This segment reveals the results of studies that should provide guidance for premium sellers, specifically put writers, and measures how often adverse moves of different amplitude occur. This type of info is especially timely given the recent market action.
A bull market and time decay provide a good environment or selling puts. A trader usually establishes a short put by selling a put option below the market. As long as the underlying goes up, stays steady or doesn’t decrease by too much the put will expire worthless. A short put though has, for all practical purposes (the underlying can’t go below zero), undefined risk and short naked puts have significant risk to the downside.
The Market Measures segment from December 16, 2014 included a study about taking losses on short strangles when the loss equalled certain multiples of the credit received. We di the same basic thing here on short puts. A study was conducted using the SPY (S&P 500) from 2005 to present. The study calculated the frequency of losses reaching 1x, 2x, 3x, 4x, 5x of the initial credit received. We sold 1 standard deviation puts ( with a 16 delta) on the first trading day of each month using the expiration closest to 45 days until expiration (DTE).
An example was given using the SPY. On August 3rd 2015 with the SPY trading at $210.00, we sold the September $197 put (16 delta) with 46 days to expiration (DTE) for a $0.97 credit. As of August 24th, with the SPY trading at $191.00 the September $197 is trading for $9,50. This price equates to an $850, or an 8.5x credit loss.
A table was displayed using the 16 delta puts. A total of 129 trades were made. The number of losses as multiple of the initial credit equal to 1x, 2x, 3x, 4x and 5x were shown. The table showed the number of trades hit, percentage of trades hit, number of losses that ended up expiring profitable and the percentage of losses that ended up expiring profitable.
A second study was conducted again using the SPY from 2005 to present. This time we held the short 1 standard deviation puts (16 delta) until expiration unless they were exited at a 1x, 2x, 3x, 4x or 5x credit loss. The results for managing winners at 50% were also included in the table displaying the results. We calculated the P/L for each management style. The table showed the P/L, percentage of profitable trades, average P/L per day, average trade P/L and largest drawdown.
Then we looked at the P/L summary of each strategy. A third table was displayed holding the puts until expiration, covering them at a 50% win as well as showing the loss as multiple of the initial credit equal to 1x, 2x, 3x, 4x and 5x. The table showed a P/L summary including the highest, 75th percentile, 50th percentile, 25th percentile and the minimum. A graph was displayed of the running P/L using all the management strategies for the 16 delta puts in the SPY.
Takeaways (partial) Despite the strategy’s significant performance over the past decade, there were still periods of significantly large drawdowns
As a result, trade size needs to be kept in check, as there will likely be even larger market sell offs, given a higher number of occurrences
Watch this episode of “Market Measures” with Tom Sosnoff and Tony Battista to learn the other takeaways and about when and if to take losses when your short puts go against you.