20-Delta Short Strangles

[MrMuppet]

I'm hoping the OP is viewing this account as pure risk capital with being willing to put such a large percentage of the accounts value into play each week. I'm guessing blowing out a sub 50k account won't have much of an impact on his retirement plan and lifestyle. I dated a divorce attorney once. (not something I'd advise). Anyway she mentioned in financial discovery the only people who ever had any money were engineers and accountants. Everyone else seemed to live the all dash no cash over leveraged middle class dream. I think this strategy can be successful but I think the blow out chances are high as its too much capital utilization.

The problem is the fact that people like OP view this kind of strategy as "income" to boost their earnings during retirement.
It can work out for many years, you add more risk...because it has worked pretty well, right?
Then you'll have a vol event and lose everything.
Selling naked options is NEVER a good strategy, especially not for retail. I mean, I do it but I'm glued to the screen 24/7 looking to square off my naked vega.


Read this, folks. Sums up short vol pretty nicely.
https://volquant.medium.com/epic-failures-lessons-from-volatility-funds-blow-ups-6f4226c8334f

Lesson number one in vol trading: Never ever short the tails!
If you want to be short 5k vega and you have the choice to sell 5k vega outright or sell 20k and buy 15k tail vega, always take the later

 

[MrMuppet]

To all, thank you for your feedback, sincerely. It correlates with a lot of the advice I got in my first journal (which I don't think any of you were on), but a new point or two was also raised. I'll be happy to engage in discussions throughout the course of this experiment, but mainly:

Let's first see if it works, without pre-arguing to death why it shouldn't/won't/can't work. I don't mean that to sound harsh, but I came to the Journals section to document an experiment, not to ask if it should work or not. I know that the conventional wisdom is that it "can't" work, and maybe this experiment will prove that. Or maybe it'll show something else. Regardless, I'm committing to posting all my trades, adjustments, and EOD balances. (If it fails, everyone will believe it, but if it succeeds no one will; I can't help with that.)

I'm pretty confident it can work after trading it for many, many months over and over with both 10∆ and 20∆ strikes in TDA paper-money accounts. I know, "It's paper money, it's not real, you get better fills, etc," but other than the margin requirements, I think it does trade pretty close to "real," because I was trading our Roth IRAs right alongside my PM trades, often on the same symbols (ICs & PCSs), and they seemed to fill, act, and close the same.

I've learned a lot about how short strangles act, and traded through some pretty gnarly drops and rallies (single stocks, not market-level events), so now I'm ready to try it with real money.

I appreciate the advice to not "blow up," but I'm only doing this with ten thousand dollars. Our net worth is north of 700k, but even if all that were gone, I'll still have a 20-year Federal retirement when I'm 62, plus Social Security a few years after that. So I'm going to be alright, but I appreciate your concern. But *IF* this works, would I scale it up? Absolutely. How much, I don't know; maybe 50k? If you could double that in a year that would be some nice play money.

And I've seen bear markets. I was one of the "geniuses" in 1999 & 2000 who could do no wrong, and I lived through 2008 with quite a bit more capital than I had in 2000. And I like the prospect of short strangles for even a bear market because of their non-directionality, but that'll have to remain to be seen.

As for my naivete in making these picks, I fully acknowledge that. But you know what? I'm tired of putting a lot of effort into researching a stock, buying or shorting it, then watching it go the other way most of the time. If blindly choosing a high-IV stock and selling way-OTM options on it "works", then I'll take that over the other way. That's what I'm out to prove or disprove here: whether it "works" or not.

To the point of "probability ITM" being just a snapshot in time: of course it is. But is there a better place to start? Cash Secured Puts are considered a beginner strategy and I'm sure everyone here is familiar with them. Say I sell one on whatever stock at 20∆ (using delta as shorthand for Prob.ITM because it's easier to say and type). If the stock's price goes down, the option's delta goes up, sure. Heck, I might even use its delta to decide when to make an adjustment to the trade. I've never said that I expect my trades to maintain an 80 or 90% chance of being OTM all the way till expiration, I've just found 10 or 20% to be a good place to start. And with the ability to roll the strikes of a SS, just like you can roll a CSP, I've found that they're just as easy to manage.

So yeah, that's the point of this journal: short strangles on blindly-picked high-IV stocks and let's see how they do. Comments on my trades or their management are most welcome. Any feedback on how to tweak the strategy are especially welcome. And if after a month or two of following this (assuming it works), if you try it yourself please share.

Take care,
Mike in Atlanta

Look, it's always the same with guys like you. Nobody here says it won't work. It will until it doesn't. You have zero experience with trading options aside from using them as a proxy for spot aka. "I'm betting that the stock won't go there at expiration"

Read the link I've posted above and you will see that people with many more years in the business did the same stuff and all came to the same end: Busto

I have nothing to add here...I'm in the business for almost 20 years now and I've met literally 100s of people who tried to do the same thing in various forms: Selling cash covered puts, "the wheel", straddles, strangles
And everyone thought they could "manage" the position. On the top of my head I know more than 30 people who lost everything. One exploded in Bunds, the other in Eurostoxx50 options, many in DAX30 Options, a couple in SPX.

And they all started out like you: Yeah, I'll try this small and see how it works. They make money 8+ months in a row and get lured in by how easy this is. No guess work, no charting, no timing. Just sell the 20 deltas because "probabilities" (lol, I'm not getting into this one).
They up the risk at the end of the economic cycle and when you start talking to them after a 10% dump in the equities they tell you how glad they are they sold their Porsche because "it's not a thing anymore, right"


Good luck my friend, good luck

EDIT: There is no need for another journal of naked short selling. There are many here on ET and they all have the same ending. It's getting boring.

 

[qlai]

Read this, folks. Sums up short vol pretty nicely.
https://volquant.medium.com/epic-failures-lessons-from-volatility-funds-blow-ups-6f4226c8334f

"I would like to argue that short volatility is a profitable strategy, IF DONE RIGHT." What a conceded view but I hear it all the time. So you are saying all those professional money managers were idiots and didn't know how to diversify and use leverage!?

I think the only way to do it "right" is do it so small that it doesn't even matter IF blow up happens. It sounds like what OP is doing, so I'm looking forward to following this journal.

 

[MrMuppet]

"I would like to argue that short volatility is a profitable strategy, IF DONE RIGHT." What a conceded view but I hear it all the time. So you are saying all those professional money managers were idiots and didn't know how to diversify and use leverage!?

I think the only way to do it "right" is do it so small that it doesn't even matter IF blow up happens. It sounds like what OP is doing, so I'm looking forward to following this journal.

The only way to do it is not to do it. If you trade so small that a black swan doesnt matter, you might as well invest into treasuries at 1.2% p.a.

Look at the article, doesnt seem like the guys were idiots, right? LTCM, Alianz, Malachite, Citadel...idiots, I don't think so. I'm sure they are 100x more sophisticated than OP who admited that he's just too lazy to do his homework to pick and time the right stocks.

But if you decide to sell insurance on a nuclear powerplant you have to deal with the consequences. It's just the nature of the strategy

 

[qlai]

If you trade so small that a black swan doesnt matter, you might as well invest into treasuries at 1.2% p.a.

Well, the idea (not insisting it's a good one) is that if you trade small, you can wait it out. All of the blow ups in that article is because they were too big and couldn't hold on to the positions. That's the irony of this strategy - If they only had more time, they would make all the money back and more. Melvin Capital comes to mind - got bailed out and still considered a great money manager.

 

[caroy]

Well, the idea (not insisting it's a good one) is that if you trade small, you can wait it out. All of the blow ups in that article is because they were too big and couldn't hold on to the positions

To this end if one had only one 20 delta strangle on and was well capitalized they could manage rick by shorting 100 shares when it crosses the short put or buying 100 shares when it crosses the long call if they had the buying power to do this. Whipsaw then becomes the risk with the price of the underlying but it would in theory prevent blowout catastrophic risks.

 

[Theinkdon]

MrMuppet, thanks for that article, very interesting. Also for your own words on the matter, from which I learned that I'll need to be mindful about scaling this up, going "all-in" if you will, and blowing up like the 30+ people you know of. But I'd like to quote you and the article to point out a possible difference between them and what I've been doing.

You mentioned people shorting "Bunds, Eurostoxx50, DAX30, and SPX." To be honest, I only maybe 'know' SPX (I do know that DAX is something like the German DOW). The article mentioned, "equity indices volatility arbitrage, long dated variance swaps, a variance swap relative value strategy between the Nikkei and I guess the Korean index, the commodities natural gas and crude, variance swap cap selling, synthetic forward variance spreads," etc, etc. I understand almost NONE of that stuff, but those aren't the instruments I'm using.

Is it just *maybe* possible that a small-time retail trader could sell strangles on good old-fashioned STOCKS, observe them, figure it out, tweak it, not get too cocky, and just possibly turn a consistent profit, all without "blowing up"? That's all I'm looking for.

You said that *I* said I'm too lazy to pick & time the right stocks. I didn't; I said I was tired of my research/effort being for naught when the stock went the wrong way. Maybe I'm not GOOD at picking stocks, I'll give you that, but I'm far from too lazy to research/learn about stocks, funds, ETFs, ETNs, options, etc. I've had some good picks across most of those asset classes over the years: the Matthews China Fund (MCHFX) doubled for me in 10 months in 2007, the ETF SILJ doubled in 4 months in 2016, and PLUG quadrupled from Nov2020 to January. Just some I tend to remember, and to say that maybe I know a little bit about how these things behave. (But betting the Nikkei against the DAX or something, forget about it.)

You pointed out that I use delta as a proxy for betting that "a stock won't 'go there' at expiration," and granted, I do. Learned that from TastyTrade, OptionAlpha, and probably others. How do YOU use options? Are you only ever long, betting that the stock's price WILL "go there"? I've tried long options and found that I don't like that I have to be right on the price AND the timing. By selling (a Put for example) I feel like I benefit from the oft-repeated, "You profit if the stock goes up a lot, up a little, stays flat, or goes down only a little." The classic "win 4 out of 5 times." I know it's simplistic, but I like it. I think because it resonates with my risk/reward psychology.

And watching short strangles play out doesn't seem to me terribly different than watching a stock's price move around. There's amplification of course from delta and gamma, and probably some other Greeks I "should" know about. But if you can see support and resistance areas on a chart (that's as far as my belief in Technical Analysis goes), and you validate your prospective strikes against them (i.e. the stock shouldn't "get there" in the trade's time horizon), then it seems pretty, I don't know, "affirming" I guess. So if I stick with what I at least kind of know (stocks & ETFs) and don't get exotic, can I get into a lot of trouble?

ET may not need another short-selling journal, but I didn't find any where people were strictly selling strangles, which is what I'm most interested in. And it was only because I wanted to talk to other people about this, and see if anyone else had REALLY tried it, that brought me to ET in the first place. I made a blog, but it didn't get any traction, so I went to Reddit, but after a few days your thread gets buried and no one comments anymore. I'd read enough on ET before this to know that a bunch of you are real hard-nosed options traders, so when I then found the Journals section of the forum that sealed the deal. I got a lot of great challenges, feedback, and dissuasions on my first start in July, but now I'm back with real money to prove if it can or can't be done.

I'll never win the "CAN be done" argument of course, because if I do it even for a full year people will just say I didn't trade it through every single type of market condition that's ever existed. Or the corollary: "It works until it doesn't." (Thanks for saying that, btw, I was waiting for it.) EVERYTHING works until it doesn't, right? Does that mean we should never try anything new, or try something AGAIN that maybe worked at one time?

But if it DOESN'T work I'll dutifully report that too, with trades and screenshots all along the way. And you can have second dibs (behind JSOP, who was first to tell me not to do this) to say, "I told you so."

So to anyone who's already told me this won't work, or who still wants to, keep the comments coming and I'll dutifully reply to the best of my limited understanding. But for the most part, maybe give it a month and see what it's done. If the account is up a lot, then maybe start wondering why it seems to be working. And if that turns into 6 months and then a year.....well, just keep an open mind, that's all I'm asking.
Mike

 

[Theinkdon]

Day 1 Update Monday, 8/23/21

Off to a great start, lost $27 AND negative margin!

• The margin I'm not worried about, they just haven't credited me the margin yet for the 5k I put in over the weekend.
• The 27Aug APPS 45P/52.5C trade went in at 0.90, Sunday's Nat price. BPE was 614, so I call ROI: ($90 - 1.30 commission) ÷ $614 = 14% if held to expiration. But the BTC order will close it at 50% profit.
• The staged CLF trade didn't go in because there wasn't enough BP after APPS. So I cancelled CLF.
• The one troublemaker was PDD, which I put on Thursday 8/19 as a 60/85. Friday the price was as high as 81 before closing at 77, so I rolled up to 70/85. They beat earnings this morning and rallied to 81 at the close, hitting 82+ AH so far. But the Call strike is at 85, plus I have 3.04 in credits, which makes the upper breakeven (BE) about 88.

 

[Theinkdon]

"I would like to argue that short volatility is a profitable strategy, IF DONE RIGHT." What a conceded view but I hear it all the time. So you are saying all those professional money managers were idiots and didn't know how to diversify and use leverage!?

I think the only way to do it "right" is do it so small that it doesn't even matter IF blow up happens. It sounds like what OP is doing, so I'm looking forward to following this journal.

qlai, welcome to the thread, and I'm glad you'll be following along. Have you ever concentrated just on strangles?
I saw that quote at the end of the article too and thought, "Well wtf!?" I'd started the article thinking the author was against short volatility, but maybe that was just a preconceived notion from how the article was presented to us.
I'm definitely staying small, but I'll tell you one thing I don't like here on ET is people either assuming you're going all-in on one strategy (and thus will "blow up"), or they go to the other extreme and tell you to (or assume you will) go zero-risk. Like there's no in-between, no diversification of products and strategies. It's not on/off, 100% risk or 0 risk, there are so many gradations in between.
And your observation about if those fund managers had had more time they would've made all the money back and then some, I think that's spot on. I've seen that time and again trading paper money, where a short strangle is showing a loss of 2 or 3 times the credit taken in, but the stock price is still between the strikes. Don't get me wrong, that's the nature of options and not something you can argue with, but the first time it really happened to me I was like, "Wait a minute, why EXACTLY is this thing underwater? It's staying between the strikes I chose, so if that remains true then it should come out profitable in the end." That's when you need capital in reserve so you don't get margin-called, and/or be willing to close other positions to free up margin.

 

[swingtrader123]

Your strategy will work provided you use a stop loss on your open positions. I do something similar; I sell 45DTE strangles with 85%OTM and use a 3x stop on the credit received. The standing stop order is necessary to protect against violent moves like Feb 2020. Without the stop your losses will mount exceptionally fast and you may panic out. You may also want to consider using different delta for your short strikes to account for the bull market. For example, short a 20delta put with a 16delta call. This give you a more wiggle room to the upside.