Edge in Selling Options Part 2: The Put-Write

Edge in Selling Options Part 2: The Put-Write

 Summary:Selling puts is normally characterized as dangerous; however, from 1986-2015, 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: bullish, flat and even moderately bearish price moves.Short puts have risk down to zero, but the put-write strategy actually had one of the lowest max drawdowns during the period tested.$100 invested in the CBOE S&P 500 Put-Write Index strategy in 1986 would be worth just about $1,700 today, clocking in at 10.1% annual returns.A CBOE study recently concluded that despite the perceived risk of shorting puts, the strategy has performed incredibly well, even during the 2008 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. The only other strategy that beat the put-write was the buy-write (BXMD – long the S&P 500 index and each month shorting a 30 delta index call option). At a glance, the BXMD’s 10.7% annualized returns during the same period seems better, but when risk is taken into consideration, it’s not.Risk RewardTrades are not risk free. Every investment has risk to it. Standard deviation quantifies said risk. According to Morningstar, “if for example a fund or strategy had a mean annual return of 10% and a standard deviation of 2%, you would expect the return to be between 8% and 12% about 68% of the time, and between 6% and 14% about 95% of the time.” Risk is one side of the equation. On the other...