Markets for Short Straddles

Quotes from atticus and sle:

You can lose more on a straddle than the underlying. Not necessarily directionally, but to vega. Imagine you're long 100 XYZ from 100 and the stock drops to 98; you're out 2 on shares. Say it's a drug stock and some trial results appear on the calendar. Vol rallies 1000bp and your short 100 straddle loses 4 on its 40 vegas.

It's difficult to lose more on the straddle due to direction, but it's also possible. I like straddles just fine, but it's more favorable to limit vol-risk, or simply have hard stops via the wings.

The harsh reality is that you can lose more then the initial premium on a delta-hedged position. Both long and short, actually.
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Yes, that is clearly true. The implications of vega exposure are not to be ignored. I try to choose underliers with above average IV within their range, but with IV on a downward slope. Hopefully, the vega exposure will actually be of use, rather than hazardous. If vega seems fearsome, however, I wonder if we could hedge it buy adding some long calendar spreads to the short straddle position.

Thanks gentlemen.
 
What is a/c ?

Quote from sle:

Yeah, the X-mass quiet...

In terms of selling straddles - you want to find (a) an asset which you expect to realize lower then implied and (b) an asset with high a/c. In fact, AC might be even more important then the actual vol, if you hedge judiciously.
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Quote from stevenpaul:

If vega seems fearsome, however, I wonder if we could hedge it buy adding some long calendar spreads to the short straddle position.

Thanks gentlemen. [/B]
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buying a calendar would increase your short gamma. if an event happens, there is a rush to buy gamma over vega.

since you are looking at selling these for the day and not for a longer trade, i'm assuming you aren't delta hedging. keep in mind that the market can stay still and vols can increase.

also, there are a bunch of new weekly options listed in equities and indexes. you may want to check them out.

it's all about picking when to sell the premium and when to cover.
 
Quote from stevenpaul:

Is it just my perception, or is the viewpoint that short straddles are relatively high risk strategies quite prevalent? It seems like the majority of the contributors here on ET and elsewhere look askance on short straddling, writing off the strategy altogether as being entirely too risky. Yet, I don't hear much about the dangers of trading outright futures contracts or trading stocks on margin. It almost seems like the prevailing viewpoint on short straddles is that they are about the most dangerous of all strategies, even more dangerous than buying a futures contract. Is that just my imagination, or do folks actually think that? If so, why do they? Seems to me short straddles are actually considerably safer than trading an outright futures contract (long or short) or trading stock on margin. In the event of a big move, at least the trader enjoys the hedge of the trade's winning leg. At worst, the short straddler suffers exposure tantamount to a single losing outright contract in the underlying. Dealing with losses doesn't seem to scare off most futures traders, but losses are unthinkable to short straddlers, it seems.

I trade with a group online sometimes, and they're always dropping $200 on such and such trade that goes bad. Of course, it's all perfectly wonderful because they diligently observed their stops, even if the trade did only last about 5 seconds. Contrastingly, I had a short straddle on the eurusd and 5-year note futures. There was a fair bit of volatility (.40% and .33% respectively) and yet the trade was very stable throughout the trading day and yielded a profit of .75% on the day. Had I been trying to call direction day trading, I know I would have gotten stopped out 3 or 4 times. But with the horrendously risky short straddle, I easily made a tidy little low-stress profit under the same circumstances. Admittedly, I am not in the habit of holding these trades too long. I try to keep them day-trades to avoid headline risk.
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Short straddles are reasonable in small doses on tame underlyings; I would not do near month ones, though. As for all the warnings you see here, there seem to be a lot of people on this site who don't do things in small doses, like the guy who just posted something implying that he is trading his entire account in diagonal bull spreads.
 
Quote from drcha:

Short straddles are reasonable in small doses on tame underlyings; I would not do near month ones, though.
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Thanks for responding, drcha. That's exactly what I wanted to get at: which underlyings? Treasury securities, particularly the shorter-term ones are tamer than, say, natural gas, but option premium is commensurately lower on the former. Despite the lower level of premium protection with the tamer underlyings, is it still best to go with those tamer markets, or is it a wash? If you do take a stand and go with the tamer markets (as it seems you do), which ones specifically would you suggest? Again, IV ought to be considered, but if we were going to put together a list of suitable candidate markets for short straddling, what would be on it? So far, my list consists of the ten-year, corn, dollar index, and Euro. How does that sound to you, and what would your list look like?

Thanks again,

SP
 
I don't see how you can make such sweeping generalizations and decide that some mkts are good for being selling vol, while others are not so good. Surely, that has to depend on what price the mkt bids vol at, which varies a lot.

All else being equal, what you're suggesting by saying that, for example, 10y notes is a better mkt for selling straddles than spooz is that the bond futures mkt systematically overprices vol more than the equity mkt. That's a rather bold statement.
 
Quote from stevenpaul:

Therein is the difficulty in choosing a market: Is a slow, dull, market with low premium options better for short straddling, or a bronco of a market with expensive, richly protective options?

In view of both practical concerns and the obvious risk of loss due to short gamma, which futures markets are best suited to short straddling in your opinions?
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I'm not familiar with the futures markets so just generalizations offered...
Short straddles are for non-directional underlyings. Period.
 
Quote from stevenpaul:

Thanks for responding, drcha. That's exactly what I wanted to get at: which underlyings? Treasury securities, particularly the shorter-term ones are tamer than, say, natural gas, but option premium is commensurately lower on the former. Despite the lower level of premium protection with the tamer underlyings, is it still best to go with those tamer markets, or is it a wash? If you do take a stand and go with the tamer markets (as it seems you do), which ones specifically would you suggest? Again, IV ought to be considered, but if we were going to put together a list of suitable candidate markets for short straddling, what would be on it? So far, my list consists of the ten-year, corn, dollar index, and Euro. How does that sound to you, and what would your list look like?

Thanks again,

SP
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I have not done them other than on TLT and FXE. But not lately; everything is moving around too much to suit me. I suggest Paul Forchione's books. He covers adjustments and selection of the best volatility conditions.
 
I've run a CTA for the last 6 years that systematically runs two strategies. The major strategy is diversified trend following on 80+ markets futures markets. The other strategy -- weighted at just 20% of the portfolio by projected volatility -- is selling at the money straddles on ES futures.

You should listen to the people who are telling you straddle selling is high risk. Many, many people -- including highly experienced traders -- have blown out accounts by selling volatility. Exhibit A: LTCM. Exhibit B: Niederhofer. Exhibits C-Z: a large number of option selling managers in 2008.

The problem is that the return is low but frequent, so traders discount the tail risk and put on bigger and bigger positions. Eventually this leads to a huge loss when an outsized market move comes along. And it's not possible to hedge against this loss.

That said, if you don't demand too much from the strategy I think there can be something good there. At least in selling vol on equity indexes. Don't get greedy and use this as a secondary, diversifying strategy. Note that it will blow up at the same time the underlying does, so it's difficult to avoid having tail risk that is actually beta.

I've backtested my strategy back to 1986 -- a lot of things have happened between then and now. That's certainly not to say new things won't come along that are much crazier than what's happened during that time period -- they certainly will -- but I have looked at how this strategy behaves during many different environments and that helps in position sizing and dealing with difficult times when they happen.
 
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