Leaderboard

In addition to the S&P 500, CBOE also tracks the same strategy on RUT with their index PUTR. Below is the historical data since 2001. Portfolio 1: PUT Portfolio 2: PUTR Past performance doesn't guarantee future results, and shouldn't be relied upon exclusively when making investment decisions. PUTR has beat PUT by 210 bps from 02/2001 - 05/2019, which is largely explained by the fact that IWM beat SPY by 199 bps (7.47% vs. 5.48%). This should not be thought of as random chance, as academic research has found there to be a persistent and pervasive size premium (small outperforms large...see charts below from Dimensional) in the historical data that is intuitive as a risk premium. For example, we can see that PUTR's 40% relative higher return (7.26% vs. 5.16%) came also with 25% higher risk (13.5% vs. 10.75%). Therefore the Sharpe Ratio's are similar. This is what would be expected in a world of highly (although not perfectly) efficient markets...All asset classes are expected to have roughly comparable Sharpe Ratio's over a long period of time, and therefore the best way to increase your expected Sharpe Ratio is with diversification. This same thought process of an expected long term risk premium can be applied to our usage of collateral in the form of ~ 5 yr treasuries. I had Dimensional create the following chart, highlighting the persistence of 5 yr treasuries outperforming T-bills since 1926. I hope readers find this type of scientific data analysis transformational to your way of thinking, as I know I certainly did when I first learned of it. I believe this type of thought process should inform your entire investment portfolio, not just this particular strategy. For example, this same process has also gone into the construction of our ETF portfolio alerts, which are provided to Steady Momentum subscribers at no additional charge. If you were seeking out advice for a health related issue you were having, wouldn't you rather get that advice from a professional who has spent their career studying peer reviewed scientific research vs. picking up a magazine at the checkout line at the grocery store or asking a friend/family member/co-worker what they think you should do? These sources of advice may be sincere, but the consequences of bad advice are simply too high. If so, shouldn't the same standard apply to your financial planning and investment decisions? 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.

It is not. (Well, it is rarely a problem). In fact, almost 99% of the time, early assignment is a better outcome. Below will set forth two common assignment examples, work through the potential outcomes, and demonstrate why assignment is typically a better outcome than having just held the position. For Steady Option’s Anchor members, there is a persistent risk of being assigned a long stock position on the income producing portion of the strategy (the short SPY puts). This only happens in sharp market declines or very close to rolling of the position, but it can happen. Assignment risks increases the closer the position gets to a delta of 1. Most recently, this happened the week of May 13, 2019.For purposes of this example, we’ll use the actual SPY positions and walk through what did occur and could have occurred in other possible market situation. In early May, the strategy sold four contracts of the May 20, 293 put for $3.11. The market started to drop. On May 19, 2019, the options were early exercised when SPY hit 285. The value of the contract when assigned was $8.11. All of a sudden, most accounts had 400 shares of SPY and were down $117,200 (4 contracts x 100 x $293). Most accounts don’t have cash in them to cover the position and may have received a Reg-T notice (a Reg-T notice is a form of a margin call by your broker). What is a trader to do? Well first, the next trading day, simply close the position. Sell the stock, and the margin call should be covered. If it’s not, you can always sell other holdings to cover it. The way the Anchor Strategy is structured, it is virtually impossible not to have available cash or stock to cover in this situation. After closing the assigned position, is the trader worse or better off than if the position had been held? In all market conditions (up, down, flat), the trader is either in the same position as not having been assigned or better off. Note: This assumption ignores transaction costs. Some accounts have assignment fees, different commissions for buying and selling stocks and options and other various fees. These fees could make a difference on the analysis, depending on a trader’s individual account. Since such fees vary widely, the below discussion ignores all fees. The Market stays flat, SPY stays right at 285 In this case, the trader sells the assigned shares back at $285, facing a loss of $8.00/share. ($293 - $285)[1]. In other words, the trader has lost $1,956 ($8 stock loss less $3.11 received for selling the original position). This seems like a poor outcome. [1] For purposes of this article, I am going to ignore the fact that the position was hedged and look at it just from the assignment point of view. However, this is better than if the trader had just closed the short put at $8.11 at the market open. In that case, the trader would have lost $2,000. (($8.11 - $3.11) x 4 x 100). By being early assigned, the trader saved $0.11/share. This is what actually happened in actual trading the week of May 13. The Market moves up the next morning What would have happened though if the market had gone up? Let’s say to SPY $288. In this case, instead of selling the stock back at $285, you would sell it back at $288. That is a loss of $5 per share ($293 - $288) for a total loss of $756 on the trade ($5 - $3.11). Once again, the trader is better off. Delta of the short put is not one, rather it had a dynamic average of .95. This means the value of the put would have declined not to $5.11 (the previous price of $8.11 - $5.11), but, by $2.85 to $5.26. Closing that option position would result in a loss of $860 on the trade ($5.26-$3.11). The Market goes down The scariest situation for a trader is waking up the next morning and the market has declined. Instead of SPY $285, the market might have continued to go down to SPY $282 (or worse). In this case, the trader sells the stock for $282, resulting in a loss of $11 per share for a total loss on the trade of $3,156 ($11-$3.11). Yet again, the trader is better off. With the market going down from $285 to $282, the dynamic delta average is .98 and time value has dropped a bit, and the short put is now worth $11.03. Closing this put for a loss of $11.03 results in a total loss on the trade of $3,168. Even if the market had plunged down to SPY 100, the two positions would have been equivalent – meaning that the loss by being assigned equals the loss of having been in the short put. In other words, in every market situation, the trader is either better off or exactly the same when assigned the position rather than having simply held the short put. The closer delta is to 1, the more likely you are to be assigned, but even in that situation, you would be no worse off between assignment and holding. But if that’s true for puts, is it also true for calls? Let’s take a common example. You sell 5 contracts of the $100 call on Stock ABC that is currently trading at $99 for $2.00. You are now short the $100 call. You receive $1,000. It expires in 3 weeks. Two weeks from now the stock is trading at $99.80 with earnings coming up tomorrow, and the option is trading at $1.00.You have $1,000 in cash and -$500 in call value. Someone exercises the option. The next morning your account looks like: Short 500 shares ABC at a value of $49,900 Long $51,000 cash ($50,000 for sale of stock at $100/share plus $1,000 from the sale) Are you in trouble? Did you lose money? Once again no, you’re not. Let’s look at what happens in each situation at market open: The Market stays flat at $99.80 In this situation, you buy back the 500 shares of Stock ABC for $49,900. You keep the $51,000 and did not have to buy back the call. So you’re up $1,1000. If you had not closed the position out, not been assigned, and the market stayed flat, the price of the option may have declined to around $0.50. Clearly, you are better off because of the assignment – by over $800. The Market goes down (any amount) Earnings come out and the price drops to $90 (or any value below $100). In this situation, you buy back the 500 shares for $45,000. You keep the $51,000 and did not have to buy back the call. So you’re up $6,000. If you had not closed the position out, not been assigned, and the market went down, the price of the option may have declined to $0.01. Again, you are better off because of the assignment – by almost $6,000. The Market goes up by less than $2 (to under $102) Earnings come out, and the price increases to $102 (or anything between the last close and $102). You buy back the shares for $51,000. This nets out the cash you already had and did not have to buy back the calls. In this situation you break even. If you had not closed the position out, not been assigned, and the market went up, the price of the option contract would have increased to at least $2.00. In this case, you are in the same boat because of the assignment. Closing the short contract at $2.00 would cost you $1,000, which nets to $0.00 with the $1,000 you received from the sale. The Market goes up by more than $2 (e.g. $110) Earnings come out, and the price increases to $110. In this situation you must buy the shares back for $55,000. Offsetting with the cash already received, you have lost $4,000. If you had not closed the position out, not been assigned, and the market went up a significant amount, the option price would have increased to at least $10. Closing this short contract out will cost $5,000. You are again better off because of the assignment. In other words, in every situation you are in an equal or better situation because of an assignment. This is because options have time value – which an early assignment forfeits to the option contract holder. Even if the option contract had no time value left in it, the worst situation is still break even. The only real risk to assignment is failing to quickly move and adjust the position (eliminate the oversized short position), your account goes into a Reg-T call, and your broker starts closing positions in a non-efficient manner.There are brokers who also require margin calls to be covered by cash deposits, instead of adjusting positions. (Very few). If that’s the case, you may get a demand for cash (and switch brokers). As long as you stay on top of your positions and address any assignments, there is no reason to fear early assignment since in all situations you will be either equal or better off on early assignments. This is why I am almost always surprised by early assignments. The only time early assignment really ever makes sense is on surprise dividend announcements that weren’t originally calculated into the option prices – and even then, as the price of the option likely moved before the assignment occurred, there may be no impact. What any option investor should always keep in mind is what to do if they get assigned early, what that will look like, and what trades will need to be entered the next business day. Being prepared prevents fear and mistakes – particularly when there is no need for that fear in the first place. Christopher Welsh is a licensed investment advisor and president of LorintineCapital, LP. He provides investment advice to clients all over the United States and around the world. Christopher 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. Christopher has a J.D. from the SMU Dedman School of Law, a Bachelor of Science in Computer Science, and a Bachelor of Science in Economics. Christopher is a regular contributor to the Steady Options Anchor Strategy and Lorintine CapitalBlog. Related articles Can Options Assignment Cause Margin Call? Assignment Risks To Avoid The Right To Exercise An Option? Options Expiration: 6 Things To Know Early Exercise: Call Options Expiration Surprises To Avoid Assignment And Exercise: The Mental Block Should You Close Short Options On Expiration Friday?

The important point is that these lessons are simple and can be systematized so that in real-time you can simply follow your well-designed plan without having to interject human judgement which is often heavily influenced by emotion and short-term performance. For example, below are the net returns of four funds representing four distinct equity asset classes from 1995-1999. This example is meant for illustrative purposes only, and past performance doesn’t guarantee future results. Notice the stark differences in performance during this time period. US equities dominated both International and Emerging Markets, especially US Large Cap compared to International Small Cap Value. Considering that the average investor instinctively thinks five years is a long enough period of time to evaluate performance, what do you think he or she might feel like doing at this point? Certainly not rebalance the portfolio back to its original weighting by selling a material amount of SPY to buy DISVX. That would feel backwards, but it’s an important part of successful long-term investing. Let’s now look at the next decade, from 2000-2009, to see why. What a contrast. From 2000-2009, US Large Cap actually produced a loss and International Small Cap Value produced the largest gain. Since most investors are over concentrated in US Large Caps, it explains why this period is referred to as “The Lost Decade.” This clearly wasn’t true of all stocks in the US or the rest of the world as we can see. Investors who abandoned diversification in 1999 would have experienced a lot of pain in the 2000’s, while the average of the four asset classes was more than double the starting value. Let’s now put the entire 1995-2009 period in context and also highlight the power of rebalancing. During this entire period, we see all four asset classes produced strong results with the average growth of $100,000 being $369,560. In other words, if an investor put $25,000 into each fund in 1995 and did absolutely nothing, the investment would have been worth $369,560 at the end of 2009. This is a compounded annual return of 9.11%, which highlights the power of equity investing. Yet you’ve probably noticed I’ve added one additional line item to highlight the benefits of rebalancing a portfolio. The rebalancing rule is as follows: Each month, review if any of the funds have drifted by a relative 25% from their target weightings. Since we are targeting 25% in each fund in this simple illustrative example, that means you would rebalance anytime a fund has drifted by more than 6.25% from the target 25% allocation. In other words, as long as each fund’s current weight is between 18.75% and 31.25%, you do nothing. During this period of 1995-2009, you would have rebalanced only eight times. But as we can see, rebalancing would have added more than $45,000 to the portfolio, increasing the compounded annual return to 9.95%! This is more of a “rebalancing premium” than we should expect over the long term, which is no surprise since I intentionally picked funds and a time period for this article to emphasize a point. Vanguard has expressed in its “advisor’s alpha” concept that a good advisor can add “about 3% per year” of value to a client’s situation of which 0.35% per year is estimated to come from disciplined rebalancing. This rebalancing premium is intuitive when we stop and think about it, as it forces us to “buy low/sell high.” Conclusion Human nature is a failed investor, and the best way to overcome the most common investor mistakes is with a well thought out evidence-based plan that incorporates the important concepts of equity asset class diversification and disciplined rebalancing. Working with a financial advisor who intimately understands these concepts can help improve the odds of a successful long-term investment experience. 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. Related articles Cash Is (No Longer) Trash Investment Ideas For Conservative Investors The Importance Of Time Horizon When Investing Steady Momentum ETF Portfolio Equity Index Put Writing For The Long Run