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Debit Spread Options Strategy vs. Leveraged ETF - YouTube
Channel: Stock Market Options Trading
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you're listening to the stock market
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options trading podcast a podcast
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helping retail traders like yourself get
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better results if you enjoy listening to
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cutting-edge options research and
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trading strategies that help you make
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consistent gains in the stock market be
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sure to subscribe now so you don't miss
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an episode
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now here's your host Jay Eric O'Rourke
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welcome back to the stock market options
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trading podcast my name is Eric and I've
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got a really cool case study for you
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guys today we're gonna be looking at a
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long only strategy trading the sp500 and
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we're gonna talk about the strategy here
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in a minute but basically what I did was
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I took you know for the past five years
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I took all the entry and exit signals
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for this strategy and on one side I
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back-tested buying and at-the-money
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called Deba spread so this is a long
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only strategy we're looking to get long
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and as you guys know there's different
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ways to get long so one way we're
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getting long for this study is buying a
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call debit spread it's also known as a
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bull call spread and then I took the
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same entry and exit signals that were
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applied to the sp500 and instead of
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buying the call spread I bought SSO
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which is a two times leveraged ETF of
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the S&P 500 so the short way to think
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about that is if the s py moves up 1%
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sso would move up almost 2% so it's it's
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it's always you know there's always a
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little bit of a give there but it's a 2
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times leveraged etfs P 500 so 2 ways
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we're gonna be getting long so the idea
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here is to compare the two strategies as
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it relates to the amount of capital you
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would need to trade the strategy and
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also just the profits and kind of talk a
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little bit about all the losses so I
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really want you to kind of understand
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how it feels to trade one of these
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strategies and the underlying theme here
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is trading with leverage right so you've
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probably read plenty of options and
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stock books and with the base idea that
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you know options give you leverage so
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that you can use less money to get
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similar exposure to buying a particular
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stock or ETF or something in general
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like if you buy a call option with a
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delta 50 you're getting exposure of a
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similar you're getting a similar risk
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exposure of buying 50 shares of that
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particular stock so a lot of times this
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is a lot cheaper and that's the general
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idea is you know you can use options for
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leverage but there's also leveraged ETFs
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such as SSO and there's there's other
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ones for various ETFs so that's what we
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wanted to kind of compare is comparing
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two different leveraged methods of
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getting long and as opposed to just you
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know comparing buying a call option
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versus buying the stock you guys
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probably read about that already so
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we're gonna be comparing a leveraged
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ETFs buying the shares no options and
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and you know using a bull call spread to
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get long the S&P 500 which is leverage
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and its own right and you'll you know
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this will make sense as we get into the
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numbers of the strategy so before we get
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into the the case study though you need
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to know that everything in this episode
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and on this podcast is for informational
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purposes only and that I Eric am NOT a
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financial advisor of any kind I don't
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hold any registrations I'm just an
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independent guy who likes to do homework
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and also in case you didn't know trading
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options can be risky and you should
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really do your own due diligence when it
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comes to managing your own money it's
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your money and responsibility I am just
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providing information that I've come
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across in my research and studies as
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sort of a convenience to you guys but I
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would definitely recommend doing your
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own due diligence before you apply money
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to any particular strategy so alright
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let's get started so the strategy we're
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using before we get to the actual trades
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we're using a study based on a
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quantitative
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trend following strategy called pure
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alpha this is something that I developed
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or at least sort of put a lot of
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homework into and in the last podcast
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episode I explained the strategy a
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little bit
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talked about the crisis alpha trading
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you vxy i definitely recommend you go
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back and listen to that one if you
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haven't listened to already we're gonna
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go to the basics here so that's I think
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that's episode three called crisis alpha
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for Black Swan events so give it give
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that one a listen when you get a chance
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the general strategy is this though
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we're looking at a long only strategy no
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short trades for right now we're we're
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looking at a weekly chart and us in a
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certain moving average and if the moving
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average is sloping up that gives you
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sort of a bullish signal or bullish sign
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that the stocks in you know an
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uptrending state and we'll be looking at
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the daily chart for entries and exits in
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the daily chart the entries and exits
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are based on the slope of the moving
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average when the slope of that same
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moving average slopes up that would be
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an entry and when the slope starts to
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turn down that would be an exit it's
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very smoothing we're using a whole
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moving average go back and listen to
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that episode when you get a chance but
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I'm also gonna put some links in the
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description of the podcast I don't know
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if you're listening to this on YouTube
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or Spotify or Apple I'm gonna put a
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description links in the description if
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you want to learn more about that
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strategy and get really get into the
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video training and all that
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definitely check the description for
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those links but it's pretty simple it
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does a great job of getting you in and
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out of the market and it really avoids
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large draw downs which is one benefit of
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the strategy so what I did was I ran the
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strategy back test on SSO that's the the
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two times bull ETF of the SP y and again
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basically if the SP y is up 1% the de
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SSO is gonna be up you know close to 2%
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the opposite is true - if the SP y is
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down 2% we've seen a lot of crazy down
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days recently sso would be down close to
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4% so it's twice the bull it's also
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twice the bear if it goes down right so
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you it's you're trading with a leverage
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right so the period of time we're
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looking at for this study on SSO is from
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March about March 2015 through mid March
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or the end of March of 2020 so it's
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pretty recent and just trading SSO with
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the pure alpha strategy
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made about 96% in that in those five
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years just taking buy signals to the
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long side and when things get really
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ugly you're not in because the weekly
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chart goes down so as trading SSO itself
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made about 96% on the amount of capital
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you you put in and out of that trade so
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just kind of as a reference during this
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period
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spwhy was only up about 29% the past
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five years and this is also kind of
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factoring in the recent corona crash so
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you know we're already seeing that
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trading a leveraged product and a
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tactical manner in this tape in this
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case it's a quantitative trend following
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strategy
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you can't outperform the market just
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trading SSO are at least in this five
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year period by a factor of three or so
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so the leverage is working let's go
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ahead and keep Trey keep going talk
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about the strategy during this five year
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period there was about 89 trades and the
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win rate was about 57% the winning
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trades were about 11 days long and the
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losing trades were about four days long
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so that's just a little kind of little
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information about you know how that
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strategy worked the duration and all
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that stuff again there's only a 57% win
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rate but you know as we know win rate
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doesn't mean all that much it's really
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how much you're making and this strategy
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did pretty well with SSO on its own
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again almost doubling your money over
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the past five years when the SP is only
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up about a third right or 30% so let's
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talk about dollar amounts real quick
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just as a reference for this study I
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allocated three thousand dollars per
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trade for SSO and that basically came
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out to profits about 2,900 we're and you
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know we're choosing 3,000 dollars of
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trade it's just as an arbitrary number
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but it'll were late here in a minute
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when we talk about the debit spreads but
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basically had you allocated 3,000 per
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trade trading the strategy you would
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have netted just under 2900 so again
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it's about a ninety six ninety seven
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percent gain on your money over the past
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five years just trading SSO and we're
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not including any Commission's there's
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no compounding of the trades were simply
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buying three thousand dollars worth of
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SSO however many shares that is for the
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entry and then we would
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and then the next trade we would adjust
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our number of shares so that we're
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trading $3,000 per share okay so let's
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talk about the debit spread for a minute
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first I want to talk about why I chose
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SP X for the study so I chose to use SP
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X for the debit spreads because mainly
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they are a european-style
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options expiration and what that means
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is there's no risk of early assignment
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and that's gonna matter when we're
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trading debit spreads called debit
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spreads because ultimately you're gonna
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be buying a call option and then selling
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a call option and when you have a sold
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call option that's potentially in the
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money near expiration there is a risk of
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early assignment with american-style
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options but since most of the indexes
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are european-style this applies to SP x
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rut in DX e OE X some of the other
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indexes this kind of plays into why we
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want to trade indexes for this or at
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least european-style options so they're
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not risk of the early assignment in case
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that call spread goes in the money which
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is actually what you want so for the SP
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x call debit spread we're gonna be
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trading at the money debit spread and
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the way that I put this into the back
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test was I basically went back I did
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these manually by the way I bought one
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call option that's in the money one one
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strike in the money so for a call option
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to be in the money the call option
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strike is slightly below price and to
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reduce the cost of the option I sold a
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one strike out of the money call option
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so we're right at the money we're
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looking at like Delta you know Delta 51
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Delta 40 a kind of spread there and
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we're buying one option call option and
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selling a second call option to reduce
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the cost and that was the setup for the
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debit spread so I went back during the 5
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years and I bought a debit spread we
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using 14 days to expiration and the
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reason why I'm using 14 days expiration
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for this example is because the average
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long trade was 11 days so remember you
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know real quick there the the strategy
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we're testing against we're
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using a technical entry and a technical
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exit so we're there's no profit target
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there's no stop-loss it's just when the
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market goes up you're gonna buy and when
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it starts to turn back over we're going
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to sell so it's a technical entry and a
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technical exit so I wanted to give our
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options enough time to cover what that
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average trade was so since the average
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duration of the trade for winning trades
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was 11 days and the average loser was 4
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days I chose to do a 14 day to
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expiration spread so that if the if it
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did go 11 days or 12 days then you could
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see max gain on that on that debit
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spread and obviously if it goes against
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you you'll be out in 4 days and you can
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exit the trade so again we're using the
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same entry and exit signal that we used
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on SSO so there's still the same number
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of trades the same durations but instead
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of buying SS so we're buying and
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at-the-money SPX debit spread with 14
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days to expiration and because the
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option that we're selling the call
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option is just out of the money if this
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trade works out and the market continues
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to move up both of those options are
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gonna be in the money which is what you
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want for a debit spread for a debit
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spread to reach max profit both strikes
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have to be in the money and if you're in
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that last week of trading and you have a
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sold call option you have that risk of
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early assignment so this is why again
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just to kind of reiterate the point this
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is why we're doing this on SP X and not
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SP y for example so real quick
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here's where it kind of gets interesting
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I'm just gonna ask you I know you're not
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gonna answer because you're on a podcast
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but how much do you think one of these
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debit spreads cost so I was looking
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through all the entries and on average
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these SPX debit spreads you know just
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single strike right at the money is
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around $3 a spread or $300 and you know
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I've seen some of them were to 80 to 75
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and a couple or were like 310 320 but
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for the most part over the five years
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that debit spread is about $300 for one
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one spread and the interesting part here
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is that
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member you know it with the SSO example
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we were putting $3,000 per trade well in
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this example with the SPX debits bread
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we're putting $300 per trade so we're
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spending tenth of the amount less did I
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say that right we're spending you know
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10 times the money for SSO than we are
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with xpx so this is a great you know
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this is a great reason why people trade
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these things because it's less capital
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especially have a small account most of
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you are gonna be able to spend $300 a
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trade and but maybe not be you know
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willing to put 3,000 a trade or more but
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with that $300 a trade and averaging
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that debits bread over the five years
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this strategy made $3500 just over
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$3,500 and again the the the win rate
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was pretty close it actually had a
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little bit better win rate and that's
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because you have a sold strike option in
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that trade and there's there was a
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couple examples where the market didn't
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do anything but the strategy actually
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you know you got a little bit better win
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rate because even though the it moved
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against you a little bit you could still
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profit so it's close enough I mean that
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the the SSO I think was a 57% win rate
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and the debit spread was a 60% win rate
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so one or two more winners which
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probably means the losers were small on
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that but anyway just wanted to throw
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some context around that again $300 per
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trade it netted just over 3500 dollars
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in profits trading one spread at a time
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so from a from a capital efficiency
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standpoint it really blew sso out of the
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water in terms of profits and all that
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stuff so so just to repeat compare those
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SS so we use 3,000 per trade we made
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about $2,900
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but trading a single SPX debit spread
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which is about 300 dollars per trade you
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actually made over 3500 dollars using
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less capital so you know the takeaway
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here is that debit spreads and this is
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what they're meant to do right debit
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spreads help reduce costs and increase
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profits compared to simply buying a
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stock or ETF doesn't mean you can't
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trade SSO if you can't trade
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options for example in a certain account
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or retirement account or something maybe
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they they don't let you do spreads you
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can still do an L leverage ETF but I
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just wanted to put some some you know
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comparison here about debit spreads
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versus a leveraged ETF because I know in
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the past most of the books will talk
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about debit spreads and or call options
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or whatever with just a regular stock
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right so the capital efficiency of the
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debit spread there's definitely a
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benefit here and I hope this study kind
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of highlighted that there's a couple
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things that we did not discuss yet and I
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think it's really important to point
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this out so we've talked about raw
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dollar amounts but we we didn't talk
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about percentage terms so for example
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with a debit spread a losing trade if
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the market you wake up the next day and
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the market tanks that three hundred
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dollars can easily lose 150 or 200
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dollars so from a percentage standpoint
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a loss on the debit spread will be a
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much higher percentage like a 50 percent
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loss 70 percent loss but you're only
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putting out three hundred dollars so
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that's a bigger loss percentage-wise for
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that smaller amount of capital so I
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wanted to kind of throw that out there
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for SS so like the average loss
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percentage-wise
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was much less from a percentage
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standpoint with that $3,000 that we
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allocated and the typically that loss
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I've seen is somewhere between one and
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five percent so you're putting more
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money out but the the volatility if you
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will the drawdown if you want to call it
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that that's not the right word here but
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you're not gonna have a fifty percent
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loss or at least in this back this
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period you're not gonna have the same
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percentage loss as you would the debit
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spread so even so you know the takeaway
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you are trading options it's which is
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even more leverage so you're risking
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more percentage-wise but the capital
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that you're out laying is much much less
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so I think it's important to point that
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out but when you're comparing you know
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debits fairly and we compared the
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profits but I wanted to just throw that
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out there when we're talking about the
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losses so so real quick if you liked
[1050]
this episode if you like this kind of
[1052]
studies and back test it would really
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mean the world to me if you could leave
[1056]
a rating on iTunes or even in Spotify
[1060]
and maybe share with a trading buddy you
[1062]
know that'll help spread the word I'm
[1064]
trying to put out as much data
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as I can and don't forget to check the
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description about the pure alpha
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strategy that this was applied to and
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you know you don't need to trade the
[1074]
pure alpha strategy that was just the
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the strategy I use for this test if you
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have a trend falling or whatever
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strategy and you already know your
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winrate and all these things I think if
[1085]
you sort of factor in comparing debit
[1088]
spreads to that other you know maybe
[1090]
stock or option you're buying I think
[1092]
it's something to maybe explore and you
[1093]
can kind of explore that on your own but
[1095]
I will put a link in the description for
[1097]
the pure alpha strategy if you want to
[1098]
learn more about that strategy so thanks
[1100]
for listening I look forward to speaking
[1102]
to you on the next episode thanks
[1104]
everybody thanks for listening to the
[1107]
stock market options trading podcast to
[1110]
join our community of options traders
[1112]
head on over to patreon comm forward
[1115]
slash vertical spread options trading
[1117]
for details but before you go you should
[1120]
know that everything discussed on this
[1122]
podcast and in this episode is for
[1125]
informational purposes only and should
[1127]
not be considered financial advice of
[1129]
any kind
[1130]
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