Most folks, in this forum and on various web sites, warn against short straddles/strangles. It's obvious why their advise is "Don't Do It". Many would recommend long wings to protect against UNLIMITED losses. In effect, this is the iron condor. They would also typically suggest that the short positions of an IC to be a strangle several strikes away from the market. Although this increases the probability of a win, the "fat tail" effect from having far otm ICs is a disaster waiting to happen. Why risk losing $9 for the chance to win $1, per leg? At least individuals such as Dagnyt (Mark) suggest that for each side you should collect at least $3 for each $10 strike differential (i.e. risk losing $7 for the chance to win $3 per leg). Although this is a negative risk:reward structure, it much better that the r:r structures most people advocate for the IC (iron condor) or IB (iron butterfly). Here's another problem: With an IC or IB, although you've insured yourself against a "Black Swan" event, and you've reduced your margin requirement for the trade in comparison to a short straddle/strangle, both the profit potential and the hi/low of the stock's price range for being profitable are 60+% less with a IB as opposed to a short straddle. Many would subscribe to the notion of having the "safety" of the insurance that the long wings of an IC/IB gives. They consider this a worthwhile tradeoff for having smaller returns. Furthermore, they'll contend that the return on margin is much better with an IC/IC - and they are right. However, when considering returns, it's more appropriate to factor the return on investment or equity (i.e. account size). This may still be higher with an IC/IB, as you can enter at least 3 times more trades with a IC/IB than you can with a short straddle/strangle for the same level of margin requirement. The Big Problem is... expectancy or probability of success with a trade. Giving up 60% or more in profit range materially skews the expectancy/profitability rate of trading an IC/IB instead of a short straddle/strangle. I don't mind paying the insurance of the long wings, which also gives me a lower margin requirement; however, I'm not convinced that it's worth the shortened profit range. Having a profitable price range that 60+% less is very disconcerting. Furthermore, with an IC/IB, you're required to remain in the trade longer to realize the profit potential. Whereas with a short straddle/strangle, you typically are able to exist much sooner with a profit. A MAJOR POINT TO CONSIDER IS THIS... So many professionals were able to generate fortunes with short straddles/strangles. As a caveat, I understand that many also lost fortunes with short straddles/stranges (i.e. Victor Niederhoffer). Nonetheless, if you're able to avoid or minimize the impact of the "black swan" events, I don't know if there's a better way to amass riches through trading, especially options trading. I think there may be a way to minimize the risk of a "black swan" event while taking advantage of the potential that a short straddle/strangle strategy offers. SUGGESTED ALTERNATIVE: Set the stop orders for each leg of the short strangle/straddle at the time the order is placed. The stop order could be the sum total of the premiums collected, plus an "acceptable loss percent or amount". Only trade european style index options. Trade in accordance with fundamentals. And finally, the BIG Suggestion... have a dedicated account to a short straddle/strangle. Periodically transfer winnings from that account (i.e. 50% - 75% of winnings). Use this account as the "black swan event" account. Never leave more than the amount of margin required if the short straddle/strangle were to loose more than the stop loss threshold. If the market gaps past the stop orders due to a major world event (i.e. WWIII or some global financial catastrophe), then at worst it'll wipe out the account, which should equate to a loss that's no more than 3 or 4 winnings. Again, such a loss assumes that the stop loss orders fail because of a Major Gap. More often than not, the stop loss orders would get filled; therefore, keeping your losses at a managable amount. With such a risk management strategy in effect, then it may be feasible to use this strategy as a very effective part of your trading arsenal. If there are ways that can improve the risk mgmt and trade mgmt for this strategy, please suggest it. Or if I'm missing a major "weak link" in this strategy, please let me know. Utimately, a primary purpose of forums such as this is to help each other to become better and more successful traders, although some use it as a stage to promote negativity or to deceive others or to boost their ego. Hopefully, we can be altruistic with this thread by "building a better mouse trap". All comments and recommendations are welcome. thanks, Walt
1. I disagree with your approach but understand it. 2. I dont think you understand the ramifications of blowing out, they come after you for the rest of it. Its not like oh, you blew out and only had 5k in the account, well shame on us for not watching you!!!! 3. The return relative to margin req might be higher on the IC/IB 4. If you are going to go this route, try buying some wing puts and calls that are much much wider than a typical IC/IB but buying them on a ratio. Model it, I think you might like the result. Mark http:/www.option911.com
I like your idea about the ratio wings far otm; the issue with that is this... they are good for extreme calamities (i.e. the crash of 1987), but otherwise they wouldn't help in most market swings, such as a 300 pt move in the market (dow). Nonetheless, I'll model it to see how well it would perform under given scenarios. I don't think I would have to worry about them coming after me for "more than the margin", unless I'm trading futures/commodities. All they can do is liquidate my position if I don't have enough equity to cover the margin requirement. Why do you believe that a broker can seek to recover more than the account balance for an equity option short transaction? thanks for the feedback...
:eek: Sign me up for one of those accounts! Check your Broker's customer agreement. Joe. D. Liquidation of Positions and Offsetting Transactions: i. IF AT ANY TIME CUSTOMER'S ACCOUNT HAS INSUFFICIENT EQUITY TO MEET MARGIN REQUIREMENTS OR IS IN DEFICIT, IB HAS THE RIGHT, IN ITS SOLE DISCRETION, BUT NOT THE OBLIGATION, TO LIQUIDATE ALL OR ANY PART OF CUSTOMER'S POSITIONS IN ANY OF CUSTOMER'S IB ACCOUNTS, INDIVIDUAL OR JOINT, AT ANY TIME AND IN ANY MANNER AND THROUGH ANY MARKET OR DEALER, WITHOUT PRIOR NOTICE OR MARGIN CALL TO CUSTOMER. CUSTOMER SHALL BE LIABLE AND WILL PROMPTLY PAY IB FOR ANY DEFICIENCIES IN CUSTOMER'S ACCOUNT THAT ARISE FROM SUCH LIQUIDATION OR REMAIN AFTER SUCH LIQUIDATION. IB HAS NO LIABILITY FOR ANY LOSS SUSTAINED BY CUSTOMER IN CONNECTION WITH SUCH LIQUIDATIONS (OR IF THE IB SYSTEM DELAYS EFFECTING, OR DOES NOT EFFECT, SUCH LIQUIDATIONS) EVEN IF CUSTOMER RE-ESTABLISHES ITS POSITION AT A WORSE PRICE. ii. IB may allow Customer to pre-request the order of liquidation in event of a margin deficiency, but such requests are not binding on IB and IB retains sole discretion to determine the assets to be liquidated and the order/manner of liquidation. IB may liquidate through any market or dealer, and IB or its affiliates may take the other side of the transactions consistent with laws and regulations. If IB liquidates any/all positions in Customer's account, such liquidation shall establish Customer's gain/loss and remaining indebtedness to IB, if any. Customer shall reimburse and hold IB harmless for all actions, omissions, costs, fees (including, but not limited to, attorney's fees), or liabilities associated with any such transaction undertaken by IB. If IB executes an order for which Customer did not have sufficient equity, IB has the right, without notice, to liquidate the trade and Customer shall be responsible for any resulting loss and shall not be entitled to any resulting profit.
thanks... I stand corrected. I wonder if IB ever had to obtain a deficiency judgement against a client because the margin liquidation was not enough to cover the losses...
I know for a fact they have, actually. As a former floor trader, I know a couple of stories about guys having to sell their houses after the market going the wrong way on them. http://www.option911.com
I like this idea better. You have a de-facto straddle/strangle from a management point of view, but cheap insurance, a lottery ticket even, if there is a black swan event.
You do not have to buy them black swan wide. I think you will find that even 10 delta calls and puts can work well with this strategy. On top of that, I ALWAYS carry a few front month wings that are less than a 4 delta in the event of a major gap or black swan. I think you will find that you don't actually need them to end up in the money for them to work. http://www.option911.com
Thinking about this question myself. A few thoughts after playing around with some modeling software. Not having traded these, would appreciate feedback on these conclusions. Biggest advantage of the short straddle over the IC is that you can sell 10-20 times fewer straddles than ICs to get a similar payoff. The straddle also has half the number of legs. Much lower commissions for the straddle, and slippage should be less as the ICs require more options and the spread has a greater percentage negative impact for the far OTM options than the ATM straddle options. Makes it more feasible to trade straddles profitably on a shorter timeframe. The time-payoff profile of the straddle is fairly similar to an ~8% OTM (15 delta) IC at current volatility levels with 4-6weeks to expiration. Comparing a 10:1 lot ratio of IC (8% OTM) to straddles, the breakevens are similar but the max loss profile is more favorable for the straddle. For the IC, max loss occurs at 9% from initial, whereas the straddle would need to move around 14% from initial to result in a similar loss (mostly due to the 10-fold difference in options involved) . This difference gives you more breathing room to stay in the straddle and a more gradual non-binary loss profile. Converting the straddle to an iron butterfly by purchasing 10% OTM wings preserves the gradual loss profile and has about a 30% lower max loss relative to the equivalent IC. The IC has a slight advantage in terms of how rapidly the position becomes profitable and has a flatter profitability profile (helpful if covering before expiration). Since the straddle involves fewer options, it is more feasible to fully hedge with the underlying (could be complementary to a simultaneous trend following strategy on the underlying). Why trade the iron condor if the straddle (or iron butterfly) is cheaper and is arguably less risky at prices around the IC strikes? Many IC traders prefer to sell a greater number of even lower delta (<10) options- no equivalent with a straddle. There are some advantages of legging in and out of an IC compared with a straddle (selling one side of the IC is not as immediately directional as selling a single side of the straddle, also the losing side of the IC can be closed earlier for 90% profit than the losing side of a straddle). The straddle is about 2-fold more sensitive to changes in volatility in the first few weeks of the position. I big IV spike will hurt a new straddle position much more than the IC. The flip side is that a straddle benefits more from a fall in IV. My overall take is that something like an iron butterfly with <10 delta wings is less risky in terms of account blowout due to lower leverage, works well in non-trending stable IV environments, but is less amenable to directional bias and trade management (primary “edges” for retail premium sellers). Any of these net-credit strategies requires strong risk management.