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Tuesday, June 25, 2019

Historical Performance of Put Writing Strategies

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I spent some time this past weekend going over some recent White Papers published on the CBOE website. One that caught my attention is titled: Historical Performance of Put-Writing Strategies, written by Oleg Bondarenko, which you can download here.

There are several important points to mention. But I’ll make it short and you can get all the details in the paper. First the historical results, now with more than 30 years of data:
Monthly At the money Put selling (PUT Index) is now a little below the S&P500 when it comes to Compound Returns. It was better for many years (read Out-performance of a Put selling strategy) until now, due to the persistent bullishness of the last decade. Other Option-selling based strategies like BXMD (30-delta Covered Call index) do still beat the S&P500, but it is not included in the study. However, when it comes to risk adjusted returns, the PUT index is still much better than the S&P500. This is clearly reflected in the summary:
  • Long-term performance. Over more than 32-year period, the PUT index outperformed the traditional indices on a risk-adjusted basis. Compared to S&P 500, PUT has a comparable annual compound return (9.54% versus 9.80%), but a substantially lower standard deviation (9.95% versus 14.93%). As a result, the annualized Sharpe ratio is 0.65 (PUT) and 0.49 (S&P 500). 
  • Volatility risk premium. Historically, the option implied volatility has considerably exceeded the realized volatility. From 1990 to 2018, the average implied volatility, as measured by the Cboe Volatility Index® (VIX®), is 19.3%, while the average realized volatility of the S&P 500 index is 15.1%, implying the difference of 4.2%. Due to high volatility risk premium, PUT has delivered attractive risk-adjusted performance.
Another interesting point is the superior results of Put selling vs Put buying. In this case using the PPUT CBOE Index which holds the S&P500 index long term while buying an out of the money Put option (5% below the market) every month:
  • PUT versus PPUT. Since June 1986, the cumulative return is 1835% for PUT and 708% for PPUT. Compared to PPUT, PUT has a much higher annual compound return (9.54% versus 6.64%), a lower standard deviation (9.95% versus 12.08%), much higher risk adjusted measures (the annualized Sharpe ratio of 0.65 versus 0.33), a less severe drawdown (the maximum drawdown of -32.7% versus -38.9%, the longest drawdown of 40 months versus 80 months). PUT has a negative exposure to the volatility risk, which accounts for 0.29% of its average monthly excess return. In contrast, PPUT has a positive exposure to the volatility risk, which accounts for -0.17% of its average monthly excess return.
Selling Put options makes sense. Buying Put options may make sense as protective measures for your portfolio here and there, but should not be used as a permanent income producing strategy. It will be a drag to long-term returns.

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