buy or sell question - 28 months analysis

To partially answer “the question” what is better: buy or sell options, I did 28 months test for SPY with the following methodology:
If price at expiration Friday is +- 0.2$ from strike, sell straddle (e.g.: price 140.15 sell straddle for next month at 140), otherwise sell strangle (put and call OTM) for next month.

At the end of the expiration month see the results (for objective comparison I selected what percentage of initial credit I am keeping, or if loss, what percentage of initial credit is the loss).
I assume 28 months covers wide range of volatility.

Comments:
1. May 2007 was the last time the strategy produced a loss!
2. Even after market big drop last few days I am still ahead $2.8 for March straddle.
3. Wide market swings last few months are more than compensated by high volatility (options price) so surprisingly I am not ‘killed’ selling in the last few months (but rather opposite).
4. The two months with big loss were in April2007 and May2007 where with low vol. spy drop a lot suddenly followed by big gain next month.

Results by month (percent of initial credit I am keeping, or if loss, what percentage of initial credit is the loss:
expiration collected at expiration percentProfit
7-Jan 2.85 0 1
6-Jan 2.7 0.03 0.9888889
6-Jul 4.05 0.06 0.9851852
7-Jun 3.4 0.07 0.9794118
6-Apr 2.95 0.15 0.9491525
7-Jul 4.8 0.43 0.9104167
7-Dec 8.55 2.34 0.7263158
8-Feb 7.65 3.14 0.5895425
7-Oct 5.6 2.33 0.5839286
5-Dec 2.85 1.36 0.522807
7-Nov 6.6 3.21 0.5136364
6-Dec 2.5 1.34 0.464
6-Mar 2.95 1.62 0.4508475
6-Jun 4.1 2.35 0.4268293
8-Mar 8.2 5.4 0.3414634
8-Jan 5.8 3.89 0.3293103
7-Sep 9.2 6.97 0.2423913
6-Sep 2.55 1.96 0.2313725
6-Feb 3.5 2.81 0.1971429
7-Feb 2.95 2.75 0.0677966
6-Nov 2.9 3.42 -0.17931
7-May 3 3.62 -0.206667
6-May 2.95 3.9 -0.322034
6-Oct 3.45 4.87 -0.411594
6-Aug 4.3 6.62 -0.539535
7-Aug 4.85 8.29 -0.709278
7-Apr 4.6 9.53 -1.071739
7-Mar 2.95 7.47 -1.532203

Attached is the csv file with all the data for 28 months at expiration (strikes around the SPY price I removed volume and open interest for clarity).

 

could you pls explain one or some rows, as I could not apply your word explanation (for instance you use percent whereas what I could see are fractions)? The study is interesting. Thanks Markg.

 

after looking at the spread sheet, I now understand what you mean. This is an excellent study. Thank you Markg

Two immediate conclusions:

1. Premium sellers (based on this data) have an edge. It should not be if one uses the realized vol, but the sellers control the game. I am not surprised.

2. It would be good to determine the return on margin. But using quick estimates, the return on margin for 28 months is around 100% which means that on average the return is 2.5% per month!

If someone cannot do better that 2.5% on margin on average, then replicating what you did can be money making.

PS: averages are geometric averages (not arithmetic averages).

 

Interesting results, but I'm not sure exactly when you are closing the positions. For example, when you say the "expiration" is 8-Jan for the trade on 12/21, this means you closed the position then? So you always close about 2 weeks before expiry?

Also, I backtested the 12/21 trade and the SPY dropped about 6% from 12/21 to 1/8. My graph shows about a (3.0) loss on a 148 straddle. And if the straddle was held to the 1/18 expiry, the loss would have been greater than (9.0). How did you calculate that trade's P/L?

Thanks for the interesting post.

Regards.

 

Wayne,
You are so right about Jan expiration (it looks obvious - after the fact - from the excel I attached that I had a typo in the only manual column I filled).

I close the position at the expiration Friday (this would be Jan 18 for Jan expiration options I sold on Dec. expiration Friday on 12/21) - do it to easily see what was the closing price on spy (on expiration I open new and close old position).
I modified the excel with the dec. expiration error (double check the rest as well).
The strategy ‘go me killed’ for December expiration but on the other hand:
December loss was equal to my Nov and Jan gain combined.

 

Hope you don't mind me clogging your thread. I posted this recently on the SPX, but I thought it might be interesting to see it here on the SPY. It is the % changes from Expiration to Expiration. I like to see just what the indices have done over the months, so you can get some quick insight into the monthly index credit spread type strategies.


Expiration to expiration changes (at Close) for SPY

Start 20051021 Price: 118.13

20051118, 125.13, %Chg: 5.93

20051216, 126.36, %Chg: 0.98

20060120, 125.97, %Chg: -0.31

20060217, 128.81, %Chg: 2.25

20060317, 130.62, %Chg: 1.41

20060421, 131.15, %Chg: 0.41

20060519, 127.10, %Chg: -3.09

20060616, 124.65, %Chg: -1.93

20060721, 123.95, %Chg: -0.56

20060818, 130.69, %Chg: 5.44

20060915, 131.96, %Chg: 0.97

20061020, 136.84, %Chg: 3.70

20061117, 140.42, %Chg: 2.62

20061215, 142.34, %Chg: 1.37

20070119, 142.82, %Chg: 0.34

20070216, 145.73, %Chg: 2.04

20070316, 138.53, %Chg: -4.94

20070420, 148.62, %Chg: 7.28

20070518, 152.62, %Chg: 2.69

20070615, 153.07, %Chg: 0.29

20070720, 153.50, %Chg: 0.28

20070817, 144.71, %Chg: -5.73

20070921, 151.97, %Chg: 5.02

20071019, 149.67, %Chg: -1.51

20071116, 145.79, %Chg: -2.59

20071221, 148.13, %Chg: 1.61

20080118, 132.06, %Chg: -10.85

20080215, 135.14, %Chg: 2.33


TOTAL MONTHS = 28
DROPS < -5% = 2
POPS > 5% = 4

 

Did you conduct your study using real market prices or theoretical prices? Did you include slippage and transaction costs in your analysis?

 

Attached Excel file sort of suggests I was using real market data with bid price (no slippage) (excel has also ask price but I removed volume and OI to limit number of columns).
I used spy options quotes from third Friday of a month (28 previous months) and copied to excel the closest ITM and OTM strikes and removed volume and oi columns.
My points:
1. The data clearly shows that buying and holding (straddles) is not very good idea and shorting volatility had advantages.
2. To limit risk and margin requirements I am still thinking about a strategy (some type of butterfly or condor) and possible adjustment (just close the position if loss is 0.5 of initial credit).
3. Will look at similar data (the same approach) but with selling straddle/strangle 1, 2, 3, 4 weeks before expiration (fixed lifetime of sold puts/call since now selling at expiration I have 4 or 5 weeks till expiration).

Question is: is it a well known fact that selling volatility is better regardless if vol. is high or low for broad index?

It rings a bell: sell when vol. high, but when vol. low - and this is not necessary true.

 

It is well known that there is a time varying volatility risk premium across all markets where options are traded. Google "volatility risk premium". In the case of equity markets, it is debatable as to whether or not this premium is sufficient to compensate for the risk in the left tail.

 

Thanks segv for pointing me in vol. risk premium direction:
Googlegives a lot of pdf research documents (a lot of them deal with currencies) but essentially what spy sample here showed was: spy positive risk premium without writing/reading research paper but with quick ‘not scientific’ observations from data.

“Volatility risk premium is generally defined as the difference between implied and realised volatility for a given maturity.” (options are more expensive than they should be, sort of).

Some relevant fragments I found on the web
<b>NOTE: all this I showed and commented about in previous postings in the thread:</b>
“It is easy to show empirically that, on average, the volatility risk premium will be positive for all currency pairs provided the observation window used is long enough.”

“Returns from such strategies tend to be similar to that of carry trades, ie. gradual increases interupted by losses during times of risk aversion (when vol tends to spike upwards).”

<b>“One way to take advantage of the volatility risk premium is to sell vol. Without transaction costs, if done on a systematic basis, this is profitable.”</b>

If you want a quick read (just answers to 2 questions 1. What is Volatility Risk Premium? and 2. How do such strategies perform in the current environment? from some senior vice president of volatility strategy at Lehman Brothers) link is provided below:

http://www.bfinance.co.uk/inst/article.do?serieId=1&docid=N12504