In this analysis, we present short straddles with short maturities and a statistical advantage.
The aim of this article is to analyze what profits could result if you were to sell a straddle on selected stocks at the beginning of the week and hold it until the end of the week ( short straddle ). How would this options strategy work if used week to week?
To do this, we sell a straddle every Monday around 4:00 p.m., with an expiry date on Friday of the same week. This short straddle will be closed (bought back) on Friday at around 10:00 p.m., i.e. shortly before the American stock exchanges close. We trade 1 contract each (1 call option and 1 put option ). The strategy generates a profit if the value of the straddle has fallen during the week.
The strategy is very short-term with a term of 5 trading days. So it is not an investment strategy, but purely speculative trading.
The main parameters of the analysis
The observation period of the analysis is 12 weeks . The sale of a straddle was simulated over a period of 5 days for 12 weeks.
Only stocks of companies or ETFs that have a market cap of at least $1 billion are considered.
The average option trading volume should be at least 5,000 contracts per day.
The spread between the bid and ask of the straddle should not exceed $1.
The hit rate (ratio between the number of winning trades and all trades) should be at least 75%.
The average win of all straddles (including losers) should be at least 30% of the premium collected.
The result of our analysis for the Short Straddles
After applying the parameters as written above, we have selected three suitable short straddles. Over the past 12 weeks, these stocks met the strict conditions of a successful weekly short straddle:
| share (ticker) | Surname | hit rate | Average profit in % of premium collected | Average profit per contract | Best trade | Worst trade |
|---|---|---|---|---|---|---|
| PFE | Pfizer | 75% | 38% | 42$ | $127 | -35$ |
| XLV | Health Care Select Sector SPDR | 83% | 48% | $105 | $240 | -74$ |
| PCG | PG&E Corporation | 92% | 38% | 18$ | 48$ | -18$ |
The simulation considers trading of 1 contract .
We take a closer look at the short straddle on Pfizer (US ticker: PFE) stock. In the last 12 weeks, 9 out of 12 short straddles on this stock have been winners, yielding an average profit of $42 per contract.
The fact that the short straddles of the last 12 weeks on this underlying were particularly successful does not necessarily mean that the future straddles will be successful. The analysis only provides information on which underlying was particularly suitable for one-week short straddles in the past. It is also possible that the coming weeks will result in losing trades before the winning streak resumes. In statistical analysis, it must always be expected that winning rows will be interrupted.
The analysis was performed such that the options always traded at the midpoint between the ask price and the bid price.
Since the maximum profit in short straddles corresponds to the premium collected, the return here is based on this premium collected and not on the deposited margin.
To enter the position, the price of the PFE share on January 23, 2023 at 4:00 p.m. is decisive in order to select the appropriate at-the-money strike prices. Entry in the following weeks is also possible.
Suppose the underlying was trading at $45 at the time the trade was opened. In this case, a short straddle with strike prices at $45 and expiry on January 27, 2023 would be an option. This straddle would yield an estimated premium of between $92 and $204 per contract (these were the minimum and maximum premiums of the last trades analyzed).
Looking at current PFE stock prices, the straddle would yield approximately $116 in premium. The option combination would then yield a profit if PFE stock trades between $43.84 and $46.16 on January 27, 2023. Those are the two breakeven points of the straddle.
The short straddle delivers a profit if the PFE share trades within the corridor defined by the blue lines at the end of the term on January 27, 2023. After the market opens on January 23, 2023, the new starting position for the straddle must be taken into account.
The principle of the short straddle
In this combination, a put option and a call option are sold at the same time. ( short put and short call ). Both options are at-the-money, meaning their strike prices are the current share price of the underlying stock (or as close as possible to the current share price). Selling gives you a bounty equal to the maximum possible profit. The risk of a short straddle, on the other hand, is unlimited.
The terms of both options are the same and correspond to the Friday when the straddle closes.
A short straddle is very easy to implement. You don’t have to trade the options individually: you can trade them combined in a single transaction, both when opening the trade and when closing it. Most options trading platform is suitable for this.
On the day the trade is closed, the entire position is closed (both the put option and the call option are repurchased) just before the market closes.
The expectation in the short straddle is that the stock will remain as close as possible to the option’s strike price until the trade is closed .
onclusion: Selected short straddles for lightning-fast trades
The backtest (retrospective analysis) presented here offers a wide range of trading opportunities, with different profit expectations and risks. With short straddles, upside potential is limited to the premium received and maximum downside risk knows no bounds when the stock is moving strongly.
This does not mean that a short straddle is any worse than its counterpart on the long side (a purchased straddle). The odds of a stock not moving can be higher than the odds of it moving a lot, favoring the short straddle.
However, historical results are no guarantee of future success. The next short straddle on PFE can result in a loss. Is recommended to try your strategies on a demo account. Like Binary option trading strategies, Short straddles are always extremely speculative way to trade options. You have to like the risk of taking such combinations of options. However, for active traders, straddles are an ideal strategy as they offer attractive entries every day and every week.
Premature profit-taking and a stop-loss to limit downside risk are recommended actions with straddles.