About four weeks ago we showed you a practical example of the use of our Spread Scanner (see our September 08, 2004 article Finding Short Straddles using Spread Scanner). Today we are going to check how well our recommendations performed.

Best candidates

As you probably remember, we used the Spread Scanner service to find best candidates for the Short Straddle Strategy. The search produced only four potential candidates and we’ve narrowed our list even further to just three instruments (one candidate looked not liquid enough to us).

So here is our final choice for the Short Straddle position:

Tab.1. Position details and margin requirements as of Sep, 7 2004

For simplicity lets assume we sell 1 contract (Call and Put) only. Position margin requirements are summarized in the “Capital Required” column of the table – we use minimal margin requirements published at the CBOE (Adobe Acrobat format).

Finally, since the Spread Scanner search results are based on Sep, 03 closing prices, we use the bid prices as of the next trading day’s close. Due to the market holiday on Sep, 6-th all of our quotes are as of Sep, 7-th close (we could've used Sep 07 open quotes, there is not much difference in fact; though we take settlement values as more "official").

As you probably remember we’ve also analyzed our picks using the Stock Sentiment service – here is what we have as far as stock trend concerned:

• CCE - unclear
• ANDW - quiet, but too bearish
• CAH - quiet, slightly bullish

We've chosen CAH as the best candidate, ANDW being the next, and CCE taking the 3rd place. Now let's have a look at where would you be now had you decided to follow our recommendations.

Performance results

We'll examine our picks one by one starting from the best candidate - CAH:NYSE. Lets have a look at the historical charts of stock price and IV Index (available in the Advanced Historical Data service):

Fig. 1 Stock price and IV Index time series for CAH:NYSE

Initially the stock advanced, but after oscillating between $46 and $48, it finally breached support level and declined to about $44. At the same time, IV Index declined too (after a short but strong advance in the second week of September). Both factors were for our good so we could expect to reap a solid profit here.

Fig. 2. below shows the time series for CAH Short Straddle returns; as expected, they dropped in the second week of September (worst return of -13.1 % on Sep, 10), but then started to advance very smoothly reaching +27.7 % as of Oct, 01 close (chart shows option settlement ask quote as exit price).

If we were happy with our 20% position return, we could have closed our position on Sep 27, with return of +20.9 %, or $200 per contract in absolute values. Well, though it is a bit late to specify our hypothetical “position close” criteria, let's do it now (better late than never):

• take profit if return exceeded +20%
• stop loss if return is lower than -20%
• stop loss (most likely) if bid price for one of the options falls to $5 per contract or lower
• close position on Oct 01 if nothing from above happens

The figures of +20 % and -20% are more or less relative, and should be adjusted according to your risk preferences. The date of October 01 is two weeks before expiry, looks like a good time to roll to the next month. Finally, bid of $5 per contract (or, $0.05 per share) means that underlying price has gone away too far from the straddle strike, and this doesn't promise anything good - time to close (and, take the loss, in absolute majority of the cases).

Fig. 2 Performance of CAH:NYSE Short Straddle

Lets look at our next candidate – ANDW:NASDAQ, please see price and IV Index time series below:

Fig. 3 Stock price and IV Index time series for ANDW:NASDAQ

Indeed, the first movement of the underlying was down, but then it reverted rather sharply on Sep 10 and settled at $13 per share after oscillations. This did not do us any good, so we will have to take a loss of -22.7 % (or $50 per contract) at Sep 13, right after the first pronounced stock advance. Had we kept our position till Oct 01, the catastrophic performance of -72.8% ($160 loss) would be the result. This is a simple example to illustrate that the time to close your position is at least as important as the time when to open it.

Our third candidate was CCE:NYSE:

Fig. 4 Stock price and IV Index time series for CCE:NYSE

The stock first had declined by about 5.4% and then stayed at around $19.15 level. We can expect to gain a profit in this situation, though not as big as with CAH:NYSE. In fact, none of the exiting criteria were met, so we could took a profit of 7.3% ($30 per contract) on Oct 01. The "worst day" for this position was at Sep 16 (kink in both stock price and IV Index), with the return of -9.7%.

Summary

Let's briefly summarize our position picks performance here:

Tab. 2 Recommended Short Straddle strategy picks performance summary

Of course these 3 trades are not sufficient to prove if the service "works" or not - more thorough back-testing is needed. We will try to revise our “strategy candidates” performance in our regular newsletters so you will be able to see for yourself that our scanners are really of practical use for you.