No Mas Puts
Vol #152 : October 26, 2023
Certain trades stick.
Losers will grate at you with missed opportunities or disastrously evident ex-post naïveté. Fortunately we do remember some of the winners, because without them there’d be no carrot to come back towards.
While much of the pandemic was a masked fog (I also had a newborn) there were two equity and one options no-trade that persist vividly from the period. Both stock trades were long term buys that were mostly remarkable for their dumb luck. I’m glad my best trade ever was for a 529 account (for multiple reasons).
Being on paternity leave I didn’t have much time for active options trading, but I did continue to execute a wheel strategy for my personal account. In preparation to take the big jump and launch my own firm, I was getting my hands dirty with the mechanics of the various different strategies from a retail perspective.
To scratch at mid-career ennui, I built a clunky back tester that simulated this aggressive long delta strategy. The first step of the wheel trade is to find a stock you want to own, and sell out of the money puts. If stock goes up you collect the premium, and if stock goes down you buy at the strike price. Once you own the stock, you sell calls against it until it rises through your call strike, you’re back to flat, and the wheel turns over.
The wheel works because stocks go up. It’s a short premium trade, but that’s not where you make the money. The theta isn’t income, it's a risk premium for being short tails. You get paid on the short put because you’re promising to buy at a fixed level even if stock is trading below that. Same thing on the upside sale, you’re letting go at the strike no matter what the prevailing market is. Options income is foregone potential energy.
After a Christmas crash in 2018, for the next year SPY was listlessly drifting upwards like a dandy at pre-war Brideshead. Wilting tails. There were a few dips to be assigned on, but nothing you couldn’t quickly trade out of. My data had included 2008 and even some of the cracks in the past decade showed relatively quick position accumulation on the downside. I thought I knew max pain.
February got dicey and then March got crazy. I remember running one of the few errands allowed - standing in a wine storage unit - and staring at Trader Workstation on my phone. Can I really sell another put? The system was right, and the answer is shoulda coulda woulda.
I was confident in my data, I had the capital reserves to justify the trade, and all the signals were saying the March 2020 puts were corpulent. But no quantity of backtests or signals can account for what goes on in your brain when someone’s telling you to wipe your groceries down with Clorox wipes. I overrode the system and tapered back my aggression. No Mas.
It’s far from rational, but my objectives changed. My risk profile for a trading account was rapidly diminishing as the world became infectious disease experts.
An options strategy could give step by step instructions for the path to El Dorado, but you have to trudge through the jungle in an N95 and continue to raise the stakes. Did I maximize my opportunity? Hardly. But it was absolutely the right decision not to sell even more vol.
I highlight this extreme because no system can be relied on to just spit out answers. Even if it did you couldn’t handle it. Trading isn’t about knowing what stocks to buy, or whether a put is cheap or expensive. No one and nothing can tell you what to do, because at the end of the day you’re the only one that has to live that experience and decide that the market pricing of something is appropriately dislocated from your own risk/reward.
While I didn’t flip to be a put buyer, I could appreciate the reasons people were paying triple the prior month’s rate for downside protection. The fact that everyone had a different opinion about what was going to happen is what makes a market. To this day there are just as many reasons to have bought those puts as to have sold them, independent of the eventual outcome.
An important part of executing a trading strategy is just showing up. If you’re going to trade, you not only need to have a thesis and some form of expected edge, you actually have to do it. If your scenario analysis rolls weekly, the implementation should too. There’s no days off for arbitrary stochastic variables that don’t care whether you're vaxxed or not. Consistency alone is difficult.
While not every week is the first wave of COVID, in the face of randomness it is critical to remain even keeled. If the strategy is backtest inspired, you can’t get fazed by inevitable down weeks; but you can try to objectively decide if this is process or outcomes.
When you’re making subjective trading decisions, there’s no such thing as a pure signal that says “do this.” . The market is smart, and only once you understand why something is curiously priced can you decide if that’s a good trading decision for you. With trillions of dollars sloshing around amongst hyper competitive entities how could there possibly be a simple answer that feels good?
That’s not to say there aren’t boundless opportunities in the markets. The catch is that markets don’t present opportunities objectively, you have to parse the ones that are appropriate to your objectives, tolerances, and strategy.
The reason the generic and often best financial advice is to consistently buy low cost diversified index funds and hold on to them is because that puts the simplest edge - time - on anyone’s side. As your horizon gets any shorter than a long time, success becomes subjective fast, and results may vary.
When $SNAP is trading at $9.78 going into earnings, and the $7.50 put is trading at $0.10 with three days to go, that’s going to pop up on any screener as one of the most expensive options out there. It’s roughly a 250% implied volatility, and the strike sits outside the beefy $1.95 straddle range. That market by the way is a penny wide and several hundred contracts up, so we’re not talking about a blind limit order that got stuck.
If your trading strategy is short duration premium collection, this starts to look interesting. Given the proper rule framework, and a diversified basket of opportunities, selling cash secured puts can have a desirable return profile. Earnings puts are even more expensive. Your chosen delta and target premiums will dictate how choppy the results are, but interesting strategies can be created at all terms and strikes. (I did a dive into the new QQQY put selling ETF here, and how even in down markets can be profitable due to the high delta options they sell.)
That SNAP put is “expensive” from an objective standpoint, but it’s trading at that level for a reason. Given how little SNAP moved it would have been a great sale, but there are also plenty of people for whom that would be a great buy. If I’d been a product manager at SNAP for a few years and was sitting on some vested or unvested shares, covering my downside for a dime (via a collar or outright put) might be very desirable. It touched there in May.
Without context, options prices are nothing more than the supply and demand for risk and volatility exposure. They’re only high or low in retrospect. And good or bad depending on what else is going on. Open interest demands that one man’s buy is another one’s sell.
Learning to trade is a constant process of understanding yourself against the market. Not just your ticks and proclivities, but where you can extract short, medium, or long term edge from the market. The setup is David vs. Goliath in nearly every dimension - even for Goliath and he captures the overwhelming majority of alpha. But David doesn’t win by chasing alpha, he wins by finding something that captures when the market is mispricing his individual goals. Even if they change and you have to accept passing on the fattest sale of the decade is a good no-trade.