Selling straddles involves selling a put and call with the same strike. Usually, the trade is placed at the current price of its underlying asset. Straddles, because they are usually placed at-the-money (ATM) bring in the greatest amount of credit. Because of that, straddles are managed more aggressively than other strategies.
This episode of Market Measures looked at selling straddles in sector specific ETFs: energy (XLE), financials (XLF), industrials (XLI), consumer staples (XLP), utilities (XLU) and healthcare (XLV). These products are historically uncorrelated. Therefore, maintaining positions in each product will still create a diversified portfolio. Also, sector specific ETFs tend to be less expensive than index ETFs, making them more affordable trades to a wider audience.
Going back to 2005, selling straddles in the ETFs used for this study produced win rates of 80% to 82% across the board, when trades were managed after reaching 25% of maximum possible profit (i.e., if the straddle was sold for a $1 credit, it was bought back for a $0.75 debit). Average profits on these trades were not enormous, ranging from $12 to $52. Less expensive stocks typically command less overall premium. The premium collected selling straddles in a $22 stock is not going to be as much as premium collected selling straddles in a $122 stock. However, during times in increased implied volatility, we can collect more in premium.
When implied volatility increases, option premium increases. In fact, when IV Rank (IVR) in SPY was above 50, average profits on selling straddles in these same products ranged from $8 to $122. Two of the ETFs used in this study, XLV and XLP saw their average profit drop, though their win rate was still 85% and 79%, respectively.
This study reinforces what most tastytraders already know: selling premium works the majority of the time. Straddles, because of their proximity to an asset’s underlying price tend to generate greater credits and therefore, are managed more aggressively. As always, taking advantage of higher implied volatility play can help increase probabilities and profits.
Josh Fabian has been trading futures and derivatives for more than 25 years.
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