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

  • Option Equivalence

    Some option positions are equivalent – that means identical profit/loss profiles – to others. Others are not. A few days ago I had an inquiry from a person trading options in a restricted account (e.g. an IRA that did not allow marginable trades or short options positions):

    By cwelsh,

    • 0 comments
    • 67 views
  • Investment Ideas for Conservative Investors

    Investors with low willingness or need to take risks often look to bank and/or life insurance company fixed-rate products to increase potential returns instead of leaving their money in conventional checking or savings accounts. Some of these product types are CD’s, structured notes, fixed annuities and fixed indexed annuities.

    By Jesse,

    • 0 comments
    • 152 views
  • iVolatility Tools: Advanced Ranker

    Here is one of the analytical tools that allows us to claim "In options we are Big Data!" For those who want to find the movers and shakers, Advanced Ranker does the job. The Advanced Ranker combines an easy to use interface with a powerful sorting logic built on IVR and IVP.

    By Levi Ioffe,

    • 0 comments
    • 132 views
  • Two Pre-earnings Momentum Trades With a Technical Trigger in Alphabet

    Both option trading backtest approaches rely on the fact that there has been a bullish momentum pattern in Alphabet stock 7 calendar days before earnings. Further, we use moving averages as a safety valve to try to avoid opening a bullish position while a stock is in a technical break down, like the fourth quarter of 2018. 

    By Ophir Gottlieb,

    • 0 comments
    • 298 views
  • Flaws in Implied Volatility

    A technical study of chart patterns, focusing on historical volatility of the underlying, reveals that depending on implied volatility is a flawed idea. Traders should remember that options are derivatives, meaning their premium value is derived from historical volatility.

    By Michael C. Thomsett,

    • 0 comments
    • 381 views
  • 7 Trading Cliches For Novice Traders

    Trading is a tough business. There is no easy money in the stock market, but there are a lot of folks who will easily take your money. What is important to know that no matter how experienced you are, mistakes will be part of the trading process. This article should help you to avoid some of those mistakes.

    By Kim,

    • 0 comments
    • 347 views
  • Iron Condor vs. Iron Butterfly

    Iron Condor and Iron Butterfly are both very popular strategies. Both of them are usually used as non-directional strategies (although butterflied can be used as a directional trade as well). Both trades are vega negative and gamma negative, but there are also few important differences between those two strategies.

    By Kim,

    • 0 comments
    • 350 views
  • Leveraged Anchor: A Three Month Review

    Steady Options has now been tracking the Leveraged Anchor from the unlevered version for three months.  The results so far have substantially beat expectations, though there is a possibility for improvements discussed at the end of this piece. 

    By cwelsh,

    • 10 comments
    • 1,058 views
  • How a Fund is Developed

    Many individuals are curious as to the testing process for a new fund.  With the plethora of funds continually being developed, having some insight into this process can be helpful for investors.  At the very least, it can provide a series of questions which should be asked in conducting due diligence on fund managers.

    By cwelsh,

    • 0 comments
    • 284 views
  • Why Dow Points Are Meaningless

    A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.” These types of headlines may make little sense to some investors, given that a “point” for the Dow and what it means to an individual’s portfolio may be unclear.

    By Kim,

    • 0 comments
    • 315 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