Short Straddle Option Strategies on SPX and RUT

Based on Short Straddle Option Strategies Dave published some highly interesting information about his straddle backtests.

So far, it supports my understanding, that Straddles are a great way to earn consistent income from options.

Being an Option Seller, all factors come down on managing risk and premium income well enough to earn profits on a regular basis.

Source: DTR Trading

Let me quote some results from Daves statistical research:

In general, we can see in the table that, to collect 10% of the credit received (10% profit taking level) required a trade duration of roughly 30% of the entry DTE. At the 25% profit taking level you needed to stay in the trade around 60% of the entry DTE. For the 35% profit taking level it was about 70% of the entry DTE; 45% profit taking took your trade duration to about 80% of the entry DTE. These estimates are for the non-IVR filtered strategy variations.

First of all, you can generally show that higher profit targets force you to stay longer in your position. If you think about it, that result make totally sense. Profits are usually coming from time decay and a loss of volatility. While time will pass by automatically, you have a a fifty fifty chance on rising or falling vola (unless you enter the trade at very high implied volatility levels).

So the more you want to earn -- the longer you will have to wait.

Now for the last table...total non-compounded returns by strategy variation. The non-IVR filtered variations had the highest returns, which is related to these variations having the most trades (100+, see table above). In general, the trend is for higher returns with higher DTE.

At the same time more days to expiration (DTE) increase your profit propability and your returns. Longer DTEs increase the time value of your sold options giving you more time to hold your position. At the same time, longer option plays are less volatile and reduce risk on larger stock market swings.

The third table shows the win rate for all of the strategy variations. The highest win rates occurred at the 10% profit taking level, regardless of IVR filter level. Most of these particular win rates were in the 90% + range. For the IVR > 50% filter, the high win rates spanned multiple profit taking levels. For the non-IVR filtered variations and the 25% profit taking level, we see many win rates at or above 80% across most DTE. For a monthly straddle trader, this isn't a bad win rate.

If you only go with 10% profit target, your chance of winning is almost always at least 90%. The problem of volatilty flips at the same time, if you do those trades on a regular basis with a high stop loss level. The reason is, that volatility is high and you can earn huge premiums here. But high vola also means huge swings in the underlying that will increase your risk of getting kicked out of the trade with a loss before you can earn your profit. A profit target that is too low also needs more time to earn back your losing trades.

So far from what I learned, a good profit target is around 25% to 35% of the received option premium. At the same time, I would put a stop loss target that is around double or triple of your profit target. Let's say, you take profit at 25% than my maximum loss to take would be 50% to 75% at best. For a profit of 35% you should give space for up to 100% of the premium received.

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