Have you noticed more buzz online about selling put options lately?

Simply put, this strategy is said to let you profit when markets rise or stay stable.

If that’s the case, using it in historically bullish markets (like stock indices) should be a surefire win, right?

But is it really that easy? In this video, we show some backtests on the S&P 500 to see just how effective and reliable selling put options really is.

The first test results are incredibly promising, but there’s a crucial insight you need to know if you’re serious about protecting your capital.

Intrigued? Watch the video now! You'll learn:
-What options are and what it means to sell put options
-Why most investors choose to buy these options instead of selling them
-The real implications of selling put options (and why you should be very cautious)

Enjoy the video!

Transcription

Introduction

Is selling options profitable? Is it worth it? Or is it just another market approach like many others?

Hello, one of the coaches at Unger Academy here, and today, I want to discuss a hot topic that is increasingly capturing the interest of retail investors.

We're talking about short selling options.

What Does Selling Options Mean?

Quickly, in less than 30 seconds, let's broadly outline what it means to sell an option.

You're simply selling the right for someone to buy an asset from us or to sell us an asset at a certain price by a specific date. That's it.

Of course, this definition misses many details, but the core idea is there.

Let's quickly illustrate this with a numerical example.

Here we're talking about a Short Put, meaning we're selling the right to sell us something, essentially.

To sell us something at what price? At price X.

Here we see the x-axis, representing the price of the underlying asset.

If we sell someone the right to sell us this asset at this price, we should collect some money for this.

Because if the price drops below this threshold, whoever holds this right will sell us the asset at a higher price than the current market price.

If instead the market price rises, we collect the premium, like an insurance policy.

Practical Application of the Strategy

Let's draw the payoff graph, which shows my actual profit or loss.

We see that if the price of the underlying asset rises or stays more or less the same, I make a profit.

If the price falls, then I start to lose.

So, the big question is: where could I apply this type of strategy?

On something like a stock index, like the American one, for example, which has generally risen over the last 20-30 years, or even more.

So this strategy profits if the underlying asset rises or stays flat or falls just a little.

Therefore, this approach generally seems to be very advantageous on something that always rises.

But, as you know, at Unger Academy, we like to backtest, to see what a certain operation would have entailed in the past.

Backtesting the Strategy on the S&P 500

In this case, we’ll see what’d have happened if we sold put options on the S&P 500 index, the largest American index and the largest index in the world.

And consequently, the one with the most products like options available to investors, including retail.

To do this, we used software. Here in front of us, already revealed in the first slide I showed you, are the results of this operation from the beginning of 2021 to today.

So it's almost three and a half years of backtesting.

Impact of the 2022 Crash

I chose this period specifically because in 2022, as some of you might know, the market fell significantly.

In January 2022, the S&P 500 index was at 4790. By October 2022, it was at 3529.

We are talking about a loss much greater than 20%. About 25%.

Performance During Bear Markets

It doesn't matter because what we are interested in is understanding how this strategy reacts to a market collapse.

In the face of a 25% drop in the index, as you can see, our strategy, which should lose as the market falls, continued to perform quite well.

Of course, not as well as when the market is strongly bullish, but if we look at the period from January 2022 to December 2022, it just kept hitting new peaks, staying more or less in line with the equity and thus with the tracking of the strategy's results.

Strategy Risks: The Black Swan

So it seems to be a very good strategy, and I assure you, it is, the numbers prove it. Because if I did this systematically, regardless of the period, wars or no wars... In short, if we took and applied this strategy, we would earn quite a bit.

So you might say: Why make a video? Why doesn't everyone do it? What's really behind this approach?

Simply put, in one word, risk. Nothing is free.

Because yes, it's true that in the face of a falling market, we can still bring home profits more or less turbulently.

But what should scare us about this strategy is what's called a "black swan," an entirely adverse and possibly sudden event that drastically alters market behavior.

The last example that comes to mind is COVID.

The COVID period starts from late February 2020 and ends around April.

I'm talking about the market shock period, where we saw, for example, the S&P 500 make a sharp drop, which was quickly absorbed over the course of 2020.

And how would this strategy have behaved? Let's see it, so let's backtest the same approach starting from a date before 2020, and we get this scenario here.

COVID and Other Crisis Examples

The scenario shows exactly what I showed you from 2021 onwards, but as you can see, in periods like COVID or the end of 2018, this strategy has problems, mainly related to exposure to this type of risk.

We are exposing our capital to the risk of a black swan.

Here we see 2020, I don't have data that goes further back, but I assure you that periods like the Dot Com crisis in the early 2000s or the housing crisis in 2008 would have caused much worse damages than what we saw here during COVID.

So this strategy certainly makes money, is certainly profitable and good because I start at the bottom left with profits and end at the top right, but there's a very high risk of losing everything.

Real Risk Considerations of the Strategy

Here, you see, we even went negative, not by a little.

And if it's true that we recovered immediately because the market rebounded, it's also true that in the face of such an operation that requires margins,

it's realistic to imagine that our broker will "liquidate our positions," meaning they will close our positions before we become insolvent in the market, so we can no longer cover the losses.

This is true because the losses on these products can be extremely high, as high as the leverage we use with these instruments.

Market history, as we see here in numbers, can also tell us about actual events involving investment funds that based their approach on this type of strategy.

One in particular I can mention is OptionSeller.com, which went bankrupt in 2018, during this drop we see here.

I remember there's a video on YouTube, if you want to check it out, where James Cordier, the former manager of this fund, talks to his investors saying that the account is gone.

So all the money that was there, all the gains accumulated, disappeared in a matter of weeks.

That said, I absolutely do not want to demonize selling Put options, far from it, because as we've seen, it can be a profitable approach, but only if managed correctly.

So it's essential to pay attention to the risks and adopt a very rigorous risk management strategy.

And what might this management involve? It might involve hedges that generally reduce the yield but guarantee protection, insurance against such events.

Also because, I'll tell you the truth, most investors buy puts.

Most investors in the stock market buy puts precisely to avoid finding themselves in such situations.

So it's a bit like we're going against the market, because remember, if we're selling something, it's because someone wants to buy it from us.

So just as I can speculate and sell a product because I think selling this insurance I can get rich, I must still be aware that on the other side, my counterpart is someone who wants to insure themselves against such events.

Practical Tips for Trading Options

In conclusion, some practical tips for managing this kind of thing: educate yourself on options and markets, be aware of what you're doing.

Carefully assess the risk and establish a risk management action plan.

Diversify your portfolio to reduce exposure, don't just focus on the stock market, as we saw with this example.

Consider hedging strategies to protect yourself from black swans.

And keep in mind that events like COVID, 2018, 2008, and 2021 can happen tomorrow.

This doesn't mean living in a depressed manner because the market will eventually fall, the market will have a storm, there will be a black swan tomorrow, etc.

But it does mean you need to be aware of the potential for these events.

So please, pay attention and verify what has happened in the past.

At Unger Academy, we deal with trading, mainly on futures but also options.

And if you want to know more, check out the link in the description. From there you can get access to many interesting resources.

You can get our best-selling book "The Unger Method", by covering only the shipping costs. Or sign up for a free presentation, just to understand what we talk about within Unger Academy, or you can even book a free strategic consultation with one of our tutors.

That said, thank you so much for following me this far. It was a very short video, but I hope I made you understand the risks associated with this operation and the potential profits.

We'll see you soon with new ideas and tips in the world of systematic trading. Bye for now and see you very soon!

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