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.

Combining Momentum and Put Selling (Updated)


In February of 2017, I wrote an article about combining together the concepts of momentum and put selling. You can find that article here as prerequisite reading. With this post, we'll look at how the strategy presented has done since then, along with some additional implementation ideas.

Selling puts on the S&P 500 has been a good strategy since the mid 1980's, based on CBOE's Put Write Index (PUT). In the referenced article, I showed how adding a time series momentum filter to PUT further improved risk-adjusted results, while also mentioning that creative investors could use assets other than T-bills/money market as the underlying source of collateral. We'll also look at that here.

 

First: Replicating the strategy in the article, how has it done out of sample the last 23 months?

 

Notes... 

Equal Weight Portfolio = PUT 

Timing Portfolio = Times series momentum applied to PUT

Vanguard 500 Index Investor = VFINX

 

1.png

 

Given that the S&P 500 has been up so strongly during the last 23 months, it's no surprise that PUT underperformed the index. This is expected during strong bull markets where put selling has gains limited to the amount of monthly premium collected. The time series momentum overlay stayed invested the entire time, thereby doing its job since there were no major drawdowns along the way to avoid.

 

Next, we can look at two examples of ways to enhance the returns of our momentum approach. First, instead of holding bonds only when momentum is negative, we'll hold bonds (instead of T-bills) all the time (via VBMFX) in addition to our put selling. This further improves results, but it should be noted that this could only be done in a non-retirement margin account. All the brokers I'm aware of would prohibit this type of portfolio in an IRA. 

 

2.png

 

The risk-adjusted results here are impressive for such a simple strategy. So what are the drawbacks? Here are a few to consider:

 

1.  We saw in the last 23 months that put selling can underperform in a raging bull market. Investors could consider substituting part of their traditional equity exposure with put selling for this reason. 

 

2. Future returns may be lower. As more market participants become aware of the strong historical risk-adjusted returns offered to those willing to sell options, more supply can impact premiums.

 

3. Risk-adjusted bond returns have been extraordinary since 1990 due to falling rates, with VBMFX producing a Sharpe Ratio of 0.78. This is unlikely going forward. 

 

4. Time-series momentum can and will occasionally create whipsaw trades. Again, the solution to this is continuing to maintain a healthy portion of your equity portfolio with traditional index funds and/or ETF's.

 

5. The returns shown are pre-tax, and option selling is tax inefficient due to the high turnover, even after considering the special 60/40 treatment that cash settled index options receive. All of the bond income would be taxable as well (although substituting VBMFX with VWITX gives similar results). The ability to defer capital gains until sold and forever when bequeathed is one of many reasons why index funds are so attractive. 

 

One more example: Instead of collateralizing 100% of our put selling with bonds, we'll do it with 20% equities and 80% bonds. Since PUT is based on large caps, we'll add factor diversification by allocating half of the equities to a US small cap value index, and the other half to an International small cap value and emerging market value index.

 

3.png

 

Adding cash equities to the portfolio further improves results, and would also improve tax efficiency. Even though this type of portfolio may be simple, its creativity makes it quite unconventional. But for someone willing to succeed unconventionally, the data suggests the minimal effort involved is worth it. And for those lacking the time, interest, or confidence to do it themselves, we run portfolios similar to this for clients if you'd like to have a discussion about it with us. Thanks for reading. 

 

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™. 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 is managing the LC Diversified portfolio and forum, the LC Diversified Fund, as well as 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

  • Traditional or Roth Retirement Account?

    When US investors save for retirement, there are many important decisions that have to be made including which investments to use as well as which type of accounts to fund. Tax favored retirement accounts such as 401(k)’s and IRA’s should be utilized to the maximum extent possible because of the opportunity for tax advantaged growth.

    By Jesse,

    • 0 comments
    • 186 views
  • My Favorite Investing Books, Blogs, Papers, and Podcasts

    There are so many excellent sources of investment education available today that I thought a short post about some of my personal favorites could be beneficial. Below are different forms of content that have been particularly impactful to my investment philosophy, and they are not in any specific order.

    By Jesse,

    • 0 comments
    • 402 views
  • Go For Gold! The Business Behind The Dazzle

    The price of gold is often in the news—sometimes it's rising, and other times it's dropping but for the most part, it has been on a steady increase for many years. It is certainly worth more now than it did twenty years ago. When its price is on the rise, we may have thought about the benefits of selling our gold for profit and making some passive income from it.

    By Kim,

    • 0 comments
    • 250 views
  • Using Bullish Calendar Spreads to Profit on MSFT Stock

    A calendar spread is an income trade where the trader sells a near term option and buys a longer-dated option with the same strike price. Usually this is done with monthly options, but it can also be done with weeklies. They are long volatility trades so can be a nice addition to a portfolio as a way to offset some short vega.

    By GavinMcMaster,

    • 0 comments
    • 482 views
  • 3 Principles to a Successful Investment Experience

    Although not an exhaustive list, what I’ll present in this article are three core principles that overwhelmingly stack the odds of a successful long-term investment experience in your favor. These three principles are asset allocation, diversification, and rebalancing.

    By Jesse,

    • 0 comments
    • 355 views
  • Important Tips For First Time Currency Traders

    Diversifying your portfolio is important for all investors, and currency investments are a great way to do that. However, there are a lot of misconceptions and common mistakes that first time currency investors make, and this leads to big losses.

    By Kim,

    • 0 comments
    • 381 views
  • Iron Condors or Short Strangles?

    In my early option trading days, I favored selling iron condors over selling strangles. I thought that selling a strangle was too risky because the potential loss was “undefined”. I thought this made sense because this is what I’d hear from other people that were more experienced than I was.

    By Jesse,

    • 0 comments
    • 1,820 views
  • How To Be A Successful Day Trader From Home

    The good news is that if trading is your passion, then it’s possible to become a successful day trader and work from home. However, it’s not as easy as setting up shop and jumping online. There are specific steps and processes you need to have in place if you’re going to be able to make a living for yourself and have a bright career and future.

    By Kim,

    • 0 comments
    • 494 views
  • 3 Key Pieces Of Advice For New Traders

    These days, everyone claims to be an ‘expert’ on absolutely everything. Apparently, it only takes having a Twitter account to be a seasoned expert on any given subject; all in all, the Internet is full of nonsense. It’s becoming harder and harder to find legitimate answers amongst the quagmire of false information online.

    By Kim,

    • 0 comments
    • 520 views
  • Why New Traders Fail

    Our first advice to new traders is: "Learn First, Trade Later". The markets will always be there, but if you start trading without proper fundamentals, your capital will be gone very fast. The barrier to enter trading is so low today, commissions are near zero, and the whole trading game looks very promising.

    By Kim,

    • 0 comments
    • 707 views

  Report Article

We want to hear from you!


@Jesse  Love these articles 

I get how PUT (CBOE) and PUTW (Wisdom Tree) should underperform SPY in a low-vol - up trending market.   When the market changed this year and has had huge pull backs and is down about 10% from the peaks shouldn't PUT and PUTW be outperforming SPY?   


Here is a quick YTD chart of SPY/PUTW and it looks like PUTW is still underperforming ......even in this market? 

 

I was speaking with a finance professor here who writes papers on options and he was saying how most of the CBOE indexes have underperformed since they became mainstream.  Is it possible the premium we used to get for selling puts has been arbitraged down to the point where we can't expect these simple indexes to outperform SPY in the future?

 

image.png

Share this comment


Link to comment
Share on other sites

Q: I get how PUT (CBOE) and PUTW (Wisdom Tree) should underperform SPY in a low-vol - up trending market.   When the market changed this year and has had huge pull backs and is down about 10% from the peaks shouldn't PUT and PUTW be outperforming SPY? 

 

A: Since the September 21st all time high, stockcharts.com shows SPY performance as -9.75% and PUTW -6.75%. PUT is about -6.5%. The same was true from peak to trough in the Jan/Feb decline. YTD the returns are similar. The path traveled matters for put selling...for example, 2015 was also a flat market and PUT returned 6.4%.

 

Q: I was speaking with a finance professor here who writes papers on options and he was saying how most of the CBOE indexes have underperformed since they became mainstream.  Is it possible the premium we used to get for selling puts has been arbitraged down to the point where we can't expect these simple indexes to outperform SPY in the future?

 

A: I talked about this in my article. "Future returns may be lower. As more market participants become aware of the strong historical risk-adjusted returns offered to those willing to sell options, more supply can impact premiums." The risk premium built into options is rational in an efficient market (meaning, it's rational to expect to be profitable systematically selling puts...otherwise insurance would be free for buyers), but theory suggests risk-adjusted returns should be similar for risk assets. That's exactly what we've seen in PUT since 2007 when it was launched in real-time where PUT has a Sharpe of 0.54 and VFIAX 0.55. Also, there are ways to improve the risk-adjusted returns of PUT in real time implementation vs. the simple index without introducing active management decisions. Research I've read from Larry Swedroe, Parametric, and AQR have written about how it may be rational for slightly better risk-adjusted returns from volatility selling type strategies to persist due to the distaste for negatively skewed return profiles by market participants in general. 

 

Share this comment


Link to comment
Share on other sites


Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs Expertido