If you’re looking for opportunity in the aftermath of the “Brexit” pullback, you’ve come to the right place.
One question a lot of traders are likely pondering at this very moment is whether to take a directional position in a post-”Brexit” world or if a volatility-based approach might be more suitable for current market conditions.
Fortunately, a recent episode of Market Measures on the tastytrade network sought an answer to this very question.
On the show, the hosts present the results of a study that analyzed whether a straight long equities strategy outperformed a short put strategy over the last 11 years of trading.
This analysis incorporated the following parameters/assumptions:
Included 30 well-known stocks and associated options (data from 2005 to present)
Compared 2 separate model portfolios - each with $250,000 in starting capital
At the beginning of each month, Portfolio #1 bought 100 shares of each equity, while Portfolio #2 sold the 45 days-to-expiration ATM put in each equity (1 contract)
On the put's expiration date, both the stock in Portfolio #1 and the options in Portfolio #2 were closed out
While the results of the study showed that the two strategies produced similar returns, a deeper dive into the data suggests that the short put strategy may have done so with less risk.
The nuances of the findings that speak to this aspect of the results are highlighted in the graphic below:
As you can see from the above information, several important risk measurements indicated that the put strategy actually had less risk than the long stock strategy. And in case it confused you, the "Average Downside Buffer" category refers to the fact that the credit received from the short put allows for some downside movement in the stock prior to loss, whereas the stock position does not.
No matter the strategy you are using, the above information provides context on buying stocks versus selling puts over a long period of time even through extremely dynamic movement in equity markets (i.e. the Financial Crisis). And while the “Brexit” may be over, it’s possible that equities could be entering another period of heightened volatility.
However, if you look at the last couple years of trading in the S&P 500, you'll notice a fairly prominent range between 1850 and 2100. The S&P 500 closed June 2nd at 2105. After the referendum in Britain on June 23rd, the S&P 500 closed around 2037.
If equities pull back even further in the near-term, and you get more bullish due to lower prices, it may be worth weighing the respective benefits and drawbacks of the two strategies explored in the study detailed in this post. Depending on your strategy and ongoing view of risk in the market, one approach may fit your portfolio better than the other.
Either way, downward pressure in equities (if it does materialize) should equate to increased volatility - a situation that almost always unlocks additional opportunity for traders.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.