In this post we’ll take a look at the backtest results of opening one SPY short call 45 DTE cash-secured position each trading day from Jan 3 2007 through July 10 2019 and see if there are any discernible trends. We’ll also explore the profitable strategies to see if any outperform buy-and-hold SPY
There are 20 backtests in this study evaluating over 62,300 SPY short call 45 DTE cash-secured trades.
Let’s dive in!
Systematically selling calls on SPY is unprofitable for retail traders and serves as a revenue stream for retail brokers. After 12.5 years of trading, the most profitable strategy generated $2,490 in profit.
In general, managing short call positions early:
- lowered win rate
- increased volatility
- lowered overall P/L
The optimal approach to selling calls on SPY to generate income is to not partake in the activity. If absolutely necessary, sell 5D calls and hold till expiration.
- Symbol: SPY
- Strategy: Short Call
- Days Till Expiration: 45 DTE +/- 17, closest to 45
- Start Date: 2007-01-03
- End Date: 2019-07-10
- Positions opened per trade: 1
- Entry Days: daily
- Entry Signal: N/A
- Timing: 3:46pm ET
- Strike Selection
- 5 delta +/- 1.5 delta, closest to 5
- 10 delta +/- 2.0 delta, closest to 10
- 16 delta +/- 2.5 delta, closest to 16
- 30 delta +/- 3.0 delta, closest to 30
- 50 delta +/- 3.5 delta, closest to 50
- Trade Entry
- 5 delta
- 10 delta
- 16 delta
- 30 delta
- 50 delta (ATM)
- Trade Exit
- 25% max profit or 21 DTE, whichever occurs first
- 50% max profit or 21 DTE, whichever occurs first
- 75% max profit or expiration, whichever occurs first
- Hold till Expiration
The initial portfolio size for this study is $100,000.
The options strategy seeks to open a position daily then close once the respective target(s) is(are) met. In a worst-case scenario the portfolio may see, on average, 35 concurrent positions. 100k is roughly the portfolio size needed to support 35 concurrent positions at the start of the study.
- Margin requirements are always satisfied
- Margin calls never occur
- Margin requirement for short CALL and PUT positions is 20% of notional
- Margin requirement for short STRADDLE and STRANGLE positions is 20% of the larger strike
- Margin requirement for short VERTICAL SPREAD positions is the difference between the strikes
- Early assignment never occurs
- Prices are in USD
- Prices are nominal (not adjusted for inflation)
- Margin collateral is held as cash and earns no interest
- Assignment P/L is calculated by closing the ITM position at 3:46pm ET the day of expiration / position exit
- Commission to open, close early, or expire ITM is 1.00 USD per contract
- Commission to expire worthless is 0.00 USD per contract
- Commission to open or close non-option positions, if applicable, is 0.00 USD
- Slippage is calculated according to the slippage table
- For comprehensive details, visit the methodology page
This study seeks to measure the performance of selling short calls.
If a SPY short call strategy is profitable on its own it can be interpreted that a SPY covered call strategy will outperform vanilla buy-and-hold SPY. Total return will be equal to the underlying SPY plus profits from selling calls against the underlying.
Conversely, if a SPY short call strategy is unprofitable on its own it can be interpreted that a SPY covered call strategy will underperform vanilla buy-and-hold SPY. Total return will be equal to the underlying SPY minus losses from selling calls against the underlying.
Early management did a better job of locking in gains and mitigating losses during market stress. In contrast, the 75% and exp strategies collected more absolute premium to offset the GFC losses and commissions.
Realized win rates for the strategies was lower than “expected” win rates in most scenarios.
Managing early lowered win rates in the 5D and 10D strategies and improved win rates in the 30D and ATM strategies.
Managing at 50% produced the lowest win rate in all strategies except 30D, in which case it was ~1% higher than hold-till-expiration.
Worst Monthly Return
Average P/L Per Day
Average Trade Duration
Earlier management results in shorter trade duration.
Positions opened with a high delta take longer to reach profit targets than positions opened with a low delta. 5D is a slight exception.
Compound Annual Growth Rate
Profit Spent on Commission
Commissions consume no less than half of all short call profits.
The “dividends” of covered calls? More than half of the revenue you receive is going to the broker in the form of dividends.
After 12.5 years of systematically selling short calls on SPY the best we could have done was make $2,490.
Given the buy-and-hold position has grown by $167,243, adding another 2.5k doesn’t move the needle much. In virtually all other scenarios we would have underperformed buy-and-hold SPY by the negative amount listed in the table.
While it’s technically correct to say selling 5D covered calls would have both lowered volatility while increasing returns – the so called holy grail – adding a 20 basis points to our total returns does not seem worth the time or risk involved.
Meanwhile, the broker has earned $1 for every hold-till-expiration trade earning a little over $3,100.
Said another way, commissions have consumed over 55% of our profits!
How did the individual trades compare to buy-and-hold SPY?
Systematically selling calls on SPY is unprofitable or generated so little return the activity could be considered unprofitable.
Covered calls supposedly only make money, right? It turns out that losses do indeed occur, but not in an obvious way. Let’s take a look.
Suppose stock XYZ is trading at $70 and a covered call is written with a strike of $80. $1 is collected in premium. Then, the XYZ eventually trades at $100 and shares are called away.
When the underlying exceeds the strike of the short call, yes, the long equity position makes money. In the example above, $30 is made on the long underlying. In the same breath we can also say that premium was received for writing the call option – $1. However, that call option is ITM and has a P/L of -$20 sans any extrinsic value.
The collective, total return of the trade is: Long Underlying Share Appreciation + Premium Received – ITM loss on call, or $30 + $1 – $20 = $11. This equation always yields a positive number when shares are called away. If the trade stops here, yes, we made $11/share in profit and the total portfolio value is indeed higher.
At this point we have a $19/share opportunity cost. Had a covered call not been written, the total portfolio value would be $19/share more. However, if this is one of many trades in a systematic covered-call strategy, we will “realize” – and I use this term loosely; loss was realized when the shares were called away – the $19 loss in a more tangible way. Specifically, it’s not until the next covered call position is opened that the loss is “realized” or felt.
In order to place another covered call trade on XYZ, on will take the $81/share in cash from the previous trade (70/share basis + 30/share appreciation + 1 in premium received – 20/share loss on ITM call) and buy XYZ for $100. One will need to deposit or otherwise pony up $19/share in order to establish the position.
While the 5D and 10D hold-till-expiration strategies were profitable according to the backtest, commission assumptions are generous at $1/contract. Prior to 2018, brokerages charges $5-$20 or more to place an option trade.
As mentioned in the SPY vertical put spread study, commissions can make or break strategy profitability. Quoting from the study:
In 2007 and for many years thereafter there were no (to my knowledge) retail brokers offering sub $2 round trip costs per contract. In fact, the cost to trade was far higher and would have hurt strategy performance even more.
The $1.00 trade fee per contract in the backtest is quite generous even by today’s standards and is a virtually unavoidable cost of doing business.
The best-case scenario was the 5D hold-till-expiration SPY covered call strategy. It generated $5,600 in revenue and spent $3,110 in commissions along the way at $1 per position for a total return of $2,490. If commissions were instead $2 the overall P/L would be negative ($5,600 in revenue – $6,220 in commissions).
Retail Broker Business Model
Why are retail brokers be pitching covered calls? It’s great for their bottom line!
It’s a strategy that generates commissions, spreads and/or payment for order flow (PFOF) on the option trades.
The covered calls strategy is “safe” in that:
- retail traders won’t be able to blow up their account implementing the strategy. Losses accrued from selling calls will be more than absorbed by the growth of the underlying SPY position.
- retail brokers experience lower customer attrition and lower customer acquisition costs since retail traders won’t be going broke or otherwise blowing up their account with this strategy
Retail traders experience muted returns while retail brokers collect the commissions on every trade.
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