As we approach the 6 month mark forward testing the Chaikin Oversold Buy Signal, It's become apparent there’s is a part of my strategy that is not working.
Lets take a second to review exactly what the signal entails, and what my strategy is. First, the Oversold Buy Signal requires the following to happen:
Lets take a second to review exactly what the signal entails, and what my strategy is. First, the Oversold Buy Signal requires the following to happen:
In addition, we also need to see positive money flow and positive relative Strength to initiate a trade in our forward test of the Oversold buy Signal. Note - We avoid stocks within 30 days of earnings for this strategy.
When a name meets the criteria outlined, we will purchase long dated options, we will hold for 30 days or until the price touches the outer volatility bands on the Chaikin platform, whichever occurs first. However, Mike and I have been purchasing different option strike prices. Both of us have been purchasing calls that expire about 6 months from the time of purchase. We purchase longer dated options in an effort to minimized the affects of the Greeks.
Mike is playing the part of a larger account holder, and I'm trading as though I have a much smaller account. To that end, Mike has been purchasing the .70 Delta option, which is a ITM ( in the money) strike, while I've been targeting the .30 Delta which is OTM (out of the money) strike. The ITM options will behave more like stock than the OTM strike. in particularly, the further ITM strike will be less affected by Theta ( time decay). In a nutshell, at the .30 Delta I need a big move in my direction during the planned 30 day hold to make up or theta and make the trade a winner. Even if the price was to go my way, if it doesn't go fast enough and far enough.... I still lose. Why would anyone purchase the .30D ? simple, cost. The OTM options demand far less premium, as the probability of landing in the money at expiration is far less.
Here is my record so far with the OBS forward test. As you can see, the 30 delta strikes haven’t been working very well with this strategy.
When a name meets the criteria outlined, we will purchase long dated options, we will hold for 30 days or until the price touches the outer volatility bands on the Chaikin platform, whichever occurs first. However, Mike and I have been purchasing different option strike prices. Both of us have been purchasing calls that expire about 6 months from the time of purchase. We purchase longer dated options in an effort to minimized the affects of the Greeks.
Mike is playing the part of a larger account holder, and I'm trading as though I have a much smaller account. To that end, Mike has been purchasing the .70 Delta option, which is a ITM ( in the money) strike, while I've been targeting the .30 Delta which is OTM (out of the money) strike. The ITM options will behave more like stock than the OTM strike. in particularly, the further ITM strike will be less affected by Theta ( time decay). In a nutshell, at the .30 Delta I need a big move in my direction during the planned 30 day hold to make up or theta and make the trade a winner. Even if the price was to go my way, if it doesn't go fast enough and far enough.... I still lose. Why would anyone purchase the .30D ? simple, cost. The OTM options demand far less premium, as the probability of landing in the money at expiration is far less.
Here is my record so far with the OBS forward test. As you can see, the 30 delta strikes haven’t been working very well with this strategy.
AS you can see more red than green, and what green there is, doesn't get us back in black.
With results like this, you have to stop and re evaluate, which is what I’ve done.
Moving forward, I’ve adjusted how I will trade OBS signals. While I’ll still trade a smaller account, I’ll try to give myself a better chance of winning without requiring more capital. Rather than purchase a single out of the money option, I will now purchase bull call spreads. That is a bullish strategy where you purchase an at or in the money call, and at the same time sell an out of the money call option against it. By doing so, I’ll solve two of my problems, I’ll be long an ITM option, and will now be benefiting from theta decay, as the sold option will decay at a faster rate than the purchased option.
Lets look closer at how Bull Call Spreads work. Lets ay we want to purchase a Bull Call Spread on stock XYZ, which is trading at $100.00 I want to purchase a 99 strike call for, say, .70 cents, and sell a 101 strike put against it for, say, .45 cents. The trade will cost me a net debit of .25cents( $25.00) my max profit would be the width of the spread minus the debit paid. So, in this case 200( 2 dollars wide)-25( .25 cent net debit)= 175.00 max profit. As time passes, theta will affect the option further away from the money more than the option closer to the money, dramatically lessening the affect of time decay. Of course, there is a trade off, we cap our gain’s at the sold option. So, if stock XYZ rallied to 105, we stop benefitting at 101, as that is our sold option strike. So, while we feel less of an affect of time decay and need less of a directional move, we cap our gains at the sold strike.
By adding a positive theta component, and purchasing an ITM strike, I hope to see a noticeable improvement in my W/L ratio. It's like so many things in life... You get what you pay for!
I believe the key to trading is developing a consistent expectancy, I would much rather have consistent single digit percentage winners, than sporadic larger winners mixed with larger losers.
I’ve already implemented this change, and have a few spread trades logged, I will keep you posted on the result of this strategy change when I close them shortly.
With results like this, you have to stop and re evaluate, which is what I’ve done.
Moving forward, I’ve adjusted how I will trade OBS signals. While I’ll still trade a smaller account, I’ll try to give myself a better chance of winning without requiring more capital. Rather than purchase a single out of the money option, I will now purchase bull call spreads. That is a bullish strategy where you purchase an at or in the money call, and at the same time sell an out of the money call option against it. By doing so, I’ll solve two of my problems, I’ll be long an ITM option, and will now be benefiting from theta decay, as the sold option will decay at a faster rate than the purchased option.
Lets look closer at how Bull Call Spreads work. Lets ay we want to purchase a Bull Call Spread on stock XYZ, which is trading at $100.00 I want to purchase a 99 strike call for, say, .70 cents, and sell a 101 strike put against it for, say, .45 cents. The trade will cost me a net debit of .25cents( $25.00) my max profit would be the width of the spread minus the debit paid. So, in this case 200( 2 dollars wide)-25( .25 cent net debit)= 175.00 max profit. As time passes, theta will affect the option further away from the money more than the option closer to the money, dramatically lessening the affect of time decay. Of course, there is a trade off, we cap our gain’s at the sold option. So, if stock XYZ rallied to 105, we stop benefitting at 101, as that is our sold option strike. So, while we feel less of an affect of time decay and need less of a directional move, we cap our gains at the sold strike.
By adding a positive theta component, and purchasing an ITM strike, I hope to see a noticeable improvement in my W/L ratio. It's like so many things in life... You get what you pay for!
I believe the key to trading is developing a consistent expectancy, I would much rather have consistent single digit percentage winners, than sporadic larger winners mixed with larger losers.
I’ve already implemented this change, and have a few spread trades logged, I will keep you posted on the result of this strategy change when I close them shortly.
Happy Trading!
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