How to Manage Short Strangles
Sep 23, 2016
As tastytraders, we have an arsenal of strategies available depending on the market. In periods of low implied volatility (IV), we have strategies. When IV spikes, or at least wakes up long enough to get off its ventilator, we have other strategies. You might say we are - wait for it - a jack of all trades. But it is not just the strategy with which we are concerned, it is also how we manage the trade.
Undefined risk trades are usually our strategy of choice for a few reasons. Premium tends to come in more quickly. Fewer legs on a trade usually means a trade is easier to get into and out of when we want. They also tend to collect the most in premium. Optimizing our probabilities of success can often rest on when we close a winning trade. In a recent episode of Options Jive, the team took a look at strangles and when a winning strangle should be closed.
A strangle consists of selling a naked call and naked put in the same underlying, with the same expiration but with different strike prices. Both options typically have strike prices just outside the one standard deviation expected move.
Compare that with a straddle, where both the put and call have the same strike price. A straddle will bring in more premium than a strangle. That should make sense since both options are at-the-money (ATM). When selling a straddle, we know we want to close out those trades when they have reached 25% of their maximum potential profit. If we want to close straddles out at 25%, is that also the place to close strangles? Depends…
The research team took a look at selling one standard deviation strangles in SPY with 45 days until expiration (DTE) going back to 2005. They then compared closing out the trades when they reached 50% of max profit, 25% of max profit or just letting the trade run to expiration.
When comparing results, closing out trades at 25% max profit yielded a 95% success rate. Trades managed at 50% were successful 90% of the time while trades held until expiration were successful 82% of the time. 82% is nothing to ignore but it is not 90% or 95%. In fact, the success rates on trades closed at 25% and 50% were so close, it’s hard to decide which management strategy is best.
When we manage trades at 50%, our daily P/L is around 77% greater than if we manage at 25% of max profit. In terms of time spent in a trade, to manage at 50% usually meant being in trades for 23.5 days versus just 13.5 days when managing at 25%.
When it comes to managing strangles, managing at either 25% or 50% should yield high rates of success. As tastytraders, we want more than just high rates of success - we also want to maximize our profits. By staying in a trade for just 10 additional days, we can significantly increase our daily P/L without giving up much in terms of overall percentages of being profitable.
Josh Fabian has been trading futures and derivatives for more than 25 years.
For more on this topic see:
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.