selling options...better than buy & hold?

It's easy to cherry-pick performance & make any strategy look good.  But with option selling, performance comparisons are very objective.  In chapter 25 of my primer Selling Options...Simply Called and Simply Put (noted on this page), I review 5 outcomes for an option's underlying stock & compare them to selling options versus the underlying stock.  The 5 outcomes are through-the-roof, up modestly, flat, down modestly & into-the-tank. 

In response to my one year old post of 10/21/18, "Flexibility, creativity...," another Dave asked me on 10/24/19 how my option selling versus TLT (the I*Shares ETF that holds long term Treasurys) worked when TLT shot up dramatically in the first half of 2019.  I had piqued his interest in my year old post of 10/21/18, when I reviewed a 24 day period in which I could have done nothing (similar to buy & hold) with my existing, sold, TLT covered call; & compared doing nothing versus the TLT covered call repair that I actually made.  During this 24 day period, the 10 year US Treasury yield rose from 3.10% to 3.20% & TLT dropped nearly $3 a share.  Had I done nothing, my strategy would have gone into-the-tank, losing 2.21% over the 24 days, or 33.54% annualized.  But by repairing my covered call & generating a premium credit, my option selling strategy still got beat up, but not as much - it dropped 1.59% over 24 days, or 24.14% annualized.  The covered call repair that I made provided a modest hedge against rising interest rates & falling bond prices.

To answer "another Dave's" query, I could only review the 3 month period ending on 3/15/19.  During this 3 month period, the 10 year US treasury yield dropped from 2.79% to 2.59% & TLT appreciated.  I compared TLT option selling versus FNBGX, the Fidelity index fund that's a good proxy for TLT because both invest in long term US Treasurys.  During this 3 month period, FNBGX went up modestly, 1.34% or 5.36% annualized.  Selling options against TLT fared better, up 2.73% or 10.93% annualized. 

By the way, the 10 year US Treasury yields only 1.80% today; TLT has gone through-the-roof since 3/15/19.  It's reasonable to say that if I had been selling TLT options since 3/15/19, my strategy would have done well, but hardly as well as buying & holding TLT. 

Option selling, in general, should beat 4 of the 5 outcomes above, losing only to through-the-roof.  But it doesn't prevent an investor from losing money!           

Lesson 1: selling puts to "buy low"

A couple weeks ago, Fedex Corp tanked dramatically.  Even though I prefer selling options against ETFs like DIA & SPY, I was tempted to look at FDX (Fedex) puts.  FDX is an economic bellweather & it dropped from about $174 to $148 on that September day.  FDX traded at $234 last December, & at $274 in January, 2018.  Puts on individual equities like FDX offer premiums that are much higher than ETFs' put premiums.  I didn't make the trade last month, but with FDX at $140.11 today, down $1.53 or 1.1%, it provides a good Lesson 1.  Here's FDX's put option chain at this time:

As a put seller, I want to position myself to buy FDX "low," rather than at the current $140.11.  I can sell the $140 put that expires on November 15, 2019 (November's 3rd Friday) & receive a $5.60 premium, the put option's BID price.  Each put contract controls 100 shares (100 X $5.60 = $560), but let's simplify the lesson by considering one share (& no commission).  Because I'm a seller of this put option, I must receive cash, the $5.60 premium.  (Of course, the buyer of this put must pay cash.)  The $5.60 hits my account on this put trade's settlement day, tomorrow.  It's non forfeitable, it's mine.  It collects interest, can be used to purchase other securities, can be withdrawn.  But it's not "free." In return for the $5.60 that I receive, I accept an obligation to buy FDX if it drops below the $140 strike price between now & the close of November 15, a 44 day period.  If FDX drops to $139, $130, $100, or even to $0, I'm obliged to buy FDX for exactly $140, the put's strike price.  But if I pay the $140 strike price for FDX, is not my real cost $140 - $5.60 = $134.40?  Buying FDX at $134.40 is buying it "low" relative to today's $140.11; more than 4% lower.  If FDX drops to $130 or $100 or $0, I'm hurting.  But not as much as if I had bought FDX outright today, at $140.11.  Now if FDX stays above $140 over the next 44 days, I will not be obliged to buy FDX & my put contract expires worthless.  My obligation to buy FDX at $140 ceases.  All I'd receive in this case is the $5.60 premium that I earned on trade day.  By the way, when I sell this put, to protect myself & my broker/dealer from a large FDX drop during the 44 days, I reserve $140 per share in my account's CORE position to finance the obligation of having to buy FDX at $140.  ($140 X 100 shares in a put contract = $14,000 on reserve.  This $14,000 earns interest in my money market fund, but the $14,000 can't be used otherwise.)  I'm selling a cash secured put in this Lesson 1 (not a naked put that requires margin availability).  If FDX stays above $140 (even if it goes back up to $274) by November 15's close, all I earn is $5.60.  If so, $5.60/$140 on reserve = 4.0% for 44 days; over 33% annualized.  To accept less risk, I can sell the $135 put & receive a $3.65 premium = 2.7% for 44 days; over 22% annualized.  With even less risk, the $130 put pays a $2.33 premium = 1.8% for 44 days, nearly 15% annualized.  What I like about selling puts (& calls), is that you can actually feel the risk, measure the risk, & then choose the strike price that satisfies your want & your tolerance.