A First Attempt At Beating The Market

Check out the other articles in the series:

• Heading Out to Sea

• Deciding on the Strategy

Even with the strategic basis for investment strategy, the devil is really in the details. As a summary, we're going to be selling calls on a leveraged vehicle in order to purchase more of the underlying stock. But when should we sell the calls, at what strike price? When should we deploy the premium? What happens when a call is exercised.

Selling The Call

Buying options is hard. Not only do you need to be correct on the direction of the stock, but also timing and amount. This is exactly why this is a good strategy to employ. We're on the other side of the trade, selling.

So let's look at our options (pun intended). If we sell call options and the price extends beyond, we keep the premium, but we sell the stock and miss out on future gains. If we sell call options and the price doesn't meet the strike at the contract expiration, we'll pocket the premiums and we can rinse and repeat. Clearly because we are a long strategy, we want to weigh heavier towards the latter option.

This translates to selling out of the money calls, and trying to pick a price that is always just out of reach. There are really 2 elements here: The right time to initiative the sale of the call option, and the price at which we should be selling.

Timing

There's a number of different options for timing, but ultimately what I decided on was to try to find those times where the stock runs up unusually quickly, but without missing out on the volatility and more specifically, the entire run up.

Luckily we can measure this with a Relative Strength Index. That is, we'll look for times when the stock's RSI reflects on overbought signal and initiate a call option. One small optimization is that we'll trail the RSI so that it can peak before initiating the sale.

Strike

Given there's less chance a target price will hit with both a higher target to hit, and less time, we'll apply this to our chosen strike price and contract expiration accordingly. That is, we'll choose a strike price out of the money (20% to keep things simple), and not too far out (2-3 weeks). We can always tune these later, but this gives us a good basis.

Repurchasing

In the case where the option has been executed, or I just have some more deposits that I'll need to deploy, we can essentially apply the same strategy to purchases. We'll wait for a 'good' time to buy more of the stock as a re-entry.

To keep things simple, we'll use the same strategy as timing the option call sells, but in reverse. We'll trail the RSI down, and purchase once it rebounds.

Pseudocode

This is ultimately what our first pass looks like:

trail max rsi
if rsi top:
  sell calls on any uncovered shares at 20% OOTM 2-3 week expiration.

trail min rsi
if rsi bottom:
   buy more shares

Pretty simple, but surprisingly encouraging. Next up I'll go over my experience with QuantConnect.