2) The call sold at the bottom of the V and the put sold to get back in the trade would bring in much more revenue than usual due to higher volatility, which increases option prices. This would offset much of the loss.
One concern, as I mentioned above, is that selling a put doesn't actually get you back into the SPY immediately. It only
potentially gets you back in at some future date, so you have no upside potential, beyond the collected premium on the put, until after it gets assigned.
However, I'm now thinking there might be a reasonably effective way to use margin
very judiciously to close that objection down, depending on your broker.
Schwab (my broker) offers an SPY near equivalent, symbol SCHX (trades transaction fee free). I'm assuming other brokers have something similar to Schwab's SCHX.
So the only slight modification to the strategy needed is that in the V scenario, when you write a naked put, you also immediately buy the ATM dollar equivalent number of SCHX shares that would equal the value of the cost at an SPY assignment. Now you have the put premium in your pocket, you remain eligible for dividends (on SCHX, instead of on SPY), and you still ride up with the market, using SCHX, if it takes off on you.
And if the market takes off for several months in a row, you just keep writing SPY puts all the way up, while still collecting a dividend on SCHX. And you reap the upside rewards of a bullish move in the market, before you get assigned on the SPY puts, with the additional benefit of not having capped your reward with written calls during that period.
Eventually, your SPY puts will get assigned, and you are now on margin for those assigned shares. You then immediately sell the SCHX position, to wipe out the margin debt, and you resume writing calls on your SPY position. Rinse and repeat.
Seems this tweak to the strategy could also mitigate much (or at least some) of the wash-sale potential, making the strategy more able to exploit realized tax losses that you would never be able to exploit using a buy-and-hold strategy.
The tricky part is that if the market falls way below your put's strike price, you wouldn't have enough equity in the SCHX position to wipe out the margin debt entirely when you get assigned. So this would introduce some additional risk, offset by the additional benefits, as compared with the unaltered strategy.
Possibly a stop loss order on SCHX a few pennies below the dollar equivalent of the SPY put's strike price is all that's needed to mitigate much of that additional risk. You could then adjust this stop upwards each month that you need to continue writing SPY puts.
If you get stopped out on a head-fake, but are not then assigned against the SPY puts, then you are no worse off (approximately) than you would have been without this tweak to the strategy; with the possible exception of generating a capital loss and a wash-sale on the SCHX position that you wouldn't have otherwise incurred by sticking to the original strategy.
But for the same reasons, a head-fake could just as easily generate an unexpected capital gain, depending on how many months you had the SCHX position in place.
Essentially, since you're not usually going to be out of the market for more than a weekend, there's no real urgency to swap back into SPY shares. You could alter the strategy further to write slightly OTM puts instead of ATM puts against the SPY. I can think of a tax scenario where writing OTM puts could be a slight advantage on the first month that you have to write the puts.
And since your upside on SCHX isn't capped by a written call, it seems plausible to suggest that you might want to keep the SCHX position on for as long as is reasonably possible, while collecting dividends on SCHX, and collecting monthly OTM premiums on SPY puts (even if slightly lower premiums than selling ATM puts) all along the way.
Volatility skew typically favors the pricing of puts over calls; which should also support a bias to keeping the SCHX trade on proportionally longer than the covered call alterntive on the SPY. In fact, it might actually support an argument that closer to the money covered calls should be sold on the SPY, simply to swap back into SCHX shares and naked SPY puts as soon as possible.
Anything else I'm missing here?