10-Delta Short Strangles

[tayte]

Its been a period of very supportive central bank policies. In the long run though, its highly likely to underperform against SPX buy and hold, especially given the credit risk youd have to take with single names, see the cboe short strangle benchmark comparison:

https://www.cboe.com/us/indices/dashboard/SSTGK/

 

[Magic]

That did NOT look good and I did panic, but then I said, "Wait a minute... Spot is 215, well between the short options, so this thing hasn't lost real money yet, should I really get this excited right now?"

Should you get excited? Don't make emotional decisions outside of your trading process, but otherwise unequivocally yes. The REAL value of your account is now less than it was before trade inception. The REAL fair value of the options you're short is now much higher. The distribution of your PnL from here into expiry is much wider. The notion that you didn't lose real money is very naive although common among beginners. The fact that this strike once had a ~10% chance of ITM expiry (given several mediocre assumptions) has no relevance at this point. Things changed since then. Think about it, if spot is sitting at or near your call strike, does the historical delta of this strike at a random fixed point in the past have any bearing on whether price is more likely to go down vs up at this point?

Basically you have gotten levered into an adverse event and you are hoping for mean-reversion to bail you out. You are engaging in a martingale. And over a long enough time horizon this will eventually blow you out. If you can make the distinction between what decisions like position sizing, hedging, etc, are just changing the shape of the distribution of your future PnL vs. which ones actually increase mean PnL that will be a good realization.

Was that gamma?

Among other things but yes. Higher gamma causes your delta position to change more rapidly in the face of price movement. How much does a 5 delta call go up in value given a +$1 change in spot vs. a 50 delta call? On these things having a large delta position is ultimately what is going to cause you the biggest losses. If it helps think of the notional value of the amount of shares you'd need to cover your delta. The position gets bigger relative to your account and produces more $$ of variance. You need to ask yourself how much variance you are holding to collect what expected PnL. Try to optimize this ratio.

"The negative skewness on this PnL distribution is awful."

Skewness being the third moment of your PnL distribution. Imo there's no fixing it for trades like these. One of the first traders to give me good advice when I was starting told me I was blinded by my ego and I needed to have empathy for other market participants. So I am always asking myself who is on the other side of my trade and why. If 10d strangles are overpriced, who keeps buying them? If they are bleeding money so rapidly why haven't they run out of capital yet? Understanding what role you're playing within the grand scheme of things can be helpful for structuring trades.

In the last sentence are you thinking that I'm actively looking for advantageous strikes, or that 10Δ just kind of puts you a good neighborhood to happen upon those?

If the underlying realized the same volatility as the implied volatility of a strike it's expected value would be zero, subject to variance from how price paths over the life of the option. If you trade shares continuously to offset your delta, you would suppress this variance very close to zero. Hedging is essentially a replication of the option in the opposite direction.

If you are selling options with no concept of what implied volatility you are shorting and no sort of idea of what the underlying will realize; you are not trading optimally. Think about it, you are essentially trusting the market to highly accurately price these things over fair value, but also to be inefficient enough to leave an opportunity for rapid compounding of capital in a very high capacity environment? At least have a conception of whether volatility is rich or cheap. At the very least you will be able to avoid marginal trades and size up bigger on the best ones.

It's good that you are trying to learn and have dialogue. You will likely learn faster if you just start trading with an amount of capital you can afford to lose. Over time you will start to notice things you never even thought of asking, like correlation of strategy PnL to macro regimes or something. And it's probably easier to discuss individual trades with someone who was following the same instrument.

Long chats about theory are nice sometimes but it's practice that is going to have you coming back to a post like this in a year or two and seeing there was a lot of concepts that went completely over your head because you didn't have the context to understand them, even though you though you understood what was being said. At least that's been the case for me returning to content from guys who are better at this than I am.

 

[caroy]

This would limit your max loss. In the end this actually is an ATM butterfly, and it’s one of the most common trades utilized by pro traders due to the max profit per dollar while having limited risk

amen

 

[Theinkdon]

Wow, you guys are AWESOME! I woke up this morning to see 9 new posts on this thread, and long, MEANINGFUL ones too. I really appreciate everyone's input and will endeavor over time to try to understand all the concepts put forth. Rather than answer everyone individually I'll use this one post to respond to the themes raised.

Magic said I'll learn faster when I start trading real money, and I totally agree with that. I have the TDA margin account set up and about 7k of "play money" to go in it, just waiting to be approved for Tier 3 options. I can re-apply mid-August so hopefully by Sept I'll be trading real dollars.

JSOP talked about ToS paper-trading generally be "rosier" than real life. I don't know though. I have real accounts at TDA (2 ROTHs and the new margin acct) so I can look at the ToS screens side by side, paper vs. real. It's Saturday and markets are closed, but looking at the CLF 23Jul option chain everything looks identical. And this hypothetical trade looks the same in both:

Now whether you'd get the same fill price, THAT'S the question! Or if you tried to sell more strangles than there was Open Interest and it just gave it to you.
Tbh, this part of it doesn't concern me much because I gotta believe they've tweaked the model to pretty much run like the real thing. And even if the PM side is a little bit easier of a game to play, if a system is making 100% in 3 months, then even if you cut that expectation in half it's still huge.

What REALLY concerns me is if Buying Power Effect doesn't act approximately the same. Because if its much higher for a given trade using real money then that would blow my ROI calcs and performance all to hell. BPE for the simulated CLF trade is 199.80, but I can't check it in the real account because the trade is illegal there.
HEY! Can someone set this trade up in their TDA/ToS Tier 3 account and check that??
Because that's what I ran into when I compared some trades in my TastyWorks supposedly "unlimited" account to ToS PM: TW was holding 2 to 3 times the collateral. This strategy would still work in those conditions, but I guess it would be 2-3x slower and not nearly as exciting.

tnatrader said:
"The big issue is gaps. If there's a big gap, good luck rolling since it's mostly intrinsic at that point. It's not as easy as it sounds to be diversified either. If there's a big macro event, all these tickers move in tandem. That's not to say there's no merit in this kind of system. Since it doubles so quickly, maybe just put 10k in and pull out money as quickly as you make it, you're basically playing roulette betting that IV will swamp realized vol. If nothing else, at least it's fun."​

Not a gap per se, but I think I survived this huge runup in AMC by rolling:

The bottom of the initial trough was May 21st at about $12. I just happened to put on an AMC SS that very day! The peak was June 2nd, 7 trading days later, at 62. So it ran up 500% in about a week and I think the trade still came out profitable. I say I think it did, but 1) maybe I didn't understand everything at the time (and intra-day negative margin did get pretty high at the end), and/or 2) it was PM and might not have acted like it should've.
I've attached a writeup of that experience as a pdf if you're interested. Beware, it's pretty long. The first 2 pages are from my daily journal, but then it got so hectic that I stopped tracking it in real time and did an after-action report (still not quite complete) I called "My AMC Saga." So there's some overlap in the Saga of the journal.

Most of these tickers do indeed move in tandem. I'd seen that before in the first 10Δ SS campaign, and then Wednesday of this week, when 12 of the approximately 20 symbols I had trades on all went down 5 to 12 percent, even though the markets were essentially flat. But even though it was a bad day for those stocks, the account was only down 6.4% at EOD, and started making that back Thursday.

Your point about putting 10k in and taking money out as fast as I make it is EXACTLY what I've been thinking. I turn 58 in 4 days and I WILL retire at 62, but ever since I was 50 I've been thinking of how I could retire earlier. So naturally when I started seeing these kinds of results I got to thinking, "Hmmm...." (Now before anyone says not to do this with my retirement money, I won't. I have a small annuity from a previous job (just 5k/yr), will have Federal government retirement, plus Social Security when that time comes. And between my wife and my TSP, 401(k), & ROTHs, and the equity in our house we're doing pretty well.)

But just imagine doing this with just $10,000 (assuming the long-term performance holds up): that's an extra 3k a month in pure play money. Right now we cruise and/or fly to a resort at least twice a year, and at the prices we're paying that 3k is almost 2 of those trips PER MONTH. Or splurge and do the higher-end cruises we don't currently do. Want to fly to Italy or something this month? Go ahead! And next month Greece, maybe Egypt and the pyramids another month. Want to buy an old Corvette to tool around in? Save that money up for a few months and buy it! And don't get me started on what you could do with 20k or 50k seed money. But I need to stop day-dreaming, keep plugging away at the system, then see if it plays out with real money. But you're right, doing this is very fun!

You and others mentioned Implied Volatility vs. actual/realized. TT has a lot of material on that, and I've done other reading that leads me to believe it's probably true, which of course is what makes selling premium work. If this keeps working for say 2 or 3 years, would that tend to prove that implied vol is indeed greater than historical most of the time?

guru, thanks for your additional thoughts on probabilities. I realize it's just a snapshot in time, and especially with the memes doesn't have a lot of credence, but as I transition away from meme stocks to 'normal' stocks I would think that probabilities would start to mean more because of the lack of these outside influences like WSB. I spoke to that some in my "AMC Saga" attached, and for a great illustration of it, just lay the 6-month CLF chart on top of AMC. You can clearly see the WSB influence in AMC, but I don't think at all in CLF.
And I know you're right, it's fear that's priced into these options, and I'm starting to think that selling them is generally the right side of that equation to be on.

Whew, this has gotten long, and I think I'm only halfway through all the great points people raised. So let me end this post here and come back later with more.

Thanks again, I'm really enjoying this discussion!

 

[qlai]

Hey, nice thread.

TLDR: High IVR stocks with at least 2M volume and weekly options, short strangles with legs at 10∆, 5-10DTE, take profit at 50%, roll untested legs up/down as the other side is challenged, to a straddle if necessary but not inverted. Roll out a week if it can't be saved otherwise.

The above sounds like Tasty Trades, but how did you get to below? Don’t they preach to “trade often, trade small?”

always trying to stay almost 90% invested. I know that's too aggressive,

If you have small account, leverage it up, and take profits out, what will you do when there’s margin call? Will you put money back in?

Your point about putting 10k in and taking money out as fast as I make it is EXACTLY what I've been thinking.

 

[guru]

You and others mentioned Implied Volatility vs. actual/realized. TT has a lot of material on that, and I've done other reading that leads me to believe it's probably true, which of course is what makes selling premium work. If this keeps working for say 2 or 3 years, would that tend to prove that implied vol is indeed greater than historical most of the time?

This should logically work when implied volatility is high (many options screeners and brokers display the IV rank), so there is nothing to prove as it's common knowledge. Pro traders do sell high/expensive volatility, but this doesn't mean taking extreme risk.
On another hand, the statement "implied vol is indeed greater than historical most of the time" is not true without context, because many pro traders also utilize gamma scalping, which means buying volatility when low (as straddles) and profiting from realized volatility when higher.

 

[Theinkdon]

Let me end this post here and come back later with more. Thanks again, I'm really enjoying this discussion!

guru, I think you first mentioned ATM straddles, and yeah, I've looked at those a lot too. When I first saw them on TT I didn't care for them mainly because of their 'peakiness'. On a gut level I prefer the wide profit plateau of a 10Δ strangle, but your "max profit per dollar" argument makes me realize I need to look at that harder.
You then segued into ATM butterflies, which caroy seconded, and JSOP brought up Iron Condors. IC's I've done a lot of, and I'm not conversant yet with Long Call Butterflies and Long Put Butterflies, but I've been playing with Iron Butterflies a bit.
I read something maybe a month ago about "lotto" butterflies or "lotto flies," have you guys heard that term? I guess it's just an ATM Iron Butterfly on a high-IV stock like GME with the tightest-possible stops, where the inflated option prices make it very cheap to buy and the payout ratio is like 8 or 10 to one. I've done maybe 10-20 of these on GME and AMC in recent weeks and I don't remember any of them losing money.
JASOP mentioned that you can sometimes get "free arbitrage opportunities" in ToS PM, and this is a prime place to see those. I've seen them, where the fly prices out at no cost, but I haven't been able to get them filled. I've had to adjust my bid until there was some cost to it, but I can't speak to how they would fill in a real-money account. Just thought I'd mention that.

Magic, your reply to me about gamma and it not being a "real" loss was perfect. In fact, it was so perfect that it's the very same argument *I've* used against the stupid maxim that "it's not a loss until you sell!" Right down to "the REAL value of your account" is less than it was. So thanks for the check-up on that, I won't be so blithe about it in the future.
Your discussion too about who's on the other side of these trades is great food for thought, but I have some questions about that. When I sell a short strangle, that's what it looks like to me I'm selling. Obviously. But on the other side of that trade does it look to "them" like they're BUYING A SHORT STRANGLE? In the old days where it was people in a pit or a Market Maker on a terminal (forgive me if I'm butchering terms and concepts), then yeah, I guess they would "see" the strangle as a bundled trade. But these days aren't there mainly just computers on the other side of our trades? I'm guessing that the computer just sees a short put and a short call and doesn't know or care what kind of overall trade they're a part of. It's really just an academic point I think, but am I way off base on that? I do agree that it's a good idea to think about why someone would take the other side of the trades you're offering.

Lastly for me right now is this gold nugget from Magic:

"Long chats about theory are nice sometimes but it's practice that is going to have you coming back to a post like this in a year or two and seeing there was a lot of concepts that went completely over your head because you didn't have the context to understand them, even though you thought you understood what was being said. At least that's been the case for me returning to content from guys who are better at this than I am."​

So, so true. I had been reading and reading and reading books, articles, forums, watching videos, etc, and while I was learning a lot, I knew the real education would come from trading real money. So when I found out that there were these simulated trading accounts, I jumped on TDA/ToS and set 2 up. (I knew about trading simulators from back in the day for stocks, but I didn't know how sophisticated they are now and that they do options too.) There were a lot of trades before that got me to where I am now with this strategy, and now that I've seen success with it I'm going to keep running it in the sim to see if it's repeatable AND for the sorts of learning opportunities we've discussed here to show up.

But my REAL goal is to be doing these 10Δ short strangles with real money. If it transfers well then I want to use it to supplement my retirement, and even teach it to my grown kids so they don't have to work all their lives. So you can bet I'll keep at it, and I'll keep posting my progress here. I'll share the good and the bad and will let you all know if it keeps working or if I give up on it. I'm not married to this strategy (but admittedly I AM excited about it), nor did I invent it, but I'd like to see other people try it and either confirm that it seems to work or doesn't.

And btw, if you're put off by the "100% in 3 months" thing, I get it. I still can hardly believe it myself, and I'm the one who did it. It's going to be hard for anyone used to 20%/yr being a good return (that would include me) to believe it's even possible. But try the strategy at lower rates of return and longer DTE on "normal" stocks. I suspect the results will still surprise you.
Thanks, all.

 

[caroy]

You then segued into ATM butterflies, which caroy seconded, and JSOP brought up Iron Condors. IC's I've done a lot of, and I'm not conversant yet with Long Call Butterflies and Long Put Butterflies, but I've been playing with Iron Butterflies a bit.
I read something maybe a month ago about "lotto" butterflies or "lotto flies," have you guys heard that term?

You could take some of your premium collected and buy cheap OTM put and call flies that are pretty wide below your put and above your call. If you have a runaway stock you could end up with lotto like profits but this would work better on high priced equities like AMZN and you'd need around 40k in buying power to put on one 10 delta strangle. You've inspired me a bit. I've looked at going live on monday with a 5 delta strangle in AMZN but I'm a fly guy so I'd buy a 100 pt wide lotto fly above and below with some of the premium collected. I'd look to exit the strangle in a day or two at 50% and leave the free flies on. Earnings end of the week in AMSN who knows. I will think about putting this on over the weekend for Monday morning.

 

[Theinkdon]

Hey, nice thread.

The above sounds like Tasty Trades, but how did you get to below? Don’t they preach to “trade often, trade small?”

If you have small account, leverage it up, and take profits out, what will you do when there’s margin call? Will you put money back in?

Hi, qlai, welcome to the thread! You're right, a lot of the concepts I'm using are from TT, but when they say "trade small, trade often" I take that to mean small position size, which is where I got 5% from (don't they say 3-5?). But the other part of "staying small" I think is that you wouldn't want to do something like this (or even just do all options, or all stocks), with ALL of your available capital, so I wouldn't do that. In the post I was writing when you posted this I said that our net worth was pretty high; not 7 figures, but on up there. Given that, could I see putting aside 20k or even 50k doing something like this? Absolutely. That's small enough relatively speaking that even if I lost it all (I shouldn't) I'm not going to be bankrupt (because I'll still have income from pensions and SS).

When there's a margin call what would I do? I'm still learning about all that, but don't you actually have 2 or 3 days to "square up" with the broker? You can do a lot with the position, or other positions in 2 days. In the simulated accounts what I've done is closed other (hopefully profitable) positions while I've finagled the misbehaving trade. That frees up BP/margin and so far has been enough to get the account positive again. Would I put new money in to essentially "save a trade"? I like to think not, that I'd just take that loss and move on, but I can't honestly answer that right now.

Do you do short strangles by chance?

 

[qlai]

That's small enough relatively speaking that even if I lost it all (I shouldn't) I'm not going to be bankrupt (because I'll still have income from pensions and SS).

Right, I got that prior to asking my question. The reason I asked is because saying that you will only allocate small amount is a bit misleading, imho. Once you get used to that “income” coming in, it is hard to stop. So you will likely keep putting new money in when that margin call comes, because you know that the probability of you getting out at break even or a profit is very high. That’s how it sucks you in.

Do you do short strangles by chance?

I do opportunistically only. I prefer to play smaller but getting higher premiums like ATM with undefined risk. Small means I would be comfortable to take assignment on the stock either long or short (that means higher quality stocks). I think it’s very much what TT preaches although I only know them from free YouTube content.

That being said, I don’t sell any premium in this low vol environment and with stocks at levels where I don’t want to be either short or long really.