Trade Management Targets
Feb 2, 2018
Applying a methodology to a discipline can often represent the difference between sustained success and intermittent success.
Here at tastytrade, we've identified a range of trade management approaches that have shown historical success in optimizing performance - combining the maximum potential reward with the minimum possible risk.
Trade management involves the institution of a system that helps with trading decisions - particularly as it relates to when positions are closed.
Approaching the financial markets in this way removes a degree of the human element (emotion) from portfolio management, and allows a given strategy to rely on the high probabilities that made it attractive in the first place.
When managing trades to specific criteria, we consequently help ensure that all trades are approached in the same way. Treating them essentially as the random numbers they represent, instead of giving one or another special status based on emotional preference.
A recent episode of Market Measures discussed in greater detail two trade management strategies often utilized at tastytrade, as well as research that helps illustrate why they have shown so much potential.
The two trade management strategies discussed on the show relate to short straddles and short strangles.
As a reminder, a straddle is an options position that involves the simultaneous purchase or sale of a call and put with the same strike price in the same expiration period. In a long straddle, both options are purchased, while a short straddle involves the sale of both options.
A strangle is slightly different than a straddle, and is an options position that results from the simultaneous purchase or sale of a call and put in the same expiration period, but with different strike prices. A long strangle is constructed by purchasing both options, while a short strangle involves the sale of both options.
For short straddles, historical data has shown that closing such positions at 25% of the credit received provides for the most efficient use of capital. The win rate and daily P/L of a short straddle drop considerably after this 25% threshold has been achieved.
The slide below summarizes straddle data backtested in SPY, showing a wide range of trade management targets, and their associated win rates and daily P/Ls:
As you can see from the above, both the 12.5% and 25% of credit received trade management strategies showed the highest win rates and daily P/L, on average.
One important difference between 12.5% and 25% was that the former showed an average trade profit of $30, while the latter showed an average trade profit of $65 (data presented on Market Measures). This piece of data is one reason some traders may find the 25% trade management target more attractive.
Moving on to short strangles, historical data in SPY was once again backtested, but this time using short strangles constructed with calls and puts of roughly 16 delta. In this instance, the 50% trade management target appeared to outperform higher and lower trade management targets, as you can see below:
While the 50% trade management target highlighted above shows some very compelling win rates and daily P/Ls, some of the other trade management targets for the short strangle also produced attractive results.
Depending on your own unique risk profile, it's possible you may view the 25% and 37.5% trade management targets as a better fit for your portfolio when dealing in short strangles.
Whether or not you are currently using trade management, the information presented in this episode of Market Measures will give you some good food for thought in the realm of trade management.
If you want to learn more about trade management, we suggest you follow a new series on the tastytrade financial network focusing on this precise theme - Trade Managers.
If you have any questions for Mike & Nick, please leave a message in the space below, or reach out directly at email@example.com.
We look forward to hearing from you!
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.
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