I keep thinking more and more about straddles and strangles and am wondering if somebody out there has figured out a way to play these profitably, preferably, very short-term to avoid theta. Thoughts?
Back test them and observe for yourself. My observations is long straddles and long strangles as a systematic trade have negative expectancy. Short straddles and short strangles as a systematic trade have a slight positive expectancy. In my opinion, you need an additional edge to make the trades worthwhile. The tasty trade reports on this may interest you, however, you need to take them with a grain of salt, as they do not publish the actual details of their study (only some details are avail). For example, the magnitude of their findings may not be correct but the sign of the value seems correct (the decimal point should be in the correct place but the digits may vary a good bit).
I've read about the J Liz (Jade Lizard) strategy but that involves credit/debit spreads and I'd like to focus on buying straddles and strangles. This eliminates margin and you try to trade neutral and fight the Greeks for profit.
What do you mean by short term, trading time or time to maturity? Longer time to maturity options are more of a volatility play. Theta is a lot less than those with a short time to maturity. Sometimes near term maturity options can be a good buy. For instance, if a company has their earnings release close to the maturity of the options, like 2 days prior, The straddle value might not lose any value. The implied vols are bid up sharply and you basically get a free straddle for one or two weeks and any movement outside earnings related news is a bonus. This usually only works with stocks that move a fair bit on earnings release. If the stock usually moves 5% on earnings, the straddle value should be 5% of underlying as well until the event. And off course last Friday straddles would've worked quite well. European index straddles were about 6% of underlying the week/day before... and the drop was up to 12%. That's 100% return.
I typically hold options for just a few days. Most times I guess the direction correctly. But then there are days where I would've made money on the other side. Talked to a few people and it seems like there are traders who only trade spreads. I would like to master straddles and strangles before moving into butterflies and condors.
I used to buy Straddle when IV dropped significantly. You have stocks every weeks with IV close to zero. Didn't experiment long enough nor backtest it. After a long & slow draw it turned positive. They were all 2 months till expiration. But sometimes I closed manually.
You Always need an additional edge, or skill, in trading the market -- the marketplace is not an ATM for no one. For most people, they might as well be playing at a casino in Vegas...atleast, it's more fun to lose there. ...just some food for thought
I went from 5K to 30K in my first 6 months trading straddles. These were outside of the US tho. I don't think my strategies would have worked for US stocks. One of the good things about them is that you don't have to guess direction. Which is why I traded them. I was paper trading and I wasn't able to get direction right so I figured why not buy both the calls and puts. I don't recommend the weeklies if your a buyer.
Of course can they be traded profitably. I have traded Asian index option straddles for years. Like with any asset in the end you need to have an edge and execute sound risk management. Professional vol desks trade straddles all day to trade gamma and Vega. They buy relatively cheap contracts and sell relatively expensive contracts and hedge other Greeks. Smart vol traders collect theta even when they are protected at the wings. The key here is that you need patience and trade a larger book and be open to constantly re hedge. As this costs larger volume can really push down execution related costs. At times my biggest risk in my index option book was not specific Greeks but fx exposure through my generated pnl in currencies that are not easily convertible. I remember that Korean won ndfs can fluctuate widely and that it sometimes messed with my realized pnl quite a bit in between hedges. Also rolls in futures came into play as quite a number index options have as underlier futures not the index itself. A lot of otc index options between dealers are traded delta hedged which involved positions in the underlying as well already at the outset of the trade but at latest when delta hedging or trading gamma. To play this professionally you need a well thought out setup. I am not sure it is doable in retail space as listed options are most of them time fairly priced, if not then they compensate through very wide spreads. There were times i made 100-200k a day risk free because broker dealers mispriced the ivols especially at times of high volatility and i simply arbed brokers against each other. That did not make me too many friends in the broker space but can still be done if executed intelligently and when one can obfuscate trading intentions to brokers by asking for two way quotes or the like. Just sharing my previous involvement with index option straddles.
-- you are actually trading vol so if you are able to identify mispricings of vol, you can do very well -- obviously, vol is structurally rich so you would be almost always tempted to be a seller of straddles -- risk management and understanding of value would be as important for buying convexity as it is for selling it -- IMHO most interesting stuff is on the long end were you can actually play games surrounding supply and demand rather then having to predict outright moves