I'm not referring to just returns but risk adjusted returns that are above similar investment opportunities. I'm not really well read in options but it appears to me that some folks like to consistently sell index options on the belief that on average it will be a good bet. It probably is but they are forced to 'stay small' because of risks associated with tail events. Lets say such strategy generates 10-20% a year and the drawdowns are around 50-60% when a tail event hits. These numbers seem to be quite similar to being long emerging market equities so there doesn't seem to be much benefit of such approach. Am I wrong for thinking like this? If there are superior risk adjusted returns, why wouldn't hedge funds be all over this strategy and compress its returns down to other similar vehicles? It seems a very easy strategy to apply psychologically so I don't see why the returns wouldn't be compressed as more participants would come in
Does selling index options offer above average risk adjusted returns?
- Thread starter Daal
- Start date
Short answer is yes. Caveat: just because it worked last 25 years doesn't guarantee future results. Data see http://www.cboe.com/micro/put/
Is there an ETF for that? This looks like an interesting investment for day traders. Most good day traders report that bear markets are usually good years for their trading beause of the volatility. Being invested in one of these could provide an interesting hedge for them. Either they make money on that or they lose but benefit from the increased volatility.
Although upon a little reflection this thing seems quite fishy. "Based on one dollar invested on June 30, 1986, index growth through December 31, 2011 was: 1153 percent for the PUT Index, 830 percent for the BXM Index, 807 percent for the S&P 500 Index, and 368 percent for the CLL Index.". 1 index beat the market, 1 matched and the other one lagged. Of course, they will tout the one that beat but going forward the strategy might get crowded. Not much different from the 'small cap effect'
A couple of points. If one is long the S&P 500 index over time and holds it, they incur no commission costs, pay no taxes year to year and have no slippage. A put seller every month incurs a short term tax each and every month. Pays a spread on every put sold and pays a commission. The total value of that alone in future dollars is HUGE. Just get out an excel spreadsheet and run the numbers 30 years out. Probably cuts the profits by half.
Second point. When you analyze data it's very important to look at your starting point. For example, if we looked at real estate returns starting from after WWII to any period going up to 2007 they look great because you got the benefit from starting at zero basically. Anyone who bought their first house in 2007 is lucky to be at breakeven.
Same is true for volatility. Before the "great moderation" vol was consistently much higher. So including this data in your sample is not wise. Rather, only use the data where we start the VIX at 12, say from 2004 or 2005 to the present. That will change the data dramatically. If the VIX stays consistently in the sub 15 range, I believe there is no way on a risk adjusted basis that selling premium makes sense especially when you factor in commission, taxes and spreads.
SPXL is a good etf to mirror options performance.
Good points
Let me try to add some data to my argument. Now this is not an apples to apples comparison but close. I'm attaching a PDF of a mutual fund that primarily sells cash covered options. I know it states in the prospectus that they also buy options but this is very infrequently. Their goal is to harvest premium by selling it. They do NOT use margin. This is important because once people start leveraging this strategy they get blinded by the returns. So in other words, if they have enough money in their account to buy 100 shares of SPY in notional terms, they would only sell one spy put thereby being cash covered.
This fund has been around for 5 years and they benchmark to the S&P 500 buy write index (CBOE). They also show you their returns "before" and "after" tax distributions. Also I don't think their numbers are updated yet for August in the table but you can see what they did on the chart. They gave back everything. For the most part, they have under performed the S&P 500 by half. I know this is not a perfect comparison but it does bring "real" trading and "real" fees, expenses and taxes and execution into the dialogue.
This fund has been around for 5 years and they benchmark to the S&P 500 buy write index (CBOE). They also show you their returns "before" and "after" tax distributions. Also I don't think their numbers are updated yet for August in the table but you can see what they did on the chart. They gave back everything. For the most part, they have under performed the S&P 500 by half. I know this is not a perfect comparison but it does bring "real" trading and "real" fees, expenses and taxes and execution into the dialogue.
Let me add another data series. This ETF sells naked puts on the 20 most volatile stocks (i.e highest implied vol) at 85% of cash value. So again, no leverage here and slightly below one to one. Interesting concept. We have two years of performance to look at. Their target is to earn 10% a year which is actually pretty good.
As you can see, they were pretty much on target in 2014 and 2015 until August. Then in one month they gave back 100% of what they made the last two years.
Again, all I'm doing here is trying to show actual data of the actual performance of these strategies in an execution environment vs hypothetical. Once you strip out the leverage, the numbers really aren't there. The performance curve in almost all cases "are" smoother though. But the ride down is always the same.
As you can see, they were pretty much on target in 2014 and 2015 until August. Then in one month they gave back 100% of what they made the last two years.
Again, all I'm doing here is trying to show actual data of the actual performance of these strategies in an execution environment vs hypothetical. Once you strip out the leverage, the numbers really aren't there. The performance curve in almost all cases "are" smoother though. But the ride down is always the same.
SPX puts are for sure overvalued the last 20 years, this is has been looked at from every angle, there is alpha in them thar indexes.
That said, I think mechanically selling premium every month on the index is, well, simple-minded (and potentially life-altering/dangerous if done with leverage or an incomplete understanding of the risk profile).
The times to sell premium are after a disaster. It will be overpriced because the sellers who survived will demand a serious pound of flesh to do the same thing that just vaporized them, and buyers will be so terrified they are willing to seriously overpay for the insurance.
People who just say I'm going to sell 45 DTE puts constantly on the SPX should really just go tactically asset allocate. If they want leverage just do portfolio margin leverage on your asset allocation. Thank me later.
That said, I think mechanically selling premium every month on the index is, well, simple-minded (and potentially life-altering/dangerous if done with leverage or an incomplete understanding of the risk profile).
The times to sell premium are after a disaster. It will be overpriced because the sellers who survived will demand a serious pound of flesh to do the same thing that just vaporized them, and buyers will be so terrified they are willing to seriously overpay for the insurance.
People who just say I'm going to sell 45 DTE puts constantly on the SPX should really just go tactically asset allocate. If they want leverage just do portfolio margin leverage on your asset allocation. Thank me later.