How'd You Do It?

Sean McLaughlin
January 12, 2023

In a recent note, I shared performance stats for our All Star Options Paid-to-Play portfolio, and in the time since, I’ve fielded numerous emails/DMs that all ask basically the same question:

How did you earn money in such a challenging market environment and do so with far lower volatility than the indexes?

Rather than responding individually, I thought it would be better for everyone if I just shared my thoughts here. After all, we can all benefit from good ideas, yeah?

I’ll try not to get us lost in the weeds with the mundane tactical maneuvers employed each trading day. Instead, I’ll stick to the high-level concepts which guide my thinking.

First and foremost, it is widely known in the financial community that volatility, or the ‘fear and greed’ that often drives volatility, mean reverts. This is because it takes a lot of energy to sustain volatility. Eventually, the thing people were reacting to becomes “baked in,” and it is no longer a scary unknown. It becomes the “new normal” and market participants soon become exhausted from the frenetic trading, square up their positions, and head off to rest or seek excitement elsewhere.

I take advantage of this frequent occurrence by positioning this portfolio in liquid instruments during such times they are experiencing relatively high options premiums resulting from current or expected volatility. To do so, I employ short strangle positions, which consist of equal amounts of out-of-the-money naked short calls and puts.

The bet I’m making is that the options will either experience a reversion in pricing to the mean, or the underlying instrument will experience range-bound trading activity. In a perfect world, I get both. In either scenario, as these short options inch their way toward expiration day, they’ll lose premium at an increasing pace (to my advantage since I’m short)

But these are not “set-and-forget” trades. I review the open positions each day, and if any position is taking on too much delta risk because the market price of the underlying is threatening to reach one of my short option strikes, I’ll play defense to reposition that trade to give myself a better chance of earning a profit or reducing the loss.

If no trades require me to play defense, I’ll look for a new position to enter.

Each day, I either do one defensive adjustment or add one new position. That’s it.

Meanwhile, we leave resting limit orders to buy (close) the short positions at our profit targets that periodically get filled at the whim of the market. I do this for every position.

Typically, I’ll have between 6-12 positions open at any one time.

In practice, it takes me less than 15 minutes per day to operate this portfolio.

In a nutshell, that’s how we’ve slept better than – and outperformed – traditional index investors over the past year.

Can you make this kind of time for yourself?

For more on how the Paid-to-Play strategy performed in 2022, head here.

Trade 'em Well,

Sean McLaughlin (@chicagosean)
Chief Options Strategist
All Star Charts, Technical Analysis Research

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