Updated: Dec 6, 2018
We are currently in all safety positions for our core Balanced and Volatility strategies, waiting for things to settle down a little bit before jumping back into this market. So if you're not following our options trading strategy, take the day off :)
Today's trade is in the VTS Discretionary Strategy. You know I like to fully explain all trade types so grab a coffee and enjoy... If you're not following our options trades yet I invite you to open a paper trading account with your broker and start getting some practice. Most will just follow my trades and that's just fine. But there might be a few of you in the community who are future option trading wizards and don't even know it yet. Open a paper account, follow my trades for a while risk-free, and who knows you may one day surpass me and teach me a few things :)
"Vol Step Strategy" video explanation is here.
The Vol Step Strategy is probably going to be appealing to many of you who are interested in trying to capitalize on the decay factor of the volatility products. Who among us hasn't looked at a chart for the UVXY and thought to ourselves, why not short it and forget it?
5-year chart of UVXY:
It seems like a good idea in theory but the problem is when volatility spikes these long vol products like UVXY can be catastrophic to those who have taken extended short positions of any significant size. Just to give you some context, using simulated data from 2008 the UVXY would have spiked about 1500%
UVXY during the last recession:
Even if you were short just 5 or 10% of your total account value that kind of extended move could wipe you out. Now you might be thinking well that's fine, I can just sell everything else in my account and hold the short shares indefinitely and it will eventually recover, right? Oh ok, but what if your shares get called away? What if your broker forces a liquidation? What if the vol products themselves go through structural changes or worse, just disappear? And what about unforeseen events? They are always lurking out there and possible so holding an extended short position is a terrible idea and I would not recommend this for my worst enemy. I've seen a few reckless traders on Twitter talking about their long-term "core short" shares that they just hold indefinitely. They are dead men walking, they just don't know it yet.
So we can't just blindly short the UVXY. That's why our volatility strategies are long only the vol ETPs and all have several mechanisms in place to determine the best time to go short vol and when we should either be safely in cash or on the long vol side.
* And remember, our volatility strategies can and often do move to cash on a single days notice so we are nothing like buy and hold. We can be out of danger very quickly which is vital
But there are ways to responsibly short Volatility ETPs and this is one of them. Enter the Vol Step Strategy.
UVXY since September 2017:
Those red hash lines are the monthly options expiration cycles with the white circles representing where UVXY expired. Notice how UVXY tends to (not always but tends to) make lower lows as we progress forward in time? If you look at it the right way it starts to resemble steps downward right? That's why I call this the vol step strategy.
The goal: By analyzing a variety of volatility metrics and market indicators, I try to determine the best time to enter the monthly Vol Step trade by buying a vertical put spread on UVXY hoping to capitalize on another step down in the following expiration.
There are a few keys to this strategy that we need to be aware of:
1) It's absolutely imperative that we allocate VERY small to these trades. I don't care how good you think you are at predicting volatility markets, at some point, you will have a streak of losses in a row. If you allocate too large an amount per trade, a few losing months in a row could seriously cost you in the long run.
2) We can't do it blindly. I know there's going to be people who think great, just do this every single week or month after expiration and reload it over and over. Slow down my friend. Remember the volatility markets are very efficient. Doing anything blindly may work for a while but the long-term expectation of profit there is 0% minus trade fees. The options market is where "smart money" plays and it's highly competitive. Believe me, everybody and their dog already knows about the decay and beta slippage of these vol products so you have no edge at all by just blindly taking trades based on a time schedule. As simple and potentially profitable as that may seem, in the long run, it approaches 0% return minus trade fees.
3) It has to be completely independent of all other trades in your account. Because we may need to open and close them at varying times these trades should not be weighed against anything else you hold in your account. I've also seen Twitter "guru's" talking about playing long and short vol positions against each other but again, that's just borrowed time and eventually, a streak of poor timing or adverse market conditions means heavy losses accrue.
VTS Discretionary Strategy The annual 25,000 model portfolio is currently at 26,061.38
The trade: Long vertical put spread on UVXY for November expiration
BUY to OPEN 5 x 16 Nov 18' UVXY 40 PUT SELL to OPEN 5 x 16 Nov 18' UVXY 38 PUT Debit: ~ 1.28
* prices change throughout the day so do the best you can. The lower the price the better.
Margin Requirement: Long vertical spreads are defined risk trades and require very little margin. It's just the cost of the contract multiplied by the options factor of 100, and then multiplied by the number of contracts.
1.28 x 100 = 128.00 margin per contract 5 contracts x 128.00 = 640.00 total margin required
640.00 / 26,061.38 model portfolio value = 2.46%
* You can scale your trade to roughly 2-3% of available capital within your VTS Discretionary allocated funds.
Risk management / future action: Often times if we capture most of the profit we close them out early to reduce gamma risk, but since these are very small allocation trades we need to factor trade fees in the equation as well. That does mean sometimes we just let them expire. If you want to keep things really simple you can also consider them "set and forget" trades where you just let them expire each time.
The Vol Step Strategy is now added to our ever-growing options trading toolbox. I have dozens of strategies so when the right situation presents itself I will slowly introduce them to the VTS community. Remember the most important aspect of successful long-term investing is managing emotions and sticking to the process and trading plan. However, learning the fundamentals of each trade is important as well so feel free to ask any questions you have.
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* All information, analysis, and articles on this site are provided for informational purposes only. Nothing herein should be interested as personalized investment advice as I make no recommendations to buy, sell, or hold any securities or positions. I'm making this website available "as is" with no warranty or guarantees of it's accuracy, completeness, or current's. If you rely on this website or any of the information contained, you do so entirely at your own risk. I do not hold myself out as a financial advisor and nothing herein is a solicitation for any fund or securities mentioned. Although I may answer general questions about the information herein, I'm not licensed or registered under security laws to address your personal investment situation. Past performance is not indicative of future results. Any and all financial decisions are the sole responsibility of you the individual.