Which color do you like better? Green or brown? I’m partial to the green curve myself. That green curve comes from writing puts…sort of. Writing puts can be a lower volatility play that makes you money in choppy or flat markets, falls more softly in down markets, and seriously under-performs when the market goes on a tear upward.
What’s a “put” and where do you put them? If you’re an old hand at options, skip down a few paragraphs. A “put” is an option. You’re buying the right to sell your stock at a set price at a set time in the future. You’d be interested in buying a put if you were worried the market might go down. If you bought a put with a strike price of $100, and your stock went down to $80, you would be able to force the put-writer to buy your stock at $100. You’d keep the difference, minus the amount you paid for the put option. People often use them as insurance when they’re unsure of the market, or simply as a bet that the market will go down.
For every buyer though, there’s a seller. Put-writers are taking the other side of the trade. They think to themselves, “I think this market is going to go up or stay flat. So I’m willing to take a chance and sell some insurance (write a put) and pocket the fee.” If the market goes up or stays flat, the put might expire worthless, and the writer keeps the fee. If the market falls, the put writer must pay the difference between the strike price and the market drop, but subtracts out the fee he/she earned.
The put-writer is happiest when the market is rising gently or is flat. The writer gets to keep the fees when the options expire worthless. If the market goes down, the put-writer loses money…but not as much money as if he/she had invested in the underlying. There’s that put-writing fee that was earned, which offsets the loss to some degree. A put-writer cannot take advantage of any wild upward movements in the market though, because the fee is fixed.
There are better explanations on put options out there, but that’s the general idea.
For regular folk who don’t want to pay monthly commissions, there are ETFs called “put-write ETFs”. You get someone to do all this put-writing monkey business for you, and the fees are nominal if you’re a long term investor. They’re pretty exotic as far as ETFs go, and many investors don’t even consider them.
There is an ETF with the ticker “PUTW” that I find interesting. It aims to track the CBOE’s put-write index, which I’ve identified below as $PUT (read more on the CBOE site here). The ETF only been in existence since 2/24/2016, so it definitely does not have a big track record. However…PUTW did track the CBOE $PUT index very closely over its short existence, to within 0.1%. That’s promising! We can therefore consider the fact that this ETF is a way to trade the $PUT index going forward, and we can look at the index going backward to see how it does against the market as a whole.
If you look at the lead image, you can see the $PUT index did exceedingly well over the time period of 2000-2016. Bear markets are still bear markets for a put-write system, but the impact is less. $PUT usually outperforms during a bear market (i.e. it loses money less quickly), makes money during flat markets, and falls behind during surges.
From 2000-2016, SPY gained 51.22%, with a max drawdown of -56.24%, and a CAR/MDD of 0.04.
During that same period, $PUT gained 172.40%, max DD was -37.01%, and CAR/MDD was 0.16. You could have leveraged PUTW (if it had existed) x1.5 and had the same risk as SPY over the long haul.
I wanted to see how $PUT performed relative to SPY (an ETF that tracks the S&P 500) year over year. Rather than just give you a table of numbers, I thought an excessive quantity of graphs was in order. Below you will find every year from 2000 to 2016 graphed, starting with an investment of $30k in each position. Red is $PUT, blue is SPY.
2012: Our first significant defeat for $PUT. What kills it seems to be the wild runs up, rather than the drops downward. Both are up for the year, and $PUT was less volatile, but it failed to take advantage of those surges.
2014: $PUT tracks SPY pretty well for most of the year. Both take a dive in October in the sharpest V-shaped correction we’ve seen in years. $PUT takes the same hit, but can’t recover sharply like SPY can. A serious under-performance at the end of the year. (The dates disappeared from this chart for some reason, but it really is 2014.)
What’s the takeaway from this? A put-write ETF could potentially make you a lot more money over the long term, with a lot less hair-pulling. Using a simple “market timing” signal could significantly improve performance as well.
I did a quick test on a basic market timing signal: enter either ETF when SPY’s 40-day moving average is over its 120-day moving average, and exit when reversed. It improved SPY’s CAR/MDD slightly, and increased profitability substantially. On $PUT, the reverse happened: profit was reduced, but CAR/MDD was hugely improved. You mileage will vary.
Another idea might be to only enter a put-write scenario if the market was within a certain percentage of a moving average. Too far above and you’re better off just buying the market. Too far below and you’re better off in cash. Haven’t tried, it, just a last-minute thought.
I should also disclose that I recently went “long” with PUTW.