SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

A Case Study in SPX Put Writing


I've written about writing naked puts on multiple occasions, as I find it to be an attractive way to gain long exposure to the underlying asset class. It doesn't have to be a decision of one vs. the other (meaning, is it better to sell puts or own the underlying asset directly?), as there are advantages and disadvantages to both.

And the same is true with determining which strikes to use when selling puts. As it turns out, over a relatively long period of time risk and reward are related, as we would expect. 

Below are the results of three backtests simulating the monthly sale of SPX put options from 2001-2017 at various delta levels (16, 30, and 50). Each test assumes you enter approximately one month from expiration and exit approximately 3 days prior to expiration (results have minimal variation if entries and exits are slightly modified). No active trade management is involved.

My tests also assume no leverage is being used, with cash fully secured by 1 month T-bills. In other words, the returns of put selling can be thought of as the yield on cash plus the net results of the option trades. No commissions, slippage, or taxes are included, so real results would be slightly lower. Given the size of the SPX contract and its liquidity, this isn't a serious issue. The strategy passes the test of real world investability.

 

Click on the image for greater clarity

Picture1.png

 

Several interesting observations can be seen:

 

1. All strikes deliver returns similar to the underlying asset (using SPY as a proxy). The at the money strike (50 delta) even slightly outperformed SPY. It should be noted that every backtest is sensitive to the start and end point, and if we started our test in 2009 SPY would substantially outperform. This is what we would expect given the limited profit potential of put selling. CBOE has data going back to 1986 showing that at the money put writing has delivered returns comparable to owning the underlying.

 

2. All strikes delivered less risk than the underlying asset, measured with standard deviation and max drawdown. This results in higher Sharpe Ratios. The Sharpe Ratio is one way to measure how well we are being compensated for the risk taken, and a higher number is better. Put selling having lower risk than owning the underlying asset is something that we can expect to persist in the future. This is often counter to the perception that many have about selling options being "risky". Leverage is what creates risk, not product/strategy. 

 

3. The farther out of the money strikes deliver higher Sharpe Ratio's, with 16 delta options producing an extremely high 0.92 Sharpe. This could be noise in the data that may not be likely to continue out of sample, but many other researchers have found similar results on additional data and underlying assets leading us to believe it's not random. Those who believed this will continue to persist may choose to modestly lever their notional exposure to produce higher returns instead of selling strikes that are closer to the money. 

 

4. If you look closely at the chart, you can see that put selling can make money even in a declining market (especially with further out of the money options, of course). For example, during the 2001-2002 bear market, 16 delta put selling was continuing to put in new equity highs. This was also the case during the first several months of 2008 where the market was declining, but not too far/too fast. When the crisis hit in the fourth quarter, the speed and magnitude of stock market losses was too great for any of the strikes to endure. No surprise there, as insurance must pay off from time to time to attract buyers. 

 

5. After a crisis period like 2008, put selling recovered quickly as option premiums were substantial. SPY didn't reach a new high until 2013, while put selling recovered it's drawdowns in 2010. This is important given the nature of our human discomfort with losses and our ability to stick with a strategy. 

 

You may even draw additional conclusions of your own from this data. So with all this being said, which strike should you sell? I don't think a binary decision needs to be made here anymore than a binary decision on if you should sell puts or just buy the ETF directly. There are advantages and disadvantages of both, but hopefully this has made it clear that put selling is worthy of at least a partial allocation for a particular asset class like US large cap equity. 

Below I'll present one additional chart that is 50% SPY, and 50% put selling with equal allocation to our three strike levels (in other words, about 16.66% each), rebalanced monthly. Given the certainty of our uncertainty about which method will be best in the future, as well as the simplicity and tax efficiency of a traditional ETF allocation, this approach could be ideal for many sophisticated investors.

 

Click on the image for greater clarity

Picture2.png

 

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse oversees the LC Diversified forum and contributes to the Steady Condors newsletter. 

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • A Global Equity Put Write Portfolio

    Many that sell equity market put options focus on the S&P 500 (SPX, XSP, SPY). Some will add small caps by selling puts on the Russell 2000 (RUT, IWM). An investor could also make their put selling strategy globally diversified by adding MSCI EAFE (EFA) and Emerging Markets (EEM).

    By Jesse,

    • 0 comments
    • 199 views
  • The Random Walk Hypothesis

    The “random walk hypothesis” (RWH) is one idea about how stock prices behave – but only one of many. It is a theory promoted in academia and believed in my many, but not so much by traders involved with handling real money. Theories aside, is the market truly random?

    By Michael C. Thomsett,

    • 0 comments
    • 279 views
  • How To Trade Options Successfully

    I’ve now been trading options for over a decade and been associated with Steady Options for seven years – hard to believe.  Over that period, I’ve learned quite a bit about option trading; how to improve, what not to do, and generally how the option markets work. I’m still learning.

    By cwelsh,

    • 3 comments
    • 525 views
  • January 2019 Performance Analysis

    No one likes losing money, and no one likes hearing "excuses". However, in an effort to be fully transparent, solicit feedback, and to improve our own performance, we're writing this article to do a further breakdown of the losses which our model portfolio incurred in January 2019. 

    By Kim,

    • 17 comments
    • 1,322 views
  • Island Clusters as Strong Reversals

    Options traders constantly seek the elusive reliable reversal signal. A few unusual but strong reversals are worth looking for, and their patterns reveal likely exceptional timing for opening or closing option trades. One example of this exceptionally strong signal is the island cluster (or, island reversal).

    By Michael C. Thomsett,

    • 0 comments
    • 357 views
  • What’s Wrong With Your 401(k)? (If anything)

    There currently are over sixty million Americans that are active 401(k) participants, and well over 500,000 total active 401(k) plans offered by employers in the United States.  Despite these high numbers, usages could be higher, as the US Census Bureau estimates that only 41% of all employees with access to a 401(k) plan utilize it, with even less funding it fully.

    By cwelsh,

    • 0 comments
    • 439 views
  • Upcoming Decay of Options

    I am on the hunt for a short volatility position for three main reasons. First, the market’s wild swings have, for the time being at least, diminished. Second, option activity has dried up as my options barometer continues to be stuck in the 4 – 6 range as traders are not making big bets in either direction.

    By Jacob Mintz,

    • 0 comments
    • 520 views
  • The Scientific Process of Increasing Expected Returns

    For many US investors, the "base case" for equity investing is US large cap stocks, most commonly benchmarked as the S&P 500. You could absolutely do far worse than owning these 500 great US companies, and the weight of the evidence suggests that most actively managed mutual funds that benchmark themselves against the S&P 500 index have in fact done worse.

    By Jesse,

    • 0 comments
    • 902 views
  • Those Golden and Death Crosses

    The use of moving average (MA) for predicting future price behavior must be undertaken cautiously. MA is a lagging indicator, so the question must be: Can a lagging indicator provide guidance for the future? Yes. The use of two MA lines and how they interact is a reliable form of reversal indicator.

    By Michael C. Thomsett,

    • 0 comments
    • 632 views
  • Trading Reverse Iron Condors When IV Is Elevated

    Our members know that pre earnings straddles and calendars have been our bread and butter strategies in the recent years. We enter those trades when the prices are cheap compared to previous cycles. However, in the last few months of 2018, Implied Volatility exploded, making most of those trades too expensive.

    By Kim,

    • 0 comments
    • 706 views

  Report Article

We want to hear from you!


Its funny how many different opinions there are on put-writes on SPX.   If you look at the Wisdom Tree PUTW etf it has not held up so well since its launch a few years ago (granted we have been in a bull market until recently).  I also came across some scholarly articles bashing the CBOE indexes and claiming under-performance vs. SPX since they were first published.

 

Today I read this: https://seekingalpha.com/article/4210320-selling-puts-good-bad-ugly which seems to advocate selling puts on the weeklies but if the underlying moves down, do not lower your strike and hold the same strike until price returns (which could be years).  

 

What do you think about adding some trend filters?  For example, when SPX is below 200 sma use the 16 delta and when above the 200 day sma use 50 delta or just hold the underlying?  

 

Share this comment


Link to comment
Share on other sites
23 hours ago, FrankTheTank said:

Its funny how many different opinions there are on put-writes on SPX.   If you look at the Wisdom Tree PUTW etf it has not held up so well since its launch a few years ago (granted we have been in a bull market until recently).  I also came across some scholarly articles bashing the CBOE indexes and claiming under-performance vs. SPX since they were first published.

 

Today I read this: https://seekingalpha.com/article/4210320-selling-puts-good-bad-ugly which seems to advocate selling puts on the weeklies but if the underlying moves down, do not lower your strike and hold the same strike until price returns (which could be years).  

 

What do you think about adding some trend filters?  For example, when SPX is below 200 sma use the 16 delta and when above the 200 day sma use 50 delta or just hold the underlying?  

 

 

I wrote about adding trend to put selling in Feb 2017, you can read the article HERE

Share this comment


Link to comment
Share on other sites
1 minute ago, Jesse said:

 

I wrote about adding trend to put selling in Feb 2017, you can read the article HERE

I think I am you but 10 years in the past.   Almost every idea I have I found you already have a post and research on it.

How does the future look?  :)  

Edited by FrankTheTank

Share this comment


Link to comment
Share on other sites
2 minutes ago, FrankTheTank said:

I think I am you but 10 years in the past.   Almost every idea I have I found you already have a post and research on it.

How does the future look?  :)  

 

I feel that way about others in finance as well! I'm confident that the future for basic put selling will be good because the basic intuition of a sustainable risk premium is pretty solid. Sellers are taking on the risk that other market participants are looking to insure, and in an efficient market, that produces a positive expected return over time for the seller. I think the ideal approach is to diversify that risk across symbols, strikes, and expirations as much as is reasonably possible. 

Share this comment


Link to comment
Share on other sites


Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs