Buy a one-year index long call option, with the long position 5% In The Money (ITM). For example, if SPY were trading for $50 per share, open the long position at $47.5, with the end date 12 months in the future.
In the table below I’ve shown this strategy using the S&P500 option (SPY). A couple of notes are in order:
- SPY now has quarterly options extending out 2 years, so for SPY this strategy could be done on a quarterly basis. As of this writing QQQ only has one-year options expiring in January, so for QQQ this strategy could only be done on an annual basis.
- The table below is done on an annual basis, rather than a quarterly basis. For SPY the quarterly options weren’t available in the earlier years. In any event, keep in mind this table represents very few data points.
Options are only traded at discrete values, so usually it isn’t possible to trade an option with a strike price precisely 5% below the equity price. I selected the next strike price above the target price.
Here is the table, showing the return each year.
The ‘Return’ in the tables is the percentage of the underlying asset that was made as a profit or loss. Let me give two examples from the SPY table.
For 2006, if SPY were trading for $50 per share and a long call was opened on 200 shares (200 * $50 = $10,000), the profit would have been (7.70% * $10,000) = $770.
For 2008, if SPY were trading for $50 per share and a long call was opened on 200 shares (200 * $50 = $10,000), the loss would have been (13.16% * $10,000) = -$1316.
Note that in this strategy money is made by how much the index goes up (if at all). Thus, no profit is made unless the index closes up by at least the amount of premium paid. Maximum loss is when the market goes down by 5% or more.
The average premium over these 11 years was 11.55% (maximum 16.84%, minimum 9.61%). The average profit over these 11 years was 4.74% (maximum 24.41%, minimum -13.16%).
This is an analysis of past performance, but past performance is not a guarantee of future performance.
Comments / Questions: joseph AT StockMarketMovement.com