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May 6, 2016

Formula for Realistic Expectations | Market Measures

By:Josh Fabian

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

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.

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