A CBOE study recently concluded that despite the perceived risk of shorting puts, the strategy has performed incredibly well, even during the crash. Specifically, the study tested selling at the money puts on the SPX one month out and investing the secured cash in three month treasury bills.
Trades are not risk free. Every investment has risk to it. Standard deviation quantifies said risk. On the other side, investors have reward. This could simply be annualized returns.
Putting the two together bring more context to the numbers. The risk reward of any strategy is key. When looking at the put-write strategy, the data is clearly favorable.
The study tested a number of options strategies from iron condors to covered combos and buy-writes. Out of all the samples, put-writes had the most favorable risk reward profile—an annualized standard deviation of The put-write dramatically outperformed its competition from a risk reward point of view, risking less for every unit of return.
Another factor to consider when looking at different strategies would be the historical drawdowns. With this in mind, put sales naturally have the worst case scenario of the underlying asset going to zero. The below profit and loss graph displays this.
While max loss is indeed a factor to consider, the data suggests this is not a likely occurrence, especially on an index with stocks in it. The premium received from selling the aforementioned put actually protected investors from realizing the entire max drawdown. The chart below displays the gross premiums received each calendar year for the put-write index and the recently launched weekly put-write index.
Investors will note the gross premiums received from the strategy directly correlate with spikes in implied volatility. Tweaking the duration of the short puts resulted in even better drawdowns.
The new WPUT index drawdowns are displayed below. This index sells at the money puts on a weekly basis and invests in one-month Treasury bills to cover the liability from the short SPX put option position.
The largest drawdown for the period tested was Weekly puts, when aggregated, brought in more premium than the monthly options each year during the study. Most famously Warren Buffett, one of the richest men in the world, is a fan of put sales. The Oracle of Omaha is a seller of puts in size. Some over the counter contracts expire out in January —a long term investment for him. On a mark-to-market basis, Mr. His investment has been working in his favor due to time decay and bullish price action.
Capping off the downside scenario is an answer to this problem. Investors can purchase an out of the money put option to limit the worst case scenario, thus reducing the capital needed to put on an investment like this, essentially making this a credit spread with a similar net position delta and theta for example , but not as extreme as it would be otherwise just naked short.
In any scenario or strategy, there is clearly an edge in writing put premium. The put-write, and buy-write for that matter, take advantage of this. Portfolios that leverage this data essentially bring in alpha from fading the implied move and keeping a positive net delta over time.
Overall the PUT outperformed its competition from a few angles: Similar studies have looked into put writing on different products. Similar results were also found. Similar logic can perhaps be also applied to single stocks. While historical data does not guarantee future results, studies like these give investors confidence when testing out a new strategy on a different product or when evaluating a new manager. Put sales have historically been an alpha generating strategy, as long as realized volatility ends up being lower than implied volatility.
Moreover, drawdowns and the risk-reward profile are equally important when evaluating said new strategy or put sale application. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities. Edge in Selling Options Part 2: Selling puts is normally characterized as dangerous; however, from , the strategy had the best risk-reward profile out of multiple strategies tested, as measured by standard deviation divided by total return.
Modern managers leverage the put-write to benefit in multiple market scenarios: Short puts have risk down to zero, but the put-write strategy actually had one of the lowest max drawdowns during the period tested. Risk Reward Trades are not risk free. Drawdowns Another factor to consider when looking at different strategies would be the historical drawdowns.
Oleg Bondarenko, University of Illinois at Chicago While max loss is indeed a factor to consider, the data suggests this is not a likely occurrence, especially on an index with stocks in it. Oleg Bondarenko, University of Illinois at Chicago Tweaking the duration of the short puts resulted in even better drawdowns.
Oleg Bondarenko, University of Illinois at Chicago Following the Big Traders Weekly puts, when aggregated, brought in more premium than the monthly options each year during the study. Oleg Bondarenko, University of Illinois at Chicago The put-write, and buy-write for that matter, take advantage of this. Options and Volatility Strategies Tech Trend:More...