Thursday, March 11, 2010

Learnings from a veteran ex-floor trader...

I am writing this post as a record of a conversation I had with a veteran ex-floor trader.

Apologies for the messy notes but the conversation drifted across many topics and I had one hour to get as much out of it as I could.

First subject was how to repair a trade that is going against you.

- If the price of whole BWB spread gets beyond your comfort zone, then it might be time to get out of the trade
- Put a dollar limit (e.g. $2) to buy the spread back as a stop loss
- 1:5:4 Difficult roll it out
- Don't push it out to the next month - what if it goes against you?

Adjustments I have at my disposal
a) close
b) change to a regular butterfly 1:2:1 505:515:525
c) Open new position 520/525/535 push the loss point at expiration further OTM but adds more risk (margin held)
d) change to 1:3:2 close 2 x 515/530

Refinements to the BWB entry rules

- Position long strike at expected move or at 5% OTM whichever is greater

- OEX moves 4-5% on average per month for the past 10 years
9% is the normally the garbage tail for the BWB

- 1:3:2 weekly trades! 1 week to go ONLY (is this OEX Weeklys?)
- 1:2:1 monthly are for the monthly trades!
- 4 weeks in advance

Long term technical analysis market outlook is required (random walk) not specific technical analysis

Measure of safety - take the expected move as the long strike if the EM is more than the 5% OTM strike

Typical returns of this floor trader is 5-10% return on margin held per month

- Conservative - long strike is at 5% or EM
- Aggressive - short strike is at the 5% or EM

Select Max width between long and short strikes for zero net debit or slight credit
Some people choose to shorten the widths between the strikes for larger credit
Widths between the strikes are impacted by the VIX (high volatility, wider between strikes)

5 comments:

dream said...

First of all, I couldn't believe how much I've gotten out of this session you had with Terry. With this refinement in place, I am confident that we can reap better profits every month.

This is simply an amazing discovery and thank you for introducing this good shit to me.

stevegee58 said...

I read in the "sweating it out" post about rolling out to the next month. This didn't make sense to me and this post reinforces my concerns.

I would argue that there isn't really a "repair" per se. I can see doing only one thing: Close the trade and open a new one using the basic search criteria.

The effect of closing and opening a new trade might look like rolling further OTM or rolling to the next expiration month. But you're still closing the old trade (either at a small loss or at a profit) and opening a new trade based on the system's setup rules.

I don't consider closing a trade to be an adjustment. The only real adjustment available is to change the BWB to a regular butterfly.

BTW, this floor trader post is really excellent and I'm printing it out to include with my notes. :-)

randomjaywalking said...

Hi stevegee,

Actually the repair I did constituted of executing (d) first and then followed by executing (c).

The cost of (d) was partially offset by the large initial credit received for initiating the first 1:5:4 spread.

Adding the (c) trade pushed my break even to 527 at expiration, whilst increasing slightly the margin held but maintaining an acceptable profit potential should the OEX close below 527 at expiration.

The position risk graph now looks similar to camel humps :)

nitor said...

Thanks for the post, the BWB strategy is very interesting, and I would like to enter some trades doing this.

Could you please elaborate on how the trades are constructed to make the 'boring' income? Especially where exactly the trade is constructed away from the current price? I am familiar with 1-2-1 BWB's.

Looking forward to your kind assistance.

randomjaywalking said...

Hi nitor,

We place the strike prices based on typical monthly behavior in the OEX for the 1:2:1 BWBs. You may want to refer to a previous post:

http://triple-screentrading.blogspot.com/2010/03/oex-monthly-historical-behaviour.html

I discuss an example of strike selection for both the Long Strike and the Short Strike.

-randomjaywalking