We believe in Short Premium strategies because our experience and our studies have proven to us that they work. It’s important though, not only to know how writing options in high Implied Volatility (IV) environments work in the long run but how they also work in the short run. It will be much easier to stick with such a strategy and benefit from Theta (time decay) if the losses are not a surprise and if the trader knows that what is a losing trade at one point often becomes a winner. Even more important may be the dynamics of managing winners.
A short Straddle has the real possibility that it can go almost immediately against you. Since most of the time we sell the at-the-money (ATM) Straddle which means both the Put and the Call have a Delta close to 50. Only if the underlying is exactly at the strike price will one leg not be in-the-money (ITM). Should there be a substantial move in the underlying without a significant drop in IV the position will show a loss. Our study was conducted in the SPY (S&P 500 ETF) from 2005 to present. Using options with a 45 DTE we sold ATM Straddles everyday (simulated). We compared holding to expiration to managing at 25% of max profit if possible.
A table showed that managing Straddles had a higher success rate, higher P/L per day and a reduced duration. Perhaps even more important was that in the 458 out of the 2184 observations in which the trade was managed at 25% of max profit would have eventually become losers.
A second table of the drawdowns or unrealized losses that were experienced during the life of the winning Straddles that were managed at 25% (when possible) was displayed. The table showed that 73% of the trades had at least 1 day of negative P/L, an average of 6 days with negative P/L and an average unrealized loss of -$134. Tom and Tony noted that this is the reason you don't cover your losses because even with these loss statistics, 81% of these trades were eventually managed at 25% of max profit.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the important takeaways and a better understanding of what to expect when selling Straddles.
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