Option Strangles: An Analysis of Selling Equity Insurance

Abstract

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.

Case study of event risk management with options strangles and straddles

“…Simon (2007) reveals significant profits, even with transaction costs, from shorting straddles and strangles on the Invesco QQQ exchange‐traded fund of the Nasdaq‐100 Index up to time horizons of 10 business days. Kownatzki and Sabouni (2019) report profitability across a wide range of strike prices when shorting SPY strangles. However, they also note that the maximum drawdowns on some losing positions can offset the gains of approximately forty prior positions.…”