Testing the strength of a strangle in the FXI
For the past 10 years, U.S. stock markets have tended to move in a single direction: up. This has been a challenge for options sellers with a neutral assumption on the market. Strategies like strangles have been tested on their upper breakevens through the past 10 years. Although the strategies have still been profitable for the most part, their performances have been hampered by the short call (bearish) side.
Anyone still worried about selling directionally neutral premium in the monodirectional U.S. markets can look elsewhere. Enter China.
The large-capitalization Chinese exchange-traded fund, iShares FTSE/Xinhua China 25 Index (FXI) has experienced virtually no price change since 2010, and as a result, has been cyclical and range-bound. That makes this underlying a directionally neutral premium seller’s dream. (See “Neutral price action,” below.)
What basic strategy can investors employ when they assume FXI will continue this neutral price action?
Strangle: Sell one 43-strike put and one 46-strike call with roughly 45 days to expiration. Look to take this off when it has made 50% of total possible profit or when the position reaches 21 days to expiration, whichever comes first.*
Investors who are more risk tolerant can sell a straddle. Sell a 44-strike put and call with roughly 45 days to expiration. This will be riskier because investors want the stock to move even less than if they had sold a strangle. However, the max payoff is more than double that of a strangle. Look to manage this more aggressively at 25% of total possible profit or roughly 30 days to expiration, whichever comes first.*
Risk-averse investors can sell an iron condor. It’s the same setup as a strangle but, in addition, investors buy the 41-strike put and the 48-strike call. Buying these “wings” will cap losses, but in exchange for some protection from big moves in the stock, investors reduce their total possible profit. Look to close this trade the same way as a strangle, at 50% of max profit or 21 days to expiration.*
Final tip: Waiting for implied volatility in FXI to increase will boost potential profits while keeping probability of profit roughly the same.
*Based on market conditions as of 2/1/20. Prices may have changed and loses may occur.
Anton Kulikov is a trader, data scientist and research analyst at tastytrade.