Traders need to understand risk to reward ratios and trade-offs in order to give themselves the best probability of being profitable and this comparison of straddles and strangles can help accomplish that. Those who think they don't need to watch this segment probably need to watch it the most.
This segment compares straddles and strangles and quantifies the differences. This is intended to increase your understanding of the relationship between risk and reward.
Shops in the mountains of Colorado sell t-shirts that say things like “No Risk No Reward”. The t-shirts display the symbol indicating the most difficult areas to ski. The idea is that it is a lot more fun to ski a difficult run than a “bunny hill”. A similar concept exists in trading. The more one risks a loss of capital the greater the possible gain.
Straddles and strangles are both undefined risk trades. Strangle are generally considered to be “less risky” because of the wider break even points and a higher initial POP. A table of a straddle and strangle (undefined risk trades) with 45 days to expiration (DTE) were displayed. The table included the average breakeven (BE) distance from the at-the-money (ATM) strike , the difference in break even and initial probability of profit (POP).
We usually see a higher percentage of profitable trades from strategies that are less risky; however, to compensate for the increased risk, straddles have greater potential profit than strangles. A second table of a 1 standard deviation strangle (SD) and a straddle in the SPY (S&P 500 ETF) were displayed. The table compared the average credit, average P/L per day and percentage of profitability of both. Tom and Tony mentioned that previous tastylive studies showed that straddles have 2 times the average P/L per trade than strangles but have a lower percentage of profitability.
The margin requirement and its associated reduction in buying power reflects the risk of a trade. A final table displayed the buying power used on a SPY (S&P 500 ETF) 1 standard deviation (SD) strangle and straddle. The table compared the average margin (capital requirement) and average return on capital (ROC).
Watch this segment of “Best Practices” with Tom Sosnoff and Tony Battista for the takeaways and other important information on understanding the relationship between risk and reward on undefined risk trades which can be the difference as to whether a trader is profitable or not. This segment teaches us how to balance the two.
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