The risk to reward ratio is one of the most important things to consider when trading so this segment features a study on using that criteria when selling strangles. This is new information and is a must for premium sellers.
The credit we receive when selling a naked option is our reward. Should the premium be too low, the risk may not be worth it. Additionally, skew almost always causes puts to be more expensive than calls and there has been a positive drift up in the market. The question then is when does the premium reach the point in which it no longer makes sense to sell it?
We created what we call a “selective strangle”. We followed our usual “rules” but only sold the call if the premium was at least ⅓ of the total premium. We sold only the naked put if the call wasn’t expensive enough.
A study was conducted in the SPY (S&P 500 ETF) from 2005 to present. We sold short a 1 Standard Deviation (SD) Strangle using the 0.16 delta on both the short call and put on the first trading day of the month. We compared it with a short 1 SD “Selective Strangle” (call must be ⅓ of total credit received). A table was displayed of 110 occurrences. The table showed the percentage of times the calls and puts were breached on our monthly mechanical Strangle.
A second table was displayed comparing the Selective Strangle to the Monthly Mechanical Strangle. The table showed the number of occurrences, percent profitable, average credit received and profit/loss (P/L).
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista to learn the takeaways and the results of the study comparing Mechanical Strangles to Selective Strangles.
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