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Straddles | Short Term Protection

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 segment reveals the results of a study to test whether a short term far-out-of-the-money (OTM) strangle is a smart hedge for a short straddle. This should be of interest to tastytraders and all premium sellers.

A short Strangle has a higher probability of being profitable compared to a short Straddle. The trade-off is that with a short strangle there is less credit received as compared to a short Straddle. There are times when a tastytrader will prefer to be short a straddle over a strangle but the capital requirements are higher and they must be managed quickly. This study examines one way to reduce risk.

One way to define our risk on a straddle is to buy a cheap call and put (a long strangle) far away from the current underlying price. This creates a wide Iron Fly. Our maximum loss is capped and it usually requires less margin than the short straddle. The question then arises if it is possible to buy cheap out-the-money (OTM) strangle as “protection” with a closer expiration in order to limit losses from outlier moves and if so, how will this affect our average profitability?

A study was conducted from 2013 to present using five large ETFs, SPY (S&P 500), EWW (Mexico), GLD (Gold), IWM (Russell 2000) and TLT (Bond). We sold the at-the-money (ATM) straddle closest to 45 days to expiration (DTE). We then bought two week, out-the-money call and put for $0.20 (each) and took the whole position off at 15 DTE. A table showed the results of percentage of winners, average P/L with 1 Standard Deviation, max loss and total profit and loss (P/L).

Watch this segment of "Market Measures" with Tom Sosnoff and Tony Battista to see whether call and put protection helps your short straddle.

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