There have been quite a few articles/blog posts written about Karen Bruton or “Karen The SuperTrader”. Notably, TastyTrade has posted many video interviews with Karen, bringing her to fame within the option trading community. But other than speculation as to whether she is real (she is), or her performance is real (it probably is), or discussions about her rules – I’ve not seen anyone backtest similar strategies.
Karen runs a hedge fund, Hope Investments, and primarily uses short puts and short call options in order to generate superior returns. Her fund is open to accredited investors, and is not required to disclose their performance, but we believe she makes 30+% annual returns.
Her general rules follow:
- Treat selling puts and selling calls as independent trades
- Sell puts at 95% probability of success (about 2 standard deviations)
- Sell calls at 90% probability of success
- Sell puts between 40-56 days out
- Sell Calls around 14 days out
- Use 50% margin (up to 80% depending on the market)
- Sell puts when the market swings down. Sell calls when the market swings up.
- Adjust positions when they become 70% probability of success.
- Use ~50% margin. Up to 80% depending on market conditions.
Her rules are fluid and other than what she has disclosed in the videos, proprietary. She has a team working full time monitoring and adjusting to the market. Replicating her exact strategy is impossible.
Selling strangles are not new. I’ve heard that a large percentage of CTA’s employ short strangle positions as they have a very high win ratio. Of course, one major market correction and your account could be liquidated. If you can avoid the market meltdowns, this strategy is lucrative.
Portfolio Margin is used in this case when selling puts and calls. The calculation for PM is proprietary by the exchanges and brokerages, but in general they stress test your entire portfolio with a -12%/+10% move in the market in order to determine your required margin. Other variables such as volatility, and brokerage specific factors, and personalized risk factors also take effect. That is to say for the same positions, I may have slightly different requirements from one brokerage to another, or even from one account to another within the same brokerage. Even specific instruments will have different risk parameters. All of which are somewhat subjective and controlled by the brokerage and exchanges.
PM offers tremendous advantage and leverage over other options.
For example, lets look at the current SPX put trading 2SD and 53 days out:
PM requires 16% the margin than RegT does and 1.6% the margin a cash margin account would. But PM margin is much more fluid than the others. As the market drops, the margin requirement is increased. The details of PM margining are much more complex – but for the sake of simplicity and due to the fact I cannot calculate the PM margin, I will assume it is a constant percentage of RegT margin.
I’m going to focus on the short puts since the short calls are a smaller proportion to the overall profits. Calls are very cheap compared to the puts, and Karen reportedly sells half the number of calls to puts. I’m sure it adds to her bottom line, but for simplicity, I will leave them out for now.
The following shows the risk profile for the SPX 1875 short put as of the beginning of April..
This trade stands to gain $600 if the SPX closes above 1875 in 52 days. But looking at the P/L in the price slices you can see just how rapidly this trade looses value as the market drops. If the market drops -12%, the trade would be under water by 7.4k. Actually, its worse than that as it does not take into account any changes to vega due to the drop.
With PM margining, the value at a -12% drop has to be greater than your account’s net liquidity. So if you have a $1M portfolio, you could sell 135 contracts. But as the market falls or volatility increases, your -12% calculation will increase and you will be placed into a close-only status.
I’m not going to attempt to perfectly replicate Karen’s trades since that is impossible – but instead focus on the viability of selling short puts. Specifically:
- Sell Puts utilizing 50% of margin
- Sell Puts at 2SD
- Sell Puts between 40-56 days to expiration
- Open 1 trade a week. Ideally on a big down day. Each trade uses 25% of trade allocation (or 12.5% of margin)
- Only hold 4 open trades at a time
- Close puts early when they reach 80% of profit
- Returns are compounded.
- I approximate PM margin as 30% of Reg-T (2X what I found above).
Under the ideal situation, trades should be closed at 80% profit in about 4 weeks.
Short Puts – No Adjustments
I first want to see just how bad short puts can be.
If you were asleep at the wheel and did nothing to protect your position, your account is clearly liquidated, and rapidly. Note this is at 50% margin, but I have seen even using 25% margin when setting up the trades, would likely result in a margin call.
Short Puts – Sell at 30% PITM
70% probability of being OTM is important to Karen’s strategy (or 30% ITM). It makes sense. At about that point, Gamma starts accelerating. This test will simply close the trade at the ask when ever the delta of the put is > 0.30 (a rought approximation to 30% ITM).
Clearly, this alone dramatically helps protect the position. There are several large drops (-30-50%) but overall, the strategy is fairly profitable due to that long quite period in 2013-2014.
Short Puts – Roll Puts down at 30% PITM
But Karen does not simply closes her puts, she rolls them down, sometimes increases those positions (as I understand it) and sells more calls to help make up the loss.
This test shows the results of rolling down the puts and placing another 2SD trade at the same expiration. It is interesting to note that this makes matters worse. Like picking up pennies in front of a steam roller. The initial 2008 crash looses 75% of the account value. The subsequent drops are similar in magnitude to those without the rolls.
The 2008/2009 data has to be taken with a grain of salt as there were no weeklies to trade. If the crash of 2008 happened today, I think the results would be slightly better due to the fact that you could spread your volatility risk over more expirations.
I was also surprised to see that rolling made matters worse. True, this is not Karen’s strategy. She also sells calls, but I don’t know how those calls could make up those gaps. Reportedly Karen turned a profit in 2008, but I am not sure she disclosed how. I’m not sure she was following the same rules or not. She likely was following the trend and trading less puts/more calls on the way down. And probably at smaller scale.
To be continued.