One of the most significant risks in premium selling is ‘tail risk’. The more contracts, the higher the notional value, which can become overwhelming in large market moves. Strangles and Straddles are prime examples of strategies that may be impacted by tail risk. So how many Strangles equal a Straddle? We need this to put context around the risk we are taking. Why wouldn't we sell 2 Strangles for every 1 Straddle we would trade?
A P/L graph comparing a Straddle and a Strangle was displayed. The graph showed that with both strategies, a large move in either direction will result in a position with nearly 100 delta (outright stock). A table comparing the credit received and the profit target of an at-the-money (ATM) Straddle to a 1 Standard deviation Strangle was displayed. Since the profit target for a straddle is 25% of max credit which is typically about twice the 50% credit received for a Strangle, is it worth selling 1 Straddle instead of 2 Strangles to cut the outlier tail risk in half?
Our study was conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. We compared selling 1 ATM Straddle versus selling two 1 Standard Deviation(SD) Strangles. We chose the option expiration cycle closest to 45 days to expiration (DTE). We sold the Straddles and Strangles everyday and managed positions at a percentage of max w profit if possible. Our Straddle profit target was 25% and our Strangle profit target was 50%.
A results table compared the win rate, average P/L per trade, average winner, average loser, largest loser and current BPR. The table showed that the Straddle was equally as profitable with about half the notional risk when compared to 2 strangles. An 11 year P/L graph compared 1 Straddle to 2 Strangles. The graph showed that the Straddle had very similar results but was easier to manage in outlier events because you only had to manage half as much. Tom elaborated, ”The difference for us is, we won't sell the cheap junk, we collect more money because we don't want to deal with the extra units.”
Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the key takeaways and the results of our study comparing selling 1 Straddle versus 2 Strangles to reduce tail risk.
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