BlueHorseshoe

Hello, I'm trying to work out whether I can use options to implement a simple directional strategy. I can't be bothered reading any more books and thought I'd take a hands-on approach for a change, so I'm trading the strategy using a simulated options account. Yesterday I bought an at the money Dec14 Call on VB expecting it to rally, which it has done. I bought at $2.50 and the mid is now $3.02, so if I sell at $3.02 I'll realize a profit of $52. If I'd bought and sold 100 shares of the underlying at the same time I would have a profit of $94. Why has the price of the option increased less than the underlying? Am I correct in thinking that if the option expired now (rather than me selling it) its change in value at expiration would have to be equal to the change in value of the underlying? Is the reason my option hasn't risen by $94 (or whatever) because there is still lots of time for the underlying to fall again? 100 shares of the underlying would have cost $11,566 and the option cost $250. Am I correct in thinking that I have had 55% of the return that I would have got from the underlying for round 2% of the outlay/exposure/risk? If I had "known" that the underlying would rally fairly quickly, would it have been better to purchase the November Call that is just a few days from expiration? Should probably have done both yesterday so that I could see exactly what happened! Many thanks for any help anyone is prepared to give. BlueHorseshoe

Hello, You're basically concerned about the possibility of an extreme event and unexpected event with little or no historical precedent (an outlier, a black swan, whatever you want to call it). Such events are precisely those that aren't expected (and their suprise usually contributes to their extremity). The fact that the S&P has never "crashed up" (or more generally that historical volatility tends far more to the downside) doesn't mean that it can't, or won't. The question you should be asking is "How much can I afford to have it crash up by? How do I manage this risk?" BlueHorseshoe

And the rest. Seemed like a good idea at the time . . . turns out the vendors were what made the market. BlueHorseshoe

NinjaTrader (the charting platform) have just launched their own brokerage arm (well, bought out Mirus Futures). Their marketing angle appears to be "no hidden costs, no volume tiers, just transparency" - might be worth a look? BlueHorseshoe

Until the end of time, no doubt. Regards, BlueHorseshoe

Hi SIUYA, My lack of clarity again (and sadly I've had neither beer nor wine for several days). The "Stock A/B" example I gave was purely by way of explaining that reinvested returns could be allocated with a separate criteria to the one used for rebalancing. So profits would not have to be distributed back to the poorer performing components. This isn't what I'm doing though . . . So I get that you are now reweighting across all portfolio instruments. Regardless of where the PL came from. That's correct. I dont think compounding makes much difference as to how you are getting it as it looks more like you are capturing a little bit of both trend following and mean reversion. That's what I have concluded, although the intention was to capture the former (as my swing trading account focuses on mean reversion and I wanted diversification of styles across the two accounts). As always, thanks for your thoughts and help. Regards, BlueHorseshoe

It's probably me not explaining myself clearly enough to be honest If you are rebalancing your whole porftolio, then you must be doing it taking into consideration all parts of the portfolio if you are doing it properly, Yes, but this isn't necessarily linked to the compounding aspect, is it? For example, suppose I draw off any profits so that the account always remained at a fixed amount by month end, but still rebalance the portfolio each month based on a consideration of all parts of the portfolio. The allocation of reinvested profits could differ from the allocations of the rebalanced portfolio aside from these. For example . . . 10k account with 60% (6k) allocated to Stock A . . . 1k portfolio profit at month end . . . Monthly rebalance, 70% of 10k (7k) allocated to Stock A, but only 30% of profits (300) allocated to Stock A, so position size is 7,300, and not 70% of 11k (7,700). ....or are you simply doing the 'dogs of the dow ' theory and buying laggards but with extra leverage on top of a evenly balanced portfolio. Quite the opposite - it's basically "relative strength" - increase position size for the leaders, reduce position size for the laggards . . . then a load of fancy machine-learning thrown at it (purely for my own gratification and entertainment - think basic strategy returns 13%, me playing around with code for a year might add at best 2% and smooth volatility of returns if I'm lucky!). You can see the shifts in weighting of each component in the subpane of the curve I've attached. One component always has a weight of zero (at the minute, metals). We're talking very long term outlook here So my guess is all you can do is simply test and see what happens over the long run and what you can live with....sometimes its great to be full tilt othertimes not. Sure. I've done this, and I'm pretty comfortable with what I'm doing. In a previous thread here I argued that the individual components of a portfolio should be 'rewarded' with increased position size dependent on their unique performance; I now find myself doing the opposite and spreading the benefit from components that have performed strongly to 'reward' equally those that have underperformed. And yet that's what masses of testing tells me is the right thing to do. Cheers, BlueHorseshoe

Hi SIUYA, The strategy is best termed 'relative strength' rather than 'breakout' - I just tend to lump anything that is directional and not mean reversion together as 'go with' - trend following included. I may be misusing the term alpha . . . I was considering an equal-weighted portfolio of the components (ie a 'passive' investment in the portfolio) as the benchmark. The portfolio as I have implemented it, with variable weights, shows (historically) a greater return than this benchmark - is this not usually termed alpha? The key question I'm asking though is this: when profits can be traced to a particular portfolio component, should the "benefit" of increased position sizing be passed to just this one component, or to the portfolio as a whole? What I have found in this instance is that performance is improved when the benefit is passed equally to every component in the portfolio. This must mean that the improvement in performance is the result of increasing position size for poorer performing components, surely? Cheers, BlueHorseshoe

Hi MM, A few are equity indices, but it's pretty well diversified with things like metals, energies, interest rates, and timber woodland in there as well. The weighting of each component in the portfolio is a dynamic feature, so the allocation to equities may be minimal (as it was in 2008 for example). The strategy has underperformed the S&P500 throughout the past few years. Kind regards, BlueHorseshoe

Hello, I've just begun trading a second account today (18 months in the planning and research), with rather different and more conservative goals to what I've done elsewhere, and I wanted to share some thoughts . . . Here's some basic info: The strategy is long-only a portfolio of 12 ETFs Positions are rebalanced monthly Allocations are the result of a rule-based adaptive algorithm Leverage is configured at 0.96 A position is held in all 12 markets at all times So here's the conundrum . . . The strategy shows a greater edge, when the simplest of money management approaches (reinvestment of return, reinvestment of dividends) is applied, than when position sizing is based on a static account size. How can this be? Imagine investing in 4 shares of single stock. After a strong month, during which the stock rallied 100%, you liquidate your position. Your equity has doubled. Does this mean that you now go and buy 8 shares of this stock? Of course not: the stock now costs twice as much. You can only buy 4 shares. Now imagine you split your equity evenly between purchases of shares of two equally priced stocks, with 2 shares in each. The first doubles in value; the second exhibits no change whatsoever. Your account has increased in size by 50%, and so some of this increase in available equity is passed on to your new position size in the second stock (the one whose value remained static). You can only buy 2 shares of the first stock, but you can buy 3 shares of the second. The second is the "weaker" stock - the one that has demonstrated the least return for a long-only trader. Now consider my long-only strategy, which is designed to benefit only from price increases. When returns are compounded evenly in allocation to all components of the portfolio, and the strategy becomes more profitable with this type of compounding, then the increase in alpha MUST COME FROM THE WEAKER PERFORMING COMPONENTS. That's right: the strategy has been designed to benefit when price goes up, but the money management element will increase returns purely by increasing allocation to those markets that have gone up the least (or even fallen). What do people make of this? In a strategy predicated upon relative strength, breakouts, trends and outliers, is the money management actually drawing out additional alpha from mean reversion, of all things? Kind Regards, BlueHorseshoe

Set its nest on fire. Beaky little bugger. Failing that, the tree in which it nests, or generally resides. Try not to set your house on fire though. We all respond negatively to fire . . . BlueHorseshoe

Hi SIUYA, What does the term 'gearing' mean? Is this simply the amount of leverage that is used? Kind regards, BlueHorseshoe

Probably a Guppy, by the sounds of it . . . BlueHorseshoe ps I have laboured to make that joke easily translate - naturally I'd say a minnow - do people in the US even know what a minnow is?

You're talking about net loss though, right? Traders don't have to be losing traders rather than winning traders, yes? You don't mean that traders following your method will literally never have a losing trade again. That a strategy will be 100% profitable is the sort of stuff that snake oil vendors suggest - I assumed your thread title was a self-aware and ironic take on this. Kind regards, BlueHorseshoe

I've never paid the BMT forum any attention either. There's a post (seemingly from moderators or 'Big Mike' himself) clearly aimed at discrediting a vendor whose (totally free) blog I have followed and found helpful. I'm not really sure why AMP would ever get so concerned over the allegations unless someone in senior management there is somewhat pious and self-righteous? How many out-and-out con men are out there with dozens of websites proclaiming them as such, yet continue to swindle unsuspecting marks to the tune of millions a year? Why would AMP get wound up over a few bad reviews on a forum or whatever? Haven't they got more important things on their mind? BlueHorseshoe