20-Delta Short Strangles

[qlai]

Have you ever concentrated just on strangles?

No. I have very similar situation to yours. I also “learned” about premium selling from TastyTrades and OptionsAlpha. When I had limited capital I thought selling premium was ridiculous. It was like - you should use up to 30% of your capital and close positions at 50% profit. I didn’t see any reason to waste time and energy to make pennies with a chance to blow up my capital. Now I am better capitalized and I am “ok” with risking small percentage of it in return for “stable income”. That being said, I am still very uncomfortable selling premium indiscriminately. Basically, I try to sell options at a point where if I get assigned, I would be ok with that small starter position. I still haven’t figured out how to generate that “stable income” lol.
There are many members here like @MrMuppet and @taowave who used to be professionals in financial markets and have knowledge and experience that let’s them trade options with real edge. Their advice is very valuable but I don’t know if retail traders can ever get to that level on their own. So we are left with trading what we “understand” which has no real edge, imho. I am assuming that is the reason why people are warning us about blowing up.

 

[JSOP]

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:

First of all, happy birthday!! In your first journal, you were only 57 and now you are 58 so I assume you had your 58th birthday some time towards the end of July and before the posting of this journal? Hope you had a good bday celebration.

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 play 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 once or twice 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. But 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? 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 up, down, or out (like you can with a Cash Secured Put, for example), I've found that they're 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

You still don't seem to understand our concern about your strategy. Our concern is not about you being right or wrong all the time or whether your strategy has a directional bias. Our concern is with the non-existent risk management of your strategy being that it can subject you to unlimited losses when you are wrong given that you don't have any protective mechanisms in place other than your broker's margin call. And with that you can lose MORE than your net liquidation capital and even your entire savings. You think your $700K savings is safe? It's not. They can all be gone in a flash. If you don't believe me, read this story below. This is a true story. The person in the story has now deceased, died penniless and with massive debt from margin calls. He did EXACTLY what you are about to do, just with a different instrument:

https://www.washingtonpost.com/arch...ped-out/090c57f7-fc75-4f02-9d22-585cf53c8548/

Numerous people before you have tried what you are about to do and they have all ended up with losses, massive losses, more than what their life savings could cover. You don't need to still try to see if it works. It doesn't. If you are really bored with your money and just want to spend it somehow by doing something, give it to me. I promise you I will spend it better.

 

[Theinkdon]

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.

Wow, thank you for all that! Maybe it's confirmation bias because I'm hearing what I want to hear, but finally I've found someone who seems to really be doing short strangles. Are they MOST of what you do with options, or something less? Not that it matters really, as long as you've found that they work for you.
45DTE, I realize I probably need to be there, or 30-45, but I kind of like the "quick-hit" nature of 5-10DTE. I do need to study and compare that more though.
A 3x stop, yes, I do that too. But my stops are mental; are you actually doing a preset stop order? I do like to roll for credit, but I've had one or two paper trades where I've bought to close at 3x credit.
Your last 2 sentences indicate to me that you've studied these for a while (or maybe this is common knowledge among stranglers), because I've thought a lot about staggering the strikes, "skewing" the strangle if you will in the direction of the broader market. I'd have to go back to my blog to find where I wrote about it, but a month or two ago I actually came to a somewhat opposite conclusion: I went through a spate of strangles being challenged or breached on the Put side almost exclusively, so I'd decided that at the very least I'd "round down" (away from the money) on the Put side, to give myself that little extra wiggle room. What I *didn't* do then was look at the direction of the broader market to see if maybe that was why. And I didn't really study that any more, but I need to.
I'm excited you've found my journal, and hope you'll come around and critique my trades. Do you have a trade journal here or somewhere else?
Mike

 

[JSOP]

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.

Stop-loss won't do a thing in the face of huge price movement. The bid/ask spread will be so wide the slippage will be so huge that it would make no difference if you get assigned or margin called.

 

[swingtrader123]

I have learned the hard way that mental stops don't work for me, so I place a stop order once I get filled. The 45DTE just get you further out from the current price so you have time to react to the market. I almost never hold to expiration. You are waiting for a drop in volatility so you can book some profits. Strangles are a numbers game. Never go for a home run. Book profits when you get them and reduce your risk. This method works for me. You have to find what works for you.

 

[swingtrader123]

The most important thing in trading is to manage your risk not your profits. Take what the market gives you not what you want or expect.

 

[JSOP]

"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.

no it's to do it with hedge; that's the only way. People still don't seem to understand the concept of everything being dynamic in options. "Dynamic" means it changes. It doesn't stay the same. The 0.2 delta strike that you see today is not going to be guaranteed to stay as 0.2 delta until DTE. It may and may even go down but it may increase and when it increases, it could increase all the way to 1 where the price of the option moves on a 1:1 basis with the underlying's value but that's only on DTE, any time before DTE, there is something called time value which will even push the price of the option to above 1:1 basis with the underlying. And since there is no limit to how much an underlying's price can increase to, there is also no limit to how much your loss on that short option can grow to, no matter how small your position if there is no offsetting long option.

This can be easily illustrated with a price scenario analysis with prices at different levels but since the OP is reluctant to do so, I will illustrate it once and for all:

Since the OP loves meme stocks so much, I will take the most meme stock of them all, GME. And I will take a strangle position on GME with 0.20delta for call and 0.21delta for put on Jan. 20, 2021 with 10 DTE to expire on Jan. 29, 2021, and just to be extremely conservative, I will take the smallest position possible, 1 contract each for both call and put representing 100 shares in each:

On Jan. 20, 2021 price of GME was: $39.12

Call with strike of 58 at 0.20delta : $1.375 (mid-price between bid of 1.26 and ask of 1.49)
Put with strike of 30 at 0.21delta : $1.66 (mid-price between bid of 1.62 and ask of 1.70)

So for 1 contract each, the OP would receive total profit in premium of 1.375 X 100 + 1.66 X 100 = $303.5 yay!!!

On Jan. 27, 2021, just 2 days to DTE, the price of GME rose to: $347.51

Call with the strike of 58 that had 0.20delta now had a 1delta and the price all of sudden has risen to: $291.275 (mid-price of 284.95bid and 297.60) Notice that the intrinsic value of the option is just (347.51 - 58) = $289.51 which is what the option is supposed to be worth but because of the time value still left on the option, the price of the option is higher than what that option is worth.

Put with the strike of 30 that had 0.21delta before now had a 0delta and the price has now dropped to: $0.175 (mid-price of 0.16 and 0.19) With the price so low, one might as well let it expire worthless to reap the full profit of $1.66 X 100 = $166 but according to OP's rules, he would TP when the option is at 50% profit so the profit on this put would be $166/2 = $83.00 assuming perfect execution.

Now let's look at the loss on the short call side: The loss would be (1.375 - 291.275) X 100 = -$28,990 not only completely erasing the entire net liquidation capital of $10,037.50 plus the $83 profit from the short put but would also result into a margin call for $(28990-10037.50 -83) = 18,869.5 IF TD did not liquidate the position before. And notice during the whole time of the position being open, there was no way OP would've had any chance to TP at 50% profit. It was immediate loss right from the beginning.

Just for the smallest position of just 1 contract for 100 shares, a huge move like this that actually happened would have not only completely erased all of the trading capital in the account but also would require the OP to put in additional $18,869.50 to pay back the broker's margin loan, cutting into OP's saving of $700K. After this loss, the OP's savings would have been $700K - 18,869.50= $681, 130.5.

And this is just with the smallest contract size of just 1 contract representing 100 shares. According to OP's strategy, he is supposed to be 80% invested with position size of 10% of the net liquidation capital so that's approx. $1000 invested and that would've resulted into $500 invested into each side so that would be presumably 5 contracts for both call and put? Then in this case, the loss would've been 5 times at -$28,990 X 5 = -$144,950 offset by the net liquidation capital of $10,037.50 and the 5 times of the profit from the short put $83 X 5 = $134,497.5 for margin call, a reduction of his 20% of his $700K savings.

Five times of losses like this with 5 contracts each, his entire savings of $700K will be gone!! If the OP has really demo traded in the paper trading account in TDA, he should've already experienced this loss in the paper trading account. I am surprised that the OP would still think that this strategy can work. I hope this scenario analysis exercise can make him realize the potentially huge risk that his strategy could be subject to if he didn't notice this in his demo trading before.

 

[JSOP]

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.

You need to read about Karen the Super trader. She does strictly short strangles. If you have watched videos from TastyTrade, you should've come across their interviews with her. She was big on TastyTrade for a while.

 

[JSOP]

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."

Yes but this ONE time that it didn't go up or stay flat but went down and went down a lot, the loss will take out ALL of the wins that you have been accumulating from those 4 out 5 times wins and more because you have no protection. That's the problem. This is not just an issue of probability in terms of how many times you win. It is an issue of when you win, how much you win and when you lose, how much you lose. Your risk/reward ratio is not 1:5 as you think it's infinite: 1 even though the probability of that infinite loss is small. This phenomenon is called "fat tail" where the risk of huge losses is at the "tail" end of a bell curve of normal distribution representing just 2.5% of the overall possibility but that amount of that huge loss is astronomical enough to bankrupt entities, hence it's "fat" giving the term "fat tail".

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

We are not trying to win an argument here. We are just trying to show you the potential risk of what you are about to do from an anecdotal and mathematical point of view. By the time when it doesn't work anymore, you might not even have the money to pay for the internet to update your journal to report to us know anymore although I seriously don't wish that upon you. Our mind has been open for long enough to see it doesn't work. You are not the only one who has attempted this. People who are a lot more capitalized than you have traded exactly like what you are about to do and have lost everything and even more. It's not even an issue of having the discipline of following the rules here; it's an issue of math.

 

[JSOP]

Day 1 Update Monday, 8/23/21

Off to a great start, lost $27 AND negative margin!
View attachment 266478

• 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.

So you are doing strangles during earnings?? OMG!!

Anyway...