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The M3 Trading System Part 2 Extreme Volatility, October 2011 Expiration
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4. Hypothetical Trades Disclaimer
Please note: Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Since, also, the trades have not actually been executed; the results may have been under or over compensated for the impact, if any, of certain market factors such as liquidity, slippage and commisions. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risks.

5. October 2011 Expiration Risk Management and Profit Targets
Trade Size: 1 RUT or 10 IWM Calls
Butterfly Call Ratio: 20 Butterflies to 1 RUT Call (2/1 ratio)
Planned Capital - $75,000
Profit Target - $7,500
Max Loss - $7,500

6. Entry Position Price Chart October Expiration 2011
We’ve had the crash and are entering into extremely volatile market conditions

7. Entry Position October 2011Expiration

8. Entry Position for October 2011Expiration on Aug 26

9. Talk About Bad Timing!

10. We Do Nothing

11. Next Day, August 30 RUT is up another $12

12. Implied Volatility will fall “IF” price stabilizes

13. Situation Delta, Theta and Gamma are OK
Positive Vega creates possibility of T+0 line collapsing
Best Options
(RUT has been up 62 points in 2 trading days!)
Roll Butterflies Up
Add Vertical Spread

14. Buy a call vertical to reduce Vega exposure

15. New Position

16. Price Chart

17. 15 Days Later September 14 – 37 DTE

18. Analyze Graph

19. 8 Days Later September 22 – 29 DTE

20. September 22 Matrix

21. Analyze Graph

22. Situation Delta, Theta, Vega and Gamma are OK
Negative Gamma trend combined with positive Delta and negative Vega to the downside creates a excessive downside price movement risk
Best Options
(RUT has been down 60+ points in 2 trading days, still 29 DTE and IV is very high!)
Roll butterflies down
Add put options

23. Roll butterflies back

24. Position After Adjustment

25. 11 Days Later October 3 – 18 DTE

26. This is serious!

27. October 3 – 18 DTE

28. Analyze Graph

29. What would you do? Add puts Remove calls
Remove bullish verticals or add bearish verticals
Nothing

30. Adding Puts Correct Gamma trend Correct Delta Things to consider…
We just had a major support break and put prices will be insanely expensive with a further downside move already priced into them. Therefore “IF” we are wrong and the market reverses, stabilizes or even continues to go down slowly, then we will likely lose a significant amount of money which may result in an unnecessary loss.

31. Removing calls, removing bullish verticals or adding bearish verticals
Correct Delta
Things to consider
Selling the calls, removing bullish and/or adding bearish verticals will help considerably to the downside. But it will also CREATE a Gamma trend problem to the upside. If the market stays put you’ll do fine but IF you are wrong and a hard whipsaw occurs then you will likely create an unnecessary loss.

32. Doing nothing Hey the Delta/Theta ratio is fine.
Why let the fact that RUT has dropped over 80 points in 4 days and broken a major support line concern you…. But even so, doing nothing is probably a better choice than the other things we mentioned although a bit irresponsible.

33. A safer approach Roll the butterflies back.
Correct Delta and allows more downside room without the negative effect of hurting the position if the market reverses.

34. Roll the butterflies back 20 points

35. Oops! Don’t forget about the call.

36. Roll Back Call

37. New Position

38. 2 Days Later October 5 – 16 DTE

39. Matrix

40. Analyze Graph

41. 2 Days Later October 7 - 14 DTE RUT up 8 more points

42. Analyze Graph

43. 3 out of 4 isn't bad

44. New Position

45. Next trading day RUT is up 20 more points

46. Analyze Graph 11 DTE

47. RUT has been all over the place

48. Situation Delta and Gamma are OK
Positive Vega creates possibility of T+0 line collapsing
Negative Theta this close to expiration will collapse T+0 line even faster
Best Options
(RUT has been up 75 points in 4 trading days!)
Roll butterflies up
Add Vertical Spreads

49. To correct the Theta and Vega problem …

50. I don’t want to stay here for too long but it works for now

51. 2 Days Later – 9 DTE RUT is at 701 Up Another 20+ Points

52. Analyze Graph

53. Sell the butterflies

54. I sold 20 – 600 butterflies and bought 10 – 650 butterflies
I sold 20 – 600 butterflies and bought 10 – 650 butterflies. I altered the butterfly/call ratio. I did this because the expense of buying 20 butterflies this late in the trade would throw off the balance between the butterflies and the calls.

55. Go to call side to fine tune the position and reduce trade margin

56. New Position

57. New Position 9 DTE

58. 2 Day Later October 14 – 7 DTE RUT up 10 more points

59. Analyze Graph

60. Price Chart

61. Vega Adjustment

62. New Position 7 DTE

63. 3 Days Later October 17 – 4 DTE

64. Price Chart

65. Greeks look good!

66. Next Day - 3 DTE RUT is up 14 points Position is negative Theta….. AGAIN!!

67. I should take the money?? If I choose to stay in… Time to get into the tent

68. Adjustment

69. I would be concerned about downside risk
Analyze Graph
I would be concerned about downside risk

70. Sell useless 600 and 640 puts, buy back 650 short puts, buy long puts and buy long calls

71. New Position

72. New position with 10% IV increase

73. Expiration Thursday

74. Do you want to expire the Trade?

75. Trade Expiration RUT does not settle on Thursday night!
The RUT settlement is calculated by taking the opening price of each of the Russell 2000 stocks on Friday.
An issue with this process is that the stocks do not start trading at the same time nor are they equally “weighted”. This means that the settlement value can be significantly different than both the closing price on Thursday and opening price of RUT on Friday.
In some cases the settlement price can even be outside the range of the RUT daily bars on both days.
Make sure you have plenty of room!

76. This example went through…
Entry in an extreme high volatility environment
Very bad entry timing and a situation where the market “took our money”
Extreme up and down moves in a range of 130 +/- points
Position drew down less than ½ our max loss
Position was checked only 1 time per day
Never took excessive risk in either direction
This win did not hinge on exact timing of adjustments nor speculating on a market direction!

77. Summary
This trade was entered in an extremely volatile market environment.
We had a very large, fast up move immediately after the position was entered which created a Vega problem.
After considering the violent reversals and very large price fluctuations that were being experienced at the time, we chose to add vertical spreads rather than roll up the butterflies to control our Vega risk because we did not want to take on the downside risk associated with rolling up the butterflies.
When the price reversed to the down side, we chose to roll the butterflies back several times rather than to add OTM put options because put option prices tend to be over inflated with violent down moves and buying put options at an over inflated price can create large, unneeded losses if the market stabilizes, reverses or continues down at a slow pace. Buying puts in this situation typically requires the market to continue an aggressive down move and for you to properly time your sale of those puts in order to benefit from them. By rolling the butterflies back, we were able to protect against further down movement without the negative effects of buying puts.

78. Summary
When the price reversed violently to the upside, we chose to add vertical spreads rather than roll up the butterflies to control Vega risk because we did not want to take on the downside risk associated with rolling up the butterflies, again, considering the violent reversals and very large price fluctuations we were still experiencing at the time.
With the continued up move and timeframe to expiration, the verticals were no longer effective in correcting our risk with the butterflies in their current position so the butterflies had to be rolled up.
As we got closer to expiration, the price of rolling up the butterflies became too costly to stay within our risk parameters but something had to be done, so we rolled up the butterflies and reduced the butterfly/call ratio to control our Delta and Gamma trend instead of rolling up and adding calls.

79. Summary
Finally, as we took the trade into expiration week and the position became more sensitive to price movement, we utilized puts to help control our downside Greeks and Greek trends and to protect our account from an excessive loss. We can use puts more effectively now because, close to expiration, you can purchase puts to control your risk fairly inexpensively.
Notice how we didn’t just look at our Greeks to decide when and how to adjust our position, we also looked at the analyze graph to analyze our Greek trends and we also considered recent price movement, IV levels and DTE to decide the best move to deal with unacceptable risk without taking on excessive risk in the opposite direction.

80. Up Next in Part 3 Review Trade Set Up Review Trade Entry
Go though August 2011 market crash, Sept 2011 expiration

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