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
