What if there was an options strategy that took just 1 hour per month to implement while outperforming the S&P 500 in both return and reduced portfolio volatility? What if the same strategy was available to any trader, regardless of your account type or size?
Options trading strategies unlock exactly these sorts of possibilities. The prudent and cautious use of option contracts allows traders to earn returns over and above those provided by standard market benchmarks. They can protect traders from unexpected volatility in the market while improving their access to outsized returns.
You work hard for your money, and it doesn't take a high level of sophistication or degree in finance to generate higher returns with less risk. You can accomplish these goals without a significant time commitment by following the strategies outlined below.
WE RECOMMEND THE VIDEO: It's Not Requried...– Stock Market Philosophy EP. 12 – Day Trading / Options Trading / Investing
Stream alerts, stock trading bootcamp, re course: it's nice if everybody agrees with you, but it's not a necessity. To be a successful stock ...
30-Delta BuyWrite Index Strategy Overview
The 30-Delta BuyWrite Index options trading strategy involves just a few simple steps:
- Sell a covered call option against that stock.
An example might serve to illustrate the strategy more clearly.
Let’s say that you buy one share of Company X for $100. When you own the stock outright without any associated derivative ownership you’re fully exposed to any upward or downward movement in its price. If the price falls to $75, you’ve lost $25. If the price increases to $125, you’ve gained $25.
But let’s also say that you sell a covered call option at a strike price of $105 for $0.50. By doing this you forfeit the potential to earn any more than $5 on an increase of the stock price. However, you also pocket the premium for the call option, which is $0.50, thereby effectively lowering the cost of owning the stock by the same amount. Now, the stock only costs you $99.50 to hold.
The gist of the strategy is that you’re trading the unlikely chance of significant upside potential for the much more likely occurrence of limited movement in the stock price and reducing the cost of ownership of the stock in the meantime.
30-Delta BuyWrite Index Strategy Performance
We’ve carried out some back-testing research for the 30-Delta BuyWrite Index options trading strategy. The results validated our optimism about this technique.
If you invested $100 in 1986 and followed the BuyWrite strategy, your investment would have grown to $1985 after the passage of 30 years. At the same time, if you invested $100 in 1986 in the S&P 500 Index and simply let your investment ride, your investment would have been worth $1599 after 30 years.
In other words, the simple strategy of selling covered call options each month against stocks you already own dramatically increased the return of those investments. The return on the 30-Delta BuyWrite Index options trading strategy was 24% higher than it was on a standard S&P 500 index strategy.
You could surely be forgiven if the improved performance of the BuyWrite strategy came at the cost of increased risk. After all, heightened volatility is often the price of improved overall performance. But this didn't seem to be the case with BuyWrite. The overall volatility of the BuyWrite portfolio was significantly lower than the volatility of the S&P 500 index portfolio.
Here are the actual numbers:
- S&P Index 500 annualized standard deviation: 15.3%
- BuyWrite Index annualized standard deviation: 13.2%
The volatility of the BuyWrite index was over 2% lower than the volatility of the S&P 500 index. Remember that this is in addition to a 24% increase in the overall performance of the index.
The reduced volatility makes sense when you remember that, along with giving up some upside potential, you reduce your exposure to downward movements in the underlying stock price. You’ve done this by reducing the true cost of owning the stock by the price of the call option contract premium. As a result, you’re less exposed to both upward and downward swings of the stock price.
A Similar Strategy: The CBOE PutWrite Index
A strategy very similar to the BuyWrite options trading strategy, called the CBOE PutWrite Index strategy, draws our attention for many of the same reasons the BuyWrite strategy seems so attractive. The PutWrite strategy increases returns over the S&P 500 benchmark and significantly reduces volatility. To execute the PutWrite technique, the investor:
- Sells a naked put option in the S&P 500 index, and
- Buys treasury bills with the premiums earned.
The payoff diagram is very similar to the BuyWrite Index. While the S&P Index investor would have earned $1599 on $100 invested in 1986, a CBOE PutWrite Index option strategy trader would have earned $1722.
Again, just like with the BuyWrite Index strategy, volatility for this investor decreased at the same time as returns went up significantly. In fact, volatility was even lower for the PutWrite investor than it was for the BuyWrite investor. The annualized standard deviation for investors following the PutWrite was only 10.2%, a full 5.1% lower than an S&P 500 index investor.
Safe Naked Options?
You may have some questions about how a strategy involving a put option can so significantly reduce volatility. After all, you may have heard that naked options (options in which you don’t have a position in the underlying instrument), like the naked put options in the above example, are inherently risky. And risk equals volatility, doesn’t it?
Well, yes and no. It’s true that your downside potential on a naked put is increased beyond what it would be in a covered put option. After all, if the price of the stock were to fall to zero during the duration of the contract, you’d be assigned the stock by the contract holder at the strike price. That would cause you to lose an amount equal to the strike price.
But there are a few key points that people may overlook with naked put options. First, in this strategy, we’re trading naked put options on an index, not an individual stock. It’s extraordinarily unlikely that the S&P 500 index would lose almost all its value over the course of one option contract. Indeed, even in brutal, bear markets, the S&P 500 might lose only half of its value.
Second, as overall market volatility increases and downside potential begins to become more likely, the value of a put option rises dramatically. It’s not unusual for naked puts in volatile bear markets to sell for up to eight to ten times more than they would in a bull market. So, while your downside potential is increased, you’re well compensated for that increase.
Volatility must always be understood as a function of return. In other words, an increased return can justify taking on additional risk as long as that increased return is worth more than the added risk.
Beating the Market
You’ve heard countless people parrot the same words. “You can’t beat the market.” You’ve heard it on the news, at neighborhood barbeques, from your parents, and on financial “news” websites everywhere.
But it is possible to beat the market with the intelligent use of options trades. It doesn’t take a huge amount of capital, sophisticated technology, or an Ivy-league finance degree to do it.
All that’s required is one hour per month and a basic understanding of covered call options. Using only the 30-Delta BuyWrite index strategy you can boost your return over the S&P 500 index by 24%. You can also reduce your volatility by a full 2.1 percentage points.
If you’re looking for something even less volatile you can go with the CBOE PutWrite trading strategy and lower your volatility all the way to 10.2% per year. While you likely won’t do as well as those who follow the BuyWrite strategy, you’ll probably still beat the S&P 500 by a substantial margin as well.
[FREE Download] Podcast Show Notes & Transcript PDF:
No time to read the show notes right now? We've made it incredibly easy for you to save time by giving you instant access to the complete digital version of today's show. Click Here to Download Your FREE Copy ?
Free Options Trading Courses:
- Options Basics [20 Videos]: Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
- Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an "edge" in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
- Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
- Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
- Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we'll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
- Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can't seem to get answered, then this section will help you.
- Portfolio Management [16 Videos]: When I say "portfolio management" some people automatically assume you need a Masters from MIT to understand the concept and strategies - that is NOT the case. And in this module, you'll see why managing your risk trading options is actually quite simple.
- Trade Adjustments/Hedges [15 Videos]: In this popular module, we'll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we'll help you create an alert system to save time and make it more automatic.
- Professional Trading [14 Videos]: Honestly, this module isn't just for professional traders; it's for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.
PDF Guides & Checklists:
- The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
- Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
- Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
- Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
- When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we'll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
- 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.
Real-Money, LIVE Trading:
- IWM Iron Butterfly (Closing Trade): Exiting this IWM iron butterfly options trade gave us a $1,100+ profit after pinning the stock price one day before expiration at the peak of our spread.
- CMG Iron Condor (Opening Trade): I just recorded my live trading platform (and real money account) as I walked through the process of entering a new iron condor trade in CMG stock. Inside you'll see me analyze, price and fill the trade in real-time.
- APC Strangle (Closing Trade): Took about $150 out of this small APC strangle trade even after the stock moved completely against our short call strikes this month. But as always, implied volatility always trumps direction and because IV went down, the value of this spread dropped more-so than the impact of the directional move higher.
- IYR Call Credit Spread (Adjusting Trade): This adjustment is good for 2 reasons. First, it reduces the overall risk in the trade if IYR continues to move higher. Second, it still leaves room for the stock to fall back down into our new profit window.
- XHB Straddle (Closing Trade): We were able to bank a $120 profit early in the March expiration cycle for our XHB straddle with the stock trading right in the middle of our expected range.
- AAPL Call Calendar (Opening Trade): Look behind the scenes as I use our new watchlist software to filter quickly and find this AAPL call calendar spread trade during overall low implied volatility in the market.
- COF Strangle (Adjusting Trade): Here I recorded my live trading screen (and real money account) showing you the entire thought process we used to make an adjustment to my current short strangle in COF to reduce risk.
- GDX Strangle (Opening Trade): With gold's high IV we are getting into a new strangle with a 70% chance of success and a decent credit for selling option premium.
- IBB Iron Condor (Closing Trade): Today we're exiting an iron condor we traded in IBB for a $142 profit. Inside you'll see me analyze the exit price and fill the trade in real-time.
Thank You for Listening!
I'm humbled that you took the time out of your day to listen to our show, and I never take that for granted. If you have any tips, suggestions or comments about this episode or topics you'd like to hear me cover, just add your thoughts below in the comment section.
Want automatic updates when new shows go live? Subscribe to the Podcast on iTunes, SoundCloud or Stitcher right now before you forget - it's fast and easy.
Did You Enjoy the Show?
Please kindly consider taking just 60-seconds to leave an honest Review on iTunes for The Option Alpha Podcast. Ratings and reviews are extremely helpful and greatly appreciated. They do matter in the rankings of the show, and I read each and every one of them!
Also, if you think someone else in your social circle could benefit from the topic covered today, please share the show using the social media buttons you see. This helps spread the word about what we are trying to accomplish here at Option Alpha, and personal referrals like this always have the greatest impact.
Sunday, December 27, 2020