Zero-Day Options: When to Take Profits?

Key Concepts

• Delta Neutral Trades: Trading strategies designed to have no directional bias, meaning they are not significantly affected by the market's upward or downward movement.
• Zero Day Research: Analysis focused on options contracts that expire on the same day they are traded.
• Put Spreads: An options strategy involving selling a put option and buying another put option with a lower strike price, used to profit from a decline in the underlying asset's price while limiting potential losses.
• Exit Mechanics: The strategies and conditions under which a trade is closed.
• Profit Targets: Predetermined levels of profit at which a trade is closed.
• Maximum Drawdown: The largest peak-to-trough decline in the value of an investment or trading account.
• Delta: A measure of an option's price sensitivity to a $1 change in the price of the underlying asset. A 50 delta option is typically at-the-money, while a 30 delta option is out-of-the-money.
• Hindsight Bias: The tendency to perceive past events as more predictable than they actually were.
• Directional Bias: A trading strategy that is designed to profit from a specific direction of market movement (up or down).

Analysis of Zero Day Put Spreads on S&P 500

This analysis delves into the performance of selling zero-day put spreads on the S&P 500, moving beyond previous delta-neutral research to explore bullish strategies in a consistently upward-trending market. The study examines various exit mechanics and profit targets over a two-and-a-half-year period, utilizing 10-minute interval pricing data.

Methodology and Data

• Data Set: Two and a half years of S&P 500 zero-day options data.
• Trading Interval: Every 10 minutes for pricing.
• Trade Setup: $10 wide put spreads initiated daily at 9:00 a.m. Central Standard Time.
• Profit Targets Explored: Ranging from 10% to 50% of the maximum potential profit.
• Exit Strategies Compared:
  • Closing positions at noon.
  • Holding positions until the close to achieve profit targets.
  • Leaving all positions open until expiration (for comparison).
• Metrics Analyzed:
  • Total number of winning trades.
  • Total profit or loss (P&L).
  • Maximum drawdown (peak-to-trough profit/loss range).
• Assumptions: All trades were assumed to be executed at the mid-price.

Analysis of 50 Delta Short Strike Put Spreads

This section examines selling put spreads with the short strike at a 50 delta (typically at-the-money) and explores different exit scenarios.

• Exit at Noon with Varying Profit Targets (10% to 50%):

  • Key Finding: Higher profit targets generally yielded higher average P&L. This is attributed to the market's consistent upward movement over the study period.
  • Observation: Targeting only 10% profit, a strategy previously employed, was less effective in this specific bullish market context.
  • Max Drawdown: While counterintuitive in a sideways market, the upward trend resulted in fewer relative losses, leading to seemingly lower maximum drawdowns for these positions. The study notes that even a $1,000 or $2,000 drawdown on a spread was not as significant given the market's trajectory.

• Exit at End of Day (Holding for 10% Profit Target):

  • Key Finding: Holding positions until the end of the day to achieve a 10% profit target increased the number of winning trades.
  • Reasoning: In a bullish market, trades that might have been losing at noon often turned into winners by the close.
  • Average P&L: Increased from near zero to an average of $27 per trade, reflecting the benefit of holding through the day in an upward market.
  • Max Drawdown: Drawdowns became more consistent across different profit targets because positions were held longer, and losses were realized at the end of the day if targets were not met.

Analysis of 30 Delta Short Strike Put Spreads

This section shifts to selling put spreads with the short strike at a 30 delta (out-of-the-money), again comparing exit strategies.

• Exit at Noon with Varying Profit Targets (10% to 50%):

  • Key Finding: Win rates were consistently high, further increasing as the short strike moved further out-of-the-money.
  • Average P&L: Similar to the 50 delta analysis, higher profit targets generally led to better average P&L, reinforcing the impact of the bullish market.
  • Perspective: The presenter emphasizes that these findings are based on hindsight and that real-time trading in volatile conditions is different from backtesting. The market's dynamics, volatility, geopolitical events, and technological advancements can significantly alter trading outcomes over time.

• Holding to Expiration (Implicitly, by waiting for profit targets):

  • Key Finding: Holding these out-of-the-money positions to expiration generally resulted in more volatility and lower average P&L compared to exiting at noon.
  • Reasoning: Selling further out-of-the-money options (like 30 delta) offers less reward for a potentially larger risk compared to at-the-money options (50 delta). Holding these to expiration means realizing those risks more often, leading to lower overall P&L and increased tail event impacts.

Key Takeaways and Arguments

• Profit Locking vs. Patience in a Bull Market: The traditional reason for locking in profits early is to maintain a high win rate. However, during the S&P 500's significant climb (3800 to 6600), most short puts were winners regardless of management. This suggests that in such directional markets, patience and waiting for larger profits were more profitable.
• Unsuccessful Strategy: The only strategy found to be unsuccessful in this dataset was taking profits at 10% and exiting losers at noon when selling zero-day puts daily.
• Downside Risk (Maximum Drawdown): No consistent pattern was observed in maximum drawdowns across different strategies.
  • Lower profit targets can help avoid serial losses (consecutive losing trades).
  • Larger profit targets mean fewer winning trades are needed to offset a loss.
• Directional vs. Two-Sided Trades:
  • In two-sided trades (where market direction is less certain), larger credits make smaller percentage gains more appealing.
  • In directional trades (like the bullish put spreads analyzed), being more patient and aiming for larger profits is generally recommended.
• "Home Run" Strategy: The put spreads, in this specific bullish market context, are described as having been a "home run."
• Hindsight and Market Evolution: The presenter strongly cautions against relying solely on historical data. Market conditions, volatility, product sizes, and external factors are constantly changing, making past performance not indicative of future results. Research from even 10 years ago may not be relevant today.

Conclusion

The analysis of zero-day put spreads on the S&P 500 over a two-and-a-half-year period, characterized by a strong upward trend, indicates that a more patient approach, aiming for larger profit targets and holding positions longer, was generally more profitable than aggressively locking in small gains. While higher profit targets led to higher average P&L in this bullish environment, the importance of considering market context and the inherent limitations of historical data for future trading decisions is paramount. The study highlights that the effectiveness of different exit mechanics and profit targets is highly dependent on the prevailing market conditions.