Wednesday, November 16, 2011

Cash Secured Puts

Cash secured put writing is a venerable strategy where an investor sells puts while simultaneously keeping enough cash for the duration of the put contracts to cover possible exercise. Note that although puts tend to be exercised upon expiration, there is a significant probability of early exercise. This strategy is typically considered a conservative strategy, in the realm of options strategies at least, because an investor will not have to fork over any additional money to cover margin calls so max loss is capped at the exercise value of the put minus premium from the put writing. Typically, this strategy is utilized when an investor expects the underlying instrument to stay largely flat (i.e., appreciate or depreciate no more than the premium generated from writing the put contract). With an options qualified brokerage account, an investor can easily execute his own cash secured put writing strategy. Some ETF managers (e.g., WisdomTree), however, have also introduced the strategy as executed on broad equity indices in the form of an ETF.

Seeing that this morning was a benign CPI day with no earth-moving news from Europe, I thought that it would be an interesting exercise to look at a volatility-selling options strategy. The strategy is a fairly conservative one, cash secured put writing. My sample is the 341 component subset of the S&P 500 with options activity today (i.e., there are bids and asks). I will be only looking at the nearest to the money strikes to the last traded price of the underlying. The puts expire in less than 3 days (Friday, 11/19/11) so there really is not much time premium left. The returns are computed as put premium (midpoint of the bid and ask) over the strike times the 100 multiplier (i.e., the amount of cash needed in case of assignment). The VIX today (the last time I looked) remains elevated over 30.

The above is a histogram of the cash secured put returns. The horizontal axis marks the returns (put premium/ (100*strike)) and the vertical the number of securities that have that return. The median, mean, and standard deviation for the returns are 0.000675, 0.00101, and 0.00111 respectively. The max is 0.01 for TSS.

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