The J. Arthur Trading Plan: Part 3

Manage Your Portfolio!

In part 1 and 2, I talked about the strategy behind my trades. However, an equally important aspect is managing the overall portfolio.

finalsheet

I put a lot of emphasis on this because the trades need to work as a whole to provide a consistent and stable profit.

First of all, my plan strives to have an even diversification of underlyings. If, for example, the entire US equity market crashes, I do not want all of my positions to get killed. This is especially important for my plan because I base my strategy on pure probabilities and volatility edge. If your plan depends on choosing a market direction, or being “right” about a stock, I think too much diversification is bad. That is not the case for this plan.

tastyworks watchlist
Futures Options in Tastyworks are a great tool for adding diversification.

They way I handle this is by classifying the underlyings I trade into different categories. These groupings are based on my own experience, and some may disagree with them.

For example, many consider XOP to be an oil underlying, yet it is still based on actual companies, rather than the pure spot price of oil. So if the S&P crashes, I would view XOP as more dangerous, yet they are not going to give us half off on the price oil itself.

Below, I will show examples of the underlying groups in which I try to evenly spread my risk. I’m not going to list all my underlyings, but just give you an idea because this is a matter of opinion and everyone should form their own plan for diversifying.

Equities: (SPY, IWM, DIA, XOP . . . . )

Metals: (GLD, /GC, SLV . . . . )

Currencies: (FXE, FXB, /6A, /6C . . . . )

Oil and Gas: (UNG, USO . . . .)

Bonds: (TLT, /ZB, . . . .)

Farm Crops: (/ZS, /ZW, /ZC . . . . .)

Emerging Countries:  (EWZ, EWW . . . .)

Overall Portfolio Target Metrics

In addition to diversification, here are some targets I shoot for on an overall portfolio. All of these numbers are going to be based on a hypothetical portfolio size of $50K. They can be scaled proportionally based on a different portfolio size.

Target Credit Received per trade: $100-150. I view credit received as a great indicator of the risk being taken for a trade (so does the market, given that is the amount it is paying you).  Some folks use the buying power required for the trade, though that doesn’t bode well for futures options since very little capital is required. Other people use notional risk, yet that doesn’t take the probabilities for that particular underlying into account (if they start giving away gold for $1, you will find me in a bunker somewhere). While $100 may seem like a small credit for one trade, I like to spread the risk over many positions. As Tastytrade says, trade small trade often (at least I agree with the trade small part).

As stated earlier, I start at the 10 delta spot when selling the options. So how would I stick to the $100-150 range for a strangle? I have some tweaks I can make. If the credit received would be too high, I move down in deltas until the credit received is within my range. If the credit received is too small, I increase the contracts and then, if needed, I move the delta down until it fits within that range. My rule, however, is that I always open a position no closer to the money than the 10 delta strike.

Theta: $50 per day for the portfolio. This is hard to reach in the first month or two of starting the portfolio without getting over allocated, yet as some of the positions get much closer to expiration, the theta number will increase.

Total Portfolio Allocation: This one area, other than diversification, where I believe trading is more of an art than a science. I don’t like to get in the habit of opening trades just because I need more trades on. That tends to burn me every time.

When there are good trades available, I put more on. When there aren’t many, I will be less allocated. Another good metric is the total open liq of the positions. This tends to be around $3K for a $50K account, and gets up closer to $3.75K if there is a lot of volatility to sell.

And finally, I try to never let my buying power become less than half of the account size. It may dip below that if the trading environment is really good, but I am stay very aware of it.

Whew . . . . I hope you have found this 3 part series on the J. Arthur Trading plan to be very informative. In the future, I will continue posting about my trading and sharing my technology solutions for managing a profitable portfolio.

Happy trading!

-J. Arthur

 

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34 comments on “The J. Arthur Trading Plan: Part 3

  1. What would you say is a reasonable expected return on an acct that size and $50 theta per day number?

    What have you seen in your own trades?

    Thanks for sharing
    Brian

    Liked by 2 people

    • J. Arthur Squiers

      In the time I have used this strategy, it has averaged a 24% return on account value per year. Granted, there is skill, discipline, and luck involved.

      Like

  2. J. Arthur,
    To what extent did your portfolio suffer during the February 2018 flash crash? Where you still able to use your normal management techniques according to your trading plan? In case your portfolio took a hit, did you already recover from it? Or how fast did you recover from it.
    My portfolio suffered a serious blow in Feb ’18’. I lost more than one year of profits in a few weeks…

    Liked by 1 person

  3. J. Arthur Squiers

    Eddy, it took me about a month to recover from February 2018. Due to the 150 DTE entry, I was so far out of the money with most of my positions that the crash, while concerning, didn’t cause any panic. This is one of the reasons I really like this plan; not saying a crash can’t hurt, but at the very least there is a LOT more time to react than if I were selling 45 DTE, 16 delta options.

    Like

  4. Thanks J. Arthur for the great series. I was wondering if you consider the IV/IVR levels on a potential trade? Do you get into these strangles if the underlying has a low IVR on tastyworks?

    Like

    • J. Arthur Squiers

      When looking for a trade, I first look at IVR and try to find one with a high IVR. If there aren’t any outstanding trades based on IVR, I then look at my diversification groups and see if my portfolio needs to be balanced out better. I am willing to take a trade with a low IVR for the purpose of balancing my diversification.

      Like

  5. I definetely like the idea of ETFs, especially for stock sectors, regions and countries, even for currencies and commodities and I looked at them before and now again with a focus on 120 DTE. However I find it very difficult to find any ETF options with a good open volume, low spreads and an acceptable premium. even with high IVR most of the ETFs pay below 20 USD for a Delta 10 and 90 – 120 days DTE, spreads are e.g. bit 0.15 – ask 0.20. Only very few ETF, fewer than a duzend, seem to be interesting to me.
    Am i missing something here? Thanks, Franck

    Like

    • J. Arthur Squiers

      Franck,
      With the list I provided in the previous part, I am able to trade almost all of them. For some of them, I increase the number of contracts. I look to be around 150 DTE, so there is more premium there.

      Like

  6. Dear Arthur,

    thanks first for your comprehensive information about your trading plan.

    I would also like to develop my own trading plan, based on tastytrade style and yours. So I would like to know, what tools do you use for development,
    just a demo account,
    learning by losing,
    tests with Option Vue / One Netexplorer
    or even programming yourself with the aid of historical options data ?

    I started recently with buying historical SPX data and now I try to develop something with Matlab, the only programming language i am familiar with.
    And one more question, did you test it also with large cap stocks ?

    Best regards

    Like

    • J. Arthur Squiers

      Frank,
      I developed my plan through some Tastytrade influence, and by reading books by successful options traders (mostly commodity options sellers that struck a chord with me).

      I tweak my strategy by observing what works with my trading, and making adjustments.
      I have never paper traded, because it doesn’t show me what type of trading I can handle emotionally. Some people are huge believers in paper trading–it was never for me.

      I find backtesting to be nice for generating ideas, but there are many important nuances that it doesn’t not take into account. I do not consider it to be the authority on developing a trading plan.

      I have never tested my plan with large cap stocks. Only ETFs and Futures.

      Like

  7. John Rose

    Would you be willing to share your excel sheet?

    Like

    • J. Arthur Squiers

      My google sheet is programmed very specifically to my trading. I think it would be difficult for others to use, as is. I did do a post on importing your Tastyworks portfolio into a google sheet, and provided code to do so.

      Like

  8. Pingback: The J. Arthur Trading Plan: Part 2 – Fire by Arthur

  9. Do you stick to a specific buying power max per trade? If your achieving a $150 credit, are you using about $3k in bp? Do you care or just looking for $150 no matter what the go used on the trade?

    Liked by 1 person

    • J. Arthur Squiers

      I’m just looking for the $150 credit. I look at buying power as a matter of interest, but it’s not a deciding factor.

      Like

  10. Steve Zoller

    Arthur, I am really intrigued by your plan. I have a question about your allocations.

    Part 2 Q&A: I try to stay close to having 50% of my capital allocated,

    Part 3: Another good metric is the total open liq of the positions. This tends to be around $3K for a $50K account, and gets up closer to $3.75K if there is a lot of volatility to sell.

    These two statements seem contradictory. Would you clarify for me? Thanks.

    Like

    • J. Arthur Squiers

      Hi Steve,
      50% of capital allocated just means how much of your buying power you are using. Open net liq of positions is referring to how much all your short options are currently worth if you added them up–not the net liq of your account. You could have a short option that is currently worth $300, but that position is using up $2k of your buying power (because of the risk the broker has calculated). I hope that clears it up.

      Like

  11. stevezoller

    Arthur, I am really intrigued by your plan. I have a question about your allocations.

    Part 2 Q&A: I try to stay close to having 50% of my capital allocated,

    Part 3: Another good metric is the total open liq of the positions. This tends to be around $3K for a $50K account, and gets up closer to $3.75K if there is a lot of volatility to sell.

    These two statements seem contradictory. Would you clarify for me? Thanks.

    Like

  12. Is your goal to get into each one of those symbols every month (gold, wheat, euro, pound, etc.) for a total credit that will allow you to reach the 2% per month target. So for a beginner…I would look to get into a well diversified position set for March and try to take in a total credit of around $4,000 per $100k account so I could take 50% profit? That would give me a high likelihood of closing for $2k each month and reaching the 2% target. Is that close to what you have had success with?

    Thanks!

    Like

    • I don’t really try to get into symbols based on months. Some positions are closed in a short time, and some stay on for a long time. My goal is really to keep the positions diversified based on what is currently in the portfolio. I have averaged 2% per month, but it’s not clockwork by month.

      Liked by 1 person

  13. J. Arthur,

    Thanks very much for documenting this plan. While mentally I know that sticking to the plan (ANY plan!) is best, so far that discipline has evaded me, but it’s a shortcoming I do recognize!

    Regarding the theta numbers, do you subscribe to TT’s “you hope to keep 25% of the theta value”, or have you seen something different in your results?

    Like

    • I don’t really focus on theta as an indication of how much I’m going to keep because risk balances theta out (there is no edge there). I do use it as a metric for how much risk I have on and how “big” my trades have gotten. I try to hit a theta range, but it can vary.

      Liked by 1 person

    • To expand on that, I don’t shoot for certain profit goals like others do (as I think that leads to making bad decisions or taking too much hero risk at times). I focus on trading my plan as best I can, keeping my portfolio risk and trade size at a certain level, and as a side effect I’ve averaged 24% a year. I don’t believe it’s something you can force.

      Liked by 1 person

  14. Just discovered your site today and am thoroughly enjoying it! It has been very timely as well, as I look to move to longer DTEs as well as commodity options.

    A question for you: Is there a reason that you do not put on front ratio spreads (I suspect that we are influenced by the same commodity option selling authors – they call it the “Maserati” of trades)? Using FRSs this past month has been very interesting as prices have come very close to my short strikes, but not put me over the 3XCreditReceived loss rule. Overall premiums are a bit less, but I believe I will sleep better as I increase my contracts, and will simplify management.

    Keep up the great trading, and the posts.

    Liked by 1 person

    • Thanks for the post! Yes, a lot of my trading plan is influenced by those guys. I tried the “Maserati” ratio trades for a while and just decided they weren’t for me–I’m sure they work well for others. I wanted to stick with one strategy and the ratios just took *forever* to reach a target profit. I have nothing against them, they just didn’t fit how I wanted to trade.

      Liked by 1 person

      • Thanks for your response – That makes sense. Reading elsewhere on your site, I see that you are averaging 39 days to hit 50% of your premium received. With that being the case, one can certainly compound faster with less exposure. A double front ratio spread is not terribly easy to get filled either.

        Like

  15. Well I gave the strategy a whirl and got smoked on oil and natural gas so fast. I had some options double in price and the opposing option didn’t decay at all so couldn’t even really roll closer and collect much premium. Other currency plays also didn’t move much but same thing happened.

    Like

    • Oil and natural gas futures are huge products and I am careful to take in a small enough credit that a doubling of value would not be harmful to my portfolio. I do have strangles on in /NG and /CL. Today /NG had a very uncommon spike and I did make an adjustment to take in an extra $80 credit.

      Like

    • Also, if I decide a position is much bigger in risk than I originally thought when putting it on–I do not hesitate to get out of it, and do not wait for my stop loss to be hit.

      Like

    • Haha, I am having the same headache. I bought a strangle yesterday on Nov 12, 2018, on the Mar19 options for /CLJ9, and today with the massive drop in light sweet crude oil, my 10 (or 11) delta put became 22 delta. I am sitting on a paper loss of $1340 after one day, much bigger than my account size can afford. I hope volatility and price stabilizes soon since I probably have to wait it out.

      I was ignorant with how much leverage options on futures provided…

      Like

      • Futures do have leverage—in addition I go by the rule of thumb that one should never sell a strangle for more credit than they could easily handle a 3x that credit in loss without being bothered.

        Like

  16. Alexander Smith

    How long have you been following this plan?

    Like

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