Comparing Trading Strategies: Iron Fly vs Short Straddle

we know through our numerous studies that high implied volatility environments offer excellent opportunities to sell premium on order entry we can choose whether to define risk limiting downside or leave risk undefined therefore collecting a greater amount of premium so in other words what we're gonna review today is just looking at a couple of different positions and then looking at those strategies and then looking at those strategies in all different market environments and again we're gonna get more clarity and more definition to some very common positions like a butterfly a short strangle whatever it is an iron fly is essentially the same thing a butterfly yep just that you collect the credit as opposed to paying the debit it's same exact I understand I'm just explaining what the difference is okay so one potential trade to consider when implied volatility is rich is that of a short straddle I've already done or strangled I've already done - oh I'm sorry two different underlines this morning four different positions in a short strangle which is an undefined risk play a variation to this trade is to define the risk by buying further out of the money options limiting both downside risk and potential profits this trade is known as an iron fly mm-hmm and Iron Butterfly whatever it's just it's it's a it's you sell rose by any other name smells just as sweet every single thing that we do is just some combination of something else sure so in this case right if they have to find one in this case the easiest way to explain it is um Tony can you just pull up an option screen for a sec sure so watch this battle pull up an option screen and he's just gonna go let's just do what I did this morning in Facebook okay okay so I'm sorry I didn't I didn't I just strangle so let's just just go to Facebook straddle stocks trading for about 50 bucks forty nine ninety one yes so let's go to the October 50 straddle so the October 50 straddle is the put and the call and if Tony was to sell the October 50 straddle it would look like this you'd collect three dollars and forty cents that's the first piece of this discussion if Tony was to tie this in to the way we're doing it today which is an Iron Butterfly I he's going to hold his hand down okay you're gonna go I mean I can sell it puts Selleck close but still puts but right okay so you're gonna you're gonna you're gonna buy the call that fifty two-and-a-half call cuz we're doing this actually we're doing these three dollars higher but that's the closest thing we do use an example in the italics I just want to show you on the software and then how do you don't want to do it this way no I do not I want to do the straddle first aft straddle give it to me and then I want to buy the fifty two and a half call so I'm just gonna hold down the control key that's right and the 47 put this is essentially now turning this into an Iron Butterfly with the same dimensions that we are we're using we're using three strikes away correct you should strike you straight like you're staying the same that's right short strikes the same three strikes higher on the calls three strikes lower on the puts that's exactly we're doing okay so it goes from a credit of what was that three dollars and forty cents that's correct to two dollars and three cents correct there's a big difference yep as a trade strategy during periods of high implied volatility what are the advantages or disadvantages of short straddles and iron butterfly's and how do the two compare to each other as they both share the same put and call short strikes now the reason we're having discussions because this morning and confirm and said somebody sent it an email they said hey what about why would I ever not I mean why don't we define the risk every single time mm-hmm so let's say so we looked at Amazon Google and Apple over a period of five years and we identified periods where the implied volatility rank crossed above 50% we placed these two trades as close to 45 days to expiration as possible allowing all the positions to run to expiration okay cool so it's Amazon Google and Apple no more going all to expiration like five years everything has to be over 50% on the entry dates we did the following we sold an iron fly three strikes wide per side and we sold an at the money straddle just like I showed you before in facebook here's an example of how we set them up got the spoo's off 75 so on the right hand side of the page is the straddle this can using Amazon selling the 280 calls selling the 280 puts on the left-hand side of the page is the iron fly's selling the 280 calls on the 280 puts and buying three strikes away the 295 calls and buying three strikes below the 265 puts that's exactly what man so there's no confusion about what we're doing hmm hey let's go next slide and the I hold on Quebec one just was it's a quick second mm-hmm sorry Linda back one please the IV rank is 58 percent on this and the stock was 277 good sorry okay thank you for that update well the IV rank is gonna play in the rest of the it's over 50% of all of them now go to the next slide so here's the cool thing about this no it's a very important point thank you for pointing it out cuz it's not over 50 at the last two slide you know what go ahead keep going Amazon the IV rank the one we're looking at here actually has 67 a half plus a did I say 845 those be a 215 you lasted long they thought Amazon the IB rank is 67 Google the amaz the IB rank is 63 Apple the IV rank is 63 now take a look at again these are doing one contract over the last five years when the IV rank is over 50% and here it is at 67 63 and 63 the iron fly and the straddle the iron fly and the straddle in all three and the iron finest travel now if you look at Amazon I fly on all three three times I flashed up that what make money in all the cases correct I'm gonna show you all right so in Amazon the difference is almost $11,000 in Google the difference is almost $5,000 in Apple the difference is very small it's only like a thousand dollars and the interesting thing is that you took some pretty big swings with the straddle in here just sitting on one contract biggest drawdown is three thousand eight thousand and seven thousand dollars there were some huge draw downs in here sure but net net over a five-year period the results undeniable yes the positive and positive that's right just take a look at the percent winners down below 65 80 I'm sorry 65 is the iron fly 80 on the straddle 68 on this travel 73 on the straddle and remember we do these straddles the intent was to be 68 percent point to every single time or 16.8 I'm sorry what happens here is 80 68 and 73 you can see where that edge is in selling in selling premium that's correct the iron fly line and that's the average IV rank it wasn't the exact list for the average bullet race yeah I mean the iron fly is a little bit different but again those those IV those returns on a percentage basis were pretty strong people ask us all the time Tony about they say hey guys what about these big draw downs that we face and our answer is always the same okay you face big draw downs but the reality of a big draw down is that over time you still come out ahead here's the perfect example correct and these draw downs were significant eight thousand seven thousand three thousand but in the end you always come out ahead correct you know it's funny you know people have you know they're they're apprehensive to do something like this but they have no problem sitting in a position for 30 years that basically has draw downs too I mean the market moves significantly in a different direction but they don't look at that as like you know doing anything risky let's go next slide so both strategies over the course of five years generated a positive a positive P&L as expected this straddle had a higher probability of success when compared with the iron fly however we also saw significant draw downs even though they were expected let's go next slide so for comparison though we decided to see how these strategies performed in periods of low volatility we looked at Apple because we just kind of isolated Apple and then we identified when the IV rank was below 50 and here are the results we think Apple is very liquid - okay but but just just you know how he just did these strangles when implied volatility was over 50% actually up close to 70% because look at the same exact study when the IV rank and Apple was thirty seven point eight three mm-hm and can you imagine what had been when I went Apple is even lower than that this is the same exact study and I'm exact period of time and the straddle lost $12,000 during that period of time and the percent winners was only 58% unbelievable Wow should be ten percentage points higher wow that's unbelievable that that's the whole argument right there that's the whole game changer that's everything we've been working to get to that we never understood and that also goes to the point where people say you know do I want to sell why do I want to sell premium on premium is high when premium is high that's a that's implying that the stock is gonna move a lot if I sell a straddle I don't want the stock to move a lot I wanted to stay inside of its of its range here were proven to you that you want to sell premium when Premium aside go back Linda to slides please sorry I won't right there so if you look on the right-hand side of the page under Apple the IV rank is 63 that's the average over five year period and if you look at the straddle it made $11,000 $11,000 from doing that you know just the at the money straddle if you go three slides forward to 10 of 11 you end up seeing that it lost $12,000 when you did just at the 30 you know when you dipped below 50 that is scary you go from minus 12 to plus 11 just because you executed when you're supposed to execute that's the best information we've ever provided I mean up from a long-term perspective that's the game-changer that is the best flat out the best information information we've ever delivered I like it let's go last slide we see a dramatic difference in P&L win percentage when comparing these strategies in high-low periods of implied volatility as a defined risk replacement for a straddle the iron fly has its merits depending on your risk tolerance these strategies may also be plausible for your portfolio particularly appearance of high implied volatility you know what there was almost no issue with that with the returns on the Iron Butterfly but those are big wide and fairly risky you know risky in the sense that they just you know they take some time over a couple of years yep because you're not necessarily gonna nail one right away and you have to you have to be very mechanical over a long period of time to do it but Tony the results for lo implied volatility versus high implied volatility undeniable did you send an eyeball I said it before you you copy me

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Keywords: tastytrade, tastytrade.com, tasty trade, tastytrade network, tom sosnoff, tony battista, finance, options trading, how to trade options, trading options successfully, tastytrade options, financial investment, stock market, market measures, iron fly v short straddle, short straddle, iron fly, trading strategies, proft, loss

Id: YcQcpZ3EmCE

Length: 10min 59sec (659 seconds)

Published: Fri Oct 04 2013