Market Measures

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Increasing Size in High Probability Trades

Market Measures

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

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 a higher probability versus a smaller trade with a lower probability?

Study
  • S&P 500 (SPY); 2005 to Present
  • Used 45 DTE options
  • Compared selling 16 delta Call and Put (strangle) versus 5 delta Call and Put according to following:
    • Sold 5 delta Strangle as many times as required to reach 16 delta Strangle credit
    • Managed 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!

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