Trading like an Escape Artist: How I made money in October trading S&P Futures Options with 2x leverage

October was a scary month for stocks: the worst monthly S&P 500 return in seven years! And November is off to a volatile start as well! We haven’t even seen a real correction yet but apparently, the drop was bad enough for me to got inquiries from friends and former colleagues asking how I’m doing with our portfolio and if (and when?) I’m going to come back to the office again! Sorry, not anytime soon! As I detailed in the post two weeks ago, we are not too concerned about one month of bad returns early in retirement.

Some friends and readers of this blog were specifically concerned that my options trading strategy might have been hit badly by the wild swings. After all, I’m doing this with a little bit more than 2x leverage and with the market down about 7% does that mean we lost more than 14%? Of course not! To all the rubbernecks out there who suspect we had a bad car wreck in our portfolio last month, I’m happy to report that we actually made a small profit with this strategy in October! And continued to do so in November! How awesome is that!? Well, there were a few close calls but I was able to escape any major damage. It took some Houdini Skills (or luck???), hence the title image of escape artist Harry Houdini (Picture Credit: Lomography).

Let’s take a look at the details…

Recap: Selling naked put options

As I detailed in the two option trading posts a long time ago (see Part 1 and Part 2), selling naked put options means that we are (voluntarily) exposed to the least attractive return profile; unlimited downside and limited upside potential. Because not many financial actors want to tolerate that and because there is a huge demand for downside protection (buying long puts) from other investors, there has been a pretty persistent “insurance premium,” meaning that folks pay significantly more for a put option than its expected payout. This has been thoroughly documented, see for example a nice piece from the CBOE on how a put selling strategy has superior risk/reward characteristics than the underlying passive S&P500 index investment.

What I particularly like about the put writing strategy is that we can make money in sideways moving market, even slightly downward sloping markets. True, we give up the upside potential! But being retired we are no longer in the game of trying to hit home runs because we became financially independent (FI) a long time ago. But we definitely enjoy the more stable income from option writing, i.e., the fact that we can cushion the equity downside with the option premium, see chart below. This is for an unleveraged short put at-the-money i.e., strike price at or close to the current value of the underlying:

Return diagram from our option post two years ago. Writing (unleveraged) put options, we either outperform the index (regions 1,2,3) or we underperform the index but still make money (region 4).

In practice, I implement the strategy with (at least) three little twists:

  1. I sell “out-of-the-money” put options, i.e., those with a strike below (often significantly below) the current value of the underlying. This gives me enough “breathing room” in case the index goes down. Comes in very useful in a month like October 2018! 🙂
  2. I use leverage because the yield of the out-of-the-money options is obviously lower than the at-the-money options. But the risk is also lower, so I am comfortable with a little bit of leverage!
  3. I do this with the shortest possible horizon: Since there are three expiration dates every week (Monday/Wednesday/Friday), I sell options every M/W/F with the closest possible expiration day (W/F/M). For example, on Fridays, I would write options expiring on Monday, only one trading day after! On Mondays and Wednesdays, I sell options with just a two-day expiration on Wednesday and Friday, respectively.

Now the relative return profile looks a bit more complicated, see the chart below.

From the options trading post in 2016. Despite the leverage, it takes a very sharp drop to lose more than the index!

Now one can lose more than the index (region 1), but only if the index suffers a pretty significant loss.

Show me the numbers! How did we do in October?

Let’s look at our cumulative return chart below:

Cumulative return of the Put Writing strategy since the beginning of October. There was a small drawdown in October but overall, the portfolio was up!

There was one big drawdown in early October, causing about a 2% loss for the month. But there was a swift recovery back to just above zero on October 12, more on that later! But apart from that, the P&L chart is one nice straight line up. We were up by about 1.03% in October and another roughly 0.6% in the first two weeks of November (as of November 16). Not a bad return profile especially when compared to the S&P500, see the chart below:

Put writing, even with leverage, was a much smoother ride than the underlying equity index! S&P500 Price index in orange, Total Return Index (with dividends) in gray.

It looks like the small drawdown in early October correlated with the big drop in the index on October 10 and 11. But while the S&P500 recovered only a small fraction of the losses on October 12 and stayed down 5% for the month we were able to jump back into positive territory! Beautiful!

How is it possible to make money if the market is down so sharply?

Very simple! The market was down but never dropped much below my strikes. In other words, going back to the put option return diagram above, for the most part, we

were in region 3 “Profit while the benchmark loses” and only once we got briefly into region 2 “lose but less than the benchmark.”  Never into the dreaded region 1 “Lose more than the index.”

As scary as the month of October may have been, the meltdown happened relatively gradually. Sure, there were a few days with drops of 1% and more, even two 3+% drops on October 10 and 24. But none of the sharp declines happened out of the blue like the scary February 5 meltdown earlier this year. Or the Chinese devaluation in 2015. In other words, the fear of a large stock market decline had already been priced in! The VIX (fear index) was already sufficiently high and it means that I was able to sell options with strike prices far enough out of the money that even the big declines didn’t pose too much of a risk.

How far out of the money? Let’s look at the time series of the S&P500 index vs. the strikes of the put options I sold, see the chart below. I plot the E-mini futures contract prices at 4:00 p.m. Eastern Time (gray line) versus the strikes of my puts. Sometimes I sell options at only one single strike price, but most of the time I sell at a range of different strikes, so, I plot the minimum and maximum put option strike. Notice that when the big jumps occur in the strike prices, it’s because the old options expired and I rolled into a new set of options every Monday, Wednesday and Friday. In any case, according to this chart, the index only dropped below my strikes once around October 11 and 12. The rest of the time we always made the maximum profit, which explains the cumulative return chart going up so smoothly most of the time. But even on October 12, when we ended up only slightly underwater, “only” half of the options lost money and the other half expired worthless (maximum profit for us).

Closing index value vs. the min and max option strike in our portfolio. Note the drop on October 10 and 11 and the October 12 in-the-money expiration of some of the options!

Small technical note: The index line in this chart is the S&P500 closing value at 4:00 p.m., (when the options expire) adjusted by a small margin (1 to 2 points, to account for the small difference between the futures and spot price). I do have the E-mini S&P500 futures closing prices, but only at 4:15 pm, a 15 minutes after the options expiration time. But for this exercise, I needed the price of the ES Future at 4:00pm.

Even the October 12 loss could have been prevented!

There was one occasion in the entire time span where I deviated (slightly) from my usual strategy. On October 8 (Monday) I sold puts with strikes ranging from 2,745 to 2,785 with an expiration on October 12 (Friday) instead of October 10 (Wednesday). Why? Because I knew we will on a flight from San Francisco to Seoul, South Korea on October 10, (part of our epic 7-month, 20+ country world tour), landing right around the options expiration time. The plane ended up landing just on time, so I could have actually rolled the contracts that day, i.e., let the Wednesday options expire worthless (the index closed just above the highest strike price of 2,785) and sell the Friday options with a much lower strike due to the spike of implied volatility. But I didn’t know that in advance and I didn’t want to bet on the plane landing on time. If there had been any delay I would have been afraid about having options expiring in the money while I’m still in the air, flying somewhere over Vladivostok, Siberia. Of course, Murphy’s Law struck and in hindsight, it would have been better to roll on Wednesday. Well, you win some, you lose some! Luckily, half the options expired worthless (=maximum profit for me) and the other half was in the money by only a few points. So, instead of wiping out a month or two of option revenue I “only” lost most of the income month-to-date.

But make no mistake! It was a scary month!

Kicking myself about the bad timing of the October 12 options wasn’t the only unpleasant experience. There were a few occasions of what I call “point landings,” where the equity index future dropped to within just a few points to our highest strike price. You make the maximum profit for the option but you came so very close to losing money:

  • On October 5, the index finished at 2885.57, the futures at maybe 2 points above that. That was the closest call in a long time with my strikes at 2885! Watching the last few minutes of trading that day was a bit like watching a basketball game in overtime! Never a dull moment in the ERN household!
  • On October 24, the index finished at 2656.10 after a late-session sell-off. Futures at around 2658, which is just 8 points above some of the strikes of my short puts! Close call!
  • On November 12, the index finished at 2726.22, the futures at around 2727.75, which is still comfortably above my highest strike of 2715. But a few minutes before the close, the S&P got dangerously close to my strikes. I was sitting at the breakfast table on the cruise ship, getting ready to get off the ship to explore Lifou, New Caledonia, but couldn’t really enjoy the food so much because I was glued to the screen and “cheering” for the ES E-mini contract to stay above 2715!
Apart from the loss on October 12, there were three more close calls where options expired worthless but very close to getting in-the-money!

Dr Ern Loves Negative Skewness

So, in other words, even though the return profile looks really nice in hindsight, the last one and a half months weren’t exactly a walk in the park! I’m just saying this to make clear that selling naked put options is not some kind of magical money-making machine. It takes some stomach to run this strategy successfully in the long-run! In fact, human nature is naturally very opposed to this extremely negatively skewed return profile, as I pointed out in a post last year: “We are so skewed!” If anyone wants to replicate what I’m doing, please start with a small account and some “play money” to see if this works for you!

So much for today’s status update on my options strategy. Sorry if this post got a bit technical! Maybe the normal ERN blog audience didn’t get much out of this post but I wanted to write a post for my option trading honchos (Bob Jane, John, etc.) with some additional details on how we did during this crazy time! Good luck everybody, embrace the volatility!

Please leave your feedback in the comments section below!

Picture Credit: Lomography




86 thoughts on “Trading like an Escape Artist: How I made money in October trading S&P Futures Options with 2x leverage

  1. Very useful, thanks ERN.

    The thoughts about short duration to limit risk are interesting. Warren Buffet took exactly the opposite position and wrote very LONG term (years) index options when markets were down, because he reasoned that markets will not stay down “forever” but traditional Black-Scholes valuations don’t account for that — option premiums keep getting progressively bigger with longer durations, despite what he considered to be lower risk.

    But of course then you will also need very deep pockets to cover the potentially very big margin fluctuations in the meantime — this strategy won’t work well with leverage.

    Liked by 1 person

    • Thanks!
      Well, Buffett with his big cash hoard has very deep pockets. Also, it’s noteworthy that Mr. Warren “Derivatives are weapons of mass destruction” Buffett was using this same strategy of selling vol through derivatives.
      I like his general idea, too, but there aren’t enough instances where you can apply his specific strategy. I hope the next Global Financial Crisis is still year (decades?) away. 🙂


  2. I would assume that position management is also key. Maybe it goes without saying, but it’s not like you’re putting your whole nest egg on the line every three days.

    Did you hear about James Cordier at He blew up 290 managed client accounts during the Natural gas spike last week. Apparently they were short far OTM calls on NG futures and just got steamrolled.

    Not only did everybody get zeroed out, they actually went negative so the clients all owe the broker now. It’s not clear how much the “debit balance” is, and probably varies by client anyway.

    YouTube video updating clients on account status (gut wrenching IMO):

    Tweets linking to email notice clients received:

    Transcript from a previous interview about their “risk management” policies:

    To get completely wiped out like they did, it seems highly unlikely that they were following all of their own risk management rules.

    But I think it’s a really valuable reminder of the damage that can be done with leverage. By its nature, the type of black swan event that can blow you up happens VERY FAST.

    Trade carefully!

    Liked by 1 person

  3. ERN this is NOT for the faint of heart or Unsophisticated investors……99.99999% of your readers ought NOT to be doing this…Only someone like you can pull this off.. 🙂

    Liked by 1 person

  4. Do you have a formula for choosing your strike price? If yes, have you backtested the strategy based on it? Have you considered hedging the strategy perhaps with a back ratio spread or being long put LEAPs and creating a calendar spread?

    Liked by 1 person

  5. “human nature is naturally very opposed to this extremely negatively skewed return profile”

    I thought it was the opposite way around. I think buying OTM puts and losing money day after day in the hopes of one big win is much more difficult for most investors.

    “couldn’t really enjoy the food so much because I was glued to the screen”
    I imagine not paying attention to it would help you stomach the volatility and allow you to enjoy your FI life at the same time!

    Liked by 1 person

    • Zachary: I guess we’re wired the same way. Buying OTM protective puts you’ll lose money almost all the time but you’ll be amazed how many institutional investors want this…

      And agree: sometimes it’s best to not look. Ignorance is bliss during the volatile swings, especially intra-day. 🙂

      Liked by 1 person

      • Hi ERN,

        I glad I found your blog!! I also used to work in the Asset Management business also before retiring and slow travelling around the world with my wife (seems we’re following your footsteps). We just started this at the end of September.

        I also trade equities and options – writing strategies but no naked calls, I can’t stomach the risk, I’ve also moved away from leverage now that we’re retired.

        Institutional money is funny, they ask for the insurance to protect against these events but they also hammer you if you’re below the benchmark.

        That is my real name and people do call me Ern. 🙂

        Liked by 1 person

    • “human nature is naturally very opposed to this extremely negatively skewed return profile”
      Some examples of things people buy to avoid negatively skewed return profile are all insurance policies, extended warranties, buying (rather than selling) lottery tickets, gamblers in casinos (rather than taking the house’s side).

      Liked by 1 person

  6. Hey ERN, thanks for the update! You’re better than me buddy. I’ve been trading options for over 18 years and I still can’t stomach the risk of naked options. You’re my hero ha ha. It’s good that people can see the “benefits” of options during down months, but also the “risk”. It’s not for the faint of heart, but that’s why I like them. Options force me to be a better version of myself. And oddly enough, I trade options because I hate losing money. FYI: I’m a fellow FIRE member who also trades options. I passed you so many times at the Orlando, FinCon, but failed to say hi. Sorry about that. I gotta run, but here’s to more options success for you…

    Liked by 1 person

  7. I would like to watch the energy in the ERN household during trading. Haha! “Watching the last few minutes of trading that day was a bit like watching a basketball game in overtime!”

    Liked by 1 person

  8. You mention that you could have avoided the 10/12 loss by selling the Wednesday 10/10 put, but assuming you sold a similar amount of premium wouldn’t you have sold a much closer strike expiring on Wednesday and loss more that day?

    Also how did you recover the 10/12 loss so quickly, are you holding the future once assigned until getting back to the strike price?

    Liked by 1 person

    • The premium is a function of time to expiration and the strike (and other things, like implied vol). Of course, I would have received less premium for the Wed puts but I’m happy with receiving only half the premium M->W and the other half W->F. I don’t recall the exact strieks I would have sold at for the W expiration, but they tend to be similar for a given p.a. option yield.

      You recover the loss so quickly becuase once the options are at the money or close you have a high Delta. I never hold on the underlying very long. In fact, in this case, I already sold the ES a few minutes before close to hedge out the 1.00 Delta of the in-the-money puts.


  9. Thanks for the update and shout out. I may be self-ish in saying this but I hope for more articles on options in the future.

    I am but one of your deciples and I feel like I’m learning more and more trading every day.

    Options trading is really fun, I look forward to it every expiration day (unless my options are ITM). It’s easier to buy and hold index funds when there’s something to play with.

    Sorry again I couldn’t make the ChooseFI meetup. I had no idea it was on until it was too late to pull out of my plans.

    Please let me know if you ever come to Sydney again.

    Liked by 1 person

  10. Ever considered options on the VIX? I made a few hundred when I bought VIX puts in mid-Oct when the VIX hit 23 and sold them for a 50% gain in early Nov. when VIX dropped back down to 18. Today VIX hit 23 again so I’ll see if I can repeat the feat (with play money I can stomach).

    The theory is: When VIX is ~12 it can only go up. When VIX is ~23 there’s a near certainty it will go down several points sometime in the next 2-3 months (see charts). Unlike the indexes, VIX is forced to revert toward its mean because if it stayed too high or too low for too long, demand for probably-profitable condor strategies would drive IV back down or up.

    If course, VIX could hit 50 tomorrow, but with a long option position and plenty of time to expiration, I’ll wait it out.


    • I like that idea. I would never sell call options on the VIX (same skewness problem as the Nat Gas debacle). But buying them as a hedge against losses in the put option selling is something I’d like to consider in the future! Especially when the VIX goes down to 10 to 12 again it’s time to buy!


  11. Thanks for the great info. I’ve done only covered calls and buying puts on positions I own.

    It seems to me with naked puts you could lose a lot of money very fast if you get a black swan event. How do you protect against that especially with the market volatility now – on the one hand, you get good prices selling puts, but on the other hand, the prices are high for a reason?

    Liked by 1 person

    • I have thought about hedging the extreme downside and there are two obvious routes:
      1: Buy an even deeper out of the money put to hedge the downside.
      2: Buy long exposure to the VIX
      Both should ideally be done only periodically when vol is low.


      • I guess you would cash in the longer term put if you suffer significant losses on the short term sold puts. But what if the market then continues to go down? Do you buy a new put despite the high volatiility? Something I have been wondering is why not also sell calls, especially when volatility is high? Then if the market goes against you you only lose half as much. I know that calls won’t bring much income when volatility is low and likely the market will go against you then.

        The usual solution is just to sell put spreads instead of naked puts but that cuts the income a lot of course and given your experience so far wouldn’t cut the losses much. I guess the bottom line for me is I don’t like this very skewed distribution of returns even though the idea of “printing money” by creating securities is attractive.

        Liked by 1 person

        • Never sell a naked call, unless it is part of a spread or other limited risk formation. A naked call is the most dangerous position in all of optionland because the potential losses are unlimited. At least if you sell a put on a stock that goes to zero, you have a zero boundary limiting your losses.

          When you buy an option, you risk 100% of the amount spent. When you sell an option, you may be risking thousands of percents.

          Liked by 1 person

  12. Hi Big ERN,

    I have been selling credit spreads since April with a small portion of my portfolio (less than 5%). I essentially dropped to a 1% gain for the year after October (ouch!) However, I still feel option selling is such a great complement to a low cost index portfolio. I’m glad someone who has achieved FI and someone so knowledgeable in finance is discussing this strategy. As other comments have mentioned, this needs to be used with CAUTION. At one point I was up over 30%, but leverage is a double edged sword. I learned the hard way in my 20s using some serious leverage to trade FX, so I knew that the 30% I was up at one point (annualized something like 269% at the time) was not sustainable.

    For readers who want to learn more about options trading. I would recommend OPTION ALPHA blog /podcast /resources.

    Thank you for such insightful posts!

    Liked by 1 person

    • Thanks and thanks for the option alpha blog link. Looks interesting!
      Yeah, with option selling there is a bit of “the Lord giveth, the Lord taketh” and I’ve seen 8 months of option revenue wiped out in 2-3 days. August 2015 and February 2018. But it’s still a neat strategy for income generation in FIRE!
      Thanks for stopping by!


  13. ERN,
    I like the idea of being on the selling side of insurance for once. But, for those of us who are not as wise, or experienced, as you are:
    Are there any funds (that you would consider investing in) that employ a similar scheme? I.e., aim to replicate the performance of the CBOE S&P 500 PutWrite Index.
    If not, perhaps this is a business opportunity and a way to supplement your income in “retirement!” (you could be collecting the fees rather than paying them. I’m only half joking…)
    Absent a suitable way of outsourcing this work, is there an options simulator that you could recommend? A low-risk environment where I can learn more about options and the mechanics of this type of trading seem like the next-best step.
    Thanks and keep up the good work!

    Liked by 1 person

  14. I did not make it through October quite so unscathed but have been doing all right over the year with a similar approach. I’m always interested to read about how you’re faring with this and see what I might want to be thinking about differently.

    Liked by 1 person

  15. Very interesting. I have a few questions since I never traded options. Are you only trading options on the E-mini futures? and why are you using that? what about put options listed on the SPX Index or other indices? are those too expensive in terms of bid/ask spread or too illiquid? tx!

    Liked by 1 person

    • I will give it a go to answer your questions but one caveat is I am a newbie to this.

      1. E-mini futures allows leverage via selling naked. At least from what I understood, I couldn’t sell SPX puts without it being backed up by the notional amount.

      2. I think you got it right regarding other indices. SP 500 Eminis are probably the most liquid and has tighter bid/ask spread.

      Liked by 1 person

    • Currently, only the puts on E-Mini. I have to pay for the data subscriptions at Interactive Brokers and CME traded E-mini options give me everything I need. Good b/a spread, low fees, just one one data feed/subscription.
      But people have been running this strategy successfully with SPX options.


  16. Great post! Always enjoy reading your technical pieces. How do you think about tail scenarios with this strategy? Say, a repeat of 2008 where markets drop ~40%, and your 2x-3x levered positions drop ~80-120%?? Thanks!

    Liked by 1 person

    • I was wondering about the same!!! G20 summit in Argentina probably. I’d suspect if USA/China declare the talks about trade have failed and threaten new tariffs then we’ll lose the recent gains pretty quickly…
      Let’s cross our fingers we make it in one piece to Monday! 🙂


  17. Again a very interesting post…Would say that unless one trades these strategies one self, they are only offered tailored to institutional investors but if you were to proceed a cooperation with an institution to replicate your strategy I would say that the most efficient way would be by offering it in a certificate or a note format (guess you know that already).

    Still, would be interesting to hear which if any product you would recommend as an alternative and which is already out there. Writing on a monthly basis seems to have its disadvantages and then of course the costs of trading has to be kept to a bare minimum if you do it very frequently.

    Thank you for another very interesting post!


    Liked by 1 person

    • The ETF with ticker PUTW charges 0.35% annual fee. And the principal cash doesn’t earn much interest.
      I think the most efficient way of offereing this as a product would be whrough separately managed accounts. One would have to set up an RIA business first, though.


  18. Has anyone been able to find any information on if CME will be closing the futures and futures option market on 5th December 2018?

    What would be the strategy if there is a closure? Sell the Friday put on Thursday and accept one less trading day of premium, or sell the Friday put on Monday?

    Liked by 1 person

        • Er, not much I guess? I assume it’ll end up being something like a week of Fridays, in so far as each time will just be 1 trading day until expiration. Mon sell Tues, Thurs sell Fri, Fri sell Mon as usual?

          I actually have no idea how an unexpected missing day affects normal expiration choices, so I’m probably going to be figuring this out on the go as you are.


        • I believe the Wednesday options will have to use the Tuesday close as their settlement value. So, the Wed options just got their time to expiration cut by one day.

          The strategy would then involve selling the Wednesday options on Monday and the Friday options on Tuesday.
          One small issue would be what happens to the margins? I suspect I need to pay margin interest because for 24h I’d have twice the exposure than I normally have. Have to mull that over…


          • Thanks for clarifying the mechanics of what to do when trading closes. This will help during Xmas closures I’m assuming too.

            So much to learn from you. 🙂

            Liked by 1 person

            • The difference between the holiday schedule and this one is that the holidays are known already in advance. If Christmas Day falls on an Options expiration day then that expiration day is just shifted by a day.
              But now it looks like Tuesday is the expiration day (the day before, it already shows up as Dec 4 expiration on my IB smartphone app). But there will be no Thursday expiration. I’ll have to write options Tuesday to Friday now.
              Well, you learn something new every day! 🙂


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