Risk Management Lessons and Portfolio Strategies
Explore the intricate world of risk management through the lens of LTCM's downfall and learn valuable insights on portfolio strategies and market conditions. Discover how to manage risks effectively and optimize risk-reward scenarios in your trading endeavors.
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Presentation Transcript
The Option Pit Method Portfolio Management Option Pit
Portfolio Management Risk Management Lesson- LTCM Diagnose Market Conditions- VIX Zones Managing position Adding positions together Learn how to find edge in the market-Gold Course
First a story on Risk Management Risk Management is about what you don t know The entire financial crisis was a risk no one thought of, but there was an earlier one: LTCM What killed them? Short option positions and trying to pick up nickels that cost 100 s of millions of dollars to billions of dollars
What Brought Them Down? Risk Arb in the Ciena/Tellabs take over (CIEN collapsed as LTCM lost 100s of millions chasing a $1 arb which was essentially selling an ATM (lots of short gamma) put in a $100 stock) Carry trade in two different securities causing long/short misallocation (3nd World Debt/US Treasuries on the Russian default) Selling Premium in the SPX at 13 IV tens of millions of dollars- Yes selling near position limit at a 13 VIX. Data set only went back to the early 90 s
LTCM Implosion Is Instructive. Remember according to LTCM, the risks they were taking were next to impossible to lose money on REALLY? If they could have held on, LTCM would have eventually made money The key is risk management!
Vanilla Risk Brought Down LTCM Risk Management is for what you don t know Retail traders experience Mini-LTCM all of the time You can t win if a single loss is too big Use the Greeks Delta, Gamma, Theta, Vega Profit and Loss targets to help manage risk Set up the best risk reward scenarios you can
Volatility based Risk Management VIX is generally pricing the expected move Zone 1 VIX 10-13 Zone 2 VIX 14-17 Zone 3 VIX 18-21 Zone 4 VIX 22< and bigger The VIX is telling you what the expectation is at any point in the market cycle. Does you book of positions fit what is going on?
Volatility based risk management Positions that work in a falling VIX are very different from ones that work in a rising VIX The recent changes in volatility have been quite large. What is your net Vega? Did your positions fit what was going on? Trouble comes from a change in VIX Zone most of the time For an individual equity or ETF that is a change in volatility (think quartiles for volatility)
Option Prices Matter Simply put why are things trading the way they are? Investors need to understand how to price options first. - Option Pit calls this conditional trading - The VIX Zone is a market condition and effect how a position will perform
What is Conditional Trading A concept of creating options positions best suited to perform in the current and future market conditions. Managing Risk is also part of conditional trading. The first thing to realize is putting on positions that have little chance of success is a losing battle.
Breaking down AAPL AAPL in the lower quartile gives time spreads a better chance AAPL in the upper quartile gives short time spreads a better chance Selling option premium wants the IV to collapse, near always. The two keys are direction (delta) and volatility (vega)
How do options work to control risk? The Greeks- essentially knowing how a position structure will perform before during and after the trade
What is Conditional Trading Selecting positions in terms of Greeks and Risk Management techniques as in instead of I like a stock the trader sees the Greeks associated with the underlying at current pricing levels will help generate edge in a trade.
What is Portfolio Risk Management? Finally- Creating a balanced book of option trades so if disaster falls from the sky you as an investor can respond when conditions are multiple times better to trade. You need to have cash available Some trades need to be working if other ones are not You need to close or adjust
Beginning Risk Management Watching your trade Go downhill with no plan Is the road to ruin. However if you know your Positions changes when Something happens that Is a different story.
Setting up the SL and a book of trades The SL has had a tough start in 2016 Too many oil bottom trades Not taking profits from 2015 But ultimately risk control kept things from getting out of hand Friday added around $400 to the PL BUT We are doing better than the market as a whole We have lots of available dollars
Welcome to the Strategy Letter Open Trade PL Does not include Closed trades
Stock and put positions In a short term (or long term) stock positon, you need a kill spot That number is around 20% Use a mental stop Or you can buy a put This way you can manage the dollars at risk I will roll once Writing calls can help The net synthetic call goes into the risk cal
AMJ Synthetic Call Calculation AMJ 24.22 Feb 24 puts @1.60 Stock price + put price strike = 1.82 synthetic all costs
Adding long gamma When VIX is very high some long gamma generally helps At least the positions pick up P/L when the underlying moves This helps add to a positive contract count When VIX explodes, it is the long contracts that help, not the short ones Owning some contracts before VIX jumps helps the most
Managing Open Contracts After closing parts of a position there are usually left over contracts We keep them to trade against, as in sell options Hold them as a lottery ticket in case the underlying makes a strange move
SL positons additions CMG TAKING PROFITS GLD Closing due to no action (short contracts closed previous) FXE- Will sell forward contracts RUT- Taking profits UVXY- more VIX curvature VXX- Long volatility call for a credit
Managing a book For the SL, 10 position is about max Take profits in the winners ABC When adding position, how does it fit our risk profile? Walk through the Greeks Keep cash available- at least 50% No more than 1% of risk per position Let s do this live now with the current SL
Reviewing Positions Adding same side-of-the-market positions should be for more edge We learn about edge in the Gold Course Essentially it is buying cheaper volatility, selling more expensive volatility and managing the risk in between.
Summary The market moves per VIX Zone All option positions will move to their Greek character Understand how the Greeks work to construct and manage positions Add and subtract positions that help balance the overall portfolio of options
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