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.
A shorthas a higher probability of being profitable compared to a short . 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. 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. 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 , 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.