Sell puts, then calls...to eliminate guesswork?

In my primer, Selling Options...Simply Called and Simply Put, I insist that my strategy eliminates the need for guesswork.  All I need to do is select an expiration - I use monthly options; & a strike price that's attractive to me - a strike price at which I don't mind a put or call assignment.  I.e., I'm amenable to being put-assigned to buy or call-assigned to sell at my strike price.  Of course, the premium that I receive for selling the put or call must be attractive compensation for my obligation to buy or sell the underlying.  I have no need to guess the future direction of the underlying's price (I even admit that I'm not good at doing so).

To measure my performance, since I only use monthly options against ETFs, I evaluate the month between option expiration Fridays.  I measure my option selling strategy versus a buy & hold strategy for the ETF.  I recognize 5 market outcomes:  

1. through the roof.
2. up modestly.
3. flat.
4. down modestly.
5. into the tank.

If the market for my ETF goes through the roof, my option selling strategy will do very well, but not as well as buy & hold.  If the market goes into the tank, I'll also lose, but not as much.  But if the ETF's market is flat, or up or down modestly, option selling is often a real winner. 

No need to guess?  I sell the put or call & often hope for 3 outcomes:  up or down modestly, or flat.  But if the underlying goes through-the-roof, even though I do very well, I am often disappointed to leave money on the table - to not get it all!  And if the underlying tanks, even though I lose less, I'm often disappointed about the loss! That's when, at times, I apply a repair strategy (a roll strategy).  It's my  sometimes-mistaken effort to out-guess the market. 

On 12/23/19, I began using XLE - the energy ETF - exclusively in my sell puts, then calls strategy.  Starting with $467K.  In almost all of the 19 months through 7/16/21, my option selling strategy's performance compared as expected versus a buy & hold performance vis-a-vis the 5 market outcomes above.  But my overall 19 month option selling strategy dismally under-performed buy & hold.  During this 19 month period, XLE dropped 13%, from $61.67 to $53.65 (including the $4.97 in divs).  My option selling strategy lost 18%, down to $382K!  I would have expected a single digit loss.

Although I had some successful repair strategies, I made 2 critical errors using them.  In March, 2020, I repaired my strike price from $32 to $26, when XLE was around $23.  I guessed that XLE would stay (COVID-) weak, but it moved to nearly $34.  In March, 2021, I repaired from $47 to $55, when XLE was around $53.  I guessed that XLE would remain strong, but it dropped to around $49.  

The March, 2020 error cost me $41K & the March, 2021 error cost $21K!  Without these mistakes, my 7/16/21 value would have been $444K, down only 5% & in line with my expectation.             

 

  

   

the great compromise

An investor asked about a "...favorite investment strategy..." & "...backtesting?" 

I sell puts, then calls in my IRA against ETFs.  Currently, I'm using XLE - the energy ETF - exclusively.  (I've used DIA, SPY, EEM, EFA & TLT.)  I'm reluctant to use individual equities because I still hear footsteps as a result of once highly respected companies like Enron, Tyco, SunMicrosystems crunching investors at this century's turn.  Even Apple was painfully in the single digits back then.  With ETFs, if I get put under lousy circumstances, as I did with XLE a few months ago, at least I own a diverse mutual fund.

Backtesting?  I compare my option selling performance to the buy & hold performance of the underlying ETF.  Versus the 5 buy & hold market outcomes below, my performance is as follows, which is actually how it must be when selling options:

1. Through-the-roof with buy & hold?...as I sell puts, then calls, I generally do well but underperform.
2. Up-modestly w/ buy & hold?...I generally outperform.
3. Flat?...I generally outperform.
4. Down-modestly?...Generally outperform.
5. Into-the-tank?...I generally outperform, while still getting beat up!

Here's a good example:

• On 7/21/20, XLE was at $38.38.  I sold the XLE 8/21/20 $42 covered calls & received a $0.53 premium.  XLE closed at $37.55 on 7/27/20, down $0.83 from July 21.  Of course my XLE shares were also at $37.55 on July 27's close - down the same 83 cents - but I have the 53 cent premium in my IRA's back pocket.  A hedge against the 83 cent loss.
• A bit later on the same July 21, XLE was at $38.22.  I sold the XLE 8/21/20 $38 put & received a $1.67 premium.  If this put were assigned at 7/27/20's close, I'd pay the $38 strike price for the then $37.55 XLE, a 45 cent principal loss.  But I'd have the $1.67 in my IRA's back pocket.  While an XLE buy & hold dropped 67 cents from $38.22 to $37.55, I'd have the $1.67 premium minus the 45 cents in principal loss.  Another hedge against an XLE loss.

For me, the most frustrating buy & hold outcome to compete with is when my XLE goes through-the-roof.  My sell puts, then calls strategy generally does very well then, but not as well as buy & hold.  The great compromise of option selling!