Unless you've been buried under a rock somewhere, you'll know that we've experienced a big, broad market move from the late December "Dump Everything, Including the Kitchen Sink" lows at SPY 234 to where we finished Friday. If you were bullish assumption directional in virtually any broad market instrument or exchange-traded fund at or near those late December/early January lows, well, you're feeling pretty awesome here. However, if you went nondirectional at those same lows (short strangle, short straddle) in light of the high volatility environment that existed at that point in time, you may be struggling with call side test and have your share of inverteds on. With that in mind, here are a few tips for managing tested nondirectionals, particularly short strangles and short straddles.
1. Don't Panic/Take Time To Manage The Setup Thoughtfully. If you've been selling short strangles or straddles for any period of time, you'll know that markets move. You can't have a perfectly delta balanced setup all the time, and you probably shouldn't try to keep things that way. Constantly going for delta neutral costs you fees and commissions at the very least and subjects you to potential whipsaw if you're too aggressive. Take a deep breath, close your phone's trading app, and look at the setup again when you've got sufficient time to evaluate what you should do, which should include looking at all your options (rolling the untested side up, rolling the whole setup out, adding needed delta via an additional setup,* or a combination of those).
2. Stay Mechanical As To "When." I generally have a few rules as to when something must be done with a broken setup: (a) A side is approaching worthless (<.05). (b) There is ex-divvy assignment risk. (c) Time is simply running out. All other times are basically "non-must" times when you probably should just hand sit on the setup and attempt to allow the probabilities to work out without intervention. I would note that hand sitting patiently for one of these "must do" points in time is the hardest thing to do in practice, but probably gives better results than constantly fiddling with the setup. (I tend to be a fiddler, so I can speak from experience).
3. Stay Mechanical As To "Where."
Intraexpiry Rolls: My general rule on intraexpiry rolls is to roll the untested side toward current price to a strike that will cut net delta position in half where there is side test or the side to be rolled is approaching worthless, assuming that doing that will be productive from a credit received standpoint. For example, if the position's net delta has skewed out to -50, look to roll the untested side to a strike that will reduce that net to =25. As a possible alternative rule, roll the untested to the 30 delta strike; it won't necessarily cut your net delta in half, but it's also a good mechanical rule.
If an intraexpiry roll won't be productive (<.25 is kind of my cut off), look to roll out for duration.
Rolling For Duration: I generally look to roll the tested side "as is" and the untested to the 30 delta strike.
4. Be Familiar With "Inversion Math." If either an intraexpiry/duration roll results in an inverted setup, keep in mind that the number of strikes the strangle is inverted must be subtracted from total credits received to determine your max profit potential in the inverted. For example, if you received 2.00 for a short strangle and rolled for a 1.00 credit to an inverted that is 2 dollars wide, the max profit potential of that setup isn't 3.00 (total credits received); it's the total credits received minus the width of the inversion: 3.00 (total credits received) - 2.00 (inversion width) = 1.00. Your scratch point is still 3.00, but you won't be able to get out of that setup for less than 1.00 max, so there's no point in shooting for 1.50, for example. Conversely, rigorously attempt to avoid rolling to an inversion that is wider than total credits received, since you won't be able to exit that setup at your scratch point profitably.
5. Look to Bail On Inversions At Scratch. Broken setup risk is generally not centered, the probability of profit is lower than an original setup, max profit potential generally isn't ideal as a function of how much buying power a broken is tying up, and there is there is random assignment risk, depending how deep in the money the tested side is. A scratch is always better than a loser.
6. Keep Track As You Go. Regardless of which type of roll you do, keep track of total credits received as you do each one. Going back through your platform or brokerage statement to look at what you received in credits adds work to the basic scratch calculation process and can lead to addition/subtraction errors as to where your scratch point lies. I have a spread sheet for active trades to avoid doofy addition errors. Aside from calculating short strangle scratch points, it's just a good habit to have a spreadsheet, particularly with things like covered calls, where you can work positions over several months, if not years, of time.
* -- Getting required delta via a separate setup (short calls, short call verticals, downward put diagonals, short skewed strangles/straddles for short delta; short puts, short put verticals, upward call diagonals, long skewed strangles/straddles for long delta) is also something that you can do to delta balance, but it naturally adds its own risk.
1. Don't Panic/Take Time To Manage The Setup Thoughtfully. If you've been selling short strangles or straddles for any period of time, you'll know that markets move. You can't have a perfectly delta balanced setup all the time, and you probably shouldn't try to keep things that way. Constantly going for delta neutral costs you fees and commissions at the very least and subjects you to potential whipsaw if you're too aggressive. Take a deep breath, close your phone's trading app, and look at the setup again when you've got sufficient time to evaluate what you should do, which should include looking at all your options (rolling the untested side up, rolling the whole setup out, adding needed delta via an additional setup,* or a combination of those).
2. Stay Mechanical As To "When." I generally have a few rules as to when something must be done with a broken setup: (a) A side is approaching worthless (<.05). (b) There is ex-divvy assignment risk. (c) Time is simply running out. All other times are basically "non-must" times when you probably should just hand sit on the setup and attempt to allow the probabilities to work out without intervention. I would note that hand sitting patiently for one of these "must do" points in time is the hardest thing to do in practice, but probably gives better results than constantly fiddling with the setup. (I tend to be a fiddler, so I can speak from experience).
3. Stay Mechanical As To "Where."
Intraexpiry Rolls: My general rule on intraexpiry rolls is to roll the untested side toward current price to a strike that will cut net delta position in half where there is side test or the side to be rolled is approaching worthless, assuming that doing that will be productive from a credit received standpoint. For example, if the position's net delta has skewed out to -50, look to roll the untested side to a strike that will reduce that net to =25. As a possible alternative rule, roll the untested to the 30 delta strike; it won't necessarily cut your net delta in half, but it's also a good mechanical rule.
If an intraexpiry roll won't be productive (<.25 is kind of my cut off), look to roll out for duration.
Rolling For Duration: I generally look to roll the tested side "as is" and the untested to the 30 delta strike.
4. Be Familiar With "Inversion Math." If either an intraexpiry/duration roll results in an inverted setup, keep in mind that the number of strikes the strangle is inverted must be subtracted from total credits received to determine your max profit potential in the inverted. For example, if you received 2.00 for a short strangle and rolled for a 1.00 credit to an inverted that is 2 dollars wide, the max profit potential of that setup isn't 3.00 (total credits received); it's the total credits received minus the width of the inversion: 3.00 (total credits received) - 2.00 (inversion width) = 1.00. Your scratch point is still 3.00, but you won't be able to get out of that setup for less than 1.00 max, so there's no point in shooting for 1.50, for example. Conversely, rigorously attempt to avoid rolling to an inversion that is wider than total credits received, since you won't be able to exit that setup at your scratch point profitably.
5. Look to Bail On Inversions At Scratch. Broken setup risk is generally not centered, the probability of profit is lower than an original setup, max profit potential generally isn't ideal as a function of how much buying power a broken is tying up, and there is there is random assignment risk, depending how deep in the money the tested side is. A scratch is always better than a loser.
6. Keep Track As You Go. Regardless of which type of roll you do, keep track of total credits received as you do each one. Going back through your platform or brokerage statement to look at what you received in credits adds work to the basic scratch calculation process and can lead to addition/subtraction errors as to where your scratch point lies. I have a spread sheet for active trades to avoid doofy addition errors. Aside from calculating short strangle scratch points, it's just a good habit to have a spreadsheet, particularly with things like covered calls, where you can work positions over several months, if not years, of time.
* -- Getting required delta via a separate setup (short calls, short call verticals, downward put diagonals, short skewed strangles/straddles for short delta; short puts, short put verticals, upward call diagonals, long skewed strangles/straddles for long delta) is also something that you can do to delta balance, but it naturally adds its own risk.