Despite the major averages being in correction territory in September followed by a volatile October, ending with a massive sell-off and heightened election volatility during the first week of November, realized gains were generated. Following the 10 rules in options trading throughout the recent market volatility has generated positive returns in all three market scenarios.
Defining risk, leveraging a minimal amount of capital, and maximizing returns is the core of options trading. All of this, combined with a statistical edge, provides smooth and consistent portfolio appreciation without guessing which way the market will move. The results over the course of September, October, and the first week of November demonstrate the durability and resiliency of options trading as a means to drive portfolio results.
An agile options based portfolio is essential to navigate these pockets of volatility. The recent September correction, October nosedive, and election volatility are prime examples of why following the 10 rules of options trading is key to an effective long term options strategy. Overall, in May, June, July, August, September, October, October, and thus far in November, 149 trades were placed and closed. An options win rate of 97% was achieved with an average ROI per trade of 7.5% and an overall option premium capture of 88% while outperforming the broader market despite the September correction (Figures 1 and 2).
Figure 1 – Overall option metrics from May 2020 – November 6th, 2020
Figure 2 – Smooth and consistent portfolio appreciation while matching the broader market gains and outperforming during the market sell-off in September. An overlay of an options/cash/long equity hybrid portfolio and the S&P 500 post-COVID-19. Even under the most bullish conditions, the hybrid portfolio outperformed the index with ~50% in cash
Positive Returns Despite September, October, and November Volatility
The recent September correction, tail end October nosedive, and election-induced highly volatile early November provides an excellent opportunity to demonstrate an options-based portfolio's durability and resiliency. A positive $1,251 return, a positive $2,585 return, and a positive $705 return for the portfolio's options portion was achieved in September, October, and the first week of November, respectively. Over this ~10 week period, a win rate of 92% was also achieved (46 wins / 50 total trades).
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Following the 10 rules in options trading via leveraging small amounts of capital, defining risk, and maximizing returns have generated a positive return in the portfolio's options portion. The positive options returns were in sharp contrast to the negative returns for the overall market in September. Generating consistent income without guessing which way the market will move with the probability of success in your favor has proven successful despite these market conditions.
Compared to the broader S&P 500 index, the blended options, long equity and cash portfolio have outperformed this index. In even the most bullish scenario post-COVID-19 lows where the markets erased all the declines inflicted by the pandemic, this approach has outperformed the S&P 500 by a solid margin through 31OCT20 (Figure 2).
Overall, in May, June, July, August, September, October, October, and thus far in November, 1xx trades were placed and closed. An options win rate of 97% was achieved with an average ROI per trade of 7.5% and an overall option premium capture of 88% while outperforming the broader market through the September, October, and initial November volatility (Figures 2, 3, 4 and 5).
Figure 3 – Overall option metrics from May 2020 – November 6th, 2020
Figure 4 – ROI per trade over the past ~150 trades
Figure 5 – Percent premium capture per trade over the last ~150 trades
10 Rules for an Agile Options Strategy
Risk management is paramount when engaging in options trading. A slew of protective measures should be deployed if options are used as a means to drive portfolio results. When selling options and running an options-based portfolio, the following guidelines are essential:
1. Trade across a wide array of uncorrelated tickers
2. Maximize sector diversity
3. Spread option contracts over various expiration dates
4. Sell options in high implied volatility environments
5. Manage winning trades
6. Use defined-risk trades
7. Maintains a ~50% cash level
8. Maximize the number of trades, so the probabilities play out to the expected outcomes
9. Continue to trade through all market environments
10. Appropriate position sizing/trade allocation
Maximizing Return on Capital
Risk-defined trades (i.e., put spreads, diagonal put spreads, and iron condors) maximizes the return on investment. Often, a double-digit realized gain over the course of a month-long contract is possible. Whether you have a small account or a large account, a defined risk (i.e., put spreads and diagonal put spreads) strategy enables you to leverage a minimal amount of capital, which opens the door to trading virtually any stock on the market. Since the risk-defined approach has a max loss, the required capital is equivalent to the max loss.
The dual threats of the election and resurgence of COVID-19 cases domestically and abroad were volatility events that investors need to heed. The September correction, tail end October nosedive, and initial November volatility reinforces why appropriate risk management is essential. An options-based approach provides a margin of safety while circumventing the impacts of drastic market moves and contains portfolio volatility. A positive $1,251 return, a positive $2,585 return, and a positive $705 return for the portfolio's options portion was achieved in September, October, and the first week of November, respectively. Over this ~10 week period, a win rate of 92% was also achieved (46 wins / 50 total trades).
Sticking to the core fundamentals of options trading, one can leverage small amounts of capital, define risk, and maximize investment return. Keeping an outsized portion of your portfolio in cash is essential to long-term success. Despite the indices being highly volatile over the past ~10 weeks, following the 10 rules in options trading has generated positive returns in all market conditions for the portfolio's options segment. The positive options returns were in sharp contrast to the overall market's negative returns in September. This negative backdrop demonstrates an options-based portfolio's durability and resiliency to outperform during pockets of market turbulence. To this end, cash-on-hand exposure to broad-based ETFs and options is an ideal mix to achieve the portfolio agility required to mitigate uncertainty and volatility expansion.
Thanks for reading,
The INO.com Team
Disclosure: The author holds shares in AAPL, AMZN, DIA, GOOGL, JPM, MSFT, QQQ, SPY and USO. The author has no business relationship with any companies mentioned in this article. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned.