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Old 11-13-2011, 08:11 AM   #101
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I've done enough research over the past 6-8 months and watched how naked puts perform in real time under just about any scenario to have full confidence that my back test was done correctly. Its not exact, but I have confidence that it's pretty close.

In 2009, SPY was +26.5%. Naked puts were +38.8%.
In 2008, SPY was -37.1%. Naked puts were +15.9%.

Naked puts outperformed SPY in every year from 2005-present so I don't agree that that will only outperform in a down market. When the market rises sharply in a short time frame like it did last month, then yes, naked puts will lag, but even in a great year like 2009, the majority of weeks the market goes nowhere and the puts are racking up profits. The biggest criticism of selling naked puts or covered calls that I've seen is that you make small amounts week after week and then you get killed one week. This is true. In a bad week, you can lose 8-10 weeks worth of profits but long term its a winning strategy. Most people just don't have any patience and give up as soon as they see one bad week because its gut wrenching to lose 2 months worth of profits in 2-3 days. If it was easy, everyone would do it.

I also tested monthly naked puts vs weekly naked puts and the weeklies outperformed dramatically. I've traded monthly naked puts in real time and found them to be pretty lackluster with returns just slightly above the SP500 so I stopped trading them back before weeklies had even been invented.

So while I appreciate a healthy does of skepticism, I believe you are wrong. I believe that the weeklies naked puts will significantly outperform the SP500 and the weeklies will significantly outperform monthlies.

Having said all of that, I'm really not all that concerned with how much naked puts outperform the general market, just that they make money. I'm fully invested already and would never buy SPY on margin because margin interest rates are too high. I'm only using my margin as collateral to finance the naked puts. Any profit is gravy on top of whatever returns I get from my B&H portfolio
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Old 11-13-2011, 08:38 AM   #102
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I've done enough research over the past 6-8 months and watched how naked puts perform in real time under just about any scenario to have full confidence that my back test was done correctly. Its not exact, but I have confidence that it's pretty close.

In 2009, SPY was +26.5%. Naked puts were +38.8%.
In 2008, SPY was -37.1%. Naked puts were +15.9%.

Naked puts outperformed SPY in every year from 2005-present so I don't agree that that will only outperform in a down market. When the market rises sharply in a short time frame like it did last month, then yes, naked puts will lag, but even in a great year like 2009, the majority of weeks the market goes nowhere and the puts are racking up profits. The biggest criticism of selling naked puts or covered calls that I've seen is that you make small amounts week after week and then you get killed one week. This is true. In a bad week, you can lose 8-10 weeks worth of profits but long term its a winning strategy. Most people just don't have any patience and give up as soon as they see one bad week because its gut wrenching to lose 2 months worth of profits in 2-3 days. If it was easy, everyone would do it.

I also tested monthly naked puts vs weekly naked puts and the weeklies outperformed dramatically. I've traded monthly naked puts in real time and found them to be pretty lackluster with returns just slightly above the SP500 so I stopped trading them back before weeklies had even been invented.

So while I appreciate a healthy does of skepticism, I believe you are wrong. I believe that the weeklies naked puts will significantly outperform the SP500 and the weeklies will significantly outperform monthlies.

Having said all of that, I'm really not all that concerned with how much naked puts outperform the general market, just that they make money. I'm fully invested already and would never buy SPY on margin because margin interest rates are too high. I'm only using my margin as collateral to finance the naked puts. Any profit is gravy on top of whatever returns I get from my B&H portfolio
Please don't misunderstand me.

All I'm saying is that, theoretically, I don't believe that weekly puts should outperform monthly puts if both are priced fairly. If you are saying that weekly puts tend to be systematically overpriced, I don't disagree that this may be the case. In fact, if this is the case, one should be able to exploit this inefficiency in a market neutral way, perhaps by selling weeklies and buying monthlies.

And, as you say, in a rising market, you will make the maximum return, regardless of whether the strategy outperforms the S&P 500, and that is good.

The only thing I am questioning is your assertion that a strategy of selling weekly cash-secured puts is expected to outperform the S&P 500. If you really believe this, why not go long cash-secured weeklies and sell short SPY to remove market risk.
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Old 11-14-2011, 06:55 AM   #103
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There's no doubt in my mind that selling weekly SPY puts and buying monthly SPY puts would be a winning strategy with very little risk. However without any in depth research, my intuition tells my that I would have to trade 100 times as many contracts to make the same amount of money that I can make just selling the weeklies puts. My risk is much higher of course but as long as I'm not trading positions sizes big enough to put my portfolio in jeopardy then I'm not all that worried about it. I've seen the week by week data from a year as bad as 2008 and I'm OK with that amount of risk.
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Old 11-18-2011, 08:45 PM   #104
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As I said above, a weekly strategy gives you a lot more times to play the game, so you should reach a statistically significant number of trials sooner.
I like that about the weeklies. With monthlies, a couple bad months and it has you wondering about the strategy. But you get quicker feedback and faster averaging with the weeklies.

The other thing I like is, I tended not to sell calls in the months with an EX-Div, as assignment was too hard to predict. With weeklies I can decide to stay out 4/52 times, rather than 4/12 each year.


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The only thing I am questioning is your assertion that a strategy of selling weekly cash-secured puts is expected to outperform the S&P 500. If you really believe this, why not go long cash-secured weeklies and sell short SPY to remove market risk.

But you could only have half as much invested this way, no? Half would need to be held against the short?

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Old 11-18-2011, 08:47 PM   #105
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OK, so after thinking about it some more, I decided to open a SPY put calendar spread with weeklies and monthlies. Not to replace my naked puts, but in addition to them.

I sold 10 Nov25 Weekly 122 Puts for 2.07 each
I bought 10 Dec 122 Puts for 4.44 each.
Total debit of 2.37. Next week I'll sell 10 more slightly ITM puts against my long position and see where I'm at.

Next Friday I will sell 10 more weeklies and go from there.
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Old 11-18-2011, 09:11 PM   #106
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OK, so after thinking about it some more, I decided to open a SPY put calendar spread with weeklies and monthlies. Not to replace my naked puts, but in addition to them.

I sold 10 Nov25 Weekly 122 Puts for 2.07 each
I bought 10 Dec 122 Puts for 4.44 each.
Total debit of 2.37. Next week I'll sell 10 more slightly ITM puts against my long position and see where I'm at.

Next Friday I will sell 10 more weeklies and go from there.
I'll be watching, so please do keep us informed.

I forgot to mention, based on the fast feedback I'm getting with the weeklies, I'm trying a little different strategy:

I only sell calls against 1/2 my position initially. If the market moves up significantly in the next few days, I'll sell against the remaining half at a higher strike that can still give me a premium close to what I got on the first half.

Pros:

1) If the market keeps moving up above the strikes and caps my gains, my opportunity cost is not as bad (might still be a profit) as going in all at once, since 1/2 was at a higher strike.

2) If the market doesn't go above either strike, I still take about the same premium (maybe more).

Cons:

1) Higher commissions.

2) If the market drops or stays flat, I might not get to sell against the second half.

For the past few months though, my data says that the split method improves the returns. The nice thing is, it is very easy to compare - I just look at my actuals versus selling 2x the first transaction. Of course, what works for several months may not work going forward, but so far so good.

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Old 11-18-2011, 09:41 PM   #107
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The other thing I like is, I tended not to sell calls in the months with an EX-Div, as assignment was too hard to predict. With weeklies I can decide to stay out 4/52 times, rather than 4/12 each year.
Good point.

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But you could only have half as much invested this way, no? Half would need to be held against the short?
If you are fully cash-securing the short puts, there would be enough excess margin with that cash to carry the short SPY position, as well.

Another way to think about it is in a relative sense. If utrecht really believes (and this is what I am questioning) that the cash-secured puts will outperform SPY over the long-term, why hold SPY at all? Sell SPY and use the cash from the sale to secure the short puts. IOW, replace the SPY holding with cash-secured short puts.
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Old 11-19-2011, 06:51 AM   #108
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Another way to think about it is in a relative sense. If utrecht really believes (and this is what I am questioning) that the cash-secured puts will outperform SPY over the long-term, why hold SPY at all? Sell SPY and use the cash from the sale to secure the short puts. IOW, replace the SPY holding with cash-secured short puts.
I'm not holding SPY at all.

You obviously have a very good understanding of options. I cant seem to figure out why you dont think the naked puts will outperform SPY when Im seeing it both in a back test and in real time. Unless we are talking about 2 different things. Can you explain what formula you are using when you calculate returns for what you are calling "cash secured puts"? I might be misunderstanding you.

YTD

SPY...-1.7%
Naked Puts...21.9%

Its a dramatic difference in returns over every measure of time. 7 year back test, YTD back test and in real time for over 6 months.
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Old 11-19-2011, 08:59 AM   #109
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I'm not holding SPY at all.
I didn't think so. I was confused by FIRE'd@51's comment to short SPY, I was thinking he meant short an equal amount of SPY as you sell Puts, but I guess he meant just sell it so it isn't held at all.

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I cant seem to figure out why you dont think the naked puts will outperform SPY when Im seeing it both in a back test and in real time.
Speaking for myself, I just don't really expect to see much of any relationship between the performance of selling the options versus the performance of the underlying. It may be the case over the past 7 years you are looking at (and we have to realize that your back testing is just an estimate). Your YTD number for example - SPY was about flat, so it isn't surprising that a put selling plan could surpass that. But what about during a Bull market?

The option price is a function of VIX, time, strike, SPY price, and risk-free rates. VIX is just the market's best guess at volatility, and I think one of the biggest things affecting option performance is what happens in reality, versus the expected volatility.

Imagine a period of time where SPY is steadily rising. The increases in SPY could exceed the Put premiums. Or you could get whipsawed, take a loss on the Put, but SPY recovers.

I'm not saying that the put sales won't exceed SPY performance, just that I don't see a reason that it needs to be so.

caveat - the above was written on a single cup of coffee, a dangerous thing for me to do when writing about options....


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Old 11-19-2011, 11:53 AM   #110
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Speaking for myself, I just don't really expect to see much of any relationship between the performance of selling the options versus the performance of the underlying. It may be the case over the past 7 years you are looking at (and we have to realize that your back testing is just an estimate). Your YTD number for example - SPY was about flat, so it isn't surprising that a put selling plan could surpass that. But what about during a Bull market?

The option price is a function of VIX, time, strike, SPY price, and risk-free rates. VIX is just the market's best guess at volatility, and I think one of the biggest things affecting option performance is what happens in reality, versus the expected volatility.

Imagine a period of time where SPY is steadily rising. The increases in SPY could exceed the Put premiums. Or you could get whipsawed, take a loss on the Put, but SPY recovers.

I'm not saying that the put sales won't exceed SPY performance, just that I don't see a reason that it needs to be so.
This is what I was trying to demonstrate analytically in several of my posts above. You have said it more clearly in words.

These option strategies are highly path-dependent, and unless there is systematic mispricing of the options, I see no source of excess return.
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Old 11-19-2011, 11:58 AM   #111
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I was confused by FIRE'd@51's comment to short SPY, I was thinking he meant short an equal amount of SPY as you sell Puts, but I guess he meant just sell it so it isn't held at all.
No, I meant it the way you first interpreted it. We are absolute return investors. Unlike professional money managers, we do not get paid for outperforming the S&P 500 when it goes down. We are not joyful to be down 10% when the market is down 20%, because we have still lost money. Actually, we would rather underperform in an up market because we still make money.

Suppose you were an infallible stock-picker - you could always select a group of stocks that will outperform the market and generate positve alpha every year. You could still lose money if the market went down by more than your alpha. To guarantee a positive return every year, you could short the market against your group of stocks, effectively earning the risk-free rate plus your alpha every year.

Alternatively, suppose you are a long-term investor who wants to maximize the annual return over a long period of time, and are not bothered by the possibility of a down year. You want to capture the market return (which presumably will be greater than the risk-free rate over many years) in addition to your alpha. You would then simply hold your group of stocks, thereby earning the market return plus your alpha over many years.

If you believed (erroneously?) that selling cash-secured puts was an alpha generator, you could follow one of the two strategies above.
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Old 11-19-2011, 12:17 PM   #112
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I'm not holding SPY at all.
From your post #101:

"I'm really not all that concerned with how much naked puts outperform the general market, just that they make money. I'm fully invested already and would never buy SPY on margin because margin interest rates are too high. I'm only using my margin as collateral to finance the naked puts. Any profit is gravy on top of whatever returns I get from my B&H portfolio"

I interpreted (perhaps incorrectly) that this meant you were already long SPY (or something akin to it, e.g. an S&P 500 index fund).

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Can you explain what formula you are using when you calculate returns for what you are calling "cash secured puts"? I might be misunderstanding you.
I believe I am calculating it the same way as you are - dividing the $-return on the naked puts by the notional underlying amount
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Old 11-19-2011, 12:20 PM   #113
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OK, so after thinking about it some more, I decided to open a SPY put calendar spread with weeklies and monthlies. Not to replace my naked puts, but in addition to them.

I sold 10 Nov25 Weekly 122 Puts for 2.07 each
I bought 10 Dec 122 Puts for 4.44 each.
Total debit of 2.37. Next week I'll sell 10 more slightly ITM puts against my long position and see where I'm at.

Next Friday I will sell 10 more weeklies and go from there.
Just an observation.

Assuming the puts were approximately at-the-money and that SPY goes ex-dividend on Dec 16, it appears (using Black-Scholes) that the implied volatilities of the puts you bought and sold were the same. Thus, it appears you are playing a fair game with no statistical edge due to the weeklies being over-priced relative to the monthlies. The trade may ultimately be profitable due to path-dependence (and perhaps you have a view about this path dependence that you are trying to implement using a calendar spread), but there doesn't appear to be any structural reason why, over the long-term, one would expect to earn an excess return from putting on many trades like this in a purely mechanical way.
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Old 11-19-2011, 12:58 PM   #114
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From your post #101:

"I'm really not all that concerned with how much naked puts outperform the general market, just that they make money. I'm fully invested already and would never buy SPY on margin because margin interest rates are too high. I'm only using my margin as collateral to finance the naked puts. Any profit is gravy on top of whatever returns I get from my B&H portfolio"

I interpreted (perhaps incorrectly) that this meant you were already long SPY (or something akin to it, e.g. an S&P 500 index fund).



I believe I am calculating it the same way as you are - dividing the $-return on the naked puts by the notional underlying amount
WHat I meant was that I have a B&H portfolio just like everyone else. Most people on this board probably have their money at a mutual fund company. The majority of my taxable account money is at E-Trade and Optionshouse. I have individual stocks, ETFs and some mutual funds. I use the margin available from those stocks and funds (as well as some cash in the account) to trade options. I dont hold any SPY or SP500 index fund right now but even at the times when I do, it really has nothing to do with my naked put strategy. I'm not specifically trying to hedge anything or sell covered calls against any long stock positions that I plan to hold long term.
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Old 11-19-2011, 04:18 PM   #115
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Just an observation.

Assuming the puts were approximately at-the-money and that SPY goes ex-dividend on Dec 16, it appears (using Black-Scholes) that the implied volatilities of the puts you bought and sold were the same. Thus, it appears you are playing a fair game with no statistical edge due to the weeklies being over-priced relative to the monthlies. The trade may ultimately be profitable due to path-dependence (and perhaps you have a view about this path dependence that you are trying to implement using a calendar spread), but there doesn't appear to be any structural reason why, over the long-term, one would expect to earn an excess return from putting on many trades like this in a purely mechanical way.
You understand options theory much better than I do. Ive gotten my education thru "on the job training". One thing Ive learned is that in real life, things don't always go like they should in theory. I have a copy of "Options As a Strategic Investment" right in front of me and Ive read it from cover to cover more than once. I've read several things in this options bible that clearly don't work the same way in real real life as he writes about in the book.

There may not be any structural reason or any theoretical reason why this SPY calendar spread will work, but I'm 90% sure it will. The reasons are pretty obvious to me, which is why I cant seem to figure out why you don't see what I see.

As far as the naked puts go, yes, they will under perform when the market is going straight up, but that's what? 5%-10% of the time? Every single week that the market doesn't go up at least 1 1/4 - 2%, the naked puts outperform. All those weeks added up together make it almost impossible not to outperform SPY overall.
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Old 11-19-2011, 05:13 PM   #116
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OK, so after thinking about it some more, I decided to open a SPY put calendar spread with weeklies and monthlies. Not to replace my naked puts, but in addition to them.

I sold 10 Nov25 Weekly 122 Puts for 2.07 each
I bought 10 Dec 122 Puts for 4.44 each.
Total debit of 2.37. Next week I'll sell 10 more slightly ITM puts against my long position and see where I'm at.

Next Friday I will sell 10 more weeklies and go from there.
utrecht,

This is a very interesting strategy. On a scale of 1 to 10 on understanding options I would give myself a 4. I have been selling the weekly puts on the SSO over the last several months and have done well. I usually sell way out of the money during the week and average .10 to .20 per option.

I'm trying to understand how this will work out. If SPY drops to 118 by Nov25 do you close your position and take the loss on the short puts? Then sell the Dec2 118's?

As of Nov25 at 118, wouldn't your long puts be worth more than the loss on the short puts? Would you close that position then and take the profit?

Thanks
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Old 11-19-2011, 05:50 PM   #117
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There may not be any structural reason or any theoretical reason why this SPY calendar spread will work, but I'm 90% sure it will. The reasons are pretty obvious to me, which is why I cant seem to figure out why you don't see what I see.
Tell me the reasons that are "pretty obvious" to you, and I'll try to respond.
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Old 11-19-2011, 06:19 PM   #118
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utrecht,

This is a very interesting strategy. On a scale of 1 to 10 on understanding options I would give myself a 4. I have been selling the weekly puts on the SSO over the last several months and have done well. I usually sell way out of the money during the week and average .10 to .20 per option.

I'm trying to understand how this will work out. If SPY drops to 118 by Nov25 do you close your position and take the loss on the short puts? Then sell the Dec2 118's?

As of Nov25 at 118, wouldn't your long puts be worth more than the loss on the short puts? Would you close that position then and take the profit?

Thanks
If SPY drops to 118 at the end of next Friday, I will buy back the weekly 122 and sell the weekly 118 for the following week. However, the monthly puts will NOT have increased in value as much as the weekly puts have increased, so I will have a loss at that point, not a profit. The closer an option is to expiration the more it will move, so the weekly will move faster than the monthly.

It will cost me about $4 to buy back the weekly and the monthly will be worth about $5.7. If I closed out everything I would lose about $0.68.
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Old 11-20-2011, 11:52 AM   #119
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If SPY drops to 118 at the end of next Friday, I will buy back the weekly 122 and sell the weekly 118 for the following week. However, the monthly puts will NOT have increased in value as much as the weekly puts have increased, so I will have a loss at that point, not a profit. The closer an option is to expiration the more it will move, so the weekly will move faster than the monthly.

It will cost me about $4 to buy back the weekly and the monthly will be worth about $5.7. If I closed out everything I would lose about $0.68.
So you estimate that, if SPY is 118 at the close on Nov 25, the calendar spread will be worth 1.70. At what price of SPY do you estimate that the calendar spread would be worth 2.37? How about on the upside? That is, at what price of SPY above 122 at the Nov 25 close, do you estimate that the calendar spread would be worth 2.37?
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Old 11-20-2011, 04:21 PM   #120
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Utrecht is the basic principal here that since monthly option is priced at ~2x a weekly as predicted by B-S, selling 4 weekly will make twice as much as a selling a single monthly?

This of course assumes that market is flat. However the market has been basically flat for the six month which is why the strategy has worked out so well. I think when I return from visiting my mom in Dec I will switch from writing slightly out of the money monthly calls and puts (a short strangle) to weeklies

I would point the reason the strategy has done so well when you back tested it for 7 years (correct?) is that in 2004 the SPY was between 1120 and 1200. Thus we have had 7 or (10+ actually) years of a flat market. BTW you should be including dividends in your calculations vs holding SPY. Looking at the SPY chart, I would guess that except for late 2008 when selling weekly puts would have been very ugly and the 2009 rally, this strategy would outperform the SPY by a good margin.

The obvious trick of course is to be smart/lucky enough to stop selling puts when the market crashes. I'd be interesting in seeing your data from 9/2008 through 2009.
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