Hey everybody, Gracer here from the tastylive Research Team.
We often get asked whether it’s better to use the strikes that an expected move calculation provides or to use the strikes that the options suggest, based on probabilities. While these strikes are typically very close or the same, skew will often times cause the puts to be further away when looking at the probabilities.
This is important because markets will tend to move faster to the downside. By using the probabilities, we will give ourselves slightly more room to the downside. We wondered what would be the difference in placing a mechanical 10 point wide iron fly compared to a more dynamic approach of buying the wings at 1 standard deviation (SD)?
We tested the Fixed Iron Fly against the Dynamic Iron Fly by looking at data from 2009 to the present in three underlyings with 222 total occurrences.
We found that even though the buying power was a little higher when using the probabilities, it was well worth it. This method of defining your risk resulted in 47% more profits and a higher win rate.
Bottom line: by using the probabilities that the market provides, we’re able to increase our profitability compared to a static method of defining our risk.
If you want to take a closer look at this research, watch the full archive here. And check out the tastylive show archives at the same time! Lots more great research in there for you.
OK, I’m Chris Grace, for the tastylive research team. Thanks for watching my Market Measures Notebook!
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.