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AW: What options to sell?



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Gitanshu,

thanks for your interesting post, and also for the friendly and constructive
approach you are taking. Like yourself, I entered into this thread in a
spirit of trying to be helpful. There is nothing I stand to gain through my
posting here, and I assure you I would immediately fall silent if any
flaming arose from it.

As you surmised, I am well aware of the points you are raising. Though the
counterexample you were using does not describe my position quite
correctly - I would not think it advisable in Guy's case to buy puts with
only one week to go - still I agree that there are many different spread
positions that could be used to trade direction to good advantage.

In fact, one additional strategy that I like to use sometimes to trade
direction is the sale of backspreads (provided volatilities are right, and
there is a certain volatility skew). So there are indeed many avenues to
explore in any given situation, as you were rightly stating.

Now let me explain why I don't think these applicable in the case of Guy's
system.

Anyone who has ever devised a mechanical trading system will have had this
experience: you change a certain parameter a little - just a little! - and
test results start diverging by a wide margin. Unfortunately, most of the
time this happens, results deteriorate.

Now here we have this successful trading system that it took Guy and his
family 30 years to develop. Don't you agree that Guy would be well advised
to be extremely careful, even reluctant, to change his system?

There can be no doubt that replacing futures with option spreads, especially
those where one gets short premium, thus limiting possible profits,
constitutes a fundamental change of main characteristics of a trading
system. To name only one effect that is immediately obvious - the big per
trade profits (up to 150 points, as Guy stated) just wouldn't have occurred.
It is true that losses (up to 62 points), too, might have been less, but
since the system had 19 winning trades and only 3 losing ones, the use of
credit spreads would very likely have led to a severe deterioration of the
system.

Besides, many types of spreads require the use of stops, or at least
constant supervision and readjustment; readjustment "rules" are not really
clear-cut because there is a choice of option strikes and volatilities and
deltas, even different follow-up strategies, with the ensuing action to be
individually determined by the trader in each and every case. If you can
call this a "system" at all, it will certainly not be the same system Guy
had been trading before.

That is why I didn't take spread trading into consideration in my posts. The
only option strategy that would preserve the characteristics of Guy's system
at least to a reasonable extent, would be the simple purchase of puts or
calls, as the case may be.

This strategy may indeed prove useful in catastrophic situations such as the
October 87 crash where prices moved more than 12 standard deviations, an
event that statistically should have occurred less than once in the history
of the universe.

Kind regards,

Michael Suesserott