Well, I finally got a glimpse into the super secret strategy and as promised, I'm going to share (drum roll please). It's a fairly conservative strategy, but no holy grail. Thankfully, friend's dad, we'll call him for short, has come off the holy grail bit. I think he still puts too much stock (ahem!) into the strategy, but I hope to put some mathematical evidence before him so that he at least comes out of the clouds. The strategy is buy 100 shares of SPY at the beginning of each month. You then sell a call at the next strike and buy a LEAP put at one strike beneath your stock purchase price. Here's what the P/L model looks like on the strategy.
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I wasn't quite spot on when I heard the strategy, I guessed that it had the profile of a calendar spread. I was close. It looks more like a butterfly since the strikes are flexible and therefore the profit zone can be wider. Below, I've modeled a butterfly spread.
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The stock cost alone to open the first position is around $8,000. Plus the LEAP Put isn't cheap (about $1500). Assuming he's not getting margin credit, he's out $10,000 per spread. Where with the butterfly, the cost of the one above is about $335. The P/L profiles look nearly the same, I'm not sure about the greeks. I think the first position is long vega where the butterfly is short vega. Aside from being a dumb move from a margin standpoint, this is nowhere near a holy grail. The risk/reward looks somewhere near 1:3 and has a 3 to 1 odds of landing within one sigma of today's prices. So breakeven at best. Since options are a zero sum game, this is no surprise. Any pricing discrepancies are usually arbed out before us little people even see them.
I really don't believe that putting this position on blindly month after month is going to outperform the stock market. I think he's break even over time with the occasional streak of good luck. Option positions, like stock positions, have to be put on when you feel you know something that the market doesn't. The market knows what the first of the month is and what the volatility of the S&P 500 is. This is not news. This is a viable strategy when other elements are taken into consideration such are price from mean and implied volatility.
I explained that like all options strategies, this one has a time and place. I don’t discard any strategy. To put it on blindly doesn't make a lot of sense.
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