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Trading options for income: Does IV Rank matter?

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In our quest to understand trading options for income, we often consider trading Strangles when IV Rank is high (over 50). Just how is the P&L affected if we trade when IV Rank is low as well?

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 on P&L with low IV Rank, Tasty Trade recently tested the following ETFs over a 5 year period: SPY, GLD, EWW, TLT, and IWM. On the first day of each month a 1 SD (standard deviation) Strangle was sold with close to 45 DTE (days till expiration). The P&L was tested with positions held to expiration and exited when 50 percent of the premium was reached. IV Rank was categorized as high if it exceeded 50; low if not.

The results: high IV Rank trades had only 73 occurrences compared to 241 occurrences for low IV Rank; yet its P&L exceeded at both the 50 percent ($3,710 vs. $3,499) and expiration ($6,535 vs. $5,762) holding period. Also, high IV Rank had a much lower max loss (-$721 vs. -$2,655).

In conclusion, it is interesting to note that the percent of winners for a 50 percent hold period is very close between high and low IV Rank (93% vs. 90%). And, despite the max loss being 3.6x greater for the low IV Rank, the P&L is positive and nearly the same. It would be interesting to see how the max loss would be reduced (and P&L improved) if we went to 1.5 SD and a shorter DTE (like 7 days vs. 45 days).

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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