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  1. What I began to realize over the years was that the risk I was taking with iron condors was excessive, so the thought of selling a “naked” strangle was unimaginable. This risk was due to ridiculously large position size, or leverage, and over time I began to understand this reality better. An iron condor is simply a short strangle with long options that are further out of the money than the short options. Some traders refer to the long options as “wings”. Because an iron condor creates a maximum potential loss equivalent to the width of the spread, traders make the mistake of often trading their account up to or near the maximum number of contracts that would wipe out most of their account if that max loss occurred, which during periods of low market volatility may be as minor as a 10-15% drop in the market.The average intra-year drawdown for the S&P 500 has been about 14% since 1980, so this is something that occurs almost every year. This is of course why you hear so many stories of retail traders and credit spread/iron condor newsletters blowing up. As is almost always the case, the risk isn’t really the strategy…but instead the position size of the strategy! There’s no strategy so good that enough leverage can’t make it a blow up waiting to happen. Due to the nature of out of the money option selling, the negatively skewed return stream can take a while to materialize when there are long periods of relatively calm market conditions. Today, I think of a strangle as a cash secured put along with an out of the money short call. Thinking about the trade this way transforms a short strangle from seemingly risky into a rather conservative trade, due to the position sizing rule. For example, with SPX currently trading at about $3,000, a strangle would be sized at about 1 contract per $300,000. Compare this to selling 10-point wide put and call credit spreads to create an iron condor, and many newsletters might suggest that you sell something like 275 contracts per $300,000 of capital! Think about that for a moment…technically the iron condor has “defined risk” of $275,000 (ignoring the credit received), while the strangle has “undefined” risk because the short call is naked and prices can theoretically rise forever. Yet the risk is immensely different for the two trades due to the number of contracts involved. The strangle has a positive expected return and will very likely survive and succeed over the long-term due to the well documented Volatility Risk Premium (VRP), while the iron condor will cause an eventual blowup. When someone says they prefer iron condors over strangles because the risk is “defined” with an iron condor, they probably haven’t spent a lot of time thinking about position sizing. This should be the biggest lesson from this article…risk is defined by your position size to a much greater degree than it is by the strategy. Yet it’s a topic that is not well understood or appreciated by most traders. I think about an iron condor similar to how I’d think about owning 100 shares of a stock and then buying a protective put. A strangle is like owning just those 100 shares, while an iron condor is like owning those 100 shares along with an out of the money protective put. That put will reduce your downside during extreme selloffs that are greater than the market already baked into prices, but at a substantial cost over the long run (again, due to the VRP). To illustrate this, I backtested SPY strangles and iron condors using the ORATS wheel. Selling 30 delta strangles on SPY since 2007 has produced an average annual return of 5.34% (volatility of 8.36%, Sharpe Ratio 0.64), while a 30 delta iron condor with wings set at 20 delta returned only 0.15% (volatility of 3.08%, Sharpe Ratio of 0.05). I ran the test a few times just to make sure I was getting consistent results. The additional transaction costs and performance drag of the long options is so significant that almost the entire return generated from the short options disappears. Conclusion On your journey as an options trader you’ll hear a lot of conventional wisdom repeated over and over that simply isn’t true or provides incomplete information. One of those myths is how selling strangles is risky and instead a trader should sell an iron condor. This statement tells us nothing about position sizing. If you read this article and are still resisting the information I’m sharing, ask yourself this question: Is the reason you still want to use an iron condor over a strangle due to how you might look at the expected return of the strangle as I’ve laid it out and feel a little underwhelmed? Perhaps this article is also what you need to hear instead of what you want to hear, because I know I was in that camp at one time. You might consider that the 5% return of the SPY strangle since 2007 is similar to the long-term global equity risk premium, which serves as the benchmark for virtually everything since so few investments have been proven to be able to reliably exceed it over the long term.Until someone shows you an independently audited decade plus long track record of a fund or newsletter selling iron condors with the “X% per month” average returns that are often fantasized about and marketed to new traders, use the position sizing algorithm presented in this article instead as your baseline. Think in terms of notional risk instead of margin requirements, and you’ll substantially reduce the risk of an unrecoverable negative surprise on your trading journey. Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios. Related articles Selling Naked Strangles: The Math Selling Short Strangles And Straddles - Does It Work? Selling Options Premium: Myths Vs. Reality Karen The Supertrader: Myth Or Reality? Karen Supertrader: Too Good To Be True? How Victor Niederhoffer Blew Up - Twice The Spectacular Fall Of LJM Preservation And Growth James Cordier: Another Options Selling Firm Goes Bust Trading An Iron Condor: The Basics The Hidden Dangers Of Iron Condors
  2. First, a reminder: Straddle construction: Buy 1 ATM Call Buy 1 ATM Put Strangle construction: Buy 1 OTM Call Buy 1 OTM Put Reverse Iron Condor construction: Buy 1 OTM Put Sell 1 OTM Put (Lower Strike) Buy 1 OTM Call Sell 1 OTM Call (Higher Strike) When buying a straddle, we are buying calls and puts with the same strikes and expiration. When buying a strangle, we are buying calls and puts with different strikes. The strangle will have the largest negative theta (as percentage of the trade value, not absolute dollars). Further you go OTM, the bigger the negative theta. If the stock moves, the strangle will benefit the most. If it doesn't it will lose the most. I found that if I have enough time before expiration, deltas in the 25-30 range provide a reasonable compromise. For lower priced stocks, I would prefer a ATM (At The Money) straddle (buying the same strikes). Strangle on a $20 stock might be very commissions consuming, plus the negative theta might be too big. Please note that when I'm talking about the theta being larger or smaller, I'm always referring to percentages, not dollar amounts. In absolute dollars, the theta is always be the largest for ATM options. However, since those options are also more expensive in dollar terms, percentage wise the theta will be the smallest. Generally speaking, dollar P/L is usually similar for strangles and straddles. However, since strangles are cheaper in dollar terms, percentage P/L will be higher for strangles. This applies to both winners and losers, which makes a strangle a more aggressive trade (higher percentage wins but also higher percentage losses). If the stock price moves significantly, strangles will likely produce higher returns. But if the stock doesn't move and IV increase is not enough to offset the negative theta, strangles will also lose more. For higher priced stocks (over $100) I will usually do RIC. Since you sell a further OTM strangle against the purchased strangle, this reduces the theta of the overall position. It might be the least risky position and still benefit from IV jump like AMZN trade. I prefer to have spreads of $5 for RIC. Since I don't know what will happen with the stock I play, I prefer to have a mix of all three. In case of a big move, strangles will provide the best returns. When IV is low, RIC will provide some protection against the theta while still having nice gains from time to time. Remember: those are not homerun trades. You might have a series of breakevens or small losers, but one down day can compensate for the whole month. This is why I want to be prepared when it happens. In August I had 4 doubles in two days (but I played mostly strangles). When you want to trade earnings and expect a big move, those strategies can provide excellent returns. RIC has limited profit potential, but when the stock moves less than expected, it can provide better returns than straddle or strangle with less risk. The bottom line: Strangle is the most aggressive trade, with higher risk and higher reward. It has the highest negative theta (as percentage of the trade price) so it will lose the most if the stock doesn't move and/or IV doesn't increase enough to offset the theta. RIC is the most conservative trade. Straddle falls in the middle, and many times it provides the best risk/reward. Let me know if you have any questions. Related articles How We Trade Straddle Option Strategy Reverse Iron Condor Strategy Why We Sell Our Straddles Before Earnings Want to learn more? We discuss all our trades on our forum. Start Your Free Trial
  3. Jesse

    Bullish Short Strangles

    My investment philosophy is built upon harvesting risk premiums with positive expected returns. Examples of risk premiums that meet my personal criteria for inclusion in a portfolio include the equity, size, value, and volatility risk premiums. The volatility premium is the persistent tendency in the options markets for implied volatility to exceed realized volatility. This should not be perceived as market mispricing, but instead, rational compensation for risk to the seller of option contracts.This is similar to how insurance companies are profitable over the long term by collecting more in premiums than paying out in claims and other expenses. Buyers of insurance are willing to lose a relatively small amount of money in the form of recurring premiums in order to transfer the risk of a large loss. Sellers of insurance need a profit incentive in order to take on this risk. A bullish strangle is a way to gain some exposure to the equity premium with reduced downside risk. Every option strategy includes tradeoffs, and the bullish strangle tradeoff is less upside capture in a rising market…and even potential losses. I’ve used the ORATS Wheel to complete backtests from 2007-current on 3 different equity index ETF’s…SPY, IWM, and EFA. The trading parameters used were: DTE: 30 Short Put Delta: 40 Short Call Delta: 16 Exit: 80% of credit received, or 5 DTE, whichever occurs first Collateral yield: None Results: This is impressive considering that no collateral yield is included. For example, US Treasury Bills are conventionally used as a risk-free form of collateral for option selling, and would have added just under 1% per year to the total returns during this period. Adding some term risk to the equation with 5 Year Treasuries, similar to what we do in Steady Momentum, would have added almost 4% per year during this period along with diversification benefits that would have increased the overall Sharpe Ratio. Conclusion Options are a great addition to a portfolio for the disciplined and well-informed trader/investor. They don’t have to be used as a speculative tool, nor do they have to be used in a high-risk manner. The bullish strangle is potentially a great strategy for an investor with a more guarded outlook on the equity markets or who simply lacks the courage to buy traditional index funds. Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University. Jesse manages the Steady Momentum service, and regularly incorporates options into client portfolios. Related articles: Selling Naked Strangles: The Math Selling Short Strangles And Straddles - Does It Work?
  4. Michael C. Thomsett

    The Gut Strangle Strategy

    This approach will work if you believe that profits will accumulate when you work with in-the-money positions rather than at- or out-of-the-money ones. For most traders, this long shot keeps them away from the “guts” and sets up a preference for the less expensive long or less risky short forms of strangles. These can be opened in either configuration whether you own stock or just want to work with options. Gut strangle (long) A long gut strangle is the purchase of an ITM call and an ITM put. The idea is that either side needs to move enough points to exceed the cost of the options. It is typically opened when you expect a big move but you’re not certain of the direction. For example, a stock tending to move a lot after earnings surprises may jump higher or fall lower, and a surprise is expected. The long gut strangle is a gamble because you will need many points of movement, but it also can pay off in a big way if the move takes place. This sets up unlimited profit potential along with limited risk. A profit occurs when price moves more than the total cost to open the position: Underlying < long put strike – net premium paid Underlying > long call strike – net premium paid The gut strangle will break even in two circumstances: Net premium paid + long call strike Strike of long put – net premium paid The risk in the long gut spread is limited. It occurs when the underlying price ends up in between the two strikes: Net premium paid + strike of long put – strike of long call Gut strangle (short) A short position is set up by selling a call and a put, both in the money. This version establishes limited profit with unlimited risk. It is the opposite of the long guts because both profit and loss are flipped. With the sale, you receive the net premium for the two in-the-money options. This is the appeal of the short gut strangle. However, you also have to ensure that collateral is posted in your margin account for both options. Depending on the strike, this could be an inhibiting number. The short gut strangle is an oddity. The short put has the same market risk as a covered call, but the short call is a high-risk position. It combines low-risk and high-risk in a single strategy. The limited profit is equal to the net premium received, and it occurs when the underlying ends up in between the two strikes: Net premium received + short put strike – short call strike Breakeven occurs in two positions: Net premium received + strike of short call Strike of short put – net premium received Maximum risk can be substantial and is unlimited. It occurs whenever the underlying moves above or below the strikes and exceeds premium received: Price of underlying < strike of short put – net premium received Price of underlying > strike of short call + net premium received This can be modified away from the strangle and set up as a straddle, but more important than this is the analysis of potential profit or loss overall. The gut strangle is rarely employed because profits are difficult to earn and risks are difficult to overcome. Even so, it deserves consideration in the range of possible options strategies you could deploy. Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.
  5. Introduction Several investors expressed interest in trading instruments related to the market's expectation of future volatility, and so VIX futures were introduced in 2004, and VIX options were introduced in 2006. Options and futures on volatility indexes are available for investors who wish to explore the use of instruments that might have the potential to diversify portfolios in times of market stress. VIX is a great way to hedge your long portfolio. It is a well known fact that during severe market downturns, VIX spikes significantly, which can offset some of your portfolio losses. However, you cannot trade VIX directly. There are few ways to trade VIX: ETFs/ETNs. iPath S&P 500 VIX Short-Term Futures ETN(NYSE:VXX) is just one example. VXX trades first and second month VIX futures. Unfortunately, VXX is not designed to be held beyond very short period of time due to contago loss. Most days both sets of VIX futures that VXX tracks drift lower relative to the VIX—dragging down VXX’s value at the average rate of 4% per month (30% per year). In fact, VXX is probably one of the worst long term investments. VIX futures and Options. Options and futures are investments with a definite lifespan; not only do investors have to be right about the direction of volatility, but also the timeframe. Of course if you buy VIX calls and volatility spikes, you can make some significant gains. But most of the time, those calls will lose money due to the fact that VIX drift lower, and those options will lose value over time. Possible solution: VIX strangle This article describes the following strategy of going long VIX: Purchase VIX put options that expire 3 months out and are 2.5% out of the money and simultaneously buy 4th month call options that are 20% out of the money. These positions are established each month on a date that is half way between the 3rd and 4th month expiration dates. Two months later these option positions are rolled. The put leg of the calendar strangle can help reduce the cost of the long call. Typically, when hedging through purchasing an out of the money call option on VIX to gain protection against tail risk there can be an undesirable carrying cost for the position. In periods of low volatility the long put position will benefit from the term structure of VIX futures pricing as the time to expiration for the option approached expiration. The long call position will be in place to potentially benefit from market conditions that result high higher implied volatility for the market as indicated by VIX. The general idea is that short term futures are declining faster than long term futures, and if VIX stays stable, the put gains will offset the call losses. Basically the strategy will roll the trade every two months. Expected results During calm periods when VIX stays stable or drifts lower, we can expect the trade to produce 10-15% gains or end up around breakeven because the puts gains will offset or slightly outpace the calls losses. However, during periods of volatility spike, the calls should gain significantly, and in some cases, the whole structure can deliver 50-100% gains. This is basically a cheap way to go long VIX and hedge your long portfolio, without experiencing losses during calm periods. We have made several changes to the strategy in order to better adapt to the current market conditions. Related articles VIX - The Fear Index: The Basics VIX Term Structure Top 10 Things To Know About VIX Options Want to see how we implement this strategy in our SteadyOptions model portfolio? Start Your Free Trial
  6. The problem is you are not the only one knowing that earnings are coming. Everyone knows that some stocks move a lot after earnings, and everyone bids those options. Following the laws of supply and demand, those options become very expensive before earnings. The IV (Implied Volatility) jumps to the roof. The next day the IV crashes to the normal levels and the options trade much cheaper. Over time the options tend to overprice the potential move. Those options experience huge volatility drop the day after the earnings are announced. In many cases, this drop erases most of the gains, even if the stock had a substantial move. In order to profit from the trade when you hold through earnings, you need the stock not only to move, but to move more than the options "predicted". If they don't, the IV collapse will cause significant losses. However, there are always exceptions. Stocks like NFLX, AMZN, GOOG tend on average to move more than the options imply before earnings. It doesn't happen every cycle. Few cycles ago NFLX options implied 13% move while the stock moved "only" 8%. A straddle held through earnings would lose 32%. A strangle would lose even more. But on average, NFLX options move more than expected most of the time, unlike most other stocks. NFLX reported earnings on Monday October 17. The options prices as indicated by a weekly straddle "predicted" ~$10 (or 10%) move. The $100 calls were trading at $5 and the puts are trading at $5. This tells us that the market makers are expecting a 10% range in the stock post earnings. In reality, the stock moved $19. Whoever bought the straddle could book a solid 90% gain. Implied Volatility collapsed from 130% to 36%. Many options "gurus" advocate selling options on high flying stocks like NFLX or AMZN, based "high IV percentile" and predicted volatility collapse. However, looking at history of NFLX post-earnings moves, this doesn't seem like a smart move. As you can see from the table (courtesy of, NFLX moved more than expected in 7 out of 10 last cycles. For this particular stock, options sellers definitely don't have an edge, despite volatility collapse. If the stock moves more than "expected", volatility collapse is not enough to make options sellers profitable. Generally speaking, I'm not against selling options before earnings - on the contrary. For many stocks, options consistently overestimate the expected move, and for those stocks, this strategy might have an edge (assuming proper position sizing). But NFLX is one of the worst stocks to use for this strategy, considering its earnings history. Related articles Why We Sell Our Straddles Before Earnings Why We Sell Our Calendars Before Earnings How NOT To Trade NFLX Earnings The Less Risky Way To Trade TSLA If you want to learn how to trade earnings the right way (we just booked 26% gain in NFLX pre-earnings trade): Start Your Free Trial