Those confused as to why we believe in managing straddles at 25% of max profit and 1 SD strangles at 50% won't be after watching this segment which makes it all clear. The Doctor makes a house call to cure your confusion.
We are often asked why we believe in managing straddles at 25% and strangles at 50% of max profit. Dr Data (Michael Rechenthin, Ph.D.) explains it all and makes it clear. He begins by explaining the theoretical option pricing model reasons first. He follows that up with some strong empirical data.
The first graph shows the theoretical effect of Theta on both a straddle and a strangle. Some notations are added which show profit levels at different time frames along with the percentage of max profit. Mike makes clear that the key figure is profit per day.
Another graph shows a straddle versus several different strangles. It makes clear that it takes much more time to reach 50% of max profit on a straddle and that the farther you go out on a strangle the faster you achieve the 50% level. Gamma risk is why it’s a big mistake to hold a straddle to expiration. Gamma risk “explodes” in the last few days.
The empirical data was shown next. Dr. Data first gave us the info for a 1 SD strangle. The results of managing at 25%, 50% and held until expiration and the median average for each was listed for P/L, days held, and most importantly P/L per day were show, Mike emphasizes that we should be concerned about the efficient use of capital. A similar table is shown for straddles. The results are noteworthy.
Watch this segment of the Skinny on Options Data Science with Tom Sosnoff, Tony Battista and Dr. Data for the takeaways and to understand from a theoretical and practical standpoint why managing straddles at 25% and strangles at 50% is the most efficient use of capital.
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