Sunday, July 31, 2016

Dr. Putwrite or: How I learned to Stop Worrying and Love the Vol

The majority of my trades are pure long vol plays (long straddles/strangles). However, ever since the CBOE released a study it sponsored analyzing a putwrite strategy on the S&P 500 index which showed one could have attained slightly higher returns with less volatility than being long the index, I've been intrigued by the concept.

I wanted to take a look at the worst case scenario for a putwrite strategy. For that, I looked at VRX which is about as bad as it gets (save for VXX or a company that goes bankrupt arguably out of nowhere i.e. GTAT) I also took a look at OIH, which dropped from $30/share in November of 2015 to $20.46 in early January of 2016 during the general market rout and oil rout.

A few caveats:
1. All data input was done manually, potential for error exists.
2. I attempted to get put prices as close to open as possible. Some of the put prices are "fair" estimates of where a put could have been sold for. Furthermore, puts were written as close to ATM as possible.
3. Returns also assume putwrite is held straight through opex. One would have needed an iron-clad stomach for some of the mid-week realized volatility in VRX...
4. This study excludes commission costs, capital gains taxes and dividends.
5. I built my VRX spreadsheet first, and wish I had set it up like the OIH spreadsheet.
6. Study includes gap returns if assigned on Friday. So, if I get put stock at 28/share friday and it opens on 27 on Monday, that -$1.00 gap is included in the return.

Now for a few takeaways on VRX: (spreadsheet here)
1. This assumes I went long stock on September 28, 2015 at $197.50/share, and held through July 29, 2016 where the stock closed at $22.30/share. This is a net loss of -$175.20, or a -88.7% return.
2. If I wrote puts every week, my net loss (total p/l from writing weekly puts + total p/l from gaps when assigned) would be -105.24, for a net loss of -53.3% through July 29, 2016. 
3. If I knew to skip earnings weeks AND conference calls, but wrote puts every other week my net loss would be -6.81, or -3.45% through July 29, 2016.
4. Regarding the above line, I would have missed out on $103.20 of put write losses and another $4.24 in assignment gap losses.
5. A -53.3% return sucks, but it's a lot better than being down -88.7%!

OIH takeaways: (spreadsheet here)
1. I wish I had compiled my VRX spreadsheet like I had for OIH.
2. This assumes I went long the ETF on November 30, 2015 at $30.82/share and held through July 29, 2016 where the ETF closed at 28.19. This a loss of -8.53%.
3. Had I written weekly puts starting November 30, 2015, through July, 29, 2016, I would have realized a profit of $2.50. However, I would have realized a net loss of -$1.43 due to assignment gaps. This reduces the return to $1.07, or +3.47% vs. the ETF price of $30.82 on November 30, 2015.
4. The putwrite strategy broke even at +0.58% on April 11, 2016, while being long the ETF had a return of -11.97%.
5. It hasn't paid to be long the ETF yet, while the putwrite strategy has been in the black for the past eight weeks.

The putwrite strategy's Achilles heel:
1. Onerous trading commissions, capital gains taxes, and liquidity issues have the very real possibility of sinking any benefits to implementing a weekly putwrite strategy.

Final Takeaway:
Feel free to laugh hysterically the next time you hear someone say that writing cash-secured puts is risky. The returns from writing weekly puts aren't just "a little" better than being long stock, they're far superior.

1. CBOE: New Study on Weekly, Monthly PutWrite Indexes Released
2. CBOE: An Analysis of Index Option Writing for Liquid Enhanced Risk-Adjusted Returns
3. VRX spreadsheet
4. OIH spreadsheet 

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