Experiment

Anybody up for an experiment?

So I have been asking myself, “how do you really test a trading plan?” I think a lot of people would say that you back test your plan. However I don’t like that idea because the past is what has influenced your trading plan. Hence your trading plan may be nothing more than influenced by history.

So, “how do you test a trading plan?” I came up with 2 requirements – 1) it must be traded going forward and 2) it should eliminate company specific risk. Okay, so #1 is easy, you either paper trade it or do it live but what about number 2? Best way I can find to eliminate company specific risk is through an ETF that represents the market that also has a lot of liquidity/volume. My best selection for this is the QQQQ (represents the Nasdaq 100). I would have preferred using something more like the SPY but the Implied Volatility of the QQQQ is closer to the stocks that I pick.

So, why am I doing this? Well for the past year I have professed that “covered calls” is an art and not a science. I refused for most of that time to even put a trading plan in place. I know I am ANAL in nature having practiced as a CPA for many years and maybe that is why I liked covered calls because I was able to “loose the ANAL stigma” that everybody in my industry has. Well, my anal-ness caught up with me on this rainy weekend. I have gone back over the past year and analyzed what I do for covered calls and I have quantified it into a few simple steps. I believe the success has primarily come from playing both ends of the stick (NPs and CCs) and closing out positions when a better use of capital is available. I have condensed and revised my original trading plan from my blog (stockrent.blogspot.com in the education section) into a new set of rigid mathematical standards that represent what I have been doing over the past year. These new steps are as follows:

ENTRY METHOD: All positions will first be entered by selling a Naked Put. The sale will be for one-quarter of the total anticipated position in the portfolio. (i.e. if we want a total of 400 shares we will initially enter an NP for 100 shares or 1 contract). All positions will be entered in either the near month 1 month from options expiration.

MAINTENANCE: Naked Puts will continue to be written until a position is "put" to the account. At that time a covered call will be written on that new stock position at the strike price that it was put to the account in order to maximize monthly income. In the same month a new naked put will be written on the position at a 5% discount to the then current price of the stock. For example if stock ABC was put to us at $30, we would then write a covered call for $30 on that stock AND enter a new Naked Put for $28.50 thus effectively collecting income on both ends of the stock and averaging down the position cost. In subsequent months all CCs will be written ATM to maximize income.

ROLLING and BUY BACKS: Anytime an NP or Covered Call is trading at 20% of the original sell price the contract will be bought back and immediately rolled to either an ATM Covered Call or for Naked Puts a new 5% discount at the then current price.

Tomorrow morning I will begin a live test (with real money) of this strategy by entering 1 NP on the QQQQ. I will update performance and return on this strategy each month……..

THOUGHTS OR COMMENTS ARE GREATLY APPRECIATED!