Skip to main content

Can you make a 100% per year return on capital selling put options in SPY?

Selling put options is a very popular stock option strategy.  It is analogous to selling insurance, by collecting a premium to give the option (policy) holder the ability to sell stock a specific price obligating the seller to buy it at that price.

2 Popular reasons to sell put

  • Willing to buy stock at a lower price than currently
  • Neutral to bullish opinion and premium attractive enough premium to risk against capital

In the first scenario, if the price goes lower and expires in-the-money, the investor gets to buy at the strike price AND collect the premium.  In the second scenario,  if the trader is correct will collect the premium and even if slightly wrong can still come out ahead if the premium is large enough.  Eg.  SPY is trading 470 and sold an at-the-money put (470) for $7, but at expiry the stock closes at 465.  In this scenario, the trader was wrong, but still makes (470-465+7) $2 if he immediately closes the SPY position on expiration.

How much Option Premium is collected?

Currently a 30 day at-the-money put option on SPY costs $7.81 when the price is 470 (with an implied volatility of 13.4%, with VIX currently at 18.7%).  Since 1 contract represents 100 shares, the actual premium for 1 option is $781.  The amount of margin (Reg T) required is $10,119.27.  So the option premium collected for required initial margin is 7.7% ($781/$10,119.27).

Can you lose more than the initial margin?

YES.  This is one of the complexities of managing option contracts.  For example if the SPY went to 0 at expiration the buyer would still need to pay 470.  Meaning the seller of the option would have the following PnL

  • Put PNL = (current price - strike price + premium) x contracts
In this scenario, it would be ( 0 - 470 + $7.81 ) x 100 = -$46,219.  In this scenario that would be -457% loss (-$46,219 / $10,119.27).

Although this is theoretically possible, it is very improbable.  A more reasonable approach would be to estimate based on standard deviation moves. A 2 standard deviation move would make the price around 425, giving a loss of ( 425 - 470 + $7.81 ) x 100 = -$3,719.  In this scenario that would be a -36.8% loss (-$3,719 / $10,119.27).

For reference a 3 standard deviation move would make the price around 405, giving a loss of ( 405 - 470 + $7.81 ) x 100 = -$5,719.  In this scenario that would be a -56.5% loss (-$5,719 / $10,119.27).

So maximum profit would be 7.7% and a reasonable loss would be -56.5% loss.

What kind of range does the premium have?

The premium for the above example was for 30 days out and a implied volatility of 13.4% for an at-the-money option.  The volatility range of 30 day option can be approximated by looking at the range of the VIX as the SPY implied volatility is generally about 4 to 5% below the VIX when it is stable.

VIX Range and ATM ivol estimate from 1993-01-29 to 2021-11-19

meanstdmin25%50%75%max
vix19.548.299.1413.5317.5723.0382.69
ivol14.543.294.148.5312.5718.0377.69

The magnitude change in implied volatility corresponds to roughly the magnitude change in option premium.  So currently being 13.4%, gives a premium/initial margin of 7.7%, if it where increased by 1.5x to 20.1% the margin would increase to about 11.5% and decreased by about 1.5x to 8.9% would decrease the premium to about 5.1%.  These would correspond to slightly above the 75% in table above for ivol and close to the 25%.  

Meaning the a reasonable range for premium/initial margin to be 5.1% - 11.5%.

So with 12 months in a year a rough estimate looks like currently about 7.7% x 12 = 92.4% with reasonable bounds being 61.2% (5.1%x12) and 138% (11.5%x12).  So it is possible to make 100% a year selling 30 day put options if they all expire worthless.

Is it reasonable to assume to collect all the premium?

No.  It is probably reasonable to collect less 50% of the premium if you have a lot of occurrences.  Making put selling about 46.2% with lower profitable range of 30.6% and 69%.  The main issue is that if you get a lot of big losses in a row, it will be hard to recover, so the sequence of wins and losses is very important.  To survive drawdowns, a good strategy can be to reduce the size.  
 
For example, cutting the risk in half. would now make the profitability 23.1% with a range of 15.3% and 34.5%, but would make a 2 and 3 standard deviation loss go from -36.8% to 18.4% and 56.5% to 28.3%, which is mathematically much harder to recover from.

Takeaways

  • It is possible to make 100% a year selling 30 day at-the-money put options, but would need probably all the options to have enough premium value and expire worthless.
  • Assuming collecting about 1/2 the premium and cutting the risk in 1/2, the returns could average to 23.1% (range between 15.3% to 34.5%) with a 2 standard deviation losing month at 18.4%.  
  • Cutting another 1/2 of risk using 25% of capital would make the return average 11.6% (range between 7.7% to 17.3%) with a 2 standard deviation losing month at 9.2%.  (which is in the range of the historical performance of SPY). 
Labels:

Comments

Post a Comment

Popular posts from this blog

using options to recover from a big move against me when buy a stock for shareholder benefits - RCL attempt to repair position

Shareholder Benefits Owning shares of a company can entitle you to special benefits when consuming products or services.  For example, Royal Caribbean Cruises (RCL) provides $100 onboard credit per Stateroom on Sailings of 6-13 nights.  With an upcoming cruise booked and most of my portfolio in cash, I decided to take advantage of this offer.  I've done a few cruises in the past and definitely enjoyed Royal Caribbean, especially having young children; and can imagine I will take more cruises with them in the future. The Purchase of Shares I didn't do any deep Fundamental or Technical Analysis, but looked at a 5 year chart seeing the stock priced at $135 before the COVID-19 pandemic, and during the pandemic reached a low of around $24.  When I purchased the shares it was $40 and dropped in price for the 2 preceding days.  Since I bought at the end of the day, I figured I would sell a call option (overwrite) the next day as the volatility was high around 85%....
Post a Comment
Read more

How does theta change through time when selling strangles? SPY, META, IEF

What is Theta? Theta is amount of value that an option position changes each day due to the passage of time.   For example, SPY closing at 411.99 and Implied Volatility (IVOL) 22.58% SPY 9/16/22 (47 DTE) Strike delta price theta 376P -0.15 3.12 -0.09 440C 0.15 1.97 -0.07 The above table shows that the 376 Put has a theta of -0.09.  This means the option will lose $9 a day (each contract represents 100 shares so -0.09 x 100 = -$9. To standardize, the theta/price is a ratio that can be used.  In our example  -$9/411.99 => -0.02%. Table of Theta for 15 delta Strangles for SPY, META, and IEF Information was pulled from market data on 7/31/2022 taking the initial strikes and seeing how the data changes for different upcoming Days to Expiration (DTE).  (15 delta Strangles for SPY correspond to 376P and 440C). SPY is the most active ETF for S&P 500. IEF is an ETF of 10 year Bonds. META is the ticker for the company formerly known as Facebook. Analysis 1) T...
Post a Comment
Read more

Trading Ethereum (ETH) merge? Are the CME Ethereum Options on Micro Futures markets reasonable?

Ethereum Merge Brief Background Most people are aware of Proof-of-Work (consensus mechanism to validate blocks on the blockchain - this is done with miners solving math problems (work)).  Ethereum, the second largest Crypto Currency is moving from a Proof-of-Work to Proof-of-Stake (consensus mechanism that validates blocks through a validator (like voting) system).   The main reason for doing this is to get away from miners wasting electricity solving useless math problems to a system that doesn't waste energy on miners.   One argument against moving to Proof-of-Stake, is that it becomes more about controlling a large number of validator nodes (so in a sense, the larger validators have more say, whereas Proof-Of-Work rewards are more 'fair' as it is randomly distributed. Either way you look at it being positive or negative, it is an event that can be traded as the current estimated merge date (the date the blockchain switches from Proof-of-Work to Proof-of-Stake...
Post a Comment
Read more