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[SwingTrader]

[SwingTrader]

Starting my back test which will give me examples of diagonal trades to post here. Let us start with Nov 2012 expiry (29.11.2012). Since I am not in a trade I will look for the most recent ema crossover. It was a bullish crossover. So I will have to wait for a high pivot to break so I can take a long trade. Bullish crossover was on 27.11.2012. The high pivot to break was the one indicated on the chart, it was the 7th Nov high. NF closed above this high on 29th Nov. A trade could have been taken on this day just before close in the last hour. Let us say we take the trade on the next day at market close. Trade taken on 29th itself would have been much better though but we will take the trade next day to keep things interesting.



On 30th Nov NF closed at 5909.05. The combo that gives us the minimum required 30% hedge is this:

LONG NF JAN13 5700 CALL @ 282.85
SHORT NF DEC12 5900 CALL @ 87.45

The hedge % is 30.91%. The pricing is not that good as we had to select a diagonal that was completely ITM (long and short option strikes are below the NF price). This gives us more protection against down moves but restricts the profit too. Anyway, I have to take it as going deeper ITM does not make any sense and going slightly OTM will not give us the required minimum hedge. Here is how the position turned out:



Do note that NF closed lower than where it closed on the day the trade was initiated. The position profited even though the trade went sideways to down. The low profit was due to this and the fact that we could not take a ITM-OTM long-short diagonal. The one we took was completely ITM.

For the trade stats I will take the lowest profit from the last 3 days before expiry. The reason for this is my suggestion that one should close the trade at least 3 days before expiry. But it is left to the person taking this trade to decide. Profit/loss will fluctuate wildly in the last 3 days before expiry.

[SwingTrader]

A key point before I continue posting the backtest / examples:

The idea of posting these trades is not to show how well this strategy profits or how good these trades are. The important take from these posts should be the low risk idea of diagonals. Once the initial 4-5 days are over the risk in a properly priced diagonal goes down quickly. Even in the first 4-5 days the risk is lower than in a vertical spread. This idea is the focus of my strategy. Diagonals will never give you 100-200% return like an OTM option could. But it will also not destroy your trade if things go wrong which can happen very easily. This becomes very important when you are trading huge size. I will take 10-12% on average per month anytime as I understand it is huge in the long run. Any additional profit due to volatility movement will be a bonus.

The previous example was for the Dec 2012 trade. I will now move ahead and take each signal as and when it is triggered. Hopefully we get at least one trade each month.

[bpsingh]

Swing Trader, You have mentioned about MA crossover followed by break of swing pivot to get sense of direction. However, sometimes the order can reverse, we may first have pivot break followed by MA crossover. Does it make any difference?

[SwingTrader]

[SwingTrader]

Trade no. 2

The last trade expired on 27th Dec 2012 (expiry day). We look for the next trade after that. The chart below shows that we had seen a probable sell signal but it did not trigger. NF did not close below the trigger (prior low pivot). We got an EMA crossover soon and then NF closed above prior high pivot on 1st Jan 2013 and we take the trade on this day at close.



NF closed at 6007.50 on this day. Here are the possible diagonals:

LONG NF FEB13 5900 CALL + SHORT JAN13 6100 CALL (Hedge % : 22.63%)

This is the standard ITM long + OTM short combo I begin with. But the hedge % is less, so I go more ITM...

LONG NF FEB13 5800 CALL + SHORT JAN13 6000 CALL (Hedge % : 32.11%)

This meets the required 30% hedge so I take this trade. This again, like last trade, is completely ITM diagonal. So one should be prepared for average profit of 10-12% in case of sideways move (15-18% or more if volatility explodes), 18-20% if price moves 100-200 pts from entry (25% or more if volatility too explodes).

Here is the P/L table for this trade:



I would exit around 3 days before expiry and we get around 13% which is about the right estimate for a ITM diagonal in a sideways move. Note that this too was a sideways range trade like the first trade as price did not close much higher than on trade entry date. If price had moved higher, we could have seen 18-20% profit.

While this trade is going on I would be looking all the time for a bearish signal. If triggered, the bullish would be closed and a bearish trade initialized. We saw a EMA crossover down on 25.01.2013 but price did not break the prior low pivot, so no bearish signal triggered before expiry on 31.01.2013.

We watch for either a high pivot break to initiate bullish trade (continuation signal) or a bearish signal to initiate bearish trade. First signal seen is taken.

[SwingTrader]

Trade no. 3

The previous trade got over at Jan expiry and we start looking for signals after that. We had seen a EMA crossover down on Jan 25th but the low pivot prior to that (on 17th Jan) did not break after the crossover negating the crossover. We got another crossover down on 31st followed again more clearly on 1st & 4th Feb. The low pivot in question (the one that had to break for a short signal) was was the 24th Jan low. It broke on 4th Feb when we got a daily close below this pivot. A short is initiated on this day.



Possible diagonals:

NF closed at 5996.30 on 04.02.2013. Here is the possible diagonal combos:

LONG NF MAR13 5900 PUT + SHORT NF FEB13 5700 PUT (Hedge %: 12.69%)
LONG NF MAR13 6000 PUT + SHORT NF FEB13 5800 PUT (Hedge %: 18.86%)
LONG NF MAR13 6100 PUT + SHORT NF FEB13 5900 PUT (Hedge %: 27.10%)
LONG NF MAR13 6200 PUT + SHORT NF FEB13 6000 PUT (Hedge %: 36.60%)

Now this is tricky. The 6100-5900 combo itself is totally ITM (almost 100 pts ITM). Going more deeper ITM than this means we will not profit much even though we get lot of protection against loss. So the choice is to accept slightly more risk and go for 27.10% hedge (6100-5900) or go for 6200-6000 which may give us max 10% profit. I would probably go for 6100-5900 and take slightly more risk knowing that it is still safe as the position will be 100 pts ITM. Let us check the P/L table for both the diagonal combos.

*** THIS KIND OF DIAGONAL PRICING IS USUALLY SEEN WHEN INDIAVIX IS DOWN TO VERY LOW LEVELS. IN JAN END - EARLY FEB VIX WAS BELOW 15. THIS MAKES OPTIONS VERY CHEAP. SINCE WE RELY ON DECENT OPTION PREMIUM FOR OUR SHORT OPTION WE SEE THE PRICING ISSUES AS ABOVE. IN SUCH CASES COMPROMISING SLIGHTLY ON HEDGE % IS FINE AS LONG AS THE POSITION IS ITM ***


P/L table for LONG NF MAR13 6100 PUT + SHORT NF FEB13 5900 PUT diagonal :



P/L table for LONG NF MAR13 6200 PUT + SHORT NF FEB13 6000 PUT diagonal :



The profit difference is significant based on which strikes are selected. The difference is more pronounced due to the low VIX levels.

[Gemini]

Dear ST,

Thanks for sharing such a beautiful approach to trading for people like me who are unable to be continuously in front of chart during the market hours.

I consider that Nifty has now turned bearish ( PARSAR, ema 3/15 on daily TF as well as ema3 below NS in weekly TF) and hence want to initiate bearish diagonal trade. I believe that following combination shall be chosen:

1. Long NF 6100 P, Feb14 : LTP 129
2. Short NF 5900 P, Jan 14 : LTP : 48

Ratio is 37% providing good hedge. ( But much more than 30%, hence may impact the return).

Please comment / advise.

[rk_a2003]

Better the hedge %.Better the protection and better the returns too.If your directional call went right.

[vinay28]

[rk_a2003]

[vinay28]

I meant puts and not shorts

[SwingTrader]

[Gemini]

Dear ST,

Thanks. I have noted few critical points that you highlighted.

1. Uisng same system consistentaly for trade signal.
2. System to have higher probability of generating signals valid for longer term (say, more than 2 weeks). Based on this, I am inclined to focus on weekly charts!
3. Be careful during initial week and have a stop-loss level.

Let me pursue this trade and share the results.

Regards.

Dear Vinay: Noted. Hopefully, you will share why you think so.

[SwingTrader]