Short Volatility

Naked short volatility (straddles/strangles) does have unlimited risk. However: (1) You can use defined-risk structures like iron condors, (2) Proper position sizing limits exposure, (3) Stop losses prevent catastrophic losses. The risk is real but manageable with discipline.

Maximum profit is the premium collected. For a short strangle collecting S$1.00, max profit is S$1.00 per share. Annualized returns of 15-25% are possible with good management, but expect drawdowns during volatile periods.

Avoid when: (1) IV is low (IV Rank < 30%) - premiums aren't worth the risk, (2) Before major events - IV can spike and big moves occur, (3) In strong trends - directional risk is high, (4) If you can't monitor the position.

Short strangle sells naked OTM options (unlimited risk). Iron condor adds long wings for protection (defined risk). Iron condor collects less premium but has known maximum loss. Iron condor requires less margin and is suitable for smaller accounts.

Enter at 30-45 DTE. Take profit at 50% of max profit. Close by 21 DTE to avoid gamma acceleration. If thesis fails (big move or IV spike), exit according to stop loss rules rather than holding to expiration.

The first 50% of profit typically comes in the first 50% of time. Holding for the remaining 50% exposes you to accelerating gamma risk for diminishing theta returns. The risk/reward of holding past 50% profit is unfavorable. Closing early also frees capital for new positions.

Straddle: Maximum premium, narrower breakevens, highest gamma risk, need stock at strike. Strangle: Less premium, wider profit zone, lower gamma risk, profits in a range. Use straddle if very confident about price staying at current level. Use strangle for more room.

0.16-0.20 delta (~1 SD) is common - balances premium collected with probability of success (~68% both sides OTM). More aggressive: 0.30 delta (more premium, lower probability). More conservative: 0.10 delta (less premium, higher probability).

Options: (1) Close entire position and take loss, (2) Roll the tested side to later expiration for credit, (3) Roll tested side further OTM, (4) Convert to iron condor/butterfly if naked. Key: Don't let a manageable loss become catastrophic.

Defined risk (iron condors) for: smaller accounts, less monitoring ability, desire for peace of mind, unknown max loss is unacceptable. Naked for: larger accounts, experienced traders, higher premium requirements, ability to actively manage. Many successful traders use defined risk exclusively.

Institutions: (1) Maintain strict position limits by underlying and portfolio level, (2) Track aggregate Greeks especially vega, (3) Use tail hedges (long OTM puts), (4) Have strict risk protocols for crisis events, (5) Diversify across many underlyings and expirations, (6) Use systematic rules-based approaches.

Typical win rate is 70-85% depending on strike selection. However, average losses are typically larger than average wins. A strategy might win 80% of the time for S$0.50 but lose 20% of the time for S$2.00. Net edge depends on risk management.

In crisis: (1) Don't panic-sell at worst prices, (2) Assess whether it's temporary spike or regime change, (3) Consider reducing exposure incrementally, (4) Don't add to positions, (5) After crisis passes, rebuild cautiously. Survive first, then recover.

Short vol strategies often show high win rates and steady returns, giving decent Sharpe ratios during normal times. However, during crisis periods, large drawdowns occur. The Sortino ratio (which only counts downside volatility) may be more appropriate. Long-term Sharpe often disappoints due to tail risk.

Track portfolio theta (daily profit) and gamma (movement risk). Rule of thumb: Portfolio should be able to withstand 1-2 SD move without devastating loss. If theta is S$500/day but 1 SD move costs S$5,000, you're taking 10 days of theta as gamma risk. Size to survive the stress test.