Why Selling OTM Strangles Is Not Always Better Than Selling Straddles
Summary
The document examines whether selling out-of-the-money (OTM) strangles must outperform selling at-the-money (ATM) straddles when OTM implied volatility is higher. It challenges that conclusion by explaining that higher tail premiums compensate sellers for exposure to large moves and possible shifts in the underlying’s level. A comparison based only on implied and realized volatility does not capture those risks.
The answers point to market-specific skew: directional expectations and changes in option supply and demand can shape which side commands a higher premium. If skew compensation is judged excessive, traders may use a short-strangle, long-straddle position, often called selling a fly, to express that view. The discussion offers conceptual reasoning rather than empirical results or a method for identifying mispricing. Its main caution is that neither structure is universally superior; the choice depends on the market and the trader’s assessment of tail risk and skew pricing.
Key ideas
- Higher OTM implied volatility reflects compensation for risks associated with large underlying moves.
- Comparing implied volatility with realized volatility alone does not establish that a short strangle is superior.
- Directional expectations and option supply and demand can influence the shape of volatility skew.
- A trader who sees skew as overpriced may buy an ATM straddle while selling OTM options.
- The relative merits of strangles and straddles depend on market conditions and subjective pricing judgments.
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Full text
# Selling Strangle or Selling Straddle # Selling Strangle or Selling Straddle Assuming positive skew premium & continuously delta hedged, is selling OTM strangle always a superior strategy than selling ATM straddles (hence P&L is theoretically simplified as 0.5 * Gamma * Spot ^2 * (IV^2 - RV^2)), since OTM IV is higher? Thanks. ## Answer by user35980 (score 4) https://quant.stackexchange.com/a/76769 This is a bit like saying it's "a superior strategy" to lend $100 for 2 years rather than for 1y year because you earn twice as much interest. The skew premium is there to reflect directional risk in the underlying rebasing itself to a materially different level, and the market participants' anticipated impact on demand/supply of options written on that underlying such a rebasing would entail. Moreover, most markets have a directional bias which drives the skew: for example in EM FX options markets the bias is to a sell-off rather than a rally so OTM calls > OTM puts. It may well be that the skew premium may be being overpriced - in which case options traders "sell flys" i.e. buy atm straddles vs selling strangles. So I would remove the "always" from your statement and make it subjective. ## Answer by user68819 (score 4) https://quant.stackexchange.com/a/76770 There's a reason why the otm IVs are higher to begin with. Market moves/returns exhibit kurtosis. This implies most of the time they move in a confined range, from time to time they exhibit very large moves. When they exhibit very large moves, you probably don't want to be short cheap tails. Hence rational traders would demand a premium to be short these, driving up the price and thus vols of otm options. Each market has its own dynamic and thus Skew shape.
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