Questions about the PCCRC - New York Traders Expo

Last Feb 22nd, I had the privilege to talk to a good sized audience at the Traders Expo in NYC. I was fortunate enough to have a very advanced group, who asked very relevant questions. Here are some of them for those of you who are trying the PCCRC on your own, and have not yet joined my group.

Why do you choose all at the money, 2:1 proportion of long:shorts? Have you tried different number of contracts per leg?

Try the KISS principle: “keep it simple stupid”. My rules are born of hundreds of backtesting trades over several years using Optionetics Platinum. When I started my testing, data were available to 2000 only, so I tested various markets between 2000 and my first real money PCCRC in 2005. In order to do as many tests as possible, I simplified my entry, using the 2:1 proportion, all at the money options. I quickly learned that the trade was Delta positive at the start, when using my configuration. Turns out that this was a serendipitously good choice and this is why:

By making my entry at as Delta positive trade, I assure a profit if the stock goes up. My PCCRC is not just simply a Vega play. Making the PCCRC Delta neutral and Gamma neutral, you expect to profit from a rise in volatility, but if the stock rallies, you are not likely to make money. My PCCRC is moderated by Delta, but it is not just another bullish trade because it still has considerable Vega exposure.

If a stock goes up, implied volatility (I.V.) usually decline, although I have seen cases in which a stock goes up with increasing volatility, but that is a rare, though highly profitable occurrence. On the other hand, when a stock goes down, suddenly, it usually does with a spike in I.V., which means that you’d be protected against an unexpected decline.

One of the most damaging occurrences to a Vega-only trade is the takeover of the company in question. This usually results in a strong move up in the stock price, but also a dramatic drop in volatility. So long as you follow my rules, you are likely to make a profit because the format of the PCCRC as described, is Delta positive.

Have you tried changing the number of contracts per leg?

Here I follow the old saying: “if it ain’t broke don’t fix it!”. I did my research with the format I have described and got excellent results. As attractive as it might seem to modify the number of contracts per leg to obtain a specific amount to exposure to each Greek, it would not have the backing of my extensive backtesting. Would I go back and back test again, this time making sure that I get a Delta neutral, Gamma neutral, Theta positive and Vega positive trade to begin with? probably not, because it would require much more time to enter each adjusted trade. As I explained above, I have obtained consistent results already. The modified PCCRC would probably be a different animal altogether.
What is the best way of submitting an order to the floor?

Here again, the 2:1 ratio in the PCCRC may be a good thing. Suppose you enter a PCCRC such as this: -10c, -10p, +20c, +20p for a simple debit and a bid:ask spread of less than $1.0. Now consider this one here: -11c, -9p, +23c, +17p or some variation thereoff. Your debit in this position could not be simplified, so your bid-ask spread will be much variable, so first, you are likely to have difficulty entering the whole position for a single debit, in my experience it is a little more difficult to find the fair price for the second than the first.

Why not legging into the trade rather than entering the whole thing as for a debit?

Back in 2005, when I started trading the PCCRC, I had an OptionsXPress account, and they do not have a way to enter the PCCRC in a single ticket. I was forced to enter the trade in two portions. First, I entered one of the two long straddles, usually between 11:00 and 12:00 Pacific, because I always found this period to have the lowest volatility. In addition, I believed the long straddle to be the most difficult to fill. The remaining portion, I entered as a double calendar, which can be enter in OptionsXPress as a “condor”, or a four legged position with equal number of contracts per leg. I found this to be hard and stressful, and sometimes the second portion would not fill. Since what I want is a PCCRC and not a long-term straddle or a double calendar, I simply prefer to enter the whole thing as a single trade. If it does not fill, I can make the determination that the trade I am considering is not liquid enough for my purposes, and I abandon the idea altogether.

After some research, I have found that the floor traders would much rather do two straddles (one short, one long), separately, and that these would fill faster. Is it worth accommodating the floor traders, would I get better fills that way? I have not truly investigated this, but my goal in doing the research would be which one of the two forms of entry would yield the better fill price for me.

Why do both calls and puts in the short side? Here again, my research into the PCCRC did not explore all possible permutations. However, we know that there should be parity between the ATM calls and puts, so selling either should be the same as selling both. Therefore selecting the one that yields the largest credit should be the one to choose. However, my goal is not necessarily to have the short contracts expire worthless. I also want to profit from a strong move in either direction. We know that Vega tends to decline in an up swing and increase in a strong move down in the stock price. Would selling exclusively calls or puts in the front month actually change the results in my PCCRC? here again I would have to start my research from square one, even if in theory there should be no difference. I simply choose to stick with what I have already researched.

For good or ill, I chose to simplify my entry in order to do as many case studies as I could in my back testing. There are certainly many variations of the original concept that I could be testing. My designed has been proven successful in situations in which a stock jumps in price with declining volatility, or in cases where stocks have outperformed the market for months, or are breaking out to new highs. These stocks are the darlings of Wall Street, or they have fundamentally sound reasons to be outperforming the markets. These stocks also tend to have high Statistical Volatility (SV), that is, they can make strong moves in either direction. So why bother trying to find the next best thing or hope that market direction will change? the big winners exist in any market. I believe that my search strategies can find them easily, and the PCCRC takes good advantage of them, whether the markets go up or down, or whether some bad piece of news changes the outlook in these stocks overnight.