Hi all,
I wanted start a thread to discuss a Forex Options Strangle System (FOSS), as I have been applying a similary system to equity indexes for the last year with good success. I have become a pretty conservative trader over the last few years and focus as much or more on how not to lose and how to reduce drawdown as I have been on maximizing returns. You have to survive in order to fight another day. Thus, on index options, over the last 7 months I am up 16% with no more than a 2% draw down on a monthly basis.
Because of that success, I have been trying they strangle system on forex in a paper account. In the last two months I am up 18% with 0% draw down on a monthly basis. However, I am unclear whether that was skill or that was luck. Hopefully a good discussion here will flesh out which it was and how to replicate it.
What is a Strangle and how do you make money with it?
=========================================
The purpose of this section is to discuss exactly what is a strangle and how one makes money at it. A strangle is simply:
1) Buying or selling an out of the money put and out of the money call on the same instrument with the same expiration.
Buying a Strangle:
ASSUME: EURUSD @ 1.42500
Buy 100,000 EURUSD Call @ 1.4500 Nov 19 Expiration = 0.0200
Buy 100,000 EURUSD Put @ 1.4000 Nov 19 Expiration = 0.0206
Total cost: 0.0406 x 100,000 = $4,060
Now basically you are 406 pips in loss on the trade at the start. So your break even is:
1.4500 + 0.0406 = 1.4906 or
1.4000 - 0.0406 = 1.3594
You then make $10 a pip above or below those two values. The interesting thing with Buying or being Long a strangle is you don't care which way the price moves, just that it moves.
Selling a strangle:
ASSUME: EURUSD @ 1.42500
Sell 100,000 EURUSD Call @ 1.4500 Nov 19 Expiration = 0.0190
Sell 100,000 EURUSD Put @ 1.4000 Nov 19 Expiration = 0.0196
Total revenue: 0.0386 x 100,000 = $3,860
You get to keep all the revenue as long as the EURUSD stays between 1.4500 and 1.4250. This is probably too tight a range, but the idea is understandable. You want to not be wrong, you want the price to stay within a range and keep the premium.
How does margin work with strangles?
============================
If you are buying a strangle you need the amount of cash in your account to purchase the full amount of the strangle. In the example above, you would need $4060 in your account to buy the strangle.
If you are selling strangles, you get a ton of leverage. However, before we go into the formula we need to talk about delta. Delta is the rate of change for every point up the currency makes. For an At the Money (ATM) option, delta is around .50. Meaning that the option changes price 50% of the price move. So if the EURUSD goes up 100 pips, the ATM option price goes up 50 pips.
Now, for margin on forex options the formula is:
2% x Delta x Size of trade.
For an ATM 100K EURUSD option, the margin would be around:
2% x .5 x 100,000 = $1K
For an OTM 100K EURUSD opiton, the margin is much different as delta is different. A way OTM option may have a delta of .1 so the margin is:
2% x .1 x 100K = $200
Now here is where things get interesting, delta is netted out on all your positions. What this means is that if you have sold a Call and Sold a put, you net delta is the Call Delta + Put delta, which can appoach zero if they are evenly spaced. Also, you can only really reserve margin for one side of a strangle. Thus if you are short a Call and Short a Put, you only have to use margin for either the Call or the Put as you can't be wrong on both. So as the currency price moves towards one strike, you really get double margin as you only reserve margin on one side.
What is the FOSS?
==============
I SELL option strangles in order to capture theta, or the time decay in the value of the option. Every day that passes the option value decreases a little, just as the option value changes either up or down as the price of the currency changes up or down.
Since the margin rules are very advantagous, you can really make some money. I sell a strangle, 3-5x the ATR of a currency some 20-40 days out and wait. I look for support and resistance lines and try to sell them just outside of those lines so I have some built in price protection.
But the big question is what to do when I am wrong. When the price moves towards one of my strikes? Well, in that case I just eat the loss and buy back the option, and immediately turn around and sell another one, further out of the money, further out in time, and a little smaller, basically just looking to make back my loss. Since if I lose on one side, I keep all the money on the other.
Open Issues
============
So what is there to discuss? The big question is what is the best method to determine where prices WILL NOT GO TO. This takes a bit of reverse thinking as usually traders worry aobut, and make money, based on predicting where the price will go.
Example trade
============
So here is a live trade I just made:
GBPUSD: 1.6150
Sell 100,000 GBPUSD Call @ 1.6700 9-17 expiry = 0.0016
Sell 100,000 GBPUSD Put @ 1.5550 9-17 expiry = 0.0016
I have a slight downside bias on the GBPUSD and thus extended the lower strike by 50 more pips. Currently to hold this position I am using $300 in margin, but at the strikes will use no more than $1000 in margin for both legs.
In other words if the strangle expires I make $320 on between $200 and $1000 of margin. If I have to roll on leg because the price approaches the strike, I keep $160 on $1000 of margin at the time of the roll (assume the price doesn't come back to the lower strike. Those kinds of returns per trade are pretty great, even if you are wrong on one side.
A screen shot is attached.
So again any thoughts or ideas on how to predict where a price of a currency won't go would be greatly appreciated.
I wanted start a thread to discuss a Forex Options Strangle System (FOSS), as I have been applying a similary system to equity indexes for the last year with good success. I have become a pretty conservative trader over the last few years and focus as much or more on how not to lose and how to reduce drawdown as I have been on maximizing returns. You have to survive in order to fight another day. Thus, on index options, over the last 7 months I am up 16% with no more than a 2% draw down on a monthly basis.
Because of that success, I have been trying they strangle system on forex in a paper account. In the last two months I am up 18% with 0% draw down on a monthly basis. However, I am unclear whether that was skill or that was luck. Hopefully a good discussion here will flesh out which it was and how to replicate it.
What is a Strangle and how do you make money with it?
=========================================
The purpose of this section is to discuss exactly what is a strangle and how one makes money at it. A strangle is simply:
1) Buying or selling an out of the money put and out of the money call on the same instrument with the same expiration.
Buying a Strangle:
ASSUME: EURUSD @ 1.42500
Buy 100,000 EURUSD Call @ 1.4500 Nov 19 Expiration = 0.0200
Buy 100,000 EURUSD Put @ 1.4000 Nov 19 Expiration = 0.0206
Total cost: 0.0406 x 100,000 = $4,060
Now basically you are 406 pips in loss on the trade at the start. So your break even is:
1.4500 + 0.0406 = 1.4906 or
1.4000 - 0.0406 = 1.3594
You then make $10 a pip above or below those two values. The interesting thing with Buying or being Long a strangle is you don't care which way the price moves, just that it moves.
Selling a strangle:
ASSUME: EURUSD @ 1.42500
Sell 100,000 EURUSD Call @ 1.4500 Nov 19 Expiration = 0.0190
Sell 100,000 EURUSD Put @ 1.4000 Nov 19 Expiration = 0.0196
Total revenue: 0.0386 x 100,000 = $3,860
You get to keep all the revenue as long as the EURUSD stays between 1.4500 and 1.4250. This is probably too tight a range, but the idea is understandable. You want to not be wrong, you want the price to stay within a range and keep the premium.
How does margin work with strangles?
============================
If you are buying a strangle you need the amount of cash in your account to purchase the full amount of the strangle. In the example above, you would need $4060 in your account to buy the strangle.
If you are selling strangles, you get a ton of leverage. However, before we go into the formula we need to talk about delta. Delta is the rate of change for every point up the currency makes. For an At the Money (ATM) option, delta is around .50. Meaning that the option changes price 50% of the price move. So if the EURUSD goes up 100 pips, the ATM option price goes up 50 pips.
Now, for margin on forex options the formula is:
2% x Delta x Size of trade.
For an ATM 100K EURUSD option, the margin would be around:
2% x .5 x 100,000 = $1K
For an OTM 100K EURUSD opiton, the margin is much different as delta is different. A way OTM option may have a delta of .1 so the margin is:
2% x .1 x 100K = $200
Now here is where things get interesting, delta is netted out on all your positions. What this means is that if you have sold a Call and Sold a put, you net delta is the Call Delta + Put delta, which can appoach zero if they are evenly spaced. Also, you can only really reserve margin for one side of a strangle. Thus if you are short a Call and Short a Put, you only have to use margin for either the Call or the Put as you can't be wrong on both. So as the currency price moves towards one strike, you really get double margin as you only reserve margin on one side.
What is the FOSS?
==============
I SELL option strangles in order to capture theta, or the time decay in the value of the option. Every day that passes the option value decreases a little, just as the option value changes either up or down as the price of the currency changes up or down.
Since the margin rules are very advantagous, you can really make some money. I sell a strangle, 3-5x the ATR of a currency some 20-40 days out and wait. I look for support and resistance lines and try to sell them just outside of those lines so I have some built in price protection.
But the big question is what to do when I am wrong. When the price moves towards one of my strikes? Well, in that case I just eat the loss and buy back the option, and immediately turn around and sell another one, further out of the money, further out in time, and a little smaller, basically just looking to make back my loss. Since if I lose on one side, I keep all the money on the other.
Open Issues
============
So what is there to discuss? The big question is what is the best method to determine where prices WILL NOT GO TO. This takes a bit of reverse thinking as usually traders worry aobut, and make money, based on predicting where the price will go.
Example trade
============
So here is a live trade I just made:
GBPUSD: 1.6150
Sell 100,000 GBPUSD Call @ 1.6700 9-17 expiry = 0.0016
Sell 100,000 GBPUSD Put @ 1.5550 9-17 expiry = 0.0016
I have a slight downside bias on the GBPUSD and thus extended the lower strike by 50 more pips. Currently to hold this position I am using $300 in margin, but at the strikes will use no more than $1000 in margin for both legs.
In other words if the strangle expires I make $320 on between $200 and $1000 of margin. If I have to roll on leg because the price approaches the strike, I keep $160 on $1000 of margin at the time of the roll (assume the price doesn't come back to the lower strike. Those kinds of returns per trade are pretty great, even if you are wrong on one side.
A screen shot is attached.
So again any thoughts or ideas on how to predict where a price of a currency won't go would be greatly appreciated.