In this segment of Market Measures, we will look at the relationship between position size and position risk. Does it make sense to make a larger trade with aversus a smaller trade with a lower probability?Study
- S&P 500 (SPY); 2005 to Present
- Used 45 DTE options
- Compared selling 16
Call and Put (strangle) versus 5 delta Call and Put according to following:
- Sold 5 delta as many times as required to reach 16 delta Strangle credit
- all trades at 50% profits or expiration
We have to sell 3½ 5 Delta Strangles to collect the same credit as a 16 Delta Strangle (on average).
This boosts the tail risk and Buying Power by roughly 3½ as well.Results
- Increasing size in high probability trades increases tail risk
- Higher probability trades reduces ROC, since we must put up more capital
- Trying to mimic returns by moving short strikes out and increasing size can actually increase the volatility of returns.
For more on the win rate, management timeframe and average P/L, tune into the segment!