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.

Equity Index Put Writing For The Long Run


One of my all-time favorite investing books is Jeremy Siegel's Stocks For The Long Run, which is currently in it's 5th edition. It's a true classic that I refer back to often.  Professor Siegel lays out the compelling case for equities over extended time horizons such as 20 or 30 years.

Yet as compelling as equities may be over the long run, professeor Siegel notes that "fear has a greater grasp on human action than does the impressive weight of historical evidence." We believe the attractive characteristics of collateralized put writing may give many investors the courage they need to indirectly participate in the equity markets for the long run.  

We recently launched our Steady Momentum service that includes alerts for an equity ETF portfolio and an equity index and ETF put write portfolio. As an options focused website, naturally most of our subscribers are primarily drawn to the options portfolio. And for good reason, as equity index put writing is equally as compelling as owning equity ETF and mutual funds directly. In some ways, even more so. 

 

An August 28, 2018 InvestmentNews article titled "Equity index put writing: A strategy for uncertain markets" is a great read to develop a better understanding of collateralized put writing.  Using the historical data of the S&P 500 CBOE PutWrite Index (PUT), the author shows how writing cash secured puts produced similar returns as the underlying S&P 500 index, but with lower volatility and maximum drawdown. One particular chart in the article provided a great visual of how put writing tends to perform in different environments.

 

image.png.b86a0a91c06dc70210a9958a73b4c089.png

 

This next chart shows the total performance of PUT (portfolio 1) vs. the S&P 500 (portfolio 2).

 

1.png.4016ee7be3ddf0babb08acda2880f797.png

 

In our Steady Momentum put write portfolio, we believe we can make incremental improvements to further increase the attractiveness of a put write portfolio. For example:

 

  1. PUT holds winning trades until expiration. Writing puts limits profits to the premium collected. During rising markets, we believe we can capture more upside by rolling trades before expiration when the vast majority of profits have already been earned. Sitting on dead options for several days or even weeks doesn't make much sense to us.
     
  2. PUT will also hold losing trades until expiration, which means during large market declines it will at times act like synthetic stock. We believe we can slightly reduce downside by incorporating time-series momentum into our strike selection process, as well as by rolling losers prior to expiration. Both #1 and #2 are modest active management techniques, as we want to maintain the "beta" of put writing overall. In other words, the historical evidence is clear that PUT certainly isn't broke, so we don't want to spend too much time fixing it.
     
  3. PUT holds short term 1-3 month US Treasury bills as collateral.  In our Steady Momentum put write portfolio, we believe it's sensible to replace T-bills with a small amount of term risk in the form of a low cost 3-7 year US Treasury ETF serving as our collateral. The term premium of 5 year Treasuries minus T-bills has been just under 2% per year over the last century, with premiums often showing up when most needed (equity bear markets). Of course, this is not guaranteed to be the case as well in the future, so we consider this an expected risk premium. 
     
  4. PUT is an index based on just one underlying, the S&P 500. Just as we believe in size and geographical diversification when owning equities directly, the same is true in designing a put write portfolio. In addition to the S&P 500, we add exposure to the Russell 2000 and the MSCI EAFE indices. CBOE also has an index for put writing on the Russell 2000, PUTR, since 2001.
     
  5. In addition to asset diversification, we believe we add incremental improvements to risk adjusted returns by adding time diversification. PUT holds all contracts in the same expiration at the same strike.  The dynamics of option greeks mean that PUT will sometimes move dollar for dollar with the index and at other times only pennies on the dollar.  Our Steady Momentum put write portfolio splits up its holdings into more than one expiration, and often times more than one strike, in order to produce more consistent exposure over time. We don't necessarily believe this improves absolute returns, but is likely to improve risk-adjusted returns.    
     
  6. Lastly, PUT is fully cash secured, or collateralized.  Due to all of the above expected improvements, we believe it's reasonable to use a modest amount of leverage to increase expected returns. Our Steady Momentum put write portfolio targets notional exposure of 125%. Just as owning more shares of the underlying index increases your expected return, so does selling more contracts. We understand that many have a binary view on leverage, as there certainly is a graveyard of traders and trading funds that no longer exist due to excessive leverage. The irony is that many who subscribe to our service realize it's much more conservative than what they are used to because their past experience with put selling was in the form of highly leveraged credit spreads. Simply put, our very modest use of leverage is designed to make sure that we survive for the long run.

 

Conclusion 

 

The evidence of owning equities is compelling, but many are too frightened to do so because of short term volatility. Cash is comfortable in the short term and is hard for many investors to let go of. Collateralized put writing is one potential solution, allowing an individual to maintain their cash position and simply overlay a put selling strategy resulting in lower volatility and a higher success rate than owning equities outright. When implemented in a manner like we've described, put writing may even offer the opportunity for excess returns relative to indices. But as an advisor to clients for over a decade now, I can tell you this isn't what matters or what our Steady Momentum put write portfolio is really about. Instead, it's about simply staying in the game. This is what determines long-term real life outcomes. I'll take above average patience and discipline over above average intellect every single time when it comes to investing.

 

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 manages the Steady Momentum service, and regularly incorporates options into client portfolios.  

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

  • Is This Rally for Real?

    After being down over 35% from the all time high, S&P 500 has rallied over 20% from the recent lows in just two weeks. Is this rally for real? Or is it just a bear market rally, a "dead cat bounce"? What the "experts" are saying? Has the market bottomed? Will the selling resume?

    By Kim,

    • 0 comments
    • 149 views
  • Financial Planning Lessons From the Pandemic

    The first quarter of this year will end up being one of the most volatile quarters of our investing lives. Many lessons can be learned. Perhaps none are more important than the basic principle of maintaining sufficient cash liquidity in the form of an “emergency fund” during both our working and retirement years.

    By Jesse,

    • 0 comments
    • 98 views
  • Human Nature and Option Risk

    Traders may tend to think of risk in purely mathematical terms. It can be quantified by analysis and by a deep understanding of probability. But there is more to this than just the math, and for options traders, some of the intangible considerations might have more impact on trading decisions than the formulas.

    By Michael C. Thomsett,

    • 0 comments
    • 169 views
  • Anchor Analysis and Options

    Anyone who has been trading the Anchor Strategy over the past few months should be extremely happy with its performance.  Now that many have realized how well it performs in down markets, one of the most common questions is “what should I do now?”

    By cwelsh,

    • 0 comments
    • 94 views
  • Discount Stock Shopping In High Volatility Markets

    The COVID-19 pandemic has rocked markets over the past month. The fear of the virus, the fear of the impact on global economics from the mitigation taken on by governments, and, finally, the fear of "what’s next" has propelled the VIX.

    By Drew Hilleshiem,

    • 0 comments
    • 392 views
  • The Fallacy of Market Timing

    The headlines say it all. "The worst day since the financial crisis". "Markets in turmoil". And today was "Stock markets post best day in years as governments fight coronavirus with cash". Could anyone predict the crash? And can anyone tell us where we are headed next week/month/year? Is it possible to call the tops and the bottoms?

    By Kim,

    • 0 comments
    • 324 views
  • Long Option Risks

    Among all options, the most easily calculated payoffs are those for long options. But there remains a great misunderstanding, even among experienced option traders. This must be clarified before moving forward. The misunderstanding is often seen expressed online and in the literature: “75% of long options expire worthless.”

    By Michael C. Thomsett,

    • 0 comments
    • 371 views
  • Option Payoff Probability

    Many options analyses focus on profit, loss and breakeven. These show what occurs on expiration day, assuming the option remains open to that point. But this is not realistic. Most options are closed or exercised before expiration, is calculation of how probable a payoff is going to be, how likely the loss, or the exact neutral outcome (breakeven), are all unrealistic.

    By Michael C. Thomsett,

    • 0 comments
    • 470 views
  • Value of Trend Following During Periods of Market Volatility

    Our trend following system looks at two things when planning a position. The first piece is obviously the direction of the trend.  Does the system signal up or down?  The second piece of a position plan is how much risk we are going to take. 

    By RapperT,

    • 1 comment
    • 1,050 views
  • Intrinsic vs. Extrinsic Value

    A lot is written about intrinsic value, but how does it work and what does it mean? The fact is, intrinsic value is an estimate of how future premium levels will change. It is base don current volatility and a set of assumptions. In dividing premium into its component parts, most descriptions deal with intrinsic and time value.

    By Michael C. Thomsett,

    • 0 comments
    • 525 views

  Report Article

We want to hear from you!


Great article @Jesse

I think the psychological factor is one of the most important - yet one of the most overlooked. Even if the put writing performs the same as S&P 500 (and we do expect that Steady Momentum will outperform with our tweaks) - the average investor has a much better chance to stay in the game and not to panic. Experiencing 50%+ drawdown on your portfolio is not easy - reducing it to only 30% goes a long way. And with the tweaks, it should actually be even smaller.

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