At the core of options trading is defining risk, leveraging a minimal amount of capital, and maximizing return on capital. Options enable smooth and consistent portfolio appreciation without guessing which way the market will move. Options allow one to generate consistent monthly income in a high probability manner in both bear and bull market scenarios. Over the past 8-plus months (May-December), 186 trades were placed and closed. A win rate of 98% was achieved with an average ROI per winning trade of 7.7% and an overall option premium capture of 82% while matching returns of the broader market and outperforming during market downswings. An options-based portfolio's performance demonstrates the durability and resiliency of options trading to drive portfolio results with substantially less risk. The risk mitigation element is particularly important, considering markets are richly valued as measured by any historical metric (Figures 1 and 2).
Figure 1 – Overall option metrics from May 2020 – December 31st, 2020
Figure 2 – Overall option metrics from May 2020 – December 31st, 2020
Compared to the broader S&P 500 index, the blended options, long equity and cash portfolio have matched 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 kept pace with the S&P 500 returns through 30NOV20 with substantially less risk (Figures 4, 5, and 6).
Overall, in May, June, July, August, September, October, November, and December, 186 trades were placed and closed. A win rate of 98% was achieved with an average ROI per trade of 7.7% and an overall option premium capture of 82% while outperforming the broader market through the September, October, and initial November volatility (Figures 1, 2, 3, 4, 5 and 6).
Figure 3 – ROI per trade over the past ~190 trades
Figure 4 – Percent premium capture per trade over the last ~190 trades
Figure 5 – Smooth and consistent portfolio appreciation while matching the broader market gains and outperforming during the market sell-off in September and October. An overlay of an options/cash/long equity hybrid portfolio and the S&P 500. Even under the most bullish conditions, the hybrid portfolio has matched or outperformed the index with a ~50% cash position
Positive Returns Despite September, October, and November Volatility
The September correction, tail end October nosedive, and election-induced highly volatile early November provide a great opportunity to demonstrate an options-based portfolio's durability and resiliency. A positive $1,251 return, a positive $2,585 return, and a positive $2,797 return for the portfolio's options portion was achieved in September, October, and November, respectively (Figure 6).
Figure 6 – Generating consistent income despite negative returns for the S&P 500 index in September and October
The positive options returns were in sharp contrast to the negative returns for the overall market in September and October. 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.
10 Rules for an Agile Options Strategy
An agile options-based portfolio is essential to navigate pockets of volatility and circumvent market declines. The September correction, October nosedive, and election volatility into November are prime examples of why risk management is paramount. Despite the market volatility, positive returns in all three market scenarios were generated with options. A slew of protective measures should be deployed if options are used to drive portfolio results. When selling options and managing an options-based portfolio, the following guidelines are essential (Figure 7):
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. Place probability of success in your favor (delta)
10. Appropriate position sizing/trade allocation
Figure 7 – 10 rules for long-term successful options trading as demonstrated
The September correction, tail end October nosedive, and initial November volatility reinforces why appropriate risk management is essential. This approach provides a margin of safety while circumventing the impacts of drastic market moves as well as containing portfolio volatility. In the face of volatility, consistent monthly income has been generated while keeping pace with the broader market returns and outperforming during periods of market weakness.
Sticking to the core fundamentals of options trading, one can leverage small amounts of capital, define risk, and maximize investment return. Following the 10 rules in options, trading has generated positive returns in all market conditions for the portfolio's options segment over the past 8 months and counting. The positive options returns were in sharp contrast to the negative returns for the overall market in September and October. 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 long positions via 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.