The Option Strategist Newsletter: 2016 Performance Review

By Lawrence G. McMillan

The past year was another good year for the performance of The Option Strategist Newsletter (TOS).  For the year, overall, TOS performance was a gain of 34.6%.  The largest area of profit were the futures put ratio spreads, followed by a superior performance from the put-call ratio recommendations.  SPY put ratio spreads also performed well, as did event-driven straddle buys.  The worst area of performance was the DSI-based recommendations (more about that later).

Note that these figures include all positions opened during the year of 2016.  Hence, some of the positions were still open at year-end, and thus the results may change somewhat when all of the realized gains are taken into account.

This follows a strong performance in 2015, as well.  As noted above, when we compile these statistics, we include open positions at the end of the year.  By the next year’s Performance Review, those positions have been closed out, and they are usually closed out at a slightly different profit or loss than was in the previous year’s report.  We bring this up now because at the end of 2015, we had reported the overall returns for that year to be 34.9%.

Click Here to view the complete 25 Year Track Record

However, last January started out with a severe market decline, and several positions that were open at year-end 2015 suffered – particularly the futures put-call ratio spread that was in place.  Hence, the official performance for 2015 (after all positions had been moved into the “realized” column) was a gain of 27.4%, which is still quite good – just not as good as last year’s report showed.  The Performance Summary Table (PS Table) follows the article, and is on pages 5 and 6. It reflects these changes for all the categories listed in 2015.

Hedged Strategies

These include all positions in which there is a hedge – a bullish side and a bearish side to the spread, for example.  This does not include simple bull and bear spreads, which fall into the speculative category.

There were 119 hedged positions recommended last year, which is about average.  Of that group, 73 made money (63%).  Once again, the high annual return of this category (66%) was due in large part to the very short holding period of the event-driven straddles (a matter of days) and the put ratio spreads (three weeks apiece). 

Futures Hedged Strategies

This year (2016), there was only one strategy in this category – the put ratio spreads.   There were no futures straddle buys, nor other strategies utilizing futures options. 

There were 17 put ratio spreads, and they were all profitable.  There was a large loss on a futures put ratio spread at the beginning of January 2016, but that spread was opened in 2015 and so its results are included with the 2015 results.

                        #  positions: 17
                       Profits: 17 (100%)
                       Avg. Invt.: $45,776
                      Avg pft/loss: $2,861
                      Avg holding period: 20.6 days
                     Avg annual: +110.8%

Note that the Average Investment is larger than it had been in past years.  That is because we have made two adjustments during the year to raise the amount of margin required for this strategy.  The first adjustment came in February after brokerages generally raised S&P futures margin requirements in the wake of the volatile market that was taking place at the time.  Later, in October, we started using the R. J. O’Brien margin requirement as the margin for these spreads – rather than SPAN or something lesser.  This “switch” increased the margin requirement a second time.

Equity Hedged Strategies 

In this category, we had three basic types of positions this year: 1) event-driven straddle buys prior to earnings (event-driven biotech straddle buys are in the speculative category), 2) cash-based naked put sales, and 3) event-driven straddle sales prior to earnings.

No other equity option strategies were recommended during 2016 – no straddle buys, no calendar spreads, no ratio spreads, etc.

Of the three strategies used, only the event-driven straddle buys made money.  3 of 4 cash-based naked put sales were profitable, but the fourth one (BTUUQ) overcame the other three, barely.  Event-driven straddles sales produced a small loss. 

In total, these three strategies had the following results:

                        #  positions: 66
                      Profits: 34 (54%)
                       Avg. Invt.: $2,880
                       Avg pft/loss: $31
                       Avg holding period: 6.6 days
                       Avg annual: +59.1%

We have traditionally not included the margin-based naked put writes in our overall results, and it’s hard to go back and change that now.  For 2016, the margin-based naked put writes  had these characteristics:

                        # position: 26
                       Profits: 22 (85%)
                       Avg Invt.: $5,129
                       Avg Pft/Loss: +$8
                       Avg annual: +2.9%

Index Hedged Strategies

This category included the SPY put ratio spreads, which performed very well – 17 profitable trades and no losing trades (similar to the futures put ratio spreads).

In addition any $VIX backspreads or $VIX straddle buys were included in this category (but not the $VIX/SPY put or call hedges).

Finally, the weekly SPY calendar spreads fall into the category as well.

                        #  positions: 20
                       Profits: 16 (80%)
                       Avg. Invt.: $48,645
                       Avg pft/loss: $423
                       Avg holding period: 38.8 days
                       Avg annual: +8.27%

The average investment is so high in this category because of the SPY put ratio spreads.  We allow 25% of the naked strike as collateral margin, and since the stock market has continued to rally, that “naked strike” keeps getting higher and higher – thus increasing the margin requirement.

The SPY calendar spreads showed a tiny loss for 2016 – the first loss since we started using this strategy.  Without delving into the results too deeply, it is likely that the extremely low volatility over the course of the year weighed heavily on this strategy, as the weekly combos that were sold just didn’t counter the weight of the occasional adverse market move.

The $VIX backspreads and straddles showed a small loss for the year.

SPY Calendar Spread Strategy

                        Year                Profit
                        2011                +$1,360
                       2012                +     640
                       2013                +     689
                       2014                +     430
                       2015*              +  5,031*
                       2016                –       92

*:position size was doubled, starting in 2015

Intermarket Spreads

A wide variety of strategies can theoretically fall into the category of “Intermarket Spreads.”  For 2016, through, there were only a few types of positions in this category.  By far, the great majority of them were the $VIX/SPY put hedges.  There were a couple of $VIX/SPY call hedges (when the market declined, which was rare), and one $VIX/SPY hedge using the underlyings.  In addition, there was one $VIX futures calendar spread, which was a large loss, and finally the Heating Oil – Gasoline spread which was an exceptional winner.

                         #  positions: 16
                       Profits: 6 (38%)
                       Avg. Invt.: $6,636
                       Avg pft/loss: $132
                       Avg holding period: 25.2 days
                       Avg annual: +28.9%

Once again, hedged strategies did very well overall, generating over $61,000 of profit, with 63% of all positions profitable. 

Speculative Positions

In contrast, speculative positions have not kept pace with hedged positions over the years.  While all positions involve a certain degree of speculation (even arbitrage to a small extent), what we include here are outright put or call buys without any offsetting hedge.  There are a few bull or bear spreads, but they aren’t really hedged either, for they only make money if the underlying moves in the desired direction.

We break these speculative positions up into two categories: those based solely on put-call ratio charts and those that aren’t.

Speculation Based Solely on Put-Call Ratios

Once again, put-call ratio recommendations involving stocks were very profitable.  This continues the trend that began last year, when we only used signals that were generated from extreme levels on their put-call ratio charts.  That has proved to be a very profitable adjustment to the strategy, from the way it was operated prior to that. 

2016 Put-call Ratio Based Trades

Category        Postns Wins(pct)       Pft/Loss

Equity             35           15 (43%)      +$14,357
Index                 1             0 (0%)               –240
Futures             7             2 (29%)             –624
Total               43           17 (39%)      +$13,493

Earlier, we referred to the fact that open positions at the end of one year can have a markedly different realized P&L when they are closed out during the ensuing year.  This factor was evident in put-call recommendations in stocks from 2015.  At year-end 2015, there was a profit of $4,134 in those positions, some of which were open positions.  By the time they were all closed out – in early 2016 – that profit had grown to $13,571. 

Speculation based on other criteria

As well as the put-call speculative recommendations have performed over the past two years, the other speculative recommendations – ones whose position number usually begins with “S” have performed poorly.

2016 Non Put-call Ratio Based Trades

Category                    Postns              Wins(pct)            Pft/Loss
Equity                         12                    6 (50%)               –$2,317
Futures                       19                       4 (21%)              –17,514
Index                           3                      2 (67%)                  +3,540
$SPX systs                  35                     15 (46%)              +65
Total                           69                    27 (40%)               –$16,226

The first category in the above table, “Equity,” consisted of a couple of takeover rumors and 10 biotech event-driven straddle buys.  The “Futures” row above was all DSI-based recommendations.  The “Index” row consisted only of what we call the Big (Volatility) Short – buying VXX puts – and it was profitable.  The final row “$SPX Systems,” is all of the various trading systems that we used this year based on $VIX or $SPX.

Clearly the big problem here is the DSI-based recommendations.  The past couple of years we have tried to combine the DSI signals with extreme weighted put-call ratio signals.  Those extreme signals worked well with individual stocks (see the description above), but it just doesn’t seem to work for DSI.  So, we are going to eliminate this type of trade, for it just hasn’t worked consistently enough.

25 Years Of History

The first row of the PS Table on the following pages shows the summary results for 25 years of recommendations.  The hedged recommendation have dominated, producing an annual gain of 14.4%.  Speculative trades over the years have lost a small amount of money. 

In individual profit categories, hedged futures recommendations are clearly the overall winner.  In the hedged categories, decent profits have been posted in covered writes (a category we have abandoned for naked puts), naked puts, and index selling strategies (put ratio spreads). 

Somewhat ironically, equity option hedged strategies have done very poorly over time (remember that the SPY put ratios are in the “index hedging” category).  Only the use of the event-driven straddle buys in the past couple of years has improved that performance.  “Regular” equity option straddle buys and calendar spreads lost a lot of money for several years, which is why we do not employ them any longer.

There are some overall winners in the speculative categories too.  The largest by far is put-call ratio recommendations on futures, even though that hasn’t been very profitable in the last two years.  There are also overall profits in speculative index trading and in “$SPX systems.” 

Summary

In summary, 2016 was again a strong year for hedged positions – especially futures hedged positions – as has been the case for many years.  This was a second strong year for speculative positions based on equity put-call ratios.  With the elimination of DSI-based futures speculative recommendations, we seem to have a good array of strategies that have been able to produce profits over the years.

Click Here to view the complete 25 Year Track Record

This article was published as part of The Option Strategist Newsletter on 2/17/2017. Receive immediate access to all articles by subscribing today.