Alert

Cardano, the sixth largest crypto asset by market cap, is now available to trade on tastyworks. Here’s what you should know.
tastytrade

Exiting Positions Before Expiration

Oct 22, 2015

By: Sage Anderson

Maximizing returns in any type of investment is a critical philosophy whether it be securities, real estate, or a business.

Options trading is no different, as traders seek to leverage the most efficient risk-reward ratio possible when executing, managing, and closing trades.

Expiration is a critical period for option traders as contracts inch closer to ultimate settlement value - meaning careful management of these positions can help drive increased returns alongside minimized risk.

This very topic was discussed on Market Measures recently and today on the blog we are focusing on this dynamic subject.

One key consideration regarding expiration is deciding when one should close a position - or more specifically - is there an optimal window of time to close an options trade prior to expiration?

Tom Sosnoff and Tony Battista, the hosts of Market Measures, present some key studies done by tastytrade that can help provide an answer to that question.

It's important to remember that as options get closer to their expiration day, the theta decay of out-of-the-money (OTM) options will slow. This is a result of lower absolute option prices and tail risk (sudden, outsize moves).

Depicted below is the graphical representation of slowing decay for OTM options:

The slowing of decay alongside lower absolute option prices is the definition of a declining risk-reward ratio. Lower option prices mean the reward side of the equation has collapsed, while we still hold the same risk profile from the original trade... this is especially true of short premium structures.

In order to better understand this declining risk-reward ratio in terms of options approaching expiration, the tastytrade team ran studies on SPX options using the following criteria:

  • 2005 to present using a total of 1012 observations
  • Sold one standard deviation strangles in SPX (16 delta on each leg)
  • Used the expiration closest to 45 days-to-expiration (DTE)

Analyzing that data, the Market Measures team discovered that by closing a position two weeks prior to expiration, a trader's theoretical percent of profitable trades increased to 85%. The analysis of the results are depicted below:

As you can see above, exiting a position two weeks before expiration (on average) allowed a trader to access the highest percent of winning trades as well as the highest P/L per day. However, the trader did have to sacrifice a portion of the total average trade P/L.

It's important to remember that holding a trade all the way through expiration also has capital ramifications. By closing the trade two weeks before expiration, a trader can redeploy into another attractive position rather than waiting for that final piece of decay.

Further research by tastytrade on this subject provides additional evidence that the two-week window does help with trade and capital efficiency.

On average, profits only increased by 3% by holding a trade through the last week of an option’s life and only by 16% for the last two weeks. This means that on average we collect 84% of our profits during the first 30 days of the trading cycle.

Even more interesting is the fact that 97% of profits are collected, on average, prior to the week of expiration.

The above means that the headache that can often come along with managing option positions during that last week of expiration may not be worth the stress nor the time. By closing positions whose performance is beginning to slow, a trader can redeploy capital into more attractive positions while avoiding a declining risk-reward ratio.

We hope you'll watch the entire episode of Market Measures focusing on exiting positions before expiration when your schedule allows.

Please don't hesitate to contact us with any questions on the expiration topic at support@tastytrade.com

We thank you for being the most important part of the tastytrade community!

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.

© copyright 2013 – 2021 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.