David P. Simon, “Examination of long-term bond iShare option selling strategies,” Journal of Futures Markets advance online (2009).
This article examines volatility trades in Lehman Brothers 20+ Year US Treasury Index iShare (TLT) options from July 2003 through May 2007. Unconditionally selling front contract strangles and straddles and holding for one month is highly profitable after transactions costs. Short-term option selling strategies are enhanced when implied volatility is high relative to time series volatility forecasts. Risk management strategies such as stop loss orders detract from profitability, while take profit orders have only modest favorable effects on profitability. Overall, the results demonstrate that TLT option selling strategies offered attractive risk-return tradeoffs over the sample period.
Unfortunately, I couldn’t find a preprint available anywhere online. The author claims that options on the TLT ETF are more desirable than options on Treasury futures because the ETF options are electronically traded. That’s a strange claim to make: options on the 5- and 10-year notes are traded electronically on CME Globex, as are options on 30-year bonds. But this is a minor point. From the conclusion:
The results demonstrate that unconditionally selling strangles and straddles in the front contract one month before expiration and holding through expiration results in attractive risk-adjusted returns. Average profits after transactions costs including 5 cent bid-ask spreads and with delta hedging are a highly statistically significant $1,200 to $2,300 per $20,000 of options sold and winning trades outpace losing trades by a 2:1 ratio. The
absence of delta-hedging results in substantially higher and again statistically significant average profits, although at the expense of more overall volatility and more severe losses on the largest losing trades. Overall, the results indicate that the profitability of these trades owes to the benefits of time decay offsetting the costs associated with negative gamma.
One important result was that the strategy is only profitable provided traders negotiate the bid-ask spread; selling the bid and buying the offer was apparently enough to remove any worthwhile edge.