One of our favorite strategy is to sell option premium by shorting 1 Standard Deviation (SD) Strangles. We can define our risk at order entry by purchasing “wings”, a farther out-of-the-money (OTM) call and a farther OTM put, which creates an Iron Condor. We wondered, how does the risk/reward profile change under various “wing” widths?
The first study was conducted in SPY (S&P 500 ETF) with data from 2005 to present and a total of 1,300 occurrences. Using options closest to 45 days to expiration (DTE) we compared selling 1SD Strangles to 1SD Strangles with long out-of-the-money (OTM) wings distanced at $5, $10, $15, $20, $30 and $40 from the short strikes. All trades were held to expiration. A table of the results were displayed. The table included the percentage profitable at expiration and the average P/L on them. The table showed that the wider the wings the higher the probability of profit (POP) was similar to the undefined risk Strangle.
A graph of the width of wings versus the average return on capital (ROC) when managed at 50% of max profit was displayed. The graph showed that Iron Condors with closer wings tend to have a higher ROC because less capital is required at entry, and as we widen our wings the cost of defining our risk, diminishes the capital efficiency.
We ran a second study with the same parameters as the first except we managed winners at 50% of max profit when it was possible. A table of the results was displayed. This table included the percentage profitable, average P/L, Duration of the trade and average ROC. The table showed that the Short Strangle had the highest average P/L and the $10 wide Iron Condor had the highest ROC.
For more on Iron Condors see:
Market Measures from January 19, 2016: "Iron Condors | Defining Risks"
Tasty BITES from March 7, 2016: "Risk One To Make One Iron Condors"
Best Practices from March 22, 2016: "Choosing Wings Based on Probabilities"
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the important takeaways and the study results comparing Short Strangles to Iron Condors of various widths to find the optimal width for your trading.
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