We like to sell premium in high Implied Volatility (IV) environments. Our favorite strategy is one that is Delta Neutral, a Strangle. Since no trader is right every time we need to know what to do when we are wrong. What are the three main ways we can adjust a trade?
Our first choice if one side of our strangle is tested is to roll the untested side. We typically sell the 1 Standard Deviation dynamic Strangle so that means we sell the put and call closest to a 16 Delta. Once one leg of our Strangle has been tested we roll the untested side to the strike closest to the 30 Delta. Our second choice, if there is not enough premium to collect or if there is not enough time left to expiration is to also roll out to the next month. The more days to expiration (DTE) there are the more premium we can collect but we want to stay around the 45 day optimum time period. Should the market move very rapidly against us we can always invert our strikes. None of these should increase our margin costs so we wouldn’t be committing any more capital.
Another choice would be to buy or sell the underlying or use Vertical Spread against our losing position or to sell an option in a correlated underlying. This would increase our capital costs and we would see further buying power reduction and is not ideal and Tom specifically warned against this. What Tom said we should absolutely never do is to add on to the losing position. Should our short call be tested we do not want to add another short call and the same for our short put if it is tested. When trading a defined risk strategy we should be prepared at the time of order entry to take the maximum possible loss as defined risk trades are generally difficult to roll without committing more capital.
For more on Rolling see:
Market Measures from June 26th, 2015: “Rolling | When Where and Where”
Tasty BITES from August 19th, 2015:“Rolling Down | Defined Risk”
Options Jive from January 11th, 2016:“Rolling Strangles - When, Where, How”
Options Jive from January 21st, 2016: “Rolling | Calculating Profit Targets”
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the important takeaways and how to play defense to salvage your offense when your trade plan goes awry.
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