What is The Best Way To Short Options?

Using PUT and BXM to gauge the performance of options-shorting strategies

May 14, 2015 at 9:04 AM
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If there's one thing that defines 2015 so far, it's that at the end of the day/week/month, nothing much tends to happen. Like the prices on the board better last week? Not to worry, you'll probably see them again next week. And so on. Churn, churn, churn.


So, it sure seems like good times for option-shorting strategies. The Chicago Board Options Exchange (CBOE) indexes several, including the CBOE S&P 500 PutWrite Index (PUT):


"On Friday, May 8, the CBOE S&P 500 PutWrite Index (PUTSM) closed at 1501.08, its highest all-time daily close and the first time the index closed above 1500. PUT is an award-winning benchmark index that measures the performance of a hypothetical portfolio that sells S&P 500® Index (SPX) put options against collateralized cash reserves held in a money market account."


That, of course, makes some sense. Over time, a strategy that mimics PUT does quite well. But here's what's a bit odd: It hasn't done terrific in 2015, at least on a relative basis. Here's PUT vs. the SPDR S&P 500 ETF Trust (SPY) for this year:


Chart courtesy of TDAmeritrade thinkorswim

It's about 100 bps better than SPY, which is nice, but it's literally only accomplished that in the last couple days. It actually modestly trails another very similar CBOE index: CBOE S&P 500 BuyWrite Index (BXM). PUT indexes rolled put sales, whereas BXM indexes rolled buy-writes. They sound like they should track almost identically -- and they do -- but BXM has outperformed a bit all year.

Chart courtesy of TDAmeritrade thinkorswim

It's important to remember that these are indexes, not funds. So, why would the theoretical buy-write outperform an identical put sale? It really shouldn't; they should be essentially equal, if it's the same strike. And selling puts might tie up less capital. But what if I told you there was an even better way to take advantage of the range in 2015 than either of these?

Remember our friend the VelocityShares Daily Inverse VIX Short-Term ETN (XIV)? It's the inverse of the iPath S&P 500 VIX Short-Term Futures ETN (VXX). It's not identical to selling puts, but it should behave in a similar fashion. The contango drift in VXX mimics the time decay of a regular option. Here's XIV vs. PUT in 2015:

Chart courtesy of TDAmeritrade thinkorswim

Now THAT'S outperformance. Of course, you can't get that without risk. Volatility has declined across the board this year in a big way. That's mostly thanks to the pop at the end of 2014, and the pleasures of arbitrary endpoints. If we get a vol pop, XIV might wildly underperform SPY and PUT and BXM in shorter time frames. All of which highlights an oddity of the strategies highlighted by PUT and BXM: Options-writing strategies reduce the volatility of returns!


Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.



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