Options spreads are more complex. Often, a spread is opened for a credit, not a debit, even for a long position. It can be a very miniscule amount compared to the share equivalent of the spread. How much money, then, do I have in the game?
I use the concept of yield on risk in calculating results for option spreads. Vertical option spreads have a defined maximum loss, and also maximum gain. So I calculate my result as a percentage of the maximum loss, which is also the maximum risk.
This tells me how how the position performed based on what I really had at stake in the trade, how much I could lose.
That system, however, falls apart with synthetic futures, a structure composed of a calls and puts, one type of contract long and the other short, each leg having the same strike price and expiration date.
Synthetic futures, unlike vertical spreads, are unhedged. Risk is unlimited to the upside for a short future, and limited to the downside only by zero for a long future. The effect of synthetic futures on buying power reflects the high degree of risk.
But synthetics don't go to infinity, nor to the drop to zero, except under the most extraordinary circumstances.
In my prior calculations on such positions, I've used the same method in calculating a maximum loss by subtracting strike prices and adding in the debit/credit. Since both strike prices are the same, however, the calculation really has nothing to do with yield on risk. It's a straight buy/sell percentage change calculation based on the premiums.
I'm changing my method by calculating a pseudo-vertical spread with the strike price of the two legs being one element and the actual share price at the time of entry or exit being the other element, and then adjusting as I do with verticals by the entry and exits debits/credits.
For synthetic long futures built from calls, the long "strike" will be the actual strike price adjusted by any debits/credits, and the short exit "strike" will be the share price at exit.
Synthetic short futures built from puts will reverse the two. The short "strike" will be the adjusted actual strike and the long "strike" will be the price of the shares at exit, adjusted by the exit debit or credit.
In practice, the change in method can make a huge difference and produce numbers that, frankly, seem to be of a more rational magnitude, given the actual dollar impact on my account.
I've had one pure synthetic future series since I started using the structure, XLP, a short future that I exited on Jan. 24.
My new yield (loss) on risk for the XLP short synthetic futures is -81% over 49 days, compared to the old calculation of -306.4%.
I've exited three synthetic future positions since I began using the structure and have updated the results reported in updates to my analyses to reflect the new method of calculation. They are:
My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.