Pages

Sunday, June 15, 2014

A study of Super trader Karen's trading process

I've been interested in studying the trading process and mindset of successful traders. Today, I reviewed what I learned from Karen's interviews from the trading process perspective.

Karen treats trading as a process and manages the process all the time. As far as I can see, her trading process involves the following elements as discussed in her interviews:
o   A suitable set of strategic trading rules,
o   An advanced trading software platform,
o   A successful trading mindset and psychology,
o   A daily trading routine,
o   A trading number game management,
o   An experienced trading team,
o   A Sufficient amount of time and money for trading and learning, and
o   Others.

Karen’s daily trading routine starts from market open hour till the end. The constant watch on the market by her trading team allows them to react to market changes promptly. Karen’s trading rules help them staying away from over-trading or over-adjusting. Her high degree of confidence on the high probability trades enables her of proper trade actions in the face of market uncertainty.

Karen treats trading as a number’s game so that she can play it objectively. She enjoys playing the big game all the time and taking the market challenges as well. There are no feelings wrapped around her trades or positions, as they are just numbers to her. The ability to turn emotions and perceived risks into a set of trading numbers and to focus on the numbers helps traders to decouple themselves from emotions and irrational trading actions. The emotion and fear are the biggest obstacles in trading and they take down most traders. The focus on trading numbers takes away the feeling of heart-ripping during adverse market conditions. As a result of the application of high probability trades by going far out of the money, a heavy percentage of Karen’s positions are winners.

Karen had discussed her learning and trading improvement process. She had more failures than successes in initial years. She was willing to invest in learning knowledge with a large amount of money and time that many other people may not be comfortable with. Her education fee at Investools alone cost over 20K USD. Small traders may have this limited amount in their trading accounts.

Karen established a tremendous trading team of about 6 members. 5 of them are experienced retail traders and 1 is an accountant. She encourages different ideas from team members. They usually will listen to each other, discuss the ideas and agree as a group. From time to time, they will test water with new ideas using a small amount of capital. If the new idea is proven to be working, then they don’t hesitate to apply it in full scale. The selling of weekly option was a good example of this process of adopting new ideas.

Some traders may get extremely disturbed if the temporary position loss becomes very big. Karen does not get emotional about any of her positions. When positions are in danger, she will do whatever it takes to fix them and make them back to the original profit at the expiration date as described in Section 6 Trade Adjustment Rules. She is not bound by the future direction of market moves, but always reacts to it if the ITM probability and profit percentage of her positions indicate to her for adjustments.

Karen suggested traders to look at the profit and loss numbers of the portfolio but not to focus on the P&L. This is reflected on her trading team structure as well as there is only one accountant (vs 5 to 6 traders). With this team, the traders should be able to focus more on the other important trading numbers. Personally, I think the key numbers Karen discussed in the interviews can be summarized as the following:
·         ITM probability
o   First factor used to determine if opening, closing or adjustment is required
·         Prices and trend of the underlying
o   Second factor used to determine if adjustment is required
·         Stress-tested market crash losses vs net liquidation value
o   Critical number that indicate how many contracts to sell
·         Option premium changes and time to expiration
o   Available options for adjustments


Karen stated she is willing to take losses when necessary and she will keep existing profit in her positions also. However, there were no examples discussing when to give up positions for losses (probably after the portfolio margin runs out). It’s worthwhile noting that Karen did not indicate any rules based on position losses. She did not mention any direct trade reaction to the amount of loss of a position. Her trade adjustment rules are based on ITM probability and the current market trends.

Saturday, June 7, 2014

Which index option provides better premium return per volatility?

Major indices have their own volatilities over the last 5 years as shown in the chart below. The volatility $RVX of RUT is consistently higher than those ($VXN and $VIX) of NDX and SPX. For example, RUT had a 59% higher volatility than SPX on June 6 of 2014. This difference was on the high side. On March 1 of 2010, RUT volatility was 17% ((20.43-17.42)/17.42) higher than that of SPX which was a normal difference. The volatility of NDX is only slightly higher than that of the SPX most of times.

Karen stated she prefer to trade SPX over NDX and RUT. She had a good year (probably 2009) trading RUT with relatively higher return. But she likes the lower risks trading SPX. She does not want to trade NDX which has higher risk with similar return rate.
How do we know we are getting a good return for the risk of a trade using each vehicle of different volatility? I made a simple attempt to investigate the covered return per implied volatility of each trade and showed the results in the top right corner of the above chart. Basically, the covered return for each call and put option on 6-7-2014 were obtained from the TOS analyzer. The options had 41 days to their July expiration date. The calls had around 10% ITM probability and the puts had around 5% ITM probability. The implied volatility of each individual option was obtained from the TOS analyzer as well. I assume the ratio of covered return over IV would give us a fair measurement of return for the IV of each trade.

As can be seen in the table embedded in the above chart, selling puts of SPY, IWM, and QQQ would have similar returns (about 6%) on this date. Given SPY is less volatile, SPY put would be a good choice. For the short calls with 41 DTE, SPY does have lower returns (12.8%) than IWM (14.5%) and QQQ (14.6%). Please be advised that this study includes one set of data from one day only. It may not be generalized for other days. Further study is required to understand it more deeply.