So i did backtest on the S&P500 buying ATM calls and puts and selling on the 3rd friday of the month and found the long straddle strategy is generally quite unprofitable even in times of high volatility. Don't know whether this was just a fluke or what, but just wondering what people's experiences here are with reacting to high volatility with long straddles? Or should I not be looking too much into these backtests?
When volatility is high straddles are priced relatively expensively based on implied volatility so the premiums are relatively inflated and you could also lose money on vol crush. Most people ignore the greeks but understanding them explains a lot how options work, especially IV.
Read books by Jeff Augen and William Gallacher. Make sure you are modelling your backtests correctly. IV Trade here at ET has great insights on them as well.
IMHO: I don't understand why you would think Long Straddles would be profitable an any volatility environment. -- If you flip your back test to short straddles, I think you will observe a slight profitable edge (given adequate sample size).
Check out "long put synthetic straddles". It more or less neutralizes the vol crush. If anything you want some vol, because you're looking for movement. Works best with the puts of the underlying at $1 increments, must be liquid, and keep the spread between the bid/ask below 4%. Go out between 60 and 90 days, so theta doesn't eat you alive. And last but not least, start your puts out as close to -50 deltas as possible . Your buy in has to be 200 shares to 4 puts, or if you can get a .01 or .02 slippage on the puts, go for 400 shares to 8 puts, for it to work correctly. If your underlying takes off either way, buy more to keep it delta neutral and lock in profit or just close it out. If nothing happens in your SMALL time frame, which is quite often, just close it out and eat tiny money. If you're like me, and don't like short selling, this is worth a look. Good luck
Below is a reply I made last Sunday in the SPY put wkly diagonal itm debit spread thread. Both the buyers and sellers of the ATM 206.50P/207.00C weekly strangle would have broke even. But the sellers held much more risk than the buyers during the week. SPY closed the week at $204.50 IMO ..... the above results would be a typical week. And of course there would be rogue weeks throughout the year that severely impact the results. Good for the buyers, bad for the sellers.
Of course it's not as simple as that -- nothing is. You will quickly learn that trading is an art and science. You think you will be a money printing press as easy as this...
jones75, how would the synthetic put straddle be relatively immune from vol crush? The Pnl profile is the same as long 1 call long 1 put...Thanks.
Think of it this way. If it was a regularly profitable strategy, why would anyone ever sell options? It would always be a losing proposition. Hence the price of options increase until that is no longer the case. As it is right now, it'll be generally a losing strategy unless there's a black swan event (which benefits the buyer).
Take ER for a minute; just before the announcement the stock is trading at $50 and then the news comes out. $50 stock drops to $45. Your puts vol may drop for a few moments only, then the vol starts to escalate and the further the stock drops the higher the vol. And if you're unfortunate enough not to see the vol drop, the rising delta will more than cover you. And if the $50 stock escalates, you're unaffected by vol, which opens up the possibility of bringing your trade back to delta nuetral and locking in profit.