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Turning The 'Boring' IBM Into A Huge Option Winner

|Includes: International Business Machines Corporation (IBM)

PREFACE

Selling puts is a common option strategy during a bull market, but it turns out that looking at a lower risk put spread, and being rather clever in how we treat earnings, yields powerful results in International Business Machines Corporation (NYSE:IBM). More urgently, if we do not look at this approach, we would likely miss some worthy short put spread opportunities and incorrectly identify them as losers. This is one of those cases.

STORY
There is a lot less 'luck' involved in successful option trading than many people know, and it's not about guessing stock price direction. Let's review this phenomenon right now for IBM. Let's first examine a two-year back-test of a short put spread strategy implementing these rules:

* Trade monthly options (roll the trade every 30-days).
* Avoid earnings
* Test short put spreads for two-years

Here's how to implement this quickly in the back-tester:

If we do this test, we find that the best short put spread to employ is the 30 delta, 10 delta put spread.

RESULTS
If we do a short put spread in International Business Machines Corporation over the last two-years but always avoid earnings we get these results:

Sell 30 Delta Put, Buy 10 Delta Put
* Trade Frequency: 30 Days
* Always Avoid Earnings
 
Gross Gain: $3,206
Gross Loss: -$1,646
Short Put Spread Return: 101.6%
Stock Return: 11.3%

Out-performance: 90.3%

The results above reveal two critical pieces of information. First, we see a strong performing short put spread with a 101.6% return. But, just as important, we also see that the 101.6% return in theshort put spread considerably out-performs IBM stock over the last two-years, which hit 11.3%.

Altogether we're looking at a 90.3% out-performance while taking less risk than owning the stock outright and always avoiding earnings risk.

GOING FURTHER
While out-performing the stock and avoiding the risk of earnings is a powerful implementation of a short put spread, there's even more going on here. We can repeat this back-test but this time examine only trading earnings. Specifically, we open our short put spread two-days before earnings, let the earnings event occur, and then close the position two-days after earnings.

Here's how easy the test is. We simply click the appropriate buttons.:

Now we examine the results for that same 30, 10 delta short put spread.

Sell 30 Delta Put, Buy 10 Delta Put
* Trade Frequency: 30 Days
* Only Trade Earnings
 
Gross Gain: $596
Gross Loss: -$1,317
Short Put Spread Return: -43.8%

Now we see explicitly the impact of avoiding earnings. Holding the short put spread position in International Business Machines Corporation through earnings under-performed the stock and certainly under-performed a short put spread that avoided this risk.

In fact, our strategy to avoid earnings beat the strategy held only during earnings by a whopping 145.4%. The reality is that it's remarkably easy to overlook this implementation without diving just a little deeper than the standard option analysis.

WHY IS THS HAPPENING?

There are two phenomena that have persisted throughout time for IBM that are driving these results.

First, IBM stock tends to dip after earnings -- at least enough for it to be a rather risky startegy to be short puts. Here is a two-year stock return chart for IBM along with earnings dates indicated with the blue 'E' icon:

Second, other than those bumps from earnings, IBM stock has been rather quiet. In fact, its rolling 360-trading day historical volatility (HV360) is just 20.88%, even with earnings factored in.

The short-put spread while avoiding earnings allows us to benefit from an instrument that doesn't have large down swings.

There are several other instruments that mimic this behavior. Qualcomm, Apple and Coca-Cola are just a few.

TRADING TRUTHS
When we take the time to go through this analysis, which really isn't very hard with the right tools, this approach with International Business Machines Corporation reveals that this ethereal concept of 'options expert' has been made made far too complicated and even intangible.

You can see a video of the back-tester in action here:
Tap here to see the CML Pro option back-tester.

Thanks for reading, friends.

Risk Disclosure
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.

Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.