Forex Options Strangle System

Ken, great question. Here is what happened:

1) I was sitting on a short USDJPY put at 87 with a DEC 17 expiry. Over Thanksgiving, the markets freaked out because of Greece's debt default and the USDJPY spiked down to 84.81 as a low, before closing at 86.52.

2) This price action was a pin / doji bar and is a sign of a reversal.

3) Combined with a divergence with the internals indicator, I had confidence that the USDJPY would rally over the next 1-2 weeks or until expiry.

Attached is screen shot of the situation:

a) The black line is the put strike. It is between the two red lines which are the start and end of the option.

b) The red lines are where I entered the position and when it expired.

c) The purple lines are the lows in the actual price of the USDJPY and the lows in the Internal's difference. You can see that the price of the USDJPY reached a new low, but the Internal's didn't. This divergence is USUALLY indicative of a reversal, but combined with the price action, I stuck to my guns.

However, the price of the USDJPY at the end of the month was 86.37, since the spike happened on the 27th, and then the weekend hit right after. I was thus holding an option that had an open net of about -$1500 at the end of the month. This is what caused the small draw down on a monthly basis.

We should not however that the market did rally, the option expired, I captured all of the profit back and Dec therefore came in at +42%. I hope that helps explain the issue.

Since January of 2010 is closed, here is an update on my performance.

Hi Scattergood,

So you are able to measure the overall trend and delta-trend using your indicators over the entire currency ? Did this help you with the USDJPY trade in Nov. ? Also, do these indicators play a fundamental role in your options strangle system or will any standard indicators work ?

thanks,
sckid

Hi Everybody,

I apologize for the delay in psoting, but options trading is a slow process and things go busy in other areas. Now however I ready to post and give you all updates and more info on the system.

This will be the first of two posts today, and it will go over the performance of the FOSS so far.

I am happy to report that the performance is, IMHO, stellar. The attached table and chart show the following:

1) One losing month out since inception, or 1 out of 7.
2) Max monthly drawdown of -3.69%
3) Max monthly gain of +42.26%
4) Total net returns of +128.72%
5) Annualized net of average monthly returns of +220.67%

Not shown in the table or chart are the fat that I only had to 'roll' one leg of one trade so far (which is discussed in the next post) and that the trades had the following:

1) A total of +1085 trade pips were collected. Trade pips are just the raw, non size adjusted returns.
2) A total of +1323 total pips were collected. Total pips are the trade pips x the lot size of the trade.
3) A total of 29 trades were closed.

All of the above seem to show that the FOSS is a solid, if not very exciting and plodding way to make some serious returns.

As promised here is a full discussion of the one trade so far that I have had to roll. Please refer to the attached image of the chart to understand the discussion below.

On the chart you will see 4 labels, each is explained here:

A1 = On 01.05.10 I sold 200K worth of the 2.15.10 Calls with a 1.4950 Strike @ 47 pips for +$940.
A2 = On 01.05.10 I sold 200K worth of the 2.15.10 Put with a 1.3700 Strike @ 38 pips for +$760.
B1 = On 02.05.10 I bought back 200K worth of the 2.15.10 Put with a 1.3700 Strike @ 183 pips for -$3660.
B2 = On 02.05.10 I sold 200K worth of the 5.20.10 Put with a 1.3000 Strike @ 183 pips for +$2980.
C = On 02.15.10 I sold 200K worth of the 5.20.10 Calls with a 1.4250 Strike @ 90 pips for +$1800.

The left most vertical red line is when I initated the trades.
The vertical blue line is when I rolled the put (B1 & B2).
The middle vertical red line is when I initated the 5.20.10 Call.
The right vertical red line is when the 5.20.10 wil expire.

Now here are a few things to consider:

1) The original strangle (A1 + A2) would have netted $1700 if I didn't have to roll.
2) By rolling I turned the Put leg (A2 - B1 + B2) into a break even trade essentiall with a $80 net gain.
3) By adding the Call leg after the roll (C) I made the total trade a $2820 gain if I do't have to roll by May.

Now why is the above important? Because the maximum amount I needed in the acount for this trade was the margin and the loss absorbtion for one leg:

Margin = lot size * 0.02 * .5 (delta for an ATM option)

200K * .02 * .5 = $2000

Loss Absorbstion = 200 pips * $/pip at risk

200 pips * $20 per pip = $4000

So I had about $6000 of my account to deal with this trade. If everything works out until May 20, 2010, I will net $2820 on the $6000, or about 47% from January until mid May, 5.5 months. And this is for a 'bad' trade that I had to roll with.

If I didn't need to roll then I would have collected $1700 on the $6000 or 28% in just over 1 month.

Please post any questions or comments, I am happy to try to repsond.

Ok, the month of April 2010 is done, and I am happy to report that it was another pretty good month. It came in at +21.28%. Here are the stats:

1) One losing month out since inception, or 1 out of 8.
2) Max monthly drawdown of -3.69%
3) Max monthly gain of +42.26%
4) Total net returns of +150.01%
5) Annualized net of average monthly returns of +225.01%

The activity for the month was as follows:

Option Exercise/Expire
EUR/USD Put Expire : 04/15/2010 Hour : NY 4:00 PM @1.310000 3/10/2010 Pip Sell -200,000 0.0025
EUR/USD Call Expire : 04/15/2010 Hour : NY 4:00 PM @1.385000 3/22/2010 Pip Sell -200,000 0.0019

Option Trade Activity
242559 GBP/USD Call Expire : 05/20/2010 Hour : NY 4:00 PM @1.580000 04/08/2010 Pip Sell -300,000 0.0053 1,590.00 USD

Open Option Positions
Contract Description Trade Date Option Type Long / Short Quantity Premium Price Delta Market Value Of Options CCY
EUR/USD Put Expire : 05/20/2010 Hour : NY 4:00 PM @1.300000 02/05/2010 Pip Short -200,000 0.0149 0.0050 -1,000.00 USD
EUR/USD Call Expire : 05/20/2010 Hour : NY 4:00 PM @1.425000 02/15/2010 Pip Short -200,000 0.0090 0.0010 -200.00 USD
GBP/USD Call Expire : 05/20/2010 Hour : NY 4:00 PM @1.580000 04/08/2010 Pip Short -300,000 0.0053 0.0027 -810.00 USD


Also attached is the chart showing the monthly gains.

Sorry for the long delay in posting, but the FOSS system isn't really geared to lots of trades and lots of posts. I am happy to report that I have been able to compile my 12 months of trading and the results are something I am VERY happy with:

1) 3 losing months since inception, or 3 out of 12.
2) Max monthly drawdown of -17.68%
3) Max monthly gain of +33.32%
4) Total net returns of +120.2%
5) Annualized net of average monthly returns of +120.2%

I found out that the powers that be (NFA / CFTC) have a specific method of calculating returns which is now used in this post here. This is why some of the numbers may different than from previous posts. Their method is to calculate the month start to month end returns, average them, and then annualize them. They also do this because if you add additional funds to your account you need to calculate the profit and loss on an amount that is different than your initial starting capital.

The attached charts show the net % change in the account and the value of $10K if it had been invested over the entire year.

As always if anybody has any questions or comments, I am happy to try to spend some time answering them.

I just wanted to ask you some good books about Forex options...i know Spot but options i dont know anything....so read some stuff


also what is the meat of your system ...when u put FOSS you expect that it "WILL HIT THE PRICE" or you expect it "WILL NOT HIT THE PRICE"...


THanks
V

Indianguy,

Thanks for asking the question. The 'meat' of the system is "WILL NOT HIT THE PRICE". Whenever you sell an option your profit is the amount of money you collect in premium, and no more. So you DO NOT WANT the price of the underlying to reach the strike.

Thanks,
Scattergood

Some people have been privately asking me to show some of the trades as this kind of trading takes place over longer time periods and happens infrequently.

Attached is a chart showing all of the USDJPY trades that were made, 4 in all. The red lines show the entry and exit points (expiry) of the options.

In total, these four trades collected $3766.82 on a starting balance of $8730 in option premium and only one trade was ever beyond the strike.

I explain in a post above why I kept that trade on.

As always, questions and comments are welcome.

Commendable work mr. Scattergood..
Wish u the same success in times to come.
Cheers..

Thanks, I appreciate the good wishes.

Here is a similar method I have been using successfully over the last few months (averaging 30% account growth per month. Worst month +10%, best month +67%).

Ideally I sell options at 45-30 days from expiry. I aim to sell a strangle but in order to maximise premiums leg in. The screenshot below shows the (centre line) linear regression point calculated over the last 60 days. The orange lines out from this are 2 standard deviations away, and the further out orange lines are 3 standard deviations away. The red lines are the average monthly price range over the last year, weighted more heavily to the recent months.

Basically I wait for the price to approach 2 standard deviations from the linear regression point and when it looks like it is consolidating or turning around sell an option at a strike price just outside of 3 standard deviations. If this is combined with the price touching the monthly average range lines and some support or resistance then it is an even stronger sign. In the example attached these criteria are met exactly, so I would be looking to sell January puts at a 1.28 strike. Ideally the price then heads up the other way and I sell a call above the current range in a few days time. Note that sometimes it doesn't work this way and I'm left with a naked call or put.

At current prices this sale would result in more premium received than margin required if the price moved to 1.28 and I had to roll out & down.

Previously I was trying to sell exactly at the regression point and opening both legs of the strangle at the same time at 2 standard deviations, but this often resulted in having to roll out to the next month. I haven't had to roll out a position since changing to 3 standard deviations - no doubt it will happen sooner or later though.

Note: Ignore the sell line showing in the example, it is from an EA I am testing.

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Are you going to start a CTA and trade for other people? What FCM do you use?

Not sure if you're referring to scattergood or me? My answer is a resounding NO! I prefer to sleep at night. Aside from that complying with ASIC's requirements makes doing any form of business in Australia cost ineffective - guess I could move to Singapore!

Are you using some indicator for stnd deviations and avarage monthly pirce range lines? If so, would you be so kind and post it?

Regards

scattergood
Would it be fair to say that you have been Lucky in this strategy in ref to only few times your upper or lower strike prices have been touched.
What if there would have been "rolling forward" required in trade after trade?
Or a HUGE spike! where the rolling cost is too much ( It did happen to me once)


I had heard a saying when writing naked options... you eat like a king every month but you may xxxx like an emperor one month!

No disrespect intended I can see that you put some efforts in this strategy but if this was so simple than many broker would have marketed this concept

Any way, what your thoughts on Protected Buy write? specially with leverage offered

1)Long spot
2)buy a long dated Put
3) Sell monthly calls

As is famously said, "luck is the residue of design". Look ALL traders do not have 100% certainty in the price movement direction of an instrument. So isn't your argument that all successful traders are lucky?

No, I don't think I have been lucky. Trading is about finding an edge, something that gives you a more informed decision. Think predictive vs. predictable. That the sun will come up is predictable. Death and taxes are predictable. Everything else is at best predictive. Things are likely to happen, but not sure to happen, except....

Time. Theta, or time decay is totally predictable. Every day is another new day. In options trading that means that every day your sold option will decrease in value somewhat. However, it may increase in value because of the movement of the instrument. So, you have to make informed decisions as to where an instrument may or may not be going. That is the art of trading and what separates successful vs not successful traders.

The system you describe may or may not work. It depends on volatility expansion of the instrument.

If you buy the EURUSD at 1.3300 and but the 210 day put at 1.33 for 420 pips, then you have to sell the 30 call 7 times for an average of 60 pips each. That may be doable especially if the volatility increases making all option premium goes up. But if volatility goes down, then you may not get your average price. Also, you don't really realize profits until the END of the long dated option. Your system is a bet on volatility which is ok, but not my thing.

I have used a strangle system for the past 4 years with consistent results. Since every day you are making money because of decay it is straight foward. The real trick to consistency is risk management. What to do when you get sharp moves!