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.

Maximize Returns With Option Overlays


Investors in 2018 are faced with a challenging investing environment for both US stocks and bonds. So what can an investor do to increase portfolio returns without taking on too much additional risk? Those comfortable with and capable of trading simple option income strategies like strangles may be able to accomplish this objective.  

A popular option strategy is the short strangle, which consists of selling an out of the money put and call. My personal backtesting and real trading experience is that this strategy on equity market ETF's or cash settled indices can increase portfolio diversification and if overlaid on a portfolio of underlying assets like mutual funds or ETF's can also increase total returns. 

 

When you sell a strangle, you bring cash into your account. By doing so, you can "overlay" this trade on top of a portfolio consisting of ETF's or other investments without paying margin interest. Before we get too deep into the weeds, lets deal with the elephant in the room...you've heard strangles are risky. Is that true? The answer isn't that simple, as the trade isn't what measures risk, instead, it's the position size. Excessive leverage is risky, but strangles don't have to be traded this way. I'd encourage every option trader to not only consider the margin requirement of any particular option trade, but the notional risk. For example, think in terms of a 1 contract SPY strangle with SPY trading at $280 as theoretically being a $28,000 position (stock price X 100), similar to how buying 100 shares of SPY at $280 is a $28,000 position. When sized this way, a typical strangle will actual have less risk than the underlying asset.

 

With this in mind, let's look at a rough example of how we could implement this idea in a $100,000 account. First, we'll look at the performance of a 50/50 stock/bond portfolio that is rebalanced monthly since 2000.

 

1.png

 

This portfolio would have returned a little over 5% annually, with a standard deviation of 7.31%, producing a Sharpe Ratio of 0.54. 

 

Next, we'll add a 50% strangle allocation to this same portfolio. Yes, this equals 150%, which does make this concept only possible in a taxable margin account. The strangle allocation is based on our own backtesting platforms and proprietary rule sets and includes hypothetical trades on both SPY and IWM. A trader would sell 2 strangles on SPY in a $100,000 account to approximately replicate the concept. 

 

Blue: Stock/Bond Portfolio

Red: Stock/Bond/Strangle Portfolio

 

 2.png

 

The 50/50/50 portfolio nearly doubles the annualized return to over 10%, and only with a modest increase in standard deviation to 8.37%. This increase in risk adjusted return substantially improves the portfolio Sharpe Ratio to 1.05. Even with a 50% increase in total portfolio allocation, the portfolio risk only slightly increases due to the low correlation of the strangle strategy to both stocks and bonds. This example is only meant to show the concept of an option overlay in action, and the potential benefits of doing so. Many other creative ideas could be implemented with other underlying assets and option strategies. My investment advisory firm, Lorintine Capital, currently implements these concepts in managed accounts as well as in one of our private funds, LC Diversified Fund. We are happy to have discussions with investors interested in a professionally managed solution, or ideas on how to implement this concept on their own.  

 

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. 

Edited by Jesse

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

  • Options: Debt and Net Return

    This is the last in a series of articles about how dividends affect option value and volatility. In picking stocks for options trading, what are your criteria? Analysis of dividends, debt and net return – all fundamental tests – help identify strong value companies (and lower-volatility options) versus weak, high-risk stocks.

    By Michael C. Thomsett,

    • 0 comments
    • 166 views
  • Can you "Time" the Steady Momentum PutWrite Strategy?

    As a financial advisor, investment advisor, hedge fund manager, model developer, and newsletter signal provider for over a decade now, I've had the opportunity to see quite a bit of human nature in action.

    By Jesse,

    • 0 comments
    • 200 views
  • How Steady Momentum Captures Multiple Risk Premiums

    Our Steady Momentum PutWrite strategy attempts to outperform the CBOE PUT index, which writes cash secured puts on the S&P 500. An investable version of this strategy can be purchased with the ETF PUTW. The historical data for PUT extends back more than 30 years, highlighting how writing puts can be an attractive strategy.

    By Jesse,

    • 0 comments
    • 438 views
  • The Effect of Dividends on Options Pricing

    The theory of dividends and underlying stock prices is simple: The underlying price is expected to decline on ex-dividend date, by the amount of the dividend. As a result, option prices should decline as well. Under this theory, calls for higher dividend stocks should be valued lower and puts should be valued higher.

    By Michael C. Thomsett,

    • 0 comments
    • 313 views
  • 5 Ways To Identify Fake Forex Broker Reviews

    Many traders or future traders shop for a broker to work with and find endless reviews on the web, and not all are genuine. Here are 5 ways ways to separate the good from the bad. There are lots of sites that specialize in forex broker reviews and lots of talk about brokers in various forums.

    By Kim,

    • 0 comments
    • 180 views
  • 3 Dividend traps to Watch For

    Dividends are almost universally viewed as positive aspects of stock selection and options trading. The higher the dividend yield, the more positive. But does this ignore some dangers in dividend trends? In fact, there are three ways in which dividends can mislead traders and create positive impressions when in fact, the news is negative.

    By Michael C. Thomsett,

    • 0 comments
    • 248 views
  • Dividends and Options

    Steady Options has received numerous inquires into how dividends impact options, option prices, and the owners or option contracts. The impact of dividends should be understood by any option contract trader.  Fortunately, the rules for option contracts and dividends are clear and straightforward. 

    By cwelsh,

    • 0 comments
    • 283 views
  • When Can You “Trust” a Backtest?

    There's a joke in the financial industry that "nobody has ever seen a bad backtest". There certainly are bad ones, but nobody ever markets them. They just get thrown in the trash. Even academics can fall prey to this.

    By Jesse,

    • 0 comments
    • 230 views
  • Increasing Yield Through Covered Calls

    When starting out with options, a natural place to begin is with covered calls. It’s a very easy to understand strategy for those that are familiar with stock ownership. The strategy involves buying a stock in lots of 100 shares. The total size will depend on you account size and how much exposure you want to take.

    By GavinMcMaster,

    • 0 comments
    • 327 views
  • Alternative Investments: Real Estate Construction

    One of the most common complaints received from investors relates to low yields, low returns and/or the inability to have a reasonable cash flow from investments. This is particularly true for investors who feel that they have too much invested in the stock market.  Many want to diversify into real estate of one form or another.

    By cwelsh,

    • 0 comments
    • 214 views

  Report Article

We want to hear from you!


Thank you Jesse for a very interesting perspective of selling strangles.

As many of you know I'm not a big fan of selling naked strangles. However, as Jesse mentioned to me, people think they are ‘risky’ b/c of horror stories like Karen the ST…but it’s not about the trade that made what she did risky, it was excessive leverage.

The bottom line is that a short strangle by itself is not necessarily "risky" if it's done with responsible position sizing. 

Share this comment


Link to comment
Share on other sites

I agree 100% - "risk" is not defined strictly by the type of position, but by proximity between strikes and resistance/support, moneyness of option to current price, volatility level, and number of positions opened. One of the great problems in the industry is a perception that risk is identified simply by the title of the trade. It is more complex.

 

Share this comment


Link to comment
Share on other sites

Interesting article Jesse - would be a lot stronger / more substantial with a) guidance on what deltas to sell and b) what deltas were sold in the back testing of the strategy from 2000 (assuming a consistent strategy was applied).

Do those backtested returns imply being short the strangle through expiration? 

What's the plan for managing it if under pressure?

Thanks, Sam

 

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