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Consistent income trading options: IV rank and scaling

IV rank and scaling
IV rank and scaling

In our quest to understand trading options for income, we consider adjusting the number of options based on IV Rank. For example, as IV Rank of the underlying increases, will the P&L improve if we increase the number of options traded?

To answer this question, Tasty Trade recently conducted a test using the SPX over a 5-year period (for a total of 60 trades). On the first of the month, giving the Monthly option 45 DTE (days till expiration), a short Strangle was placed; the position of the short strikes was based on the following: 1 SD (standard deviation) for IV Rank > 50; 1.5 SD for IV Rank 25 - 49; 2 SD for IV Rank < 25.

A short Strangle is an option strategy in which two OTM (out of the money) options are sold from the same option chain: one Call and one Put.

As a base reference, regardless of IV Rank, two short Strangles were used. This base is then compared to the following scale: 4 short Strangles at 1 SD; 3 short Strangles at 1.5 SD; and 2 short Strangles at 2 SD (same as the base reference).

The results: P&L increased over 50 percent over a 5-year period when we adjusted the number of contracts based on IV Rank. However, the largest win and loss were twice the base (of 2 contracts regardless of IV Rank); this occurred when IV Rank was greater than 50 percent. We can see from the graph, that the biggest impact to the P&L curve occurred on three occasions (out of seven, when IV Rank was above 50 percent).

In conclusion, adjusting the number of contracts based on IV Rank did have a significant impact on P&L. However, to have a clearer understanding of scaling, keeping the SD fixed would isolate the effects of scaling based on IV Rank.

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