Systematic options trading

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dantes
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Systematic options trading

Post by dantes » Sun Nov 27, 2011 8:53 am

Dear TB community,

I am trying to develop a systematic strategy on options and would love to hear opinions on its feasibility.

Let's assume the strategy goes like this:

1. At the beginning of each month, select a strike +/- X from current spot level
2. Within this universe, get call/put prices for expiry Y months in the future
3. Open a long straddle* as follows:
strike = spot +/- X
expiry Y months in the future

*: simultaneously buy 1 put and 1 call of the same underlying, strike price and expiration.

For example, if:
- today is 01/11/11
- current spot level is 1000
- X = 5%
- Y = 3

Then go long a Feb 2012 strike 1050 straddle.

The idea is to optimize/backtest on all parameters above.

The option data is in this format:
http://www.marketdataexpress.com/Popup/ ... ption.aspx
http://www.marketdataexpress.com/dataEO ... aspx?u=SPX

Any thoughts on the feasibility to implement/backtest such a strategy with TBB?

How best to build a portfolio of option prices in a TB-friendly format?

How would you implement steps 1-3 as per above?

Thanks in advance for your thoughts.

Dantes

sluggo
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Post by sluggo » Sun Nov 27, 2011 10:55 am

The first thing to do is hire the team of programmers who will implement this for you. You need them to be involved in the decisions because some (indeed, many) equally-useful alternatives will have wildly-unequal cost (difficulty) of programming.

One possible idea is to create a unique "instrument" for each option that is considered for trading. I think it might make life easier for the programmers if these instruments are named in a way that makes it easy to deduce the underlying, the strike, the expiry, and the direction just by parsing the name. For example,

TCEGOLD_P_4365_2012_06_30

might indicate a futures option on Gold at the Tokyo Commodity Exchange, the option is a Put, the strike price is 4365, and the expiry is 30 June 2012.

You'll want a much shorter "symbol" for that instrument; but there may be too much information to embed in a three- or four-character symbol. You may be forced to use uninformative symbols and a lookup table. So the Put option above might have the not-parseable-by-humans symbol "PXIQ", for example.

dantes
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Post by dantes » Sun Nov 27, 2011 1:51 pm

Thank you Sluggo - let's see if my team of programmers (i.e. me) is up to the task... :)

Dantes

mojojojo
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Re: Systematic options trading

Post by mojojojo » Tue Nov 29, 2011 1:14 pm

dantes wrote:Dear TB community,

I am trying to develop a systematic strategy on options and would love to hear opinions on its feasibility.

Let's assume the strategy goes like this:

1. At the beginning of each month, select a strike +/- X from current spot level
2. Within this universe, get call/put prices for expiry Y months in the future
3. Open a long straddle* as follows:
strike = spot +/- X
expiry Y months in the future

*: simultaneously buy 1 put and 1 call of the same underlying, strike price and expiration.

For example, if:
- today is 01/11/11
- current spot level is 1000
- X = 5%
- Y = 3

Then go long a Feb 2012 strike 1050 straddle.
If Y = 3, wouldn't you be trading the April contract?

Is it doable? Sure. Anything is doable with enough time and/or money. Is it WORTH doing, I'm not sure.

So your planning on buying a strangle (straddles are ATM) at the begining of everything regardless of the market condition? How long are you planning on holding? What's your exit strategy? Will you leg out or sell both at the same time?

I see what some of these guys go through dealing with futures, I can only imagine what it's like dealing with options.

drm7
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Post by drm7 » Tue Nov 29, 2011 2:28 pm

Here is a strategy that has already been backtested. Looks interesting. You'll have to know a few things about option pricing to get the parameters correct, though.

What astounds me is that the equity curve doesn't look like a typical "short volatility" curve. There is another paper published by GMO called "What the Beta Puzzle Tells us About Investing" that explores the concept behind this strategy.
Attachments
Hedge Fund Replication Jurek Stafford.pdf
Hedge Fund Replication with Options
(492.3 KiB) Downloaded 320 times

dantes
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Post by dantes » Tue Nov 29, 2011 3:25 pm

Mojojojo, drm7 - thanks for your input.

I'm starting from the assumption that trend following returns resemble those of lookback straddles: http://edge-fund.com/~msewell123/FuHs01.pdf
Specifically, trend followers tend to perform as if they are long "volatility" and "market event risk," in the sense that they tend to deliver positive performance in extreme market environments.
Hence - Markowitz-style - strategies that either sell volatilty or perform well in low volatility regimes should complement trend following quite well.
For example carry trades, iron condors, or buy-write strategies.

Limited maximum downside - Taleb-style - however is key, so iron condors/iron butterflies seem worth exploring.

To make things easier, I would then just let the options expire.

I'm basically after a strategy that pays "carry" in quiet times.
It will suffer when volatility gets out of hand, and hopefully that is when trend following kicks in with nice over-sized returns.

Wish me luck...

Dantes

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