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Study Confirms What We Already Knew

The Performance of Options-Based Investment Strategies:
Evidence for Individual Stocks During 2003–2013

Link to full paper


Using data from January, 2003, through August, 2013, we examine the relative performance of options-based investment strategies versus a buy-and-hold strategy in the underlying stock. Specifically, using ten stocks widely held in 401(k) plans, we examine monthly returns from five strategies that include a long stock position as one component: long stock, covered call, protective put, collar, and covered combination. To compare performance we use four standard performance measures: Sharpe ratio, Jensen’s alpha, Treynor ratio, and Sortino ratio. Ignoring early exercise for simplicity, we find that the covered combination and covered call strategies generally outperform the long stock strategy, which in turn generally outperforms the collar and protective put strategies regardless of the performance measure considered. These results hold for the entire period 2003–2013 and both sub-periods 2003–2007 and 2008–2013. The findings suggest that options-based strategies can be useful in improving the risk-return characteristics of a long equity portfolio. Inferences regarding superior or inferior performance are problematic, however, as the findings reflect the Leland (1999) critique of standard CAPM-based performance measures applied to option strategies.

Evidence (charts based on data that goes back to 1986) that buy-write strategies (BXM) and put-writing strategies (PUT) outperform collar strategies (CLL) and simple buy and hold is widely distributed and well understood by experienced option traders. Those studies are based on index options and the study quoted above concentrates on individual stocks. But the conclusions are familiar.

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Adjusting in Stages. The Reality.

Question (black font) and answer (blue font):

Dear Mark, Hello Antonio

Firstly hope everything is OK as you don’t write too frequently in the blog. I am writing much less these days, and most of that appears in my column.

Maybe you remember me Sure I remember you because throughout the years I have done some questions and also was in the premium forum a few months. I got out because it coincided with a strong work time and also left trading because of the poor results.

I came back to the idea of ​​the Iron Condor and re-reading some post I would like you to validate this system and give me your opinion about it.

The idea is to adjust risk by closing in stages as you suggest and I explore the numbers.

In these low volatility times, it seems to make an IC by generating a 3$ credit is very difficult. 2.5$ could be easier with delta 15 ~ It’s a different world today, and we must adapt to current market conditions. Just be certain that you truly like (i.e., you are comfortable owning) the positions you are trading — and not merely following a formula for deciding which iron condors to trade. For example, when IV is low, 15-delta iron condors would be less far out of the money than they used to be. Perhaps you would be more comfortable with a lower delta…maybe 12. That is a personal decision, but I want you to think about it. Do you want a smaller premium coupled with a higher chance of success? It is very difficult to answer that question.

Scenario: I trade 3-month iron condors.

Closing the not-adjusted (i.e., profitable) spread 3 weeks before exp at an estimated cost of 0.50$

I trade 6-lots of the iron condor, collecting 2.50$ in premium for each. Total cash collected is 1,500$.

First adjustment: Close ~20% position (1-lot). losing 100$. I would close only the threatened half of the IC. I encourage exiting the whole iron condor.

Second adj: close ~30% position. losing $ 150 per iron condor (2 contracts) = 300 loss.

Third adj. close remaining 50% position. losing $ 250 (3 contracts) = 750 loss.

Let’s examine the worst (or at least a very bad) scenario: we would have to adjust every month of the year: This is very harsh. This scenario should seldom — if ever — come to pass.

  • Six times: 3 adjustments, exiting entire position.
  • Six times we make only 2 adjustments.
  • Assume that we NEVER get to earn the maximum possible profit (zero adjustments)


3 adjustments:
1500-100-300-750-300 (spread value not threatened $50×6) – 60 (commission) = $ -10 [i.e., we lose $10 for the trade]

2 adjustments:
1500-100-300-300 (spread value not threatened 0.5×6) – 60 (commission) = + $ 740

a) Lose $10 six times per year: = -60

b) Gain 740 six times = 4,560 ….. ….. 4500$ year ….
Total Annual Performance = 4500/18000 = 25%
This would be a very satisfactory result.
Unfortunately the math is very flawed.

***You are assuming that it costs $100 to exit at the first adjustment, but that is the LOSS, not the cash required. To exit one iron condor at a loss of $100 costs $350 to exit.

Similarly, when you exit after two adjustments (at a $150 loss per IC, it actually costs $800 cash – i.e., your original $500 plus $300 in losses).

Exiting after three adjustments costs the $750 loss plus the original $750 premium. Total cost is $1,500.

Thus your numbers should be:
a) The 6 times when three adjustments are required: collect $1,500, pay $350 for adj #1, pay $800 for adj #2, pay $1,500 for adj #3, pay $60 in commissions: Loss = $1,210.

b) The 6 times that two adjustments are required: collect 1500, pay $350; pay $800, and pay $150 later to exit the three winning spreads; pay $60 commissions. Net profit is $140.

The Discussion

As I say I’d appreciate an opinion as deep as possible, because regardless of other possible adjustments we can make, I think the way you handle the IC goes here.

One practical difficulty is this: How aggressively do you try to exit when adjustment time arrives? If you do not bid aggressively to exit the position, the loss may get much higher than $100 before your trade is executed. If you bid very aggressively, then you may be paying too much to exit positions that have not yet reached the adjustment stage. You must think about this.

Honestly I pulled away from trading because i was not getting good results, but I continue thinking that IC are great and that your way is one of the best to do it. Please remember that no method is ever good enough – unless you feel comfortable when trading. Why? Because discomfort leads to poor decisions. Also: When you examine the correct numbers (above), you will see that you cannot make any money when you anticipate making three adjustments approximately 6 times per year. Adjustments are expensive and we make them to be certain that we keep our losses small. However, you must expect to make one or fewer adjustments — most of the time — for the iron condor strategy to be viable.

Please tell me if there is some way to communicate privately. Thank you. Send email and we can discuss. rookies (at) mdwoptions (dot) com



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Three Questions from a Reader

1. What’s your strategy on buying LEAPs options? In order to avoid time decay, when do you roll out if you have a long term view and would like to hold on the securities as long term investment? I guest the pros probably do it within at least 6 months of remaining time value?

    I do not buy LEAPS or any other options.

    If I were to buy LEAPS calls, I would buy options that are in the money — but ONLY on a stock that I want to own because I anticipate that the stock price will move higher.

    When buying any option, “worrying” about time decay is important – but it is not your primary consideration. And when buying LEAPS options IMPLIED VOLATILITY (IV) is far more important than time decay. I know that you are new to options, but please take this statement as true: When you pay too much for the options, your chances of making money on the trade are reduced significantly. It is a very bad idea to buy LEAPS options when IV is relatively high. To get more information on IV, read this article and follow the links.

    When you have a long-term view and when you know that you plan to own the options for a long time, then you want to buy an options with less time value (rather than one with more time value). That means owning an option that is even deeper in the money. In this example, I would buy the Jan 2016 70 call with no plan to roll until expiration is nigh (unless I roll to a higher strike price, per the discussion below).

    I would roll ONLY when two conditions are met:
    I still want to own call options on this stock (as you probably do). But sometimes, you must be willing to accept the fact that this stock is not going to move higher and that you made a mistake buying the call options in the first place. Do not make the mistake of rolling just to get more time.
    Also: IV cannot be too high or else you are paying far too much for your new call option.

    When would I roll? When I have a nice profit to protect. For example, let’s assume that you buy a call option on stock XYZ whose current price is $80 per share. The LEAPS call expires in Jan 2016. I would buy the call with a strike price of $75 (In the money). If the stock rallies (assume it goes to $92) and if I believe that the stock will move still higher, I would sell my Jan 2016 75 call and buy the Jan 2017 85 call or the Jan 2016 85 call. The decision would be based on how much time remains before Jan 2016 arrives and whether I prefer to own a 2016 or 2017 call. NOTE: The Jan 90 call is not sufficiently in the money and is not a good choice for the person who plans to hold onto the option for a long time.

2. When you sell put/call options, do you sell for a 1-month expiry options or longer so that the premium is higher but takes longer for the option value to decay due to longer time frame?

I do both, depending on the situation. My recommendation for you – as a newer trader – is to write options that expire in about 60 days. That is a good compromise between less risk (shorter-term options come with little protection against a loss) and the less rapid time decay.

3. As my portfolio is small and $10k, like most rookie traders, I am comfortable with selling 1 or at most 2 covered contracts of puts/calls options. But the premiums is very little for a forward 1 month expiry options. This prompted lots of newbies, to take unusual large risky position on selling naked puts like 10 contracts which can be disastrous when volatility increased. What’s your take on this?

***If the premium is too small and if it does not allow you to make a satisfactory profit (THINK IN TERMS OF PERCENTAGE PROFIT, NOT ON TOTAL DOLLARS PROFIT) then you have chosen an inappropriate call/put option to sell. Find another stock or better yet, choose a longer term option. DO NOT increase position size just for the chance to earn more money. This is a risk that no trader can afford to take.

You may even have to find a broker who charges lower commissions, but please, never increase risk just because the potentials gains are too small. The only time to increase risk (and that would be going from 2 options to 3; never from 2 to 10) is when you deem the trade to be extremely attractive.

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The Art of Making Decisions when Trading

One of my basic tenets in teaching people how to trade options is that rules and guidelines should not be written in stone and that there are valid reasons for accepting or rejecting some of the ideas that I discuss.

When I offer a rationale or explanation or a suggest course of action, it is because I have found that this specific suggestion has worked best for me and my trading. I encourage all readers to adopt a different way of thinking when appropriate. The following message from a reader offers sound reasons for taking specif actions regarding the management of an iron condor position. My response explains why this specific reasoning is flawed (in my opinion).

The question

Hi Mark,

I have some questions on Chapter 3 (Rookie’s Guide to Options) Thought #3: “The Iron Condor is one position.”

You mentioned that the Iron Condor is one, and only one, position. The problem of thinking it as two credit spreads is that it often results in poor risk-management.

Using a similar example I (modified a little bit from the one in the book) traded one Iron Condor at $2.30 with 5 weeks to expiration:
– Sold one call spread at $1.20
– Sold one put spread at $1.10

Say, a few days later, the underlying index move higher, the Iron Condor position is at $2.50 (paper loss of $0.20):
– call spread at $2.00 (paper loss of $0.80)
– put spread at $0.50 (paper profit of $0.60)

I will lock in (i.e., buy to close) the put spread at $0.60 for the following reasons and conditions:
1. it is only a few days, the profit is more than 50% of the maximum possible profit
2. there are still 4 more weeks to expiration to gain the remaining less than 50% maximum possible profit. in fact, the remaining profit is less as I will always exit before expiration, typically at 80% of the maximum possible profit. so, there is only less than 30% of the maximum possible profit that I am risking for another 4 more weeks.
3. the hedging effect of put spread against the call spread is no longer as effective because the put spread is only at $0.50. as the underlying move higher, the call spread will gain value much faster than the put spread will loss value.

Is the above reasoning under those conditions ok? Will appreciate your view and sharing. Thank you.

My reply

Bottom line: The reasoning is OK. The principles that you follow for this example are sound.

However, the problem is that you are not seeing the bigger picture.

1. There is no paper loss on the call spread. Nor is there a paper profit on the put spread. There is only a 20-cent paper loss on the whole iron condor.

2. When trading any iron condor, the significant number is $2.30 – the entire premium collected. The price of the call and puts spreads are not relevant. In fact, these numbers should be ignored. It is not easy to convince traders of the validity of this statement, so let’s examine an example:

Assume that you enter a limit order to trade the iron condor at a cash credit of $2.30 or better. Next suppose that you cannot watch the markets for the next several hours. When you return home you note that your order was filled at $2.35 – five cents better than your limit (yes, this is possible). You also notice the following:

  • The market has declined by 1.5%.
  • Implied volatility has increased.
  • The iron condor is currently priced at $2.80.
  • Your order was filled: Call spread; $0.45; Put spread; Total credit is $2.35.

Obviously you are not happy with this situation because your iron condor is far from neutral and probably requires an adjustment. But that is beyond this today’s discussion — so let’s assume that you are not making any adjustments at the present time.

That leaves some questions

  • Do you manage this iron condor as one with a net credit of $2.35? [I hope so]
  • Do you prefer use to the trade-execution prices?

If you choose the “$2.35” iron condor, it is easy to understand that this is an out-of-balance position and may require an adjustment.

If you choose the “45-cent call spread and $1.90 put spread” then the market has not moved too far from your original trade prices, making it far less likely that any adjustment may be necessary.

In other words, it does not matter whether you collected $2.00, $1.50, $1.20, $1.00, or $0.80 for the put spread. All that matters is that you have an iron condor with a net credit of $2.35.

3. You should consider covering either the call spread, or the put spread, when the prices reaches a low level. You are correct in concluding that there is little hedge remaining when the price of one of the spreads is “low.” You are correct is deciding that it is not a good strategy to wait for a “long time” to collect the small remaining premium.

If you decide that $0.60 is the proper price at which to cover one of the short positions, then by all means, cover at that point. (I tend to wait for a lower price).

If you want to pay more to cover the “low-priced” portion of the iron condor when you get a chance to do so quickly, there is nothing wrong with that. However, do not assume that covering quickly is necessarily a good strategy because that leaves you with (in your example) a short call spread — and you no longer own an iron condor. If YOU are willing to do that by paying 60 cents, then so be it. It is always a sound decision to exit one part of the iron condor when you deem it to be a good risk-management decision. But, do not make this trade simply because it happened so quickly or that you expect the market to reverse direction. If you are suddenly bearish, there are much better plays for you to consider other than buying back the specific put spread that you sold earlier.

4. The differences in your alternatives are subtle and neither is “right’ nor ‘wrong.”

The main lesson here is developing the correct mindset because your way of thinking about each specific problem should be based on your collective experience as a trader.

Your actions above are reasonable. However, it is more effective for the market-neutral trader to own an iron condor than to be short a call or put spread.

You are doing the right thing by exiting one portion of the condor at some “low” price, and that price may differ from trade to trade. But deciding to cover when it reaches a specific percentage of the premium collected is not appropriate for managing iron condors.

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Volatility Indexes: VIX and RUT

Interesting story in today’s Wall Street Journal online.

Most people are familiar with the VIX, the CBOE Volatility Index. It uses options prices to measure the expected volatility of the S&P 500 index. A lesser known index is the RVX, the CBOE Russell 2000 Volatility Index. This uses the exact same formula as the VIX, but applies it to the Russell 2000′s stocks.

As you might imagine, the RVX has historically run higher than the VIX, given that it measures the expected volatility of an inherently more volatile small-cap stock index. According to Russell Investments, the “premium,” or the difference between the two indexes, has historically been around 29%. But in 2014, a year that was at first a wild ride for small-caps, and then a wild ride for everyone, the relationship between the two has been both historically wide, and historically narrow.

Read the whole story at the WSJ site

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Iron Condors and Soaring Option Volume

(Reuters) – Growing concerns about the economy and markets sent volatility soaring on Wednesday [Oct 15, 2014] and pushed trading volume in the U.S. options market to its highest level in more than three years, as traders moved to hedge their portfolios on fear of further market gyrations.

You can read the whole article at the Reuters site.

Is it time for Iron Condors?

The increase in implied volatility suggests that investor complacency may have ended and that fear has returned.

The question for traders is whether it is time to adopt premium-selling strategies (the iron condor, for example), or if it is better to wait for even higher volatility. One thing is certain: getting into this game before the volatility highs have been reached is a treacherous undertaking. I recommend waiting because it is better to avoid iron-condor risk when we do not know whether the current period of increased volatility is just beginning.

My advice: If you are an experienced iron condor trader, it is okay to nibble, but I would not want more than 20% of my cash (the cash set aside for strategies such as the iron condor) in play at this time.

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Free eBook Revised and Updated

Introduction to Options: The Basics has been revised and updated. It remains a very basic introduction to options, but now it has even more useful material. The book is still free, and you can download it or get it from your favorite online bookseller.

Volume 0: The Basics

Volume 0: The Basics

NOTE: DO not pay $0.99 at
It is free everywhere — except at amazon.

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The Rookie’s Guide is now an eBook

I’ve been asked to do it many times, and I am happy to announce that the Rookie’s Guide to Options, 2nd edition is available in eBook format.

At this time, the only versions available are Kindle and pdf.

The new eBook and the paperback version were updated (minor changes) Sept 11, 2014.

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