If the recent spike in volatility has you combing the market for new ideas, a recent episode of Tasty Bites may be worth a few minutes of your time.
This hard-hitting installment of a tastytrade mainstay focuses on the Emerging Markets ETF (EEM) and presents data that suggests that EEM could be a good fit for traders seeking outlets for short premium positions.
The reality is that the SPY trades for nearly $200/share, making the margin requirements of this instrument somewhat prohibitive for many independent traders.
On the recent edition of Tasty Bites, the team examines whether EEM might provide a similar risk/reward profile to SPY for short premium traders seeking an underlying with a lower absolute value (EEM trades closer to $40).
Unlike the SPY, which tracks an index of 500 companies leveraged primarily to the US market, the EEM is comprised of 800+ stocks domiciled in emerging markets around the world.
Country-specific risk in the EEM is broken down into the following concentrations (approximately):
China - 26%
South Korea - 15%
Taiwan - 12%
India - 9%
Brazil - 8%
Other - 30%
Representing a large number of companies from a variety of global regions, the EEM is highly diversified - even when compared to the breadth of the SPY. This can be viewed as a net positive for premium sellers due to reduced overall exposure to stock-specific (idiosyncratic) risk.
The tastytrade team was impressed enough with the EEM as a potential proxy for SPY that a much more detailed analysis was made of the the historical performance of short straddles deployed in EEM from July 2008 to present.
The study backtested selling EEM at-the-money (ATM) straddles with approximately 45 days-to-expiration (DTE) and then compared managing the positions at 25% versus holding the positions through expiration.
As you can see from the results (pictured below), managing the trades at 25% of max profit helped improve the success rate of an ATM short straddle in the EEM by approximately 15%:
It should be noted that average P/L also dropped when managing to 25%, as did average days held - meaning returns were diminished, but capital was returned more quickly.
Not stopping there, the Tasty Bites team went one step further and isolated out past occurrences in EEM only when Implied Volatility Rank (IVR) was greater than 50. Because IVR data was only available from March 2012, this backtest was limited to a somewhat smaller window of time.
In this case, the results showed that by managing to 25% and only deploying trades when IVR was above 50, the relative attractiveness of the strategy improved significantly. A comprehensive table summarizing the findings from this second backtest can be found in the Tasty Bites episode entitled “Emerging Market Straddles.”
We invite you to watch the entire episode for a complete review of the information presented on the show.
It should be noted that the EEM may be subject to different macroeconomic risks than the SPY as a result of the respective components tracked by each ETF. Prior to deploying positions in either security, traders should ensure the potential exposure(s) matches their risk profile and strategy.
If you have any follow-up questions on the EEM, or feedback from past trades you’ve made in this index, we hope you'll reach out at firstname.lastname@example.org or leave a comment below.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.