Analysis of Automatic Strangle Trade on Expansive

Symbols of Korean Option Market

Young-Hoon Ko1 and YoonSang Kim2
1

Department of Computer Engineering, Hyupsung University

Department of Computer Science and Engineering, Korea University of Technology and
Education, Cheonan, Korea
yoonsang@kut.ac.kr

Abstract.This paper proposes a method for effectively implementing the

pyramid strategy. Although the rate of return is the most important factor for
investors, an investment is not very practical if it requires maximum drawdown
(MDD), which places unbearable burden on the investor. The pyramid strategy
is based on the short strangle strategy and adopts the multiple-entry approach.
Risk management is an essential element of derivatives trading, and the
pyramid strategy is very efficient because it combines mutual and dynamic
hedging. However, in operating the pyramid strategy, choosing a specific
exercise price results in significant differences in terms of profitability and
stability. This paper analyzes thetameasurement of decreasing time-value of
an optionto propose a method for achieving profitability and stability
simultaneously. The proposed approach involves adding stability by selecting
deep out-of-the-money (OTM) options in early monthly contracts, and moving
to near OTM options with high theta values in late monthly contracts to pursue
profitability. To verify the validity of the proposed method, automatic strangle
trades was simulated based on real data of Korean option information system.
The simulation was performed using the multi-chart automatic trading analysis
tool. The results of simulation using March 2012 contracts confirmed that the
proposed method produces higher returns and offers greater stability than
conventional methods.
Keywords: Short strangle, Pyramid strategy, Theta.

Pyramid Strategy with Expansive Symbols

KOSPI index futures and options provide various opportunities for equity investors as
well as for speculative traders. Strangle trading is one of the representative strategies
for trading derivatives. Compared to straddle trading, which trades at-the-money
(ATM) options, strangle trading involves transactions of OTM options and incurs less
slippage loss because of the greater trading volume. The pyramid strategy is a
multiple-entry approach based on short strangle. Risk management is an essential
element of derivatives trading, and the pyramid strategy manages risk using two types
of hedging: mutual hedging and dynamic hedging. Mutual hedging involves using call
and put options simultaneously to compensate for loss on one side with gain on the

- 393 -

other; mutual hedging is incorporated in strangle trading. A good investment strategy

must achieve both profitability and stability. Stability can be generally measured with
maximum drawdown (MDD), which is equal to the maximum loss that an investor
can take. The pyramid strategy is a highly advisable approach of both profitability and
stability. The pyramid strategy begins with choosing an exercise price of an option.
Since options are listed with exercise prices in 2.5 point intervals of the stock market
index, there are many types of OTM options. Near OTM yields higher return and
lower stability, whereas deep OTM is the reverse. This paper proposes a method for
effectively implementing the pyramid strategy. In order to pursue profitability and
stability simultaneously, the proposed method analyzes theta, which measures the
time-value of an option, and informs when and how much exercise price should be
selected. The proposed approach involves adding stability by selecting deep OTM
options in early monthly contracts, and from the middle of the month when the theta
value begins to decrease, converting to a near OTM options strategy to secure high
profitability and stability simultaneously. To verify the validity of the proposed
method, profitability and stability are analyzed by performing simulation using the
multi-chart automatic trading analysis tool.

Experiment and Results

Derivatives are traded based on underlying assets, and the index futures are based on
KOSPI200. Since the ATM exercise price of the opening price on February 10the
initial price of the current month contractwas 265, prices of March contracts are
formed around 265. The closing price on March 8expiration date of March
contractswas 262.85, and Call 262.5 was settled.
Table. 1 Profits and MDD of each exercise price
Profit

Call 280
Call 275
Call 270
Call 265

339,000
790,000
1,468,000
2,673,000

MDD

-26%
-49%
-79%
-110%

Trades

15
15
9
44

Odds of making profit

67%
53%
55%
46%

Analyzing the equity curve, it can be seen that Call 280 is an OTM option, which
generates profit in the early phase but the profit remains static from mid-phase
onward. Analyzing the equity curve of the ATM exercise price with Call 265, it can
be seen that the profit displays a zigzag curve in the initial stage and drastically
increases from mid-point onward.
Therefore, maximum return can be achieved by selecting Call 280 in early current
month contracts and Call 265 in contracts in the latter half of the contract period.
Since return is the profit earned relative to the amount of money invested, carefully
choosing the exercise price is very important in buying options, a single contract of
which usually has amargin requirement of 3 to 4 million won. Next we examined the
daily profits of Call 280 and Call 265. In early stage of the contractfrom February
10 to 24approximately 70% more profits were realized. However, there is also

- 394 -

heightened instability because MDD increased by 4 times. In the latter part of the
contract periodfrom February 25 to March 8Call 280s profit was 0, whereas Call
265 yielded a profit over 2 million won. Therefore, trading Call 280 in the first half of
the contract period and Call 265 in the second half is the optimum choice in terms of
profitability and stability.

Conclusions

This paper proposed an efficient method to implement the pyramid strategy. The
proposed method achieves profitability and stability simultaneously by analyzing
theta, which quantifies the decrease in options time-value. (Select deep OTM in the
first half of monthly contract period for stability and move to near OTM with high
theta in the second half to pursue profit.) Simulation tests were performed using the
multi-chart automated trading analytical tool in order to verify the validity of the
proposed method. Test results were compared between deep OTM Call 280 and near
OTM Call 265. In the first half, Call 280 and Call 265 yielded profits of 339,000 and
585,000 won, respectively with MDD of -26% and -110%, respectively. In the second
half, Call 280 and Call 265 yielded profits of 0 and 2,088,000 won, respectively.
Using the proposed method, we were able to achieve stability in the first half of the
monthly contract period by selecting Call 280 and earn high profit in the second half
by trading Call 265. From the results of simulation performed using March 2012
contracts (real data of Korean option information system), we were able to confirm
that the proposed method is superior to conventional methods in terms of profitability
and stability.

References
1. Kang. Sucheol, Kim. Hechul, collection of trading strategy investra,Bumhan Books
Publishing, Seoul(2004)
2. Kim. Junggeun, international financial markets and technical analysis,BubmunPublishing,
Seoul(1994)
3. Young Hoon. Ko, Journal of software society, n Exchange Method of the Signal in a MultiEntry Strategy for MultiChartsPortpolio. 22,1(2009)
4. Young Hoon. Ko, Yoon Sang. Kim, Journal of the Korea Society of Digital Industry and
Information Management, An analysis of Performance on the strategy of ladder trades in a
symbol pool by Multicharts. 6,2(2010)
5. Young Hoon. Ko, Yoon Sang. Kim, Journal of Journal of the Korea Society of Digital
Industry and Information Management The Profit Analysis of Straddle Sell by Entry-Time
and Delta at System Trading. 6,1(2010)6.
Cambridge Driving School Eco-Driving tips
http://www.cambridgedrivingschool.net

- 395 -