An In-depth Volatility Analysis: Strangle vs. Straddle
An In-depth Volatility Analysis: Strangle vs. Straddle
By:Kai Zeng
Dampen volatility by exiting positions ahead of the expiration date
- Straddles, because of their higher delta and gamma, tend to show greater volatility in P/L, which can intensify as the expiration approaches.
- Managing the timing of your exit from these positions is crucial.
- For high delta strategies like straddles, consider closing out earlier to maintain volatility within a manageable range.
The primary distinction between Straddles and strangles lies in their construction and the resulting risk-reward profiles. A straddle, which involves selling both an at-the-money (ATM) call and an ATM put option at the same strike price, often displays more significant volatility compared to a strangle, owing to its higher delta and gamma values.
Delta measures how much an option's price is expected to move per one-point change in the underlying asset. Gamma reflects the rate of change in delta itself as the underlying price varies. Therefore, even minimal price fluctuations can lead to substantial profit or loss (P/L) swings in a straddle, making it a more volatile strategy.
On the other hand, a strangle, which consists of selling calls and puts with different strike prices, tends to be less sensitive initially because the options are out of the money.
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In an analysis of SPY 45-day options, we observed the weekly profit/loss (P/L) as well as volatility changes in strategies with different delta values: 16, 30 and the straddle with a delta of 50.
Consistently, we noted the volatility in P/L gradually escalates as the expiration date approaches. However, this rise in volatility becomes less pronounced as the expiration draws near.
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What's particularly noteworthy is how the volatility spikes with higher delta strategies. By expiration, the P/L volatility of a 30Δ strangle was found to be double that of a 16Δ strangle, while a straddle (50Δ) experienced even more significant spikes in volatility each week, peaking near 80% as expiration loomed.
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Given these observations, an effective risk management tactic is to consider exiting your positions ahead of the expiration date—this could significantly dampen volatility. For straddles, which are particularly sensitive because of their high delta, exiting even earlier than 21 days to expiration (DTE) can strike a better balance between profitability and volatility.
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Kai Zeng, director of the research team and head of Chinese content at tastylive, has 20 years of experience in markets and derivatives trading. He cohosts several live shows, including From Theory to Practice and Building Blocks. @kai_zeng1
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