Watch HowardCohodas Trade Index Options Credit Spreads

This is a discussion on Watch HowardCohodas Trade Index Options Credit Spreads within the Trading Journals forums, part of the Reception category; Originally Posted by arabianights Anyway, question... are you mostly trading greeks here or just expressing an outright view? The simple ...

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Old Nov 25, 2010, 5:22pm   #8
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by arabianights View Post
Anyway, question... are you mostly trading greeks here or just expressing an outright view?
The simple answer is no and no, but for those who understand the Greeks and directional bias, it is an incomplete answer.

Other than choosing what index's options I will use, the only two criteria I use are the Probability of Touching and the amount of credit I require. These choices are not driven by the Greeks or a directional bias, but the Greeks clearly show that the Iron Condor will have a delta of near zero. The market, when determining the prices of the options and the credit available, has a market bias built into it. If I am only able to form one of the spreads of an Iron Condor, then there is a built in bias.

Warning:
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Although the process I describe is deceptively simple, there is a lot of study and testing that went into developing the strategy. Although I have only taught this to a few friends and family, It took a 20 hour class to cover the details of the risks and management of these trades. These details cannot effectively be communicated by just watching me trade.
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Old Nov 25, 2010, 5:32pm   #9
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

That is more a point about the limitations of black-scholes than anything else...
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Old Nov 25, 2010, 5:46pm   #10
 
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FAQs

HowardCohodas started this thread I'll try to keep this post updated as needed.
  1. 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.

  2. 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.
  3. 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 5:50am. Reason: Added material
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Old Nov 25, 2010, 5:58pm   #11
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

What's this about students?
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Old Nov 25, 2010, 6:57pm   #12
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by arabianights View Post
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.
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Old Nov 25, 2010, 7:05pm   #13
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

I wouldn't mind attracting student, so long as they're under 21...
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Old Nov 25, 2010, 7:37pm   #14
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Phil's still at uni...

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