Any edge in diagonals?

Maverick74, sle
Thanks for your posts, guys. Kind of weird feeling when a freshman student suddenly enters class room with 2 professors debating about Einsteins's theory details :)

Well, I'm not holding to expiration in strategy #3 actually, which I want to discuss. I held to expiration in strategy #2, where I short front month strangle (and the main goal is to expire both legs worthless) and long back month just for protection.

In fact I wouldn't keep to expiration long front month strangle in strategy #3 as I don't want to let it fall to 0. I will close all positions as soon as a sharp move occurs, which should fill front options with more value then back ones.

In the posted example I would open Oct16 options on 08/02 (that's 45+ DTE as far as I remember) and close them on 08/16 (30 DTE approx.) or even earlier as I would be happy with generated PL.

Please keep in mind that I'm not trading ATM straddles etc. I trade OTM (not deep OTM) strangles with all 4 legs priced equal premiums. So equal premiums in front and back months means more delta in front and less in back month. This means front month usually has to be more volatile then back month, so any move in UL generates profit.

Again, where're the cons?
 
A strategy has no edge, it is just a strategy (long stock, cal. spread, diagonal). Any "edge" comes from when and how you enter and your analysis.
 
@Dael , in this example you're trading gamma and vega. Gamma long, vega short... because you are long front month and short back month as well as long a tighter strangle than the short one...

So, any move will make you money when the move is in a short enough time period, before you lose too much on theta (time decay). I wouldn't say front month is more volatile... because in options the volatility (IV) is more about the underlying.

So, this is just a gamma/vega trade.

The cons are... paying theta/time decay and when a move happens when there's no more gamma in the front month options, and you're effectively trading vega short and gamma short with your short strangle in the back month...
 
JackRab
Thanks, that's an easy explanation.

Yeah, I understand that theta decay is the main con of the approach, although front side can rise much even almost at expiration (if it's close enough to ATM, of course), which can't generate profit, but can compensate loss at least.

And even in my worst case scenario of minimal UL price change losses of front month side are well compensated by back month side, which loose much too.

I've done paper trades on crude oil (as most volatile commodity) via EOD price quotes from Feb15 to Jul16 (with a few months with no quotes, when I couldn't save them), everything seems to be OK.

OK guys, thanks all for conversation. I'm open to discuss anything related to the strategy.
 
Dael said:
Correct me if I'm wrong. While doing some math and live trades with long/short front/back month futures options, that was the way of my thinking and trading path:

1. Let's short naked strangles (yeah, want to cut both sides, and don't like directions in trading). Open 1 month DTE strangle, wait for its expiration, collected premium turned to realized PL, cool. Till the moment of sharp move, where both increased unrealized PL and margin requirements hit your account to death.

2. OK, let's add some protection. Don't like verticals in the same month, so try diagonals: short front month, long back month, then after some research long back-back month :) i.e. short Sep strangle, long Nov strangle.
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You're talking about an iron condor, except that you're using longer dated options. It's kinda pointless to do things they way you laid out here.

First of all, if you choose your strikes wisely and don't write the strangle too far in the future...i.e. it's better to do them 1-2 weeks in the future, not 1-2 months out... you will be able to roll the option whose side moved against you forward by a week if its close to expiration. If it's not, you can just let it ride until the price reverts to mean...and it will, because there's no way you are dumb enough to write a short strangle on a stock or ETF that has upcoming volatility expected in the future.

That's option one. Option two is simply to close one side of the strangle which is further out of the money while simultaneously buying or shorting the underlying to convert it into a covered call/put.

Example, you did a short weekly strangle on SPY with strikes of Put - 215 / Call - 220 for 10 contracts and next week it started creeping up to 219. In this case you would buy back the puts at a profit and buy 1000 shares of $SPY, thus ending up with a covered call.

If it started sliding, toward 216, you could buy back the calls at a profit and short 1000 shares to end up with a covered put.

Option 3 is to write fewer contracts so that you can afford to buy the stock without having to buy back the options you wrote prematurely, thus allowing you to continue collecting theta on both sides while hedging your position on one side as needed. This way you can reverse the long/short underlying position in response to any volatility that comes up.
 
Maverick74 said:
What you are profiting from is the front spread correlation. In other words, the front month on CL is the delivery month and therefore is more volatile then the back month. When you buy the front month straddle and sell the back month you are synthetically buying a CSO option (calendar spread option). CSO's are highly sensitive to correlation. When the correlation goes to one, vol goes to zero and you lose. When correlations drop below one, vol increases and that spread will profit. You have to consistently model the correlation accurately to profit long term from this. What you have had so far is purely blind luck.
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What would be the best way to model this type of thing ?
 
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