02 - SPY/SPX 7 DTE Income Strategy Deep Dive

So, first, there's podcasts. We're going to do a deep dive into my SPY/SPX7DTE income strategy. I know a lot of people have asked questions in the past. I have my mechanics on the trading page, which I'm mainly his little sparse. But honestly, it's a very simple strategy, and a lot of the nuance is really in the logic and reasoning behind the mechanics as simple as they appear. And, you know, understanding the more kind of gave you the conviction to run this. And we're going to go over the entry criteria, exit criteria, delta selection, you know, the trade setup and talk a little bit about the expectancy and long term metrics. So, this came about originally. This was the actually the first of my three income strategies that I developed with essentially we were looking for a strategy that is consistent and kind of can produce income. And is what I call evergreen basically you can put it on any environment and you have a reasonable expectation of having a consistent level of income. And so as the name implies, this is a seven DTE strategy with naked put options. Some people have basketball spreads and I'll cut that a little bit later or maybe another episode. But essentially with sp1 spx there's three explorations. So I'm putting a naked put option at the end of the day, Monday, Wednesday and Friday, each one is seven DTE. So you have basically in steady state three positions staggered and overlaid at any one time. The delta selection is 10 to 20. I'll get into that in a little bit. And you have a 2x stop loss to clarify a 2x stop loss means you are setting the stop trigger at three times the credit. So if you collect the dollar you're setting the stop at three times at $3. Meaning if it gets triggered you will have a net loss of 2x right if you collect the dollar and pay $3. Your loss is $2. Not accounting for slippage which we do need to cancel that but I'll get into that as well. There's no profit target. And that's it. That's why on my internet mechanics page, you know, you see three lines 70 T10 to 20 delta to X stop and there's really not much else. Why do we do this? First of all, the 2x stop loss again, bar and slippage, we're trying to establish a risk to the make one risk reward profile. Right. So because when you get stopped, you know, it's 200% loss and you're hoping to take full credit 100% wins. So with this, you get this to risk to the make one and that means that we are having a break even win rate of 66.6%. Essentially, as long as you win two out of three, not kind of slippage, you're going to break even which also means that as long as your win rate is above that breaking win rate, now so 70 75 80% you're going to have positive expectancy. And that's kind of what it boils down to is basically the expectancy. We're looking for about a 75 80% win rate because you will in fact get a little bit of slippage depending on which instrument to use. If you look on my trade logs, there is a loss multiple column, which kind of factors that in. So there is kind of scrolling through here, you know, 2.1, 2.2, you'll see some larger losses, which is way above two, which is for gaps. I'll get into that a second. But with slippage, you know, it's going to lower the expectancy a little bit, but I'm just going to take one example if we have a 75% win rate. So, you know, you're losing 25% of time losing 2x and then you have a 75% chance of winning the full credit. Then if you kind of do the expectancy math, which is essentially, you know, 75% times 100 and then 25% times 200 you someone up, you're going to get an expectancy of 25% or 25% expected premium capture. In other words, for every dollar of premium, you're going to look to bank or profit 25 cents on the dollar. Now, why this particular delta selection when I when I started is that actually did 30 delta at one point, this was due to some back testing results and it looked okay. You know, there's seven years we made a lot of seven years, we made a little less. But then one year I ran it live at 30 delta. And I was heading about the 70% win rate, which you know, and theory should be slightly positive about 10% premium capture, 70%. And you know, after about nine months, I hit a number of stops and then I noticed that I was at zero, right. I went back to break even. And then I went back and this was before, you know, because my trade logs weren't as detailed back then, I went back and isolated out the extra loss from the slippage and loan behold, you know, what I was expecting about 10 to 13% premium capture and it up, I was paying 10 to 13% in slippage. So it perfectly negated on my profits. So because of that, I realized, okay, so 70 30 delta, you know, paying down to be about 70% win rate, which should be making money, but then after slippage wasn't. So I decided it just to scale back the delta. And I wanted to scale it back as much as possible. And then I had the 10 to 20 range in my mind and do the testing, the trading, you know, should give you a 80% roughly when we're depending on on the market conditions and just volatility and everything. And why the range of 10 to 20 because there's a concept called a credit targeting, which I think I'll develop episode to that. But the idea is if you're sizing, you know, people talk about sizing trades consistently. And then I'm going to talk about the contract size because if I'm collecting, you know, when volatility is higher collecting $5 for one and $3 for another $1 for another, you know, you could subject yourself to sequence of the current was just bad luck. But what if you happen to only win the larger, sorry, you only win the smaller trades and you only lose the larger trades. That's going to skew the expectancy even if the probabilities in fact play out. So it's actually very important to get the same amount of credit. So if you look at my trade logs, you're going to see that it's a very consistent credit collection. Now it's going to scale up and down slowly because I do a fixed percentage of my account. But the way I do it is I tend to want to go as low delta as possible. I don't go over 20 delta. I don't go under 10 because, you know, there's reasons for if you go under 10 delta, the pot will be higher, but the credit is lower and slippage and fees as a portion. It's just it's just it eats in too much of the profit as a as a percent. So I'm going to look to when I'm putting on a trade, I'm going to look to adjust contract and or delta to hit my credit target. So for example, if I wanted to collect the $1,000, right, you can collect $1,000 by doing 10 contracts at a dollar or 20 contracts that for decent. So my sort of setup is I'm going to first of all, let's say I want to part get a smaller amount of contracts. I want to do 10 contracts at a dollar. I'll look to go to the option chain and go, is the 10, you know, $1 below the 20 delta. That 10 delta perfect. And I'll do the 10 contracts at a dollar. But if the $1 is above 20 delta, you know, because when volatility is lower, you're naturally going to have lower premium for the same delta. Right. So actually, when volatility is higher, it's the opposite. You can click more for the for the same delta. So at the $1 credit, I'm targeting is above the 20 delta. You know, I will basically increase the contract size. Right. If I if I'm going to instead of paying contracts, I'm going to do 15 contracts for the same $1,000, I only need to collect, you know, instead of a dollar each 66 cents me track, because I'm raising a contract. So I'm raising a leverage, but I'm lowering the credit per contract. I'll go back on a chain. I go down. Okay. So the dollar was too high. Let's go to the 66 cents or whatever my target credit is at that contract size. And if it's above, sorry, if it's under the 20 delta, which is my cap, then, then, then, then, then, I go for it. Now occasionally, I might even go a little lower. So sometimes I'm willing to scale up the size a little bit. This is where there's a little bit of finesse and just right now. So it's a July 13, 2021. And, you know, I'm routinely trying to click maybe at least 55 cents 55 to 60. Now again, if I can click higher and stay under 20 delta or 15 delta. It's fine. But just right now, I've been trying to not go under, you know, 55 cents. So I couldn't collect about 60 cents. I'll look at that delta for the 60 cents. And, you know, if it's in kind of 15 delta. I'll go for that. Now, I say 20 delta max, but this is really kind of extreme. Well, it's super low. I am comfortable around the 15 delta range. Now, if I can go occasionally when is a big spike, then I can go to 10 delta and collect a good amount of premium and keep the contract size down. That's perfect as well. So that's how the delta selection and adjusting for the credit works. Now, as far as entry time, I always enter in the last five minutes. This is purely for consistency. Some people talk about, oh, can I enter in a bit of a day if there's a bit drop and spike. You could, but there's a couple things. One, this is meant to be 70 to eat. If you enter right at the bottom. beginning of the day, you really have like seven and a half days, right? I want to consistent time and trade for each position. I just don't see, you know, and, and, and yes, you think this opportunity, you see, oh, you know, the market's down. I wish I were to cut the bottom of something, but like you're going to do so many trades, you're going to overlap so many trades. And with three trades a week, um, here basically having, you know, over 100, 54, 156 occurrences a year essentially. So just let the probabilities play out. There's no need to try and catch that. I've, again, if you want to do it, it's fine. Um, but what there is, what are the things? Is this a more psychological because this is an overnight trade. I, I don't like going into the overnight on the first day, marking a locks already. So let's say you put on a minute or the day and the market goes down. You're ready, marking one X or one and a half X or something. Then you're even at more risk of gaping past the, the two X lost that we opened down again. So I want to enter close to it and then day when the market's about to close and just have a flat position, hopefully, um, going into the end of the day. So that is the entry criteria. Um, the stop loss, really nothing to say there. Um, click the dollar set it after, click the descents set it at 150, um, 200% loss. That, that's, that's really it. Um, now what about gaps? If you look at my logs, you will see that there are, in fact, losses, you know, greater than two X, that's from the gap. Um, five X, four X, five point two X. And yes, it's scary, but that is part of the strategy that I accept. I just, you know, take it for what it is. And you don't need to try to hedge this or do it fancy. If you're not comfortable, they just trade smaller, right? So if I'm, uh, I use an example, my mechanics page currently, I say I click 0.15%. Right. That's 0.15% of the account per week or 0.05% of the account per entry. So if you kind of a quick round number, so for $100,000, I'm only looking to collect $150 a week or $50 an entry. So you can go big and that's because I run multiple strategies. So I'm not trying to make a huge return on this one strategy. But you can scale this to whatever size, but the reason I point that out is the size of your trade basically determines the relative size of your losses and volatility. So if I'm collecting, uh, half a percent per entry, I stand to lose one percent per entry. And yes, I have had everything wiped out of one week's, you know, book is your one, seven to three positions and then one big move all through your wiped out. So, you know, if you've collected a half a percent per entry and one percent, sorry, one and a half percent per week, right, you stand to lose three percent on, you know, a wipe out, which is, which is ready. You can look at my trade logs. But, uh, yeah, just just keep that in mind. So there is the stop loss gaps and okay, reestablishing rolling back in pre-COVID. I was trading that spy by Austrian IWM. So this was actually a weekly trade, one occurrence per week, which is still pretty good. 52 occurrences a year. And I used to, I used to reestablish, I used to, for example, if I was putting on the trade on Friday, expire next Friday, and it got stopped out on the Monday or Tuesday, I would reestablish for that same day. I wouldn't go out further past the seven days. And this worked for a while because if I, if I got stopped out, I could, you know, sometimes, uh, VIXWP spike, I might even go up a little bit of the delta. And I could make back half the loss. And that worked at that, you know, things work until they don't, right? And what happened was a COVID happened. So I got stopped out four times in a row, I think, in the same week on the last week of February. And I was trading a little larger, a little higher delta. And because I was thinking I could play the potholes and, you know, I didn't have my credit card in the mechanic that then. So I took a really large loss. Thankfully, the hedges that I had on covered that, but I realized that reestablishing doesn't really play nice with these mechanics because when you're using a hard stop, you know, that's really your safety mechanism. It doesn't give time for the trade to recover. But a lot of people, you know, that's why they like the idea of rolling and re-adjusting, because you kind of give the trade time to recover. But this is meant to be that, right? Look, you're going to put on a trade, you know, basically every few days, about three times a week. So if you even almost think of that as pseudo-rollant, right? Like if you get stopped out, you're going to put on another one. So that in and of itself is adjusting your delta, your overall exposure and adjusting the position. So there's, it just doesn't work well with this style of trading. So I don't reestablish, right? So if I get stopped on a Monday, well, I'm going to put on on the trade at the end of that day. Now, I guess it's a time with a little bit of discretion. If you guys stopped out on a halfway through the Monday and you think that's the opportunity to put another one on for the next Monday, fine, go ahead. I don't. I wait until the end of the day. Again, just for consistency. So if I get stopped out on the Tuesday, I don't do anything. I wait until Wednesday, because I have other strategies like the 4 to 5 DT or the other ones where I'm going to have plenty of other opportunities and engagement. For this one specifically, I do not reestablish. I just went to the end of the day, one day Wednesday Friday, you know, put it on, you know, three times a week. So let's see, we've gone over the entry criteria, the credit targeting stop loss, why I don't reestablish the capture rate. So I'll go over real quick. If you go to my page, there's a trade log. Of course, you can see every trade. The Mechanics tab has my, there's a section with open positions. You can see the ones that I put on. Anything that's closed, I will move to the trade log, which feeds into the P.O. graph. And you can see this year has been, you know, that's super smooth, but I would call that an upward trending line. I mean, so right now, we took a wipe out last week, everything outlaw. So that really tanked, but we were almost, we were running hot at, you know, we got back up with 30% premium capture now, around 21. If I have a couple more winners, that should go back up. So yeah, looking just at 2021, for example, this strategy got hit hard and March went back to zero, climbed back up, got hit, you know, not back to zero, Clans a lot from May through July took a hit last week. And I'm going to log a couple more trades. And hopefully, and I'm hoping that this ends at, you know, 25% premium capture, which is kind of a gold standard. And one way of sort of, you know, with, with this system, and this is how all my strategies kind of work. But when you have this consistent entry and where you can have a reasonable expectation of the, the PL on average, you know, per trade, what you can do is you can almost kind of program and your target of recurrent and size your trade that way. Again, I'll use a round number for example. Okay. So let's say I have a, I'll use a larger number so we can see some just the, when start dividing things with this is too small. So if you have a million dollar account. And I want to make, I'll just choose the number 10%, right? If I want to make 10%. So on a million dollars account, I need to basically make $100,000 a year and $100,000 a year. Because remember, I'm expecting our targeting 25% premium capture. So if I want to profit 100,000, I need to collect, right? So if I divide by 0.25, I need to collect $400,000 in order to hopefully profit 100,000. So there's 52 weeks in a year. So take the 400,000 divided by 52, meaning I need to collect $7,600 per week, three entries a week, $2,500, right? So $2,564 per entry. Not that point you can probably trade, you know, a couple contracts of SPX or 20 contracts of SPY. Again, using all of those delta and credit size contract size adjustments. But that's it. I mean, it's for me, it's very interesting because, you know, people who trade, you know, they say, you make as much as you can and you take what the market gives you. And of course, with my strategy, you're still taking what the market gives you, right? If you get stopped out, you don't make anything, you're not going to make anything. But to have something in a mechanic and a roadmap to follow where you can reasonably try to target something and really ground that and really work backwards from your goal, you know, start from your goal, work backwards to how to get there. I think that's kind of very powerful in a sense, right? So I, you know, if I do this and I might click my $2,564 of credit per entry and I just do a three times a week and set the stop, I will hope and have a reasonable chance to make $100,000 a year. And that's really what it comes down to. So I might do another episode, just talk again about expectancy and premium capture. This one I want to focus on specifically the 7DP strategy. So yeah, that's it. Take a look at my pages. Again, the trade pages, www.tradebusters.com. There's a lot of content on there. There's a link on there. You'll see in fact links to all my strategies. But this is the SPY/SPX7DTE income strategy. Hope that helped.