A strangle is a delta-neutral (at order entry) 2-leg option strategy that is comprised of a short put and a short call that are opened at the same time and with matching expiration dates. Maximum profit is the credit received from both short legs and is achieved when the underlying is between the short strikes at expiration.
Opening a short strangle position on an underlying is speculation that the realized volatility of the underlying will be less then the implied volatility. It’s not a “pure play” on volatility – like a volatility swap – due to the delta exposure that shifts as the underlying moves, but it’s a reasonable start / substitute for a retail trader.
Research suggests that 7-DTE short SPX puts have generally experienced positive expected value. Meanwhile, research also suggests that 7-DTE short SPX calls have generally experienced a negative expected value.
Since we know that the call “side” of a short SPX strangle strategy is systematically unprofitable, it would therefore make sense to simply sell the put only. This of course begs the question: “what’s the point of a strangle?” Is there a diversification benefit between the calls and puts where the sum of the parts is greater than the whole? Or is it a strategy invented by brokerages and trading educators to maximize commissions and minimize risk of account blow up in order to extract the most value from account holders?
We’ll take a look at the backtest results of opening one short SPX strangle 7-DTE position each trading day from Jan 5 2007 through Oct 31 2023 and see if there are any discernible trends.
We will also explore the performance of the s1 signal. The s1 signal is a boolean (TRUE / FALSE) daily indicator that attempts to identify the days in which short put and short vertical put positions on the S&P 500, and far-ITM short call and short vertical call positions on VIX, are most likely to be profitable at expiration. s1 is based on data from Cboe and S&P Global.
This study seeks to explore the following theses:
- if we open and hold-till-expiration a short SPX strangle 7-DTE position on the days in which s1 is TRUE, and take no action on the days in which s1 is FALSE, we will outperform, with regard to total return, risk-adjusted return, max drawdown, and max drawdown duration (and consequently capital efficiency), a strategy that opens and holds-till-expiration every trading day
- if we open and hold-till-expiration a short SPX strangle 7-DTE position on the days in which s1 is FALSE, and take no action on the days in which s1 is TRUE, we will underperform, with regard to total return, risk-adjusted return, max drawdown, and max drawdown duration (and consequently capital efficiency), a strategy that opens and holds-till-expiration every trading day
- if we open and hold till expiration a short SPX strangle 7-DTE position on the days in which s1 is TRUE, with a max margin utilization target of 100%, we will outperform, with regard to total return, risk-adjusted return, max drawdown, and max drawdown duration, a 100% SPY buy-and-hold portfolio with dividends reinvested (total return)
To test these theses we will:
- limit order entry to only the days in which s1 = TRUE to see if the strategy outperforms daily entry with regard to total return, risk-adjusted return, max drawdown, and max drawdown duration (and consequently capital efficiency)
- limit order entry to only the days in which s1 = FALSE to see if the strategy underperforms daily entry with regard to total return, risk-adjusted return, max drawdown, and max drawdown duration (and consequently capital efficiency)
- limit order entry to only the days in which s1 = TRUE, with a max margin utilization target of 100%, to see if the strategy outperforms a 100% SPY buy-and-hold portfolio with dividends reinvested (total return) with regard to total return, risk-adjusted return, max drawdown, and max drawdown duration
Performance of the s1 signal is explored in different contexts in other s1 signal studies.
There are 15 backtests in this study evaluating over 37,500 short SPX strangle 7-DTE trades.
The data used in this study was provided by ORATS via a professional license paid for by spintwig LLC.
Build the same ORATS trade logs used in this study with an individual license, discounted up to 66% for spintwig clients and readers (affiliate link) or download the finished product from our trade log store.
Let’s dive in!
- Symbol: SPX
- Strategy: Short Strangle
- Days Till Expiration: 7-DTE +/- 4, closest to 7
- Start Date: 2007-01-05
- End Date: 2023-10-31
- Positions opened per trade: 1
- Entry Days:
- each trading day
- each trading day in which the s1 signal = TRUE
- each trading day in which the s1 signal = FALSE
- Entry Signal: s1 signal
- Timing 3:46pm ET
- Strike Selection
- 5 delta +/- 4.5, closest to 5
- 10 delta +/- 5, closest to 10
- 16 delta +/- 6, closest to 16
- 30 delta +/- 8, closest to 30
- 50 delta +/- 8, closest to 50
- Trade Entry
- 5-delta short put / 5-delta short call
- 10-delta short put / 10-delta short call
- 16-delta short put / 16-delta short call
- 30-delta short put / 30-delta short call
- 50-delta short put / 50-delta short call
- Trade Exit
- Hold till expiration
- Max Margin Utilization Target (short option strats only): 100%
- Max Drawdown Target: 99% | account value shall not go negative
- Margin requirement for short CALL and PUT positions is 20% of notional
- Margin requirement for short STRADDLE and STRANGLE positions is 20% of the larger strike
- Margin requirement for short VERTICAL SPREAD positions is the difference between the strikes
- Margin requirement for short CALENDAR SPREAD positions, where the short option expires after the long option, is 20% of the short option
- Margin requirement for long CALENDAR SPREAD positions, where the short option expires before the long option, is the net cost of the spread
- Margin requirement for short IRON CONDOR positions is the difference between the call-side strikes if both sides are the same width, otherwise margin requirement is the width of the wider side
- Early assignment never occurs
- There is ample liquidity at all times
- Margin calls never occur (starting capital is set using hindsight bias so that max margin utilization never exceeds 100%)
- Apply a 20% discount to displayed results. For example, if a strat depicts a CAGR of 10%, assume that it’ll yield 8% in practice.
- Prices are in USD
- Prices are nominal (not adjusted for inflation)
- All statistics are pre-tax, where applicable
- Margin collateral is invested in 3mo US treasuries and earns interest daily
- Option positions are opened at 3:46pm ET
- Option positions are closed at 3:46pm ET (4:00pm if closed on the date of expiration)
- Commission to open, close early, or expire ITM is 1.00 USD per non-index underlying (eg: SPY, IWM, AAPL, etc.) contract
- Commission to open, close early, or expire ITM is 1.32 USD per index underlying (eg: SPX, RUT, etc.) contract
- Commission to expire worthless is 0.00 USD per contract (non-index and index)
- Commission to open or close non-option positions, if applicable, is 0.00 USD
- Slippage is calculated according to the slippage table
- Starting capital for short option backtests is adjusted in $1000 increments such that max margin utilization is between 80-100%, closest to 100%, of max margin utilization target
- Starting capital for long option backtests is adjusted in $1000 increments such that max drawdown is between 80-100%, closest to 100%, of max drawdown target
- Positions that have an exit date beyond the backtest end date are excluded
- For comprehensive details, visit the methodology page
Hindsight bias was used to maximize Reg-T margin utilization for each strategy. This allows a “best case” scenario for the option strategy to outperform the benchmark by identifying the minimum amount of starting capital necessary to successfully (eg: avoid margin calls) complete the backtest.
Max Drawdown Duration
Average Trade Duration
Average Trade Delta
Compound Annual Growth Rate
Profit Spent on Commission
Let’s take a closer look at the short SPX strangle 7-DTE 16-delta trade. We’ll look at opening a position daily, opening a position only on days when s1 = TRUE, opening a position only on days when s1 = FALSE, then benchmark everything against buy-and-hold SPY with dividends reinvested (total return).
Starting Capital and Margin Use
Win Rate Stats
Profit and Loss Stats
Comparison of Sides
To help us answer the question of whether short strangles have a diversification benefit by combining put and call legs or if it’s a low-risk means for brokers to boost their commission income, let’s look at the same short SPX strangle 7-DTE 16-delta trade and compare each leg’s performance side by side.
Distribution of s1 signals
The s1 = TRUE signal, while suggesting order entry on roughly half the trading days since 2007, is not evenly distributed throughout time. Here’s a breakdown of participation rate by year:
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