I was wondering if someone could help me with an idea I had in considering long term trend following systems which would usually use the cash index or equivalent vehicle to trade.
For example a simple ruleset:
* At the final day of each month:
** If the closing price of the cash index is > 10 month closing price SMA invest in the index
** If the closing price of the cash index is < 10 month closing price SMA invest in cash
Can this be converted to an options trading rule, such as:
* One week before OpEx:
** If the closing price of the cash index is > 200 day closing price SMA invest N% of assets in long 1m call options at the strike price closest to the 200 day closing price SMA; where N = distance in % from 200 day closing price SMA.
** If the closing price of the cash index is < 200 day closing price SMA invest in cash
In this way you should only suffer a % loss equal to the distance from the SMA in any given month (plus long call premium) in the event that the price declines below the SMA during the course of a month.
The reason I am interested in this idea is basically because long term trend following systems which trade only once a month avoid whipsaws for systems which don't utilise hysterisis, but also suffer greater drawdown during events like Oct 1987 and similarly in Jul/Aug/Sep 2011. I feel like using long calls instead of buying the underlying will allow me to take advantage of once a month trading while still being protected from large intramonth movement.
What I'm concerned about:
* The drag on returns which paying long call premium each month will have.
* The logic of my options trading rule not being logically equivalent (i.e. suffers greater drawdowns and returns less on trends)
* High IV forcing me to overpay for long calls (although my data indicates most of the high IV months are where cash index < trend filter).
* Anything I can't obviously think of