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Trading options for income: Strategy statistics

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In our quest to understand trading options for income, we rely on the Probability Model to determine where to place our short strikes for both the Strangle and Iron Condor (IC). Just how accurate is the Probability Model given a high IV (implied volatility) environment is the focus of this article.

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).

A short Iron Condor (IC) is a defined risk option strategy composed of the following: an OTM (out of the money) Put credit spread and an OTM Call credit spread, both within the same option chain. A credit spread is a vertical option strategy composed of a short OTM option plus a long further OTM option. The capital at risk is the difference between the short and long strikes less the premium received. A one lot IC requires 4 options (2 options per leg).

A short Chicken Iron Condor is a defined risk option strategy composed of the following: a NTM (near the money) Put credit spread and a NTM Call credit spread, both within the same option chain. The objective of this strategy is to collect 45 to 50 percent of the width of the strikes. The capital at risk is the difference between the short and long strikes less the premium received. A one lot Chicken IC requires 4 options (2 options per leg).

To determine how accurate the Probability Model is, Tasty Trade recently conducted a test over 5 years using the following ETFs: EWW, GLD, IWM, SPY, and TLT. The test criteria was as follows: enter a trade on the first trading day of each month if the IV Rank is greater than 50; the DTE (days till expiration) should be around 45 days; and hold the position through expiration. The Strangle and IC (5 point wide spreads) should have their short strikes at 90 percent OTM (1.25 standard deviation) for a POP (probability of profit) around 80 percent. The Chicken IC (2 point wide spreads) should have its short strikes located at the first strike just OTM to collect between $0.90 and $1.00.

Our expectation for the Strangles and 5 point ICs is that the percent winners would fall around 90 percent. For the Chicken IC, our expectation is 50 percent.

The results: with 70 total trades, the Strangle had 93 percent winners, the IC had 91 percent, and the Chicken IC had 54 percent. It is interesting to note that the Strangle had an average ROC (return on capital) of 5.85 percent vs. 5.49 percent for the IC vs. 8.46 percent for the Chicken IC. The largest loss was the Strangle at -$560 vs. -$462 for the IC vs. -$108 for the Chicken IC.

In conclusion, this would indicate that the Probability Model in high IV environments is quite accurate. I would question the average ROC of the Strangle, since it is not clear whether Tasty Trade used a 1 SD (standard deviation) measure rather than the more appropriate reduction in buying power (or margin requirement). In addition, testing shorter periods (for example, a 7 DTE) would reveal (from our own testing) a higher ROC and P&L.

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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