I do most of my backtesting on straddles (or strangles) to keep things simple and prevent overfitting. But when trading I buy hedges at top and bottom to reduce the required margin, which technically makes it an Iron Butterfly (or Iron Condor). The thing is, I can live with the extra premium+brokerage for hedge legs but I need the margin benefit (2.5 lakhs/lot vs 1 lakh/lot).
Am I the only one who does this?
Do you have an estimate of how much income the additional margin/leverage generated,
specifically for you, based on your trades over a significant period of time?
Maybe you could compare that estimate with the cost of the hedges
to see if one consistently exceeds the other
and decide accordingly.
Just one thought-process. Not sure if the most important/relevant either.
I usually buy the hedges one day before the weekly expiry. That takes care of the 2% ELM, and by this time the hedges of near strikes (around +/- 2%), end up being quite cheap.
I did this for multiple weeks, and on at least two occasions, I was able to exit the hedge on expiry day morning (basically did early rollover) at a good profit on the hedge part.
So, net net I think I didn’t lose any amount on hedges. But if you buy hedges much earlier, then it is quite a significant cost, and also, you might be overleveraging.
The actual benefit for me is that it allows me to trade more lots with a smaller capital in my trading account.
The best and worst daily pnl varies but total pnl converges over any 6+ months period. The brokerage is also quite manageable at 10+ lots as long as I don’t take multiple entries.
That is an interesting approach. I can see how the hedge may profit on its own in case of a gap-up or gap-down. Unfortunately, my current backtest is only capable of intraday trades so I can’t verify it.
That’s just an intermediate “benefit”.
Also, without hedges, what are your alternate risk-management strategies?
All of my trading has been intraday and during 2024-now. I typically buy hedges about 6-8 strikes otm, so it doesn’t really protect me from typical directional moves.
In my backtests for the 2024-2025 period, Short Iron Butterfly has similar payoff/lot (and drawdown) compared to the Short Straddle, except that I can trade double the lots because of margin benefit. Different Stoploss values can significantly change the payoff. I typically use 20-40% SL on net pnl based only on the total premium of the ATM straddle in both cases. For the 2020-mid 2022 and mid 2022-2023 periods, that returns of the two strats are very different.
Iron Butterfly for margin efficiency makes sense. I trade multi-leg strategies and usually place orders through the price ladder on combined premium, so I manage it as one position.