The second section of the trading plan should provide a detailed analysis of each trading strategy that will be utilized. It is important that each strategy has it's own set of rules that are unique. What works as a stop loss for one strategy may not for the other. The questions that want to be answered for each strategy are:
1) Maximum allocation and risk on each trade
2) Minimum acceptable return on equity
3) Specific details regarding expiration
4) Exits & stop losses
5) If / When statements
6) Underlying stock specifics
7) Volume & bid/ask requirements
8) Analysis of the Greeks
9) Analysis of Implied Volatility
Specific Trade Rules Regarding Non-Directional Positions:
1) No more than 50% will be put at risk in an individual
non-directional position. For example, if the overall portfolio
allocation at the inception of the non-directional position is $1,000,
the non-directional position may not have a potential loss of more
than- $500. This rule will keep the portfolio diversified from
individual risk.
2) A minimum of 50% probable return is required for a
non-directional position to be considered. For example, if the
potential loss on the non-directional position is -$500, the potential
return must be a minimum of -$250.
3) No more than 45 days until expiration may remain when a
non-directional position is opened. For example, if the non-directional
position has 56 days until expiration, the position would not be
acceptable and will be re-assessed when expiration is 45 days or less.
4) A stop loss target must be set before opening a non-directional
position. This target should not exceed 50% of the potential loss on
the non-directional position (see rule 1). For example, if the
potential loss on the non-directional is -$500, a stop-loss must not be
above the -$250 loss level.
5) If a non-directional position achieves 50% of potential profit
with more than 3 weeks until expiration, it must be closed out for a
profit. At this point time decay will be negligible and the position
will be at higher risk to give back gains from rises in the underlying
price or volatility.
6) Underlying issues with high Betas and high Average True Range’s
(ATR) should be preferred non-directional position candidates. This is
important because low Beta underlying issues typically have lower
premiums priced into the options, which increases the risk and
commission levels of the trade as well as lower the returns on equity.
7) Candidates must offer tight bid/ask spreads and heavy underlying
volume of at least 10 million shares per day. Attempts to open
non-directional position on low volume, illiquid underlying issues will
lead to wide spreads and higher commissions as well as poorer returns
on equity. Also, the non-directional position targets should be mainly
Exchange Traded Funds (SPY, DIA, etc.) that mirror Market Indexes.
8) Delta risk will be weighted on the overall portfolio. However,
attention must be paid to individual non-directional positions’ Delta
as well. For example, the portfolio will attempt to maintain a near
Delta-neutral position to offset systemic whiplash.
9) Implied Volatility levels must be comparable to Historical
levels to attain targeted credit levels. Higher IV levels will be
preferred. For example, if the IV levels are 10% or lower than the HV
levels, premium priced into the options will typically be poor, which
increase risk and decreases returns on equity.
Please fill out Section 10.2 of the Trade Plan Template.
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