Bill Luby

Put-Writing: Too Often Overlooked

Excellent comments, all. I must confess that I have not made a habit of responding to the comment stream here at SA, but that is going to change going forward.

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