Implied Volatility (IV) continues to be low. This is frustrating for us as there isn’t as much probability of profit (POP) when using low IV strategies and since it keeps us from selling option premium especially our favorite 16 Delta / 1 Standard Deviation Strangles. We began thinking about variations on our usual strategy. Would we get better results by extending duration to 75 days or even 100? Will the increase in credit received and the increase in IV (Implied Volatility increases as you go out in time) make up for the longer period the trade is held?
Our studies have told us that the “sweet spot” for selling options is 45 days to expiration (DTE). The May 26, 2016 segment of the Skinny on Options Modeling, “Why 45 DTE is the Magic Number” explained why it works according to the model. Perhaps though, a low IV environment is different? Our Study was in the SPY (S&P 500 ETF) from 2005 to the present. On the first trading day of every month we sold 1 Standard Deviation Strangles, with the expiration closest to 45 DTE, 75 DTE and 100 DTE. We looked at just the occurrences when IV was below 15.
A table of the study results of the SPY 100 DTE, 75 DTE and 45 DTE Strangle was displayed. The table included the P/L per trade, P/L per day, average number of days in the trade, win rate and biggest loss. Though the P/L per trade was higher, the P/L per day was not much more attractive given the larger number of days in the trade. Another table showed the results for each DTE level when managing winners at 50% of max profit. This table showed that when managing trades the P/L per day of the 75 DTE and the 45 DTE was the same. Our return on capital (ROC) might be the same but the 45 DTE area allows us to increase our number of occurrences and the chances that the “law of large numbers” will work in our favor. Tying up capital for a longer period also may cause us to miss out on better opportunities and there is less liquidity farther out which can cause slippage.
For more on Extending Duration see:
The Skinny On Options Math from November 6, 2014: "Extending Duration In Low Implied Volatility"
Market Measures from June 2, 2015: “Low IV | Extending Duration”
Market Measures from November 10, 2015: “Extending Duration in Low IV”
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results and analysis of our study on extending duration in low IV environments.
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