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Part 4 - Exits, Triggers, and Capital Control
Part 4 - Exits, Triggers, and Capital Control
John Locke
– Slide 2 –
Entry Review
M3/BWB Entry Configuration Acronyms
◦M3Ub (Unbalanced)
◦Example: 75 DTE BWB on the NDX that scales in on a time schedule transitions into a
condor and rolls back when threatened – NDX/M3U BWB LT/GRTFD ST/RB
– Slide 3 –
RO – Risk Off only (verticals in any location IE roll up shorts, roll back longs)
– Slide 4 –
E – Exit
RB – Roll Position Back/Reset Position
PC – Adding put protection and correcting for reversal at the same time
*PGC – Put with Greeks Corrections and Upside Corrections (encompasses all other
strategies)
SF – Sell Futures/Stock
RS – Reverse Scale in
– Slide 5 –
◦Max loss/Profit target (Staying in a trade after PT is acceptable ONLY IF a new exit
strategy is developed)
-– Make sure you consider price movement AND take into account IV considerations
(Gamma/Gamma Trend) in the calculation
– -– For example: If SPX moves 50 points either way over night and I get the expected
IV shift, is my draw down expected to be more than I am willing to risk
– Slide 6 –
◦Not freely willing to risk a reasonable draw down from current P/L (psychologically
compromised)
◦3 strikes and you’re out! Multiple adjustments needed in opposite directions and P/L is
dropping (market is too volatile for current position structure)
– Slide 7 –
Note: Exit mandatory when ROE is triggered – Below are some optional exit criterion to
consider
Optional:
◦Exit when position crosses maximum value if trade is near profit potential (State a
number) (NOTE: Profit potential is not necessarily profit target)
◦Exit on high price day “if trade is within XX profit potential and the position gains XX
more than modeled”
◦Exit when hitting “an adjusted max loss or adjusted profit target”
– Slide 8 –
Optional:
◦I’ve found it beneficial in most cases to reduce max loss number by the amount of
highest profit that was in trade (Tends to reduce$ losses but may lower win/loss ratio)
◦I’ve found it beneficial in most cases to reduce profit target number by the amount of
highest draw down of the trade (Tends to improve win/loss ratio but may reduce $
profits)
-– Example: Adjust a 10% profit target to 5% if trade gets drawn down over 5%
– Slide 9 –
◦“I can’t lose money on this trade” OR “I want to make money on the trade” is not a
goal!!!!”
-– Every trader “wants to make money” yet very few traders do.
– -“I must not lose this trade” or “I must make money on this trade” is a very poorly
structured and impossible goal
The reason a trader gets stressed and doesn’t know what to do is because they are
giving themselves that they must meet an impossible condition or there will be intense
pain. This will will put your mind into a confusion loop which will result in stress and
irrational decisions.
“Once you set a clearly defined and realistic objective… the decision on what to do
becomes clear” – John Locke
– Slide 10 –
◦There is no “correct” DTE in general. There is only correct DTE for specific
objectives and even that will vary from situation to situation.
◦If your objective is “minimize losses” then the further from expiration the better.
◦If your objective is to generate as much return as possible, closer to expiration tends to
be better.
General guidelines
– Slide 11 –
Entry Triggers
DTE, while good for a reference point, is not a great entry trigger
◦Pricing often does not follow the model and can vary greatly from day to day
◦Just as if you were buying a used car or a house, you want to have an idea of what
optimal pricing is for your position, given the current conditions
◦Ask What the position has been priced at lately?” And then purchase it at a
low relative value (4X4 example)
◦Understand position price relative to:
-– DTE
– -IV level
– Slide 12 –
Entry Triggers
Choose a DTE range based on your objectives and then do the best you can to enter on
a “low price day” within DTE criterion
◦Obviously this is subjective!! You can use specific criterion but ultimately this is always
a judgement call.
◦When you buy something for resale or an investment “the probability that you’ll make
(or lose) money on that investment is determined when you buy it”
-– Understand that entry pricing can drastically change the probability of the trade.
– Slide 13 –
Entry Triggers
◦Sometimes an opportunity to buy a low price does not present itself, in that case you
need to make the choice whether or not to enter anyway, knowing your probabilities of
being profitable are reduced.
– -Consider entering a reduced position size and have plan for a scale in should pricing
improve
– Slide 14 –
◦There is no “correct” location for entry in general. There is only a correct location for
specific objectivesand even that will vary from situation to situation.
◦If your objective is to “minimize losses” then further back the better.
◦If your objective is to generate as much return as possible enter with short strikes
closer to the asset price.
General guidelines
◦Very conservative: Upper long strike >2 % below asset price or as far back as you can
get away with and still have a good graph
– Slide 15 –
Assuming we are in standard BWB trade (Entering >30 DTE and >40% under the the
money with shorts
◦A general non-directional bias entry on BWB that will survive most down moves and
only take small losses with a really big up move is -1 to -2 per lot
– Slide 16 –
Adjustment Triggers
Greeks
◦Position Delta
◦Vega
◦Theta
◦Gamma
Price Points
Time
◦Estimated loss or gain with certain price movements and volatility changes, including
skew predications
– Slide 17 –
These are good general guidelines for any “neutral” BWB trade, that do well most of the
time
Up Adjustment
◦Theta <50% entry Theta – At < 50% entry Theta a BWB will likely draw down with a
continued up move
◦Delta/Theta >1Delta /1 Theta – At 1/1 Delta/Theta ratio a BWB is either losing money
or marking time
Up or Down Adjustment
◦Vega (all same month options) More negative than (-1) per lot – Generally lack of
negative Vega can be problematic with T+0 line stability outside tent
◦Theta is more negative than (-1) per lot – Generally negative Theta can be problematic
with T+0 line stability especially outside tent
– Slide 18 –
Adjustment Triggers
Assuming non directional bias
Price points – Effectiveness of using price points will vary drastically depending
on IV, DTE and options prices specific to the given environment and therefore is
often combined with other triggers
◦Price points for scale in trades – Generally 20-30 points on RUT///30-40 points on
SPX///75-100 points in NDX
◦Specific price points for adjustments would be so dependent on positioning and goals –
I don’t have a general guideline here
◦If done in varying expiration cycles, your frequency would be dependent on how much
you want to manage as you’d be managing multiple trades at the same time
– Slide 19 –
Adjustment Triggers
Assuming non directional bias
– -Adjust when upside projections drop P/L more than 2.5% PC with a 30 point move on
RUT///50 point move on SPX///100 point move on NDX
◦If playing for mean reversion (IE neutral trader) adjust to ½ of limit
◦If planning for a trend adjust more aggressively or possibly allow the limit to shift signs
– Slide 20 –
◦There is no need to keep the same wing sizes or the same number of contracts on
each side
It is quite simple to control capital and reversal risk by rolling in long strikes and making
wings smaller and/or larger in conjunction with a directional adjustment. You simply
move your options to where they will create a position that is within the parameters you
are trying to create
◦If you adjust down or up and that creates too much reversal risk for your parameters
OR too much capital in the position, roll in the appropriate long strike
◦Keep in mind that in most cases making wings shorter puts a “drag” on the position and
the position will perform more poorly IF the asset settles down
– Slide 21 –
Building Trades
◦How much and under what conditions are you willing to lose?
– Slide 22 –
◦Wing Width: Lower 50 points / Upper is variable – (ideally upside drop < of 5% total risk
but ok to exceed to meet Delta guidelines)
◦T+0 projections must be < AML with a move of 30 points RUT/50 points SPX
◦PC $5000
◦PT $500
◦ML $500
– Slide 23 –
◦56 DTE
◦PC $50000
◦PT $5000
◦ML $5000
◦AML $7500
– Slide 24 –
Questions
When do we use them??
RO – Risk Off only (verticals in any location IE roll up shorts, roll back longs)
– Slide 25 –
Questions
When do we use them??
RO – Risk Off
◦“Go To” standard adjustment
◦In a perfect world, the asset may rise a bit and then sink back into tent and we need to
do nothing
◦Use RO:
-– Subjectively – To raise the expiration line and potentially greater profit/less loss
without creating additional upside risk
– Slide 26 –
Questions
When do we use them??
◦Sometimes the asset rises more than normal creating a situation where the RO
adjustment is no longer effective in bringing satisfactory profits nor is it sufficient to bring
the position back from a loss
◦ Use ROR:
-– If asset is moving relatively normally and in your opinion is that normal movement is
likely to continue – To bring the profit tent closer to the asset price to greatly increase
your profits if asset has a somewhat normal retracement
◦Avoid ROR:
◦If asset is extremely over extended, experiencing greater than normal volatility or if for
some reason you are expecting a much larger than normal price movement in either
direction
– Slide 27 –
◦Sometimes entry pricing is obviously poor or price volatility is more than your position
will likely handle and/or you are overly concerned of a large move
◦Use SP:
-– If in your opinion strongly favors a more than normal price move OR if entry pricing is
extremely poor to increase protection against large price moves and/or make more
money with those moves by entering part of the position (¼, 1/3 or ½) and waiting for
price movement to add to the position
◦Avoid SP:
-– If your opinion strongly favors price movement that will not allow you to scale in
– Slide 28 –
Questions
When do we use them??
◦This is essentially used with the same conditions as SP except with SG we get are
using a Greeks trigger rather than a price point. The Greeks trigger is more consistent in
its risk control as the risk in a particular position can vary greatly in varying market
conditions and DTE
◦Use SG:
-– If in your opinion strongly favors a more than normal price move OR if entry pricing is
extremely poor to increase protection against large price moves and/or make more
money with those moves by entering part of the position (¼, 1/3 or ½) and waiting for
Greeks to trigger limits to add to the position
◦Avoid SG:
– Slide 29 –
Questions
When do we use them??
1.Can be used with the same conditions as SP to partially enter position when pricing is
poor or a large move is likely to limit risk with the drawback of being worse off if no
market move and pricing deteriorates
2.Can be used to literally create a new/different trade every week thereby being in 4
different trades which may or may not increase probability depending on specific
circumstances
◦Use ST:
-– If in your opinion strongly favors a more than normal price move OR if entry pricing is
extremely poor to increase protection against large price moves and/or get scale in with
more favorable pricing
◦Avoid ST:
– -If your opinion strongly favors price movement that will not allow you to scale in
– -In the context of varying expiration dates, if monitoring and adjusting multiple trades
is problematic for you/your situation
– Slide 30 –
_________________________© 2016 Locke in Your Success,
LLC._________________________
Questions
When do we use them??
◦Sometimes the asset rises more than normal creating a situation where the RO
adjustment is no longer effective in bringing satisfactory profits nor is it sufficient to bring
the position back from a loss
◦ Use GCT:
-– When RO will not bring satisfactory profits or bring the trade back from a loss AND
your opinion is that a long sustained up move is unlikely – To bring the profit tent over
the asset price to greatly increase your profits if asset has a somewhat normal
retracement, stays stagnant or only moves up slowly
◦Avoid GCT:
◦If asset is experiencing much greater than normal volatility or if for some reason you
are expecting a strong continued up move as GCT gradually takes on significant upside
risk
– Slide 31 –
Questions
When do we use them??
◦Sometimes the asset rises more than normal creating a situation where the RO
adjustment is no longer effective in bringing satisfactory profits nor is it sufficient to bring
the position back from a loss
◦ Use GCTFD:
-– When RO will not bring satisfactory profits or bring the trade back from a loss AND
your opinion is that a long sustained up move is 50/50 or greater – To bring the profit
tent over the asset price to somewhat increase your profits if asset has a somewhat
normal retracement, stays stagnant or moves up moderately
◦Avoid GCT:
– -If for some reason you are expecting a strong continued up move as GRTFD
gradually takes on some, but usually minimal, amounts of upside risk
– -If for some reason you are expecting a larger than normal down move as GRTFD
gradually tends to increase
– Slide 32 –
◦When well inside (near or ahead of short strikes) or in front of the tent
– -Provides downside protection with minimal reversal risk yet still close enough to short
strikes to overcome a stall or moderate market move
– -Short futures or SPY or IWM or related ETF work well here also as T+0 line is still
stable however this will create significant reversal risk, therefore you’ll need to be active
and set a time to remove hedging
– Slide 33 –
-– Generally bearish verticals with an upside correction to reduce reversal risk are the
best choice UNLESS for some reason you think the market is going to blow apart
–
– -Generally shorting futures or selling related ETF work ok as well. Could start to run
into T+0 line stability near edge but reversal risk is a bit reduced and you still need to be
active in removing with a hard reversal
– -Generally buying puts “starts” to become problematic due to T+0 line instability
should the asset price stall or grind down
– Slide 34 –
– -– T+0 line becomes unstable. Adding puts and or shorting futures/ETF should only be
a temporary intraday solution as put will destabilize T+0 even further and short
futures/ETF will not do anything to stabilize the line
Note: In a complete meltdown, puts and/or ratio spreads will provide the best protection
however they also create the most unstable T+0 lines if the market stalls or has only a
moderate down move, therefore a roll back or exit is most often going to be a better
choice
– Slide 35 –
What’s Next?
– UB 1
– UB 2
– UB 3
– UB 4
– Slide 36 –