Short Premium Research Dissection (Part 25)

I left off with the most intense scrutiny of this research report yet.

I undertake this scrutiny as best as I can in lieu of sketchy methodology details (last two paragraphs here) and failure to disclose the standard battery—both issues I have mentioned several times throughout this mini-series.

I am trying to determine whether the worst loss cited in the study described here for a similar high-risk strategy is likely to be part of our author’s data set as well. If this is the case, then why does it subsequently take so little time to rebound to new equity highs [in this graph]?

At the end of the last post, I decided the October 2008 trade should be in the analysis while the November trade should not (volatility filter). By estimating open/close dates for both, I was able to estimate the market moves:

The November drop is slightly larger in terms of price move (percentage). The October drop is worse in terms of volatility. Taken together, I think there’s a really good chance the October trade would be a bigger loser than November and consequently the worst loss overall. This leaves me wondering how it could take less than one year to recoup the losses.

If the largest loss were November, then the VIX filter helps and my concerns are assuaged. If 2008 included consecutive losses, however, then my concerns are magnified. And again, less than one year to recoup losses in a 2009 period when volatility was easing only gradually…

I can’t know anything for certain. Putting together the analysis from the last three posts, all I have is suspicion, doubt, and skepticism: none of which are encouraging for research that cost me good money.

Zooming back out to the end of Part 22, something marketable must come from the lower margin use percentage (MUP) of limited-risk trading. Maybe with the lower MUP, I feel more comfortable to deploy other [non-correlated] strategies in combination. With high risk, MUP must be viewed as something that could easily multiply after a sudden, large market move. None of that matters for limited risk because the largest possible MUP is always staring me in the face.

If nothing else then perhaps a limited-risk strategy saves me from the worst sales pitch ever. This could mean everything.

We need not end with the 10% improvement of CAGR/MDD for limited-risk over high-risk strategies (Part 21 table). Time stops are a good next step for exploration (see second paragraph here ). I suspect X% of maximum potential profit comes sooner whereas the biggest losers come later (exploding gamma). Indeed, a 75% profit target can only be hit with waning days to expiration if and only if the market trades in the vicinity of the short strike (with a -100% max loss lying in wait to greet an outsized market move). As an alternative to time stops, smaller profit targets (e.g. 5-20%) and stop losses (e.g. 10-30%) are more common among similar approaches discussed by other traders.