Top 3 Most Profitable Market-Neutral Option Trading Strategies

In the video titled “Top 3 Most Profitable Market-Neutral Option Trading Strategies” by Options with Davis, you will learn about the top three strategies that can help you make profits in option trading regardless of whether the market goes up or down. These market-neutral strategies seek to profit as long as the market stays within a given range. The video explains how to determine this range using the expected move, which represents the range the stock is expected to move in. By using options in market-neutral trading strategies, you increase the probability of profit compared to traditional trading styles. The video also discusses different strategies such as the Iron Condor, Jade Lizard, and Strangle, emphasizing the importance of managing trades, position sizing, and risk management for successful implementation.

Top 3 Most Profitable Market-Neutral Option Trading Strategies

Introduction

In this article, we will discuss market-neutral option trading strategies. These are strategies that allow for profit regardless of whether the market goes up or down. Instead of having a bullish or bearish bias, market-neutral strategies seek to profit as long as the market stays within a given range. We will explore the benefits of these strategies, how to determine the expected move, and how to use options in market-neutral trading. Additionally, we will address issues with implied volatility and expected move, and provide insights on how to take advantage of the expected move. Lastly, we will explore three of the most profitable market-neutral option trading strategies, along with managing the trades, position sizing, and risk management. We will also highlight Tastytrade studies on strategy profitability.

Benefits of Market-Neutral Strategies

Market-neutral strategies offer several benefits compared to traditional trading styles:

  1. Profitability regardless of market direction: With market-neutral strategies, you can profit as long as the market stays within a given range. This means that you are not dependent on the market going up or down, allowing you to capitalize on various market conditions.

  2. Trading within a given range: Instead of predicting whether the market will go up or down, market-neutral strategies focus on trading within a specific range. This reduces the pressure of having to accurately predict market movements and allows for more flexible trading.

  3. Increased probability of profit: By using options in market-neutral trading, the probability of profit is often higher compared to traditional trading styles. Options provide more flexibility and allow you to tailor your trades to different scenarios, increasing the likelihood of a successful outcome.

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Determining the Expected Move

The expected move is a key factor in market-neutral trading strategies. It represents the range in which a stock is expected to move within a certain timeframe. Determining the expected move can be done through various methods:

  1. Calculating the expected move: The expected move can be calculated using a formula that takes into account the stock price, implied volatility, and the number of days left until expiration. This calculation provides an estimate of the potential price range.

  2. Tools for determining expected move: Trading platforms such as TD Ameritrade and Tasty Works often provide expected move data. These platforms use their own algorithms to calculate the expected move based on various factors. This data can be found in the option chain section of the platform.

  3. Implied volatility and option chain: Implied volatility is a measure of the market’s expectation of future price fluctuations. By analyzing the implied volatility levels and the option chain, you can get an idea of the expected move. The option chain displays the different strike prices and their associated premiums, allowing you to evaluate potential price ranges.

Using Options in Market-Neutral Trading

Options play a significant role in market-neutral trading strategies. They offer greater flexibility and allow for more precise trade execution. Here are a few key points regarding options in market-neutral trading:

  1. Options as a component of market-neutral strategies: Options provide the ability to construct various market-neutral strategies, such as iron condors and strangles. These strategies involve a combination of options that aim to profit from price movements within a specific range.

  2. Comparison with traditional trading styles: Market-neutral trading with options differs from traditional trading styles, which often involve taking a directional bias. Instead of betting on whether the market will go up or down, market-neutral strategies focus on profiting within a range. This can provide more opportunities and reduce the risk of being on the wrong side of a trade.

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Issues with Implied Volatility and Expected Move

While implied volatility and expected move are valuable tools for market-neutral trading, there are a few issues to be aware of:

  1. Overstatement of actual volatility: Implied volatility tends to overstate the actual volatility of a stock. This means that prices often stay within the expected move more frequently than the probability suggests. It is important to consider the historical accuracy of implied volatility when determining trade strategies.

  2. Actual occurrences within expected move range: Studies by Tastytrade have shown that actual price movements tend to occur within the expected move range more often than the probability suggests. This provides opportunities for market-neutral strategies, as the range may be wider than initially anticipated.

  3. Opportunities for market-neutral strategies: The overestimation of implied volatility and the higher occurrence of price movements within the expected move range create opportunities for market-neutral strategies. By utilizing these strategies, traders can benefit from the discrepancies between implied and actual volatility.

Taking Advantage of Expected Move

Once you have determined the expected move, there are several ways to take advantage of it:

  1. Iron Condor: The iron condor is a popular market-neutral option strategy. It involves selling two vertical spreads, one put spread and one call spread, with strike prices within the expected move range. The long options in the iron condor help define risk, while the short options generate income. Profit is made as long as the market stays within the expected move range.

  2. Jade Lizard: The jade lizard is a variation of the iron condor strategy that aims to increase profitability and the probability of profit. The jade lizard involves selling a put option, selling a call spread, and collecting a credit. By removing one side of the long leg, traders can receive a higher credit, increasing their potential profit.

  3. Strangle: The strangle strategy involves selling both a short put and a short call outside the expected move range. This strategy allows for a wider potential price range but comes with higher risk. The goal is to collect premium from both sides of the trade while managing risk through proper position sizing.

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Managing the Trades

It is crucial to effectively manage market-neutral trades to ensure profitability. Here are a few key points to consider:

  1. Monitor positions regularly: Market-neutral trades require regular monitoring to ensure they stay within the expected move range. Keep an eye on market conditions and any potential factors that could impact the price movement of the underlying security.

  2. Exit around 21 days: It is generally recommended to exit market-neutral trades around 21 days before expiration. This allows for sufficient time decay and reduces the risk of adverse market movements. Exiting trades earlier helps protect profits and manage potential losses.

  3. Position sizing and risk management: Proper position sizing is essential in market-neutral trading. Since these strategies involve defined risk, it is crucial to allocate an appropriate amount of capital to each trade to manage risk effectively. Consider a risk-to-reward ratio and set stop-loss levels to protect against outlier moves.

Tastytrade Studies on Strategy Profitability

Tastytrade, a popular financial network, has conducted studies on the profitability of market-neutral option trading strategies. These studies have shown that, over the long term, well-managed market-neutral strategies can be profitable. However, it is important to note that individual results may vary, and proper management of trades is critical to success.

In conclusion, market-neutral option trading strategies offer an alternative approach to trading that allows for profit regardless of market direction. By focusing on a specific price range, traders can increase the probability of profit and reduce the reliance on predicting market movements. The iron condor, jade lizard, and strangle are three profitable market-neutral strategies that can be utilized to take advantage of the expected move. However, it is essential to effectively manage positions, practice proper risk management, and stay informed about market conditions.