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Jun 2, 2015

Best of Market Measures: On Straddles (Part 2)

By:Sage Anderson

In a recent tastytrade blog post, we reviewed two of the most common options trading strategies: straddles and strangles. These somewhat related tactics represent a couple of the most-utilized strategies observed in the modern options trading environment.

The previous blog post highlighted the mechanics of executing these trades as well as other tastytrade content that has focused on this very critical subject.

In a May 2015 segment of Market Measures, Tom and Tony took the topic one step further by examining tastytrade’s in-house research on a segment entitled "Straddles: Managing Winners."

The primary question that Tom and Tony focused on during this particular episode was the optimal approach to employ when striving to maximize profit and minimize risk after entering a straddle trade. On the show, Tom and Tony present some compelling research done by the tastytrade research team that supports the philosophy that actively managing trades can help improve the risk/reward balance inherent in any options trade.

As is often the case, the research team ran their study based on selling premium (short straddle) and included five of the more common products traded by the tastytrade team ($SPY, $IWM, $TLT, $GLD, $EWW). In these five symbols, the team looked at every possible instance for selling at-the-money (ATM) straddles that were closest to 45 days until expiration (DTE) since January of 2009 (375 total occurrences).

The team ran three different scenarios on this data in which they:

a. held the trade to expiration

b. managed the trade at 25% of maximum profit

c. managed the trade at 50% of maximum profit

The study results illustrated that managing winning straddle trades at 25% of maximum profit can increase potential P/L by 11%. Additionally, a 25% management strategy versus a 50% management strategy also reduced the time of overall trade exposure by a compelling 40%.

The net result of this research suggests that managing winning straddles at 25% of potential profit has historically increased return while also reducing risk - an ideal scenario in any market environment.

An example of the 25% maximum profit management strategy would be if you sold an ATM straddle in XYZ for a $4.00 credit and closed the trade (bought the straddle back) once the value had decreased to $3.00.

Additional information on straddles and strangles can be found under the "Learn" section on the tastytrade homepage.

As always, we welcome your comments and questions...so please leave them here in the comments below!

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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