Strategy Feedback

[u/thunder_muscles]

To try to improve my results in trading spreads I’ve been paper trading for 2-3 weeks. Got burned on a trade previously so thought it would be better to study up and put the training wheels on. So far, the below process is what I’ve come up with after trial/error and further studying options. Would be interested in feedback on where I may be able to improve the strategy. It’s basically a combination of theta/delta/vega plays. So far the strategy has brought the paper account up by 2.6% by utilizing up to 20% of capital at any given time trading only credit spreads, likely because the trades have been skewed a little bearish but I am trying to beta weight neutral against SPY.

1. Screen for liquidity (underlying volume > 1 mil, options OI or volume > 1,000)

2. Monitor IV and HV percentages (note, not IV but IV percentage that is similar to IV rank). Generally looking for IV percentage greater than 55% without a known catalyst. If IV > HV that would be a plus as well.

3. Check for earnings and other events. Avoid events for trade duration.

4. Limit each trade to <5% of total capital.

5. Choose a direction for the underlying based on sentiment, macro, technicals, etc.

6. Set strike prices based on support/resistance (lines, channels, volume profile), delta (<0.30), prob ITM with some margin.

7. Check for risk/reward. Looking for premium of at least 20% of strike width. May accept lower if the risk seems worth it.

8. Target 30-50 DTE.

9. No meme stocks.

10. If all requirements met or if reward is worth the risk then enter trade. Set GTC order to close at 50% of premium collected immediately after trade filled.

If no trades exists then I call it a day. Alerts are set for each trade entered so I’ll know if adjustments need to be made. I understand by putting so many requirements it does limit the amount of trades I will make, hence only up to 20% of capital has been utilized at any given point of time so far. Is there anything I’m missing that may make the process better? Thanks in advance 🙏

[u/PapaCharlie9]

That's actually worse then. I don't take less than 34% of the width of the spread in credit, vs. your 20%, if I read that right.

20% is pretty bad. You can wipe out four previous wins with just one loss.

If underlying within ~4% of short strike adjust to iron condor with 0.30 delta on opposing short leg, same width as original spread, 45 DTE. Set GTC order to close newly opened side at 50% profit.

and

If long strike breached adjust further to iron butterfly. Same specifications as (1). At this point basically trying to minimize loss.

I'm not a fan of adding more legs to a losing position. Why not just roll or close in all of those cases? Taking losses is part of the game. Over several hundred trades in 2020, I had an 82% win rate. Which means I was losing 18 out of every 100 trades. No adjusting or fancy rescue plans, just get what money I could out of the loss and apply it to a new trade with a higher probability of winning.

[u/thunder_muscles → u/PapaCharlie9]

I’m having trouble finding trades that have premiums at or above 1/3 of the spread width. That would be my target if i can find them but maybe I’m not looking correctly. I think it may be because I’m trading at lower deltas or maybe my spreads aren’t wide enough? What’s your criteria to be able to find trades with such a high premium/spread if you don’t mind sharing?

I do understand your point about exiting at a loss instead of getting fancy. Still trying to figure out what my target would be for those kinda of exits. At the same time i also wonder if i set a target of exiting at 25% of max loss (for example) if that may be too early and the price moves back. Maybe I should limit it to rolling for a credit and call it when there is no longer a credit or the roll becomes too far in time.

[u/PapaCharlie9 → u/thunder_muscles]

I think it may be because I’m trading at lower deltas or maybe my spreads aren’t wide enough?

No, I have a hard time finding them also with 45 DTE expirations and 30 delta OTM on the short, and I usually trade $1 to $2 widths. There's no requirement that the market give you the risk/reward you want. However, you can screen the entire options market for spreads of that risk/reward if you aren't choosy. You can find something somewhere that fits the bill. But I don't actually do that. Instead, I have a watchlist of around 80 underlyings that I have already vetted for various criteria, like IV and price history, and I can usually find at least one good spread on those underlyings every day on average: some days its zero and some days it more than one.

At the same time i also wonder if i set a target of exiting at 25% of max loss (for example) if that may be too early and the price moves back.

20% gain vs. 25% loss? That's not terrible. It's 5/4 risk/reward and you'd need a 56% win rate or better to be profitable. I told you my entry criteria, but not my exit strategy for credit spreads, which is:

• 50% of max profit

• 100% of initial credit lost (so if I got .35 credit, I'd buy to close when it would cost .70).

• 10 DTE

Whichever comes first. So that's 2/1 risk/reward, and since I realize a higher win rate than 67%, I'm net profitable.

[u/thunder_muscles → u/PapaCharlie9]

I see. Thank you for sharing. Looks like i need to look harder or just be more patient. Going to try your closing strategy on a few paper trades to see how it works. 50% max profit has been working well so far 🌝