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

  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 7 comments
    • 603 views
  • What Trading Can Offer To A Newcomer

    For any first-time investor, one of the most important questions to ask is “why are you doing this?”. Getting into investment can be thrilling and open up new worlds for you, but it can also be draining both physically and emotionally, with long days and sudden market moves always a genuine risk.

    By Kim,

    • 0 comments
    • 101 views
  • Updated: The Performance Gap Between Large Growth and Small Value Stocks

    Eight months ago on July 21st 2020 I posted an article, The Performance Gap Between Large Growth and Small Value Stocks. Over the long-term small cap value stocks have outperformed large cap growth stocks, although not over more recent history.

    By Jesse,

    • 0 comments
    • 263 views
  • 6 Ways to Invest Your Money That Aren't Cash Savings

    It’s always a good idea to keep some of your money in cash so if there is an emergency and you need money in a hurry, you can access it without having to worry. However, cash savings are not your only option if you have money left over at the end of the month, and there are a lot of other options that could bring greater returns.

    By Kim,

    • 0 comments
    • 320 views
  • Jade Lizard Options

    The jade lizard is one of those bullish spreads with limited maximum profit, and no risk on the upside. It is a combination of a short put with a short call spread . The credit this creates is higher than the span of the spread. To set this up, two actions are required:

    By Michael C. Thomsett,

    • 0 comments
    • 547 views
  • Are Your Emotions Trying To Tell You Something?

    As a trader, you may find yourself frequently trying to ignore or rationalize emotions.  You may have even created your own “solutions” to manage them. You exit early to lock up profit and avoid a potential blow-up if the trade turns against you.

    By Jared Tendler,

    • 0 comments
    • 360 views
  • Stock Trading Basics: 5 Rules for Successful Stock Trading

    You might be a stock trader, or just interested in learning more about how to trade and make the most out of your stock investment. Regardless, successful stock trading is not that easy. You must first have the financial capital to start and a very great endurance for risks.

    By Kim,

    • 2 comments
    • 505 views
  • Hourly Financial Advice for DIY Investors

    A large percentage of the Steady Options community consists of do it yourself (DIY) investors who prefer to manage their own trading and long-term investing accounts. This is a great way to gain firsthand experience about how markets work, but at times it may be beneficial to get professional input on investing and other personal financial planning decisions.

    By Jesse,

    • 0 comments
    • 309 views
  • Seagull Spreads

    Some varieties of call and put spreads are also called seagull spreads. It is so called because it contains a body and two wings. If the body is short, the wings are long, and vice versa. This 3-contract strategy includes two calls and a put, or two pouts and a call.

     

    By Michael C. Thomsett,

    • 0 comments
    • 435 views
  • Are Hedge Funds Good Investment for You?

    Right now, people are feeling at a bit of a loss as to what to do with their money. Those who usually invest are probably well aware that the market is pretty tricky right now. During unprecedented times, there are often unprecedented outcomes when it comes to investments.

    By Kim,

    • 0 comments
    • 436 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 Expertido