Options Trading Series: Part 13 – Year 2024 Review

January 14, 2025 – Happy New Year, everybody! I hope you had a quiet, relaxing Christmas season and a great start to the New Year. As I’ve done in prior years, I want to update you on my options trading strategy: How was the performance in CY 2024? Are there any strategy changes? How did I deal with the volatility in August and December? I also want to share some general thoughts and observations to rationalize the long-term profitability of my options strategy.

Let’s get started…

Options Trading Strategy Details

I didn’t implement any new features, but for readers who are new to this topic, here is a quick recap of what I’m doing:

1. Every trading day, I write (=short) 1DTE CBOE puts on the SPX index. This has been my bread-and-butter strategy for the last 10+ years because it accounts for most of my trading profits.
2. In addition to the overnight puts, I monitor the market open and write additional SPX index 0DTE puts, which expire on the same day. I would usually take a break from the 0DTE puts if the market opens down significantly, where my overnight puts are in danger of losses, and I don’t want to add even more downside risk.
3. I write 0DTE calls on the SPX index. I hinted at this innovation during the 2023 update, and now I have a full calendar year of returns, and the results look pretty promising. I also write 1DTE calls very, very occasionally. But I would only do so on Thursdays before the third Friday of the month when I can write calls for the AM closing.
4. Occasionally, I write longer-dated vertical put spreads, usually 30 to 180 days to expiration. I normally do so after a significant drop in the index when implied volatility spikes. They are often wildly OTM, i.e., sell a 1600 put and buy a 600 put. I try to generate a premium around $1.00-$2.00.

Discontinued features: I had mentioned in earlier posts and comments that I was planning to hedge the downside with some long VIX exposure. I bought a few VIX Call options about 6-8 months out, usually at a 24 to 25 strike. I usually did so when markets were calm and the premium looked cheap. But alas, that didn’t do it for me. Even during the market blowup on August 5, only the August contract VIX call saw a spike attractive enough to call this a hedge. The VIX term structure went into extreme backwardation, so the impact of the vol spike on the, say, December 2024 VIX call was tiny. To hedge against a vol spike, I would have to sell such a massive number of VIX calls that I would “throw away the baby with the bathwater.”

Some stats on the contracts I traded in 2024

People frequently ask me what exact options I sell every day. It varies daily, and I target no fixed percentage or index point number above or below the index level when picking put and call strikes. But here are some stats for my fellow options traders. I use the same chart format as in earlier years:

• The median overnight puts premium was 10 cents. The average was 16.3 cents. The range was $0.05 to $4.60. That’s not a typo; after the 3% intra-day drop on December 18, following the FOMC release, I sold a few “haymaker” puts for this awesome premium and about 6% out-of-the-money!
• The same-day puts and calls had mostly 10 cents premium.
• The same goes for Calls: most had a 10-cent premium, though I also sold a few $0.05 contracts earlier in the year. I’ve now moved to almost exclusively $0.10 calls.
• The mean deltas were 0.0043 for 1DTE puts, 0.0068 for 0DTE puts, and 0.009 for the calls. And I know the puts have negative deltas, but I plot the absolute values here for easier comparison.

How far out-of-the-money, and how much implied volatility (IV) do I get for my contracts? I plot those in the next set of charts:

• I wrote overnight puts with strikes around 5.3% (median) or 5.7% (mean) away from the current index. The range was 1.9% to 23.5% (not a typo; that was after the August 5 market shock!)
• The 0DTE puts were about 2.1-2.3% OTM, while the 0DTE Calls were about 1.4-1.5% OTM
• The median implied volatility (IV) for the 0DTE puts was 33.4%. Positive skewness pushes the means a bit higher to 36.1%. Occasionally, I sell puts with a 100%+ implied volatility, especially during the stress periods in early August and late December. The maximum IV for the 1DTE puts was 191.5%!
• For the 0DTE contracts, the implied vol was in the low 20s for the puts and around 15 for the calls.

When do I trade my contracts? And how does my implied volatility compare to the then-prevailing VIX index?

• No surprise here: I trade most of the 1 DTE puts right around closing time. But occasionally, I already “double-dip” and sell the next-day puts during the morning hours.
• I sell most of the 0DTE Puts and Calls at the open. But sometimes, I trade a few more contracts, usually around 10:00 and 12:00. The shortest time to expiration for a call was only 2 minutes and 9 seconds.
• I sell most of my overnight puts trade at an IV, usually 2x the CBOE VIX. The same-day puts about 1.5x and the Calls at 1x VIX. That’s about what you’d expect due to the negative skewness. Specifically, large upside moves are less likely than large downside moves. And to be sure, I know the 30-day VIX is not an ideal comparison for the 0-day and 1-day vol selling. But I still love that chart!

0DTE/1DTE Options Trading Performance in 2024

My 0DTE and 1DTE put strategy returned just under $100,000 in 2024. Notice that these returns are in addition to my portfolio returns. So, I make the gains, dividends, and interest in my Stock/Bond/Preferred Share portfolio, and the options trading supplements that. In the chart below, I plot the cumulative daily gross option selling revenue (black), the net profit (green), and the losses (red). Loss is the difference between the actual and maximum gain. The net loss is, of course, a little bit less because you made the premium. But I like to track the gross losses, i.e., everything less than making the entire option premium. As we can see from the chart, the 19 loss events (when the red line moves a step up) are spread out pretty evenly throughout the year. Every calendar month, I had at least one loss. April and December had three. The longest stretch of no losses was between the August 1 and September 30 losses.

Here are some more detailed stats; see the table below:

• I traded just over 11,000 contracts. Notice that these are not 11k individual trades. One trade is anywhere from 1 to 25 contracts.
• $124k+ total premium collected, net profit $95,861.10, which is 77.3% of the gross revenue. I call this the PCR = Premium Capture Rate. It’s not the best PCR ever, but certainly nothing to sneeze at either.
• The overnight puts are my bread-and-butter business, accounting for almost half of the gross revenue and two-thirds of the earnings. The minor “loss” was due to a small trade error: I sold two puts too many and bought them back immediately. The 2-way commissions plus the $30 in premium not earned caused a $35 gross loss, and the net loss was about $5.00. But everything else worked out just fine.
• I also traded a few overnight calls, but only occasionally, when the expiration was in the AM, i.e., on the third Friday of the month: $650+. Not bad.
• The 0DTE puts performed poorly this year, with only a 32.2% PCR. Although this figure looked better all year, the December losses dragged it down.
• The 0DTE calls compensated for the poor 0DTE put performance: they earned me an extra $21.5k with a PCR of 61.5%.
• Also, isn’t that intriguing!? The S&P 500 was up 23% (price index) and 25% (total return index), and my 0DTE short calls (i.e., selling the upside risk) did better than the 0DTE short puts. In any given year, the general direction of the stock market predicts very little about the profitability of the 0DTE put vs. call selling!

How to deal with volatility: August 5

Monday, August 5, 2024, was a day to remember in the short-volatility world. It reminded me of the February 5, 2018 meltdown. On August 2, when the S&P 500 closed at 5346.56, I had sold puts with strikes between 4800 and 4975. Between 7% and 10% out-of-the-money felt safe at the time. The premiums were also quite impressive, between $0.40 and $1.15. But on Monday, the market opened at 5151.14, already down almost 200 points or about 3.66%. My short puts had rushed well past the max price I usually set before throwing in the towel, even though their strikes were another 175 to 350 points from the index level.

So, I consciously decided that the market was likely overreacting to the Bank of Japan’s interest rate move and decided to do nothing. My instinct was that it didn’t make sense that a surprise central bank move in Japan would derail the US economy and financial markets. It ended up being the right thing to do. The index bounced around in the 5,100s but ended at 5,186, far away from my strikes. I made the entire premium, even though intra-day, I had wiped out about four to five months of options-selling income.

How to deal with volatility: December 18-23

December 18 is probably still fresh in everyone’s memory. The FOMC met that day and announced its interest rate decision. And rocked the boat by throwing cold water on investors’ rate-cut optimism. Within the last two hours of trading on December 18, the S&P 500 fell by 3%. And it knocked out my stop-loss orders. Even worse, I got a two-for-one loss that day because, after the first stop loss was executed, I sold more puts, further out of the money, only to get stopped again on those as well.

Next, I had a loss on my 0DTE calls on December 20 and another on the 0DTE put side on December 23. What saved my December performance was the fact that the 1DTE puts made so much money around that time to compensate for those losses. Notice how the black line shoots up during that time in the cumulative return chart above. Well, you win some, you lose some.

Longer-term put spreads

Despite my stern warning in an earlier post, I occasionally sell longer-dated vertical put spreads (some call them “credit spreads”). I always target 30 to 180 days out. Specifically, I’d sell one put far out of the money and buy back one even farther OTM with the same expiration date. The long put helps with margin management. I target a premium of at least $1.00 and typically sell such spreads when we go through a volatility spike. I plot the cumulative returns below.

I made a total of about $9,700 extra from those trades. Not bad! But this portion of put selling was definitely a bumpy ride! August 5 sent me down a cool $7k, but the vertical spreads quickly recovered. In fact, on August 5, in response to the big vol spike, I sold some additional spreads with net premiums between $3.35 and $6.25 for December and October, with strikes for the short put between 1600 and 2000 and 600 and 1000 for the long put. It didn’t look very likely that a central bank surprise halfway around the world would take the US stock market down by 3000+ points or 62% in just a few months. So, I’ve now gotten into the groove of selling between $1,000 and $1,500 worth of put spread premium expiring monthly. It’s small potatoes compared to my other options trading activities, but it takes very little time, and every dollar matters.

The overall portfolio in 2024

How did the rest of the portfolio perform? First, let me display the CY 2024 return stats; please see the table below. I report stats for bonds (10-year Treasury benchmark), stocks (S&P 500 total return), and a 40/30/30 benchmark, i.e., 40% stocks, 30% bonds, and 30% cash (i.e., short-term safe assets, like T-bills). Why 40/30/30? My taxable options trading portfolio at Interactive Brokers is about half of my financial assets, while the other half, all in tax-advantaged accounts, is 100% equities. Since I like to have a weighted overall allocation of 70% equities, 15% bonds, and 15% cash to hedge against Sequence Risk, I’d need to target 40% stocks, 30% bonds, and 30% Tbills portfolio in my taxable account.

The put selling contributed 4.8% to the annual return. 18.3% came from the other part (equity mutual funds, preferred shares, bonds, cash). The total return was 23.9%. That may be a bit smaller than a 100% equity portfolio (+25%). But that’s an inappropriate comparison because I’d never want to be 100% equities in retirement. Compared to the 10.5% I could have gotten from the 40/30/30 benchmark, my 23.9% looks spectacular.

Also, notice the impressive put writing risk vs. return stats: The annualized risk was only 0.4%, and the Information Ratio was 10.62, which is fantastic. Also, notice that the monthly put writing returns actually had positive(!) skewness, negligible betas with both bonds and stocks, and extremely low correlations to the other returns. Of course, over longer horizons, say the last 10 years, my options trading IR was a bit more modest. “Only” 3.0, but that’s still very fantastic. There aren’t too many hedge funds with an IR/Sharpe Ratio of 3!

Interesting Research on Options Trading Strategies

The idea of selling insurance for profit is neither my invention nor new. If you don’t believe some random guy on the internet like me, I want to provide some additional reading material to support the philosophy underlying my strategy.

AQR’s Paper “Covered Calls Uncovered”

In 2015, there was a great article aptly titled “Covered Calls Uncovered” in the Financial Analyst Journal (FAJ), the in-house journal of the CFA Institute. Two brilliant researchers at the famed hedge fund AQR wrote it: Roni Israelov & Lars N. Nielsen (2015) Covered Calls Uncovered, Financial Analysts Journal, 71:6, 44-57. Available online: https://doi.org/10.2469/faj.v71.n6.1.

The article is free to CFA Institute members like myself but likely behind a paywall for everyone else. But I like to summarize it quickly: The authors first simulate the returns of a covered-call strategy with at-the-money strikes. It’s not even close to my strategy in at least two dimensions (strike and days to expiration), but bear with me. The authors then split the covered call returns into different components:

1. A constant 0.5 Delta Equity allocation. (=Passive Equity) Why 0.5 Delta? At inception, the covered call has a net 0.5 Delta, +1.0 from the equity portion, and -0.5 from the short at-the-money call.
2. A Delta-hedged short-call position. The delta-hedging is daily. Notice that the short call option had a Delta=-0.50 at inception, so we would pair this with the remaining 0.5 equity allocation. But over time, that Call delta might change. Because we want to distill the pure short-volatility component orthogonal to any equity beta, we adjust the equity exposure to make the net equity exposure precisely zero. (=Pure Short Volatility)
3. The difference between the initial call Delta and the dynamic Delta-hedging in Part 2. Notice that component 3 picks up the “slack” from component 2 and will guarantee that the sum of the three components will always be the simple covered call strategy, i.e., 100% equities minus a Call option. (=Equity Timing)

Why is there (implicit) market timing in a covered-call strategy? A covered call position will have varying deltas on its way to expiration. And the deltas look like a “valuation” strategy (not to be confused with value investing, the topic of last month’s post). For example, if the index falls, your covered call’s net Delta rises. So, you’re essentially betting on mean reversion, i.e., after the fall, you throw in more equity exposure and hope for a recovery. Likewise, if the index rises, your delta declines, so you take less equity risk. Again, this looks like a valuation or mean-reversion strategy.

In any case, the authors calculate the return stats of the covered call strategy and its three components. I have included a screenshot below:

Some observations:

• The covered call strategy has a slightly higher Sharpe Ratio than the passive equity strategy. Notice that the Passive Equity strategy is only a 0.5x equity exposure, so the excess return of a passive equity strategy would have been around 7.0% (simple) and 6.4% (geometric), beating the covered call strategy. However, 100% equity would also have a much higher volatility (17% vs. 11.4%).
• Short Volatility had an impressive Sharpe Ratio of 0.98. You get a 1.9% extra return for only 1.9% risk! Also, people always wonder how statistically significant an alpha is. If we want to test the Null Hypothesis (H0) that the short-vol strategy doesn’t add any alpha, we can calculate the t-stat as IR times the square root of the years. In this case 0.98*sqrt(18.75)=4.25. We can easily reject the H0 of zero alpha (p-value = 0.00001)
• Equity timing adds a lot of volatility with very little return. The IR is only 0.1, so the slight outperformance is not even statistically significant. (The t-stat would be only 0.43, with a p-value of 0.433, so we cannot reject the H0 at any reasonable significance level.)

The takeaways from this article are threefold. First, the pure and distilled put selling part, orthogonal to any equity beta and equity timing, has a desirable risk vs. return profile. A Sharpe Ratio (actually, Information Ratio (IR) would have been the better terminology in this context) of just under 1.0 is quite impressive. Recall that this 1996-2014 simulation includes two of the worst bear markets in recent history, with a 49% drawdown in 2000-2002 and 56% in 2007-2009!

And importantly, this is only the most basic options strategy, i.e., plain-Jane monthly covered call selling with at-the-money strikes. With my more sophisticated approach and selling the even more attractive options, i.e., deeply OTM puts and calls, I have generated an IR of about 3.0 over the years. So, keep a portfolio of productive assets (stocks, bonds, preferred shares, etc.) and then add the pure option-selling/short-volatility portion only, but not the noisy and risky and almost return-free market-timing portion. Covered call writing, cash-secured puts, etc., are for the unanointed masses and YouTube Fin-fluencers. Savvy investors should do what I do!

Second, to get the best risk vs. return profile, it’s recommended to set the DTE of your options as low as possible, tantamount to the Delta-hedging in the AQR paper. In other words, you never want any day-to-day varying delta exposure from your short options. Instead, reset your bets every day and start anew. And just to be sure, I don’t need to do any additional Delta hedging because a) I sell my puts so far out of the money that they have negligible Deltas at inception, usually below 0.01, and b) they all expire after one day anyway.

Third, the article provides the perfect rationale against attempting to make back your money after a put-selling loss, which is often called the “Wheel strategy.” See my post from last year: Part 12 – Why the Wheel Strategy Doesn’t Work. You don’t want to mix options selling and market timing, and the AQR paper has the receipts: the market timing part is very volatile and has low or even zero expected return. You’d ruin your Sharpe Ratio when chasing after past losses. After 13+ years of experience trading this strategy, I recommend that a loss is water under the bridge; it’s best to reset your bet every day and try again.

Robert Litterman’s “Who Should Hedge Tail Risk?”

The second link I want to share is a great paper by Robert Litterman, also published in the FAJ: Litterman, R. (2011). Who Should Hedge Tail Risk? Financial Analysts Journal, 67(3), 6–11. https://doi.org/10.2469/faj.v67.n3.7. It, too, is likely behind a paywall. However, the almost identical content is also available on YouTube; please check out Robert Litterman’s video here. If you don’t know, Robert Litterman, a former partner at Goldman Sachs, is the guy from the famous Black-Litterman model. And yes, the “Black” in Black-Litterman is Fischer Black from the Black-Scholes options formula. Small World! And a fun fact and bragging right: I know Dr. Litterman. We’re both University of Minnesota Economics PhDs:

Anyhoo, Litterman makes the excellent point that hedging against tail events is often prohibitively expensive. Indeed, it is so costly that instead of hedging against tail risk, it can be preferable to simply reduce exposure to this risk factor and then sell the tail risk insurance for an extra return. 

He presents an example of an investor with a 100% equity portfolio (=portfolio 1). The 2005-2011 window would have been a frustrating experience: Only 0.9% annualized returns but 24.5% annualized volatility; see the table below. Hedging the tail risk with a 10% allocation to a long-VIX ETF (ticker VXX) as in portfolio #2 would have reduced volatility, but you also gave up 1.55 percentage points in return. You would have done better simply scaling down the risky equity position to 75% and holding 25% T-bills as in portfolio #3: Your volatility is lower, and your average return would have been higher than any of the #1 or #2 portfolios. Finally, reducing your equity position to 50%, shorting(!) the VIX ETF, and holding the rest in T-bills would have been the best option (portfolio #4) in terms of both return and risk.

What I’m doing in my taxable account is precisely what Robert Litterman proposed! I can’t hold 100% equities because that’s too much tail risk, especially in retirement when you have the added headache of Sequence Risk. One could do a 75/25 portfolio, but that’s still not ideal. We should do 50% equities and add the short-vol as another return-generating engine while keeping the rest in lower-risk, diversifying assets. I don’t think the 50/10/40 split is gospel, but the direction toward less equity beta and more volatility selling is undoubtedly optimal.

Robert Litterman also had another great nugget. For example, he lists this question to be considered before buying tail-risk insurance:

“Is the governance structure […] leading management to consider buying tail-risk
insurance […] to protect itself, which may not be in the long-term best interest of the fund’s beneficiaries?”

What a great point! Part of the tail-risk insurance demand is likely due to people working at and running institutional investor portfolios, such as pension funds, endowments, sovereign wealth funds, etc. The managers likely buy insurance to protect their interests, often to the detriment of the funds’ ultimate owners and beneficiaries. This leads to market inefficiency due to a principal-agent problem. As long as this inefficiency exists, it is payday for us options traders! So, the profitability of selling tail-risk insurance is not just a statistical fluke. Instead, there are some fundamental economic reasons to justify this rich options trading premium.

As a side note, I understand my options trading differs from the VIX selling Litterman proposes. But I claim that options selling is an even better route to selling volatility. If you remember, I always warned against shorting VIX because it seemed to have too much tail risk for my taste and an unattractive risk vs. return tradeoff; see my 2017 blog post on that topic. So, Litterman’s simulations likely underestimate the benefit of selling tail risk.

Podcast appearances

Finally, I want to give a shoutout to the podcasters who waded into the options trading topic and were generous enough to feature me in 2024:

• Jason at Two Sides of FIRE had me on the program to chat about my options trading strategy.
• Jason also featured David Sun, one of my option-trading buddies. I also recommend checking that one out—it has lots of great information from a guy who runs an options-trading hedge fund. I’ve learned a lot from David! David also has his own podcast, “The Trade Busters.”
• David Baughier at Forget About Money interviewed Brad Finn and me about our respective options trading experiences. The interview is an excellent introduction to options trading if you’re new to the subject.

Conclusion

OK, we’re at 4,500 words; it’s time to wrap up. 2024 was a terrific year for options trading, both in dollar and percentage terms. I sold the 1DTE puts far enough out-of-the-money that all puts made their full profit. My same-day puts had a bumpier ride, but I’m glad I had the supplemental income, as I am now taking less risk with my 1DTE contracts. While the percentage return dwarfs compared to the 25% total return in the S&P 500, it’s nice to have that additional return on top of my other portfolio.

How was your options trading experience in 2024? I look forward to your comments and suggestions below!

Please check out the Options Trading Landing Page for other parts of this series.

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