This is similar to a diagonal put spread, but the long and short options have the same expiration date. E.g., buy a 3 month QQQ put that’s 5% out of the money, and sell a 3 month QQQ put that’s 1% in the money. This strategy tries to make money by collecting the put option premium.
I’ll give an example to clarify.
In March, buy a 3 month put on QQQ that’s 5% out of the money. At the same time, sell a 3 month put on QQQ that’s 1% in the money. Repeat this in June, September, and December.
In the table below I’ve given the return from implementing this strategy from 2006 – 2014.
The return column represents the return as a percentage of the underlying asset on a single transaction. I’ll give two examples of this.
Suppose that in 2010, QQQ was trading at $100 per share, and each quarter 1 3-month option was purchased (1 option = 100 shares = $10,000) and 1 3-month option was sold. The return for 2010 shown in the table is +3.5%, so this means the profit over the course of the year was 3.5% of $10,000 or $350.
Similarly, suppose that in 2008, QQQ was trading at $100 per share, and each quarter 1 3-month option was purchased and 1 3-month options was sold. The return for 2008 shown in the table is -6.3%, so this means the loss over the course of the year was 6.3% of $10,000 or -$630.
To compare this with the diagonal put spread, you need to multiply each entry in the table below by 3 (since the diagonal put spread, as described, has 3 transactions open at all times, whereas the put spread strategy described here has only 1 transaction open at a time).
With that out of the way, here is the table showing the return each year:
The average return was 2.4%, the highest was 9.0%, and the lowest was -6.3%.
The purpose of the long put in this strategy is to cap losses. You can see that in 2008 the long put in this strategy served that purpose, but there was still an annual loss.
This is an analysis of past performance, but past performance is not a guarantee of future performance.
Comments / Questions: joseph AT StockMarketMovement.com