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Uncovered put Covered call Dividends are not earned. Dividends are earned as long as shares are held. The uncovered put can be exercised, but this can be avoided easily, by closing the position, rolling it forward, or waiting for worthless expiration. Covered calls can be exercised, and 100 shares of stock must be delivered at the strike. Exercise can be avoided by closing or rolling the in-the-money covered call. Time is an advantage. The closer to expiration, the more rapidly time value declines. The uncovered put can be closed at a profit or allowed to expire worthless. Time is an advantage. The closer to expiration, the more rapidly time value declines. The covered call can be closed at a profit or allowed to expire worthless. Moneyness determines whether to close or roll the uncovered put. An out-of-the-money put will expire worthless; an in-the-money put is at risk of exercise. Moneyness determines whether to close or roll the covered call. An out-of-the-money call will expire worthless and can be replaced; an in-the-money call is at risk of exercise, in which case shares will be given up at the strike. Collateral is required equal to 20 percent of the strike value, minus premium received for selling the put. This is advantageous leverage when compared to the covered call. No collateral is required for a covered call. However, to buy 100 shares of the underlying, 50 percent must be paid, and the remaining 50 percent is bought on margin. The timing for opening a naked put is essential to reduce exposure to unwanted exercise. The best position for a naked put is when the underlying price moves through support and you expect price to retrace back into range. For example, the chart for Amazon.com (AMZN) shows examples of when this occurred. The highlighted price moves both fell below the trendline shown on the chart. Given the long-term bullish trend for AMZN, it was reasonable to expect the price to reverse to the upside. This is what occurred in both instances. A second consideration is creation of a buffer zone between current price per share and the selected strike for the short put. Because AMZN is a high-priced stock, the opportunities for buffer zones are significant. For example, after the huge decline in February from nearly $1,500 per share down to 21,350 by February 6, anticipating a rebound would be well-timed. During the trading day of February 8 and about 30 minutes into the session,AMZN was trading at $1,416.36 per share. A couple of naked put trades to consider at that moment: The 1,410 put expiring in one day (Feb. 9) was at a bid of 10.05. This is incredibly rich considering the one-day expiration. The strike was six points below current price. That, plus the net $1,000 for selling the put, sets up a buffer zone of 16 points. The 1,362.50 put expiring in eight days (Feb. 16) showed a bid price of 13.05. This is 54 points below current price. Adding the 13 points received for selling the put, this creates a 67-point buffer zone over an exposure period of eight days. Time decay will be rapid. Typically, options expiring in one week lose 34% of their remaining time value between Friday and Monday. In this example, that spans February 9 to 12 – three calendar days but only one trading day. The timing and buffer zone are the two keys to a successful short put strategy. Whether you select extremely short-term (one day) or a little longer (eight days), the profit potential is attractive, in large part due to the recent volatility in the market and in AMZN, which fell 150 points in two days. The extreme move in price makes the point that timing is everything with this strategy. The likely bargain hunting at such a low price makes an upward move likely. By February 8, price had always moved from the low of $1,350 to $1,416, recovery of 66 points out of the 150 points previously lost. As with all options strategies, especially those involving a short position, this one has to be monitored every day. Because things change rapidly in volatile markets, you need to get out when you can to maximize profits or, in worst case situations, to mitigate losses. The need for a buffer zone and attractive premium levels makes the naked put a potentially profitable strategy, even for the conservative trader. Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Publishing as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.
If 75% to 90% of "professional" money managers fail to beat the S&P500, then you are also guaranteeing better results than most "professionals". So, overall you are being extremely lazy, keeping trading costs to a minimum, as well as tax liabilities. You are paying very little attention to the markets and still, beating the vast majority of participants while nicely growing your nest egg. I also argued that perhaps selling out of the money Calls, in addition to holding the index, was even better but I was not sure until I saw the evidence: BXM, an index that simulates a permanent Covered Call strategy on the S&P500 and has beaten the market in almost three decades. I discussed BXM in the Covered Call vs Buy and Hold article. Well, today I want to talk about another very simple strategy that beats most traders/investors: Short Puts on the index, the CBOE PutWrite Index (PUT) Option selling strategies constantly cap the maximum profit in your positions. If you are Short Puts and the market rallies +30% like it did in 2013, then you make money but the buy & hold investor outperforms without question as he didn't put a ceiling to his maximum potential profit. This can be illustrated by the last five years of unstoppable Bull markets: However this is the only scenario where the PUT index under-performs. Option selling strategies constantly reduce cost basis and generate more consistent profits which overtime lead to out-performance over the Buy & Holder and smoother equity curves (Just notice in the small example above how the draw-downs are smaller for PUT). If you are selling a Put on an index and the market moves sideways you out-perform the buy & holder who went nowhere. If the index goes up, slightly (by less than the premium collected by the Put seller), the Short Put strategy still outperforms the buy and holder. If the market falls, the short Put loses, but the cost basis for the investor is smaller than that of the buy and holder, who is also losing. So, in these three scenarios the Short Put wins over Buy and Hold which only outperforms during very strong markets. Based on this idea, the PUT index was created by the CBOE years ago and it aims to simulate a permanent Short Put strategy on the S&P500. Taken from the CBOE site: "PUT is an award-winning benchmark index that measures the performance of a hypothetical portfolio that sells S&P 500 Index (SPX) put options against collateralized cash reserves held in a money market account. The daily historical data for the PUT Index now extends back to June 30, 1986." So, what is the performance of the PUT Index anyways? Well, according to the CBOE, going back to 1986 the PUT index has returned +1153% as of this writing, handily outperforming the S&P500's +807% return in the same period. What is more remarkable is the fact that it has done so with about 30% less volatility than the S&P500. In terms of Risk Adjusted Returns, PUT shows a Sortino Ratio of 0.90 vs 0.50 for the S&P500. So, less risk, better returns. It's not that the strategy has obtained better returns because it is "riskier". It is in fact less risky. Without a question, PUT is a superior strategy than Buy & Holding SPY (as proxy for holding the S&P500). But what about BXM? Is PUT better than BXM, the permanent Covered Call index? Again going back to the CBOE data, the answer is an unequivocal yes. Both PUT and BXM have outperformed the SPX and have done so while suffering about 30% less volatility than the S&P500, but in terms of absolute returns, PUT beats BXM. Since 1986: PUT: +1153% BXM: +830% S&P500: +807% That is as of this writing (October 2015) The next interesting step would be to investigate how a portfolio made up of both PUT and BXMperforms, with half the capital allocated to each index. I'm curious about the potential of that approach where you are owing SPY, receiving dividends from it, selling Covered Calls on it and additionally shorting Puts to constantly reduce cost basis. All happening at the same time. This simulation is possible given the fact that the data on both indexes is public and free. So, I'll see what I can do. Even if the absolute return of this approach is about the same, it could still be worth it if it shows better risk-adjusted returns and even smaller draw-downs. Folks, has anybody seen some research on this? A portfolio combining both PUT and BXM? If so, feel free to share in the comments section. Another nice thing about PUT is that it is compatible with tax advantaged accounts, like an IRA. Even though deep down, the mechanic is that of naked short selling, in practice you are simply "long" an Index, so it's perfectly legal. If I were a passive Index follower with a very long term horizon of more than a decade, I would definitely invest in BXM and PUT instead of the S&P500. Without question. That way, I'm not only beating the majority of retail traders and professional money managers. I'm also beating passive index followers in the long run and suffering much less throughout the process (less volatility and smaller draw-downs). UPDATE: After some email communication with readers it has been confirmed that both the PUT index and BXM index are just benchmarks for a public strategy but cannot be invested on directly. However, there are instruments that follow both index and can be used for investing or active trading. PBP can be used as a substitute for BXM and HVPW can be used as a substitute for PUT (Thanks Cherry) For more information on the PUT index, visit the following CBOE pages: - Definition and Results at a high level - The PUT index methodology - Research on PUT's out-performance over BXM This article was written by my good friend Henrik aka The Lazy Trader. The article was originally published here.
The options, by themselves, are not dangerous tools. I mention that because one of the long-lasting misconceptions about options is that they are dangerous to use. It is possible to use options to speculate (gamble), but options were created as hedging, or risk-reducing, investment tools. An alarming number of financial professionals, including stockbrokers, financial planners and journalists are in position to educate the public about the many advantages to be gained from adopting naked put writing (and other option strategies), but fail to do so. Many public investors never bother to make the effort to learn about options once they hear negative statements from professional advisors. Except for extremely bearish prognosticators, no one ever suggests that owning stock is anything but the most prudent of investment strategies. Yet, writing naked put options is a significantly more conservative strategy and definitely less risky than simply buying and owning stocks. As such it deserves to be considered as an attractive investment alternative by millions of investors. Who should consider writing naked (uncovered) puts? 1. Investors Who are bullish on the market Who are bullish on specific stocks Who want to buy a specific stock at a lower price Who adopt a buy and hold strategy Who want additional income from their holdings 2. Traders Who want a higher percentage of winning trades Willing to consider holding a position for a month or two Who want to begin a spread position with a bullish leg Strategy Objective Why would you want to write naked puts? What is there to be gained? Writing puts is a bullish strategy. When selling the put, you are attempting to achieve one of two investment goals: Profit. You are bullish on the stock and expect the put option to lose value, and perhaps expire worthless as time passes. If the latter happens, the option premium (cash from selling the put option) becomes the profit. Buy stock at a discount. If the put option is in the money when expiration arrives, you will be assigned an exercise notice and be obligated to buy the stock you want to own at a discount to today’s price. This is an intelligent method for an investor to gradually add positions to a long-term portfolio. NOTE: When you are eventually assigned that exercise notice, the stock may be below your target purchase price. However, if you had entered an order to buy stock at that target price, you would be in worse shape than the put seller (who cushioned any loss by the amount of the premium). This post was presented by Mark Wolfinger and is an extract from his latest book Writing Naked Puts (The Best Option Strategies). You can buy the book at Amazon or sign up for our free trial and get it for free. Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Mark has published four books about options. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University.
After 7 years of bull market, many traders forgot the meaning of risk. They think they can just buy call options and/or sell puts and make outrageous digits returns every year. I suggest that everyone reads Mark's post, it's an excellent read with a lot of wisdom. Is selling naked puts a good strategy? Mark's response is fairly long - here are the most important points: "This is not a conservative strategy. Not even close. It is a high probability play, with many profitable months. I cannot imagine a strategy in which I earn a profit month after month for several years. Yet this strategy could provide those results. The question is: how much is at risk? No matter what anyone tells you about risk, you just know that either nothing terrible is going to happen, or if it does happen that you will react in plenty of time. Let me assure you that in Oct 1987, puts were not buyable at any price that you would have been willing to pay. You did live through the winter of 2008, but if you have truly been doing this for 24 months, you began at the right time. You missed out on the excitement of Sep and Oct of that year. Have you considered what would have happened had you begun in August 2008, instead of 3 or 4 months later? If you have access to TradeStation (or if your broker offers back-testing – I believe thinkorswim does), go back to August expiration, choose options to sell for the Sep and Oct expirations and then follow the trades." I am NOT telling you what to do, but you have not been through what I have. You have not seen how quickly money can vanish from your account. What is your risk/reward? We are familiar with some services that advocate selling naked puts on 25-50% of their portfolio. In our opinion, this is a financial suicide. This strategy obviously performed very well in the last few years. Interestingly enough, the track record of those services usually doesn't go beyond August 2011, not to mention October 2008. One of them has data going back to 2009 (again, not 2008 ), but August 2011 is missing. Coincidence? To give a fair margin of safety, the strikes are usually far enough from the money to give you around 2-3% potential return on margin. Well, 2-3% per month sounds very good, but what about the risks? In a month like August 2011 (not to mention October 2008) the loss could easily reach 30-50%. In October 2008, it could wipe out your account. Is 2-3% per month worth the risk? The latest case of Karen the Supertrader who implemented similar strategy of selling naked options provides a good example of the risks. How our strategies handle risk? Let's take a look at our strategies and see how they handle risk. SteadyOptions At SteadyOptions, we trade a mix of non-directional strategies. They might include Iron Condors, Calendars, bufferflies, earnings straddles etc.. The idea behind earnings straddles is buying a straddle 5-10 days before earnings and hold it till earnings. The strategy is based on my Seeking Alpha articles Exploiting Earnings Associated Rising Volatility and How To Rent Your Options For Free. We expect the IV increase to offset the negative theta and/or book some gamma gains in case the stock moves. In periods of low IV, the earnings trades are expected to produce 3-5% average return, and theta positive trades like ICs and calendars are expected to provide us most of the gains. However, the earnings trades serve as a nice hedge to the theta positive trades in case of a quick and sudden move. To see how they performed when the markets become volatile, take a look at August 2011 returns here or July 2012 returns here. Those trades are basically our black swan event insurance, and we get it for free - in fact, most of the time we even make some money on it. Anchor Trades An Anchor trade's goal is to prevent loss of capital while still generating a positive net return in all market conditions. This strategy began with the premise that it must be possible to virtually fully hedge against market losses, without sacrificing all upside potential. It is expected to lag the S&P 500 in a strong bull market like 2013. In 2013 the lag was larger than expected due to poor selection of stocks. Going with ETFs instead of stocks would lag the S&P only by few percentage points, which means that the hedge almost paid for itself. The impact of not experiencing losses in down market years, while only slightly lagging (if lagging at all) in positive and neutral years, is astronomical over any extended period of time. Again, it is very easy to become complacent in the current bull market - but the market will correct at some point. It's not a matter of if but when. And when it does, you will be thankful that you are hedged. As an example, the Anchor return in May 2012 was +4.6% while S&P plunged -6.2%. In 2008 when S&P was down 38.4%, the Anchor was up 27.9%. Steady Condors Steady Condors is a market neutral, income generating, manage by the Greeks strategy. The trades are primarily risk managed variations of iron condors. The big difference (in addition to how the adjustments are made)between the Steady Condor main trade (MIC) and the "traditional" Iron Condor trades is the fact that MIC uses a put debit spread plus some far OTM puts for black swan event protection. This protection is placed when the trade is initiated - in other words, we buy protection when we want to, not when we need to. The result is that in case of market crash or black swan event, the trade actually becomes vega positive and those hedges provide an excellent protection. We conducted a case study for the August 2011 trade (available on members forums). It's a fascinating read. During the life of the trade, RUT was down over 11% - yet the trade was closed at profit target of 5% on Aug. 4. Interestingly enough, on Aug. 8 RUT closed down 64 points at 650. If you wouldn't have taken the trade off on the 4th the trade would actually have been up 67% at the end of the day on the 8th. This is the power of protection, combined with exploding Implied Volatility. Conclusion When comparing different strategies, don’t forget to consider both historical performance AND historical drawdowns in both up and down markets. Mark asks the following question: "How much will you lose if the market opens 20% lower one day, RUT IV (RVX) moves to 90 or 100, and the option markets get very wide?" This is your stress test - does your portfolio pass it? Want to see how we handle risk? Start your free trial