Stocks & Commodities V. 32:2 (16-21, 40): Static Option Income Strategies: Do They Work? by Giorgos E. Siligardos, PhD

Stocks & Commodities V. 32:2 (16-21, 40): Static Option Income Strategies: Do They Work? by Giorgos E. Siligardos, PhD
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Static Option Income Strategies: Do They Work? by Giorgos E. Siligardos, PhD

Myths vs. Facts

If youíre trading options, youíve probably heard of static option income strategies. They promise low but almost riskless profits every month by selling premiums in up, down, or sideways markets, and you donít have to make any predictions about the direction or the volatility (implied or actual) of the underlying. Sounds too good to be true, doesnít it? Hereís what you need to be aware of before you start trading them.

Todayís technology and rapid dissemination of information and the friendlier trading environment in derivative products for retail traders gave birth to the so-called option income strategies. These are mostly multileg positions in options aimed at earning small profits month after month. In their most popular (and extreme) versions, these strategies apply static, global, and specific entry or exit rules, eliminating any guesswork about the direction of the underlying.

In this article I will discuss the theoretical background of the most widespread of these strategies, the systematic short iron condor (SSIC). Iíll explain why it became so popular and why the widely touted probabilistic arguments ó in theory and in practice ó used to support it are misleading. Letís see if itís possible for the average trader to be profitable over the long run when using SSICs.

The SSIC, briefly

The SSIC strategy is based on systematically shorting iron condor (IC) positions with options that are sufficiently out-of-the-money (OTM). A theoretical diagram of a profit/loss graph of a short IC is displayed in Figure 1. Such a position is composed of two vertical credit spreads:

* A vertical credit spread with OTM puts having strikes below the current spot price

* A vertical credit spread with OTM calls having strikes above the current spot price.

All options involved are based on the same underlying and have the same time to maturity. The underlying is usually a stock market index (SMI) for the following reasons:

* SMIs move much more smoothly than single stocks

* Most options on SMIs are European, which eliminates the possibility of early execution for the short legs of ICs

* Option markets on large SMIs such as the Nasdaq 100 (NDX) or Russell 2000 Index (RUT) are liquid and their bid/ask spreads are significantly narrower than the bid/ask spreads of single-stock options.

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