Straddle/Strangle Ideas

[cuegis 683]

I know that this trade, of a ratio of long straddles, to fewer, short, closer expiration, strangles, has been used exclusively as a "pre-earnings" trade.

But, I was thinking, why couldn't this be a very effective trade in non-earnings environments?

But, not holding it too long. Maybe 10 days - 2 weeks, with 30 day long straddles, and 2 week short strangles, in a similar ratio to the trades that we have already been doing.

My idea was to screen for candidates, whose HV (actual volatility)  is trading at a much higher number, than it's implied volatility is pricing in to it.

I know that IB's TWS platform has a "screening" page, where you can set up a wide range of parameters, and screen for this, among the most liquid underlyings.

Wouldn't this be an ideal environment, other than earnings, to use such a strategy?

The risk is time decay, and as with the original trade, the short strangle will help to offset that risk to some degree.

 

So, a drop in IV, on your long straddles, is the other risk.

But, if you can screen for candidates , whose underlying, is moving much more than the IV is pricing into it, this could be a viable approach.

That is the idea.

Now, I was looking for some feedback as to why this would not be a good idea.

Also, as is the case with any long gamma trade, there has to be a plan as to when to re hedge the changing deltas.

[Kim 7,513]

This could be a very interesting idea. The big advantage is that IV of long options is not elevated, so gamma gains will accumulate much faster. The downside is that if the stock doesn't move, there is nothing to support the straddle value. Lets explore it and get more feedback from members. 

[cuegis 683]

28 minutes ago, Kim said:

This could be a very interesting idea. The big advantage is that IV of long options is not elevated, so gamma gains will accumulate much faster. The downside is that if the stock doesn't move, there is nothing to support the straddle value. Lets explore it and get more feedback from members. 

Thanks Kim. It just crossed my mind, and seemed like it could work because of the ability to scan for underlyings with large differentials between HV and IV.

So, I was looking for members to tell me why it was a bad idea, if it was, I wouldn't be offended. That is what I'm looking for . It is constructive, because it will keep you away from something you might have missed.

If this proves to have some merit, for those willing to take on the additional risk, you can also just buy the straddle, or any other positive gamma trade setup, without the short strangle.

There are plenty of situations, where the stock is having consistently volatile , daily ranges, and the IV is not reflecting it.

One situation where that would be likely, is if the movements are to the upside.

Because IV naturally falls on up moves, even though the daily fluctuations can be just as great, or even greater, than if were an equally volatile , down trending market.

[candreouTrade 59]

@Kim - cant we trade an underlying that tends to move with non-farm payroll news etc? Maybe an ETF that tracks a currency pair?

 

 Have you looked into other events, other that earnings, that also increase IV?  

Edited April 30, 2018 by candreouTrade

[Yowster 8,029]

A few thoughts on the non-earnings periods hedged straddles:

• If setup using same ratios as pre-earnings trades, I think we wind up with a trade where you NEED the stock price to move to show a profit.   If you don't get the stock price move then short strangles would likely not cover RV decline, which will be much steeper without earnings IV increase propping it up.   You would lower your losses, but you wouldn't have trades where you make a small profit purely from the short strangles which happens quite often with the pre-earnings trades.
• However, during non-earnings times the IV differential of the short and long is not as great and is usually comparable.   Therefore, the gamma gains on long will be closer to what they are with the shorts.   The gamma of the shorts will still be higher because they expire sooner, but the difference in gamma will not be as great as with the pre-earnings trades.
• Therefore, for hedged straddle trades outside of earnings, we may be able to use higher ratios (2:1, 5:3).   Note that this comes off the top of my head based on how gamma will act and would have to be backtested and/or paper traded first.

[candreouTrade 59]

@Yowster - thanks for your comments, that sound reasonable. Also i like your point about the 2:1 and 5:2 being a possibility.

 

Would stocks that are close to their 52 week high, be a good candidates for low IV and stocks that would tend to move a little more?