Extreme events occur in the markets more often than we think. Economic disasters, discovery of frauds, political instability to name a few negative extremes. Same way positive extremes like outstanding result season, end of political uncertainty, or just pure heavy liquidity. These extreme events drive the markets in just one direction completely. And like I said, they occur more often than we think.
I had a look at data from Jan 2007 till June 2011. That covered 55 series. I took the open of the series as the starting point and looked at where the series ended from open. The details are in the excel sheet attached.
On 29 occasions we ended more than 200 points from open. 18, 10 and 8 times we ended more than 300,400 and 500 points respectively from open.
How can we trade for these extreme events and benefit from them? One way is to buy options both call and put (Strangles),say 200,300,400 or 500 points away.
Say 2011 August series opened around 5485 levels.
Then 200 pts Strangle would be 5700ce(Rs.28/-) and 5300pe(47/-). One side would be the second OTM and the other side would be the third OTM. Together at open they would have cost 75/-. For my study, I have taken it as 80/-. Same way the 300 Strangle costs Rs.40/-, the 400 Strangle costs 20/- and the 500 Strangle costs 10/-. These are approximations as much depends on the volatility, but they are fair enough approximations. I assumed passive trading of buying on the first day of the series at open and closing on the day of expiry. Costs have been ignored as they would constitute a small part of the cost as a whole.
I will give the summary here for the 55 series I checked. The details are in the attachment
200 Strangle: Total points gained is 6733pts, total cost is 55*80/- = 4400pts. Net points gained is 2333. Out of 55 trades winners are 29.
300 Strangle: Total points gained is 4336pts, total cost is 55*40/- = 2200pts. Net points gained is 2136. Out of 55 trades winners are 18.
400 Strangle: Total points gained is 2825pt, total cost is 55*20/- = 1100pts. Net points gained is 1725. Out of 55 trades winners are 10.
500 Strangle: Total points gained is 1925, total cost is 55*10/- = 550pts. Net points gained is 1375. Out of 55 trades winners are 8. What these points means in money terms is that in the last 55 months if you had brought 500 Strangle, it would have cost you, 50*10=500/- per month for one lot and for 55 months you would have spent 55*500 = 27500/- and would have had a return of =1375*50=68750/-. For this you should have been willing to take 8 winners out of 55 trades. Tough ask but then the risked amount is low.
When you look at the results, you may want to dismiss some of the months thinking "but that kind of a wild swing occurs once in a while". That is precisely the point in trading for the outliers.
Having the data of the last 55 series, you can choose your strangles with care.
http://www.4shared.com/document/znk6Kvyo/Trading_for_the_outliers.html
I had a look at data from Jan 2007 till June 2011. That covered 55 series. I took the open of the series as the starting point and looked at where the series ended from open. The details are in the excel sheet attached.
On 29 occasions we ended more than 200 points from open. 18, 10 and 8 times we ended more than 300,400 and 500 points respectively from open.
How can we trade for these extreme events and benefit from them? One way is to buy options both call and put (Strangles),say 200,300,400 or 500 points away.
Say 2011 August series opened around 5485 levels.
Then 200 pts Strangle would be 5700ce(Rs.28/-) and 5300pe(47/-). One side would be the second OTM and the other side would be the third OTM. Together at open they would have cost 75/-. For my study, I have taken it as 80/-. Same way the 300 Strangle costs Rs.40/-, the 400 Strangle costs 20/- and the 500 Strangle costs 10/-. These are approximations as much depends on the volatility, but they are fair enough approximations. I assumed passive trading of buying on the first day of the series at open and closing on the day of expiry. Costs have been ignored as they would constitute a small part of the cost as a whole.
I will give the summary here for the 55 series I checked. The details are in the attachment
200 Strangle: Total points gained is 6733pts, total cost is 55*80/- = 4400pts. Net points gained is 2333. Out of 55 trades winners are 29.
300 Strangle: Total points gained is 4336pts, total cost is 55*40/- = 2200pts. Net points gained is 2136. Out of 55 trades winners are 18.
400 Strangle: Total points gained is 2825pt, total cost is 55*20/- = 1100pts. Net points gained is 1725. Out of 55 trades winners are 10.
500 Strangle: Total points gained is 1925, total cost is 55*10/- = 550pts. Net points gained is 1375. Out of 55 trades winners are 8. What these points means in money terms is that in the last 55 months if you had brought 500 Strangle, it would have cost you, 50*10=500/- per month for one lot and for 55 months you would have spent 55*500 = 27500/- and would have had a return of =1375*50=68750/-. For this you should have been willing to take 8 winners out of 55 trades. Tough ask but then the risked amount is low.
When you look at the results, you may want to dismiss some of the months thinking "but that kind of a wild swing occurs once in a while". That is precisely the point in trading for the outliers.
Having the data of the last 55 series, you can choose your strangles with care.
http://www.4shared.com/document/znk6Kvyo/Trading_for_the_outliers.html