New Members Entry Point – If you’ve arrived on this page looking for the k1 Project and all the reference material on Phil’s strategy, follow this: Front Page of the K1 Project
k1p Table of Contents
- Introduction – motivations, approach, and rules for the virtual portfolio (this page)
- Supporting Analysis – A Year of SPY Trades
- The Virtual Portfolio – positions and actions (this page)
Welcome to my new experiment, an attempt to pull what I’ve learned together into a working virtual portfolio that provides steady income, defined risk, and fits around my full-time job. The K1 Virtual Portfolio (k1p) is an attempt to crystallize, explain, document, and exercise a simple version of Phil’s LTP strategy that seems to work for my risk tolerance and lifestyle. There are several characteristics I have tried to fit into this approach to make it work for me and my life.
Life Constraints for my virtual portfolio:
- Full-time job – I work from home 4 days a week, so it’s easy to follow the markets and keep up with my positions, but I can’t always be watching every little move, and my positions must be stable without constant monitoring. Sometimes I get caught up in conference calls that prevent me from seeing the action, and I don’t want to hang up from a call only to find that my positions have been crushed by some event in the markets.
- Unconnected moments – I spend one day a week on-site with my client, a location I call "the cave" for its truly appalling network access. Ironic, because the system I’m working on for them is an advanced communications network. The virtual portfolio must be able to stand on its own on those days when, like this previous Thursday, the market takes a HUGE dumper.
- Laziness – I live on the west coast, and normally sleep through the market open. My wife doesn’t like to get up early either, so the idea of me dragging out of bed every morning to catch the open is a non-starter. The virtual portfolio must be stable through the excitement of each day’s open.
- Better than Covered Calls – I’m seeking a predictable strategy to yield a couple percentage points a month on my virtual portfolio, without a lot of volatility. I don’t necessarily need the 40-50% Phil can produce on his LTP (although I’ll take it if I can get it!). If I can figure out how to reliably produce 25% a year within my risk parameters, I’m golden. At this point, I believe I know how to do so. The k1p is my stake in the ground.
Over my year on PSW, I have seen a number of other members trying to manage their trading with similar constraints. If you find that my situation shares some similarities with yours, then I expect you’ll find my approach useful, at least as an intellectual exercise to help you build your own strategy.
General Approach:
As you all know, I’ve put a lot of study into Phil’s LTP strategy. There are several key moving parts to it, but the piece that works best for my mindset is the premium business. Over the past 6 months of market craziness, I’ve been most impressed by the way my positions hold up when the market turns south. It’s never fun to ride out a fall, but the ability to roll my position (long AND short) down a strike for essentially even money has given me a solid appreciation for the Core Strategy, and solidified in my mind the first contingency strategy.
In the past couple months, I’ve also been handed some lessons thanks to Visa (V). An aggressive gainer, I’ve been covered and missed out on big pops over and over again, finding myself seriously behind my caller. After yet another frustrating moment recently, I finally realized what I was doing wrong (not enough length), and finally gained control of the position. This experience established the second contingency strategy for me.
The whole approach that works for my risk tolerance crystallized after a short obsession with Iron Condors, reading some very interesting essays on market-neutral positions. Iron Condors are cool, but I’m not happy with their transaction costs, nor am I comfortable with the risk vs. reward, particularly in comparison to what I’ve learned from Phil about how to adjust calendar trades. Essentially, I’ve discovered that I want a portion of my virtual portfolio to be dedicated to market-neutral trades, earning income by capitalizing on theta decay in the positions.
Credit where it’s due: my approach is at its heart an implementation of Phil’s strategy. I have not originated anything here. There are services out there that will provide you with calendar trades, probably yielding more than the virtual portfolio I’m putting together. My reason for doing this is to document in a semi-public way what I have learned and to share the results. If my journey helps any of you figure out a way to manage your own virtual portfolio to suit your own lifestyle, so much the better.
Central Ideas of my approach:
- Market Neutral: I will establish positions that are essentially delta neutral, in order to capitalize on theta (time value) decay in the short options. I will try to diversify across market sectors as much as possible, although there will be some limits due to the size of my (small) virtual portfolio. Though I tend to be uncomfortable with short puts, I intend to work into double-diagonals or at least a mix of call calendars and put calendars to keep some semblance of balance.
- Very long on the long side: In contrast to Phil, with his uncanny knowledge of the market, thousands of companies, and their earnings and performance targets, I intend to rely on reasonable fundamentals and the leverage available with length. So where Phil would choose an appropriate long option based on his estimate of where that stock should be in 3/6/9/12 months, I will simply buy the longest LEAPs available for the companies I take positions in. As a related idea, I will steer clear of stocks whose back month options don’t provide enough length to really work the system.
- Cash flow advantage: My research into long calendars has shown me that there is a significant discrepancy in the cost per expiration period associated with front month vs back month options. To put it simply, it is possible to collect up to almost 3 times as much cash in premium per expiration period than you pay up-front to buy your long position. The landlord example (Core II) works perfectly here, paying 1.00 per share per month for your long and collecting 3.00 per share per month in premium will make you plenty of money over time, no matter what the market does.
- Compounding: Over time, I expect to be able to apply the excess cash flow to establish new positions, leading to a compounding effect. I know (intellectually) that compounding is a powerful force, but would like to be able to demonstrate it clearly.
- Boring, Slow moving, Inexorable: I don’t expect to post a lot of trades. Buy the LEAP, sell the front month call, wait. Since the positions will always be fully covered, there will be the occasional roll trade, but since rolls are all about spread, they’re not time-critical. If I find that positions need to be closely monitored, I’m going to have to re-think the whole thing. That hasn’t been my experience so far, but I don’t know everything.
I hope some of you find this exercise interesting. If you choose to play along at home, I’m a big fan of the ToS PaperMoney platform for testing out new ideas, especially when the source (k1) is questionable.
The Trades:
Since this is an LTP approach, I expect to sneak into positions slowly. There are a couple beaten-down stocks I’m looking at (GE, VLO, TGT to name a few) but I’m not in a huge hurry to put cash to work. Once I do, I will figure out a good format for recording the trades and post a spreadsheet.
Update 6-July: Some additional backtesting has convinced me that the double-diagonal is the right way to play this strategy. Essentially, the DD puts you in position to benefit from the trend no matter what it is. The winning side makes excellent returns while the losing side holds position, averaging out to a quite reasonable return. There are probably ways to drop off the losing side after a trend gets going, but the beauty of not needing to pick a direction really helps solidify the virtual portfolio.
