Equity Options

Are there predictable times when selling covered call options outperforms selling cash-covered put options? In his March 2010 paper entitled “Buy-Write or Put-Write, An Active Portfolio to Strike it Right” (the National Association of Active Investment Managers’ 2010 Wagner Award runner-up), George Yang investigates using trend signals to trigger switching between covered call and put writing. The test portfolio consists of: (1) a long position in the S&P 500 Total Return Index (SPTR); (2) cash (Treasury bills); and, (3) a short position equivalent to the value of (1) plus (2) in at-the-money, next-month call or put options on the S&P 500 Index. The Golden Cross/Black Cross Rule (the 50-day simple moving average crossing above/below the 200-day simple moving average) applied to SPTR triggers switches between calls (after black crosses) and puts (after golden crosses). Using daily closes for SPTR, the S&P 500 Buy-Write Index (BXM) and the S&P 500 Put-Write Index (PUT) during June 1988 through December 2009 (21.6 years), he finds that: Keep Reading

Reader Jeff Partlow passed along the question of whether options on Exchange-Traded Funds (ETF) are Section 1256 contracts, qualifying for 60% long-term and 40% short-term capital gains treatment. Using applicable parts of U.S. Code Section 1256 and IRS Publication 550, we find that: Keep Reading

Does reluctance of traders to hold naked short positions in individual stock options over weekends induce a weekend effect for option prices? In the February 2010 revision of their paper entitled “The Weekend Effect in Equity Option Returns”, Christopher Jones and Joshua Shemesh employ a portfolio approach to investigate a weekend effect for put and call options on U.S. stocks. They compute portfolio excess returns as the equally weighted average of individual option contract returns based on bid-ask midpoints, in excess of a short-term yield. Using price data for a filtered set of U.S. equity options and for the underlying stocks over the period January 1996 to June 2007, they conclude that: Keep Reading

Reader Jeff Partlow asked and wondered: “Are you aware of research on the before and after impacts of company earnings releases on option prices? As a covered calls investor, I have gone back and forth about whether the increased option premiums available prior to earnings release makes it more advantageous to: (1) sell options prior to earnings release to take advantage of elevated premiums; or, (2) avoid companies with an impending earnings release to avoid the risk of negative earnings surprises.” Keep Reading

Do returns for covered calls on individual stocks vary systematically with stock volatility and liquidity? In the January 2010 version of their paper entitled “Option Returns and Individual Stock Volatility”, Jie Cao and Bing Han compare monthly returns of portfolios of short-term (formed about 1.5 months from expiration and held one month), at-the-money covered call options sorted by either total volatility (standard deviation of daily stock returns over the previous month) or idiosyncratic (market-independent) volatility of the underlying stocks. They also examine a double sort by market capitalization and total volatility. Using daily stock and option price data for a broad sample of U.S. equities over the period January 1996 through December 2006, they conclude that: Keep Reading

Covered Calls Advisor Jeff Partlow commented: “Selling a cash-secured put is essentially equivalent to a covered call when done at the same strike price and expiration date. But I’ve observed that cash-secured put sellers tend to select more conservative out-of-the-money strike prices, whereas covered call sellers tend to establish more aggressive out-of-the-money strike prices. Also, the result in ‘Outperformance from Mechanically Selling Covered Calls on a Stock Index’ is questionable to me because the July 2004 ‘Passive Options-based Investment Strategies: The Case of the CBOE S&P 500 BuyWrite Index’ by Ibbotson Associates and the October 2006 ‘An Historical Evaluation of the CBOE S&P 500 BuyWrite Index Strategy’ by Callan Associates show, respectively, that 2% out-of-the-money and at-the-money covered call strategies outperform a buy-and-hold approach.” Keep Reading

In his 2010 book Put Option Strategies for Smarter Trading: How to Protect and Build Capital in Turbulent Markets, author Michael Thomsett “explains all the put-based strategies [for individual stocks] in detail and shows how even a troubled market presents great opportunities to keep you in control. The worst aspect of volatile markets is a sense of not having control over events, and puts can be used to offset this apprehension. You have probably heard that astute traders can earn profits in all types of markets. Puts are among the best devices to accomplish that goal.” Some notable points about the book are: Keep Reading

Do buy-write strategies, wherein investors buy stocks and simultaneously sell matched out-of-money call options, generally outperform their underlying stocks? In other words, do option premiums more than compensate for any sacrifice of capital gains? In their January 2010 paper entitled “The Efficiency of the Buy-Write Strategy: Evidence from Australia”, Tafadzwa Mugwagwa, Vikash Ramiah and Tony Naughton examine the performances of buy-write strategies on the Australian Stock Exchange for portfolios formed monthly, quarterly and yearly at different levels of call option out-of-the-moneyness. They test the profitability of buy-write strategies during weak and strong markets. They measure the effects on buy-write returns of underlying stock liquidity (turnover ratio), dividend yield, firm size, book-to-market ratio, earnings per share and price-earnings ratio. Using prices, firm fundamentals and out-of-the-money call option prices (actual and modeled) for 179 stocks over the period January 1995 through October 2006, they conclude that: Keep Reading

A reader asked: “I am interested in finding a strategy to day-trade around the opening of trading. I would prefer the first half hour but would not be opposed to looking at strategies holding until the close or even the next day. With the high-frequency traders becoming the new liquidity providers, day traders like me aren’t left with much of an edge. I think the first half hour may still hold some opportunity. Do you know of any first half hour plays that I might start to build from?” Keep Reading

A reader asked: “I have been looking into portfolio hedging using index put options, but I cannot find any analysis on the efficiency of using at-the-money (ATM) versus out-of-the-money (OTM) puts. Do you know of any research focusing on this question?” Keep Reading