3 advantages of undefined-risk strategies

The 3 Advantages of Undefined-Risk Strategies

By:Dr. Jim Schultz

They offer a high probability of success, unfiltered exposure to the Greeks and easy adjustment

  • Undefined-risk options strategies always yield higher probabilities of success than defined-risk strategies.
  • You get unfiltered exposures to the Greeks with undefined-risk options strategies, such as negative vega and positive theta.
  • Defined-risk strategies are difficult and clunky to adjust over time, whereas undefined-risk strategies are much easier to adjust.

Naturally, defined-risk strategies are attractive because your overall risk in the trade is fixed over the life of the position. But that safety net comes with several disadvantages not found with undefined-risk positions.

Here are three advantages that undefined-risk strategies have over defined-risk strategies:

1. Higher probabilities

First, undefined-risk strategies always have higher probabilities of success relative to a defined-risk strategy around the same strikes in the same stock. This has to be the case because otherwise there would be little incentive to ever go naked on a position.

Still, the differences in probabilities on a short put vs. a short put spread, for example, can be significant and add up over time.

By not buying the leg that would define your risk, you’re increasing the credit collected on the trade. This added credit leads to wider break-even points on the trade, which in turn, equates to a higher probability of success.

2. Unfiltered Greek exposure

Second, undefined-risk positions give you unfiltered exposure to the Greeks, such as positive theta and negative vega. This is beneficial because as premium sellers, we want to take advantage of volatility’s tendency to contract and the time decay from the passage of time.

When you enter a short-premium, defined-risk trade, however, you have an equal number of long options covering your short options. These long options end up diluting the Greek exposure you have with your short options. As a result, you don’t end up with nearly the short vega or long theta you would have with an undefined-risk position.

3. Easier adjustments

Third, undefined-risk strategies are much easier to manage and adjust over time, relative to defined-risk strategies. Having only short options in the strategy (i.e. short strangle), or at least having more short options than long options (i.e. ratio spread or jade lizard), enables you to collect additional extrinsic value whenever you want to roll out and extend duration.

This is not the case with defined-risk strategies, which often require a debit to add duration to a strategy that has moved against you. Paying a debit to roll defined-risk strategies isn’t something we normally do because any debits you might pay end up increasing your risk and decreasing your return on that defined-risk position.

Jim Schultz, a quantitative expert and finance Ph.D., has been trading the markets for nearly two decades. He hosts From Theory to Practice, Monday-Friday on tastylive, where he explains theoretical trading concepts and provides a practical application of those concepts to a trading portfolio. @jschultzf3 

For live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro.

Trade with a better broker, open a tastytrade account today. tastylive, Inc. and tastytrade, Inc. are separate but affiliated companies.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer.  Options, futures, and futures options are not suitable for all investors.  Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.

tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.

tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.

tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.

© copyright 2013 - 2024 tastylive, Inc. All Rights Reserved.  Applicable portions of the Terms of Use on tastylive.com apply.  Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.