No put options met my criteria this past week so no new positions were opened. The HLT puts that I sold on August 28 hit my buy target price and that trade was closed for a 77.8% gross profit over a 19-day holding period.
The table below shows my put option trades since May. The four open positions will likely be closed by the end of the week.
Given that the S&P 500 is up by more than 16% since the beginning of May, selling puts has been an easy way to generate extra income. It has felt too easy to me and I am curious to see how my put selection criteria and trading strategy perform in a more difficult environment which is sure to come.
Earlier this year, I began selling puts on US stocks as a means of increasing my portfolio value beyond that which I am achieving with tactical asset allocation using ETF’s. Over the course of the past number of months, I believe I have improved my ability to select puts that will, overall, provide profitable trades. As of this writing, I have five open positions and for all positions, I have a buy order that is good-until-cancelled to buy back the puts at a 75% profit. If the puts aren’t bought when 21 days-to-expiry remains, I will buy the puts at the market price to close out the trades.
This post just may be the start of me listing puts each week that have passed my filters.
The style of investing I use is most commonly known as Tactical Asset Allocation (TAA). The majority of investors who employ this style of investing with liquid ETF’s probably reallocate at the end of each month. Personally, I reallocate three times each month for a more robust investing methodology.
Very recently, as a means of producing additional investment income, I added a new component to my methodology which involves selling options on the more liquid ETF’s that I hold. I sell cash secured puts and covered calls. The rationale behind this component of my strategy is that the ETF’s I hold are most likely to rise in price in the very near term or, at the very least, not decline meaningfully. That being the case, properly selected puts with 30 to 50 days to expiry remaining should expire worthless more often than not.
Covered calls are a little different in that the ETF’s I hold should increase in price in the next 30 days or so and calls sold at a similar delta as the puts I sold are more likely to be exercised (i.e. the ETF units would be called away by the purchaser if the price of the ETF is above the strike price on expiry day).
At this point, I won’t get into how I select the puts and calls to sell other than to say I pick appropriate days to sell the options. In my opinion, not every day is a great day to sell either a put or a call.
The table below illustrates the small number of option trades that I have closed so far. Please note I do have open trades and some of them are in losing positions. If I closed out the losing positions at the time of writing this post I would have an overall positive result (i.e. my option selling would have produced positive income).
If you have some knowledge of option strategies you would recognize that selling a put and a call with the same expiration date is a short strangle. At a most basic level, that is what I am doing. A common short strangle approach used by options traders is to sell 30 delta puts and calls in equal numbers on the underlying stock or ETF and buy them back when a profit of 50% or 75% is achieved. Looking at the Gross Return column in the table above you will note that the lowest gross return so far was 75.6% so that gives you a very good indication of the profit return which will trigger me to close out the option.
In the future, I plan to provide updated tables for my closed option trades and time will tell if my selling puts and calls on the ETF’s I hold will prove to be a sustainable means of producing additional income within my investment portfolio.
Tactical asset allocation (TAA) is most often based on the investor trading once-per-month and that once occurs on the last trading day of each month. There may be an inherent problem in the selection of the same day each month on which to rebalance the portfolio and this is referred to as timing luck.
Fortunately, Walter at Allocate Smartly and Corey Hoffstein at Newfound Research wrote about timing luck as it pertains to TAA so there is no need for me to reinvent the wheel.
The Allocate Smartly post is here and the Newfound Research post is here. If you are a TAA investor, I strongly suggest you read both articles and consider the timing luck issue if you are making allocation adjustments only at month end.
The take away from both articles is that trading on the same day each month, be it the last trading day, the eleventh trading day, etc, introduces the risk that the performance results are due, in part, to the day selected to trade. To remove timing luck from a TAA, both articles present the solution that the investor divide their TAA portfolio into equal weights and rebalance each segment on a different day of the month. The assumption is that the rebalancing days are equally spaced apart.
I have decided to take the advice of Water, Corey and other professionals that I have spoken to. I divided my portfolio into four equal segments and, going forward, will adjust the weights of the ETF’s on a weekly basis. Segment 1 which is 25% of my portfolio will be adjusted on the last trading day of week 1 (which was last week in my case). Segment 2 which is 25% of my portfolio will be adjusted on the last trading day of Week 2. Repeat for segments 3 and 4. On the fifth week, the process repeats starting with segment 1.
As for my portfolio, it slipped by 2.54% in March resulting in a year-to-date loss of 3.34%.
Outcomes. When you are a long-only investor and the markets behave like they did in 2017 it is easy to focus on outcomes and tend to allow your mind to diminish the importance of process. When your equity chart increases every month for twelve months straight you have full confidence in your process because the outcomes are so darn favorable.
Then February 2018 hits you. The outcomes that your brain has become accustomed to change dramatically and your focus switches to process. Every day the financial media reminds you that volatility has returned with a vengeance like you haven’t experienced in so long that you forgot what it feels like. This is very unpleasant. Gut-wrenching even. Suddenly there is a voice in your mind screaming that there must be something wildly amiss with your process.
Process. It is far more important than outcome and it is what we, as investors, should be focusing on but why would we when we produced positive returns every single month in 2017. Our investing process must have been sound given how smooth and upward sloping our equity curve was last year.
Doubts. If you have them about your process there is nothing quite like a spike in volatility and a swift drawdown to make you question whether your investing strategy is in dire need of an update. New rules perhaps. Tighter stop losses would have worked so well this month. Buying cheaply priced puts in January now seems like such an obvious move that you should have made.
Relax. If you have a sound strategy that has proven itself over time then now should be no different and you must ignore the alarms from the financial media and relax. Now is not a time to jump ship and abandon your strategy. Surely you have read about the gains you would have enjoyed had you bought stocks in Berkshire Hathaway and Apple decades ago and just held. I suspect you also understand that you would have had to endure many drawdowns in excess of 40% between then and now. What we are experiencing lately is child’s play compared to those drawdowns.
My advice is to stay the course (assuming that your course is a systematic investing strategy that suits you and will provide you with returns and drawdowns that are acceptable), don’t pay attention to the alarmist headlines in the media, and if you are in the accumulation phase of your investing plan continue to contribute each month.