Adjustment for short strangle

[hedgex]

Reading the book The Option Trader Handbook for adjustments for short strangle and got disappointed as the book says that there is nothing you can do, I got an idea.

You can keeping making up for strong moves in the underlying and never lose.

Suppose stock XYZ is trading at 25 and you short a strangle: put@20 and call @30.

If XYZ moves to 30, you sell a put at 35. IF it moves to 35, you sell a put at 40. On the way down, if it moves to 20, you sell a call at 15. If you draw the P/L chart, you'll see that you are always ahead of a loss, always in the profit zone.

This operation should be generally applicable. If you are short a call and the market goes against you, you just sell a put ITM at a higher strike to counter the loss on the call. If you keep doing this within the same expiry date, some options will end up ITM but you still win.

Has anyone tried this strategy?

 

[Norman_Shey]

Nice try but not.

If you sell the next put out after it moves that's fine, but you won't get enough for it to make up for the loss on the put you already are short. You're just digging a bigger and bigger hole is all.

 

[MTE]

Quote from hedgex:

Reading the book The Option Trader Handbook for adjustments for short strangle and got disappointed as the book says that there is nothing you can do, I got an idea.

You can keeping making up for strong moves in the underlying and never lose.

Suppose stock XYZ is trading at 25 and you short a strangle: put@20 and call @30.

If XYZ moves to 30, you sell a put at 35. IF it moves to 35, you sell a put at 40. On the way down, if it moves to 20, you sell a call at 15. If you draw the P/L chart, you'll see that you are always ahead of a loss, always in the profit zone.

This operation should be generally applicable. If you are short a call and the market goes against you, you just sell a put ITM at a higher strike to counter the loss on the call. If you keep doing this within the same expiry date, some options will end up ITM but you still win.

Has anyone tried this strategy?

Good luck with this strategy!

 

[wayneL]

Like Norman & MTE say... Good luck (but it won't work)

You can hedge delta with underlying or morph the strangle gradually with verticals, keeping delta neutrality... buuuut you're effectively gamma scalping in reverse.

If +decay > the losses you lock in when you hedge, you make a profit. If not, you lose.

You can end up right when you're wrong doing this, but you can also ending making yourself wrong when you were right.

A cautionary note from Cottle in "The Hidden reality":
"Firstly, here is the reason biggest reason anyone losses money [in options trading]: EGO!

With options traders it is exacerbated by the fact that options trader’s think they are so smart.

When other traders are wrong they get out and move on.

When options traders are wrong they try to brain their way out of it or convince themselves that there is a better way --- a repair strategy"

 

[spindr0]

Quote from hedgex:

You can keep making up for strong moves in the underlying and never lose.

Man those are good mushrooms are good!

Suppose stock XYZ is trading at 25 and you short a strangle: put@20 and call @30.

If XYZ moves to 30, you sell a put at 35. IF it moves to 35, you sell a put at 40. On the way down, if it moves to 20, you sell a call at 15. If you draw the P/L chart, you'll see that you are always ahead of a loss, always in the profit zone.

As the underlying continues to move against you, the delta of the newly sold option will decrease while that of the short option that you're defending will remain constant at one. As they slowly suuuuck the cash from your account, your next light bulb moment will be overwriting.

 

[wayneL]

Quote from wayneL:


"Firstly, here is the reason biggest reason anyone losses money [in options trading]: EGO!

With options traders it is exacerbated by the fact that options trader’s think they are so smart.

When other traders are wrong they get out and move on.

When options traders are wrong they try to brain their way out of it or convince themselves that there is a better way --- a repair strategy"

This may be wrongly attributed. Upon checking Hidden Reality, this quote does not seem to appear in there.

Apologies if so.

But still a good quote, whoever said it or wherever it is from.

 

[pengw]

I remember there is a book called Options' Edge that talks about how to hedge a short straddle positions.

However if underlying make two big moves in both direction by going up then going down or verse vesa, the hedge will lose.

 

[JJacksET4]

I agree with what the others are saying, plus I would add that there is even more risk then what you are thinking.

If the stock gapped tremendously, you could find yourself in a situation where you are forced to close the position. For example, while it would be very unlikely, if the stock had killer news and gapped to $500, what would you do?

Also, if the stock went to 0, good luck making any money back selling 0 strike puts!

That all being said, personally I think the best hedge against a short straddle/strangle is a farther out strangle put in place at the same time - i.e. making it a long iron condor.

JJacksET4

 

[spindr0]

Quote from JJacksET4:

If the stock gapped tremendously, you could find yourself in a situation where you are forced to close the position. For example, while it would be very unlikely, if the stock had killer news and gapped to $500, what would you do?

I haven't seen a $25 stock gap to $500 since observing former_mmaker trades on the FANTEX

 

[hedgex]

I was thinking of options on ETFs with 2-3 months in maturity. The of a 50% move is slim.
As a simpler example of the adjustment I was thinking of, let's start with an ATM put@25. If the stock goes up to 27, sell a call@29. If it goes to 29, sell another call@31. Let's say the term ends with the stock at 30. The first put@25 and the last call@31 expire worthless. I am still net short a call@29 which results in a loss of $1 on assignment.
But I sold an ATM put and and two OTM calls, which offset the loss on the ITM call.
If the stock ends at $26, I get to keep all the premiums.

On the P/L chart, you get a wide profit range.

More interestingly, sell two straddles at 20 and 30. If the stock ends up in the range, you get a call and a put assigned to you. Don't they cancel each other out?