"Risk comes from not knowing what you're doing" ― Warren Buffett
Most investors make stock picking much more complex and much less rewarding than is necessary. I'm not referring to those that just park their money in a mutual fund and look at it once a year or so, but, rather, those that attempt to pick winners, watch the market closely and possibly go "in and out" of stocks. After all, the vast majority of articles on Seeking Alpha are directed towards picking the winners or avoiding the losers.
I'm always hearing stories about the "smart move" someone made on XYZ Stock and how much they made. That's nice, but does it really matter? What really matters is how much your total portfolio returns, year in and year out.... after subtracting losers from winners and considering the miniscule returns from the cash component.
There are many articles written that cover selling Put Options. Most of these articles can be divided into two categories.... 1) Selling Puts for Extra Income, and 2) The Dangers of Selling Puts.
I haven't found any articles that actually recommend selling Puts as a complete Stand Alone Investment Strategy. So, I thought it a good idea to do so.
So let me offer the simplest of strategies --- selling Puts on the SPDR S&P 500 ETF (SPY) instead of trying to research, pick and follow a number of stocks.
Heresy, you say !!! Surely digging deep into financial statements, gathering information, painstakingly choosing a particular "winner", a great mutual fund or money manager or carefully analyzing market conditions is the way to go. Not so --- say I.
Surely some investors will outperform the broad market, but the data (and statistical certainty) dictates that the majority of investors, including money managers, will underperform the broad market. After all, not each and every football team can score more points than they give up.
So, let's look at the actual comparative performance of selling ATM monthly Puts on the S&P 500, comparing it to a Buy/Hold/Reinvest dividends on the S&P 500 (SPTR Index) covering the period of January 1, 2000 through July 2012. What makes this so easy to analyze is that the CBOE created an index (PUT index) that tracks selling ATM puts, monthly, on the S&P 500.
For those that are curious, the annualized return for the S&P500 Total Return (includes dividends) is 1.78%, whereas the annualized return for the Put Sale Strategy is 5.47%. Triple, that's right triple, the return.
To be fair, the PUT does tend to trail the SPTR in rapidly rising markets, but this is more than offset by its outperformance when the market is down, flat, or slowly rising. In the last dozen years, the PUT only trailed the SPTR three years (one was a tie).
Now, I can't say, emphatically, that selling puts on, say the SPDR Energy Sector ETF (XLE) or a particular stock would have the same result. The less diversified or the higher-beta the stock or ETF the more variable the result. That means regular Put Selling on securities other than the S&P 500, itself, could show significantly different results...up or down. Most importantly, that isn't the whole point of the article
In fact, what I'm suggesting, is that selling ATM PUTS each month on the S&P 500 (in this case SPY), is so compelling, just forget about everything else and do this. Unless you are a whiz, you are unlikely to get Portfolio Returns that will match these results. The S&P 500 also provides more than enough diversity and even indirect global exposure to satisfy the avid asset allocator.
Of course, those that are willing to "bet the ranch" and go "all-in" on a few stocks, or buy "canned goods, gold, guns and bomb shelters" will pooh-pooh this strategy and that's fine. It's just not my cup of tea.
Now, no recommendation would be complete without discussing tax and risk issues. Under current tax regulations, stocks can receive favorable capital gains tax rates and dividends can also receive favorable rates. Selling PUTS, however, taxes all net investment gains as ordinary income. This can be an important distinction and well worth some "number crunching". If, however, the Portfolio is in an IRA or ROTH ... "full steam ahead".
What about the risk that surrounds selling Puts? Well, of course, selling Puts subjects the investor to downside risk, but no more risk had they bought the stock to begin with. In fact, when the market trends down, selling puts will lose less than outright ownership. An automatic risk reducer !!!
Summary: This article illustrated the returns available through a strategy of selling monthly ATM PUTS on the S&P 500. Historically, significant investment gains would have been achieved. I see nothing that would lead me to conclude that such a strategy would not continue to outperform the S&P 500 Total Return over the long term.
Many may think me too bold or even ridiculous, but the facts bear out that most investors would be better off completely abandoning stocks and ETFs in favor of this simplified approach.
I could have added a number of additional reasons for selling Puts, such as lower volatility, beta enhancement, Sharpe Ratio, etc, but the curious can find it all on the CBOE Web Site. I also could have "teased" the market timer by varying the strikes ITM or OTM. And, as my regular readers might have guessed, I'm planning another article, very soon, with a "tweak" to this strategy. For now, I'll let the experts ponder what I've offered.
Conclusion: Each investor can spend their time researching, picking, asset allocating, diversifying, second guessing and so on. If they are good, or lucky, they'll beat the broad market, but they have to beat the odds. Or, they can play tennis, go boating, have dinner with their spouse, stop obsessing and sleep nights while they outperform the broad index by selling an ATM put on the SPY, once a month, every month. Choice is yours.....
Additional disclosure: I buy and sell options on SPY,XLE