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Multi-Leg Position Delta: Leave No Leg Behind

Feb 16, 2016

By: Josh Fabian

At tastytrade, option spreads like verticals, short strangles and iron condors form the core of our strategies. And those strategies involve two or more options.

Take a short strangle. It’s short an OTM call and an OTM put. We enter that short strangle as one single transaction so we have the short call and short put in our account simultaneously. We don’t “leg” into the short strangle by selling the put, for example, then waiting a while and selling the call. But why not?

It comes down to delta.

A short strangle has a pretty low delta because the long deltas from the short put are offset by the short deltas of the short call. And the goal of a short strangle is to make money from time decay, not picking the direction of the stock or index. Legging into a short strangle turns the low delta time decay trade into a high delta trade that depends on guessing the direction of the stock price correctly. And all our research at tastytrade suggests that stocks have a 50/50 chance of moving higher or lower. Do you like to have your money rely on a coin flip? Neither do we.

Here’s a real-life example: MSFT has 57% IV rank. I don’t know which way MSFT is going to go, but I want to collect some of the rich option premium that the 57% IV rank provides. With MSFT at $51.50 (as of Jan. 28), the March weekly 49.5 puts have a 32 delta and the 53.5 calls have a 32 delta. The short put would create +32 deltas and the short call -32 deltas, and give the short 49.5/53.5 strangle a delta of 0. If I try legging into the strangle by selling the 49.5 put first, I have +32 deltas in my account.

If MSFT goes up, great! But if MSFT goes down, I’m long 32 shares of the stock. Not so great. I don’t really want many long or short MSFT deltas in my account, so I enter the short strangle as one trade.

Some people think that they can get a better price for a short strangle, for example, by legging into it. Sell the put and see if the stock rallies so they can sell the call at a higher price. Do that, and you’re really trading a 50/50 stock bet. That’s not the tastytrade way. Focus on the time decay and probability. Those are things you can control.

Josh Fabian has been trading futures and derivatives for more than 25 years.

For more on this topic see:

From Theory to Practice: Expected Move Calculation January 27, 2016
Confirm and Send: I’ve Lost My Short Deltas August 25, 2015

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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