A Belated Performance and Strategy Update

Well...I did it again. I hit a rough patch, and I shied away from updating my blog. This has happened repeatedly. I really should stop hiding when the shit hits the fan.

Oh well. February and March where ugly and stressful. The market swung WAY down, then swung WAY up - screwing me on both sides. Perfect. At least April expiration finally allowed me to get back on track - earning 13% for the month. That's more like it. 

The experience of the past few months exposed some flaws in my approach; However, April's result gives me confidence that my fixes are a step in the right direction.

As the market appears to have formed a bottom (at least in the short term), leading stocks have begun to break out, showing some promise for the market as a whole. While I continue to seek profits from selling out-of-the-money (OTM) options premium on the S&P, I also am now attempting to catch some upside on the aforementioned market leading stocks.

To achieve this, I've begun purchasing bullish call spreads in selected stocks. My risk is limited to the purchase price of the spread, and I'm limiting the amount of positions I hold so as not to exceed the income I receive on selling OTM SPY call options. In otherwords, to offset the outlay of cash to purchase these bullish call positions on market leading stocks, I'm selling OTM call spreads in the S&P (SPY) as a hedge. I'm attempting to convert my SPY trades into a 10% portfolio gain per month. Meanwhile, trying at worst, to break even on my bullish trades.

Each Month:

If the market tanks hard, the worst thing that should happen is all my bullish positions will expire worthless, but I'll keep the entire premium I received on selling SPY call options - and thus earning a modest profit. 

If the market rips up, my SPY trades will have to be constantly adjusted, reducing the income from this hedge...meanwhile, many of my bullish stock positions should see impressive gains. This time the result would most likely be a nice profit.

If the market goes sideways, I should make around 10% on my portfolio for the month

I've included the italics because, as I've learned over the years, things don't always work out the way you planned.  

All-in-all, this seems like a good proposition. We'll see.

Calendar February Results

29% LOSS for the period Feb 1-Feb 28. Ouch.

As I mentioned in the previous post, this was an ugly month. The market broke out of its recent range in a decidedly bearish way. Make no mistake about it, The stock market hates the stimulus plan and President Pork Sandwich's plan for inflating the US out of the doldrums.

The bearish breakdown in the market killed my short put verticals. Most notably, I am caught in positions in WFC (a bank), GENZ, AMGN, and UNH (healthcare related) which are getting killed every time Obama opens his mouth.

Hopefully, these losing positions which will be rolled over will be next month's (or the month after that) gains. Only time will tell.

In the meantime, while still adhering to the same overall trading strategy, I've changed the way it's implemented.

Previously, while attempting to construct a portfolio of short spreads to collected time premium, I was entering verticals in various stocks, while attempting to stay as close to delta neutral as possible. And to manage these multiple positions, I beta-weighted the portfolio against SPY. My profit curve took a similar shape to the profile of a cross between a short Iron Condor and a long Butterfly.

Well, besides the profit downside this past month, what I really learned is what it's like to be a Fireman. With between 15-20 different spread positions on at one time, when the market decides to go hard in one direction (in this case, down)... all of a sudden you have multiple positions running against you at the same time that need to be closely monitored and regularly adjusted. I felt like a fireman constantly putting out small fires all over the place.

This led me to change the means by which I aim to achieve the same result: instead of constructing a portfolio of various short vertical spreads, I can much more efficiently achieve similar results by selling Iron Condors on SPY. The SPY is very liquid and therefore I can trade in and out of relatively easily. By selling ICs beyond one standard deviation out at various points as the market moves, it seems to be a less stressful way to achieve similar results - with less risk. Besides, it'll be easier to manage.

I will be exploring taking this one step further beginning with April expiration. When I begin trading April options (in about a week), I will begin trading Double Diagonals (short near month, long back month) in an effort to establish Iron Condors with better risk/reward and hedge against Vega risk.

Let's see if we can turn this ship around and get back on track. I'm mildy confident that within two months, I will have weathered this storm and recouped a majority of losses on current open positions, and then be able to strictly focus on trading double diagonals in SPY.

Strategy Overview

The strategy that I will be employing will be centered around a mix of Fundamental and Technical analysis of stocks.

Stocks of companies I will be selecting to trade and invest in will be leaders in their fields. These companies will be experiencing strong quarterly and annual Earnings per Share (EPS) and sales growth, and will be members of top performing industry groups. Their stocks' price performance will already be outperforming at least 70% of all other stocks' performance. These stocks will also be experiencing increased accumulation by large mutual funds and hedge funds (institutional buyers).

From this pool of eligible stocks, I will be determining entry points based on break-out and trend continuation chart patterns.

My method draws heavily on the teachings of William O'Neil of Investors Business Daily as well as Richard Dennis and William Eckhardt of "Turtle Trader" fame in the commodities arena.

I will not invest more than 10% of total investible cash in any one company and will seek to limit my portfolio to no more than 20 companies at any one time (utilizing leverage where necessary).

During periods when the broad markets are in correction (as they are currently), I will attempt to take profits on the way up sticking to a 3:1 profit target. This means I will attempt to take profits three times what I am risking upon initiation of the position. For example, If I purchase XYZ stock at $100 and my stop-loss is $90, I will exit my position for a profit at $130.

During confirmed rally periods for the general market, I will give winning positions more room to grow. While maintaining a strict stop-loss, I will let violations of 50-day trendlines be my signals to exit positions.

As Jesse Livermore, one of the greatest Traders of all time has been known to repeat (in paraphrase): "The best money is made in the sitting and the waiting". When general markets are in confirmed rallies, I will attempt to do just that.

Without giving away the farm, this is a broad overview of how I will build my investment portfolio. If my hypothesis is correct, and I execute according to this strategy, it is my belief that I can target annual returns in the neighborhood of 100%. While this number is certain to cause investment professionals from all corners of the globe to scoff at my assertion, I believe it is absolutely within the realm of possibility. It is my intention to find out.

Wish me luck.

Sean McLaughlin
Chicago, IL