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Market Measures

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Quantifying Directional Risk

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.

This in-depth study quantifies the amount of directional risk traders take when selling puts, calls, and strangles. By comparing pure premium decay, what we’d collect if the underlying didn’t move, with actual premium decay we can put numbers around the directional risk we’re taking with each trade.

The Study:
  • SPY
  • 45 Days to Expiration
  • 2005 – Present
  • Recorded the Non-Movement Occurrences Where the Stock Price is Less Than 0.5% Away from the Original Stock Price at Order Entry
  • Compared:
    • 16 Delta Call, 16 Delta Put, 16 Delta Strangle

The delta risk is significantly greater for calls versus puts because of the inherent movement in the underlying price. Thus, the realized P/L is much greater for puts versus calls. When we incorporate the strangle, we see that it represents a nice middle ground between call and put decay.

By managing our directional risk, short strangles can realize greater than 50% of their theoretical profit because the calls make money when the puts are being tested and the puts make money when the calls are being tested.

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