The goal of our paper is to analyze the full return characteristics of option strangles and to develop a set of models to help investors avoid getting steam-rolled. Our results show that selling SPY strangles are generally profitable across all time frames and widths even during the critical crisis year of 2008. Our model posted the largest average returns of 18.28% in 2009 followed by 16.85% in 2011. However, the payoff profile of a short option strangle exposes the contract seller to a potential for unlimited losses. Our evidence on maximum drawdowns indicates that losses on some positions can be the equivalent of the profits gained on approximately forty prior positions. This payoff profile has given rise to the metaphor of selling option contracts as the equivalent of "picking up nickels in front of a steam roller." We use information that is available at the time a position is under consideration to predict the profitability of strangles and to avoid strangle positions with potentially large losses.
Event risk environments may involve an elevated probability of both volatility regime shifts and sharp, abrupt price changes, either up or down. Purely direction‐oriented risk management approaches are not necessarily well‐suited for these market conditions. In this exploratory case study, we look at the possibility that non‐directional options strategies, such as straddles and strangles, may offer interesting benefits in the management of potential event risk environments. Our research involves only the case of the S&P500® Index from 2018 through 2020. We utilize the Market Sentiment Meter from CME Group to identify periods in which event risk may be present and particularly when the probability of sharp, abrupt price changes may be elevated. Our findings in this specific case suggest that selling option straddles and strangles during typical market conditions and then buying option straddles and strangles when the market sentiment switches to a more extreme state offers potential as an effective risk management approach for event risk. More research is needed over longer periods and for different securities, including international equity indices, to explore the usefulness of options strategies for event risk management.
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