Selling option premium using Strangles is probably our favorite strategy for many reasons but to be successful we need to let the probabilities play out. To do that we need to avoid a margin call. The guys then asked, “How much risk can we take before worrying about getting a margin call? Where is the sweet spot for risk?”
All margin calculations here are based on trading in a regular margin account. A table of the 3 largest up and down moves for a SPY Strangle over the past 11 years was displayed. This was to give us a good idea about risk. The table included the trade entry date, the SPY price, the percentage price change and the expansion of Buying Power Reduction (BPR) as a multiple of the initial credit. Surprisingly the up moves had larger BPR expansion than the down moves.
Our study was conducted in the SPY (S&P 500 ETF) from 2005 to the present. The initial account value was $100,000. Using options with 45 days to expiration (DTE), we sold the 1 Standard Deviation Strangles. The first trades were entered on January 1, 2005 and we closed the positions on the first business day of the next month. We then re-entered a new 45 DTE 1 SD Strangle. We compared the Strangle performance using a capital allocation for a regular margin account of 20%, 25%, 30% and 50% and also compared those levels to a long 100% SPY underlying.
A graph of the results showed that by using 50% of your capital allocation on Strangles, you might have some margin issues. The graph showed that a capital allocation of 30% was optimal and consistently outperformed the SPY and never required a margin call. Tom noted that you can control risk through capital allocation. The takeaways contained key points about the results.
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the key takeaways and the results of our study on the proper use of capital allocation when selling Strangles to control your portfolio risk.
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