Put selling is a popular investment strategy that has helped people make millions. It outperforms both equity and bonds in flat market environments and offers low volatility returns with a high current yield.
Put Selling Definition
Put selling refers to agreeing to sell a put option on a share in order to get a high premium for buying stocks at a fixed price in case it drops below that specific level by the expiration date.
It’s believed that short puts make up nearly 25 percent of mutual fund option positions. On the other hand, about 60 percent of positions are to buy, which offer a similar return/risk profile.
Why Put Selling Attracts Investors
Selling puts attracts investors as it is believed to offer higher yields at a lower risk than choosing to buy stocks. Let’s compare the two option based on figures collected over a period of ten years:
|Annualized Return||7.1 percent||7.3 percent|
|Standard Deviation||12 percent||18 percent|
For this period, the put selling Sharpe ratio was 1.3x the SPXTR. In simple words, put selling is less volatile while offering a higher current income.
We should also mention that put selling works well across all environments. While it’s more profitable in bullish environments, it remains moderate in downside scenarios.
Here are some numbers:
- When S&P 500 Was Up: On average, put selling on average failed equity by 3.7 percent and the Investment grade bond index by 5.14 percent.
- When S&P 500 Was Down: Put selling surpassed the S&P 500 Index by 3 percent in 2007 and by 14 percent in 2008, while underperforming the bond index by 8 percent in 2007 and by 20 percent in 2008.
|When S&P 500 Was Up||7.1 percent||7.3 percent|
|When S&P 500 Was Down||12 percent||18 percent|
It is best that you choose a stock that offers a high FCF yield as such shares typically improve results (no added volatility yet +250bps per year). This method tends to outperform other methodologies such as techniques based on market cap or implied volatility, as seen over the last ten years.
In addition to this, choosing stocks based on FCF yield can help investors reach a higher Sharpie ratio. According to reports, investors achieved a 1.35 Sharpie ratio for the last ten years by using this strategy. The figure is impressive and nearly 3x the SPXTR.
The report also found that selling 30-day options can be more profitable than selling 12-month options.
But Not Without Risks
While put selling can be beneficial it does have some risks. However, we must say that the general consensus seems to be wrong. It isn’t riskier than owning shares.
Selling fully-collateralized puts isn’t as risky as buying shares. The premium that you collect provides cushioning in case shares fall. ATM put selling proved to be a profitable venture in 2008 as it managed to outperform the SPXTR by nearly 14 percent.
It might be a good idea to consider this investment technique if you’re interested in making good returns.