Introducing the Bittman Strategy

January 8, 2015 | Jack Slocum

In 2012 Jim Bittman, Director of Program Development and a Senior Instructor for The Options Institute at CBOE, gave a presentation that outlined a 2-step strategy for trading the S&P 500 Index (SPX) using weekly options. The strategy is particularly attractive because Mr Bittman supplied very specific entry and exit points, back testing data, probabilities and a detailed comparison vs trading once a month using standard monthly SPX options. This weekly strategy was one of the primary strategies that inspired the development of Alta5.

In this article, we will discuss the results and challenges faced while manually trading the strategy Mr Bittman outlined, how Alta5 has solved those challenges while increasing returns by 1.5% per week and how to set up and use the Bittman algorithm for yourself.

The Strategy

For those experienced with options trading, below is a high level overview of how the strategy works. It is non-directional and involves selling either a Bull Put or Bear Call credit spread each week after the SPX moves a calculated amount in either direction.

Entry

  1. Calculate a 1/4 and 1/2 standard deviation (SD) move for the SPX using Wednesday’s closing VIX.
  2. Use SPX open price on Thursday  and the values from step 1 to calculate 1/4 and 1/2 SD moves up and down.
  3. When SPX touches either 1/4 SD, sell “opposite” credit spread with a strike price 1/2 SD on the other side. This can happen Thur or Fri of the same week or Mon, Tue or Wed of the following week. The closer to it is to expiration the smaller the credit collected but with a higher probability of being profitable.

Exit

  1. If the market retraces to the opposite 1/4 SD price then immediately exit the position regardless of profit or loss.
  2. Otherwise, let the options expire worthless on the following friday and keep the full credit received when selling the spread as profit.

Expected Results

66% +1.20 +1.20 x 2 = +2.40
34% -1.40 (avg) -1.40 x 1 = -1.40
Profit per share after 3 trades: = +1.00

If you would like to watch the presentation, the slides and full video are available for download on Hamzei Analytics’ website. Livevol also has a great explanation with example.

Strategy Results  (Before Automation)

I had great success using the strategy at the end of 2012 and over most of 2013 with an average return of 3.2% per week including winners and losers.

Here are some of the things I liked about this strategy:

  1. 3.2% per week average return
  2. 79.3% winners over 39 weeks
  3. Taxed favorably (60% long-term / 40% short-term)
  4. PM settled options (unlike RUT)
  5. European-style SPX options  (no risk of early exercise breaking spreads)

Here are some of the challenges I encountered using this strategy:

  1. The bid/ask spread on SPX options can be very large ($.50 to $1.50) and trying to get a favorable price in between is challenging – especially with spread orders because they can’t be modified. Enter an order around the mark price, wait a few seconds to see if it fills, cancel the order, wait for it to cancel, and then create a new order to try again – sometimes 3 or 4 times while the price moves against you. This is probably the most frustrating part about trading SPX spreads and where most investors, myself included, leave the most money on the the table.
  2. You have to monitor your positions every day. The market can move against you quickly and you have to be ready to close the position to prevent extended losses.
  3. Sometimes it’s hard to take the loss. I am usually pretty disciplined but I failed to close a couple positions when I was supposed to resulting in larger losses.
  4. SPX has a complex variety of options available on different option chains. Standard AM settled options are mixed in with Weeklys, Quarterlys, and if the expiration falls on the 3rd friday of the month, there is a special SPXPM chain.

Improvement with Automation

In early 2013, I started researching ways to solve those challenges using automation. I found that the algorithmic trading platforms available to individual investors all have the same focus: programmable quantitative analysis for equity trading. Very few have support for options at all and none provided the level of support needed to automate the trading strategies I was using without extensive custom development.

At Alta5, our focus from the beginning has been to create a trading platform designed specifically to automate trading strategies like the one presented by Mr Bittman, for use by everyday investors. For  developers, it features a standards based, object-oriented API and a visual, color-coded drag and drop Algorithm Builder. The platform also transparently solves many of the challenges faced by active traders – like the bid/ask spread.

Smart Pricing

The #1 challenge of any options strategy (and #1 in the list above) is the bid/ask spread. Smart Pricing addresses this by making customizable, high-speed, incremental price changes to orders until they fill. For complex orders that can’t be modified (like spreads) it automatically handles the workflow to cancel and resubmit new orders.

Reasons to use Smart Pricing:

  • Fully automates shaving the bid/ask spread – saving capital.
  • High-speed, split-second changes to order prices that can’t be duplicated manually.
  • Ensures all orders follow the complex CBOE order pricing rules.
  • By using timed “limit” orders with incremental price changes, it naturally defends against high frequency traders who use small orders and speed to “sniff” out how much investors are willing to pay.
  • Easy 1 step setup for everyday investors.
  • Extremely customizable for algorithm developers, including creation of completely custom pricing rules.

The Strategy

alta5 is in active development and the current version may be slightly different than pictured below.

Setting up a new Trader using the Bittman’s strategy is very straightforward and requires no technical knowledge.

1. Click “New Instance” in the Strategy Marketplace. An “Instance” is a running copy of an algorithm customized by the settings supplied in step 2.

altarithm - bittman create algorithm instance

2. Select an account to use, Paper Trading or your brokerage account. For settings that match the values Mr Bittman used in his presentation, select the “Default” settings profile and click “Create Instance”.

altarithm - bittman create algorithm instance

For advanced users, custom parameter settings are available (large screenshot).

3. Your instance will start “unfunded”.  Enter the amount of available funds you wish to allocate to the instance and a memo (optional).

altarithm - bittman allocate algorithm funds

That’s it, the algorithm is ready to trade for you.

It will wait for the entry signals defined in Mr Bittman’s presentation and automatically enter and exit positions for you each week. It will notify you as it enters and exits positions or if it encounters any problems.
altarithm - automated trading notifications

Take Over at Any Time
Although the algorithm is fully automated, in Alta5 you always have the option of exiting any position immediately or pausing the bot to take over and manage a position manually.
altarithm - exit automated trading position

Results with Automation

My bot has been trading live for about 14 weeks and my average return has been 4.7% per week (an improvement of +1.5%). Smart Pricing increased my average premium collected by $.12 per share. My win-rate (75.8%) is slightly lower, but my average loss $ amount was much lower – probably due to strict, real-time adherence to the exit rules.

altarithm - bittman trading algorithm results

Comments

  1. philerupper

    When are you going to release the beta? I am interested in using the Bittman algorithm and would like to test it. What are you planning to charge for your services? There is not much info on your site.

  2. AUGUSTINE MCCLAY

    I’m very anxious to learn this trading system. Please tell me how I can get additional information and subscribe to your service.

  3. jackslocum Post author

    @Augustine, please add your name to the beta list. we are opening up the beta in groups. thanks!

  4. Paul

    Would you happen to have a link to a recording of the Bittman 2-Step Credit Spreads presentation that you refer to? I was able to find the PDF file, but not a recording of the actual presentation. Not even on the CBOE site.

  5. Ben

    Why use Thursday as the start date for the algorithm? SPX weekly expire at Friday close (except for monthly), shouldn’t Monday be used as the start?

  6. jackslocum Post author

    @Paul, several links are in the 2nd paragraph.

    @Ben, I would assume that Thursday produced optimal results in backtesting for Mr. Bittman.

  7. Jack Slocum Post author

    Baur, we’ve redesigned the fund allocation process to a fixed amount per opportunity and a lifetime maximum. In the past I’ve had success using 35% of available capital per individual opportunity.

  8. jim mckee

    Guys, can you expand on 1/4 – 1/2 SD..? I use a SD chart to determine my entries already so is that equitable to .25/.50 SD’s..? If so, awfully tight…

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