Short Premium Research Dissection (Part 16)

Our author stops after the discussion on allocation and restates the [curve-fit] strategy as her full trading plan.

We get a relatively thorough methodology description here, contrary to my reference in this first sentence of paragraph #5.

She follows with a reprint of the previous performance graph and table of statistics discussed with one slight alteration. The asterisk, last discussed in the third paragraph here, now has a corresponding footnote:

     > *Please Note: Hypothetical computer simulated performance results
     > are believed to be accurately presented. However, they are not
     > guaranteed as to the accuracy or completeness and are subject to
     > change without any notice. Hypothetical or simulated performance
     > results have certain inherent limitations. Unlike an actual
     > performance record, simulated results do not represent actual
     > trading. Also, since the trades have not actually been executed, the
     > results may have been under or over compensated for the impact,
     > if any, or certain market factors such as liquidity, slippage and
     > commissions. Simulated trading programs, in general, are also
     > subject to the fact that they are designed with the benefit of
     > hindsight. No representation is being made that any portfolio
     > will, or is likely to achieve profits or losses similar to those
     > shown. All investments and trades carry risks.

Was this footnote meant to accompany all “hypothetical portfolio growth” graphs (i.e. Part 8, paragraph #2)?

She advises:

     > …be realistic about your sensitivity to portfolio drawdowns…
     > choose a trade size you can stick to long-term. Changing…
     > sizes based on how aggressive/conservative you’re feeling on
     > a particular day can lead to worse results.

I agree. I also think this would have been a great place to illustrate what parameters matter to us as traders versus what parameters matter to investors screening us as potential money managers. This is good fodder for a future blog post.

She closes with a howitzer:

     > …based on the drawdowns observed in these backtests, and
     > the unpredictable nature of the stock market, I personally
     > do not recommend implementing any of the “undefined-risk”
     > strategies shown in this section. I displayed the research
     > anyway because I want you to see what can go wrong…

While I would like a couple more sentences detailing why, I appreciate these honest conclusions. I believe “undefined risk” should be accompanied with the worst sales pitch ever.

She gives clues about her thinking as the next section begins:

     > The problem more conservative traders may have… is
     > that the downside loss potential is substantial,
     > especially when sizing trades based on a certain
     > percentage loss on the premium received.

“Substantial” probably means the -24.3%, -22.8%, and -18% drawdowns in 2008, 2011, and 2015 respectively: numbers mentioned earlier. I wish she had proceeded to describe “your worst drawdown is ahead of you” (third-to-last paragraph here).