As many of my readers know, my favorite option strategy is to sell out-of-the-money put credit spreads. The win rate is very high because we can make money even if the stock remains stagnant or even falls a modest amount. Furthermore, limiting the margin requirement by selling put spreads instead of naked puts substantially increases the trade’s rate of return.
Two academic studies–one from 2006 and a more recent one from 2012–back up my opinion regarding the superiority of the put-selling option strategy, concluding that while many option strategies lose money, put selling is one of the few option strategies that outperforms a buy-and-hold stock portfolio. The 2006 study states on pages 17 and 22-23:
In agreement with previously presented results and prior literature, many option portfolios have risk-adjusted performance worse than the benchmark portfolio. However, some option portfolios exhibit risk-adjusted performance which exceeds that of the benchmark stock-only portfolio. When three-month options are used, written put portfolios for all moneyness levels (OTM, ATM, ITM) generate high returns and exhibit positive abnormal performance.
Table 2 on page 27 of the 2006 study ranks option strategies in descending order of return and selling puts with fixed three-month or six-month expirations is the most profitable strategy. At fixed 12-month or longer expirations, buying call options is the most profitable, which makes sense since long-term call options benefit from unlimited upside and slow time decay.
This study supports my strategy of selling puts with 2-to-5 month expirations and buying LEAP call options with one year or longer expirations. Below is an excerpted reproduction of the study’s table 2 for options that have fixed three-month expirations during both 10-year and 22-year holding periods:
|
Option Strategy |
Annualized Return: 10-Year Holding Period |
Annualized Return: 22-Year Holding Period |
|
Sell ITM Puts |
11.1% |
13.4% |
|
Sell ATM Puts |
10.5% |
12.8% |
|
Sell OTM Puts |
9.3% |
11.5% |
|
Sell ATM Covered Call |
8.5% |
9.6% |
|
Sell OTM Covered Call |
7.8% |
10.5% |
|
Buy ITM Call |
7.7% |
10.0% |
|
Buy OTM Call |
7.1% |
10.1% |
|
Buy ITM Put |
4.5% |
8.1% |
|
Buy OTM Put |
0.7% |
5.6% |
I’m not surprised that selling puts is the most profitable options strategy, but I’m a bit surprised that selling in-the-money puts is the best strategy. This is probably because the study does not include the horribly bearish 2008-09 stock market period. If the study were updated today, I bet selling out-of-the-money puts would be the number one options strategy.
Learn more about options trading by checking out my free report, Learn Options Trading.
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