Trading the Alpha Rotation Model Using Options

The Alpha Rotation trading system uses trading signals generated by a quantitative strategy developed by MarketGauge around a select group of Big View indicators. In addition to the condition of the indicators, the strategy requires additional market phase and market condition confirmations to generate new signals and position changes.

While the original Alpha Rotation models trade the ETFs (SPY & TLT), the model signals make great setups for trading the underlying options as well. This service provides full trade setup and alerts for trading the Alpha Rotation system using options. We will provide instructions ahead of time for which option to buy, when to buy it, and when to sell it.

Two Approaches

We have a “Conservative” and “Aggressive” version of the model. The Conservative model will tend to buy options that have lower volatility and returns relative to the Aggressive model. Please review the performance statistics of each to determine which is the best model for your trading style.

Portfolio Allocation and Position Sizing

This is a key decision that will have large implications on the performance of your options portfolio. Since options provide natural leverage, you will need to keep part of your portfolio in cash or available as a buffer.

If you were trading your entire portfolio in options, it would only take a couple bad trades in a row to significantly impact your ability to keep trading the strategy. For this reason, we recommend only trading options equal to a fraction of your total portfolio (5%, 10%, 20%, etc…).

Let’s walk through an example of a 10% portfolio allocation. If you had a $10,000 portfolio, a 10% allocation to options would be $1,000. If the option’s price was $200 ($2.00 per share), you could buy 5 options contracts for $1,000.

If those options doubled in price when you sold them, your $1,000 in options increased to $,2,000 and your total portfolio went from $10,000 to $11,000. You would then find 10% of the $11,000 portfolio to find how much available capital you have for the next trade. In this case, your next options trade would be $1,100.

If those options lost 50% of their value, your $1,000 in options would only be worth $500 when you sell out of them. So, your total portfolio would go from the starting $10,000 to $9,500. You would then find 10% of the $9,500 portfolio to find how much available capital you have for the next trade. In this case, your next options trade would be around $950.

You would use the same basic calculation method if you are allocating 5% or 25% of your portfolio to options, only changing the allocation percentage to match your desired allocation.

Increasing your portfolio options allocation percentage increases your total risk and your total reward potential.

For any trading strategy to be successful, you have to stick with it. It is very important for you to accurately and realistically determine your own comfort level with trading options and the volatility that comes with it so that you can stick with the Alpha Rotation trading signals.

New Trade Entry Alerts:

When the Alpha Rotation system gets a fresh entry signal, an email and text alert (opt-in) will go out detailing which option strike and expiration to buy for the Conservative and Aggressive models. You would follow the entry alert and “buy” the appropriate number of contracts for the model you are trading the following day on the open (or when the alert specifies to buy).

Exit Alerts:

The options model will exit its positions when the Alpha Rotation model either reaches a stop, reaches the first target, or rotates out of the position. Stops and targets will be specified in the open positions based on the underlying ETF reaching a predetermined stop or target.  For instance, we might have a stop at $300 and a first target at $320 in the SPY. If the SPY reaches either of these levels, the Alpha Rotation options models will fully exit their positions. You will know these levels ahead of time, however, an email and text alert will be sent out shortly after any of these levels have been hit.

Example Trade Entry Alert:

Here is a typical example of an Alpha Rotation trade alert:

“Alpha Rotation New Trade Entry 12/9/2019: Conservative: Buy SPY-301-4/17/2019 Aggressive: Buy SPY-327-4/17/2019”

The above alert would mean the Conservative model should buy the appropriate number of contracts of the SPY ETF 301 strike that expires on 4/17/2019.  The Aggressive would buy the appropriate number of contracts of the SPY ETF 327 strike that expires on 4/17/2019.

Order Types to Use:

Options typically have lower liquidy and trade volumes than stocks and can also have very wide bid/ask spreads. We do not recommend using market orders for options or placing options orders prior to the open. We do recommend using limit orders to place trades. It may be best to let the market settle for a couple of minutes after the open before placing orders. For entries, it is usually possible to place the limit price between the midprice and the asking price. For Instance, if the Bid was $11.00 and the Ask was $12.00,  it may be possible to complete a trade anywhere between the Midprice ($11.50) and the Ask ($12.00), although the order is far more likely to get filled or filled quickly the closer you are to the Ask price ($11.75 or higher). If the order does not get filled at your limit price, you may need to adjust the price up to ensure it gets filled.

Time Based Exit 

If the option you bought has less than 20 days remaining before expiration, we consider it out of time, and it should be sold at the market even if it has not reached any targets. Sometimes this will yield a gain, but there will also be times that this will result in a loss. Based on average trade lengths, if you go out 120 days from entry for the options expiration, this should be a rare event. We will send out any time-based exit alerts ahead of time before you will need to execute them.