The document outlines a put writing strategy as an alternative to traditional equity allocation, explaining the basics of options, the goals of put selling, and the advantages of this strategy compared to covered calls. It highlights historical performance data showing that put writing can generate competitive returns with lower volatility and risks, particularly during market downturns. Key findings indicate that the strategy is effective in monetizing the volatility risk premium, offering a robust cushion against losses while collecting higher premiums in volatile markets.

1. Put Writing Strategy
“Alternative to Long Only EquityAllocation”

2. Put Writing (Selling) Strategy Overview:
 Option Basics
 Strategy Goals
 What is Put Selling?
 Covered Calls/ Buywrites
 Historical Data
 Volatility Risk Premium & Directional Skew
 Across Market Conditions
 Variations
 Summary

3. What is an Option?
Option Basics
An option is a contract that gives the purchaser the right, but
not the obligation to buy or sell an underlying asset for a
specified price, at or before a designated date.

4. Buying
Puts vs. Calls
Option Basics

5. Option Basics
Selling
Puts vs. Calls

6. Profits for selling options
Option Basics

7. Buying options at different strike
prices
Option Basics

8. Selling options at different strike
prices
Option Basics

9. Goals
 Many investors seek
strategies that generate
high current yields, low
volatility, and strong
returns in markets that
are flat or slightly rising.
There is a strong desire
to find equity-like
returns with less
volatility than long only
allocation to stocks.
Strategy Goals
 Put writing strategies and
covered call strategies offer
the ability to fulfill these goals.
However, it will be shown that
put writing is a more effective
strategy than a covered call.

10. Put Writing
What is put selling?
A put writing strategy
involves selling a put
option on a stock in
order to collect a
premium for agreeing to
buy shares at a specific
strike price should it drop
below that level by
expiration. Treasuries
are usually held as
collateral in amounts
equal to the maximum
possible losses.

11. Covered Calls/ Buywrites
Covered Calls/ Buywrites
 A covered call, also
know as a buywrite,
involves selling a call
option while also
buying the underlying
security for which the
option was written.
 Put writing is the
synthetic equivalent of
a buywrite.

12. Growth of One Dollar
Historical Data
 The Chicago Board of Exchange has
created several option strategy
benchmarks that give reasonable
representations of put selling and
buywrite strategies.
 The S&P 500 PutWrite Index (PUT)
invests cash at one- and three-month
Treasury Bill rates and sells a
sequence of one-month at-the-money
S&P 500 puts. The treasury bills act
as collateral in an amount equal to
the maximum possible losses from
the put sales.
 The S&P 500 BuyWrite Index (BXM)
sells at-the-money (ATM) S&P 500
Index calls with one month to
expiration against a long position in
the S&P.

13. Historical Data
Compound Annual
Returns
Standard Deviation

14. Return and Volatility
 Over the last 10 years, selling
ATM puts earned 3.4% in income
per month, totaling to 40%
annually.
 And over the same 10 years, the
strategy showed a volatility of 12%
as compared to the S&P volatility
of 18%. The selling of at-the-
money 1-month puts realized
annual returns of 7.1%, slightly
below the annualized return of
7.3% for the S&P.
 The PUT index had the best return
on volatility with a Sharpe Ratio
that exceeded not only the S&P
500 but also the BXM.
Historical Data

15. More Recent Historical Data
Historical Data

16. Volatility Risk Premium
Volatility Risk Premium
& Directional Skew
Writers of put options
effectively monetize the
volatility risk premium
(VRP) that leads to
systematically overpriced
options.
Volatility risk premium
results from the consistent
positive spread between
implied volatility and
realized volatility.

17. VRP & Directional Skew
Volatility Risk Premium
& Directional Skew
 The level of volatility
predicted regularly exceeds
the actual level of volatility
experienced.
 This higher predicted, or
implied, volatility adds to the
value of the option and
results in the calculation of an
option price greater than its
true value.

18. VRP & Directional Skew
Volatility Risk Premium
& Directional Skew
 In the prior ten years, the average one-month at-the-money volatility calculates to
20.1% while the actual realized volatility was 17.1%.
 This three point spread shows the overestimation for volatility due to option markets
pricing wider distribution of returns than is characteristically realized.
 Along with the excessive expectations of overall volatility, participants in the option
market have predicted greater probability of downward market moves than of upward
movements.
 This downside skew has typically been
overestimated, as the realized skew has
been less than what was expected.

19. Why VRP Exists?
Volatility Risk Premium
& Directional Skew
“One problem with buying equity puts
is that equity volatility tends to be very
expensive. Who is the natural seller
of equity puts? No one. Who is the
natural buyer of equity puts?
Everyone. The world is long equities,
and people like owning insurance, so
there is an excess of natural buyers
for equity puts. That is why equity
option prices are structurally
expensive.” – Colm O’Shea

20. Across Market
Conditions
The put selling strategy provides
steady returns in bullish market
environments and moderate
drawdowns in rapidly declining
market scenarios. Put selling
joined the S&P 500 66% of the
months the index finished up.
However, in down months, put
selling only saw 55% of the
downside of the S&P 500. During
up years of the S&P 500, put
selling lagged behind equities by
an average of 3.7%. In two recent
years that the S&P 500 was down,
the put selling strategy
outperformed the S&P 500 by 3%
and 14%.

21. Premiums Collected
Across Market Conditions
 The premiums collected on put writing vary with relation to the current market conditions. As
volatility increases, option prices increase as a result. This allows for put writers to collect
higher premiums on the puts they sell. And as a result, during the very volatile market
conditions of 2008, one-month at-the-money put writers were able to collect their highest
monthly premiums ever at 9.1%, as compared to the average monthly premium of 3.4%.
 Selling fully collateralized puts is less risky than buying equity outright. The reduction in
risk, as compared to outright stock purchases, is a result of the premium collection which
provides a cushion or buffer effect in the instance that share prices fall. This premium not
only reduces the maximum potential loss
that could be experienced, but also
provides a cushion from immediate
losses, as downside exposure to the
stock will not be incurred until the stock
price has already begun to fall.

22.  The cushioning effect against
losses increases alongside
increases of option premiums.
Therefore, as option
premiums and volatility
rapidly increased during the
financial collapse of 2008, so
did the related cushioning
effect. The expanded
cushioning effect, from the
collection of extremely high
annual premium of 62%, was
the main reason for put selling
outperforming the S&P 500
by 14% in 2008.
Historical Data

23. Strike Selection Variations
Variations
 One of the easiest aspects
to modify would be the
moneyness of the options
written.
 More risk-averse investors
would most likely desire to
sell puts that are far out of
the money.
 These writers would have a
lower likelihood of losses but
also collect lower premiums.
 The further the options are sold out-of-the-money,
the greater the Sharpe ratio and the greater the
reduction in annual returns.

24. Term Structure Variations
Variations
 Selling twelve-month puts instead of one-month puts allows for investors to
reduce annual transaction costs and operational costs.
 This method is not recommended though. Compared to selling 1-month puts, this
modification is less efficient at monetizing the VRP, collects lower premiums, and
has lower average returns and Sharpe ratio.
 In addition, there has been
a large decline in the
transaction costs for put
sellers as the bid-mid
spread has dropped from
14 bp to 6 bp. And thus,
this change results in more
efficiency for 1-month put
selling.

25. Term Structure: Anecdotal Reasoning
 “Often, the longer the duration of the option, the
lower the implied volatility, which makes
absolutely no sense….. Option-pricing models
assume that volatility increases with the square
root of time. This assumption may provide
reasonable approximations for shorter time
intervals, say one year or under, but if you have
a very low standard deviation, and you extend it
for a very long time, it doesn’t scale properly.
For example, if a one-year standard deviation is
5 percent, assuming that the nine-year standard
deviation will only be 15 percent is probably an
underestimate.” – Jamie Mai

26. Put Writing Summary
 Selling fully collateralized puts is less risky than buying
stocks.
 Put selling has similar returns to equities along with a
lower drawdown risk, which results in outperformance
during years of weak equity performance.
 Put selling has shown lower risk than buywrites when
both strategies focus on OTM options downside
directional skew that overestimates downward market
moves as compared to upward moves.
 Put writers are able to collect higher premiums as OTM
puts are overpriced compared to OTM calls.
Summary