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Consistent income trading options: Increasing capital deployment of the SPX

SPX Capital Redeployment
SPX Capital Redeployment

In our quest to understand trading options for consistent income, we often consider the impact on P&L of entering new trades as soon as we close the last. This method increases the use of risk capital without adding to capital at risk, effectively improving capital efficiency. A recent article on Capital Redeployment tested the effects on five ETFs; this article will focus on just the SPX using short Strangles and exiting at 25 percent of premium received.

A short Strangle is an undefined risk option strategy in which an OTM (out of the money) Call option is sold while concurrently selling an OTM Put option, resulting in premium received. The max gain is the premium; the max loss cannot be determined which is why this is called an undefined risk trade. A one lot Strangle requires just 2 options to be sold (1 option per leg). When trading low cost underlyings, like ETFs, the Strangle offers the opportunity to bring in more premium than is practical with an Iron Condor (IC).

To determine the impact of increasing capital deployment on the SPX, Tasty Trade recently conducted a test from 2012 through May 2014 monthly expiration (a total of 28 months). To increase the number of redeployment trades, winners were exited when 25 percent of the premium was reached.

The test criteria was as follows: enter a 1 SD (standard deviation) short Strangle at the first trading day of each month, with about 45 DTE (days till expiration); exit the trade when 25 percent of premium is reached, or hold to expiration; if exiting with a profit and 15 DTE or more remain, enter another 1 SD short Strangle; repeat as often as possible.

The results: when comparing redeployment at 25 percent vs. single trades exited at 50 percent, the latter had a higher P&L, higher Percent Winners, highest Daily P&L, and lowest Max Loss.

In conclusion, while the overall totals seem to indicate that the redeployment at 25 percent is less desirable than a single trade exited at 50 percent, a closer look reveals a different conclusion. If we only look at redeploying twice (rather than three or more), the P&L would be $17,278 (25%) vs. $14,890 (50%). This difference is significant, while the Max Loss is close (-$2,977 vs. -$2,871 respectively).

Also, since the time period (from 2012) is predominantly bullish, it would be helpful to see if the losses for the Third and Fourth trades occurred predominantly on the Call side of the short Strangle. Perhaps testing at different SDs (for example, 1.5 SD and 2 SD) would yield interesting and revealing results.

And then there is the consideration of Weekly trades using the 50 percent exit strategy for a single trade. This represents, on average, 4.33 trades per month (compared to the 2.78 trades of this test).

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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