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BookingAlpha Option Trading Advisory

Tuesday, April 11, 2017

How has your trading style changed? Is there still potential for a +30% year?

I'm looking at your results in the previous years and am amazed by the impressive results in 2012, especially compared to those in later years. In terms of SP500, 2012 is also a good year, but isn't the best year (2013 has a significantly higher return). I'm curious to know how your strategies have changed from 2012 to today. Is it that you took on more risks in 2012 by committing more percentage of capital and/or staying closer to the money? Or is it just that the market condition was quite special in 2012 compared to other years (for example, no sudden rally or sell-off)? Or maybe something else? Basically, are the results from 2012 possible to replicate? - Jordan

Good question.

The short answer is: Yes, it is possible. However, it is not something to be expected with consistency year after year.

There is no evidence suggesting you can obtain higher than 30% returns year after year for decades on end. In fact, only very few cases throughout history have been able to achieve this at the professional level. And not even the almighty Buffet.

The Barclay's Discretionary Traders Index is averaging 7.37%/year after three decades. (with some survivor-ship bias, as funds that under-perform and die stop being tracked).

What we do know, is that 90-95% of traders lose money, and that anywhere from 75%-90% of professional money managers fail to beat the S&P500 on any given year. This means that a +10% avg annual return in the long run puts you at an elite level, as you make money (therefore beating 90-95% of traders), and you beat the S&P500 (beating the vast majority of professionals). +15% is great. Anything above 20% is awesome. Its the cold, hard truth that those who know better, don't want to talk about.

Now, as for my own trading in particular, yes, it has changed over time. A lot.
But before we get into that, we have to talk about market conditions...

No single strategy is a perfect fit for all market conditions. The last few years have been very challenging to navigate for options sellers. First due to the unstoppable rally (contrary to most people's fears the hardest environment for an Options seller is the dull ever up-trending market). The Call side is much harder to effectively defend than the put side. Also, the consistently low levels of volatility seen in the last few years have made it that more challenging, as you collect mediocre premiums and also have to get your positions closer to the money for that purpose. Opportunities also become scarcer.

When I started trading options back in 2010, Options selling newsletters were making money left and right. It almost seemed too easy. 2010, 2011 and 2012 were years of good two-side market price action and decent volatility levels that made the game much easier. Many of these newsletters were showing 40% - 70% annual returns without breaking a sweat. Most are extinct now.

Making +30% one year doesn't necessarily mean you are a great trader. It means two things:

1- You are taking significant risk. Yes, there is no way to make out-sized returns without taking greater risks.

2- The market conditions were a good fit for your particular trading style.

Then 2013-2016 happened. Out of those 4 years, 2015 was easier to navigate, with VIX spikes here and there and not too trendy of a market. 2013-2014 was nightmare. 2016 and 2017 (so far) not great years either. It is unfortunate, but it is what it is.

Back to my own trading.
Even though the returns in 2012 were good, I am definitely and by far a better trader today. Trading the 2012 style would have caused devastating losses. Actually, the first two months of 2013 clearly proved this when I was down 14.22%. That's what forced me to reconsider my style. From there I made +26% in the other 10 months; enough to end up 12% positive for the year, still trailing the index, of course, but 2013 was perhaps the toughest of all.

Here are some of the changes implemented over time:

1- I used to enter positions only during oversold or overbought environments. So, no Iron Condors or Elephants or anything like that. Just pure Credit Put Spreads and Credit Call spreads during market extremes. That was enough for me to make more than 30 trades per year. Notice how things have changed. So far this year (April, 2017), we haven't had a single one of those extreme environments (according to my rules to determine extremes). This goes to show you how the market environment is completely different now. Had I been waiting for extremes only, like in 2012, I would have made exactly zero trades this year. This eventually forced me to consider trading Iron Condors during no man's land conditions. Something I didn't use to do at the beginning.

2- Another difference: In 2012 I would wait longer to defend a position and would do so only when the price of the index was 5 points away from my Credit Spread. Say I was trading a 1500/1510 Credit Call spread. I would only adjust it in the event SPX reached 1,495. That's like 47 deltas. Trading the ETFs I would wait for a 1 point difference. So, I would adjust a 150/152 CCS when SPY hit 149. The good thing about that is, you don't take 'unnecessary losses' early that would have been eventual winners had they been left untouched. The downside: once the losses come, (and they will) they are much bigger, as evidenced in the 7.80% draw-down suffered in October of 2012 and the aforementioned 14% draw-down of Jan-Feb 2013. Nowadays, I make adjustments when the short strike price of my credit spreads reach 30 deltas. Had I kept the 2012 stye, I would have had a devastating 2013 and perhaps wouldn't be writing today.

3- In 2014, realizing the challenges of defending the Call side, I started trading Unbalanced Iron Condors.

4- In 2015 I started partially hedging threatened spreads by buying options.

5- In 2016, I started trading Elephants, as the track record clearly showed that even the Unbalanced Iron Condor was not the greatest solution to cope with unstoppable rallies.

6- The other subtle difference is that, as my account started to grow, I became more conservative. After all, losing 10% on a six-figure portfolio is way more money than losing 30% on a $10,000 account. For simplicity, I kept the $10,000 account-based track record for a while, but I was adding money to my account (savings from my day job) month after month, reaching $80,000 by the end of 2015 and into the 6 figures now. So, whereas in 2012 I would deploy 20% in one position, today it is more like 15%-17%. Whereas in 2012 I would take everything all the way to expiration, today I'm more ready to take gains early. Also delaying the adjustments (read 2012) represents taking more risks. Add up these three factors and yes I was definitely applying a riskier style. But, the market happened to provide a good fit for that behavior that year. Without a doubt, I would have gotten killed had I kept my ways.

As for making 30% nowadays with the current style.
Yes, it is theoretically possible but again, it needs some market cooperation.
Assuming an Unbalanced Iron Condor every month ($2,200 credit), plus an Unbalanced Elephant ($1,400), and let's say 6 individual Credit Put spreads throughout the year ($1,200 credit each) . That's a total credit collected of $50,400. On a $100,000 portfolio that's a potential +50% return. Now, out of that, start taking some gains early instead of at the maximum level; subtract 2 or 3 thousand in commissions; subtract the money lost by inevitable losing trades, and there is still potential for $30,000 net gains or a +30% year. But again, it will depend on the market environment. Just as any other strategy.

I hope I answered your question.

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