addadi@nana.co.il wrote:

Hello,
I've read you great book (create your own hedge fund) and I'm planning to start using the option writing very soon,
however I came across a presentation of Matthew Moran (Vice President, CBOE) from a conference held
this year (http://www.capitallinkforum.com/cef/2006/pres/05_moran.pdf) in page 12 there's a comparison of the Total Return Indexes from June 1988* – Mar. 2006 and you can see that after 16 years BXM (that served as evidence that the option writing strategy works in your book) out performed the SPTR (SPX with dividends reinvested) only by few percent, and that's without taking into account the broker charges. Considering the cost of the charges (especially when some brokers offer free dividend reinvestment plans) makes the total return of SPX higher that BXM, and it is much less maintenance to buy & hold for 16 years that conducting 192 (16 x 12) monthly transactions over the years. I'd like to know what's your opinion about that and how well this example serve as an evidence for the whole strategy.

By the way, according to Moran, BXY which is based on 2% OTM is more successful than options closer to the money.

Thanks,
Guy Addadi

Hello Guy,

Thanks for your comments on the book.

Yes, the BXM only outperformed the S&P 500 Index by a modest amount over the 16 year period studied.  However,

• The BXM was much less volatile.  For the individual investor, that means significantly reduced fluctuations in the value of his portfolio. That's important to many investors - especially during market downturns.
  
• There were some extremely bullish years during that period - a situation that is not likely to occur again soon.
• The BXM performed much better than the stock portfolio when the market was not strongly bullish
• In today's world, commissions have become almost insignificant, if using a deep discount broker.
  

Thus, if you expect, or want to allow for the likelihood of very bullish markets, then you may be better off holding a stock portfolio. 
But, if you believe these are uncertain times for the market and that many possible world events could play havoc with the markets, then owning  a hedged portfolio may be better for you.  (And there are strategies not covered in the book, such as collars, that provide even more protection - if you are willing to sacrifice a significant portion of your potential bullish profits.)

I am unaware of brokers that provide free dividend reinvestment.  Many individual companies allow their stockholders to reinvest dividends for free.  That's not the same thing, although the result is the same for the stockholder.

Yes, there is MUCH less maintenance and much less work to do is you simply hold a stock portfolio. But for me, trading is fun and I love the process.  If you think of it as a task, then you must take a stand - either hold stocks hoping for a very bullish market, or hedge your investments (with the time and effort required).  Remember, if you write 3-month options, the return may be reduced, but so is the time required to manage the portfolio.

As far as writing 2% OTM calls goes, nothing wrong with that - and it works best in bullish markets.  In fact, you could modify your writing strategy from month to month or write OTM calls for those holdings (ETFs or individual stocks) on which you are most bullish and write ATM or ITM options on the remaining positions.  Mix and match is definitely the order of the day here.

Mark