A Strategy of Buying Weekly SPY Straddles

I performed a back-test of weekly SPY volatility for the past year and discovered that in just about half the weeks, the stock fluctuated at some point during the week by $3 either up or down (actual number 27 of 52 weeks).  That means if you could have bought an at-the-money straddle for $2 (both an at-the-money call and put), about half the time you could sell it for a 50% gain if you placed a limit order to sell the straddle for $3.  As long as the stock moves at least $3 either up or down at some point during the week you can be assured that the straddle can be sold for $3.

Here are the numbers for SPY for the past six months:

SPY Straddle Chart

The weekly changes (highlighted in yellow) are the ones where SPY fluctuated more than $3 so that a 50% gain was possible (by the way this week is not over yet, and the stock fell over $3 at one point yesterday).

An interesting strategy for these months would be to buy 10 at-the-money SPY straddles on Friday (or whatever your budget is – each straddle will cost about $200). With today’s low VIX, an at-the-money straddle last Friday cost $1.92 to buy (one week of remaining life),  In the weeks when VIX was higher, this spread cost in the neighborhood of $2.35  (but actual volatility was higher, and almost all of the weeks showed a $3.50 change at some point during the week).

Over the past year, in the half of the weeks when the stock moved by at least $3, your gain on 10 straddles would be $1000 on the original straddle cost $2.  If the change took place early in the week, there would be time premium remaining and the stock would not have to fluctuate by quite $3 for the straddle to be sold for that amount.

The average loss in the other weeks would be about $700, maybe less.  On Friday morning, the worst-case scenario would be that you could sell the 70 straddles for $700 (causing a loss of $1300). This would occur if the stock were trading exactly at the strike price of the straddle – on Friday morning it could be sold for about $.70 because there would be some time premium remaining for both the puts and calls.  The maximum loss that occurred in about a third of the losing weeks was about $.70 but another third of the weeks when the 50% gain was not triggered, you could have broken even (on average) by selling the straddle at the close on Friday.  I calculated that the average loss for all of the last 12 months would be about $700 in those weeks when the 50% gain was not triggered.

This means an average investment of $2000 (10 straddles) would make an average gain of $150 per week. While that might be considered to be a decent gain by most standards, it could be dramatically improved if you varied the amount that you invested each week by following the volatility patterns.

There was a remarkable tendency for high-volatility weeks to occur together.  In the above table you can see that at one point there was a string of 14 weeks when 12 times a 50% gain was possible (high-lighted in yellow) and two weeks (high-lighted in red) when a small gain was possible because the closing price was greater than $2 away from the starting price.  Only one week out of the 14, 5/28/13 would a loss have occurred, and that would have been negligible because the stock closed $1.86 lower, almost covering the $2 initial cost of the straddle.

The same went for low-volatility weeks – there were strings of them as well. At one point early in 2013 the strategy would have incurred a string of seven consecutive weeks when no 50% was possible, and in the last six months pictured above, there were two four-week strings when SPY fluctuated by less than $3 in either direction.

If you invested $4000 in weeks after you made a gain and $2000 in weeks after a 50% gain was not possible, your net gains would be much higher.  This is the most promising part of the strategy.

Another way of playing this strategy would be to invest only in those weeks when a 50% gain would have been possible in the previous week, and sit on the sidelines for the other weeks.  Of course, since the average gain for all weeks was positive (but small), you would be giving up a little by not investing each week.

In this world of low option prices (VIX is at historical lows) and relatively high volatility, this might be an exceptionally profitable strategy to follow.  We plan to carry it out in one of the portfolios we run at Terry’s Tips.