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Trading options for income: Capital redeployment

Capital Redeployment
Capital Redeployment
OptionsAnnex.com

In our quest to understand trading options for income, we often consider re-entering a trade after profitably managing a winner. That is, immediately placing another Strangle in the same underlying, at the same risk level, after closing a profitable trade. The expected advantage of capital redeployment is that we are more efficiently utilizing capital, and thus improving our profits.

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 if capital redeployment helps, Tasty Trade recently conducted a test over five years of five ETFs: EWW, GLD, IWM, SPY, and TLT. The test criteria was: initiate a Strangle at the beginning of each month if the IV Rank (implied volatility) exceeded 50; the risk level is 1 SD (standard deviation) for a POP (probability of profit) of 68 percent; close the trade when 50 percent max profit is achieved, then initiate another Strangle at 1 SD if the DTE (days till expiration) is 15 or greater (this trade is closed at 50 percent max profit; else held till expiration). As a basis for comparison, the initial trade is held through expiration.

The results: the P&L on the initial 50 percent max profit trades generated a P&L of $3,372.50 vs. $7,594.50 when the P&L of the second trade is added; this compares to $6,534.50 for base (holding the initial trade through expiration). The average percent winners of the initial trade is 91 percent, which is the same for the second trade as well; this compares to 87 percent for the base.

In conclusion, re-entering a second trade to increase capital redeployment did improve the P&L by $1,060 (or 16.8 percent) compared to the base. There were only 75 trades during the five year period (across five ETFs), and the second trade brought that number up to 128 (an additional 53 trades) without regard to IV Rank. It would be interesting to see the results without the IV Rank requirement.

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