Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for March 2024 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for March 2024 (Final)
1st ETF 2nd ETF 3rd ETF

Equity Options

Can investors/speculators use equity options to boost return through buying and selling leverage (calls), and/or buying and selling insurance (puts)? If so, which strategies work best? These blog entries relate to trading equity options.

Actual Retail Option Trading/Returns

Given wide bid-ask spreads, do retail option traders systematically bear large losses? In their January 2024 paper entitled “An Anatomy of Retail Option Trading”, Vincent Bogousslavsky and Dmitriy Muravyev characterize retail option trading in the U.S. by exploiting data from a trading journal that attracts retail investors by offering advanced tracking/performance verification tools. When users subscribe and link their brokerage accounts, their trades (past and future) are automatically imported by the journal and verified. Using data for 5,182 traders who initiated 2.1 million trades worth about $20 billion (of which about $8.8 billion involve options) during January 2020 through December 2022, they find that: Keep Reading

Historical U.S. Equity Returns for a 5-Year Horizon

A subscriber asked about the historical experience (distribution of outcomes) of an investor with a 5-year horizon (holding period). To investigate we consider returns for 5-year intervals rolled annually at the end of the year based on:

  1. Annual nominal and real total returns for Shiller’s long-run S&P Composite Index during 1871-2022, offering 146 overlapping 5-year intervals (only 29.2 independent intervals). We frictionlessly reinvest dividends annually.
  2. Annual nominal capital gains for the S&P 500 Index during 1927-2022, offering 91 overlapping 5-year intervals (only 19.2 independent intervals).

Using much shorter samples available for assets such as exchange-traded funds offers results and comparisons of very low reliability. Using annual returns for the two indexes as described, we find that: Keep Reading

0DTE Strategy Outcomes

Are Zero-Days-to-Expiration (0DTE) options attractive trading vehicles? In his November 2023 paper entitled “0DTE Trading Rules”, Grigory Vilkov surveys outcomes for popular strategies that each day take unhedged positions in cash-settled 0DTE options on the S&P500 Index and hold to expiration. He considers simple trading rules that open positions at a fixed time (10:00 in the main analysis and 13:00 and 15:00 in additional tests) and hold to expiration at 16:00. He augments available prices by interpolation to construct test data for moneyness from 0.98 to 1.02 in 0.00125 increments. He then computes profit/loss statistics for both standalone calls and puts and for selected option strategies, including: at-the-money (ATM) straddles; strangles; bull call and bear put spreads; call and put ratio spreads; and, risk reversals. Excepting the straddle, he considers several combinations of strikes, from in-the-money (ITM) to out-the-money (OTM). He also estimates the variance risk premium as the implied variance minus realized variance while positions are open. Using 0DTE option 30-minute price data during September 2016 through May 2023, he finds that: Keep Reading

Look-ahead Bias in Option Trading Backtests

Numerous option trading studies report finding strategies with remarkably high mean returns and Sharpe ratios. Are these findings too good to be true? In their October 2023 paper entitled “Too Good to Be True: Look-ahead Bias in Empirical Option Research”, Jefferson Duarte, Christopher Jones, Mehdi Khorram and Haitao Mo investigate the extent to which look-ahead bias drives extraordinarily high average returns and Sharpe ratios in two distinct option strategies: one based on stock characteristics (January 2012 through June 2020), and the other associated with liquidity provision in the options market (January 1996 through April 2016). They first replicate the strategies as published, and then recast the strategies with careful attention to what information is reliably available before trading. Using data over the above sample periods required to replicate and correct the original studies, they find that: Keep Reading

Beat the Market with Covered Calls?

Do covered call strategies, which offer both long equity and short volatility exposures, beat their underlying equities? In their October 2023 paper entitled “A Devil’s Bargain: When Generating Income Undermines Investment Returns”, Roni Israelov and David Ndong test a strategy of each month selling and holding to maturity cash-settled covered calls on the S&P 500 Index selected to meet a target annualized option yield (based on moneyness). For example, if the target annualized option yield is 6%, they sell calls at 0.5% of the index price each month. They consider a full sample period of nearly 25 years and a subsample covering the second half. Using S&P 500 Index and index call options data to test the specified covered call strategy during January 1999 through June 2023, they find that:

Keep Reading

Are Equity Put-Write ETFs Working?

Is systematically selling covered equity put options, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider four equity put-write ETFs, two dead and two living:

  1. US Equity High Volatility Put Write (HVPW) – oriented toward individual stocks (dead).
  2. ALPS Enhanced Put Write Strategy (PUTX) – index-oriented (dead).
  3. WisdomTree PutWrite Strategy Fund (PUTW) – index-oriented (living).
  4. BMO US Put Write (ZPW.TO) – oriented toward individual stocks (living).

Because available samples are fairly short, we focus on daily return correlation with SPY, average daily return, standard deviation of daily returns and daily reward/risk (average daily return divided by standard deviation of daily returns). We also look at compound annual growth rates (CAGR) and maximum drawdowns (MaxDD) based on daily data. We consider SPDR S&P 500 ETF Trust (SPY) and CBOE S&P 500 PutWrite Index (PUT) as benchmarks. Using daily returns for the four ETFs as available through early August 2023, and contemporaneous daily returns for SPY and PUT, we find that: Keep Reading

Are Equity Index Covered Call ETFs Working?

Is systematically selling covered call options on equity indexes, as implemented by exchange-traded funds (ETF), attractive? To investigate, we consider five equity covered call ETFs:

  1. Invesco S&P 500 BuyWrite (PBP) – seeks to track the CBOE S&P 500 BuyWrite Index (BXM).
  2. Global X S&P 500 Covered Call (XYLD) – seeks to track BXM.
  3. Global X NASDAQ 100 Covered Call (QYLD) – seeks to track the CBOE Nasdaq-100 BuyWrite V2 Index (BXNT). We use CBOE NASDAQ-100 BuyWrite Index (BXN) based on availability of historical data.
  4. First Trust BuyWrite Income (FTHI) – holds U.S. stocks of all market capitalizations and sells at-the-money to slightly out-of-the-money covered calls on the S&P 500 Index up to 20% of fund assets, laddered with expirations of less than one year (we use BXM as a benchmark).
  5. Global X Russell 2000 Covered Call (RYLD) – seeks to track the CBOE Russell 2000 BuyWrite Index (BXRC).

We focus on average monthly return, standard deviation of monthly returns, compound annual growth rate (CAGR) and maximum drawdown (MaxDD) based on monthly data. We consider SPDR S&P 500 ETF Trust (SPY), Invesco QQQ Trust (QQQ) and iShares Russell 2000 ETF (IWM) as underlying stock index proxies. Using monthly dividend-adjusted returns for the five covered call ETFs since inceptions and contemporaneous monthly levels of all benchmarks/underlying index proxies through April 2023, we find that: Keep Reading

Retail 0DTE Option Trader Performance

Should individuals who trade zero-days-to-expiration (0DTE) S&P 500 Index options expect to make money? In their March 2023 paper entitled “Retail Traders Love 0DTE Options… But Should They?”, Heiner Beckmeyer, Nicole Branger and Leander Gayda examine performance of retail 0DTE S&P 500 Index option trades. They focus on effects of the introduction of daily expirations for such options in mid-May 2022. Using daily S&P 500 Index option trade data from CBOE, including trader-type transaction codes, during January 2021 through February 2023, they find that: Keep Reading

Cheap Options for Stock Market Crash Protection

Does the difference in individual stock/market return relationships between good times (relatively low correlations) and bad times (relatively high correlations) present an easy and efficient way to hedge against stock market crashes (tail risk)? In their March 2023 paper entitled “Tail Risk Hedging: The Search for Cheap Options”, Poh Ling Neo and Chyng Wen Tee test the ability of a portfolio of liquid but cheap put options on individual stocks to protect against equity market crashes. They reason that:

  • These options are inexpensive compared to equity index put options.
  • During good times, the relatively low return correlations across stocks limit option portfolio drag.
  • During market crashes, the spike in these correlations confers on the option portfolio tail risk protection comparable to that of equity index put options.

Their tests encompass three stock market regimes: (1) up months have positive monthly returns and no daily return less than -5%; (2) down months have negative monthly returns but no daily return less than -5%; and, (3) tail risk months have at least daily return less than -5%. At the end of each month, they construct a crash protection put option portfolio as follows:

  • Select an out-of-the-money put option for each optionable stock with delta closest to -10% and six months to a year until expiration.
  • Exclude those with ex-dividend dates prior to expiration.
  • Exclude those with bid-ask spreads over 50% of the bid-ask midpoint.
  • Allocate 2% of the value of the S&P 500 Index position equally to each of the cheapest 20% of remaining put options.

Most analyses assume option buys and sells occur at bid-ask midpoints (no frictions), but they do look at impacts of effective bid-ask spreads up to 50% of the quoted spread. Using daily returns for the S&P 500 Index, S&P 500 Index put options and individual U.S. stock put options during January 1996 through December 2020, they find that: Keep Reading

Performance of Defined Outcome ETFs

Defined outcome Exchange-Traded Funds (ETF) use complex options strategies that buffer against loss but cap gain to generate a defined outcome for investors over a predefined period. Are they attractive? In their February 2023 paper entitled “The Dynamics of Defined Outcome Exchange Traded Funds”, Luis García-Feijóo and Brian Silverstein analyze average performance of the Innovator Defined Outcome ETF Buffer Series from 2019 through 2021. They also model the performance of the underlying strategy and simulate average outcome during January 2013 through August 2022. They consider three benchmarks: SPDR S&P 500 ETF Trust (SPY); 50% allocation to SPY and 50% allocation to iShares Core US Aggregate Bond ETF (AGG); and, iShares MSCI USA Min Vol Factor ETF (USMV). Using actual and simulated returns for the selected defined outcome ETFs/benchmarks as described, they find that:

Keep Reading

Login
Daily Email Updates
Filter Research
  • Research Categories (select one or more)