Options Trading Game Analysis - Derivatives Essay Example

Options Trading Game| CJ Pierro| | FIN 659| 4/25/2013| | Throughout the semester I employed a multitude of options strategies ranging from bearish and bullish to volatility plays and arbitrage plays - Options Trading Game Analysis introduction|| CJ Pierro| | FIN 659| 4/25/2013| | Throughout the semester I employed a multitude of options strategies ranging from bearish and bullish to volatility plays and arbitrage plays. While I have had some experience investing in equities I have never dug in and experimented with options in this manner. As the semester progressed I had gained more and more knowledge and was able to look back at my trades and understand more clearly why they performed they way they did and whether or not my trade ideas were smart plays in the market.

My overall portfolio performed well in the sense that at the end of eight weeks my net worth had increased by 22. 2% to $122,154, implying an annual return of 249. 3%. Each week I attempted to make at least two to three new trades and toy around with different strategies. Figure 1. Portfolio Performance vs. S&P500 Figure 1 tracks the net worth of my portfolio over the eight week period. The graph shows a steady increase in net worth with some dips and jumps along the way.

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The net worth did not track the gains of the S&P 500 too closely after the first few weeks since I was still able to make money on weeks in which the index saw a decrease. Additionally during the first three weeks I held options on the SPY ETF which contribute to the majority of the correlation. From this chart it can also be deduced that increasing my margin requirements did not have a direct correlation the performance of my portfolio. This is magnified my the near zero interest rates this account gained over the week, typically earning less than $1.

In the following pages I will discuss specific trades I found interesting over the course of the trading game. Week 1 During the first week of trading I opened three positions: an SPY strangle profiting $2,800, a MSFT bull call spread profiting $500, and an XOM calendar spread profiting $11,600. Table 1. XOM Calendar Spread. Table 1 shows the XOM calendar spread that was put on in week 1 profit $11,600, as mentioned above, with an expected return of only $773. I found this unexpected gain of $10,827 to be attributed to the relatively large increase in Implied Standard Deviation (ISD).

This large increase had a greater impact on the January ’14 call, since the ISD increased greater compared to the April call. While both options seemed to be mispriced I believe the January call must have been priced worse. Week 2 During the second week of the trading game I continued to maintain the SPY strangle profiting $1,550 and the XOM calendar spread losing $800. The new position I added was a naked put write of TBT. Table 2. SPY Strangle. Table 2 shows the SPY strangle that was held on for a second week. According to the Greeks, the expected profit was $8,689 however the traded on made $1,550.

This is due to overestimation of the ISD for the put, which accounted for two thirds of the difference. I believe the main reason the put lost twice as much as expected was due to the increase in the delta over the course of the week, from -0. 358 to -0. 206, which is explained by the inaccurate ISD. Week 3 During week three of the game I removed by SPY strangle and opened a bullish vertical call spread on SPY which lost $2,950, a risk reversal on TOL which profited $14,000, a bear ratio spread on DIS which lost $300, and a calendar straddle on ICE which also lost $300. Table 3. TOL Risk Reversal.

I found the TOL risk reversal to be particular interesting. I opened this position because the housing starts report came out during that week and I expected it would prove positive for TOL. I was surprised to see my expected profits be so accurate in regards to the actual profits. I believe part of this had to do with the relatively gamma neutral position of the trade and it shows that the ISD’s were very accurate week to week. Week 4 During week four I maintained my position in TOL losing $13,500 and the ICE calendar straddle which lost $318. I added a naked put in NUAN which profited $1,250.

I did not hold the same calendar straddle week to week however; I adjusted it so that it was delta neutral. Table 4. ICE Calendar Straddle. Table 4 shows the delta neutral calendar straddle. I found it interested that although the position remained relatively delta and gamma neutral it still profited less than expected. This is due to the increase in the ISD of the short puts and decrease in the ISD of the long calls and the large exposure to vega. Additionally, had the position remained a balanced in terms of number of options bought and sold, the overall difference in expected return versus the actual would have been closer.

Week 5 During the fifth week of the trading game I opened a put butterfly on CME and maintained my delta neutral ICE calendar spread and NUAN naked put. The CME butterfly profited $250, the NUAN naked put profited $500, and the ICE calendar straddle profited $4,350. Table 5. ICE Calendar Spread. I again chose to revisit my ICE position since it made $4,350 when it was expected to lose $597. One thing to note is that my model was unable to equate an ISD for the short April put at the week end which shows that it must be mispriced.

This factor alone contributed about a third of the difference. Over half the difference in returns was attributed to the long January call which saw a large spike in ISD. Week 6 In week six I put on a different CME butterfly spread, which I had thought was an arbitrage opportunity but ended up losing $8,800. I additionally opened a delta neutral vertical put spread on JPM which lost $3,500. Table 6. CME Butterfly Spread. I opened this trade because I knew it violated the rule the twice the price of the middle option should not exceed the sum of the price of the surrounding options.

My mistake here was that I should have been long the middle option and short the surrounding options because either the middle option is overpriced or the surrounding two must be underpriced. As shown by the change in ISD’s the June 62. 50 put was overpriced due to a drop of close to 5%. Week 7 In the final week of the trading game I wrote covered September 85 calls on SSYS. Although the equity totaled a loss of $9,795, the option gained $2,745 which helped offset the net position by 28%. I opened this position in order to hedge against an adverse move in the stock price, which did indeed occur.

Table 7. SSYS Covered Call. Table 7 shows that while the position made a profit, the ISD shows that the option may have been overpriced. However, since the equity showed a 10% decrease over the course of the week it would be expected that the ISD would increase and therefore provide a greater profit. Conclusion Over the eight weeks of the trading game I feel I have gained a much greater understanding of the different options strategies, when to employ them, and what to look for in order to increase profitability or decrease downside risk.

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