Put-Writing: Too Often Overlooked 23 comments
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Shame on me for going a year and a half without mentioning the CBOE S&P 500 PutWrite Index (PUT), a recipient of the Most Innovative Benchmark Index award at last year’s Super Bowl of Indexing Conference.
Given all the market volatility for the past three months or so, I suspect that a put writing strategy is probably not top of mind for most investors at the moment. In fact, a put write strategy like one tracked by the PutWrite Index will generally outperform the S&P 500 index in a down trending market and significantly outperform the S&P 500 index in a sideways market. Much like a covered call strategy, however, a put write approach will not match the gains of the underlying index in a strong bull market rally.
The CBOE describes the PutWrite Index methodology as follows:
“The PUT strategy is designed to sell a sequence of one-month, at-the-money, S&P 500 Index puts and invest cash at one- and three-month Treasury Bill rates. The number of puts sold varies from month to month, but is limited so that the amount held in Treasury Bills can finance the maximum possible loss from final settlement of the SPX puts.”
Additional information about the PutWrite Index is available at the CBOE PutWrite Index splash page.
I mention put write strategies for four reasons:
- If we continue in a non-trending market, as I expect we will, this is an excellent investment approach
- Ennis Knupp just published a superb analysis of the PutWrite Index: Evaluating the Performance Characteristics of the CBOE PutWrite Index
- Put write strategies have historically outperformed the more widely utilized buy write strategies
- Properly implemented, a put write strategy is not as risky as most investors expect
At a minimum, readers should check out the Ennis Knupp paper and get a better sense of the essence of put write strategies. Those who expect the markets to do anything other than rally significantly might also want to start implementing that strategy on their own.
Note that while there are currently no ETFs that utilize a put write strategy, it is a volatility strategy that is practiced by hedge funds.
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This article has 23 comments:
Good article.
You say in #3 that "Put write strategies have historically outperformed the more widely utilized buy write strategies". Since these two strategies are synthetically equivalent, their performance results should be basically equivalent. What is your evidence supporting your statement?
Jeff
You may want to check to see if that award winning index is still active.
Yahoo Finance shows no trading activity and no plot of past prices.
Stockcharts.com doesn't list that symbol, but it does list other such CBOE symbols as
$BXM --- CBOE Buywrite Monthly Index
$BXD --- CBOE DJIA Buywrite Index
"Properly implemented, a put write strategy is not as risky as most investors expect"
And in a market environment like the last several months, you could lose a significant portion of your original capital, regardless of how 'properly' you implemented the strategy.
Example:
Sell a nearby 1000 ATM SPX put for 10 and you earn 1% in a month if you trade without leverage. However if SPX declines to 700 you will lose a net $290 of every $1000 you started with, a 29% loss in one month.
Repeat for a second month perhaps and you are going to be down nearly 50%. It will take you 4 years of 'perfect' trading to get even.
Selling puts can be very profitable, but mostly should be done when you want to buy the underlying anyway and hoping either to keep the premium (at a hefty yield), or be 'forced' to buy your stock at a discount to the strike price (which you were happy to pay in the first place).
Writing them blindly can be costly during a far tail market event.
Writing puts only involves commissions for the option sale where buy / writes involves commissions for the stock and the opton sale. Mathematically the reward and risk profile are the same, but it costs more to implement the buy / write.
I myself am winding up a naked put position in EXM that I entered a month ago. I sold Jan 5 puts for 0.80 with five weeks remaining and the underlying trading just above 6.
Today, with a week to go, EXM closed at 8.91, and my puts are 0.05 ask. Assuming that EXM doesn't plunge below 5 in the next week, the options will expire and I will keep the entire 0.80 for a yield of
0.80 / 4.20 = 19% in 5 weeks.
If the price does go down, I am comfortable owning EXM at a net price of 4.20. The dividend is 1.60 and I can write 5 strike calls for more income until the shares are called away.
If you're finicky about commissions, that would be understandable. But I trade my clients' accounts in managed (fee-based) accounts, with no ticket charges. So I would just close the position out and lock in a gain. Just me.
Good job on EXM.
in your example, take into account that after a 30 % decline in one month, the implied volatilities will be much higher and in the 2nd month you'll get way more than 1 % for writing a put, maybe something closer to 8-10 %.
You'd have lost about 26 % vs 37.6 % with the S&P 500. Quite respectable.
I agree that put writing on stocks that you are not willing to own is a questionable strategy and should be used with extreme caution by all except the very analytical trader.
I would offer one reason why put writing and call writing might, at times, be synthetically NOT equivalent. There are times when the time value of puts differ significantly from the corresponding calls. If you are going to average over long times, I agree with the synthetic equivalence statement. At any point in time the relationship can be distorted.
To readers in general - - -
One problem you may encounter is that many (but not all) brokers, especially on-line discount brokers, will not allow put writing. I have encountered this situation with a number of clients.
Bill Luby - - -
Thanks for opening this subject with a good and concise article with some good reference links.
My apologies to you both. It was Jeff who raised the synthetic equivalence issue. Sorry.
On Jan 09 05:00 PM Smarty_Pants wrote:
> I don't mean to be overly critical of the article, just to point
> out potential 'gotchas'.
>
> I myself am winding up a naked put position in EXM that I entered
> a month ago. I sold Jan 5 puts for 0.80 with five weeks remaining
> and the underlying trading just above 6.
>
> Today, with a week to go, EXM closed at 8.91, and my puts are 0.05
> ask. Assuming that EXM doesn't plunge below 5 in the next week, the
> options will expire and I will keep the entire 0.80 for a yield of
>
>
> 0.80 / 4.20 = 19% in 5 weeks.
>
> If the price does go down, I am comfortable owning EXM at a net price
> of 4.20. The dividend is 1.60 and I can write 5 strike calls for
> more income until the shares are called away.
i'm puzzled by the issue of some discount brokers not wanting to permit put writing. i suspect it has more to do with the trading experience and capital position of the trader than anything. it's not for a novice.
cash covered put writing in an IRA account is a great way to establish positions in stocks you would be willing to own at a price. i've used it for years at both schwab and fidelity.
one thing that's become apparent in this market cycle is how much market risk is inherent in any individual security traded. it far outweighs the risk in the individual security.
True, discount brokers can sometimes give you grief about option strategies, but if your account is large enough they usually find a way to be amenable.
On Jan 09 07:07 PM John Lounsbury wrote:
> Smarty_Pants - - -
>
> I agree that put writing on stocks that you are not willing to own
> is a questionable strategy and should be used with extreme caution
> by all except the very analytical trader.
>
> I would offer one reason why put writing and call writing might,
> at times, be synthetically NOT equivalent. There are times when the
> time value of puts differ significantly from the corresponding calls.
> If you are going to average over long times, I agree with the synthetic
> equivalence statement. At any point in time the relationship can
> be distorted.
>
> To readers in general - - -
>
> One problem you may encounter is that many (but not all) brokers,
> especially on-line discount brokers, will not allow put writing.
> I have encountered this situation with a number of clients.
>
> Bill Luby - - -
>
> Thanks for opening this subject with a good and concise article with
> some good reference links.
There's a spreadsheet in the files section of my JustCoveredCalls group that shows a comparison of a covered call vs a cash secured put.
finance.groups.yahoo.c.../
On Jan 09 09:06 PM icandoitdon wrote:
> put writing and buy-writes are synthetically equivalent only if you're
> writing at the money puts. writing out of the money puts provides
> a significant downside cushion, which can account for out-performance
> during declining markets.
>
> i'm puzzled by the issue of some discount brokers not wanting to
> permit put writing. i suspect it has more to do with the trading
> experience and capital position of the trader than anything. it's
> not for a novice.
>
> cash covered put writing in an IRA account is a great way to establish
> positions in stocks you would be willing to own at a price. i've
> used it for years at both schwab and fidelity.
>
First, as Jeff noted and most understand, puts and covered calls are indeed synthetically equivalent. It appears, however, that executing two synthetically equivalent strategies -- particularly with puts on widely traded indices for which there is strong demand for puts as portfolio insurance -- can yield slightly different results over time. In aggregate, these results that have a tendency to favor selling puts.
If one looks at a graph of the performance of the PUT vs. the BXM, the divergence in returns starts to become noticeable starting in about 1999 and has persisted up to the present.
Regarding difference in performance of put-write vs. buy-write strategies, I think there are two likely reasons for the difference, which tend to favor the put approach:
1) slight differences in the skew that tend to price puts higher than calls, particularly during times of extreme market stress
2) as noted above, the lower transaction costs (commissions and slippage) associated with fewer transactions in a put-write vs. buy-write approach
For more on the skew differential, try this from Howard Simons:
www.thestreet.com/stor...
Also check out the comments from Jason Ungar of Ansbacher in this Steven Smith column for more information about the performance differential being tied to the skew: www.thestreet.com/prin...
Since this issue has received a fair amount of attention, I will probably post an follow-up on the blog shortly, with a graph of the PUT and BXM and encourage readers to comment on the differences in the results of the two strategies.
Cheers,
-Bill
I agree that puts are probably more active on the heavily traded indices as investors look to hedge their long positions. However, for individual stocks, the returns for buy-writes vs put-writes are more inline with each other, so either strategy produces similar results, even when considering commissions. I trade covered calls at Interactive Brokers where the commissions are very low and they don't charge commissions for exercise/assignment. I've compared my buy-writes to the same strike put-write and, as stated in my previous reply, sometimes the buy-write produces a higher return and sometimes the put-write produces a higher return. But overall, the returns are almost the same, as one would expect. If the returns were significantly different, it would provide an arbitrage situation, which the market makers would soon take advantage.
the point i was trying to make (and did it poorly i guess) is that the superiority of one strategy over another depends largely on the nature of the market, i.e. fearful or hopeful, bull or bear, and how each strategy is employed. whether i'm doing buy writes or put writes depends largely on my view of the market and/or stock. i own specific stocks only when i believe they are undervalued and i sell a call options against them to capture an income premium..not for downside protection, which is nil. i sell puts only against stocks that i believe are worth owning only at lower prices. this has been a traders market that has favored deep out of the money put selling....not buying and holding. while my put writing strategy has had modest losses over the last year it's been far superior to a buy-write strategy. just look at the performance of BTY.
On Jan 10 11:18 AM CCWriter wrote:
> Actually, buy-writes and put-writes are synthetically equivalent
> at the same strike price, either ITM, ATM, or OTM. The Black-Scholes
> option pricing model factors in interest and dividends to price the
> calls and puts about the same. When you calculate the back to cash
> return for either, including interest on cash in the account and
> dividends, the returns are quite similar. However, there can be pricing
> differences such that sometimes the buy-write will have a higher
> return and sometimes the put-write will have a higher return.
>
>
> There's a spreadsheet in the files section of my JustCoveredCalls
> group that shows a comparison of a covered call vs a cash secured
> put.
>
> finance.groups.yahoo.c.../
>
>
>
>
>
> On Jan 09 09:06 PM icandoitdon wrote:
You decided that EXM was cheap and worte the Puts.
Yes, you made a profit.
You missed out on the upside when the stock went from $6 to $9.
Your gains were less than buying the stock.
If I had owned the stock, and bought the put from you for insurance, I'm the winner.
All of the back slapping you have got for this is BS.
On Jan 09 05:00 PM Smarty_Pants wrote:
> I don't mean to be overly critical of the article, just to point
> out potential 'gotchas'.
>
> I myself am winding up a naked put position in EXM that I entered
> a month ago. I sold Jan 5 puts for 0.80 with five weeks remaining
> and the underlying trading just above 6.
>
> Today, with a week to go, EXM closed at 8.91, and my puts are 0.05
> ask. Assuming that EXM doesn't plunge below 5 in the next week, the
> options will expire and I will keep the entire 0.80 for a yield of
>
>
> 0.80 / 4.20 = 19% in 5 weeks.
>
> If the price does go down, I am comfortable owning EXM at a net price
> of 4.20. The dividend is 1.60 and I can write 5 strike calls for
> more income until the shares are called away.
You decided that EXM was cheap and worte the Puts.
Yes, you made a profit.
You missed out on the upside when the stock went from $6 to $9.
Your gains were less than buying the stock. " - Augustus
What you say is true. But I would still have made the same profit if the stock stayed at $5.01 the entire time through expiration and you would have only made $0.01 for tying your money up that entire time in a business area which is currently undergoing a big slowdown.
Given today's market environment and the huge slowdown in shipping worldwide, I couldn't be sure that a rebound in price would occur. I could be fairly certain that the stock was worth at least $4.20 and that I could probably get out better than even in a few months in the worst case.
I am happy with a 19% return in 5 weeks on my money. I am not looking to double my money or to tie it up waiting for a big rally. Honestly I wouldn't have taken the trade if EXM hadn't been beaten into the ground despite trailing earnings that were twice the stock's price. Even at greatly reduced earnings the stock was unlikely to stay below 5 for long. If my puts were exercised I could write calls until those were exercised too, making another 15% to 20% per month while I waited.
Great discussion folks. Many good points.
John: You are right about the skew toward higher prices on puts. However, if the market slides, the premiums on puts also increase faster as fear grows. The extra premium received entails a bit more risk if the trade goes wrong and you have to back out. That's the thinking behind my 'only sell puts on what you're willing to own' comment. I guess that's my final consideration of the risk in a trade: am I willing to own the stock at that price? I usually don't plan to unwind a trade gone wrong, though with an index option you would have to I suppose. I try to stick with equity options, margin is much lower.
For what it's worth, Ameritrade recently began allowing cash covered put selling in their regular accounts with only the lowest level of option trading approval. I have kept an eye on the margin figures they show for my EXM trade and they have been well below the full cash coverage amounts but I have full option trading privileges, so you might be able to push the envelope a bit there if you felt comfortable with the risk involved.
On Jan 09 04:48 PM Smarty_Pants wrote:
> Wasn't put selling part of the 'portfolio insurance' that helped
> cascade the stock market downward in 1987?
>
My EXM puts expired worthless today. I get to keep the entire premium.
19+% in five weeks on roughly 20% of my account balance. Account gains by nearly 4% in the first 3 weeks of the year. Off to a good start.