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OPTIONS TRADING

TRADING SYSTEM
OPTIONS STRATEGY
OPTIONS SYSTEM
LAB LAB
LAB
FIGURE 1 — PARABOLIC SAR CHART
The parabolic SAR works best during strong trending periods, which

Parabolic SAR developer Welles Wilder estimated occur roughly 30 percent of the time.

with credit
spreads
Market: Options on the S&P 500 index
(SPX).

System concept: The most profitable


options lab we have tested used the direc-
tional movement index, developed by Wells
Wilder in 1978. This lab tests another of
Wilder’s indicators — the parabolic SAR.
Sometimes known as the stop-and-
reverse system, the parabolic SAR is a calcu-
lation that acts as a stop-loss point under- Source: MetaStock
neath long trades and above short trades
(Figure 1). The parabolic SAR is often used FIGURE 2 — BULL PUT SPREAD RISK PROFILE
to determine the direction of an asset’s A November 1030-825 bear call spread was entered on Oct. 26, 2009 when
momentum and when momentum has a the market closed at 1067.
higher-than-normal probability of switching
directions.
If the parabolic SAR lies below the current
price, the market could be bullish, and if it is
above price, the market may be bearish. In
this lab, all transactions are placed when
price crosses the parabolic SAR calculation.
Bullish signals are triggered at the close after
price crosses above yesterday’s parabolic
SAR value. Bearish signals are triggered at
the close after price crosses below yester-
day’s parabolic SAR value. (Standard set-
tings were used: an acceleration factor of
0.02 with a maximum of 0.20.)
When signals appear, the system enters
credit spreads by selling an option (a put for
bullish signals, a call for bearish ones) at the
first strike beyond one standard deviation.
The system also buys a same-type option 10
Source: OptionVue
points farther OTM — far enough out-of-
the-money (OTM) to ensure the credit is suf-
ficient. Note: This distance varies depending on the under- Trade rules:
lying and current market conditions.
Ideally, credit spreads make money as time passes. If the Bullish signal
underlying’s price goes nowhere or moves away from the When price crosses above yesterday’s parabolic SAR
short strike, the spread’s value will decline toward zero as value, enter a bull put credit spread as follows:
the likelihood of the short strike finishing in-the-money
(ITM) decreases. 1. Sell five puts at the first strike that is beyond one
Figure 2 shows the potential gains and losses of a standard deviation.
November 1030-825 bear call spread entered on Oct. 26, 2. Use the first expiration month with 21 or more days
2009 when the S&P 500 index closed at 1067. The trade will remaining.
be profitable if the S&P 500 closes below 1130.89 at Nov. 20 3. Buy five puts at a strike price 10 points farther OTM.
expiration. continued on p. 18

FUTURES & OPTIONS TRADER • December 2009 17


OPTIONS TRADING SYSTEM LAB
FIGURE 3 — SYSTEM PERFORMANCE
Exit: Let the spread expire worthless The parabolic SAR system gained 133 percent since January 2004.
unless a bearish trade is triggered.

Bearish signal
When price crosses below yester-
day’s parabolic SAR value, enter a
bear call credit spread as follows:

1. Sell five calls at the first strike


that is beyond one standard
deviation.
2. Use the first expiration month
with 21 or more days remaining,
3. Buy five puts at a strike price 10
points further OTM.

Exit: Exit if underlying touches the


Source: OptionVue
short option’s strike. Otherwise,
allow the credit spread to expire months, the winning percentage dropped to 70 percent,
worthless. reducing the overall win rate to 85 percent.

Starting capital: $10,000. — Steve Lentz and Jim Graham of OptionVue

Execution: All entries occur at the close when price cross- STRATEGY SUMMARY
es yesterday’s parabolic SAR value. The system may hold
both bullish and bearish positions at the same time. Initial capital: $10,000
However, duplicate signals are ignored until a position clos- Net gain: $13,250
es. Percentage return: 133%
Option trades were executed at the average of the bid and Annualized return: 22.6%
ask prices at the daily close, if available; otherwise, theoret- No. of trades: 82
ical prices were used. The standard deviation was calculat- Winning/losing trades: 70/12
ed with a probability calculator using the implied volatility Win/loss: 85%
(IV) of the at-the-money call in the relevant month. Each Avg. trade: $161.59
spread held five contracts per “leg.” Commissions were $5 Largest winning trade: $1,580.00
per trade plus $1 per option ($20 per spread). No commis- Largest losing trade: -$2,340.00
sions were included when a spread expired worthless. Avg. profit (winners): 447.93
Avg. loss (losers): -1,508.75
Test data: The system was tested using options on the Avg. hold time (winners): 36
S&P 500 index (SPX). Avg. hold time (losers): 19
Max consec. win/loss: 29/2
Test period: Jan. 12, 2004 to Nov. 20,
2009.
LEGEND:
Net gain — Gain at end of test period.
Test results: Figure 3 shows the per-
Percentage return — Gain or loss on a percentage basis.
formance of the system, which gained
Annualized return — Gain or loss on a annualized percentage basis.
$13,250 (133 percent) in six years, a 22.6-
No. of trades — Number of trades generated by the system.
percent annual return. In the test’s first four
Winning/losing trades — Number of winners and losers generated by the system.
years, the strategy had a winning percent-
Win/loss — The percentage of trades that were profitable.
age of 93 percent. But in the final 18
Avg. trade — The average profit for all trades.
Largest winning trade — Biggest individual profit generated by the system.
Option System Analysis strategies are tested Largest losing trade — Biggest individual loss generated by the system.
using OptionVue’s BackTrader module (unless
Avg. profit (winners) — The average profit for winning trades.
otherwise noted).
Avg. loss (losers) — The average loss for losing trades.
If you have a trading idea or strategy that Avg. hold time (winners) — The average holding period for winning trades (in days).
you’d like to see tested, please send the trad- Avg. hold time (losers) — The average holding period for losing trades (in days).
ing and money-management rules to
Max consec. win/loss — The maximum number of consecutive winning and losing trades.
Advisor@OptionVue.com.

18 December 2009 • FUTURES & OPTIONS TRADER

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