Insane Emergency RE strategy

[drcha]

I don't want to discourage people from trading options, since I use them a lot and I think they are an excellent tool. But I think that ERD50 is speaking truth. The probabilities are priced in. Options do not constitute a free lunch. Things do mean-revert.

I want to point out to the novices who may be reading this post that you can lose your entire margin in a credit spread (or you can lose your entire investment in a debit spread, which is essentially the same thing as a credit spread--it's just a question of whether the money is tied up in the option or in your required cash margin). And if 1987 happens tomorrow, you *will* lose it all. You may argue that 1987 isn't going to happen tomorrow. Well, it probably isn't. But it will happen again, sometime.

So trade small, set some stops if that's your style, get out before expiration--essentially, establish some prudent entry and exit rules for yourself and follow them. Trade at a level where you would not be too adversely effected if 1987 did happen tomorrow.

[dixonge]

Quote:

Originally Posted by drcha I don't want to discourage people from trading options, since I use them a lot and I think they are an excellent tool. But I think that ERD50 is speaking truth. The probabilities are priced in. Options do not constitute a free lunch. Things do mean-revert.

How does this apply to short-term Out-of-the-money spreads on both sides of the price? I can't imagine an index mean-reverting both up *and* down 100-150 points within a 30-day period. Well sure, anything is possible, but that seems like a rare event.

But even if it happened, just roll your positions up and out...

Quote:

Originally Posted by drcha I want to point out to the novices who may be reading this post that you can lose your entire margin in a credit spread (or you can lose your entire investment in a debit spread, which is essentially the same thing as a credit spread--it's just a question of whether the money is tied up in the option or in your required cash margin). And if 1987 happens tomorrow, you *will* lose it all. You may argue that 1987 isn't going to happen tomorrow. Well, it probably isn't. But it will happen again, sometime.

If you have all your money in put credit spreads, yes. It's a major reason for an iron condor type of approach...

Quote:

Originally Posted by drcha So trade small, set some stops if that's your style, get out before expiration--essentially, establish some prudent entry and exit rules for yourself and follow them. Trade at a level where you would not be too adversely effected if 1987 did happen tomorrow.

With credit spreads I rarely get out early, although there is no commission to buy them back at .05 or lower. But yes, rules and position size and risk are all important. It's the main reason I stopped doing straight calls on individual stocks. Way over my risk tolerance!

UPDATE: I really don't care to continue posting details of individual trades but my portfolio has now gone from $5k to $50k in one year and I've been invested around 80% all year in credit spreads. I've learned good lessons which will serve me well in the coming years regarding position size, putting multiple positions on one strike and month, and legging out vs. rolling. My average monthly gain is 3.4% and projections still look good.

[ERD50]

Quote:

Originally Posted by drcha The probabilities are priced in. Options do not constitute a free lunch. Things do mean-revert.

Quote:

Originally Posted by dixonge How does this apply to short-term Out-of-the-money spreads on both sides of the price? I can't imagine an index mean-reverting both up *and* down 100-150 points within a 30-day period. Well sure, anything is possible, but that seems like a rare event.

Think about it - if you bet on BOTH sides of the price, it is true that only one can get 'hit', but you doubled your chances that one of them will get hit. It didn't change a thing, risk/reward wise.

Back to the roulette analogy - easier to look at this from the 'house' side:

A gambler comes in and puts bet after bet on #17. The 'house' would not laugh and say, 'hey, this guy just keeps losing, this is a great bet for the house!'. The house knows that in the long run, that bet is no different than playing red/black, even/odd, etc.

You are similar to the 'house' here - you keep winning small bets time after time, but somewhere along the line that big payout will come. If that was not the case, I can assure you that people smarter than both of us combined, with more resources and connections would be playing these with computers. But as enough people did that, they would drive the prices back into balance (where I think they are now).

Now take that a step further - the gambler start betting on #17 AND # 15. He CAN'T win both! So the house will never lose both either (just like you can't lose with spreads on both sides of the price)! But again, it doesn't change the odds, because he doubled the chance that one or the other will come up. The 'house' just yawns.

Quote:

UPDATE: I really don't care to continue posting details of individual trades but my portfolio has now gone from $5k to $50k in one year and I've been invested around 80% all year in credit spreads. I've learned good lessons which will serve me well in the coming years regarding position size, putting multiple positions on one strike and month, and legging out vs. rolling. My average monthly gain is 3.4% and projections still look good.

And now VIX is down, making this a bit tougher game to play. It's great that you are ahead of the game now, I'm hesitant to "wish you luck" though - because it is increased confidence that gets people in trouble with these things. The more you put in the worse the eventual 'hit' may be. So instead, I'll say I'm glad for your success (and not surprised, that's how these work), but as they said in Hill Street Blues, "Be careful out there!".

-ERD50

[walkinwood]

Dixonge,

How much time have you spent in the countries you propose to live in?

Your plan - especially the aggressive investment scheme - sounds scary to me, but all the best. You may want to put away a sum equal to your budgeted expenses in a safe investment & be aggressive with the rest. I haven't read every post in this thread, so if I missed that - apologies.

[dixonge]

Quote:

Originally Posted by ERD50 Think about it - if you bet on BOTH sides of the price, it is true that only one can get 'hit', but you doubled your chances that one of them will get hit. It didn't change a thing, risk/reward wise.

In theory, yes. But in real-world trading, not so much. For example, on 10/16 I purchased Dec 940/930 put spread on SPX which was around 1084 at the time. This morning I purchased De. 1170/1180 call spread around 1109 on the SPX. This second position was added after the SPX moved 25 points away from where it was on 10/16, not to mention the time value decay. (I could close the 940/940 today for commission only) So my risk on the put spread has dropped off when adding the spread on the call side.

Quote:

Originally Posted by ERD50 And now VIX is down, making this a bit tougher game to play.

To keep the same gains requires moving closer to the price, yes. But since volatility is down, the odds are better for NOT having the price move against you. Six of one, half dozen of the other (in a sense)

[ERD50]

Quote:

Originally Posted by dixonge In theory, yes. .... So my risk on the put spread has dropped off when adding the spread on the call side.

Dropped off, but not eliminated. If it was eliminated, that would show in the price.


re low VIX:

Quote:

To keep the same gains requires moving closer to the price, yes. But since volatility is down, the odds are better for NOT having the price move against you. Six of one, half dozen of the other (in a sense)

Agreed 100%. My point was that the game has 'changed' in that you do have to move closer to the strike - some people view that as 'riskier', but I think that is misguided.

It's all 'six of one, half dozen of the other', plus or minus a bit. The gain/loss is generally aligned closely with the odds. With your approach, it can be a long time before the pattern appears. Just like my previous roulette example with the house and the #17 gambler - the 'house' should not be surprised at all if the house 'wins' 37 times in a row, or even 74 times in a row. But in the long run, the house has a 5.26% advantage. No more, no less. Regardless of the bet placed.

-ERD50

[Square]

Dixonge, The only thing I have to say is that there is a reason the MM are trading these small spreads with you. I could be assuming incorrectly, but I really think you should understand better what you are doing. Though Ill admit I didnt read every post or know your options understanding.

Read understand and live natenberg " Option Volatility & Pricing: Advanced Trading Strategies and Techniques" from front to back many times to understand options models we put tens of millions of dollars into building our models. Your 5k-50k is just a situation of "fooled by randomness" your an outlier waiting to get crushed. ("fooled by randomness" another great book btw, but focus on natenberg first.)

[Nords]

Dixonge, how 'bout an update?

[dixonge]

Quote:

Originally Posted by Nords Dixonge, how 'bout an update?

By Monday my balance will be up to $63K. Trades are still expiring worthless as planned. Recently had to roll a couple of positions up and out since the market is irrationally continuing to go up ( ) which resulted in those positions giving up about 10% of their original gain. That affected my overall gain for the month very minimally, and that is generally how things have gone from day one. Even though volatility is down I'm still averaging 2.7% monthly gains (calculated as credit - commissions / portfolio balance)

[Bimmerbill]

How does tax affect your monthly gain? Income, capital gains, etc?

[dixonge]

Quote:

Originally Posted by Bimmerbill How does tax affect your monthly gain? Income, capital gains, etc?

I get the 60/40 split (Section 1256) since the majority of my trades are on SPX. And since I was doing mostly straight calls/puts in 2007-8 on AAPL - well......let's just say I have a lot of carry-forward losses to use.....

[Nords]

Thanks-- I've enjoyed the updates.

[dixonge]

further update - March and April (so far) have been big months, plus we made an overdue deposit so now up to $72K

[Moemg]

Quote:

Originally Posted by dixonge further update - March and April (so far) have been big months, plus we made an overdue deposit so now up to $72K

I reread the original posts . So how long do you plan to be able to live on the $72K and where ?

[dixonge]

Quote:

Originally Posted by Moemg I reread the original posts . So how long do you plan to be able to live on the $72K and where ?

Retirement is about a year away. If we haven't moved into the $125k range by then we may have to delay.

Also, I Do not know if I have mentioned it in this thread or not, but Plan A is now to travel in the states via a used truck/trailer combo. This is subject to change, of course, but is the current plan.

[dixonge]

Quote:

Originally Posted by Square Your 5k-50k is just a situation of "fooled by randomness" your an outlier waiting to get crushed. ("fooled by randomness" another great book btw, but focus on natenberg first.)

The fact that I am responding to this particular post should tell some of you something....

I just now decided to look up this particular book. I cheated and read the summary on Wikipedia first. This particular quote resonated with me this morning:

According to Taleb: "Option sellers, it is said, eat like chickens and go to the bathroom like elephants", which is to say, option sellers may earn a steady small income from selling the options, but when a disaster happens they lose a fortune.

I can't say that I have lost a fortune but I've lost enough to quickly shatter my illusions as to this particular investment strategy. To make a long story short, when Thursday's close is 1071 but the next morning's (expiration day) settlement price is established at 1051.....well, it isn't pretty...

To recap, I have been looking for an investment strategy in which I can achieve an acceptable balance between risk/reward. Mechanical investing did great during the dot com boom, but I had no good exit strategy and ended up staying out of the market for a few years after the bust. I lost a meager 401k to a bad real estate investment deal which forced me into bankruptcy. I really liked LEAPS on AAPL except for the volatility part. I moved into index credit spreads as a way to ameliorate this volatility, and was quite content with making 2.5% on my spreads. I wasn't swinging for the fences every time. And yet I still got kicked in the gut.

Was it randomness? Volatility? Karma? Or maybe all of the above?

I'm not sure, and at this point I'm not sure I care. However, our early retirement plans are not dead. We have resolved to fight through and persevere. Fortunately we have positioned ourselves to set aside a lot of money over the next year. At this point about the only thing I am sure about is that none of that money will ever see a brokerage account. I'm done with the market, and I think I've given it a fair shake over the last decade. And frankly, if a 25-year-old were to ask my advice for long-term investing, I'm not sure what I would tell them! The market works great if the timing is right, but most will tell you that timing the market is near impossible. Buy and hold works good until a recession hits (every 5-7 years or so). And any other method that might juice your returns will also probably crush them.

Any way, were I 25 I might possibly get back in there and find another strategy, but right now the only thing that sounds half-way secure is backed by the government. I still have lots of 'options', but I'm done with Wall Street.

So sure, go ahead and tell me all the ways in which I'm wrong. Enlighten me with all of the things I *should* be doing with my money. Just don't be surprised if I remain unpersuaded...

[REWahoo]

Quote:

Originally Posted by dixonge So sure, go ahead and tell me all the ways in which I'm wrong. Enlighten me with all of the things I *should* be doing with my money.

I won't do any of that.

What I will do is thank you for sharing your experience with us, warts and all. People are eager to boast of their success but few have the fortitude to share the news when things don't work out as they had planned/hoped. I appreciate your willingness to tell your story.

[calmloki]

+1 Good fortune to you.

[ERD50]

Quote:

Originally Posted by REWahoo I won't do any of that. What I will do is thank you for sharing your experience with us, warts and all. People are eager to boast of their success but few have the fortitude to share the news when things don't work out as they had planned/hoped. I appreciate your willingness to tell your story.

REWahoo said it better than I could, so I'll just +1 that. I really do appreciate the updates - I wish it didn't turn out that way for you but it is what it is.

I still wouldn't 'give up' on the market. It may be the best thing out there, despite the problems. Maybe we can revisit that later.

-ERD50

[Moemg]

I appreciate the update and hope you succeed at finding a way to live your dream !