When trading a smaller account, one that is tastyBITE-sized, it is always important to consider margin costs. Limited capital means limited opportunity so every opportunity to lower buying power reduction (BPR) should be considered. Perhaps our favorite trade strategy is the Short Strangle in high Implied Volatility (IV) and high implied volatility rank (IVR) environments. We can buy cheap “wings” (an out-of-the-money (OTM) put and call) to turn the position from an undefined risk to a defined risk and a resulting smaller BPR. How much is the difference in BPR and how does the added cost impact our P/L, days in the position and other key metrics?
Our study was in the SPY from 2005 to the present. We sold options with 45 days to expiration (DTE). We compared our standard 1 Standard Deviation Short Strangle which is comprised of a 16 Delta short put and call, to the same Short Strangle turned into an Iron Condor by purchasing the OTM put and call closest to 0.10. We managed at 50% of max profit if this was possible and on the downside exited the trade if the loss equaled 2X the credit received and lacking either of those possibilities we carried the trade to expiration.
A table displayed the results of the study comparing the two strategies. The table showed that the two strategies were similar although some profits were given up when purchasing wings and it took more time to take profits. Notably the the Iron Condor did not give much relief to the average buying power requirement and 37% of the time the hit to buying power was greater for the Iron Condor than the Short Strangle. Another table revealed that the largest loss for each strategy was almost identical.
For more on Strangle Replacement see:
- Market Measure from August 11, 2015: "IRA Expectations | Strangle Replacement"
Watch this breakthrough segment of tasty BITES with Tom Sosnoff and Tony Battista for the important takeaways and the study results on whether turning a Strangle into a defined risk trade is worth it.
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