We often discuss the reasons for not selling short term options. Though they have greater theta values, the premium received is lower and the strikes are much closer to the stock price. This makes it easy for losses to occur very quickly due to the increased gamma risk for short-term options.
Knowing this, what are the disadvantages to selling long-term options with more than 150 days to expiration? Firstly, the bid/ask spreads are generally much wider because there is less activity in further expiration cycles. Second, the vega or volatility risk increases with longer term options. Lastly, selling longer term options ties up our capital for a much longer time period, leading to a lower number of occurrences.
A table is shown that compares strangles in the expiration cycles with 55 days to expiration and 174 days to expiration. Consistent with the previous statements, the 174 day strangle had a wider bid/ask spread, higher vega risk, and less potential profit relative to the number of days in the trade.
We previously ran a study and found that historically, our typical 45 day strangle will reach 50% of max profit in 25 days, on average. We ran the same test over the same time period and calculated the amount of time it took for 180 day strangles to reach 50% of max profit. The result was 84 days, or 59 days longer than 45 day strangles. Based on these averages, we can generate almost four times more occurrences by managing 45 day strangles at 50% of max profit.
The only exception to trading longer term options is when we trade covered call diagonals. This means we are buying long-term call options and selling near-term calls against it to reduce basis. This allows us to replicate covered call positions with much less capital.
Join Tom Sosnoff and Tony Battista for their take on the subject!
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