For months I have been posting articles, commentary and true examples on my PCCRC strategy and the different situations in which they have turn out to be profitable. I have received little criticism, which is unfortunate because it is only through challenge that I can give an explanation that could set at easy the most skeptical of minds, while warning of potential dangers to those willing to see only the successes and not the failures.
Here are some comments that have been made of the PCCRC outside this board, that I would like to deal with:
Jack (jwong139) posted:
“On the debit/risk issue - I could also say that PCCRC is a capital intensive strategy. Of course advanced traders think that debit is irrelevant but the risk is (which is my thinking too!). But one still need money (the debit) or marign (the risk to be set aside) before you can open such a trade. So, giving a person a $100K account, he may choose trade with more debit/less risk per Platinum information or with less debit(or credit)/more risk per Platinum information. At the end of the day, he/she has to understand the risk/reward and ask himself whether he is comfortable with it.”
It should be clear by now that the risk in a PCCRC as stated in a Platinum risk graph is not valid because a decline in IV of your long options may hurt the performance of your trade. This is why is so important that you enter trades that are at the low end of their implied volatility charts. The true risk (how much money you could lose) is not properly stated by the Platinum risk graphs. However, it should be obvious that my selection of 3 basic situations in which the PCCRC can be highly profitable should be high in the mind of a trader:
1. Stocks after earnings report with exceeded expectations and raised guidance.
2. The best performing stocks of the last 90 days. This is the “high flier strategy”.
3. The volatility Skew: select stocks with high front month IV and low back month IV.
I have presented many examples of each of these strategies.
There is not such a thing as a sure thing, so occasionally you will have stocks that do not perform as expected. In such cases, I do not expand my losses after one month. I hardly ever let my losses exceed 20%. However, my gains may exceed 50%. Take the recent GOOG, RIMM and AAPL examples. BTW, today’s gains in these and other trades, have brought my performance of the last 12 months to 34%. I don’t like tooting my horn too much, because I have had plenty of bad experiences in the last few years. But I am happy to share the good the bad and the ugly.
Strangling Condor: “Juan states his PCCRC has not that much risk. I say true, 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. It is all about money management. If you are comfortable spending $15000 on a new car, when you are done using it, do you give it away for free? No, you sell it for what it's worth.”
The amounts of money (debit) that I am willing to bet are based on my own confidence in the trade. I know that there is no scenario in which I would lose all the capital (as long as I follow the rules of entry). I am perfectly willing to lose 10-20% in some trades because I can make as much as 50% in others. The beauty of the PCCRC is that there is no limit to the Upside or the downside potential of my trade, not is there a limit to my gains if the IV of my long options jump. If the stock goes sideways, I can still exit the trade as though I was trading a calendar spread.
The reason I show you my actual trades, is only so that you see exactly what I am doing. There are plenty of Gurus out there and snake oil salesmen that will show you their sure thing trades that they don’t dare to trade themselves.
Finally, I invite questions and controversy. I have insisted that I am a trader like you are, not some Master that can teach you a get rich scheme. I have shown you what I know and even what I do without reservations. The results speak for themselves. I have not been shy about what has worked and what has not. So please feel free to ask and express doubt. That would only help me clarify my ideas better.
When settling upon a system of trading you should ask yourself: Would my system work over and over and over again under most market conditions as long as I follow a narrow set of conditions and a strict set of rules? or am I at the mercy of unexpceted market reversals? As you become comfortable with that system you will begin to increase the investment capital until the unpredictable happens. Would you be able to recover from that very unexpected market move?
Thank you so much Jack and StrangleCondor.
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14 comments:
Juan,
If you don't like tooting your own horn, I'll toot it for you. OK, that sounded a little creepy...forget I said it.
At any rate, I'd be happy to criticize if only I knew enough to find a problem with the system. So far, and granted, all of my research has been backtesting at this point, I have been far more successful finding and implementing profitable trades using the guidelines you've set forth (for entry, adjustment and exit) than any other strategy I've tried up to this point in my options trading career.
Frankly, as long as I've followed your rules, my test trades have been successful. I did 3 backtest trades today; 2 were winners ($3660 and $4000) and 1 was a loser (-$1170). Plus, these trades were done in May, June and July and we all know how difficult those months were for the market. In fact, I specifically picked those months to backtest to see just what would happen to a PCCRC trade when the overall market was declining.
I guess the only criticism that I have is in your choice of entering stocks based on volatility skew. It sounds great in theory but, from what I've noticed, this skew typically happens right before an earnings report and even though the skew exists, the long straddle IVs are also pumped up to historically high levels. When the IV drops for both shorts and longs after earnings, the longs are often crushed as much as the shorts because there are twice as many contracts in place even though the short IV drops twice as much. Does this make any sense?
Add to that the fact that the stock could gap down after the earnings report putting your trade in the loss zone of the PCCRC risk graph and you might as well have waited until after the earnings announcement to see what the report and guidance would be and then enter when 1) IV is back to historically low levels and 2) You know everything you need to know.
I may be way off base here, let me know if I'm missing something. Perhaps there needs to be some caveat that trading IV skews is okay as long as the long IV remains at historically low levels. That way the IV crush will affect the shorts but not the longs.
Matt
Thanks, Matt, I sense for your post that you have sufficient experience to appreciate wahat I have been trying to show others. I am glad that you have come up with the same conclusions.
Indeed, even in an unfavorable market, there will always be the outperformers. Inevitable, these will be the stocks with better than expected earnings and even increases in earnings guidance. In such situations you may fear that a bull call spread or a long call may easily be losing propositions, particularl right after earnings. But the PCCRC provides a built in hedge.
With sufficient time, such fundamentally out performing stocks will outperform the markets. Even if eventually the stock hits a top, the PCCRC allow you to collect gains to the down side too, as long as you transform your trade in a timely fashion by selling a portion of your long call, while retaining the delta neutral basic nature of the trade.
Remember also that following earnings, there will be a volatility decline, so indeed, it is better to wait after earnings before entering a trade, even if you note a skew. However, the IMCL example of months ago, proved profitable because a skew occurred which was not associated with earnings, but with legal problems. The collapse in front month options may not reverse, but within days after earnings, the long term options begin to increase in volatility.
A good example currently in the making is LXK. We will see how the skew breaks down after earnings tomorrow.
Thanks for your comments, Matt. You make me feel that I am not wasting my time.
Thanks.
Hi juan ever research delta hedging the PCCRC with stock if it goes down
No, I never trade stocks, anymore.
The point of the PCCRC is to have results equivalent to stocks if the underlying moves up, but have a downside protection (or even profit potential) if the stock goes down.
If that happens and I feel that the underlying is about to jump, it is just as convenient to sell long puts (as long as the resulting risk graph represent a good opportunity.
Buying the stock would also increase my debit with no additional benefit (except perhaps nulify the potential Vega gains).
So no, I would not introduce stocks into the equation. However, if you experiment with it and find some interesting results, feel free to share.
Hi Juan, looking at the PCCRC risk graph, it seems that there is a death zone below the entry. I have see that the delta is constant in the zone. It can be neutralised by shorting the approiate stocks. If position is large, it may be worth the hedge and make PCCRC delta neutral in the zone.
Try
Short AMD -2 Nov 20 Call/Put
Long AMD +6 Apr 20 Call/Put
and short 100 AMD stock
Tell me what do you think
anonymous..
This is not at all what I have tested or presented here.
AMD recently dropped significantly and the stock is below 30, which is my cut off point.
I would not be the one to discourage exploration. I just cannot comment on something I have not tried myself. So go ahead and experiment, but please follow the rules laid out in my many posts, if you'd like to follow my trading style.
Also, instead of shorting the stock, consider just adding to your long puts. There is nothing wrong with having more puts than calls. In fact that is a PCCRC by definition.
I am concerned that the IV on AMD is just too high and a decline in IV may end up hurting your trade. This is why I only trade options with IV below 40%, at least for the long options.
Juan,
I know you've spoken briefly about this before but could you explain to me your reasoning for choosing the 6 day SV and 7-149 day IV when picking PCCRC candidates using the IV/SV Chart? Through my backtesting, I can clearly see that it works, I'd just like to understand why it works.
Thanks,
Matt
Hi Matt.
First, I attended a seminar in which Alex Jacobson talked about actual volatility. He said that Actual volatility and not Statistical volatility is what is relevant here and now. He described how to calculate actual volatility, but I decided that it was more practical to enter the 6 day SV as an approximation, that it would be to calculate the actual (one day) volatility.
If the SV is high and the IV is low, we could conclude that this situation will reverse, either by an increase in the SV of the stock (a strong Delta move) or an increase in IV, which would produce Vega gains in my position.
Both GOOG and AAPL have such profile, and thus they are good candidates for a PCCRC. This typically happen right after earnings. Take a look at the candidates I am looking at for entry into PCCRCs: AMZN, EAT and NFLX.
These reported good earnings recently, but the IV has declined rapidly, as it usually happens after earnings. SV is high now, but the stock prices should settle for a few days, or weeks. Eventually, a follow through jump will occur with an accompanying increase in IV. This is where your profits will appear.
By the way, Alex Jacobson is a very knowlegeable guy. Take a look at his Volatility seminar in ISE's webinars.
http://www.iseoptions.com/education/presentations/webinars_archive.aspx
Juan,
That makes perfect sense to me. Why take the time to calculate the actual current volatility when an approximation will do just fine.
BTW, 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.
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Matt
Juan,
I'm just getting up to date on your strategy. I have a few positions on and have some thought to share.
1. I'm looking at this strategy as one end of continuum in the calendar spread universe. One end attempts to make profits with theta (standard calendars). By ratio-ing the longs, you reduce the negative gamma of the calendar, lifting the wings, eventually ending up in your PCRCC strategy.
So far I'm treating these as a pure vega play. I look for stock with very spiky IV's, preferably predictable spikes around earnings dates. And very low IV. I set up the trades to be about delta neutral (usually requires a few more long puts than calls) then sell as many near term straddles as will get me near theta neutral. This gives me almost pure vega exposure. I look at my risk as the sum of two numbers: 1. the depth of the valley between teh current stock price and the upward slope away from the current price. (I define this as my 'delta risk' - the worst case scenario assuming unchanged volatility.) and 2. the difference between the current IV on my long options and the lowest IV in recent history (that's my vega risk). I compare that total risk against the vega potential defined as a reasonable target IV based on past IV spikes and the current IV on my long options. My goal is to exit just prior to the earnings date.
I have some thoughts on how to roll for best effect - but I'll leave that for a future post. Would you have any comments on my thoughts above?
Thanks for creating this blog and sharing.
Eric
You can certainly modify the number of contracts per leg, to change the configuration to your liking.
Without a doubt, there is a lot of flexibility in the structure, but I am begining to like the post-earnings entry for the following reasons:
1. IV drops after earnings.
2. Stocks with good reports will eventually pressure the stock up (hence I don't mind having the bullish bias you get with even number of shorts and longs.
3. IV will beging to rise over the following months, up until the next earnings report.
4. Limit the duration of the long calls to one month after earnings.
Your proposed trade will have to be studied as a separate and different entity, and be sure that you test it in a fairly narrow set of conditions, not the least of which would be an IV of less the 40% for the long options. A case of IV skew could be another approach.
You may find some kind of system in which IV is more or less predictably on the rise. That would result in profits, even if the stocks do not move in either direction.
Please share your examples, so we can discuss them.
OK. I'm struggling with the following: Are these a vega play while tolerating a certain amount of theta losses or are these theta plays where you need to be mindful of volatility levels since they are positive vega? The answer will drive the ratio of longs to shorts. Thoughts?
Eric
Hi Eric.
I have said that these trades are more like a carriage being pulled by 3 horses named Theta, Vega and Delta. When one fails one of the others pick up the slack.
If you expect ONE of the Greeks to work every time, and then ignore the other Greeks, you may lose an opportunity.
Take AAPL as an example. I had a Jan/April $85 PCCRC until today. Vega had ran up in anticipation of Today's Mac World announcements. I could have close the position because of my Vega gains.
However, because the stock had moved up, and then down and was now close to my strike price, it was clear that I had also Theta gains, but to wait until next week's expiration would not have been a good move, since one would have expected a strong move in either direction. Using Optionetic's platinum site, I realized that rolling over my shorts to Feb would be a good move with a difference of >$1 between shorts (both puts and calls) of the two months.
I was monitoring the announcements in MacRumors.com. As soon as Steve Jobs said that there was a phone, I made the rollover. The stock began to rally and I.V. declined just a tad. In this case, DELTA took over while Tetha and Vega stopped working.
It is quite possible that Vega may decline, but I now expect Delta to be the big factor here.
It is important that you backtest a lot of these to get a sense of what to do at the right time. I was lucky this morning, I have to admit, but I had enough knowledge on AAPL and news impact on the PCCRC to know that IV would decline. The rollover reduced the impact of Theta and Vega and set me up for Delta gains
I hope this helps. My short answer is DO a lot of back testing. The learning experience is worthwhile
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