Saturday, March 20, 2010

OEX Monthly Historical Behaviour

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There is an entry criteria in the strategy that we follow for ratio spreads and BWBs that state that the best ratios are often found 5% OTM from the current underlying price. I initially took this as gospel and it was not until I was sweating out the March 1:5:4 Call BWB that I realized the exact reason why this 5% number was given as part of the entry criteria (and why I should have followed it!)


The OEX historical monthly close prices are available for download from the CBOE website. The data is available from 30-Jun-1986 until 30-Oct-2009.


I took the closing prices and worked out for each month how much the OEX moved up or down. I then took the absolute movement per month and worked out the percentage of the move from the previous month. Averaging out the percentage move over 280 months, the results came back as 4% or 3.55% to be exact.


This means that on average, the OEX moves about 4% in either direction. By having this average percentage move, backed by historical data, allows us to select our strikes (long/short) strikes based on our own risk appetite.


The 5% OTM rule can either be the long strike (for conservative traders) or the short strike (for aggressive traders) . This was further clarified by my conversation with the veteran ex-floor trader (see previous post).


As an example, with the OEX Friday closing price at $530.53, 5% OTM would be $557.06 for the upside move and $504.00 for the downside move.


Based on these values, we can create the ratios or BWBs at option strikes around these values.


For a downside move a conservative trader could look at the following strikes:
Long 505
Short 490
Tail (at their discretion based on margin and/or risk reduction requirements)


An aggressive trader could look at the the following strikes:
Long 515
Short 500
Tail (at their discretion based on margin and/or risk reduction requirements)


These strikes could be selected in a 1:2:1 ratio or a 1:3:2 ratio, although with the VIX being so low, getting good credits for the 1:2:1 ratio would most likely result in debit trades, those with an aggressive appetite could go for the 1:3:2 ratio at reasonable credits and reasonable margin held.


-- randomjaywalking

4 comments:

Anonymous said...

How times out of the 280 months did $OEX exceed 5% and 4%? Thanks.

randomjaywalking said...

The OEX monthly move exceeded 5% 56 times.

10 times from Jan 2008 to 31 Jul 2009.

randomjaywalking

nitor said...

How then would one adjust such a bwb when price starts going lower than the 5% target? Thanks for great info.

randomjaywalking said...

Hi nitor,

If the market moves too fast in the expected direction, then the action to take is to close the current position and open NEW position the same distance away OTM (e.g. 5%) as the initial trade.

Regards,

randomjaywalking