Retail tools can be very effective in allowing traders to manage their money. Tom and Tony stress this point with a conversation about Karen the Supertrader and her success, before getting into a related study on the SPX.

Can an undefined risk strategy have any edge, and give us any protection from the risk of an outlier move?

The guys explore this concept more with a study that looks at the $SPX dating back to 2005, with 1 and 2 standard deviation strangles sold for different levels of 2 implied volatility rank .

The results showed high win rates for 1 standard deviation strangles not filtered for IV rank. They get really interesting when IV rank is filtered to be over 50.

Here, we see that selling 2 standard deviation strangles actually resulted in no losses over the course of the study. So, barring an outlier move, it appears that the 2 standard deviation strangle strategy can protect from risk.

That being said, this kind of strategy is only feasible for certain accounts and account sizes. Nevertheless, this research quantifies the risks and rewards associated with undefined risk options positions.

Transcription:

Tony: Thomas we're back, my friend. Market Measures.

Tom: I am ready. All this is all SPX, all day.

Tony: Beautiful. Starting now.

Tom: Huh?

Tony: Starting now.

Tom: Absolutely. [Inaudible 00:24] it's got the view of the office. Karen, the Supertrader has arrived.

Tony: Beautiful.

Tom: For entourage. Yeah, she is talking to Beth. They're happy. Ola, guys. We're going to have Karen on about fifteen minutes, so it's going to be a lot of fun. She's just getting a tour of the updated studio. She's been here before, so it's fun. You ready, sir?

Tony: I am, sir.

Tom: Let's do it, SPX. I like the study that we put together today, it's called SPX Management and again, we are dedicating the show today to talking about the S&P 500 and the various trading vehicles because every time that Karen's on, we get a million questions about the SPX and everything related.

If you've never seen it before, I want to talk about this before she actually comes on, we have a couple of minutes here. She's an amazing woman, and not an amazing woman because I think she's the greatest trader that ever lived. That's not it at all. I don't … Tony and I are highly critical of all, everybody including …

We've run into, I've had the luxury of being around some of the greatest traders in the world, who I believe are the greatest traders in the world, and as results go, she's right up there. As skill set goes, I don't know yet. I haven't spent enough time with her, I haven't watched her trade enough, but I can tell you as an inspiration, I've never seen anybody do what she does using the same technology.

Tony: Very inspirational.

Tom: I mean …

Tony: Totally is.

Tom: Tony and I've seen, we say we've seen some of the greatest traders in the world trade. I don't think that's an exaggeration at all. When you talk about the one marketplace where you can find somebody that's incredibly strategic, it would be options. If you go back into the days when there was probably the most strategic traders, with cowboys, who are taking the most amount of risks, we've seen some of the best in action. Not us, but we've seen some of the best in action. It's incredible how their minds work, but we've only seen people do that on a professional level.

Tony: That's correct.

Tom: Meaning they're members of the exchange, their proprietary accounts, they have proprietary software, they're arbing different markets, they're what today we call high frequency traders, they have amazing, hundred, two hundred person, they're counterparties to every trade.

We've never seen anybody on a retail level using the same technology that we use, do some of the things that she's done as far as P&L and kind of stories of success, and then you take it one step further, she's also given away most of what she's made in, anonymously.

Tony: Anonymous on both fronts.

Tom: That's easy, okay, but anonymously, so that's what I'm talking. We're not saying … She doesn't raise money to manage her whatever it is because it's charitable, it's mostly, I would say ninety-nine percent of it is anonymous which is amazing and hands-on, and that's a very different world. I've never seen another trader do that either.

Tony: That's correct.

Tom: As far as somebody that we've generated a lot of inspiration from and so have hundreds of thousands of people that have watched her videos, and the funniest thing about it is I still [inaudible 03:38] emails and saying, "What do you guys do? You make up this whole thing?"

Tony: Of course!

Tom: On one hand, I want to strangle them, on the other hand, I just want to kind of play along with it, "Yeah, we made up the whole thing. That's my cousin."

Tony: "That's my legacy, sure."

Tom: "It's my aunt, don't worry about it." "Karen's my sister." Whatever, I want to have some fun with the whole thing because it's so ridiculous. Yeah, the story's real. I've watched her from day one. She started as an industrial student.

Tony: Funny, right?

Tom: Yeah, listen, she's an outlier. That's okay. There's outliers all over. She's an outlier, and I use her as an inspiration because what she's done, you could call her whatever you want, somebody says, "It's lucky," dude, call her whatever you want.

Tony: Uh-huh.

Tom: Nobody needs to tell me how hard it is to make a hundred million dollars using the technology we use. Nobody, I don't need somebody to tell me how easy that is to do if you had the right amount of money, I don't need it because I've been doing this for a long time. I know it's an outlier, it's next to impossible.

She's done the impossible, and I don't know with what level, skill set it is. What impresses me is her ability to stick with something. What impresses me is how down-to-earth and how low-key she is about it, how she, what she does with the capital, how she's persistent, and how she stumbled across things that took us years.

One of the reasons that we're doing, some of the things that tastylive is doing is because she inspired us by some of her trading methods which we weren't so sure about. Hey, I've been trading SPX since before she knew what an option was, but I couldn't figure out about managing winners. I couldn't figure out about the persistence of staying with certain … It's really, really interesting, and from an inspirational side, I think everybody, and it's really real.

Tony: [Crosstalk 05:31] benefit from it, and I think I have.

Tom: So for the most part, for the ten people that haven't benefited from it, I'm sorry, and for the hundreds and thousands that have, it's as great as stories you're ever going to hear in the world of investing, and it's amazing.

Tony: That's great! Yes, a hundred percent.

Tom: Last … Yeah, it's an incredible story, so …

Tony: Stay tuned, 9:00.

Tom: Last year, Lake Forest gave her an award as kind of the woman of the year and, you know, other people have more like awe or palm or stuff like that. She's really a remarkable woman, and so we still gain inspiration from it, so that's why she's on.

Tony: Yup.

Tom: It's not because she's going to tell you the magic formula today because she can't, because nobody could.

Tony: Just like we do everybody, she just says what she does.

Tom: That's right, we learn from it, too. We're really genuine about it. Don't email us and say, "Can I have her number, her email address," because we have to protect her privacy, you understand that or if you don't understand it, please understand it. It's not about, we're not marketing for her, that's not it at all. This is, we won't give out any information, we respect privacy, we also have compliance and legal issues, we don't even want to get into any of that. This is just about inspiration. We're not vetting everything she's going to say or any of that kind of stuff. This is all about inspiration. Hey, you know what, every once in a while, it's good to hear a real story.

Tony: Absolutely.

Tom: A fun story. It's a powerful message, and that woman can pull it off.

Tony: [Inaudible 06:56] all the struggles, absolutely.

Tom: You won't find a lot of people like that.

Tony: Mm-hmm.

Tom: Or at least we never have.

Tony: None who are associated with us.

Tom: Yeah, I mean, yeah. All right, are you ready Mr. [Matt 07:08]?

Tony: I am, so let's do it.

Tom: It's Thursday, August 21st, all this will be archived, of course, as everything always is, but again today's special topic is SPX. We are going to … In today's Market Measure cover SPX Management. The research team has done a really good job with this and hopefully you'll like also some of the new, we're changing some of the layout and some of the slides, so I think this looks a little slicker, it's cleaner, so we had a lot of good feedback yesterday.

Tony: A lot of good feedback, yeah.

Tom: From a risk management standpoint, where is our edge?

Tony: That's a great question, right?

Tom: And can undefined risk strategies have any protection from the risk of an outlier move? Now, one of the topics that I'm going to focus on with Karen today is that outlier move, and there is no answer.

Tony: Of course not.

Tom: Trust me, she doesn't …

Tony: That's what they call it an outlier. How do you do the, how do you plan for the unexpected? Well that's what they call the unexpected.

Tom: That's exactly right. So just take it all in and respect the fact that, hear people that are telling you how they deal with an outlier move that have their real positions on, and that's more important than anything else you're ever going to hear from anybody else. You can bring in five Nobel Prize winners and let them tell you how they're going to deal with an outlier, but it's not the same as the person who actually has that position on.

Tony: Mm-hmm.

Tom: I also have that position on by the way, I'm just not as good as Karen. We often stress the importance of managing winners as a way to improve probabilities and increase occurrences. When looking at a short premium, we're looking at very short premium strategies in the SPX, how does managing the winners fare, particularly in the market meltdown of 2008?

Again, our focus today, SPX, outlier moves. This is where we have a lot of emails and questions around this content. Here's the first study we did today and the criteria. SPX, we went back ten years. We're giving you a lot of research, and the reason we went back ten years and eleven years, or I'm sorry, this is nine years, and the one we did a minute ago was ten years. The reason we did this is because we wanted that 2008, 2009 meltdown in the statistics. We entered the trade on the first day of the month. We closed forty-five days until expiration. We sold the one standard deviation strangle at eighty-four percent on each leg, sixty-eight total, managed at fifty percent and we took them to expiration as well, and those are the two choices.

The discussion here, the reason we use strangles is because that keeps us consistent in all of our studies. The reason we use eighty-four percent is because if you take eighty-four percent on both legs, that's a one standard deviation move, and it's easy to see on our technology, whether to use toss or dough. Also, forty-five days until expiration is our, is what we call, well, it's our sweet spot.

Tony: That's correct.

Tom: DTE is days until expiration. So the first thing we're going to do here is we're going to look at SPX management, first managed at fifty percent of standard deviation move and expiration of a one standard deviation move. So here, you have P&L, [inaudible 10:13], let's just go through this whole thing.

Tony: Sure.

Tom: First of all, the percentages of managed at … We use a little bit different here which is P&L per day and everything else. The interesting thing here is this came out to be very middle-of-the-roadish for this research, so the P&L was about, managed at fifty percent was about one half of expiration.

The number of winners was pretty damn close. I mean, obviously, you have more winners at managed at fifty percent, but you have to have more, statistically, but the percent of winners, a little bit better, that's it. The P&L per day actually came out higher for over, this is over nine years. It actually came out higher if you took it to expiration. The return on capital is actually higher which surprised us, and the average IV rank for the nine years was twenty-nine percent, the IV rank was twenty-nine and the average VIX price was just over twenty.

So right now, if you do this today, you're looking at about the numbers a half of these.

Tony: That's correct.

Tom: So you want to put perspective around this right now.

Tony: So if it would be half of these, the losses would be probably greater, right? I mean, would you think the losses would be-

Tom: Your losses are going to be the same or maybe even greater because you have to less to work with.

Tony: Exactly.

Tom: And yet your risk … Just think about … When we put market risk into perspective, just think about how you're going to deal with the situation where you have twice as much risk. I mean you basically-

Tony: Because of entry price that you receive.

Tom: Yeah, yeah. You're getting half as much premium, taking the same out of risk. Figure out, play whichever you want. That's why this is, that's why we're in a very dangerous spot right now.

Tony: Correct.

Tom: Next, we look at the less mechanical approach and we've only entered the trade if the IV Rank was above fifty. Because of the extra premium on those dates, we also sold the two standard deviation strangles to compare the two strategies. This becomes really interesting here.

So the next study, SPX 2005 until present, now IV Rank over fifty rather than every occurrence, closest to forty-five days, sold the one standard deviation strangle and sold the two standard deviation strangle, managed at fifty percent. Two standard deviation strangle by the way is ninety-five percent statistical chance of success, one standard deviation strangle, sixty-eight percent.

The one standard deviation strangle at sixty-eight percent chance of success just before it, because I didn't point this out, you actually ended up with eighty-three percent, so that's where we talk about. That's that embedded edge, sixty-eight, eighty-three.

Tony: It was greater.

Tom: It's fifteen percent greater than the expected, than it should've been, but that's for doing it with the right number of occurrences. Now we skip and we fast-forward where the statistical chance of success now is going to be ninety-five percent total, ninety-seven and a half percent on each side, that's two and a half percent away, two and a half plus two and a half is five, subtract from a hundred is ninety-five.

Let's see what happens here. Now you're starting to manage, this is with IV Rank over fifty. Your P&L for managing at the one standard deviation at fifty percent was a negative number, but managing at one standard deviation was a positive at expiration, and you can see if you manage the fifty percent at the two standard deviation, it worked a hundred percent at a time. This is just over this ten-year period, but it's just-

Tony: But it's also the IV Rank being over fifty, too, so you're just seeing the power or the advantage or at least the opportunity to place a trade with the fifty percent over-

Tom: This is with IV Rank at sixty-six, and the average VIX price at thirty. There was only twenty-two occurrences over a nine-year period, so we're talking about two to two and a quarter times a year on average over nine years, but the win rate, a hundred percent. Now Karen is somewhere in between these.

Tony: Correct.

Tom: She's at two standard deviations, and she's big at two standard deviations. When you wonder why what she's done has worked for the last eight years or seven years, six years, whenever it's been, it's because a hundred percent of the time, that two standard deviation level where she works at, it's worked. I don't know if she's a genius or I don't know if she's got lucky, but I don't know how she's going to deal with it-

Tony: Or both.

Tom: Or both, or I don't know how she's going to deal with it if there's an outlier move, but she's done the quantity necessary for that P&L number of twenty-nine hundred which has managed to fifty percent, which seems to be around where she lives, it's worked a hundred percent at a time.

Tony: That's very cool.

Tom: So what you're starting to see here is and again, I think what the guy just wanted to say was there's a reason that we look at high IV Rank, you're talking about eighty-six percent, you're talking about eighty-two percent. I understand the first one wasn't a winner because had a big, you had a giant outlier on that biggest loss.

Tony: Sure.

Tom: You have to deal with a nineteen-thousand-dollar loser in only twenty-two occurrences, but what shows is that over time, it wasn't that bad. You got caught in a meltdown, at one standard deviation meltdown and you still pulled the thing out.

Tony: Yeah, it's amazing. Sometimes I want to hit myself over the head with a baseball bat.

Tom: Sometimes I want hit you over the head with a baseball bat, too. Sometimes I think that's …

Tony: That's a given?

Tom: Yeah, I think there's a lot of people that want to. Yeah, it's crazy.

Tony: It's good stuff. Let's take a quick break. I want to come back, I know a lot of people have been waiting for Karen to come in. We got Karen the Supertrader, next. This is tastylive LIVE!