We’ve said it before, but we like selling premium in liquid underlyings with high Implied Volatility (IV) and high IV Rank (IVR)? Unfortunately, IV is not that high in the market index ETFs that we like to trade. We looked at some of the sector ETFs and decided XLU, the utilities ETF, wouldn’t present a big hit as far as Buying Power Reduction (BPR), was liquid, not too expensive in price, had a relative high IV and looked like a good candidate for some of our favorite strategies. We wondered, what would our studies reveal?
Our study was conducted in the XLU using data from 2005 to the present. We chose the option expiration cycle closest to 45 Days To Expiration (DTE) and tested three different strategies. We shorted an at-the-money (ATM) Straddle consisting of the Put and Call closest to a 50 Delta and we managed winners at 25% of max profit (if possible). We also shorted two type of “Covered Strangles”. One is long stock combined with a short Strangle made up of a short 30 Delta Put and a 30 Delta Call. The other is short stock combined with the same short Strangle. Both “Covered Strangles” were managed at 50% of max profit (if possible).
A table of the results of the short XLU Straddles managed at 25% or held to expiration was displayed. The table included the success rate, average P/L, average days held, average win and average loss. The Straddles have a much higher success rate than option probabilities predicted and on average, the trades were profitable. A second table with the same metrics compared a long stock Short Strangle to a short stock Short Strangle managed at 50% of max profit (or held to expiration). The table showed that the short stock Short Strangles were not profitable and had a much lower POP even with management. Would there trades fair better after an up move in XLU?
A final results table looked at the XLU Covered Strangles with short stock when the XLU had a 1 week move over 1.5% versus a move of more than 2% previous to order entry. The short stock short Strangles showed a profit when entered after a rally in the XLU.
For more information on Covered Strangles see:
Closing the Gap from December 22, 2015: "Covered Strangle: Synthetic Underlying"
Closing the Gap from May 16, 2016: “Covered Strangles: Synthetic Underlying & Strike Selection”
Market Measures from September 20, 2016: "Covered Strangles: Long Stock"
Market Measures from September 28, 2016: "Covered Strangles: Short Stock"
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the very valuable takeaways and the results of our studies on short Straddles and Covered Strangles in XLU.
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