We can generalize the key strategy levels as below –
– Delta, strike selection, and effect of volatility
We know that this strategy is more profitable in a declining market. To check this, we can do some calculations to determine the delta of the overall strategy.
The Delta value gives away that the strategy is indeed attuned to changes in the market’s direction (albeit weakly). The negative sign suggests it profits when conditions take a downturn.
I’d recommend that when it comes to strikes, you employ the traditional tandem of ITM and OTM options. Remember, the trade must be done as a ‘Net Credit’. Executing this tactic with a net outflow of cash is not advised.
Let’s look at the variation in volatility and its effect on the strategy –
We can use the three coloured lines to observe the relationship between “premium value” and volatility. This allows us to comprehend how different levels of volatility affect a strategy, while taking time-to-expiry into account.
Red line – As we near expiry, the premium value does not change too much in spite of volatility increasing. In this scenario, you only need to consider the direction that the security will take and can disregard any fluctuations in its volatility.