I back-tested our July trades, with various alternative scenarios, hoping to find out whether there’s anything we could’ve done differently to improve our return. The critical point, not surprisingly, was the July 7th false breakout, which triggered two bullish adjustment trades and then reversed hard (SPY lost nearly 3% in three days), crushing the adjusted position. So were those adjustments mistakes?
Here’s the dilemma: Our latest risk-management criteria, which back-tested beautifully and worked well in the first quarter (but fell short during the extraordinarily volatile second quarter), left no doubt that the adjustments should be made. What those criteria—indeed, any quantitative rule—can’t predict is sudden, sharp trend reversals: It’s equally probable that the July 7th jump could have turn out to be a run-away gap, in which case failing to adjust would’ve left us equally, if not more, beaten up due to our upside exposure.
Three possible strategy improvements come to mind:
- Relax our upside risk-management criteria to help avoid the most damaging whipsaws – A small increase in the negative-delta trigger could have prevented the second July 7th adjustment—but, it could have led to further damage if the S&P took off from there.
- Make greater use of butterflies as upside hedges—particularly when the market gaps up into resistance. This approach would reduce volatility risk to the upside and provide more favorable opportunities for downside adjustment (short-term).
- Keep positions open through expiration, if risk is reasonable – Our “Experimental” strategy of leaving CS#1 and CS#3 open into the Friday before expiration produced a 1500% increase in profit versus our official closing trades the day before. Allowing the short positions to expire and selling the longs the following Monday would have raised that difference to more than 6000%.
- Adopt a delta-hedging strategy similar to the one we use with Condor Options – This would be viable for well-capitalized members, but the margin would be prohibitive for folks who need a predictable maximum margin requirement.
At this point, I don’t yet have an answer—if, indeed, any alternative answer is needed. For now, I just wanted to give members what they’re paying for: options education, strategic planning, and market insight. Going forward, though, we’ll be experimenting with ideas 1, 2, and 3—but, as always, we’ll stay the course with our official trades until the experimental changes prove their worth.