The Premium Stock Index Program collects premiums by writing (selling) out-of-the-money options. The seller (writer) of the option risks losing the difference between the premium received for the option and the price of the underlying futures contract. Trades are usually made 30-45 days from expiration. The goal is to exit the positions before expiration at an "opportunity cost" profit stop. This profit stop is based on the logic that underlying futures moves can accelerate the profit potential of the position. For example, if an option is sold 40 days out from the expiration date and a market move occurs which results in a 70% profit after only 5 days, the position would be covered and the profit realized. This allows for the sale of a new option (still 35 days out from expiration) and the opportunity for increased returns, rather than waiting 35 days to capture the remaining 30% of the initial premium.
What makes CBCM's strategy unique is that historical prices are not used to establish positions, and, a short-term trend indicator is used to help reduce the probability of selling options against a negative trend. The majority of methods used by advisors are based on the assumption that historical price data can predict future prices. While the use of historical price data has shown to be profitable, CBCM believes deeper drawdowns and lower accuracy are generally the result of this type of analysis. CBCM uses the future perceived value in its proprietary algorithms, derived from the current month option expiration, to determine the strike prices at which the options are sold. In addition, position sizing methods are employed to optimize risk-adjusted returns by balancing put/call exposure.
The profitability of a trading system consisting of selling ("writing") uncovered options on an index depends upon the price movement of the index. If CBCM writes calls on an index, and the calls are not bought in before their expiration, the strategy will be profitable if the index is below the strike price of the call when the call expires. If the index is above the strike price of the call when the call expires, the strategy may produce a potentially unlimited loss.
If CBCM writes puts on an index, and the puts are not bought in before their expiration, the strategy will be profitable if the index is above the strike price of the puts when the puts expire. If the index is below the strike price of the puts when the puts expire, the strategy may produce an almost unlimited loss.
In order to manage risk and mitigate losses, CBCM will attempt to buy back (cover) options before expiration if stop loss levels are exceeded.