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Option Basics: Adding to Positions when IV Rank Increases

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With options we have a lot of strategies to fit the market or underlying asset. A very common strategy is the Strangle (or the Iron Condor if you prefer defined risk). With this strategy, we are sellers of premium, which simply means the trade brings in immediate premium. It also means we can place positions that have high POP (probability of profit). Note: see charts (above) for examples of the Risk Profile of a Strangle and Iron Condor.

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When trading options in which the underlying is an equity (stock, ETF, future, etc.), we look for the following criteria: First, we are only interested in equities which have liquid options (high volume and high open interest). This is generally characterized by penny-wide bid/ask spreads.

And second, we are interested in equities which have high IV Rank Percentile (IV = implied volatility). A good percentile would be 50% or greater. This generally occurs prior to an earnings announcement, or the expectation of an event affecting the equity (merger, new product announcements, management changes, etc.). We anticipate that high IV Rank Percentile will drop (or collapse) after the event, which will improve the profitability of our position (Strangles and Iron Condors benefit from a drop in IV).

Once we have a Strangle (or Iron Condor) position, the question becomes: What do we do if the IV Rank Percentile of the underlying asset continues to increase? We could add to the position with another Strangle at the same level of risk (i.e., at different strikes further out).

To see if adding to the position with another Strangle actually works, Tasty Trade conducted a 5-year test on the following equities: IWM (the Russell 2000 ETF); TLT (20+ year Treasury Bond ETF); and FXE (Currency Shares Euro Trust). A Strangle position in each was initiated when IV Rank Percentile crossed over 50% with options that have approximately 45 DTE (days to expiration) at 1 SD (standard deviation) level of risk. When IV Rank Percentile crossed 60%, another 1 SD Strangle was added within the same option chain (but, of course, at different strikes). The positions were closed at the following profit levels: 25% of max premium, 50%, 75%, and through Expiration.

The results (see Tables above)? In each case adding an additional position increased profits significantly (often doubling profits or more), while maintaining or improving the Win/Loss ratio and increasing the average daily P&L.

In conclusion, if you're using IV Rank Percentile greater than 50% as an equity selection criteria, then adding to the position with an additional Strangle (or Iron Condor) at the same level of risk (1 SD in this test) does significantly improve your profits.

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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