On the September 29, 2016 segment of Trades from the Research Team Live, the head of our research team, Michael Rechenthin, Ph.D., aka Dr. Data, presented what Tom and Tony called a Cross-Product Strangle. The proposed trade was shorting a Call in IWM (Russell 2000 ETF) and shorting a Put in DIA (Dow Jones Industrials ETF). The trade idea included elements of a Pairs Trade as Mike was selling the Call in IWM because IWM had been stronger than DIA lately. Since the four major stock indices have a high correlation, and that includes IWM and DIA, Mike was counting on a snapback. Inspired by Mike’s idea we ran a study to compare Strangles in DIA to Strangles in IWM to Cross-Product Strangles in IWM and DIA. What would our study show?
Our study was conducted in the DIA and IWM using data from 2005 to the present. We chose the option expiration cycle closest to 45 Days To Expiration (DTE) and we compared selling an IWM Strangle with a 30 Delta Call and Put, selling a DIA Strangle with a 30 Delta Call and Put and selling a cross-product Strangle by selling the 30 Delta Call in the stronger ETF and selling the 30 Delta Put in the weaker ETF based upon the last week of trading. All trades were managed at 50% of max profit if possible or held to expiration.
A table of the results showed that all three Strangle strategies had similar results. Although the cross-product strangles had the advantage of being managed slightly earlier. A second table provided the results when filtering for instances of an IV Rank above 50. The table included the success rate, average P/L and average days in the trade. All the metrics were better with high IVR and there again was limited differences between the three strategies. Tom noted the advantages of using Futures for Pairs Trades as far as Buying Power Reduction (BPR) is concerned and contrasted this with the advantage of selling premium in options which benefits from Theta (time decay) and explained why he preferred the options.
For more on Cross-Product Strangles see:
Closing The Gap from February 16, 2016: "Intra-Sector Strategies"
Market Measures from March 3, 2016: "Cross-Products Strangles"
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results of our study on cross-product Strangles.
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