Passive income through option writing: Part 3

Back in 2016, I wrote a few posts on trading derivatives, especially options, to generate (mostly) passive income:

I’m still running that same strategy but it definitely evolved quite a bit over time. This might be a good time to write a quick update on what I’m doing and what I’ve changed since then. And for everyone who’s wondering what’s the use of this: I’m planning a future post on how selling options may help with Sequence Risk, so this is all very, very relevant even for folks in the FIRE crowd!

So, let’s take a look…

A quick recap

Selling put options exposes me to the worst possible return profile: I have (almost) unlimited downside risk, i.e., if the price of the underlying drops below the strike price then I lose the difference between the underlying and the strike price. But I have only limited upside potential; even if the underlying goes up by 100% (which is unlikely with an index over a short time frame, though) I only make the option premium, see the chart below:

putwriting-payoff-diagram2
From my earlier option post: A short put option gives you a cushion when the market drops but it limits your upside potential. If the premium is high enough this can be a highly profitable and low-risk “investment!”

Most people think that the return profile sounds unappetizing. It’s exactly the opposite of what most investors desire: unlimited upside and insurance against dramatic losses (positive skewness). But here lies the strength of this put selling strategy: Since it’s the opposite of what everyone desires the option premiums tend to be higher than the “fair” market price. It’s like a casino: people who frequent the casino pay a small fee to play and have a small probability to win a big payday (=buyer of an option) but the truly profitable business is being the casino (=selling insurance) not gambling in the casino! Same logic with the lottery. Or buying an extended warranty. Or buying insurance. It’s profitable for the sellers of those services!

So, show me the money! How would this strategy have performed in the past? Selling puts on the S&P 500 would have performed pretty well over the last few decades. You would have even outperformed (!!!) the index since 2000, see the chart below. Well, the recovery post-2009 would have been better with the S&P 500 index, but over the longer horizon, two bear markets and two bull markets, the put selling did phenomenally well!

PutW chart01
Cumulative (nominal) returns of the S&P500 (total return) vs. writing at-the-money put options once every month. Source: CBOE, see here and here for the source data.

Now, I don’t want to stress the outperformance of the put writing strategy too much. That’s because even performing in line with the S&P 500 or even slightly underperforming the S&P would have still been pretty impressive. What is truly amazing about the put writing strategy is that you generate equity-like returns but you do so with:

  1. roughly one third less volatility (~10% annualized vol, compared to about 15% in the S&P 500)
  2. significantly smaller drawdowns (i.e., drops below the all-time-high up to that point), and
  3. shorter-lived drawdowns, see the chart below:
PutW chart02
Drawdowns are much more shallow and shorter-lived when writing puts. This is much preferred from a sequence risk perspective!

That’s a huge advantage from a Sequence Risk perspective! That’s why I think selling options is a great strategy, especially for (early) retirees! If you’re still very early in the accumulation phase, sure go ahead and go crazy with equities. As I showed a few weeks ago, even a (temporary) drop in the stock market can be beneficial in that situation. But if you’re in retirement or close to retirement you’re much more concerned about Sequence Risk! So, in a previous post (Part 2), I detailed what exactly I am actually doing in my portfolio, which is slightly different from the simple short put strategy benchmark published by the CBOE:

  1. I sell puts that are “out of the money,” i.e., with a strike price a bit below today’s underlying value. The premium is a bit lower than for the at-the-money options but so is the volatility.
  2. I use some leverage to overcome the lower premium revenue.
  3. I use shorter-dated options.
  4. I invest the margin cash in higher-yielding bonds and also more tax-efficiently (Muni bonds). The CBOE PUT index assumes you invest the margin cash at a short-term (e.g. money market) rate.

But since I first wrote about this, here are some additional updates:

1: The account size is much larger!

When I first wrote the option trading posts in 2016, I already ran this with a six-figure account size. Not exactly “play money!” But that account has now grown substantially, due to both capital gains and additional contributions. Now the options trading account is about 35% of our total financial net worth, and about half of our financial net worth outside of retirement accounts. In other words, assuming that we don’t touch our retirement accounts until I turn 59.5, the put writing strategy now has to carry half the weight of generating income in retirement. And just in case you wonder, no, this blog does not in any material way contribute to our retirement budget. So, this is the real deal, not some academic exercise! This is what we actually use to finance our early retirement!

2: The leverage is lower, the premium target & option Delta is lower, and the “loss allowance” is larger

Retirement, especially early retirement, plays tricks with your mind! Suddenly, you become much less comfortable taking risks. So, when you run this strategy with some serious pile of real money and also without a day job to make up for potential losses you get a lot more cautious:

Leverage: I used to run this with roughly 3 to 3.5x leverage. Now I’m down to around 2 to 2.5x leverage. And again, there was some confusion about what exactly I mean by leverage. It’s very straight-forward to calculate your leverage ratio when you’re buying an asset. You have $100, you get a $40 loan and purchase $140 worth of assets. Your leverage is 1.4x. But how do you do this when you’re shorting a derivative? My preferred method is as follows. If I sell a put option with a 2,800 strike and a multiplier of 100 then the notional value is $280,000, also equal to the potential loss if the market were to drop to zero. If I have $125,000 per short option in my portfolio then the leverage is $280,000/$125,000=2.24. Notice that the $125,000 is about 5 times larger than the minimum margin requirement mandated by the exchange (roughly $25k). It’s always a good idea to keep way more margin cash as a cushion to avoid becoming a victim of margin calls, which is what wiped out the hapless OptionSellers.com investors.

Premium Target: The further out-of-the-money you write your put options the lower the premium. But the risk of losing money is also lower. So, I currently target an option time value of around 5-5.5% p.a., a little bit lower than the 7% I quoted in my posts from 2016. And again, the way I calculate this percentage is the annualized premium divided by the notional value. So, if I can make a $300 option premium per week and the notional value of the option (multiplier times strike) is $280k, then the time value yield is about 52×300/280000=5.57% (for an unleveraged position). The gross return is obviously larger once we apply leverage!

Also, different option traders use different methods to pin down their strikes. Delta or how many standard deviations (sigmas) you want to be out of the money. My strategy of targeting a certain yield is very close to targeting a 5 Delta or around 1.5-2.0 standard deviations below the current index level. Not every single transaction but over long-term averages.

Loss Allowance: I used to budget a loss allowance (i.e., how much of my gross premium revenue I lose – on average – when options go into the money) of around 50-55%. I’ve increased that to 60%. So in other words, out of every $100 of gross option revenue I budget I’ll keep $40. 2018 was my worst year so far, but I still managed to stay close to the 40% profit margin even after that horrendous February volatility spike. The overall average since 2012 was indeed 55% but, again, out of an abundance of caution I want to budget only 40% profits.

PutW chart03
Actual profit margins from selling puts 2012-2019. Note that in 2019 I haven’t suffered any loss (yet)! I wonder how long that’s going to last!? 🙂

So, what’s my expected option trading return? Simple Math. Let’s assume 2.25x leverage, 5.25% option yield and 60% loss allowance. I’d generate a net profit of 2.25×5.25%x(1-0.6)=4.725% annualized return. What? All this effort for such a measly return? Aren’t we supposed to earn 12-18% from investing in stocks? Hold your horses. First, your expected return from stocks isn’t 12-18%. Consult Dave Ramsey to get out of debt but fire him as soon as you get to a net worth of zero and listen to people who actually know finance to grow your assets! Second, the option revenue is only part of the equation. The beauty of the option writing strategy is that this is all done on margin! So, in other words, for every short Put option you also have another, say, $125k lying around to “play” with, i.e., to generate extra income. Theoretically, you could even invest that $125k in your standard 60% Stock, 40% Bond portfolio and use the short puts to make an extra 4.7% p.a. in addition to your 60/40 portfolio! For my taste, though, that would be loading up on equity risk a little too much. Especially considering that I already have tons of equity holdings in our other accounts. So, I keep my margin cash in a more stable portfolio. But since I first wrote this post I’ve certainly gotten a little bit more adventurous with my margin cash, which brings me to the next item:

3: Taking more risk with the margin cash

When I first wrote about this topic, I held most of the margin cash in Muni Bonds mutual funds. I have since transitioned over to a slightly more adventurous (=riskier) allocation

  • Muni Bond Funds (e.g. ABHYX): 30% of the portfolio. The yield is pretty decent! About 3.5% p.a. and that’s all tax-free!
  • Muni Closed-End Funds (e.g. NZF, BAF, etc.): 40% of the portfolio. These pay just above 5% in (tax-free!) interest. This comes at a cost, though: They are much more volatile (due to leverage!) than the lower-yielding plain-vanilla muni bond mutual funds.
  • Preferred Shares (e.g. ALLY-PA, GS-PK, MS-PI, STT-PG, etc.): 25% of the portfolio. All my preferred shares are floating-rate (or at least currently fixed, then transitioning over to floaters at a future date) to hedge against the risk of eventual interest rate hikes. Currently, the weighted average yield is just about 5.75%. Most of this is treated as (qualified) dividend income, though some also pay ordinary interest. The issuers may be very solid companies but make no mistake, Preferred Stocks are quite a bit riskier than your typical bond. They are called preferred stocks, not preferred bonds!
  • Cash balance: 5% of the portfolio. Interactive Brokers pays around 1.50% interest on unused cash balances and this is obviously ordinary income.

The weighted yield on all of the above is just about 4.6% p.a. Not too shabby! So let’s call that a 9% total return for the whole shebang; options plus margin cash returns. Subtract 2% inflation expectations and we’re at 7%. Not that bad! It’s in the same ballpark, even a little bit higher than long-term equity returns (6.7% real return) and much more than what I would expect conditional on being 10 years into a bull market. And the option strategy has lower volatility and better-looking drawdowns than equities! Case in point, October through December 2018 when I actually made money with this!

Also, I’m fully aware of the irony here. Over the last few weeks, I just finished my mammoth project, analyzing (mostly dismantling) the “Yield Shield” strategy. In case you’re not familiar with this, some other bloggers proposed the Yield Shield to eliminate Sequence Risk by investing in higher-yielding assets (spoiler alert: it doesn’t work!!!). But please note the big distinction here: I increase the yield in the fixed income portfolio knowing very well that this also increases Sequence Risk. I have no illusion (delusion?) that this would ever help with Sequence Risk. But I believe that the option-writing strategy actually has lower sequence risk than a plain equity portfolio so I can afford a little bit of extra sequence risk from my preferred shares.

4: Trading SPX options instead of S&P500 E-mini futures options

Over the years, people asked me why I would trade the futures options and not simply the SPX index options. Simple answer: while working in my finance job, that was the only asset class I was allowed to trade without preclearance from the compliance department. And by the way, my former employer was incredibly generous because I know a lot of friends at other banks that were strictly prohibited from trading any derivatives products (index options, futures, futures options). So, in any case, after leaving my job I eventually transitioned over to trading SPX options and never looked back because there are numerous advantages:

Lower commissions

One ES contract (50x) costs $1.42 in commission. That’s $2.84 for the equivalent of a 100x SPX contract. I pay a commission of around $1.24 per SPX contract. That doesn’t sound like a big difference but trading three times a week, this adds up to around $250 a year. It may not sound like a huge deal but considering that I budget around $13k to $14k in gross revenue per year from one single short put option and about $5,000 in net revenue (after paying for the occasional losses when the short puts expire in the money), then an additional $250 in fees per year is just too much!

Better margin efficiency

Both instruments, ES puts and SPX puts require around the same amount of margin. Roughly $12,000 for the ES put and $25,000 for the SPX at twice the size. But the SPX options are more margin efficient in the following sense:

I can use my Muni bonds funds, ETFs and Preferred shares as collateral for my SPX options. I’d keep a pretty slim cash cushion (maybe around 5%, or $6k out of a $125k of margin cash per option) ready to deal with a 60-point in the money loss. But I can keep the overwhelming majority ($119k) of my margin cash in income-producing assets, see top panel in the table below.

Not so if I held short ES futures puts. Interactive Brokers maintains two subaccounts, one for “securities” and one for “commodities.” If you hold short ES Futures options, IB will move over the margin requirement into the commodities subaccount. This could create a negative cash balance in your securities subaccount (see middle panel) if you hold too much of your margin cash in ETFs/MFs. That raises two issues: 1) you’ll start paying margin interest and 2) the IRS rules that your income from ETFs and MFs is no longer tax-advantaged (either tax-free or ordinary dividends) but “payments in lieu of dividends” which are considered “ordinary income” for income tax purposes! I guess the IRS doesn’t like it when people buy tax-advantaged assets on margin.

The only way to avoid the negative cash balance is to hold less money in ETFs and mutual funds, see the bottom panel. But that also lowers your income potential from the margin cash! One of the reasons why I prefer SPX options over the ES put options!

SPXoptionsMarginEfficiency
Because SPX index options are domiciled in the “US Securities” subaccount, the same as my Mutual Funds, ETFs, etc., I need very little idle cash sitting around to satisfy my margins. ES Futures options require more idle cash to satisfy margin requirements!

The convenience of cash-settled options

If the ES options end up in the money I will then end up with a long ES futures position in my account (=physical delivery). The only exception is the third Friday of March/June/September/December when the puts expire exactly on the same date and the same time as the underlying. So, with futures options, it’s my duty to sell the ES Future if short options get exercised. In contrast, with the SPX options, I simply see a debit for any option that ends up in the money. There are two advantages to cash-settlement. 1) I avoid the cost of getting rid of the long ES future and 2) I don’t have to sit front of my screen at exactly 1pm Pacific time and make sure I don’t end up ES futures (at 2.5x leverage!) right around market close. What if I miss that and the ES futures keep going down in after-hours trading? What if I have a medical emergency and I end up in the hospital and I can’t get rid of the leveraged futures position for a few weeks? The cash-settled SPX options are much easier to handle!

The only disadvantage: shorter trading hours

The only disadvantage of SPX index options is that they trade only during market hours (9:30am-4:00pm Eastern time on weekdays) while the ES future options trade even outside of market hours. You can even start your trades on a Sunday afternoon (Pacific time). But I’d never do so anyway because there’s normally very little liquidity outside of NYSE trading hours. Even when trading ES futures options I’d do so during normal trading hours 99% of the time. So, for me personally, it’s not a real disadvantage at all!

5: Trading three times a week (and sometimes four!)

When I initially wrote about this strategy I would sell options every Friday with an expiration the following Friday. Currently, I write options three times a week for the expirations on Monday/Wednesday/Friday. In other words, every Friday, I sell options expiring on Monday. Then every Monday I sell options expiring on Wednesday and – you guessed it – every Wednesday I sell options expiring on Friday. And if the last trading day of the month falls on a Tuesday or Thursday you get another expiration that week for a total of four trades that week!

There are (at least) two advantages to writing shorter-dated options. First, you have a lower probability of getting dinged by a sequence of bad days. Some of my worst losses with this strategy came when the S&P dropped four or five days in a row (think August 2015, January 2016, December 2018). With shorter options, you have the potential to avoid the big losses because you constantly “roll” your options and sell at new strikes. If the market is in a rut and keeps going down, you also move down your strikes over time. This helped me to actually make money in Q4 of 2018 because the S&P 500 fell “slowly enough” to almost never breach my strikes!

HitByMomentumChart
Writing shorter options is a hedge against a sequence of bad-luck shocks. In the top panel, we wrote an option with 4 trading days to expiration. The market drops three out of four days and we get to $13 in the money after day 4. In the bottom panel, the index stays above the strike of the option after two days. But due to the drop (and the likely rise in implied volatility), we can sell the next option with a far lower strike and avoid getting dinged from a continued fall in the index! The index dropped but we made money with both options. Sweet!!!

The second advantage is that more independent bets imply that the Central Limit Theorem has more power to work! Huh, what does that mean? As I previously wrote, selling put options generates a very (negatively-)skewed return profile: limited upside and unlimited downside, i.e., the kind of return profile that nobody wants because it’s so much at odds with most investors’ preferences that are biased toward positively-skewed returns! But even the most badly-behaved statistical distribution becomes more and more Gaussian-Normal (that nice, symmetric bell-shaped distribution) if you average over a sufficiently large number. Here’s a little numerical example:

Imagine you earn an option premium of $1 and with probabilities, 95%, 4%, 1% the option value at expiration is $0, $5 and $30, respectively. So, you earn $1 with 95% probability and you lose $4 and $29 with probabilities 4% and 1%, respectively. That’s a very negatively skewed distribution. If we simulate 20,000 samples of the average returns over 1, 10, 50 and 500 draws then the distribution of average returns over those 1, 10, 50 and 500 draws becomes more and more Gaussian-Normal, see below:

CentralLimitTheoremChart
Even a skewed distribution looks more and more Gaussian-Normal when you average over enough independent observations! 20,000

So, even a very unattractive and negatively-skewed distribution becomes better-behaved if you diversify over time. The more independent bets you can take the less scary the average distribution will look like! That’s why I try to take as many independent bets as possible, i.e., I use the shortest possible time to expiration to maximize the number of tries every year!

10_DM_Serie4_Vorderseite
Don’t you miss the old 10 Deutsche Mark note? It had a picture of Carl Fridrich Gauss and a small figure with the Normal distribution named after him! Source: Wikimedia

Of course, there are also (at least) two disadvantages of trading more frequently. First, it’s more work. Well, is it really? I’ve never timed exactly how long it takes me to do my trades every Monday/Wednesday/Friday. But last week we went skiing and I did my option trades on my Android phone while sitting in the chairlift for a few minutes. It’s not a huge time commitment! Of course, being a total finance geek I spend way more time in front of the screen looking at finance charts. Some people follow the Kardashians. I follow the S&P500 and VIX! But it’s not for everyone!

MVIMG_20190320_132851
Sitting in the chairlift and enjoying the view (Mt. Hood, Oregon’s tallest peak in the background). And doing a few SPX option trades on my Android phone, too!

The second disadvantage is that you have more chances to get “whipsawed.” It’s basically the opposite of the bad, bad, bad weeks mentioned above. Imagine the index goes down on Tuesday and Wednesday and breaks through your strike price. You lock in your loss on Wednesday only to see the index recover on Thursday and Friday. But when the index recovers you only recover the option premium, which may be way lower than the loss on Wednesday. I consider it the cost of doing business and I much prefer it over sitting through the scary negative momentum events like February 2018 or December 2018 with long-dated options!

HitByMeanReversionChart
Hit by Mean-Reversion: Sometimes you lock in the loss with the shorter-dated options. If the market reverts quickly you would have been better off selling the longer-dated options!

Side note: I’m not saying that this is the only way of doing this. A reader of this blog recently put together a nice all-in-one how-to post on how he intends to implement the options trading strategy.

Conclusion

This might be an exotic topic for the fans of the Safe Withdrawal Math posts. But I’m not a one-trick pony, so please bear with me! Also, I’m a big fan of put writing mainly because I think it has the potential to alleviate Sequence Risk. Not eliminate it, just alleviate it! So, stay tuned for a future post where I’d plan to combine the crazy exotic options trading stuff with the more mainstream FIRE, “how-to-deal-with-Sequence-Risk” stuff!

Hope you enjoyed today’s post! Please leave your comments and suggestions below!

Picture credit: Pixabay

 

All parts of this series:

501 thoughts on “Passive income through option writing: Part 3

  1. No, there are actually only two cases! For the most part the Premium was so small on the expiration day that I simply went to bed. The probability was then 0.0X percent. I think 2 times it ran against me or at least not for me – so that I took some premium but the loss chance was still present (personal assessment) – then I bought back the option and directly sold the next one… small Profit – I traded most of the time at 11 PM local time anyway due to the low premium … at the weekend I go home again

  2. Very cool to see someone else doing a similar strategy, with the biggest difference being leverage and moneyness of the puts being sold. You gave me some good ideas about keeping the cash in muni bond funds etc. I have just been keeping them as cash.

    One suggestion I have for people with smaller accounts is to sell the puts on the XSP index. The notional value is only 10x SPX instead of the 100x that the SPX options deal with.

    My current strategy is to use no leverage as a baseline, but if SPX dips (and vol increases), sell more contracts. The actual position sizing depends on my outlook on the index.

    I hope to have a portfolio as large as yours down the line!

    1. Thanks!
      Yes, the XSP is a nice tool if you start with a smaller account. ES futures options with 50x would be the next stepping stone before going with the SPX/100x options.
      Best of luck in running this sometimes underappreciated strategy! 🙂

          1. What are you thoughts on SPY vs XSP options?

            With SPY put, the worst case is I end up owning the stock right? Would this less risky then selling index put options?

  3. This is a very interesting strategy. I’m thinking about trying this. Would you be able explain how to pick the strike price with a bit more detail?

  4. Hi Ern,

    What is you approach on days like today with suddenly increased iV? Still around 5 delta to rake higher premiums?
    Are you not afraid of two consecutive days with -2.5% drops or 6-7% ish drops what happened multiples times in 08-09?

    Thanks,
    Joe

    1. Yeah, that’s the risk with this strategy. You will occasionally suffer losses. Otherwise you’d not get paid an options premium.

      If a 6% drop happens out of the blue when the VIX was at 10, then indeed, you’re experiencing a lot of pain. Normally, these big crashes happen when IV is already high and you’re selling your put about 2-3% or more out of the money, so that makes the loss not quite as painful.

  5. Lightning round! Why did you choose long puts over long calls or a mixture of both? Would a mixture of both improve the risk profile since, if you lost money on the calls, then your puts expired worthless and vice versa? Are there any good sources with the data crunched for average return and volatility metrics for options at various strike prices (atm, 2% otm, etc)? What are the best sources for the raw data? For educational materials on options math? Are you Lite or Pro at IB?

    1. I never do long puts/calls.
      I never do short calls because the premium is often too small and I find it unpatriotic to bet against a market rise. 🙂
      I haven’t used any commercially avaiable data yet. https://spintwig.com/blog/ uses some data and does extensive backtesting. Very good work!
      I do IB pro.
      I heavily rely on the option math from this book:
      https://www.amazon.com/gp/product/0471786322/ref=as_li_tl?ie=UTF8&camp=1789&creative=9325&creativeASIN=0471786322&linkCode=as2&tag=earlyretir007-20&linkId=d7648fb59b4ec09774e9acf87c32adb8
      The book also ha s a nice CD-Rom with option pricing formulas as an Excel plugin.

  6. I don’t get the leverage bit. I have been reading and following along for a while now, but I’m struggling to see how you are leveraging.

    If you have 150k and you short 1 spx index option at 3k that’s 300k exposure and according to your description that is a leverage of 2. This exposure leaves you with 150k negative buying power and I’m not sure how a broker would allow this to be processed? Are you selling these put spreads capped with a long put for a penny or something?

    Let’s say my account balance is 50k. A delta of 10’ish on xsp of 331 (336-337) underlying at the time is about 30 cents. A 6 point limit is about 1.8% drop before entering into loss territory. I can cap this with a 297 long put for a penny to make it a credit spread and the buying power loss is only 3.4k (331-297)x100. What is my leverage in this case?

    So this brings in a max of $90 in weekly premiums, which is $4680 gross per year which is about a 10% annual gross yield against a balance of 50k. This seems more or less in line with your expectations.

    Am I misunderstanding something? Should I instead sell spreads at 10 cents a piece (thus lower strikes) and instead short 3 of them instead of 1? In this case my exposure would be 10k. 1.8% drops seems relatively close before getting into drop territory.

    Thank you!!!!

    1. That’s not how derivatives work. You need around $32k initial margin and $29k maintenance margin for a short put contract. If you have $150k of equity in the account you’re OK.
      You an certainly do a credit spread (vertical spread) to limit the downside risk. But also at the risk of lower revenue,

      If you have $50k of equity and do a put with 10x at 331 ($33.1k exposure) you have less than 1x, so no leverage.

      Also caution with the XSP contracts. With a premium of $0.30 you get only $3 revenue per contract. Probably the commissions eat up most of your potential gain.

      1. Thanks, something wasn’t making sense. Finally figured out that TDA limit me to cash/holdings secured options trading.

      2. | Also caution with the XSP contracts. With a premium of $0.30 you get only $3 revenue per contract. Probably the commissions eat up most of your potential gain.

        Just a clarification for anyone else looking at XSP instead of SPX: The contracts are still 100x units. It’s only the index that’s 1/10 of SPX (which means 1/10th the risk, and about 1/10 the premium)

        The 2800 strike on SPX with a premium of $3.00 will net you $300 revenue per contract.
        The 280 strike on XSP with a premium of $0.30 will become $30 revenue per contract.

        Both contracts are still going to have $2-$3 in commissions (put credit spread on IB Pro), which hurts a lot more on XSP (10% commission) vs SPX (1% commission). It makes it harder to go out to the very low deltas.

  7. I have started selling SPX short puts on IB as well and I’m confused about the additional trading opportunity on the third Thursday of the month – like yesterday, Feb 20th (next one like this is March 19th).

    I’m confused because this put doesn’t expire ‘normally’, it’s still in my account the day after with a non-zero value. In fact, my 3355 put (alas, it seemed a reasonable strike on Wednesday) gained value over night.
    Is there something I don’t know about these Thursday options, can it still be exercised? The premium was pretty much in line with a one day exposure.

          1. Typically what are assignment cost if SPX ends up ITM? In that 9% p.a. return, aside from including inflation, did you account for taxes? (60/40 tax treatment on SPX)

            1. You would have a cost if using the ES futures options because you are charged commission to get the ES, then pay commission again to sell it. But SPX options are cash-settled at (to my knowledge) no additional cost.
              All returns are nominal pre-tax returns. You’d have to adjust the Section 1256 returns to account for taxes. In fact, if your tax rate is significant (while still working) you’d be wise to scale the leverage up by a factor of 1/(1-taxrate) to account for this. Similar thought process as this one:
              https://earlyretirementnow.com/2016/06/07/synthetic-roth-ira/

        1. When SPX options were first introduced they only had expiration and settlement at the open of the 3rd Friday of the month. In recent years it became more popular to have a settlement that coincided with the close, so PM-settling options were introduced. Then Friday weeklies….and finally the midweek options we have now. This whole time the original Friday AM settling options have remained in place, although it’s mostly institutions that use them for hedging purposes etc

        1. Whoa!!! I put the new strikes for today’s expiration at 2975, 3000, 3025.
          Two mistakes people make after a big loss:
          1: not invest at all and losing out on some of the high IV and rich premiums
          2: sell puts with very aggressive strikes to make the money back. That can backfire if the market keeps dropping.

          So, I go the middle route: sell way out the money, maybe at a slightly higher premium, but don’t be too aggressive.

          1. I definitely agree with this. When the market tanked on Monday, a 2950 put was going for $250 at EOD Monday. It had to drop 9% in 2 days to make a loss. Only issue is I can’t afford those because my account is too small.

            It’s definitely easy to make your money back right now with how high IV is. IV on Monday/Tuesday was something like 50 while the Vix was 27. This is literally free money if you can afford spx index options.

            I have been having to do xsp which has had small buffers (4-6% in 2 days instead) and smaller premiums. Still doable but not as easy.

          2. Wow I’m glad I put my stupidity out there for all to see because that’s the only way I can learn and improve. I’m only good at learning things practically so I’ve been learning on the fly since September 2018.

            1. I definitely don’t fall for this. I actively look forward to a big drop (as long as it’s not enough to hit my strike) because the premiums are so juicy.

            2. Definitely a mistake on my part! Time for me to readjust my strategy. I think the reason I fell into this trap is because of my limited experience. With such a small sample size, I found that the aggressive strikes of 100pts or more would yield such a high premium and then eventually expire worthless.

            I was lucky to escape today for some reason which I don’t understand. The index dropped below my strikes of but somehow I was able to close the trade a few minutes before expiry for approx. 50% profit.

            Why did that happen? This might embarrassingly reveal my lack of option knowledge.

            I read your comment too late so my strikes for Friday are still too aggressive at 3015!. What strikes did you go for Friday?

                1. How will you go on ? The tension is almost unbearable..I pray for the 2960… it’s still possible

                1. Do you think 2695 for Monday expiration is low enough? I had to open it as a spread (it allowed me to collect more premium than selling similarly priced xsp options and with a larger buffer). It’s about 9% OTM from close so hopefully the planet doesn’t melt by then.

                  I’m using my 75% of emergency fund cash as cash holding to meet the margin requirement for writing wide spx spreads (1 very high premium leg, and the cheapest long leg that allows me to meet any requirement). Similarly priced xsp options were lower premiums and lower otm (maybe 5%).

                  This does increase my risk since I’m increasing leverage (I’m basically exposed to much more exposure than just xsp naked 3 puts or so) but I use that leverage to write further otm than collecting higher premiums.

                  Let me know your thoughts.

                  Thanks

                2. Sorry about late reply. Yes, in hindsight that was low enough! 🙂
                  But 9% OTM when the most recent drops have been 3-4% seems like a super safe bet. It’s in line with the strikes I used!

                3. Another learning experience again. I thought I was being conservative with 2660. I hope I don’t get another nice loss again.

                  Looks like your strike is 400+ points OTM?

                4. Yeah… i went with the ES… so for the 2960 Strike i got the Future almost at 2960… seconds later the Future was directly in the profit zone… so all in all this was the best case to get the future and so i even earn more with it, then just the Premium with the Short Put… it was all within seconds – so i sold the future as fast as it was possible.

                  I wouldn’t sell minutes before the expiration… the spread is too expensive! makes no sense (for me).

                  The S&P500 last price was at 2990 so my strikes are from 7-10% under the last price…

                  2525 – i don’t think we lose 15% at Monday… almost 900 Points in 6 days…

                  So i’m a little more aggresive.

            1. Oh, wow, lucky you! I thought about you on Wednesday when the market dropped to below your strikes.
              For today (Friday) I had strikes between 2800 and 2925. Mostly around 2800-2850 but also a few at 2900 and 2925. I had already mentally prepared for losing money on those but the late rally saved my butt today! Made all my premiums!

              1. For some reason, it makes me happy to know that you think about us during your trades.

                Welp, I am a bit numb and psychologically rattled after today. I made some mistakes and it cost be dearly. I’ve wiped off a huge chunk of my portfolio.

                Mistakes:
                1. Close the trade 30mins to expiry because I was afraid the market will drop further when waiting to let them expire like usual would have been a $70K difference.
                2. Too aggressive/greedy with my strikes. Not knowingly I guess, I wasn’t “revenge trading”, it was more that these aggressive strikes would normally be such wide OTM strikes during normal times and that I have yet to be punished until today.

                What I will do forward:
                1. Lower my leverage
                2. Have much more conservative strikes
                3. This might take me a couple of years to get back to parity

                I hope I eventually get out of this funk but I think it has affected me mentally. I thought I had learned how to deal with such big losses until the biggest of all losses today.

                Looking on the bright-side, seeing your choice of strikes, I now know I have been implementing the strategy incorrectly.

                1. Yeah, sometimes one loss can bring about more losses when people lose their nerves. Happened to me too.
                  The early closing of contracts would have been painful on February 28 due to the rally during the last 20 minutes.
                  But for the record: I also try to harvest a little bit more after a big loss: slightly higher leverage, and slightly higher premium targets. But time is on my side. I’ll eventually make the money back. There’s no rush… 🙂

                2. Hmm…that’s interesting to know that you increase the leverage slightly. Maybe I should revisit my plan after that big loss.

                  Regarding targeting slight higher premiums. I think one of the big takeaways from this correction watching how you managed it was this. SLIGHTLY is the important word here.

                  My mistake was that I was targeting what I thought was safe strikes for 4x to 10x the usual premiums. Up until that big loss, I thought I was basically getting free money but now I know that’s not the case. Looks like 2x the premium is sometimes too much.

                  My strikes for this Friday are 2855 and 2920. Usually the 2920 wouldn’t have cause me to sweat but the big loss the other day has really put the fear in me haha

                3. Yeah, I did a trade on Wednesday right before close with a 2850 strike. Everything else is way below, as low as 2725. I’m getting a bit nervous about the 2850 strike now. 2920 seems a bit gutsy!

                  With slightly I mean targeting an option premium maybe 1.5x to 2.0x the normal and 1.2x to 1.5x the number of contracts. So, I’d make around 1.8x to 3.0x the premium. If you’re making 10x the usual premium, that’s a bit extreme. Don’t become like this guy: https://earlyretirementnow.com/2018/12/18/the-optionsellers-debacle/

                4. Thanks for the clarification regarding the extra premium and leverage.

                  Uh oh, SP500 futures markets hitting circuit breakers.

                  2755 and 2685 strikes looking dicey at my max strike. I hope I don’t end up being like the OptionSellers guy.

                5. That was close. Must have suffered some losses with the 2755 strikes, but only a few dollars.
                  My strikes for today’s expiration: 2400-2700. Actually mostly 2400-2525 and a few at 2600 and 2700 sprinkled in.
                  New strikes for Wednesday: 2250-2400.

                6. Looks like I’m still paying some tuition for this learning experience haha.

                  But on the brightside, after your comment the other day about the target premiums and leverage, maybe I am learning.

                  My strikes for Wed are 2300-2400. 🙂

  8. I’m honest. I got hit with 3270 too.

    In the meantime I am also considering whether the effort is worth it.

    I have been doing a live test with the more or less published system for 7-8 months. There I have tried permanently to collect 1 point in the SPX. So up to 3 points a week.

    Yesterday I lost 40 points.

    In short, I have earned in 7-8 months more or less nothing. Because it happened 2 times with a big minus. Actually even 3 times – but the third time I got out with higher risks by rolling. Which one should not actually do.

    The negative points:

    A simple Buy and Hold would have autperformed me. The SPX is about 250 points higher than my start.

    It costs me a lot of time – of course you have to open the next option shortly before the close of the market. But in reality the premiums were so low that I waited the whole trading day until the SPX dropped by 10 points to get a reasonable premium. Otherwise the risk was simply very high.

    In my country the fees are higher and I have to deposit the margin as a chash. The system is therefore also quite capital hungry.

    My thoughts are simple if a 3-4% loss 3-4 times a year means that I don’t make a profit here – then it’s just no use. And I see the danger here extremely large. The last time the Vola was so low that this 1 point in the SPX placed a strike very close to the actual price. To put it bluntly, I was perhaps only 1.5% for 2 trading days. That is just nothing. Let the index drop 3% once on Tuesday and Wednesday…

    Also yesterday I was temporarily in the red. When the SPX dropped to 3215. Fortunately it went up 10 points again – otherwise it would have been another 3 weeks.

    I’m really struggling with myself. Wasn’t the last six months representative? I took the wrong strikes. Do I need a stop loss?

    I’m also worried that I’ll be here for 2-3 years, and if there really is a day with a 6-7% loss. Maybe the next day I lose another 3% then I lose premium (10% = 330 points) that is at 3 points per week, 2 years of work.

    Yesterday evening I opened a 3070 Strike with 6 points Premium. With high Vola it is more fun. But the last weeks were just not really suitable.

    1. I hear ya. Let me also state that a 7-8 month period is not long enough to determine if a strategy is attractive.
      Just for comparison:
      I had a positive return in 2018, while the SPX lost 5%.
      I matched SPX return in 2019 to within a few 0.1%. 10+% from the option writing plus another 20+% from the bond/preferred portfolio.
      This year, is off to a bad start, but I still beat the SPX.
      And all of that at a lower volatility than the SPX.

    2. Why can’t use 2x stop loss? Your drawdowns will not be severe and equity curve will be smooth.

      During high IV environments you will get stopped out frequently. One strategy is go with longer dated options during high IV and 2-3 DTE during medium or low IV.

        1. Yes during high volatality periods you will get stopped out frequently.. During low vol periods stop losses may be effective. This will help with big losses but whisaws may erode profits.

          Whats your biggest loss on any given day?

  9. Hi Big Ern and fellow options traders! It sure makes me feel better when I come here to read these comments and see that I am not alone in getting my butt kicked this week. A little moral support helps as I navigate my way through the ups and downs of this strategy.

    I started implementing the Big Ern SPX option trading strategy last year in April and I have made a few mistakes along the way. I have gradually shifted my brokerage account holdings so that I now have enough in my municipal bond ETF to justify selling 7 SPX puts (maintaining 2.5X leverage). This is nearly as many as the 10 SPX puts Karsten sells every Monday, Wednesday and Friday.

    Although I have not actually profited from options trading so far after two big losses (one in Aug 2019 and one this week), I believe this system can work and will improve my safe withdrawal rate by lowering volatility.

    If I can eventually hit the goal of keeping 40% of my premiums after losses, this will be an excellent tax efficient method of generating monthly income as an early retiree. I am planning on staying the course.

    1. Thanks!
      Well, the S&P 500 is also roughly flat now since Aug 2019, so the opportunity cost wasn’t that large.
      My performance took a beating in February (-3%), but with the 1.5% gain in Jan I’m only down 1.5% YTD. Not bad compared to the index.
      My prediction is that in the next few weeks, probably months we’ll have rich premiums and one can make back the losses from this week.

      1. Thanks Big Ern! I appreciate your words of encouragement. What a week! Friday the 28th was very exciting. The S&P 500 kept jumping back and forth above and below my strike price of 2900. I had my eyes glued to the screen for the entire 5 1/2 hours of the trading day. It was like watching a very long horse race and it sure was nice to see my horse pull away from the pack in the last 10 minutes of the trading day!

        Thankfully, this system uses no more than 2 DTE options. I shudder to think what would have happened if we were using SPX options with a one week expiration such as you previously used. Happy trading!

    2. After a week I unretired, so you are probably doing better than me. How is that for sequence risk? I’m beginning to think investments that both beat inflation and suit my risk tolerance don’t exist. How long are boxes of corn flakes good for? Off to work I go.

      1. What do you mean by “unretired”? You mean you retired and decided to go back to work in light of the stock volatility? Then you were either too optimistic when you retired or you are too pessimistic now. Just my opinion! 🙂

        1. How do you figure? I’m looking at it rather simply: Given my age, I think X is enough. I had X, now I don’t have X. I need to stop drawing until I have X again. Maybe I’ll have an answer by the time I get to part 36 of the safe withdrawal rate series.

          1. Gotcha. Waiting for a return to X can potentially take a long time. See my post on Bear Markets quoted above.
            Or part-time work? Might save your retirement but can also take quite a long time:
            https://earlyretirementnow.com/2018/02/07/the-ultimate-guide-to-safe-withdrawal-rates-part-23-flexibility/

            Or do a CAPE-based rule (See part 18). No need to go back to work, just reduce the withdrawal amounts a little bit in response to a drop.

  10. Is this strategy only meant for early retirees/planning to retire early? I have been dabbling with ES futures for the past week 0DTE trades. its been good so far. Juicy premiums far due to IV spike

    1. Not at all. I’ve used the strategy also while saving for retirement. It’s also nice for traditional retirees.
      0-DTE is nice. I’ve tried a few contracts here and there, But my bread and butter business is still Mon-Wed-Fri-Mon. 🙂

      1. 0 DTE for the past week working pretty well. Rich premiums with far OTM strikes. Crazy IV. Today when the market dropped at the open I entered 5 contracts from 2700 to 2600 strikes. Easy money.

        This market can drop 5% in a day without a blink

          1. I’ve been reading your strategy for years, and finally started trying it (with play money for now). I paper traded for 6 months and then Jan 1 2020 I started trading with real money. It’s been a crazy wild Rollercoaster.

            When you wrote about IV going up after a drop, I previously thought you were talking about the spike to 20% IV we got in October 2019, because everything else I’d seen up to that point was 9-15%. I never imagined it would hit 30+%, or even 50%. And if this high IV is going to be here for weeks/months, then I can see more clearly now why this strategy should be able to reliably make back the money lost if one is patient.

            My new worry is that this is too much fun. Is it a bad sign if I’m having a lot of fun right now?

            1. Good! Glad you enjoy this. I’m having fun most of the time. You see the stock market drop but you still make the premium and you’re up: that’s definitely fun.
              But don’t overdo it. Don’t become cocky/reckless. That’s how people blow up their portfolio! 🙂

      2. Hi ERN, in the Monday Wednesday Friday etc. strategy, does that mean for example during open market hours on a Monday (9:30am to 4pm EST) while you still have open positions that expire end of day (4pm?) you are opening new positions for the Wednesday expiration? Thanks.

        1. Depends on the mood that day. If my Wednesday options are in the money or only slightly OTM then I will wait before writing the new Friday options. If the market is waaayyyy above my strikes I will start selling puts at market open already. Maybe 3-5 trades throughout the day.

  11. ERN – can you keep us posted on how this strategy is holding up under these major selloffs taking place? Down 8% today! Perhaps another post after it levels off looking back at how it fared?

    1. Holding up all right. I was up 0.5% for the year as of Friday. But dropped today by about 2%. But the drop is entirely due to the risky fixed income portfolio (preferred, high-yield Munis, etc.)
      I did earn all the Put premiums. Even today (Monday) with the big drop. My strikes were. 2400-2700 for options expiring Monday. Market closed at 2746.

  12. Hi EARN,

    I’m still a little torn. I understand the trading approach and yes it has worked for me so far. In the end we even got through this extreme market.

    On the other hand, I was sweating blood and water when the futures were taken out of the market because of too high losses. I was looking for the biggest daily losses and these are around 20% in the 1930s. Puh…

    I believe you that it has worked for the last years. But when I look at the environment, we’re seeing more and more extremes. Whether it’s in nature with floods, hurricanes or extreme temperatures – everything seems to be becoming extreme. Things that should only happen once a century happen in a short period of time. bad for insurance.

    And that’s just the way it is in the markets. Of course we trade the S&P, what would happen if we traded oil. Down more then 30% in one night. What would happen if we would have bought the weeklies (friday to friday in the s&P) The depot would be totally destroyed. The other markets also seem to be becoming increasingly extreme.
    Various other indices also lost more than 10%.

    Ok we traded fr-monday daily .. and no oil – good for us.

    There’s no question it worked and with the extreme rise in volatility, the strikes are now extremely far away.

    But what if we had an extreme experience once in ten years with a low volatility – a black swan suddenly appearing could destroy your trading approach and destroy decades of premium.

    And that makes me think…

    1. This is the reason insurance selling exists. If these types of events never happened then nobody would need to purchase insurance.

      I personally don’t believe a 1987 flash crash would happen again based on fed intervention, and overall dependency by the world on the markets.

      Lastly, you can purchase cheap vix calls when the market calms down and hedge a lot of your tail risk. You can also purchase treasury etc calls when the market calms down to collect small gains in the treasury market and prepare for a blow up.

      Personally the current market conditions are ideal for selling premium. If you come into this prepared and survive the first tail event that blows the vix up then you’ll be okay for the most part.

      During the 7% Monday drops, 10% otm risk premiums were going for $700.

    2. Oil and the stock market are two ver different animals. Commodity prices are more volatile. And the volatily itself is more volatile as well. So, just like the Nat Gas spike last year (see my post on how that blew up an option shorting strategy: https://earlyretirementnow.com/2018/12/18/the-optionsellers-debacle/ ), oil can have wide swings.
      I don’t think that 30% swings are possible in broad equity indexes. For individual stocks, of course, but not the index.
      Also: despite the wild swings, I’ve earned all my option premiums this week. Recall: the 10% move occurred when the VIX was already very elevated! So, the move on 2/24 was more of a danger to option strategies than the 3/12 move. Just expressed as multiples of volatility.

    1. I did here, as of 3/4/2020
      https://earlyretirementnow.com/2020/03/04/feeling-scared-already-its-not-even-a-bear-market-yet/

      I will do another update at some point.
      In a nutshell: I’m now >0 for the year (though still slightly down since 2/19) with the put selling alone. But: my fixed-income portfolio has taken a beating and that is down about 1/2 of what the S&P500 is down. Goes to show that bonds are not safe, unless they are U.S. Treasurys… Oh, well.

      Leverage is worthwhile when you start out saving for retirement. See Part 15 of the SWR Series, “2: “Mortgage” your retirement.”

      1. 1)How do you go about withdrawing and using the income from the sell of SPX puts in retirement? 2)It seems that tranches go up every 125-150k for each SPX if using x2 leverage. What do you do with that money (<125k while you wait until you have enough to get another tranch)?

  13. Hey Karsten,

    What strikes do you have for this Wed?

    Mine are from 1700 to 1900. I was pretty worried about 1900 being too aggressive if we continue this meltdown. It’s rallied a bit now but there’s still two trading sessions to survive. I hope I didn’t do the wrong thing.

    Also crazy that 1700 was the lowest strike available.

      1. It just goes to show how little I still know. You have true mastery of this trading plan because you know when to be conservative and more aggressive.

        I was scared after selling the 1900 strikes for 6x the usual premium whereas before I got burnt, this was my usual plan after a big down.

        Looking forward to us hopefully making the full premium and for more juicy premiums to come.

  14. Hey BigERN!

    Is there a rule what would happen to our short puts if the markets close for several days?

    Regards
    Michael

    PS: I’m short the 1950’s too 🙂

    1. My strikes are all in at 1900.

      I was very disappointed in the lower premiums today but that’s because I was used to the excessively high ones in the last couple of weeks.

      Is the market just used to the “new normal” now? IV still seems high yet premiums more muted.

      Market looks to be behaving itself for now.

      1. Yeah, had to go all the way to 1900-2100 for this Friday. IV has dropped. But still at 60+ for the VIX and ~90-100 for the put IV. The new strikes are still below the recent lows. Let’s hope we don’t go fown again! 🙂

  15. Did you say you only started doing this strategy after you retired and only for more stable income? In the accumulation phase you were only getting long the indexes?

  16. Hi Thanks for all the info!
    I use interactive brokers too, but as i open the SPX option menu, i can only see dates withtn 15 days, i cant seem to find a daily or two days options.
    Can you help, thanks!

    1. In Classic TWS, enter “SPX” hit enter.
      Under “S&P 500 Stock Index – CBOE” select “Options”
      It opens up a small window with all the calls/puts. There are some tabs at the top for the different option expirations. Click to the right if necessary and there’s a tab “More”
      That should all weekly and standard options

  17. Hi! Noob here.

    Do you ever trade strangles on SPX? If not, why?

    For people who do sell future strangles…why don’t they also buy a call further OTM to protect against the risk of the call side getting tested? Does that make sense?

    1. What do you do in a bear market like today…sell SPX credit spreads?

      If I’m directionally agnostic, then isn’t a strangle the best way? Just worried about the call side risk.

          1. SPX options are cash-settled. They debit your account and that’s it.
            ES futures options are settled in the underlying. You’ll end up with the ES future at 4pm (eastern time) and you should probably sell those quickly.

            1. If you’re assigned ES, why not hang onto them until they regain their value?

              I don’t understand how selling SPX doesn’t blow you out. I think I’m missing something. If your normal equity put goes ITM at least you get assigned a stock you love. But if your spx expires ITM then you have a massive debit that wipes out a year of profits…?? What am I missing?

              1. For example, I’m looking at selling a May SPX 2080 put. It say max profit is $1,130 and was loss $206,870! That’s a terrifying steam roller, I don’t understand how you avoid that.

                1. I can answer your questions as I have been there done that. It has to with leverage and these option positions are highly levered plus /ES and SPX have large sizes even without the option contracts on top of them. The sheer size of these vs. even an expensive stock like AAPl is where the difference shows up in your example.

                  Cash Settled vs. Contract Settled:
                  I had a short /ES position that was expiring on a Friday afternoon. I was called away from my computer and came back to find it was ITM (or so I thought) and the market had closed. I would have been assigned all those shares of /ES that I would have had to hold over the weekend (and it was a holiday weekend). It would have been too large of a position size for my account and my heart was beating so fast I thought I was going to have a heart attack. I still feel shaky just thinking about it. That is what leverage can do to you if you are not super careful. I would have much rather just had to pay out (cash settle) and then know what my fixed loss was then worry about holding such a large position size over the weekend. Now, thankfully in my case I was not assigned as I barely made it over the settlement price which is not always the same as the closing price (another lesson learned).

                  Bottom line, cash settled just seems safer and less risk vs. having to get assigned and hold a huge position in your account that you may not be able to close out right away.

                  In your example of the SPX 2080 put, max. loss assumes SPX goes to zero during your holding period. That is not likely so you cannot focus on this number. You really need to use graphing software to look at the price of your position at different SPX prices over time to see what the return profile really looks like. Next, compare that to simply buying/selling the stock outright to see how your break even, losses, and profits points change in each example.

                2. Thanks Brad!!

                  Here’s what I don’t understand: what’s so bad about being assigned /ES? You’re getting to own them at a discounted price and can just hold them for weeks or months until the price recovers.

                  To me that’s the big appeal of selling puts…worst case you get to own the underlying at a discount.

                3. That is true assuming:
                  1) your position size is appropriate for your account size and level or risk
                  2) you have a directional bias (i.e. you think the stock will go up)

                  In my case, I think I had 2 /ES contracts I sold which means I would have been assigned 100 futures contracts (50 * my 2 contracts). I think price was around $3000 at the time so I would have been holding $300,000 worth of /ES futures contracts long over the 3-day weekend. If Trump sent out a negative tweet or of the market dropped 10% I could have lost $30,000 which was too large for that account and my risk tolerance. So I was using too much leverage (I am on a margin account with my broker). If it was cash settled like on SPX, my broker would have closed me out that Friday and maybe I would have owed them a few hundred bucks which was totally fine given my account size.

                  Also, I used to tell myself the same thing. “Just sell puts on good stocks you want to own”. That works until it doesn’t. I sold my first naked put on AAPL in Fall of 2018 right near the peak before it tanked. When even a good stock like AAPL is tanking all you hear is bad news about the stock and it keeps going lower and lower. You start to wonder if it really is a good stock that you want to own. I ended up second guessing myself as my losses from my short put grew and grew and closed it out for a loss. At the time everyone though we were going into a bear market so it seemed like the right thing to do but of course it rebounded and now I regret selling out too early. Anyway, its really hard to trade that way for me (selling naked puts on stocks). If its an index like SPX that may be easier to handle but just dont over leverage if you really want to own those shares and be prepared to see large losses adding up in your account when you check on it each day.

                4. Thanks so much Brad, this is very helpful for me. I’m still learning, do you mind if I ask you some more questions?

                  I understand about AAPL…for this put selling wheel strategy to work you really have to have the resolve to hold the stock for a year or more worst case scenario.

                  Here’s something I don’t understand…say you sell an SPX put and then SPX tanks. How is that only a few hundred dollars loss? Why wouldn’t it be a huge thousands of dollars loss? Perhaps you could show me an example with actual numbers?

                  As an alternate to /ES, have you tried the micro MES? Maybe a safer way to play with less margin?

                  What strategies are you into this days, what have you found works for you?

                5. Pumppunter – if you are on facebook check out some of the options groups such as tasytrade options. You will find many good people on there that are happy to answer questions and help new traders. Its actually the only reason I even go on facebook anymore.

                  In my example, because I sold my put so far away from the price of SPX, it could still go down a lot and not hit my strike. Because it just came close and barely breached my strike I could have lost maybe $400-$600. Certainly if it blew right through my strike by 10 points I would have had a lot larger loss if I waited for it to be settled.

                  I have only been doing this for a few years and frankly have not really found a strategy or system I like enough to put a lot of money into it. It sounds obvious but the truth is there is no “magic” system that can beat the market in all the different types of environments we have seen. However, if you are looking at using options for other reasons like what Big Ern does which I assume is a way to reduced sequence of return risk or to give you more of a stable income stream and reduce the risk and volatility of your stock holdings I think there are some good strategies like the wheel or even just basic covered calls. Again, these are not ways of beating the market or generating alpha, rather, they are ways of smoothing out returns and lowering volatility vs. buy and hold which is good if you are in or near retirement but if you are younger and trying to grow your account I have not seen many option selling strategies that can do that consistently enough to put real money into.

                6. Thanks Brad!

                  My goal isn’t to beat the market but just to have some monthly somewhat passive side income.

                  And ES/MES seems appealing because of the tax benefit.

                7. Just be careful with the spreads and commissions around /ES and options on futures. They can really eat away at your profits. SPX is cheaper to trade (lower commissions and smaller spreads). I think they are both taxed the same in the US so that should not be a factor. BigErn had a post awhile back in here about switching to SPX and the tax treatment.

              2. Great question. Pretty simple answer: Your method would have bankrupted you. With my method you’d have made the loss back by now, plus more.

                Suppose you’d had a $60,000 portfolio and shorted an ES put expiring on Monday 2/24, Premium earned on Friday is $0.80.
                Underlying expired 40 points in the money and you’re assigned the ES future. (SPX close was 3225, ES future somewhere around there).

                My method: I had a loss of $39.20 times 50 = $1,960.
                I ate the loss. Water under the bridge. I kept writing puts throughout the weeks and made back a total of $53 combined premiums (times 50 = $2,650)

                Your method: You had an initial loss of $40 when the index dropped to 3225. You hold on to the ES Future hoping it recovers. The index dropped even further to below 2200. That’s another 1000+ points for a total loss of over $50,000.
                At the bottom, the exchange force-liquidates your position because you didn’t have enough margin. And you would have missed out on the partial recovery since then. Not a pretty picture. That’s why I always warn not to double down and try to make the money back too quickly! 🙂

  18. I always hear selling puts was for a bullish market. If we’re in a crazy market like today, what do you do…just sell puts deeper OTM? Or call credit spreads if you think it’s bearish?

    Or what about strangles if you have no directional opinion?

    1. Very far OTM puts, that’s true.
      My experience is that after the first big drop, it’s quite profitable to sell puts because the premium is so rich. I made the most money ever in one month from put selling in March 2020.

      I don’t like strangles. I would never bet against an equity rally.

      1. Thanks very much for your answers! In the post you say 5 delta…are you even deeper now or still around 5?

        How did you not get assigned on the big drop in March? Do you have a more detailed write up or comment somewhere of what exactly you did in March?

        1. Vol was much more elevated the previous weeks (70-80 now closer to 40) I was able to sell 3 delta puts for juicy premium. With the volatility drop, I started getting back to 5 or 6 deltas for the same amount of premium. So it depends on what the market gives you. BigERN is selling SPX, you can’t get assigned it’s cash settled, you just take that loss if it happens and let the occurrences do the rest.

          1. I’m still learning, may I ask why 5 deltas? Just to have less risk and higher probability? I’m confused because TastyTrade recommends 30 delta!

            Do you trade SPX or ES? Why or why not? And do you most just sell cash secured puts?

            1. if SPX trading for 3000, then sell the next expiration for 3.00cr If SPX is trading for 2500 then sell the 2.50cr so 0.1% credit of price. The price of underlying choses your delta. This is a different strategy, very gamma dependent.
              Tastytrade at 30delta, 60% probability of touch requires constant adjustments on delta and rolling. This is not a rolling strategy.
              At x2 leverage if you have $135k you can play with SPX, if you have $75k you can play with /ES but just be ok with getting assigned and higher commissions.
              If you have a margin account you don’t need to be cash secured.

              1. Thank you! Yes i don’t want to deal with rolling or constant adjustments at all. When it’s a bearish environment, do you still just sell puts?

                And why sell weeklies as opposed to monthlies?

                And sorry but total noob question here…what is the next expiration…would it be April 13 or 15? And what is the ideal DTE for SPX/ES put selling? Tastytrade always says 45 days but it seems like everyone does weeklies.

              2. Looking at the April 13 spx puts….i’m looking for about 1% of price and I see one for 2.65cr…but it has delta of 6…isn’t that too high delta for crazy times like now?

            2. I laid out the pros of SPX vs. ES in this post in section “4: Trading SPX options instead of S&P500 E-mini futures options”

              You may go with 30 delta puts but that would not have worked out so well in the volatile times in March. 🙂

        2. Sometimes at 1 to 2 delta (i.e., 0.01 to 0.02) now due to massive spike in IV.

          I should probably write another update on the option strategy (Part 4) on how to deal with the vol. Yeah, I’m planning that! 🙂

      2. Looks like things got a little hairy in March for your closed end funds and preferred stock. They have made back most of their losses already, but who knows what would have happened if the fed didn’t step in. Are you going to tweak this strategy once they come back?

  19. What do option put sellers think of this article? This guy ran a black swan hedge fund and bought put options from you guys. And profited handsomely when the markets dropped last month.

    Option Put Selling appears to be picking up pennies from the railroad tracks. (Never mind the steamroller!)

    1. I somewhat agree with the steam roller statement but what BigErn does here is more like picking up dollars in-front of a small car that is half a mile away and driving 10 MPH. Seems to work most of the time but when it fails you get hurt a little bit but not enough to kill you and after you get hit the first time you then go back to picking up $10 bills instead of $1 bills so you can often recover in just a few months to a year. Its still a tough way to trade though.

      Nothing works well all the time. The fund that was buying puts was likely a drag of 5-10% per year over the past 10 years. When it works it works great but not many people can stand losing money year after year like these tail risk funds do.

      1. Love your analogy involving a small car going at 10 mph. Makes sense.

        BTW, the commenting system ate my link. For those who are interested, check out the Goat Farmer Doomsday Machine on Forbes. Use your favorite search engine to find it.

      2. Sorry, I read through your comment too quickly. I find it interesting that you say that a person is picking up dollar bills, and after getting hit, is now picking up tens of dollars at a time for a while. I guess the premiums during periods of high volatility are that juicy.

        Great analogy, overall! Thank you.

  20. Hi Ern,

    Sometimes if market goes up and option value goes down way before expiry. Does it makes sense to write another put with with same expiry DTE0/1? Or better to go for DTE3/4?
    Following your approach from much earlier where you switched from weekly to intra-weekly, DTE0/1 seems better than DTE3/4, no?

    Thanks

    1. Great question. Writing on an update on the option writing strategy and this was on my mind as something I need to cover! 🙂
      Short story: Yes, write additional ones already, but cautiously. I prefer the DTE0/1.

  21. It might be a while away but you’ve mentioned in the past how you liked other commentors’ idea of buying VIX calls as a hedge during low vol times. Any more thoughts on how and if you would implement this?

    1. Not sure if we are allowed to post links to other sites here but Kirk from Option Alpha goes over this in some of his youtube videos. You will have to search around a bit but its a well thought out plan of using VIX calls that are layered into each month.

      1. Thanks for pointing in the right direction Brad. Any specific videos you would recommend? I think Karsten hasn’t banned links in comments but he can correct me if I’m wrong.

        1. I think I found them. Just google “option alpha vix hedge” and watch the first few video links that come up.

  22. As of late, what deltas have you noticed you have been using when selling your SPX puts? At 0.1% of 2800, around 2.80 cr I’ve found myself selling around 7 delta. When VIX was 9-12 what was the highest delta you ever sold puts at?

    1. I would sometimes do same-day contracts (sell put in the morning expiring that same afternoon) and the delta can be >7. But for the most part, I’ve stayed between 4 and 6 during tranquil times and around 2-4 during the crazy market moves recently.

      1. In the event you are ATM or ITM on a certain expiration (put option will likely expire ITM). Do you check before 4pm if possible, let it expire ITM and then open the new one the next day at 9:30am? If it is around a 0 delta meaning its going to expire worthless do you go ahead and write the next expiration that afternoon or wait until the next day? Thanks for you input.

  23. If in 2018 you only lost once during that big correction at the end of year, what contributed to keeping only 40% of premium collected? Just curious.

      1. nice are you actively logging all your premium transactions or just the times you get tested? When you have run up days like the ones we have been having is there a threshold where you roll to put up to collect more premium?

        1. I keep track of all transactions. Currently >10,000 trades.
          I use some discretion on how I walk up or own the target premium (measured as annualized yield). That’s my special sauce. 🙂

          1. If you were living off this strategy and you wanted 5k/month after taxes/expenses leaving room for growth/inflation, how many tranches do you think one would need to sell each expiration?

            1. Great question.

              Let’s make the following assumptions:

              $120,000 capital per contract.
              Net income from puts: 4.5% = $5,400
              Preferred, 30% of margin cash, yield=5% = $1,800
              High-yield Muni Mutual Funds, 30% of margin cash: 3% yield = $1,080
              Muni closed-end funds, 30% of margin cash: 4.5% yield = $1,620
              Cash, 10% of margin cash: 0% yield = $0.

              Per contract, you generate per year:
              $9,900 total
              $2,160 ordinary income
              $5,040 dividends/LT gains
              $2,700 tax-free
              Less: 2% inflation allowance ($2,400):
              =$7,500

              To generate $60k a year, you’d need 8 contracts.
              With 8 contracts you’d stay within the standard deduction for a married couple and within the 0% bracket for LT gains and I live in WA State without a state income tax. Thus, after tax = before tax.

              Notice, all yields used here are actually a little bit below their current market yields.

              1. Thanks for the detailed breakdown. It makes sense. Can I infer that then your target premium is somewhere around .95cr per put that you are selling?

  24. May 8 expiration almost worthless. For May 11, currently the 3 DTE what strike are you looking to sell on the SPX and when would you sell it (now vs closer to end of day)?

    1. I’m shooting for a $0.75 premium over the weekend.
      I sold puts throughout the day, split into 5 tranches. It’s dependent on how the puts look that expire that day. If there’s a risk they end up in the money I wait until right before the market close. If the old puts are waaayyyy OTM then I roll the contracts earlier. 🙂

      1. I seems that because of the cost of borrowing, the only broker where this will work would be Interactive Brokers if you are using margin to have the bond and the SPX on top. Would you say that is a fair assumption? Have you backtested taking 2.00cr or 3.00cr premium per occurrence (seems even at a loss ;the premium collected which is x2 or x3 would get you back to positive and above quicker)?

        1. Oh, I have not backtested using higher premium levels. I’ve always done 5-7% annualized premium in my own trading and my backtests.
          Also, I can’t speak for other brokers. I would think that they work under similar arrangements.

      2. Are you closing out those old puts before selling a new one. When you say “roll” is that closing and then selling, or just selling?

        1. I think Karsten just lets his puts expire worthless to save on commissions. Since the SPX options are cash-settled, I assume he also just lets those expire even when they’re ITM.

          If you have ITM ES puts, then I believe he sells a ES future so that it will cancel out when he’s assigned a ES future.

          Hope Karsten can correct me if I’ve gotten anything wrong.

          1. Sure, with ES puts you can sell the ES Future if the put is ITM. The put will be hard to undo because there will be a huge B/A Spread.
            Technically speaking, you’d sell the ES Future and buy a Call with the same expiry and strike.
            But ideally, I’d just do the SPX options, let them expire, eat the loss and start working on making the money back with the next set of options! 🙂

            1. Oh wow does that mean I’ve been doing it wrong but somehow it worked despite my ineptitude?

              Do you buy a call and sell the ES Future, or are you saying that selling the ES future when you are about to be assigned one technically achieves buying a call+selling a future?

              1. Depends. If the ES Put option is way in the money and you’re right before expiration you might as well sell the ES.
                But with the long-call you’d hedge the risk of getting whipsawed if you want to clear out the short put position long before expiration.

  25. Hey Big Ern love your blog and appearances on Choose FI.

    I’ve been doing this strategy with success on Etrade using the SPY ETF. So far I’ve just been leaving my “collateral” in cash. If I took a portion of that cash and put it in the GLD ETF would Etrade consider the GLD portion as valid collateral for margin purposes?

  26. Ern,

    Just out of curiosity, have you ever analyzed when you more often end ITM – for AM or PM trades?

    Thanks

    1. Good question!
      Let’s take an example: I write puts throughout Wednesday that expire on Friday. If the market tanks on Wednesday already and then some more on Thursday and Friday, then the AM options do worse than the PM options, obviously.
      But I’ve also seen the opposite: The S&P stays constant or goes up on Wednesday, which means I sell the PM options at a higher strike. And they are the ones that go ITM on Friday while the AM options are either OTM or not as badly ITM.
      So, it can go both ways, though, it’s certainly true that the AM trades are subject to a little bit more downside risk ON AVERAGE.

  27. Weird issue,. I am not able to trade SPX in IB it says floor trading only. And for XSP, the option does not show anything and its blank. Is anyone else having these issues?

  28. Interesting to know how this strat has done in the month of March given the entire market tanked. I would imagine you lost money when SP dropped >7% a day?

      1. Oh wow? How did it work? You sold naked puts, and SP went down a lot in late Feb – mid March. I would imagine you would lose money based on your strategy if I understood correctly. Perhaps I am missing something, mind enlightening me?

  29. After the first part of the move in late Feb-early march, implied vol skyrocketed allowing someone to collect similar premium for much further out strikes, in this case >325 points lower than ATM which dodged the some of the biggest down moves in history. The strategy typically does worse in the very first part of a down move when the vix is low than in the later stages when the Vix is>30. One thing to be careful of is what you hold your margin cash in, some of the riskier high yielding funds such as closed end munis and preferred stock funds were briefly down 30-40% before the Fed stepped in to buy bonds.

  30. Did anybody else suffer a loss on the May 11 expiration. I got caught holding tranches at 2830 and had a 1k loss per tranche (SPX ended pinning end of day at 28320). My other tranches were at 2815 and expired OTM. ERN what strike were you holding during that expiration and how much did you collect for it?

        1. What determines the way you chose the strikes during an expiration. Is it time based, for example every 2-3 hrs? do you just chose strikes around a cluster of open interest?

      1. With the margin on your account; aside from SPX puts do you have bond shares? index shares? as well as like Karsten?

        1. I’m in Australia and unfortunately Interactive Brokers shut down margin accounts except for high net worth clients so I have to hold it in cash. It’s a drag on the returns for sure.

  31. You have bonds at 1x leverage and then you leverage SPX x2 with the margin in the account. Do you think that if you leveraged SPX x3 it would be more stable in terms of volatility and achieve better results?

  32. I got caught on 2 strikes this past expiration (June 12) 3060 and 3065; when I sold they were 5 deltas respectively. Did anybody else get caught ITM as well? Just trying to gauge if my strikes are too aggressive.

    1. I have been going as low as possible while trying to collect ‘decent’ sized premiums. I sold 2 strikes of 3020 and got extremely lucky that the last 15 minutes pushed us up because the intra-day low was below 2990.

      In the current economic state I personally wouldn’t follow the 5 delta rule at all. As seen by Thursday, the VIX was definitely understated IMO. My current logic is for when VIX goes <30 while the current economic climate persists to use a VIX call to provide downside protection on the exposure on the short puts.

      1. Thanks got the reply. How much did you collect when you sold the 3020? Are you holding equities in addition to selling puts? What leverage are you targeting?

        1. $35×2, I collected $70. I use spreads to allow me to amplify leverage so I can collect smaller amounts of premium but increasing the buffer to decrease chance of expiring ITM. My account is only 55k and while vol is low I have been doing 90-100 point spreads (3020 short, 2920 long) x 2 while always attempting to maintain a >5% buffer for expiration. I “assumed” a 5% buffer for 2 days would be safe but after thursday I have decided to include VIX calls whenever VIX falls again while the economic climate stays the same.

          I’m up YTD in the portfolio and that was after making some fairly bad decisions this year. If I didn’t make even some of those bad choices (these aren’t hindsight decisions but decisions based on emotions instead of logic) I’d be doing even better this year.

          This allows me to hold my spreads till expiration (saving on closing costs) and open new positions without needing to close previous ones.

          And I hold smaller equity positions, in utilities, preferreds (I consider these equity positions even if they aren’t true equity risk to be conservative) and tech total <15%. Everything else is basically some niche REIT ETFs, non-leveraged local municipal mutual funds, and some leveraged closed end funds (corporate bonds and MBS). I don't own specific security directly because I work at a fund and we can't have specific equities, bonds, etc. only ETFs/mutual funds really.

  33. Been following your posts to understand my way through.. I was trying to understand the following (under leverage). “If I have $125,000 per short option in my portfolio”. Does this mean having 125k in your account?

  34. Hi ERN,

    I’ve been running your option strategy since 6/10/20 (always good to sell your first option minutes before the 5th largest single day VIX spike; really tests your mettle to verify you will stick with it). It’s been very effective and I only have made minor tweaks, namely often selling at a little more leverage but more in the 2 delta range by selling as far out of the money as possible to generate my targeted return (excluding margin cash).

    Despite looking at the prices daily, it took me 4 months to realize… Why are ES future options and SPX options slightly different prices? It’s not huge, but in the 2-5 delta range I was eyeballing it and the premium appears to be about 5% – 10% less. Is this risk associated with having to purchase the underlying instead of cash settling? Is there something else? The margin efficiency shouldn’t matter if we view this as a supply and demand function; the put buyer doesn’t care what I do with my margin cash (assuming IBKR is, on the net, hedged so there are non-brokerage buyers and sellers…maybe that’s a bad assumption). The difference in price is much greater than the fee difference. My Google search was not fruitful.

    Thanks,

    Tyler

    1. ES settlement is based on the next quarterly future price (currently Dec 2020) whereas the SPX options are based on the actual index price. The future’s price is based on what the market expects the index price to be at expiration. For various reasons these can slightly differ, mean reversion dividends, market events, etc.

    2. FIguy already wrote a good response.
      My five cents: ES and SPX will converge as we get closer to the ES expiration date. The difference is due to dividend yield and interest rates. Because there has to be a non-arbitrage condition between the physical index holders who get the dividend stream but also have the opportunity cost of having to invest the principal vs. the futures long positions where you buy on margin (no opportunity cost) but you also don’t receive dividends. So, the two prices HAVE to deviate to assure non-arbitrage but the spread gets small and goes to zero once we get to the expiry. Hope this helps! 🙂

  35. Can you talk about your experiences with large intraday moves? In doing this strategy, intraday I’ve opened up my browser to see a -2,000%+ loss, only to recover with zero loss at expiration.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.