When a Strangle Goes Against You: Adjust or Wait?

Key Concepts

• Strangle Option Strategy: A neutral options strategy involving simultaneously selling an out-of-the-money call and an out-of-the-money put with the same expiration date.
• Standard Deviation: A measure of the amount of variation or dispersion of a set of values. In options, it relates to price movement.
• Delta (δ): An option Greek measuring the sensitivity of an option's price to a one-dollar change in the underlying asset's price. 20 Delta signifies a price change expectation of roughly 20% probability.
• Touch/Tested: When the price of the underlying asset reaches or approaches the strike price of a sold option, potentially triggering a loss.
• Trade Management: Adjusting an options position (rolling, adjusting strikes, etc.) to mitigate risk or maximize profit.
• Rolling: Closing an existing options position and simultaneously opening a new position with a different strike price and/or expiration date.

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Probability of Adverse Movement in Strangle Trades

The core discussion revolves around the inherent probability of a strangle option trade experiencing adverse price movement – meaning the underlying asset’s price moving against the position. The speaker emphasizes that traders should expect their strangle trades to be “tested” or “touched” at some point during the trade’s lifespan. This isn’t a sign of a flawed strategy, but rather a statistical inevitability.

Specifically, even when employing a conservative strangle strategy – selling options one standard deviation out-of-the-money (approximately 20 delta on both the call and put sides) – there’s roughly a 40% probability that the price will touch one of the strike prices during the trade’s duration. The speaker clarifies this figure is approximate and can fluctuate, but generally trends towards a near 50/50 chance of being tested.

Mitigating Risk Through Trade Management

While acknowledging the high probability of adverse movement, the speaker doesn’t advocate for inaction. Instead, they highlight the importance of proactive trade management to reduce the likelihood of the strangle being triggered and to minimize potential losses. Specific management techniques mentioned include:

• Managing Winning Trades: Taking profits on winning legs of the strangle before expiration.
• Managing at 21 Days: A specific timeframe (21 days) is suggested as a point to review and potentially adjust the position. This isn’t explained in detail, but implies a regular review process.
• Rolling: Adjusting the position by closing the existing options and opening new ones with different strike prices or expiration dates. This allows traders to adapt to changing market conditions.

These management techniques collectively aim to “mitigate the risk on the position and the probability of being touched or tested on one of the sides.”

The Mathematical Basis of Adverse Movement

The speaker grounds the discussion in mathematical probability. The statement, “It’s just how the math works and and works out to be, you know, around a 50/50,” underscores that the probability of price movement isn’t arbitrary. It’s a consequence of the statistical distribution of price fluctuations. The use of standard deviations and delta as metrics reinforces this point – these are tools used to quantify and assess risk based on statistical models.

Logical Flow and Synthesis

The video segment presents a clear and logical argument. It begins by establishing the expectation of adverse movement in strangle trades, then acknowledges the statistical basis for this expectation, and finally offers practical strategies for mitigating the associated risk. The connection between these points is strong: understanding the probability of being tested is crucial for developing an effective trade management plan.

The main takeaway is that successful strangle trading isn’t about avoiding adverse movement altogether, but about anticipating it and proactively managing the position to minimize potential losses and maximize profitability. The speaker’s emphasis on expecting these movements suggests a mindset of preparedness and disciplined risk management is paramount.