Unhedged Puts Suffer As Steady Rally Takes Markets To New Highs
With a week-long rally pushing the major U.S. equity indices to new record highs, buying volatility was generally a profitable strategy for the week ended December 9. Given the strong gains on the week, buyers of puts suffered significant damage, unless they had the foresight to hedge the position.
Unhedged puts were extremely vulnerable during the week, but were profitable when hedged. Meanwhile, ATM Straddles and 25-Delta Calls made money, especially on the call side.
Picking winners was a challenge at times, with losers generally outnumbering winners across the board. However, for ATM Straddles and 25-Delta Calls, the payout from the winners on average more than made up for the losers.
After a lackluster start to the week, stocks gained ground on Tuesday and accelerated higher on Wednesday. The advance lasted through the rest of the week, with the Dow, Nasdaq and S&P 500 all ending Friday's trading up more than 3% for the week as a whole. All three averages also ended the week at new record closing highs.
There wasn't a lot of news to drive the upward move. The continuing prospects of a business-friendly Trump Administration helped fuel the gain. Next week's Fed meeting is generally seen as a foregone conclusion, and while higher interest rates might generally be seen as a headwind, the lack of uncertainty about monetary policy gave stock traders confidence to add to their long positions.
For unhedged ATM Straddles, losers only slightly outpaced winners, with 48.1% of those positions returning a profit. Still, the net return for the strategy was +18.5%. Unhedged 25-Delta Calls fared slightly worse, with 42.3% coming in winners for the week. However, those winners had an average return of +537.1%, leading to an net return for the strategy of +173%.
It was a rough week for unhedged 25-Delta Puts. The strategy won only 5.7% of the time, with a net average loss of 65.5%. Even that somewhat disguises the damage. During the week, 94.3% of those positions came back losers, and those losers had an average loss of -99.7%. Basically, traders who made these bets had a 19 out of 20 chance of picking a loser, and those 19 out of 20 were basically looking at a total loss.
Disney (DIS) shares had a good week heading into next week's release of its likely blockbuster Star Wars movie Rogue One. The movie is set to hit theaters on December 16. Unhedged ATM Straddles returned +268.4%, while unhedged 25-Delta Calls returned +2,622.9%.
On the other side, it was a tough week for investors in Las Vegas Sands (LVS). Shares of the casino operator plunged after China lowered ATM withdrawal limits in Macau, a major casino market in Asia. As a result, unhedged 25-Delta Puts returned -1,310.6% during the week, while unhedged ATM Straddles returned an average of +255.8%.
For ATM Straddles and 25-Delta Calls, hedging cut into returns, though both remained profitable strategies whether hedged or unhedged. Meanwhile, leaving puts unhedged was a disastrous strategy during the week. With hedges, though, 25-Delta Puts were still able to be profitable.
Unhedged ATM Straddles returned +18.5% for the week. The return slipped to +17.6% when hedged once and dropped all the way to a +2.3% for daily hedging. For 25-Delta Calls, the return for unhedged positions was +173% for the week. This dropped to +62% for a single hedge and to +21.4% for daily hedging.
For 25-Delta Puts, leaving the position unhedged led to a massive loss of -65.5% for the week. When hedged once, though, the return turned positive, with an average profitability of +31.8%. Hedged daily, the position had a slightly positive return of +4.1%.