For the MSCI Emerging Markets Index ETF (EEM), Volatility Has Meant a Winning Option Strategy
For Shares MSCI Emerging Markets Index ETF (EEM), Volatility Has Meant a Winning Option Strategy
Date Published: 2018-08-23
DisclaimerThe results here are provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation.
LEDEWhile the iShares MSCI Emerging Markets Index ETF, ticker EEM, has had a wild ride over the last five-years that has left investors long-term holders with nearly no gains and short-term investor with potential losses, a clever multi-legged option strategy has done exceedingly well due in large part to the volatility.
We can start with a 5-year stock chart of EEM, and we can see the massive ebbs and flows that have actually repeated over a long-term view:
It turns out that an underlying price volatility, even if it's abrupt marred by steep rises and declines, works quite well as a vehicle to trade in the option market. It has worked so sell in EEM, that we find a strategy that has had a 86% win rate over five-years and is up 227%, while the ETF itself is up just 25% in that same time period.
Building the Strategy Before We See the ResultsWe constructed a multi-leg strategy, but that is not code for complicated -- it has just a few steps. Here is the entire image, and then we will break it down, leg by leg.
Now, let's review each leg.
RulesThe first leg of this trade is simply a long, out of the money (40 delta) put. That's it.
* Buy a 40 delta monthly put.
The second leg of this trade sells two further out of the money (30 delta) puts.
* Sell two 30 delta monthly puts.
The third leg of this trade sells an even further out of the money (22 delta) put.
* Sell a 22 delta monthly put.
The fourth and final leg of this trade purchases two even yet further out of the money (15 delta) puts, leaving the entire strategy long 3 options and short 3 options -- the risk is well defined.
* Buy two 15 delta monthly puts.
What Does This Mean?This is casually called a ratio spread, and specifically this is a 1 x 2 x 1 x 2 (read out loud as "1 by 2 by 1 by 2") put spread.
The idea is to create an option position that:
* Creates a credit
* Has no upside risk
* Has some downside bias (if the stock goes down "a little" it profits at the maximum level)
* Covers the short positions with a final out of the money put purchase to limit total downside.
And here is how all of that looks in a profit and loss chart at expiration. We use The trade that was back-tested on Aug 26, 2013, and closed on Sep 27, 2013.
As we discussed, this trade opens with a long put at the 37.50 strike, then 2 short puts at the 37.00 strike, another short put at the 36.00 strike, and finally long 2 puts at the 35.00 strike. And this is how the profit-loss chart looks at expiration of this trade.
This strategy is profitable in the green shaded area, and shows a loss in the red shaded area.
To get your bearings:
* The maximum loss starts at the lowest strike price, in this case, $35. Any stock price there or lower showed a capped loss at its maximum.
* The maximum gain occurred right at the second-strike price (the first short strike price), in this case $37.
This strategy does well in a bull market but does best in a slightly bearish market. It does worst when there is a large stock drop, but that loss is capped.
Finally, The ResultsHere are the results of this strategy over the last five-years.
And finally, for completeness, over the last two-years:
This option strategy returned 162% over the last two-years, while EEM was up 21.8%.
What Happened?In volatile underlyings, the goal is to find option strategies that benefit from upward and downward moves, but also create a credit upon entry of the trade, so to avoid time decay.
How to Try This YourselfWe simply used the Trade Machine® Custom Strategy builder. You can create it yourself immediately as a Trade Machine member, by simply clicking on any of the back-test links above, then click the "edit" button, and save.
You can become an expert at strategy building by watching our video which can be accessed in the link directly below the custom strategy button.
What Do We haveWe now have a custom strategy, once used on the S&P 500, once on Amazon, and now on the Emerging Market ETF EEM.
In a few mouse clicks and about 30 seconds, we empirically identify a pattern that has repeatedly turned a profit over and over again, then displayed those results with no room for confusion or doubt. You can tap the link below to become your own option expert.
Tap Here, See for Yourself
You should read the Characteristics and Risks of Standardized Options.
Past performance is not an indication of future results.
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
Please note that the executions and other statistics in this article are hypothetical, and do not reflect the impact, if any, of certain market factors such as liquidity and slippage.