Completed July Non-directional option income portfolio

In the last few trading days, I added a couple of July iron condors for SPX & RUT since the opening of the July portfolio as described 1 week ago. Market was falling in general until today on which it shot up in the morning with strong volume. So, I entered my last trades of the opening positions for this option cycle with two bull put spreads as shown below. The short puts had a delta around -23. With these two vertical credit spreads, my potential profit is similar to my regular portfolio made of all IC's, but the two vertical spreads required twice amount of margin as equivalent iron condors. They also provide a little less theta compared to the IC. However, they generate the positive Delta for the portfolio to remain close to neutral.

Although my adjustment rules seem to be clear to myself at the moment, I've been thinking about refining my exit rules as described in my recent trade review and should be able to describe the update in a new post soon.

A review on trading option Greeks

A few years ago, I attended a couple of Dan Passarelli's live Webinars and remembered him as one of the most knowledgeable and passionate option trading educators. Recently, I bought his book "Trading Options Greeks: How Time, Volatility, and Other Pricing Factors Drive Profits (Bloomberg Financial)". I did spend sometime reading interesting sections of the book. So I created an initial post on the summary table of the effects of prices, time and volatility on option Greeks and another study on the implied volatility and its time decay. Since this book is pretty useful for me, I'd like to share some thoughts on it with my readers.

Compared with a couple of other option trading books I have that cover similar topics, this book describes a mathematically simple way to manually calculate approximate option price changes using the option Greeks. It is a unique part of this book that it uses many examples to illustrate how to estimate option price changes using the option Greeks with approximation equations that involve a few addition, subtraction, multiplication and division only.

I consider this book an intermediate level one for option traders that require a solid understanding of the Greeks, as this book goes a little further beyond the introduction phase. It explains what the Greeks are, and more importantly, how the Greeks change under various scenarios which is missing in most other option trading books. This book also gives introductions about various option spread strategies and volatility spreads in particular.

I don't consider it as advanced level, as it rarely describes Greeks and their changes at option portfolio level or for complex option positions. It's not an option trading system book as well, since it does not offer any specific criteria for trade entry, exit or adjustment. To get more detailed descriptions about the 5-star user rated book (as of today) and other reader comments, you can click on the book image below.

Feb to April Trading Review

My last monthly trade review was in Feb. It seems I kept skipping my monthly trade reviews for various reasons. I think this is one area that I need improvement: don't get side-tracked by other seemingly interesting trading stuff, but use my limited time to stay more focused on my trading process. I definitely need to remind myself about it from time to time. Anyway, here's my current month trade review using my regular review template.

Trading Rules

• Adherence consistency

I think I followed entry trading rules and hesitated on the exit rules. This is partially because I'm still trying to fune-tune my exit rules since I switched to open trade for 2 month ahead.

• Skillful application/execution

I had a big trading execution error as describe here and I refined my trading desktop environment.

• Monthly rule review/study

I'm still contemplating for an optimal exit criteria that works better in low volatility markets. I also realized some issues in ThinkOrSwim Software and thus started investigation on using ThinkScript for portfolio tracking and option Greeks study.

My validation step should cover review of adjustment strategy, potential cancellation of strikes in existing position when new order is about to be placed, order size and order fills.

Psychology

• Action during uncertainty

Used the Greeks and P&L chart to determine trades and adjustments, but need improvements at exits.

• Risk Comfort ability/Adverse damage impact

There was no major risk at this period. So this was not really tested this time.

• Trade anxiety

Not much.

• Winning Altitude Development

Complete the 2nd part (integration of successful mind set) on the psychology of consistent winning altitude. Furthermore, created a 3rd part on applying successful mind set for trade exits.

Trading Time

• Trading days

It was possible to meet the target of 15 to 20 minutes per day on average. But on a busy inventory closing day, it may take 45 minutes to over 1 hour to get all trades closed. It did not include the optional trade study and blog time.

• Resting days

Studying trading option Greeks and ThinkScripts. Spent time on family and busy work as well.

Trades and Market Replay

• Market Forecast

Was expecting a market correction of some sort, but the correction signal got invalidated quickly. An overbought market can become even more overbought in strong trending markets.

• Trades and Adjustments

Did not find major adjustment errors in the last couple of months so far. Whether enough Delta were adjusted in the strong market is still a subject for further analysis.

To Do List

I should use this to-do-list to help me stay focused for my near term trading work.

• Further review of Integration of successful mind set to trading rules
• Identification of components of trading process
• Create ThinkScripts to track the portfolio for my trading and for trades similar to super trader Karen
• Quarterly Performance Analysis
• Continue investigation of the effect of price, time and volatility on option Greeks

Opening July SPX Iron Condor for non-directional option income portfolio

With 58 days to SPX expiration, it's time to get into a new option cycle. I tried to get $6.85 credit for the same IC yesterday but it was not filled as the market was falling in the later half of the trading hours. Today, market seemed to be rising slightly and the same order was filled in a couple of minutes at mid day.

I edited the chart a little bit so that it's easy to see the break-even levels, the option inventory and its Greeks, and the June probability in one chart as shown below. Again, I'll continue to build the positions in the next few days and the goal is to exit around June expiration time.

I gave the downside a little more room as usual among the conflicting market signals. This time, I think it's still possible to have a pullback for this extra falling room, even though the overbought market can also continue to be overbought for a while. The market has not shown the weakness that I'm looking for yet: distribution days in volume, churning of price actions, over-complacency as exhibited by lower VIX (VIX is not low when compared to the new high prices), etc.

The Grand Summary of Effects of Prices, Time, Volatility on Option Greeks - Part 1

I had thought I had necessary understanding of the effects of stock prices, strike prices, time to expiration and implied volatility on option Greeks. But after some more study, I realized that I need to know more details about their effects on major option Greeks such as Delta, Gamma, Vega and Theta. Today, I had some time to finish the 1st part of my study and posted here to share with everyone who may be interested. I have  not seen this kind of table in any option materials yet. Hopefully, it will be helpful for the people trading options on the Greeks.

As you can see, I'll need to complete the other cases where stock price and volatility go down. After that, I'll review my past posts related to option Greeks and make sure they are consistent with this table.

Update: The Gamma changes against time elapse need further review. It's common knowledge as expiration gets closer, Gamma risk become larger. Thus, the ATM strike Gamma must be increasing a lot faster than the OTM Gamma decreases. Also it's possible that really far OTM Gamma decreases while closer OTM Gamma may not decrease. In this way, an OTM portfolio will have Gamma increases over time.

The subject of option Greek changes against time, price and volatility for a premium selling portfolio requires a series of studies in the future and I'll post it as I progress.

Optimal Desktop setup to avoid trade execution errors

I finally got a chance to track down my trade report to investigate why there were twice as many position sizes on my May RUT calendar adjustments, as I noted while I was trying to make additional position adjustment. My trade activity report indicated I bought two calendars of $940c and $960c separately, as I recorded in my previous post. However, just a couple of minutes later, I also got an order of a double calendar of 2 contracts filled. I thought I had deleted this order as I logged before. Since this order actually gave me some profit, I did not spent extra time to investigate if this order was due to broker software issue or my own issue in cancelling the order. But next time, I definitely need to pay attention to the order cancelling info.

As a result of this trade execution review, I think I'll need to have the following desktop and software environments for my trading execution.

• The order execution alarm should be loud enough to get my attention. I had probably muted the sound as I was on a phone call at that trading time.
• The flashing executed order pane should be visible. I might have covered the order notification page as I had a bunch of windows open for various tasks.
• The email notification alert should be on as another way to get noticed about the executed orders.
• Watch and compare trading orders (size, limit price, symbols) with the orders in the TOS analyzer.
• Double check order panes before closing the trading software.

Additional thoughts on the successful mindset for high probability traders

As noted in my last post on position exit, I need to take another look at my trading mindset with regard to position exits. I had posted the integration of successful mindset into the high probability trading rules and my understanding of successful mindset of high probability traders before. After the trading in the last few months, I finally realized that my understanding and application of the mindset need further improvement for trade exits and closures, since I did not have enough thoughts about them before.

The following winning attitude is supplemented with trade entry, adjustment and exit considerations.

1.  Any outcome is possible after a specific trading action is taken.
     Good or bad outcome is possible after a trade entry, adjustment or exit.

2. Market can give us a win or a loss at each time randomly.
    After a trade entry or adjustment, market can give us a win or loss randomly. For a trade exit, we may be exited on time to receive a good profit, to avoid a loss or we may be exited earlier before more profits are captured. It's random. It's more important to follow the exit rule to avoid unnecessary losses. The exit rules can be improved after analysis of multiple trades. We should not think about changing exit rules after a trade is in progress.

3. Market is unique every day without any exact association with its past.
    We should not let past trading occurrences affect current trading. Experiences can be incorporated into the trading rules. But we should understand market is unique every day and follow the trading rules once the trade is on.

4. The high probability rules provide a higher probability only and guarantee overall successes statistically.

    The trade entry, adjustment and exit rules provides high probability statistically. It provides no guarantee for each trade at all. But over the long run, the probability can be realized if we follow high probability rules.

5. There is no need to know market's next move to make profits. We must know what we will do next, based on any possible market moves.

    There is no way to know every market move. We just need to know the risks and reactions to every possible market moves. The reaction includes trade adjustments and exits.

I'll review my integration of the successful mindset into high probability trading rules in a future post.

Exited all May RUT option positions

With 9 days to May RUT expiration, the market is still holding on substantial gains from last few days. My May RUT position showed large Greek values as shown in the following image. I had been waiting for a small pullback in the last couple of days which did not materialize. So I decided to close all the positions to wrap up May portfolio trades. On this relative calm day of the market, it took a while to get the iron condors and vertical spread to be filled.

Since the TOS analyzer does not count closed positions in the P&L columns, its P&L numbers include the open positions only. So it showed some profits here. In reality, I had close SPX and part of RUT inventories for a loss. So overall, the May month was a loss. I will calculate the P/L later in a future post.

Through this month's trading, I believe I identified a couple of weakness in my system, related to the lack of precise exit rules. My mindset analysis also need to include more considerations during position exits. I'll post more details on the lessons learned in my monthly trade review.

Another study of option implied volatility and its time decay

After my recent discovery of the volatility discrepancy in TOS analyzer, I started investigating the IV of options. In one of my post, I have showed a chart illustrating the time decay of Vega. This weekend, I further studied the time decay of implied volatility and would like to note down and share with readers.

Implied volatility is always associated with a time frame. For the composite IV of options (IV of all option chains and expiration , the time frame is 1 year of trading days. It's annualized. To estimate the IV of an individual option which has a definite life time, we can calculate the daily IV first, then multiply it by the remaining trading days to derive the actual IV of the specific option.

The daily IV = Annualized IV / square root of 256 trading days = IV / 16 in brief.

Therefore, the IV of an individual option = daily IV x square root of trading days to expiration.

Based on the above approximation, it's easy to understand that as days pass by, the IV of each option gets smaller and smaller.

Also note that the individual option's IV is directly proportional to the square root of trading days. At intraday time frame of trading, market makers will adjust the IV continuously. If other influencing factors do not change, the option's IV will decrease from market open to close. This is the intraday time decay, specially big for weekends as noted for option Theta before. In fact, Vega has very similar characteristics as Theta with the exception that IV can change in two directions (up and down) and time can only elapse.

We often use $VIX (CBOE volatility index) as a measure of overall market IV. It's actually derived as the IV of a hypothetical 30-day option of SPX using a weigthed average of two nearest expiration series. The time frame associated with VIX is 30 days here. For option trades that use two month back options, the volatility could be square root (2x22) x IV/square root(22) = 1.41 x IV which is significant bigger.

Unfortunately, TOS does not offer the feature to display IV decay over time for individual options at the moment.

Closing down of May SPX positions

Today market shot up with higher volume to demonstrate its bullishness and broke up the bollinger bands. My may SPX positions got killed badly. The portfolio Delta had reached -90 as shown in the image below.

I used the analyzer trying to figure out an acceptable combination of May option strategies for adjustment. But they all showed up very high Gamma and Vega as a result of calendars, since there are only 13 days left. So I had to close all of the May SPX option positions.

Additionally, I also closed the damaging RUT May option positions: a vertical and a calendar. I thought it was a really bloody day for me. But somehow, my real account had 2 more $940 and 2 more $960 calendars than what I had in the TOS chart. This was obvious a big mistake that I need to investigate. I had observed larger than expected differences in the real account P&L changes and the TOS analyzer. I had thought it was due to differences of brokers calculating option prices (using mid price or the worse price of bid or ask). Now, the mystery is resolved.

Anyway, the 4 extra calendars saved my account from a big loss. I added them back to the TOS analyzer as shown below. I have to close the May RUT positions pretty soon as there are about two weeks left.