting around 56 DTE
    • Close positions if profits reach 50% within 1st 16 days
    • Leave positions on after the 40 DTE neighborhood if they are not closed yet so that they can expire worthless
  • For options (calls) starting around 14 days
    • Close positions if profits reach 20% to 30% or even better 50% in a few days
    • If price continues to rise with 1 week left for call options, then take the calls away and move them to next week while keeping puts on
  • After some point of time, may stop pulling back profits since a built-in profit is realized already.
    • Leave remaining positions of current month alone and start working on next month.

Trade Adjustments
  • When ITM probability is less than 30%, no adjustment is required.
  • When price drops and ITM prob becomes 30% (an arbitrary number) or greater for puts with plenty of days left (> 30 day)
    • Adjust the position by taking it off and sell other far OTM puts about 20% ITM prob cautiously
      • Some puts may be sold 10 points lower in ITM proba and others sold 15 points lower in ITM prob
    • It may be pushed out to another week for puts (Not another month)
      • Try to fix it in current week if possible
    • It may lose one or a few dollars
      • Try to make up the loss either through selling more put or call contracts
    • Will keep existing calls as their value decrease and let them expire worthless
    • Do not use existing calls as adjustments to the losses on the puts
      • It avoids risks due to sudden market direction reversals
  • Don’t have any option ITM!

Money and Risk Management
  • The most important part of the trading game
  • Use portfolio margin and further stress test potential loses
  • Unlimited risk in theory
  • Use TOS Analyzer Tab for risk evaluations
    • The daily portfolio P&L numbers derived at 10% up and 12% down of the market price must not exceed net liquidation value in normal cases
    • Portfolio P&L losses at the crash price must not exceed net liq
      • In 2013, crash price = (current price – 100) x 88%
        • The extra cushion is added due to low volatility (11, 12 to 14)
      • In 2011, crash price = (current price – 200) x 88%
        • The less cushion due to higher volatility
    • Managing risk at this crash point assuming the portfolio had a major loss already
  • If net liq drops due to adverse market conditions, the unrealized positions are losing money but they are considered safe if they have not reached adjustment points
  • In worst cases, may buy some low valued puts or calls to offset the push from market move
    • But this is not very often
    • Don’t care or fear as long as the positions are safe
    • Do not over-manage positions

Psychology and Mindset
  • Control the emotions of both fear and greed
  • Trust statistics and high probability (Use 2 SD for 95% odds of success)
  • Use structured method and manage positions well
  • Require a high level of confidence and repeatable successes for a long time.

Team Members
  • 7 members: 6 traders and 1 controller
  • Encourage other traders to set up of trading team for additional ideas


  1. Great Work, I am sure this will go a long way !!

  2. Thanks for sharing your insight here.

  3. Hi. I am new to this board but wanted to post some comments. My background, options experience and options trading strategy are very similar to Karen’s. A difference between us is I trade in an IRA so cant use margin and must do credit spreads not naked, unhedged positions. Here are some issues that I have run into –

    1. I trade the Rut, not Spx. For a small, retail trader, Spx liquidity is poor. Spreads are very wide and 4-5 delta daily trading volume is very small so I usually get prices < mark. Also, prices are in $0.05 increments and if 20-wide spread has a $0.50 mark, I may have to cave on price to $0.45 or even $0.40. Rut pricing is in $0.01 and I can usually get filled by coming in a few cents, not $0.05 - $0.10.
    2. A big issue I have with her strategy is selling 5 delta and not adjusting until 30 delta. I have found through actual trading and backtesting that a 5 delta spread sold for say $0.50 with 55 days to exp becomes a $4.00 spread very quickly if the mkt goes against it. In order to capture that original $0.50, you must buy in the trade (realizing a huge loss) and then increase the size of your rolldown by 8x – wow, that’s a lot of $ on the line! If the mkt continues to go against you, the drawdown/risk can be astronomical…too much for me.
    3. I use Bollinger bands set at 30 days and 2.4sd, broader than Karen which eliminates small moves but provides greater safety. I only sell call spreads on upside breaks, not downside because the mkt tends to crash down, not up.
    4. I don’t randomly sell puts in a declining mkt and calls in a rising mkt. I have developed a set of 6 indicators which I have backtested thru TOS which provide me signals on when to sell. Not perfect but very good. I don’t use fibs because I am not comfortable with them.
    5. My Roic is around 1.5%/month, although the monthly #s range from -2% - +10%.

    Bottom line – I suspect there is more to her specific strategy than she mentioned, especially some intangible feel for mkt direction. Regardless, her strategy works for her but doesn’t work for me.

    Btw, I post many of my trades/comments/ indicator readings on the TOS Mytrade board, username “ironcondorz”.

    1. Thanks for your great comments, ironcondorz. I remember reading your mytrade posts before. I enjoyed them.
      Karen stated in her interviews that she just gave the generalization of generalization of her strategy. I believe She has not disclosed her full system.
      If you are interested in more heated discussions about the strategy, please join other 240 traders in our study group on Yahoo:

  4. "Close positions if profits reach 50% within 1st 16 days"

    When did Karen say that? I am trading my version of her strategy. Made about 30K so far this year. I would like to know more about her exits.

    1. I believe she said that she's closed out most of her current period positions by day 40. Then goes into the back period with just a few to expire. The goal is to get margin power back up for when the back period becomes the current to start selling again. So for puts, 56 - 40 is about 16 days. For calls, she could be doing weeklys at 14 days out.

  5. What




  6. What is the risk adjusted return?

    What is the benchmark?