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 sj8070 Howard, From what I have read so far of your system is that it seems to ...

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Old Dec 2, 2010, 1:58pm   #51
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by sj8070 View Post
Howard,
From what I have read so far of your system is that it seems to me that you have no "edge" as it were.

The expected value of an Iron Condor, must be zero, otherwise you are claiming that markets are not perfectly competitive or liquid in this way. If you believe that an Iron Condor will produce a positive return in the long run you are taking the view that the underlier is actually less volatile than the markets have priced in.

Perhaps I have misunderstood your work.

It may be easier to answer this question:
"Do you believe that this strategy would be successful in a Simple Random Walk Environment, whereby the underlier is totally random, and if not, what inferences from the market to you make to ensure that your long-run expectations are positive?"
The fundamental principles that my strategy takes advantage of is that time moves forward and that options have a finite life. If they are OTM they must expire with a value of zero.

The use of a spread offers two additional advantages. First, the downside is limited at the cost of a limited upside. Second, margin requirements are to my advantage because the loss is limited.

The formation of an Iron Condor is just icing on the cake. A second spread can be sold without the need for any additional margin than was required for the original spread. There is some additional risk, compensated for by the additional credit.

The only unique added value (as far as I am aware) that I bring to the table over what others have written about is the use of Probability of Touching as a key to choosing how far OTM the short option must be.

Another technique I use has been mentioned by some others but does not appear to be widely used. That is, actively managing the spreads throughout their lives. I do not consider credit spreads a "set it and forget it" strategy. If I have formed an Iron Condor and the market begins trending, I can frequently close the spread that achieves most of its value and enter a new spread reforming the Iron Condor. I have referred to this elsewhere as rolling. On one NOV 10 expiration Iron Condor, because of trending, I had a small loss of the CALL spread but had three nice profits on the PUT side. The trending market is often cited as problematic for Iron Condor traders. I have frequently gained more profit from a trending market than if the market had just moved sideways and the initial two spreads expired quietly.
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Old Dec 2, 2010, 2:17pm   #52
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by Hotch View Post
Liking this Howard. Assuming 160/2500 is average, 10% risk, we're looking at 15 trades a month if you compound right (give or take)?
I'm not quite able to connect the two ideas you mention. Permit me to ramble a bit in the hope that I will answer your question.

I scale by selling more spreads.

Were I not planning to teach this material formally, I would stick to one index rather than the three I trade. I chose three to cover the range of account sizes that might be found among the students. Showing real examples is more meaningful for several reasons. It better engages the student. And it illustrates that different indexes present different challenges in terms of bid/ask spread, likelihood of prompt fills, etc.

The basic approach would have four spreads open at any given time for a single index. Two for the next expiration and two for the one after that. I'm in two monthlies at once because I like to open the spread before the time decay curve reaches the "knee" so that I get a generous credit. Rolling opportunities add to the number of total spreads, but not to the simultaneously open ones.

Adding weeklies and quarterlies, available on some indices, adds two more spreads per period. At the moment, weeklies and quarterlies are in the preproduction phase (small money) of qualification.

The example that has been bandied about (160, 2500) was in fact one of my preproduction weeklies and not the production spreads I trade with serious money.
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Old Dec 2, 2010, 2:39pm   #53
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

I was just attempting to get some handle on the figures. I didn't see that you scaled in, but the simple thinking was:

10% risk, on such R:R gives 0.64% return, 1.0064^15 = 1.1 ish, so 15 trades a month makes your 10%.
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Old Dec 2, 2010, 3:05pm   #54
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Quote:
Originally Posted by Hotch View Post
I was just attempting to get some handle on the figures. I didn't see that you scaled in, but the simple thinking was:

10% risk, on such R:R gives 0.64% return, 1.0064^15 = 1.1 ish, so 15 trades a month makes your 10%.
See if this post clears things up a bit.
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Old Dec 2, 2010, 9:27pm   #55
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

I'm guessing you short iron condors most of the time. I find this interesting as in a ranging market you are basically legging the options to get the most out of the premiums? Is this right?

So if FTSE is in a range 5600-5800, you buy a call at 6000 when the market is at 5600 and sell a put 5500. Then when the market is at 5800 you buy a put at 5400 and sell call at 5900, and that makes a perfect iron short iron condor? somewhat anyway. and obviously because of the wings your margin is lower than a strangle.
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Old Dec 2, 2010, 9:50pm   #56
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by brettus View Post
I'm guessing you short iron condors most of the time. I find this interesting as in a ranging market you are basically legging the options to get the most out of the premiums? Is this right?

So if FTSE is in a range 5600-5800, you buy a call at 6000 when the market is at 5600 and sell a put 5500. Then when the market is at 5800 you buy a put at 5400 and sell call at 5900, and that makes a perfect iron short iron condor? somewhat anyway. and obviously because of the wings your margin is lower than a strangle.
My strategy is to trade credit spreads as a unit. The price of the legs is immaterial. By specifying the credit required, the fill does not take place unless that price, or better, is obtained.

The Iron Condor is just the icing on the cake. The spread that completes the Iron Condor must be able to stand on its own. The icing part is that no additional funds are quarantined (margin) to put on the second spread of an Iron Condor. This provides a nice profit boost with some small additional risk.
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Old Dec 2, 2010, 11:25pm   #57
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Quote:
Originally Posted by HowardCohodas View Post
My strategy is to trade credit spreads as a unit. The price of the legs is immaterial. By specifying the credit required, the fill does not take place unless that price, or better, is obtained.

The Iron Condor is just the icing on the cake. The spread that completes the Iron Condor must be able to stand on its own. The icing part is that no additional funds are quarantined (margin) to put on the second spread of an Iron Condor. This provides a nice profit boost with some small additional risk.
Ok. So you trade two credit spreads to create an iron condor. I get it now i think. So if you think the ftse range is 5600-5800. and the market is trading 5800. you sell a call at 5900 and buy a call at 6000 at the same expiry. When the market is trading 5600 you sell a put at 5500 and buy a put 5400.
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Old Dec 2, 2010, 11:35pm   #58
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by brettus View Post
Ok. So you trade two credit spreads to create an iron condor. I get it now i think. So if you think the ftse range is 5600-5800. and the market is trading 5800. you sell a call at 5900 and buy a call at 6000 at the same expiry. When the market is trading 5600 you sell a put at 5500 and buy a put 5400.
Unfamiliar with options on FTSE. See FAQ in signature for description of what I trade and the related distance between the short option strike and the long option strike.

If that fails to make things clear, give me another go.
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Old Dec 3, 2010, 5:17am   #59
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

Over time, my guess is this will blow up Howards account, although I hope this does not happen.

The trades are based around a mathematically derived probability of certain prices being hit. From what I understand so far, It appears that no market analysis is being performed, rather that if a TOS indicator says that the probability is below a certain threshold then the trade will be taken.

Remember that I have not studied the indicator in question but my presumption is that it will be such that it implies the probability of a losing streak is extremely low - perhaps 1 in a million. Whatever it does imply, it is just a formula and we have seen time and time again the way these formulas fail in real life.

When going over them in retrospect, there appear to be 2 common flaws, certainly in the models that have caused major crashes. The first flaw is in the assumptions fed into the model, these models need inputs and the way some of those are derived looks fairly dumb in retrospect. Obviously the inputs are based on what worked in the past. But assumptions like "house prices will rise 12% per annum indefinitely IS dumb". The second flaw is in failing to grasp the impact the use of the model has on the markets, a model that gets adopted industry wide is never adjusted for the fact that this new model is now going to impact the markets. I presume the TOS model is not used industry wide - so perhaps that issue is not going to be important here.

It appears this trading approach cannot sustain a losing streak. Howard mentions a 30% drawdown if he has a bad months. What about 3 bad months ? It may be statistically impossible but that hasn't stopped these things occuring in the past.

I hope I am wrong - both for Howard and his students but this to me sounds like a Black Swan waiting to happen.

If I am wrong, then Howard has found the Holy Grail. A purely mathematical approach to trading the markets with no technical or fundamental analysis required that will yield a consistent 10% a month.

Good luck.
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Old Dec 3, 2010, 6:13am   #60
 
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Re: Watch HowardCohodas Trade Index Options Credit Spreads

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Originally Posted by DionysusToast View Post
Over time, my guess is this will blow up Howards account, although I hope this does not happen.

The trades are based around a mathematically derived probability of certain prices being hit. From what I understand so far, It appears that no market analysis is being performed, rather that if a TOS indicator says that the probability is below a certain threshold then the trade will be taken.

Remember that I have not studied the indicator in question but my presumption is that it will be such that it implies the probability of a losing streak is extremely low - perhaps 1 in a million. Whatever it does imply, it is just a formula and we have seen time and time again the way these formulas fail in real life.

When going over them in retrospect, there appear to be 2 common flaws, certainly in the models that have caused major crashes. The first flaw is in the assumptions fed into the model, these models need inputs and the way some of those are derived looks fairly dumb in retrospect. Obviously the inputs are based on what worked in the past. But assumptions like "house prices will rise 12% per annum indefinitely IS dumb". The second flaw is in failing to grasp the impact the use of the model has on the markets, a model that gets adopted industry wide is never adjusted for the fact that this new model is now going to impact the markets. I presume the TOS model is not used industry wide - so perhaps that issue is not going to be important here.

It appears this trading approach cannot sustain a losing streak. Howard mentions a 30% drawdown if he has a bad months. What about 3 bad months ? It may be statistically impossible but that hasn't stopped these things occuring in the past.

I hope I am wrong - both for Howard and his students but this to me sounds like a Black Swan waiting to happen.

If I am wrong, then Howard has found the Holy Grail. A purely mathematical approach to trading the markets with no technical or fundamental analysis required that will yield a consistent 10% a month.

Good luck.
Appropriate concerns all. Like any business I've run, I have a process of quality control of myself and my strategy. Some of these I've mentioned earlier in this thread, but they likely bear repeating. However, lets discuss each of your points in order and see where we go from here.

Probability of Touching
I can't speak to the TOS proprietary model, but I can speak to the one I developed that came close enough to the TOS one to abandon mine and adapt theirs. My inputs were, current price of underlying instrument, strike price, interest rates, days to expiration and volatility. These are the same inputs that TOS reports that they use.

There are quite a few probability models used in options trading, all of which answer slightly different questions but all of which use the same inputs. I don't think the one I am using is any more magic or any less magic than the others.

These models are tools to be used carefully and with attention to the quality of the result they produce to see if the tool is still effective. If the quality assurance process is effective, any change in quality should be detectable before disaster occurs.

Loosing streak
From what I have learned from you, you are probably better at probability stuff than I. My understanding of these probability models is that they can be used as a proxy of the chance of the event happening. If I start with a probability of touching of 10%, then my understanding is that there is only a 10% chance, given the current market conditions, that the underlying instrument price will reach that level.

Were I to use a "set it and forget it" approach to trading, then it's pretty simple to calculate the probability of two successive failure events taking place. Since I actively manage the spreads, the probability of my loosing my maximum limit is less than is implied by the initial probability of touching would indicate. And so is the probability of two successive monthly losses.

Perhaps my explanation of how I derived my estimates was too convoluted because the 30% example was to represent only one half of the funds at risk. To reach the 30% level, would require two consecutive failure months. I tried to use this worst case (one that I never saw in testing) to provide a very conservative estimate of the expected return when losing months were included.

Common flaws in models
All models are based on assumptions and the one I use is not immune from that. All models must be monitored to see if they are effective under current market conditions. The model I use is not immune from that either. I fail to see how my model is more or any less susceptible to these challenges.

Quality Assurance
In my first post in this thread I described the reason for and the use of the journal. It is to monitor the two key components of a trading system, the strategy and the trader. There is a formal process for detecting degradations of performance of the trader separate from the model. These are designed to identify problems before they create a financial disaster.

Conclusion
Will this all continue to work as it does now? Will I be able to detect system failure before there is serious impact on my account? Have I thought of everything?

I don't know. I believe so. I doubt it. In that order.

One of the primary reasons that I started this thread was to learn from those with more experience and wisdom than I. The more I'm challenged, the deeper I have to think, the more I understand the strengths and weaknesses of my approach.

I greatly appreciate all the thoughtful questions that come with this thread.
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