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Consistent income trading options: Debit spreads and strangles

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In our quest to understand trading options for income, we often consider buying debit spreads or strangles (long positions) in low IV (implied volatility) environments. When IV is low, we expect IV to increase which benefits long positions. Given that, can an increase in IV overcome the theta decay that long positions face?

A vertical spread is comprised of two options within the same option chain (Weekly or Monthly) which are bought and sold concurrently. To form a debit spread (which takes money from your account), you buy one option with a strike that is closer to ATM while selling an option with a strike that is further OTM. A long IC (iron condor) is comprised of two OTM (out of the money) debit spreads; a long strangle is comprised of an OTM long Call and an OTM long Put.

To determine if a long OTM IC or Strangle is a viable strategy when IV is low, Tasty Trade recently ran a test from 2009 through May 2014 using the following ETFs: SPY, GLD, EWW, TLT, and IWM. The criteria was as follows: at the first trading day of each month, if the IV Rank is less than 50, enter both a long IC and long Strangle; the IC is comprised of $2 wide spreads; both the IC and the Strangle have their long strike 80 percent OTM; and the positions are held through expiration.

The results: overall with 241 trades, both the long IC and long Strangle had negative P&Ls (-$1,742 and -$5,816 respectively). The percent winners was 32 percent (29 percent expected) and 24 percent (40 percent expected) respectively.

In conclusion, it is clear that the long position, with lower probabilities of profit, did not work; the increase in IV did not overcome the theta decay. The long Strangle (which costs the most) had negative P&Ls for all the underlyings; the long IC had positive P&Ls for the following ETFs: GLD ($111) and EWW ($96); the rest were negative. It would be helpful to see what the impact on P&L would be if the positions were managed (25 to 50 percent profit exits) or shorter expirations (like the Weekly) were used.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.

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