Formula for Realistic Expectations | Market Measures
May 6, 2016
Just as in weight loss, many of us have a target goal for how much profit we hope to generate monthly. To drop a few pounds (maybe more if you wear a beret), we may limit how many calories are consumed daily. For generating average monthly profits, it is much the same.
First, we start with a goal of how much capital we want to generate. Next, we take into consideration reasonable expectations for our profits and losses. Finally, we can take that information and determine how much extrinsic value needs to be sold monthly, on average.
Research conducted by tastytrade shows the one standard deviation strangle in SPY with thirty days until expiration generates $125 in credit, on average. This was based on a study of 1,000 different occurrences during times of both low and high implied volatility.
We already know when it comes to taking profits, we do not stick around for the entire $125. We look to take profits at 50%. Therefore, we adjusted down that initial $125 by 50% to $62.50 per strangle sold.
One standard deviation strangles historically have a 90% win rate. Based on that, we can expect to have successful trades ten or eleven months out of the year. The 10% of the time we take a loss, we assume covering the trade at 2x the initial credit received or a loss of $250
From there, we can calculate an expected P/L per trade:
($62.50 x 90%) - ($250 x 10%) = $31.25 average P/L.
$31.25 is the expected profit on average per trade when selling $125 in initial extrinsic premium. Stated differently, to generate $31.25 in profit (on average), we need to sell a one standard deviation strangle and collect $1.25.
Using the metrics outlined earlier (managing profits at 50%, losses at 2x premium collected, realized win rate of 90%) this tells us, on average, when selling a one standard deviation strangle, we need to collect extrinsic premium equal to 4x our profit goal.
In case you haven’t realized it already, the word, “always” is not something we use often. If things were always a certain way, our research team would have nothing to do. Research such as this is intended to give us context around selling premium. Equally important, this is information that did not exist until we tackled it. It’s kinda what we’re about.
Have questions about the segment? Leave a comment below or reach out to us on support at email@example.com.
Josh Fabian has been trading futures and derivatives for more than 25 years.
For more on this topic see:
Market Measures | Formula for Realistic Expectations April 22, 2016
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
May 4, 2016
One similarity tastytraders share is enjoying stories from market veterans who helped pave the road we hope to build upon. Tom recently sat down with his uncle, famed investor Martin Sosnoff to discuss how Martin became involved in markets and his approach to investing.
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.
tastytrade is a trademark/servicemark owned by tastytrade.
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”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
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.