Adjusting Short Straddles For Profit Case Study

All over the internet, you'll hear stories of why short straddles and short strangles should be avoided at all costs. Stories of how trading "undefined" risk positions can blow up your account when the market moves against you quickly. While position sizing still needs to be managed appropriately, the fact remains that properly adjusting short straddles and rolling for duration and additional premium can help turn so-called losers into profitable positions.

Trade Overview:

We entered into our first position in EWZ on September 18, 2018 - $33 straddle.
We sold the $33 call and $33 put for $3.90 for October expiration.
EWZ had been through a down move to a low of $31 and was starting to rally back up.
IV was very high, over the 90th percentile.
We collected $390 initial credit at October expiration for the first set of straddles sold.
We added another laddered entry set for EWZ, selling the $33 straddles for November expiration.
As a general rule, as we get closer to expiration, we don't want to enter new trades inside 20 days.

On September 24, EWZ rallied up to $34 and then fell back down to $33.
IV was still high at this point, so we decided to spread the trade out over two contract months. So, we entered another set of $33 November straddles, collecting an additional $5.53. Trading a little bit further out, we were able to collect a much higher premium for these straddles for October expiration.
Even if IV is high, we're collecting $5 plus in premium, which gives us an $11 range to still make money by expiration.

We continued to slowly enter laddered positions.
EWZ started to move higher to around $35, and IV was still high.
On October 2, we entered another set of laddered entries in EWZ, selling the $35 straddles.
We collected $5.33 for those contracts.

Summary:

We had three straddles outstanding: three sets of two contracts each, one set in October and two in November.
The day after our entry into the $35 set of straddles on October 2, EWZ rallied really strong, really fast.
EWZ jumped over multiple gaps to reach a high of $40.
As a result, IV dropped back down to around the 50th IV ranks.
With the stock trading around $40, and us selling most of our premium at $33 & $35 strike, we were outside of our break-even point on EWZ.
At October expiration, we could not do anything with the 33 straddles that we had.

Mitigating the Risk:

If you can roll for a credit, role for a credit.
On October 8, we rolled our original $33 straddles to November using a double-diagonal order.
We took in a total credit of $1.17 on this roll.

EWZ Rally:

During October, EWZ continued to rally and continue to move higher to a peak of $41.50.
On November 2, IV was still higher than it was when we initially rolled contracts out from October to November.
We rolled these contracts out again from one expiration to the next expiration.
If you can control the position size and you know that markets are cyclical, if you can roll for a credit and extend your timeline, you can wait it out until the market comes back around.
Not every rally up or every drop lower is going to stay there forever.

Goals:

Reduce risk
Turn the position around

Adjustments:

On November 2, we rolled straddles to the next expiration month from November out to December.
We used the double diagonal orders and added them in December for higher credits.
The $35-centered straddles of November were rolled out to December for a $88 credit overall.
The $33-centered straddles of November were rolled out to December for a $51 credit each.
On the $33 straddles, we collected a blended credit of $5.81 on average per contract, moving the break-even point out to $38.81.
On the $35 straddles, we collected a total of $6.21, moving the break-even point out to $41.21.
Because of the premium collected, the break-even points had been moved much closer to where the stock was trading.

Fall of EWZ:

The day after we rolled the contracts, EWZ started to fall.
After the initial fall in EWZ, we were able to close our $35 straddles for December and buy them back for $5.25.
Total credits collected was $6.21, so we closed for a profit.
We continued to hold the $33 straddles until November 26, when EWZ made a move lower to $37.29.
At that point, we were able to exit the $33 straddles for December and bought them back for $4.94.
Total credits collected were $5.81s so again, we were able to close for a profit.

We were left with a $540 profit overall on these two series of short straddles on EWZ.

Conclusion:

You can still make a profit on a trade that is turning against you, as long as you keep rolling and adjusting.
If you are smart about how you adjust and can extend the duration, you can turn the trade into a winner.
Using this smart, mechanical, systematic approach, you can make a profit.