Comments from Matt DeFrees

Matt DeFrees has been backtesting my strategies using the PCCRC trade. I though it is worthwhile to look at what he found from his evaluation, since he sounds like an experience investor with an Optionetics Platinum subscription.

... I did 12 more backtest trades today, trying out your ">10% move in 5 days or less" entry criteria and every trade, that's right, all of them were winners. I must be doing something wrong! As the winners accumulated I kept going into the next trade saying to myself, "OK. This is it. This one has to be a loser." Nope. I've never seen this kind of success rate before. Four trades were entered between Jan-March of '06, 7 were traded during the May-June '06 correction and the last trade was entered in the beginning of August '06. All different market conditions but the same result for the PCCRC.

I've stopped rolling over my shorts so much like you suggested and closed several trades at the first "one week to expiration" evaluation point. I closed many trades at the 25-30% target you suggested as well, taking the profit off the table instead of adjusting the trade hoping for more. 30% on 10k debit per trade isn't bad (10k is about how much I'd actually trade this strategy...I'm not as bold as you).

On a couple of trades where the stock went down sharply and then recovered a little, I tried another adjustment strategy that I don't know if you've mentioned yet. Here's my criteria: If the short IV has spiked thus pumping up the value of the shorts and the stock price is sufficiently below the original straddle strike that it isn't likely to rise above it before expiration, I'll sell more calls at that strike (assuming they're worth it), abandoning the upside profit potential above the straddle strike and focusing on 1) Downside profit potential, 2) Further IV gains on the longs or 3) Possible Theta gains if the stock moves up enough to get into the Theta decay zone. This adjustment pushed the bottom half of the risk graph(which I was already in) to the right. It worked a couple of times and saved the trades but that could've just been dumb luck associated with those particular trades. NUE and LVS were the trades where this worked. Just an idea to mull over for a trade gone bad. Here are all the trades I did today if anyone cares to look them over. 3a011f2853fd8ca1be96fea9fe890994

Matt


Thanks Matt for your insights. I look forward to evaluation your trades. I too have found that I can get profits in most of my trades using this approach. My friend StraglingCondor has said "...but there is a worst case scenario where given the size of his trade, and I've seen the debit (risk) he incurs, he would lose a lot of money very fast if that scenario was hit". The truth is that the PCCRC's that go wrong won't lose you more than 10%, if you simply exit the position when it is time to rollover or close {the decision point} one week before expiration. Your results may be encouraging, but there is no system that will work every time, I believe this is as close as I have ever gotten. Yes, the "Perfect System" is a misnomer, but I feel quite comfortable placing 10% of my trading portfolio on each trade. This is important for me because I cannot keep track of more than 15 trades at a time.

This is a capital intensive trade, to be sure but not much more than holding a stock portfolio. You can’t trade effectively less than 6 contracts per trade: 1 short call, 1 short put, 2 long calls and 2 long puts is the minimum. In such cases, commissions have a significant impact on the performance of the trade. So I prefer to trade stocks above $30/share to reduce the number of contracts, and thus the cost of the trade. I have a GOOG trade, for example, with a -3 x -3 x 6 x 6 format. This would be quite prohibitive for most accounts. My philosophy is that the PCCRC is like buying stock with a built in hedge and potential profits to the upside, sideways and downside, with only very limited scenarios in which I lose money at all. By comparison, buying 100 shares of a stock like AAPL would cost me around $8000. A Portfolio of 10 stocks of this size would be $80,000. If a bear marker resembling that of the early 2000’s starts, my portfolio of $70,000 could be reduced to a fraction of that number. With 10 PCCRC’s, my portfolio may actually grow, if the stocks fall sufficiently, and the implied volatility increases too. In my worse case scenario, my $80,000 would turn into $70,000. Not a bad place to be when all around me are losing their shirts. Let's face it, one of the great advantages of Options is to be able to be bearish without trading on margin. As long as you keep the number of shorts equal or lower than your longs, you will be protected against mayor loses. So why not use the puts to hedge your portfolio against a downturn in the market? I learned my lesson with AAPL in Sept 1999.



Matt, your luck with these trades do not surprise me, but you should always consider the worse case scenario, and decide what to do if the trade does not cooperate. These days there are many candidates that match the 10% strategy. There will be a time, however, when the candidates will be few and far between. In such cases, you’ll feel the pressure to enter PCCRCs that don’t exactly meet the required rules. This is when you’ll find yourself making mistakes, and learning from them. You’ll probably also find that in real life there is an added stress that could cause mistakes. Don’t make adjustments for the sake of staying in the trade. Rather follow these conditions (all MUST be met) with every modification:

1. The resulting trade is a straddle.
2. The IV of the long straddle is below 50%.
3. The action you take reduces costs or takes profits.

The Condition 1 means that you can get additional profits if the stock moves strongly up or down. We do not want to change the neutral nature of the trade.

The Condition 2 means that your risk becomes the IV crush if the IV is too high. You will find some cases in which the stock has not move at all but you have a profitable trade. This may be because of an IV spike due to news pending. Be sure to find out what could this news be, and be sure to exit the trade before the news is released or immediately after the news release. You can always exit a trade before earnings, and enter a new one after. I have stayed in trades through earnings because the stock is far away enough from the original strike price that a reversal back to the strike price would actually be a good thing. You’ll see what I mean when you experience this. But be prepared for an IV decline after earnings. Days later, IV will begin to rise again.

The Condition 3 is evident. You can roll a trade forever and get no profits or cost reduction. These will eventually be loser. The game is not how many rollovers can you do, but how can you make the 30% profit target the sooner.

Trust yourself and keep on testing. I did not come up with this system overnight. I have been trading options since 1995 with a big hiatus between 2000 and 2002. I have been looking for a trading system that would allow me to put large amounts of capital to work with the minimum stress possible since Oct, 2002 (the bottom of the market). I implemented most of the rules of my strategy starting in early 2005. Only recently I have achieved 30% returns in the last 12 months. Only recently too, I have put most of my available capital to work in this way (Since July this year). The markets will change, perhaps turning negative. Yet the principles we have discussed in this blog, will allow us to make adjustments to ever changing market conditions. When you believe, you will start to see results. Success only comes with preparation and opportunity. The opportunities are always there. The preparation is up to you.