This morning we heard from Skip, our newest. Among the many outstanding insights Skip shared was how he allocated his capital. Skip likes to using short and we do too. We decided to run a study on the ideal amount of capital to allocate to a short Strangle strategy. What is the percentage? We can take the number generated by our study and plug it into a formula that takes the size of the account, multiplies it by the target capital allocation percentage and the divides that by the of one contract to determine the number of contracts we should use. An example using a $1 million dollar account was provided.
Our study was conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. We sold theStrangles using the option cycle closest to 45 . We only opened a new position after closing the old one. We then compared strategies of allocating 10%, 15%, 20%, 25%, 30% 35% and 50% of the capital. We then compared this to a simple buy-and-hold strategy in the SPY including the dividends.
An 11 year results graph of the study results showed that short Strangles held through expiration was profitable but did not outperform a buy and hold strategy in SPY. The graph further showed that allocating too much capital (50%) exposed the account to too much risk during large drawdowns such as in late 2008. A second results graph showed that when the short Strangles werethat all but the 10% and 15% capital allocations beat buy and hold and that the 35% allocation performed the best. Tom and Tony pointed out that we would expect that if we filtered for instances of higher our Strangles may have performed even better. Tom noted, “If you over commit your capital and you don't manage winners then you underperform. When you stay mechanical, you knock it out of the ball park.”
For more information on Capital Allocation see:
Strategies For Your IRA from August 17, 2015:
Strategies For Your IRA from May 24, 2016:
Strategies For Your IRA from June 7, 2016:
Market Measures from July 18, 2016:
Watch this segment of Market Measures withand for the valuable takeaways and the detailed results of our study on the optimal percentage of capital to allocate to a short Strangle strategy.