All tastylivers love to sell option premium and our favorite premium selling strategy is a Short Strangle in a high Implied Volatility (IV) environment. Our risk when shorting Strangles is based partly on the credit received but mostly on the Deltas of the strikes we choose. That risk is known at order entry. We usually sell the 16 Delta Call and the 16 Delta Put. We take the sum of those Deltas, 32, and subtract it from 100 for a difference of 68. That means that, according to the options model used, there is a 68% chance of the Strangle expiring between the strikes. This is why we refer to this type of a Strangle as a 1 Standard Deviation Strangle. Is this one standard deviation Strangle our best choice or is there another level that provides a better combination of risk and reward?
Our study was conducted in the SPY (S&P 500 ETF) from 2005 to present. We sold Strangles with an expiration closest to 45 days to expiration (DTE). We compared Strangles with Deltas of 45, 35, 25, 20, 15, 10, and 5.
A table displayed the various Deltas we tested along with the theoretical probability the underlying would be between the strikes at expiration and the average P/L per trade. The P/L per trade average rose as the Deltas rose but the probability that the Strangle would expire out-of-the-money (OTM) kept decreasing. A graph demonstrated that between 10 and 20 Delta is the optimal level at which the average P/L rises. The win ratio increases at its greatest velocity between those Delta levels. A final table added the rate at which the P/L per trade increased. That rate peaked between the 10 and 20 Deltas.
For more information on Strangles and Strike Selection see:
Best Practices from September 21st, 2015:“Probabilistic Strike Selection”
Market Measures from October 21st, 2015: “Price Targets | Strike Selection”
Market measures from March 4th, 2016: “Strangle Strikes Selection | Impacts Of High Volatility”
Best Practices from June 6th, 2016: “Dynamic Trading | Benefits Over Static Strategies”
Watch this segment of Options Jive with Tom Sosnoff, Tony Battista for the valuable takeaways and the results of our study so you can see which Delta level strikes are your best choice when shorting Strangles.
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