Stop loss and limit orders versus options writes-purchases to control risk and take profits.
Conclusions, more detail and simplified examples below.
Trend trading programs using stop loss and limit orders
- Risk and profit cannot be defined on individual trades potential extreme economic fundamentals can produce order execution slippage or the inability to execute orders because of “price limits” (a price limit is the maximum price movement for the day in a given market prior to the trading in that market being suspended)
- Risk and profit cannot be defined for a specific trading period (number of days/months), it is impossible to objectively define how many times you will be stopped out of your positions during a given trading period prior to achieve your profit objectives or the exact price stop loss orders will be executed on any given trade.
- You can be right in identifying the major trend and still lose money for the trading period from being stopped out repeatedly, order execution slippage, inability to get orders executed or losing discipline during drawdowns.
- Daily maintenance and monitoring of positions is intensive, stressful and frequently requires substantial discipline to consistently trade defined rules thru the inevitable draw-downs and potentially extreme economic fundamentals.
- Trade frequency for any given period is unknown, it is impossible to know how many times stops or objectives will be executed.
- The total cost of dealing spreads and clearing for any given trading period is unknown because trade frequency cannot be defined.
Trend Trading programs that use option purchases and writes
- Risk and profit can be defined on individual trades, options give you an exact price to deliver or take delivery of a position on or before a specific date in the future. Delivering or taking delivery of a position is not impacted by extreme economic fundamentals, volatility, nor do daily price limits apply.
- Risk and profit can be defined for a specific trading period, regardless of volatility or extreme fundamentals any position can be maintained with defined risk using the disclosed option write-purchase strategy until option expiration, option expirations can range from 1 day to years in the future.
- Using the disclosed strategy if you are right identifying the trend you should be profitable for the trading period. Option write-purchase strategies are immune to volatility, you cannot be stopped out, positions can be offset or delivered on or before expiration.
- Daily maintenance and monitoring of positions is minimal using this strategy both individual trade risk and total trading risk for the trading period are objectively defined.
- Trade frequency for any given trading period is defined.
- The total cost of dealing spreads and clearing for any given trading period is defined.
I believe the best way to understand the problems associated with stop loss-limit trading programs and the benefits of option write-purchase programs is to give you a simplified example in the same market, trading the same direction, at the same initial price (adjusting for delivery months). In one example I’m using trailing stop loss-limit orders and trading the front month or March delivery, the second using option writes-purchases, trading the June delivery month. Analysis, charts and quotes for all markets and delivery months is posted here.
Setting up any technical trade requires
- Identifying the trend
- Defining the risk using a stop loss order or option purchase
- Defining a profit objective using a limit order or option write
The examples below use the Swiss Franc
On February 12, 2010 the chart below shows a down-trend justifying a short position.
Example establishing a position using stops loss and limit orders to control risk and take profit
The trend is down, a short position is established at 0.9250 using a protective stop of 0.0080 points ($1,000) or a buy stop of 0.9330 with an objective of 0.0160 points ($2,000) or a buy limit of 0.9090. Too simply, if a trade is stopped out I’m reestablishing the position in the same direction at the same price with the established down trend.
Swiss 90 minute chart 2/12/2010 thru 3/5/2010
Trades and orders 2/12/2010 thru 3/5/2010 are using a simplified trend following approach with stop and limit orders (for 21 days) trading the front delivery month (March).
2/12/2010 Short 0.9250, protective buy stop 0.9330, objective buy limit order 0.9090
2/16/2010 Stopped out 0.9330 -$1,000 plus bid ask spread and clearing
2/16/2010 Short 0.9250, protective buy stop 0.9330, objective buy limit order 0.9090
2/23/2010 Stopped out 0.9330 -$1,000 plus bid ask spread and clearing
2/23/2010 Short 0.9250, protective buy stop 0.9330, objective buy limit order 0.9090
2/26/2010 Stopped out 0.9330 -$1,000 plus bid ask spread and clearing
3/01/2010 Short 0.9250, protective buy stop 0.9330, objective buy limit order 0.9090
3/03/2010 Stopped out 0.9330 -$1,000 plus bid ask spread and clearing
3/05/2010 Short 0.9250, protective buy stop 0.9330, objective buy limit order 0.9090
3/05/2010 Settlement 0.9310 open trade loss of 0.0060 or -750 with a high probability getting stopped out again at 0.9330
Net result -$4,750 from 2/12/2010 thru 3/5/2010 plus bid/ask spread and clearing (5 trades established 4 offset or -$450)
Total loss including open trade equity, dealing spreads and clearing -$5,200 for the first 21 days with 35 days left in the 56 day trading period ending 4/09/2010
Total profit or loss for the remaining 35 days of the trading period is unknown.
Conclusions
- Risk and profit cannot be defined for the individual trades potential extreme economic fundamentals can produce order execution slippage or the inability to execute orders because of “price limits” (a price limit is the maximum price movement for the day in a given market prior to the trading in that market being suspended)
- Risk and profit cannot be defined for the specific trading period (number of days/months), it is impossible to objectively define how many times you will be stopped out of your positions during a given trading period prior to achieve your profit objectives or the exact price a stop loss order will be executed on any given trade.
- You can be right in identifying the major trend and still lose money for the trading period from being stopped out repeatedly, order execution slippage, inability to get orders executed or losing discipline during draw-downs.
- Daily maintenance and monitoring of positions is intensive, stressful and frequently requires substantial discipline to consistently trade the defined rules thru the inevitable draw-downs and potentially extreme economic fundamentals.
- Trade frequency for any given period is unknown, it is impossible to know how many times stops or objectives will be executed
- The total cost of dealing spreads and clearing for any given trading period is unknown because trade frequency cannot be defined.
Example establishing the same position using option writes and purchases to control risk and take profits
Same trading period 2/12/2010 thru 3/05/2010, option expiration 4/09/2010
Purchase 0.9350 -$1,335 Call (to define risk)
Trade = Short 0.9256 Price of actual short
Write 0.9050 +$1,024 Put (collected to generate premium for the call purchase, also used as the profit objective)
Net cost of the hedge -$311 Expiration 4/09/2010 (56 day trading period)
During the same period 2/12/2010 thru 3/5/2010 the position was maintained, price on 3/5/2010 0.9316 with 35 days left to expiration.
Purchased June Call 0.9350 current value $1225 open trade equity -110
Trade = Short June 0.9256 0.9316 open trade equity -750
Written June Put 0.9050 current value $400 open trade equity +624
Open trade equity -$236
Clearing and dealing spreads -$85
Net open trade loss -$325
The position has been maintained; total risk and profit were defined for the 2/16/2010 thru 3/05/2010 period and remains defined for the entire period 2/12/2010 thru 4/9/2010 or 56 days with 35 days left until expiration.
Worst case scenario -$1,571 the short position is delivered to the 0.9350 call at a loss of 94 points (-$1,175) plus the cost of the hedge, clearing and spreads (-$396)
Best case scenario +$2,179 the short position is delivered to the 0.9050 put at a profit of 206 points (+$2,575) less the cost of the hedge, clearing and spreads (-$396)
Conclusions
- Risk and profit can be defined on individual trades, options give you an exact price to deliver or take delivery of a position on or before a specific date in the future. Delivering or taking delivery of a position is not impacted by extreme economic fundamentals, volatility, nor do daily price limits apply.
- Risk and profit can be defined for a specific trading period, regardless of volatility or extreme fundamentals any position can be maintained with defined risk using the disclosed option write-purchase strategy until option expiration, option expirations can range from 1 day to years in the future.
- Using the disclosed strategy if you are right identifying the trend you should be profitable for the trading period. Option write-purchase strategies are immune to volatility, you cannot be stopped out, and positions can be offset or delivered on or before expiration.
- Daily maintenance and monitoring of positions is minimal using this strategy both individual trade risk and total trading risk for the trading period are objectively defined.
- Trade frequency for any given trading period is defined. The total cost of dealing spreads and clearing for any given trading period is defined.
More
Looking at the weekly charts below, is it really that hard to identify trends?
Analysis, Charts, Futures and Options quotes are available for all markets on http://sites.barchart.com/pl/cta/
Examples
S&P 500 Index (SPM0) Quote | Chart | Options | Opinion
30 Year T-Bond (ZBM0 Quote | Chart | Options | Opinion
My main objectives in trading this program is to participate in major trends, not be stopped out, reduce stress, define risk for each trade and for the total time of the trading period. Given current market volatility and uncertainty, for my investment dollars I’ll be trading and recommending these types of programs. If you’d like more information or have questions on these programs please call or email me.
For more information and example trades see http://keypage.net links
25) Barchart Trend Position Option-Hedge-Write Program Gold example trade26) Barchart Trend Position Option Hedge-Write Program T-Bond example trade
Regards,
Peter Catranis CTA, IB, AP
USA +949-376-8020
US Toll-Free 800-994-5757
Mobile US+949-376-8020
Fax US+ 949-643-7111
Email peterc@catranis.com
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