Option-based trading systems
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1 Option-based trading systems Presented by Lawrence G. McMillan The Option Strategist MTA Webinar January 8, 2014
2 McMillan Analysis Corp. A Derivatives Firm Recommendations (newsletters) Money Management Option Education
3 Download pdf Plus Special offers Visit:
4 Today s Topics. Types of $VIX Buy signals based on option implied volatility Volatility futures, ETN s and ETF s The VXX System The Total Put-call Ratio System The modified Bollinger Band System Distance from the moving average system
5 Just because a pattern works for a while doesn t make it a viable system
6 Implied Volatility (IV) A guess at volatility during the life of the option When IV is low, options are cheap but when it s high, they are expensive When IV rises, the option gets more expensive (Causes: large price drops, takeover rumors, FDA hearings, etc.).
7 $VIX CBOE Invention 1993: using 4 series of $OEX options renamed $VXO in 2003 conversion Created by Prof. Whaley, Duke Univ. Changed in 2003: uses strips of two nearest-term $SPX options, to create an average 30-day volatility
8 The Playing Field: Not Just $VIX Anymore VIX is a formula that can be applied to any entity with continuous option markets over all strikes So, as more and more VIX indices come along, they will be called Gold VIX, Oil VIX, etc. So, current VIX is really SPX VIX or S&P500 VIX
9 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE)
10 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM)
11 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM) Markets: S&P 500 ($SPX), Emerging Mkts (EEM), China (FXI), Brazil (EWZ), Gold Mining Stocks (GDX), Energy Stocks (XLE)
12 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM) Markets: S&P 500 ($SPX), Emerging Mkts (EEM), China (FXI), Brazil (EWZ), Gold Mining Stocks (GDX), Energy Stocks (XLE) Each volatility index above has its own symbol ($VIX for $SPX; $GVZ for GLD; $OVX for USO, etc.).
13 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM) Markets: S&P 500 ($SPX), Emerging Mkts (EEM), China (FXI), Brazil (EWZ), Gold Mining Stocks (GDX), Energy Stocks (XLE) Each volatility index above has its own symbol. Just because an index is published, doesn t mean there are products to trade.
14 $VIX Buy Signals
15 Rating $VIX Buys
16 Current $VIX Chart
17 History of $VXO
18 $VIX Spike Peak Buy System a) If $VIX is spiking (>3.0 in 1, 2, or 3 days, close to close), keep track of highest intraday $VIX price
19 $VIX Spike Peak Buy System a) If $VIX is spiking (>3.0 in 1, 2, or 3 days, close to close), keep track of highest intraday $VIX price b) Buy when $VIX close <= 3.0 from highest intraday $VIX price
20 $VIX Spike Peak Buy System a) If $VIX is spiking (>3.0 in 1, 2, or 3 days, close to close), keep track of highest intraday $VIX price b) Buy when $VIX close <= 3.0 from highest intraday $VIX price c) Stop if $VIX close > highest intraday $VIX price d) Otherwise sell after 22 trading days
21 $VIX Spike Peak Stops
22 Latest $VIX Spike Peak Buy Signal
23 $SPX Up Too Much?
24 $VIX Spike Peak Buy System a) If $VIX is spiking (>3.0 in 1, 2, or 3 days, close to close), keep track of highest intraday $VIX price b) Buy when $VIX close <= 3.0 from highest intraday $VIX price c) Stop if $VIX close > highest intraday $VIX price d) Otherwise sell after 22 trading days Buy ATM $SPX Call Net Profit # wins 41 # losses 32 % wins 56% tot wins 1152 tot losses -505 avg win 28.1 avg loss avg trade 8.9 Max gain 93.9 Max loss Avg call cost: 37.3 Avg ROI: +23.7%
25 Gold $VIX vs. Gold
26 $VXEEM Volatility Spike
27 Composite Implied Volatility Use all options on an individual entity to compute CIV. Determine a percentile.
28 Composite Implied Volatility Use all options on an individual entity to compute CIV. Determine a percentile. Compare percentiles across all stocks. Overbought if average stock s CIV is < 10, oversold if > 90.
29 Composite Implied Volatility Weight all options traded on one entity in one day, by volume and by distance out-of-the-money.
30 Stock Options Composite Implied Volatility
31 Other Uses of Volatility: CIV Sell
32 Other Uses of Volatility: CIV Buy
33 Trading Volatility Directly: New Volatility Products Futures on $VIX (2004) Options on $VIX (2006)
34 Other VIX-like Futures Markets Tradable in U.S.: $VXEEM (Emerging Markets): VXEM $VXEWZ (Brazil): VXEW $VXN (NASDAQ) most recent: VN $OIV oil, based on Oil futures options implieds futs & options $GVX gold, based on Gold futures implieds futs & options
35 Other VIX-like Futures Markets In U.S. $VXEEM (Emerging Markets): VXEM $VXEWZ (Brazil): VXEW $VXN (NASDAQ) most recent: VN $OIV oil, based on Oil implieds futs & options $GVX gold, based on Gold implieds futs & options Europe: $VSTOXX vol futs & options Hong Kong: HSI vol futures Russia: RTS vol futures
36 A Problem With $VIX Futures? Both speculators and hedgers have sometimes been disappointed with muted movements in $VIX futures when $VIX makes a move. To counter this, stay short-term since $VIX is a 30-day measure.
37 Term Structure of Options
38 $VIX vs. $VIX Futures $VIX is based on two near-term series of $SPX options $VIX futures are based on one series of $SPX options, 30 days out There can be a large difference in these two calculations
39 Term Structure Sept-Oct 2008
40 Example: $VIX vs. Futures
41 Term Structure Trade for Market Speculation
42 Trading the Term Structure Futures Exchange (CFE) allows greatly reduced margins for a) Spread between two front months Or b) Spread between months 1 & 3 So, a highly leveraged trade is available: If Bullish, Sell front month & Buy one of the other two If Bearish, Buy front month & Sell one of the other two
43 As the curve moves from positive slope to flat to a negative slope, $SPX should be rising.
44 Trading The Term Structure Trading futures calendar spreads: high leverage, good profit potential. 9/17/07 S Oct fut B Nov fut Spread Margin: was $625 (first three months)
45 Trading The Term Structure Trading futures calendar spreads: high leverage, good profit potential. 9/17/07 9/24/07 S Oct fut B Nov fut Spread Gain: ($1,710) in one week or Margin: was $625 (first three months)
46 Trading The Term Structure Trading futures calendar spreads: high leverage, good profit potential. 9/17/07 9/24/07 10/5/07 S Oct fut B Nov fut Spread Gain: ($1,710) in one week or points ($2,840) in 3 weeks Margin: was $625 (first three months) but now $2475
47 Hedging The Risk of the Term Structure Trade Use regular broad market options (SPY, for example) as a hedge. For example, suppose you are bearish: Buy May VX futures Sell June VX futures
48 Hedging The Risk of the Term Structure Trade Use regular broad market options (SPY, for example) as a hedge. For example, suppose you are bearish: Buy May VX futures Sell June VX futures But if the market goes up you will lose on that trade, so as a hedge: Buy some SPY calls
49 PUT-CALL RATIOS For any group of options, you can calculate the ratio of puts traded to calls traded Standard : volume only Dollar Weighted : price times volume
50 PUT-CALL RATIOS Any stock, index or sector
51 PUT-CALL RATIOS Any stock, index or sector All equity options
52 PUT-CALL RATIOS Any stock, index or sector All equity options All futures options on a single underlying commodity (all gold futures options, e.g.)
53 Contrary Theory TOO MUCH PUT BUYING IS BULLISH FOR THE UNDERLYING TOO MUCH CALL BUYING IS BEARISH FOR THE UNDERLYING
54 STANDARD Put-Call Ratio Ratio = Volume of Puts Traded Volume of Calls Traded
55 STANDARD Put-Call Ratio Ratio = Volume of Puts Traded Volume of Calls Traded -Put buying generates high numbers -Call buying generates low numbers
56 Standard Put-Call Ratio Ratio = Volume of Puts Traded Volume of Calls Traded -Put buying generates high numbers -Call buying generates low numbers Keep a moving average (21 days?)
57 Stock Price and P-C Ratio
58 Symmetry in actual practice
59 QQQ NASDAQ stock Put-call Ratio Institutional Distortion
60 Weighted Put-Call Ratio Dollar volume = option price x option volume Ratio = Sum of dollar volume of puts Sum of dollar volume of calls
61 Weighted Put-Call Ratio Dollar volume = option price x option volume Ratio = Sum of dollar volume of puts Sum of dollar volume of calls Measures dollars being spent on bearish opinion vs. dollars being spent on bullish opinion
62 Weighted Put-Call Ratio Can be computed on the same stocks, futures, or indices as the standard ratio Generally gives more extreme readings Slightly improves the timing of the signals
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76 Some Different Directional Indicators Total Put-Call Ratio Modified Bollinger Bands Distance from 200-day MA
77 Total Put-Call Ratio
78 Total Put-Call System Rules Use option volume from all exchanges; include stock, ETF, and index option volume (no futures) If 21-day MA > 0.90, system is on alert for buy
79 Total Put-Call Buy Signals Once 21-day MA > 0.90, then: Buy if 21-day MA a) falls below 0.90 or b) peaks for 10 days
80 Total Put-Call Buy Signals Once 21-day MA > 0.90, then: Buy if 21-day MA a) falls below 0.90 or b) peaks for 10 days Stop: if 21-day MA a) falls below 0.90 and then rises above 0.90 or b) makes new high Note: any stop automatically leads to a new buy
81 Total Put-Call Buy Signals Once 21-day MA > 0.90, then: Buy if 21-day MA a) falls below 0.90 or b) peaks for 10 days Stop: if 21-day MA a) falls below 0.90 and then rises above 0.90 or b) makes new high Note: any stop automatically leads to a new buy History: 19 signals: 13 successes, 6 stops Total gain: $SPX points (some stops produce gains)
82 Bollinger Bands Surround 20-day Simple Moving Avg (SMA) Width determined by volatility of closing prices modified Bollinger Bands Width determined by volatility of daily closing price percent changes
83 Modified Bollinger Bands
84 mbb System Rules 1) $SPX must trade outside of +/-4 sigma Band 2) Take the trade when $SPX closes inside of +/-3 sigma Band 3) Stop out if closes outside of +/-4 sigma Band Other exits: Opposite signal Trailing stop (optimal 2% is worse than none) Other indicators disagree
85 $SPX + modified Bollinger Bands
86 Distance from 200-Day MA (in standard deviations)
87 Longest Times Above 200-day 3 rd longest bull market time above 200-day
88 Download pdf Plus Special offers Visit:
89 Thank you for attending! Contact information: Phone: Fax: web site:
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