A reader asked: “Have you considered a test of selling puts on the Russell 2000 Index only when it is above a long term moving average, such as the 10-month, 200-day, etc?”
The Strategy Test (as revised) involves iteratively selling put options on the Russell 2000 Index on a monthly schedule determined by the turn-of-the-month (TOTM) effect, wherein the tendency of the broad stock market to exhibit strength around the turn of the month mitigates the risk of selling the options.
“Turn-of-the-Month Effect in Rising and Falling Markets” looks at the TOTM effect for the S&P 500 Index relative to a 200-day simple moving average (SMA). Results suggest that the TOTM return is roughly zero in falling markets, so it can still support options selling (but with no safety margin for at-the-money options). Based on this result, selling options only when above the 200-day SMA would likely reduce risk but result in long intervals of inactivity. Some of these intervals would be front-ends of uptrends and “doldrums” during which selling options is profitable. Extending the analysis to look also at the returns from the end of TOTM to options expiration would more fully relate it to the Strategy Test. Calculating a net result is feasible, but options on the S&P 500 Index have not existed for most of the historical period considered.
In general, the histories both of the Russell 2000 Index (22 years) and of extensive options trading are fairly short for analyses using a 200-day SMA (and historical data for options pricing is not freely available).
Because the Strategy Test trades are only a few weeks duration, “Turn-of-the-Month, Options Expiration and Trend” focuses on a 10-day SMA. This analysis suggests that the interval between options expiration and the beginning of TOTM may have the greatest downside risk when the market has recently been weak. Being above this short-term SMA is favorable (less risky) but not decisive for selling put options at the beginning of TOTM.