Losing Trades: Patience is Key
Aug 8, 2017
A "virtue" is described as a "behavior showing high moral standards." According to that definition, patience in everyday life is without question a virtue.
And according to new tastytrade research presented on Options Jive, patience may also be one of the most important tools in a trader's utility belt.
While we strive to win the highest percentage of trades possible, the reality is that many of them get tested. Responding appropriately to that type of adversity isn't always easy - emotion can often get the best of better judgement.
That's why this particular episode of Option's Jive falls in the category of "must see TV" - it may help you tweak your approach going forward in a way that allows you to maximize your potential returns.
When a trade goes against us, we have three choices:
Close the position and take the loss
Keep the position and hold it
Roll the position
Today, we're breaking down historical data that helps shed light on the first two choices listed above - Close It or Keep It.
In order to gather the data necessary for this analysis, the Options Jive team ran a study incorporating the following parameters: sold 16 delta strangles in the SPY with 45 days-to-expiration (DTE) from 2005 to present.
The goal of the analysis was to isolate the losing trades, and filter the data for any discernible trends. The slide below highlights how losing trades tend to cluster toward the early part of the trade cycle:
As you can see from the above, the data showed that as time passes, trade performance tends to improve.
Further analysis of the data showed that after breaching a loss, 96% of the losing trades in the study saw profits on average in the aftermath. Furthermore, the study showed that it takes about a week for a trade to correct itself (on average).
Most importantly, the data showed that by holding all losing trades through expiration, the average P/L of combined trades was positive. Now, let’s take the analysis one step further.
In the next phase of the study, the team separated the trades into categories based on the size of loss. The metric used for this categorization was how the loss compared to the initial premium sold.
For example, if a trader received $200 in premium, then a 1x loss would equate to approximately $200. A 2x loss would therefore equate to roughly $400 ($200 x 2 = $400), and so on.
While one might instinctively think that cutting off losers as they get larger may be prudent (i.e. Close It), the data suggests that holding these types of trades may allow for mean reversion to help correct the problem.
As you can see from the summary statistics below, nearly 50% of the maximum loss incurred during the worst point of the trade management cycle was recouped (on average) when holding the trade through expiration.
Another key data point helps reinforce the virtue of patience when trading volatility.
Looking at the complete study, tastytrade observed that 79% of all trades experienced at least one losing day. As we already know, short premium strategies generally produce a high win rate (on average).
Combining these two assumptions means that traders adopting the short premium strategic approach need to understand that many of their trades may be tested along the way, but that they’ll ultimately produce a positive return over time (assuming the strategy is applied consistently).
If selling premium required zero skill or experience, every market participant would do so.
The key to this approach is recognizing that the statistics rely on instances (volume) and timeframe. The data presented in this episode suggests that by cutting off winners, volatility traders are simultaneously cutting into net return.
We hope you’ll take the time to review the full episode of Options Jive focusing on patience in short premium strategies when your schedule allows.
We welcome any comments and questions related to your own experience and hope you’ll leave a message in the space below, or reach out directly at email@example.com.
Thanks for reading!
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.
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.