The IV risk with short strangles

[earth_imperator]

This is to good to be true. If that’s the case that means that’s free money? Or am missing something. Then why do short vol firms blow up when there is vol spike?

If that’s true then that means I have been getting options wrong all this time and making it complicated. That means there is actually a difference between short put and a covered call even though their payoffs are identical?

However, I think this is too good to be true. Something ain’t right.

If the information I provided were wrong, then you can be sure that the pack would already have attacked it. Since there is nothing the like so far, then the folks agree that it's indeed like I said.

 

[MrAgi1]

If the information I provided were wrong, then you can be sure that the pack would already have attacked it. Since there is nothing the like so far, then the folks agree that it's indeed like I said.

Thanks. It seems there is a lot of basic stuffs I need to learn about options. Because this got me thinking and confused.

 

[earth_imperator]

Thanks. It seems there is a lot of basic stuffs I need to learn about options. Because this got me thinking and confused.

These things you just learned today, took me many weeks and months first to find (discover) and then to grasp (understand)... So, I hope you don't get a brain freeze or so b/c of so much new and important knowledge about options in such a short time of just a day...

 

[MrAgi1]

These things you just learned today, took me many weeks and months first to find (discover) and then to grasp (understand)... So, I hope you don't get a brain freeze or so b/c of so much new and important knowledge about options in such a short time of just a day...

Lol. It’s gonna be alright

 

[earth_imperator]

Thanks. I understand how spreads reduces vega exposure, therefore reducing/eliminating IV risk.

@earth_imperator Now let’s talk about keeping the trade till maturity. I want to understand something you said earlier. You mean if I sell a call and own the stock(cash) which results in a covered call, then you mean no matter how high IV rises, I don’t need to post extra margin to my my broker and can hold the trade till maturity?

However from the pricing calculator below. I combined a stock with a short call which gives me the payoff of a short put but the IV risk is still there before expiration. So you mean my broker would ignore that risk because I own the stock, therefore I can continue holding till expiration(and of course the high IV becomes irrelevant at expiration)?
View attachment 297757

In a Cash Account it's indeed so, Risk is pre-covered, therefore no Margin Call.
But as said the "early assignment risk" remains (but only with American Style options).
FYI: in the US, all index options are European Style, rest is American Style.
And in Europe, almost all options use the European Style.

I have always wondered why people referred to covered calls and naked put as 2 different strategies when they have exactly the same payoff? And covered call required you to buy the stock which could be higher margin.

I don't know which people you mean. They both have the same outcome (payoff), at least at expiration.

Regarding Margin Requirement (Margin Acct) and Cash Requirement (Cash Acct) see the table of TradeStation, as their table is very informative, much better than any other broker. It covers both MarginAcct and CashAcct.

 

[earth_imperator]

@MrAgi1, I can't tell anything about CoveredCall and ShortCall, as I haven't studied their details.
Though I can trade CoveredCall in my CashAcct, I chose the path to specialize myself in Puts only, so I can't tell you much about CC and ShortCalls. Maybe others can tell you more.

And: "early assignment" means your position will be closed automatically by the remote side (your counterparty). It's not a pleasure... b/c you can't decide yourself to just sit-out the losses by hoping for better times...

 

[earth_imperator]

However from the pricing calculator below. I combined a stock with a short call which gives me the payoff of a short put but the IV risk is still there before expiration. So you mean my broker would ignore that risk because I own the stock, therefore I can continue holding till expiration(and of course the high IV becomes irrelevant at expiration)?
View attachment 297757

Yes, in a CashAcct at least, since this combination is a CoveredCall.
As the name "Covered" already implies: the risk is already pre-covered, so no Margin Call or so.
But again: "early assignment" is IMO more dangerous than getting a Margin Call

 

[Windlesham1]

Just watch your gamma near expiry - Strangles are not the worst trade-that would be covered calls, and the bad part is the underlying

 

[earth_imperator]

Just watch your gamma near expiry - Strangles are not the worst trade-that would be covered calls, and the bad part is the underlying

Yes, I have similar reservations against CC. It simply binds too much capital.

The OP means Short Strangle (cf. thread title): Since such a Short Strangle consist of a ShortCall and ShortPut, then if IV rises before expiration then both of them lose (ie. a double catastrophe ).
I think a similar 2-legged Put Spread or Call spread is IMO better for such a situation of rising IV, because here the IV rise is neutral for the position as the long side cancels it out...

 

[taowave]

Say what????

Just watch your gamma near expiry - Strangles are not the worst trade-that would be covered calls, and the bad part is the underlying