We discussed the put/call price ratio in our Market Measures segment, Put Richness. Can we make a mean-reverting rank based on the ratio and use it in our trading?
Based on the graph of historical put/call price ratios, we are able to construct a rank with the expectation that it mean reverts over time, but how does this stack up when used in conjunction with IVR?Study
- SPY, 2005-2017, 45 DTE
- Sold 16 delta strangles
- Selling strangles when IVR above 50
- Selling strangles when put/call rank above 50
- Selling strangles when IVR and put/call rank above 50
- All trades held to expiration
We find that selling strangles when the put/call rank and IVR are over 50 yields significantly more P/L, a higher win ratio, and lower standard deviation of P/L compared to selling strangles using only IVR.
This does not suggest that we should wait for both ranks to be above 50 because it doesn't happen often, but rather understand that when it does happen, it makes a good opportunity for premium sellers.