Two of our favorite strategies for selling premium and taking advantage of high Implied Volatility (IV) while simultaneously generating positive Theta (time decay) are short Strangles, which are an undefined risk trade and their defined risk counterparts, Iron Condors, which is the same as a Strangle but with long outside wings for protection. What are the differences between fixed strike Strangles and dynamic strike Strangles and what are the advantages of the latter?
The fixed method results in short Calls and Puts that are both equidistant from the at-the-money (ATM) strike. Dynamically chosen strikes are selected based upon the probability that the strike will expire in-the-money (ITM) as expressed in the Delta of the option.
Equity indices almost always have a downside Volatility Skew because of the greater desire for downside protection. This results in an unbalanced distribution curve and dynamically chosen short Strangles with Put strikes that are more out-of-the-money (OTM) than the Call Strikes. This more accurately reflects the implied risk. Using static strikes may mean the strikes are too far out or too close on the distribution curve. That can result in a less than desirable risk to reward ratio for one side of the Strangle. Dynamic Strangles will have Puts and Calls with the same Delta and thus at the same height on the distribution curve. Fixed Strangles can easily be as different as a short Put with a 30 Delta and a short Call with a 5 Delta.
For more information on Dynamic Strike Width see:
Market Measures from April 23, 2015: "Fixed vs Dynamic Width of the Spread"
Best Practices from March 22, 2016: “Choosing Wings Based on Probabilities”
Best Practices from June 6, 2016: "Dynamic Trading | Benefits Over Static Strategies"
Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the important takeaways and a better understanding of the differences between fixed strike Strangles and dynamic strike Strangles.
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