Watch HowardCohodas Trade Index Options Credit Spreads

arabianights · Nov 25, 2010, 12:32pm

That is more a point about the limitations of black-scholes than anything else...

HowardCohodas · Nov 25, 2010, 12:46pm

I'll try to keep this post updated as needed.

Why do I trade so many different indexes?
I trade three different indices as a teaching device. Were I not planning to teach this material commercially, I would stick to just one.

The indices I chose have three different strike price increments. The SPX at $5, the RUT at $10 and the NDX at $25. In that fashion, each student can see actual trades that will work for the size of the account that they have. I stop at $5 increments for two reasons. First, the minimum account size that my broker requires to trade options will accommodate $5 difference in strike price spreads. And second, with $1 difference in strike prices, commissions take a significant part of your income.
Why do I trade credit spreads?
I have been only moderately successful at trading that requires a directional bias. I trade the Forex that way with some success, but I feel somewhat out of control. I'm a retired software engineer and engineers never like to feel they are not in control.

There are always two sides to any trade; opportunity and jeopardy. See Dashboard.

Opportunity
Credit spreads using my strategy attracted me for two primary reasons.
Selling Time
Time marches on and the time value of the options involved in a spread must decay to zero at expiration. I enter trades around 60 days before expiration of a series as funds become available from expiration of the current series. This is also about the time that the non-linear decay curve begins it's increasingly steep descent to zero.

No purposeful directional bias
Since I am selling time, I don't need to have a directional bias when entering a trade. Certainly, the credits available have a built in bias, but my only requirement is that it meet or exceed my return goals. To protect myself I use the probability of the underlying price touching the short strike. Some risk is assumed to get a reasonable credit. The risk level to use depends on the individuals risk tolerance. Mine and yours will be different.

Good return for the time funds are committed
Options are used for many purposes in the financial market that are not related to spread trading. These market forces permit a nice income to be generated for the time the funds are committed for the credit spread trader.

Additional Return When Forming an Iron Condor
Forming an Iron Condor when the market makes it attractive is a nice bonus. An additional return is obtained without additional margin requirements.

High Probability Trades
The choice of probability of touching limit helps estimate the probability the trade will be successful. A simple calculation of mathematical expectation will inform the trader of the limits to put on this choice when the desired return is factored in. My opinion is if a trader doesn't know how to make this estimate, he/she should consider some other activity than trading.

Jeopardy
No management of a credit spread or an iron condor is necessary if the market does not trend. This happens around 80% of the time. When the market does trend, management is required to take advantage of opportunities that develop and to avoid large losses if the trend is strong enough to overtake one of the spread positions. Sometimes the spread that goes into jeopardy must be abandoned for a significant loss. Your risk tolerance will help set this limit along with your mathematical expectation calculation.
Why do I use Probability of Touching for a proxy of an estimate the spread expiring worthless?
Before I became a customer of ThinkOrSwim, I came up with the idea that I was more concerned about the probability of the underlying instrument touching the short option strike price as opposed to the probability of expiring away from it. I reasoned that I was likely to abandon the spread if the price neared the short strike rather than anticipating a return to profitable territory.

I started out by using a Markov Chain approach of looking back over a market cycle to estimate the probability that given the time available how often did the market move sufficiently to close the gap. This, of course, blends the volatility over the look-back period and takes no account of the current IV.

I then began using Monte Carlo methods of estimating the probability of touching and took into account the time remaining and the current volatility.

Then I learned about TOS and became interested because of their deep experience in options and their feature-rich platform. As I was learning the platform, I discovered they had a probability of touching estimate as one of their built-in functions that could be added as a column in the option chain presentation. Their answer was close enough to mine that I abandoned mine and use theirs. In talks with TOS, I'm informed that the calculation is proprietary. And I have found no similar calculation in other platforms I have looked at.

The downside is that TOS has suspended granting new FIX (financial exchange) accounts to retail customers. And I am advised that after more fully integrating with TD Ameritrade, they are unlikely to restore the program. I was further advised not to waste any time in development in anticipation of these accounts being granted in the future.

When I am in my office, I use the live connection between Excel and the TOS desktop platform to populate the Excel Dashboard with current information. When I'm away from my office I use an online application I wrote to populate an HTML Dashboard with 15-20 minute old data "screen scraped" from online access for some of the spreads I have in play. And the probability of touching is simply not available. At the end of the day I update my data base that supports the online application from data I export manually from the TOS desktop platform.

arabianights · Nov 25, 2010, 12:58pm

What's this about students?

HowardCohodas · Nov 25, 2010, 1:57pm

Quote:

Originally Posted by arabianights

What's this about students?

I covered this in other posts, but the only one I can count on to read all of my posts is me.

This is a good place to repeat my situation and plans.

In the process of teaching friends and family (no charge, no income), I decided to prepare to teach this material commercially. In correspondence with the forum management about needing a vendor's badge, they decided that until I started my commercial adventure in this area, a badge was not required.

Furthermore, I am exploring advertising on this forum. If the cost fits into my advertising budget, it gives me a chance to provide funds to help support this free forum we all enjoy in return for attracting students.

arabianights · Nov 25, 2010, 2:05pm

I wouldn't mind attracting student, so long as they're under 21...

Hotch · Nov 25, 2010, 2:37pm

Phil's still at uni...

Good luck Howard, nice to have something a bit different.

spinola · Nov 25, 2010, 3:22pm

Question, maybe for the FAQ bit ?

Why or what are the benefits of trading credit spreads, condors or greeks and what not, as opposed being taught how to trade directional out rights ?

HowardCohodas · Nov 25, 2010, 5:21pm

Quote:

Originally Posted by spinola

Question, maybe for the FAQ bit ?

Why or what are the benefits of trading credit spreads, condors or greeks and what not, as opposed being taught how to trade directional out rights ?

Did I address your concerns? FAQ

Nov 25, 2010, 12:32pm	#9
arabianights Legendary Member Member Since Jan 2007 6,782 Posts	Re: Watch HowardCohodas Trade Index Options Credit Spreads That is more a point about the limitations of black-scholes than anything else... __________________ World's leading STIRs chatroom - www.propboards.com - register, then click on chat. Don't let the lack of posts on the forum put you off - the action happens in the chatroom. Targeted at locals, but hedge funds, brokers (including IDBs), market makers, and a few sizable amateurs are all represented. When it's quiet, banter is encouraged and anything goes. No nuisance spread betters please. Anyone else welcome.

Nov 25, 2010, 12:46pm	#10
HowardCohodas Legendary Member Member Since Sep 2010 1,872 Posts	FAQs I'll try to keep this post updated as needed. Why do I trade so many different indexes? I trade three different indices as a teaching device. Were I not planning to teach this material commercially, I would stick to just one. The indices I chose have three different strike price increments. The SPX at $5, the RUT at $10 and the NDX at $25. In that fashion, each student can see actual trades that will work for the size of the account that they have. I stop at $5 increments for two reasons. First, the minimum account size that my broker requires to trade options will accommodate $5 difference in strike price spreads. And second, with $1 difference in strike prices, commissions take a significant part of your income. Why do I trade credit spreads? I have been only moderately successful at trading that requires a directional bias. I trade the Forex that way with some success, but I feel somewhat out of control. I'm a retired software engineer and engineers never like to feel they are not in control. There are always two sides to any trade; opportunity and jeopardy. See Dashboard. Opportunity Credit spreads using my strategy attracted me for two primary reasons. Selling Time Time marches on and the time value of the options involved in a spread must decay to zero at expiration. I enter trades around 60 days before expiration of a series as funds become available from expiration of the current series. This is also about the time that the non-linear decay curve begins it's increasingly steep descent to zero. No purposeful directional bias Since I am selling time, I don't need to have a directional bias when entering a trade. Certainly, the credits available have a built in bias, but my only requirement is that it meet or exceed my return goals. To protect myself I use the probability of the underlying price touching the short strike. Some risk is assumed to get a reasonable credit. The risk level to use depends on the individuals risk tolerance. Mine and yours will be different. Good return for the time funds are committed Options are used for many purposes in the financial market that are not related to spread trading. These market forces permit a nice income to be generated for the time the funds are committed for the credit spread trader. Additional Return When Forming an Iron Condor Forming an Iron Condor when the market makes it attractive is a nice bonus. An additional return is obtained without additional margin requirements. High Probability Trades The choice of probability of touching limit helps estimate the probability the trade will be successful. A simple calculation of mathematical expectation will inform the trader of the limits to put on this choice when the desired return is factored in. My opinion is if a trader doesn't know how to make this estimate, he/she should consider some other activity than trading. Jeopardy No management of a credit spread or an iron condor is necessary if the market does not trend. This happens around 80% of the time. When the market does trend, management is required to take advantage of opportunities that develop and to avoid large losses if the trend is strong enough to overtake one of the spread positions. Sometimes the spread that goes into jeopardy must be abandoned for a significant loss. Your risk tolerance will help set this limit along with your mathematical expectation calculation. Why do I use Probability of Touching for a proxy of an estimate the spread expiring worthless? Before I became a customer of ThinkOrSwim, I came up with the idea that I was more concerned about the probability of the underlying instrument touching the short option strike price as opposed to the probability of expiring away from it. I reasoned that I was likely to abandon the spread if the price neared the short strike rather than anticipating a return to profitable territory. I started out by using a Markov Chain approach of looking back over a market cycle to estimate the probability that given the time available how often did the market move sufficiently to close the gap. This, of course, blends the volatility over the look-back period and takes no account of the current IV. I then began using Monte Carlo methods of estimating the probability of touching and took into account the time remaining and the current volatility. Then I learned about TOS and became interested because of their deep experience in options and their feature-rich platform. As I was learning the platform, I discovered they had a probability of touching estimate as one of their built-in functions that could be added as a column in the option chain presentation. Their answer was close enough to mine that I abandoned mine and use theirs. In talks with TOS, I'm informed that the calculation is proprietary. And I have found no similar calculation in other platforms I have looked at. The downside is that TOS has suspended granting new FIX (financial exchange) accounts to retail customers. And I am advised that after more fully integrating with TD Ameritrade, they are unlikely to restore the program. I was further advised not to waste any time in development in anticipation of these accounts being granted in the future. When I am in my office, I use the live connection between Excel and the TOS desktop platform to populate the Excel Dashboard with current information. When I'm away from my office I use an online application I wrote to populate an HTML Dashboard with 15-20 minute old data "screen scraped" from online access for some of the spreads I have in play. And the probability of touching is simply not available. At the end of the day I update my data base that supports the online application from data I export manually from the TOS desktop platform. Last edited by HowardCohodas; Nov 26, 2010 at 12:50am. Reason: Added material

Nov 25, 2010, 12:58pm	#11
arabianights Legendary Member Member Since Jan 2007 6,782 Posts	Re: Watch HowardCohodas Trade Index Options Credit Spreads What's this about students? __________________ World's leading STIRs chatroom - www.propboards.com - register, then click on chat. Don't let the lack of posts on the forum put you off - the action happens in the chatroom. Targeted at locals, but hedge funds, brokers (including IDBs), market makers, and a few sizable amateurs are all represented. When it's quiet, banter is encouraged and anything goes. No nuisance spread betters please. Anyone else welcome.

Nov 25, 2010, 2:05pm	#13
arabianights Legendary Member Member Since Jan 2007 6,782 Posts	Re: Watch HowardCohodas Trade Index Options Credit Spreads I wouldn't mind attracting student, so long as they're under 21... __________________ World's leading STIRs chatroom - www.propboards.com - register, then click on chat. Don't let the lack of posts on the forum put you off - the action happens in the chatroom. Targeted at locals, but hedge funds, brokers (including IDBs), market makers, and a few sizable amateurs are all represented. When it's quiet, banter is encouraged and anything goes. No nuisance spread betters please. Anyone else welcome.

Nov 25, 2010, 2:37pm	#14
Hotch Legendary Member Member Since Jul 2008 1,410 Posts	Re: Watch HowardCohodas Trade Index Options Credit Spreads Phil's still at uni... Good luck Howard, nice to have something a bit different. __________________ I'm just the guy that never tried, I'm just the stupid **** with brilliant luck and sometimes a bright idea.

Nov 25, 2010, 3:22pm	#15
spinola Senior Member Member Since Jun 2009 291 Posts	Re: Watch HowardCohodas Trade Index Options Credit Spreads Question, maybe for the FAQ bit ? Why or what are the benefits of trading credit spreads, condors or greeks and what not, as opposed being taught how to trade directional out rights ? __________________ Don't just stare at intraday volatility....... EAT IT!

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