6.9% Options Portfolio Return vs. 2.2% S&P 500 Return

Over the past 12 months, I’ve managed an options-based portfolio and demonstrated how this approach can offer a superior alternative to traditional stock picking. An options-based approach is very similar to running your portfolio like a business where you manage risk and take profits. Alternatively, an options-based approach is much like an insurance company where you sell as many policies as possible to collect as much premium income as possible with a premium cost level that maximizes a statistical edge to your benefit.

An option-based strategy mitigates risk and circumvents drastic market moves. Selling options and collecting premium income in a high-probability manner generates consistent income for steady portfolio appreciation in both bear and bull market conditions. This is all done without predicting which way the market will move. Sticking with dividend-paying large-cap stocks across a diversity of tickers that are liquid in the options market is a great way to generate superior returns with less volatility over the long-term.

Over the past 12 months, 298 trades have been made with a win rate of 86% and a premium capture of 57% across 69 different tickers. When stacked up against the S&P 500, the options strategy generated a return of 6.9% compared to the S&P 500 index which returned 2.2% over the same period. Options are a bet on where stocks won’t go, not where they will go, where high probability options trading thrives in both bear and bull markets.

Options Trading
Figure 1 – Basic principles and building blocks of an options-based portfolio
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Options: You Choose Whether You Win 70%, 80% or 90% Of Your Trades

Previously, I wrote an article putting forth the efficient market hypothesis termed “There's No Edge In Stock Picking” and how less than 10% of fund managers outperform their benchmark over the long-term. These bleak performance metrics and the fact that there’s only a 36% chance that you pick a stock that outperforms the index is what makes options trading so effective.

Whether you want to win 70%, 80% or even 90% or your trades, you dictate your probability of success when it comes to options trading over the long-term. If you set your probability of success at ~85% and make trades at that probability level through all market conditions over the long-term on the scale of hundreds of trades, you’ll end up winning ~85% of your option trades. Options trading allows one to profit without predicting which way the stock will move. Options aren’t about whether or not the stock will move up or down; it’s about the probability of the stock not moving up or down more than a specified amount. Put simply; options are a bet on where stocks won’t go, not where they will go.

Options trading can generate consistent income and mitigate portfolio risk while producing high probability win rates. Options allow your portfolio to generate smooth and consistent income month after month without predicting which way the stock market will move. Running an option-based portfolio offers a superior risk profile relative to a stock-based portfolio while providing a statistical edge to optimize favorable trade outcomes. Options are a long-term game that requires discipline, patience, time, maximizing the number of trade occurrences and continuing to trade through all market conditions. An options-based approach provides a margin of safety with a decreased risk profile while providing high-probability win rates that are determined by the trader himself.

Empirically, over the previous 12 months, I’ve produced a return of 8.6% relative the S&P return of 3.2% while winning 85% of my trades via leveraging ~70 different ticker symbols. Continue reading "Options: You Choose Whether You Win 70%, 80% or 90% Of Your Trades"

Your Option Contract Was Assigned - Now What?

Options trading can serve as a powerful means to generate consistent income and mitigate portfolio risk while producing high probability win rates. Options trading allows one to profit without predicting which way the stock will move. Options aren’t about whether or not the stock will move up or down; it’s about the probability of the stock not moving up or down more than a specified amount. Options allow your portfolio to generate smooth and consistent income month after month without predicting which way the stock market will move. Options are a bet on where stocks won’t go, not where they will go. Running an option-based portfolio offers a superior risk profile relative to a stock-based portfolio while providing a statistical edge to optimize favorable trade outcomes. Options are a long-term game that requires discipline, patience, time, maximizing the number of trade occurrences and continuing to trade through all market conditions.

Put simply; an options-based approach provides a margin of safety with a decreased risk profile while providing high-probability win rates. Despite this favorable trading backdrop, occasionally options can be assigned and move against you despite managing the risk profile. How do you manage these unrealized losses and navigate these assignments to mitigate downside risk and ultimately sell your assignment at a net gain? This is the scary side of options that is rarely talked about, here I’ll demonstrate the actions I take to manage these assignments.

Assignment

Even though options trading provides a statistical advantage and generates high probability win rates, being assigned shares inevitably occurs. Briefly, when selling a put option, you agree to buy shares at an agreed-upon price (strike price) by an agreed-upon date (expiration) in exchange for premium income.

You collect premium income to compensate you for agreeing to buy shares at the agreed price by the agreed-upon date. As the contract lifecycle unfolds and the stock does not break below the strike price, profits can be realized early by buying-to-close or letting the contract expire to capture the entire premium. When the stock breaks down and trades below the agreed-upon price at expiration of the contract, the stock will be assigned. Continue reading "Your Option Contract Was Assigned - Now What?"

There's No Edge In Stock Picking

Those that subscribe to the efficient market hypothesis believe that there’s no edge or advantage when it comes to picking stocks. Thus, stock-picking is a binary event and boils down to a 50/50 probability or simply chance. Everything that can be possibly known about a stock is known, and all the available information, technical analysis, and fundamental analysis is priced into the underlying stock price. The efficient market theory may be the Achilles heel of professional money managers’ performance and their inability to outperform their benchmarks. A staggering 92% of actively managed funds do not outperform their benchmark hence the massive inflows into passive index investing and ETFs.

Furthermore, when looking at The Russell 3000 Index over a 26-year timeframe (1983 to 2006) which comprises the largest 3000 U.S. companies, 39% of stocks were unprofitable investments, 64% of stocks underperformed the Russell 3000 and 25% of stocks were responsible for all the market’s gains. Taken together, only 36% of stocks outperformed the Russell 3000 index. If the efficient market theory is correct, is stock picking a useless endeavor? If stock-picking boils down to chance, is there a strategy that places the statistical odds of success in one’s favor?

Efficient Market Hypothesis

Markets aren’t always functioning efficiently. Markets can be irrational and become overbought or oversold. Outside of these extremes, however, markets are efficient, and over the long-term the vast majority of actively managed funds are unsuccessful at beating their benchmarks. Everything that can possibly be known about a stock is known, and there’s no edge in stock picking. As of Q1 2019, for the ninth consecutive year, the majority (64.5%) of large-cap funds lagged the S&P 500 last year. The longer the timeframe, the weaker the performance, after 10 years, 85% of large-cap funds underperformed the S&P 500, and after 15 years, nearly 92% are underperforming the index (Figures 1 and 2). These dismal results hold true across large-cap, mid-cap, and small-cap funds. Even if these actively managed funds happen to outperform their index, it’s due to chance, and this margin of outperformance is primarily negated by hefty management fees, rendering stock-picking useless. To further emphasize this point, for the Russell 3000, 39% of stocks were unprofitable investments, 64% of stocks underperformed the index, and 25% of stocks were responsible for all the market’s gains. Taken together, only 36% of stocks outperformed the Russell 3000 index.

Stock Picking
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What Does Life Insurance Have To Do With Options Trading?

Generating smooth and consistent income month after month without predicting which way the stock market will move is the objective of options trading. Running an option-based portfolio offers a superior risk profile relative to a stock-based portfolio while providing a statistical edge to optimize favorable trade outcomes. Options trading is a long-term game that requires discipline, patience, time, maximizing the number of trade occurrences and continuing to trade through all market conditions. Put simply; an options-based approach provides a margin of safety with a decreased risk profile while providing high-probability win rates. Essentially, options are a bet on where stocks won’t go, not where they will go. Sticking to a set of fundamentals, this approach can provide long-term, high-probability win rates to generate consistent income while circumventing drastic market moves. In July, I posted a 96% (24/25) options win rate, and over the previous 10 months through both bull and bear markets that win rate percentage was 87% (199/230). Over the previous 10 months, the options-based portfolio outperformed the S&P 500 over the same period by a significant margin producing a 6.1% return against a 2.3% for the S&P 500.

What Does Life Insurance Have To Do With Options Trading?

Insurance companies sell policies based on actuaries and risk factors, then price these polices to their advantage. Insurance companies are betting on probabilities across insurance products and sell overpriced policies above their expected losses. The insurer agrees to pay out a specific amount of money for a specific loss (i.e., death). In return, the insurance company is paid monthly premiums, and based on this risk-based revenue model; it’s a very profitable business. Insurance companies sell policies with a premium cost level that maximizes a statistical edge to the insurance company’s benefit. The goal is to collect premiums over the course of the policy and never payout on the policies they sell to you. So, the probability of paying out on the policy is very low while the premiums received, over the policy lifespan will exceed your total benefit. Continue reading "What Does Life Insurance Have To Do With Options Trading?"