I've been tinkering for a while now with-a-rules based strategy for writing credit spreads on SPY that includes a trend following overlay and some elements of the martingale system. I'm at the point where I'm ready to paper trade it live for a while, and thought it would be fun to post in here. I'll be tracking everything in excel, probably making my first "transaction" in a week or so. In this first post I'll simply describe the approach and rules. In later posts I'll get into some of my reasoning behind it. This will probably come off as more complicated than it actually is but here we go:
*Options are always written four weeks out.
*Short options are closed at 5% of the original premium or on the day of expiration, whichever comes first.
*Uptrend is defined as the price of SPY being higher than its 6 month (or 200 day) Simple Moving Average
*Downtrend is defined as the price of SPY being lower than its 6 month (or 200 day) Simple Moving Average
First: Check the price of SPY to determine if it is in an uptrend or downtrend as per the rules above:
1) Uptrend: short ATM puts and buy same number of puts with a strike 5% below SPY’s current price.
2) Downtrend: short puts at a strike 1% below SPY’s current price and buy same number of puts with a strike 5% below SPY’s current price.
If closing at a profit, repeat process.
If closing at a loss for the first time: Repeat process but ensure the net premium is greater than the previous loss, increasing the number of contracts if necessary.
If closing at a second (or third etc) consecutive loss:
1) Uptrend: repeat usual process ensuring the net premium is greater than the cumulative losses, increasing the number of contracts if necessary.
2) Downtrend: Stop trading until the uptrend resumes (then follow Uptrend process).
Basically your initial position sizing relative to the capital you’re willing to commit will dictate the maximum draw down vs reward.
For tracking purposes I will assume an account balance of $100,000 US (although I will probably do this mostly "naked" if/when I do it live, I still like to have a notional amount of capital I'm willing to put at risk to keep me in check).
I will assume worst possible price for fills (bid on short puts, ask on long puts) and factor in commissions of $9.95 + $1.25 per contract.