We recently had a discussion on the benefits of Covered Strangles on the Closing the Gap segment from May 16, 2016: “Covered Strangles: Synthetic Underlying & Strike Selection”. Many traders like to try to sell tops and buy dips. We can enhance the positions we put on at such times without altering the long Delta exposure. This can be done using a Covered Strangle. How is this done and what is involved?
Tom explained, “a Strangle is a Delta Neutral position where you want premium to decay. What’s the advantage of a Covered Strangle? Bigger returns, on a high probability strategy on top of a long stock position. Do you have any risk to the upside? None whatsoever. Do you have any risk to the downside? Sure, you had risk to start out with and now you have double the risk.”
Our study was conducted in the SPY (S&P 500 ETF) and the IWM (Russell 2000 ETF) using from 2005 to the present. We utilized the options with the expiration cycle closest to 45 Days To Expiration (DTE). We simulated a 30 Delta Covered Strangle consisting of 100 shares of long stock and short one 30 Delta Call and one 30 Delta Put. We then managed the trade at 50% of max profit for the entire position (if possible) and not just of the Strangle. A P/L graph of an SPY Covered Strangle was displayed and a table contained the details including the exact positions, credit received, max profit and Buying Power Reduction (BPR).
A table displayed the results. The table included the average max profit, average P/L, success rate and average days held. The table showed that managing the trades increased the success rate while significantly reducing the time in each trade (almost by half). A second results table using the same original metrics but filtering for instances of Implied Volatility Rank (IVR) above 50 was displayed. The table showed that waiting for high IVR improved all metrics in both underlyings and especially in IWM.
Tom exclaimed, “There are some huge takeaways here! The success rate of the long stock Covered Strangle blew us away. By reducing the size of your long stock position and adding a Strangle around it is more advantageous than just buying stock outright. This is one of the reasons that active traders are so successful.”
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the detailed results of our study on Covered Strangles with long stock that improved our P/L in all IV environments.
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