Why The Game Changer is the Best Options Strategy for Trade Management | tradeTALK Series

Mar 30, 2021

By: Kai Zeng

Traditionally, traders use three types of signals to exit or manage a trading position:

  1. Stock price level

  2. Profit/Loss Target

  3. Technical Indicators

But no scientific studies can prove the legitimacy of these methodologies. And oftentimes, these approaches are complex and challenging to follow. tastytrade’s Kai Zeng explains how to make trade management easier with a simple technique known as the “Game Changer.” Learn more about it below and in his recent tradeTalk presentation.

What is the Game Changer?

So tastytrade wanted to create something different for the retail traders. After years of research, we created a simple yet powerful management strategy to improve a portfolio’s long-term performance. 

We call this the Game Changer – managing at 21 days-to-expiration, a.k.a managing at 21 DTE. What does this mean? This means if a trader opens a 45-day position, you close and roll out your position 21 days before expiration. That’s it.

This could be confusing because this approach doesn’t require a trader to look at their P/L or follow any indicators. All they need to do is to blindly close their positions based on one simple metric - time. But time is often too vague a concept. No one has ever researched this approach before, and no one has ever executed it either. But after spending thousands of hours into research to prove its validity, we know it works!

The Problem With Popular Options Management Strategies

Before showing this strategy's performance, let’s walk through how tastytrade research helped form this technique. 

As everyone knows, the original motivation for traders to sell options is premium decay. This is a popular chart that describes the lucrative premium decay profile if the traders hold a position into expiration, theoretically.

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The acceleration toward the end of the expiration cycle attracts so many traders to wait for their options contract to expire, hoping to keep the majority of their premium.

But there are some problems associated with this approach. Realistically, unlike the theoretical model's prediction, the historical average daily P/L decreases in the second half of the cycle. 

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As a result, traders make less money than the model suggested. This is why it is so difficult for many traders to make consistent profits over the long run. It’s also why a cornerstone of tastytrade mechanics emphasizes managing winners and managing losing positions, too. 

Determining When to Exit Options Positions

One chart is not sufficient to draw the conclusion. So we were looking for more confirmation. As premium sellers, we prefer the underlying price to stabilize in a small range; the tighter, the better, so we can keep all the credit we received at order entry, just like collecting rental payments without additional costs.

Then we also found this relationship:
The underlying price movement range and holding duration have a positive correlation. 

This implies the shorter the holding duration, the higher the probability the stock will stay in a close range. This is exactly what we need.

Based on these findings, we started to consider cutting off the options position just based on time. Maybe one day before expiration, two days, one week, two weeks, or perhaps just take off the position right before the average daily P/L starts to decrease?

After intensive testing, we found a sweet spot, which is 21DTE. It makes a tremendous impact on our portfolio performance.

The Game Changer in Action

The best way to test the Game Changer is to put this strategy in a simulated portfolio. To construct this test, we created two portfolios, both started with an initial account value at $1M. In the first portfolio, we used 100% capital into a traditional buy-and-hold strategy, and we used the industry benchmark SPY. In the second one, we only utilized 25% capital into SPY 50 delta puts and managed the position at 21DTE.

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This options portfolio with 21 DTE management is a clear winner in the past 16 years. It yields 10% higher P/L with better loss control through all major market downturns.

After seeing its outstanding performance against the industry benchmark, the next logical question is WHY?


Why The Game Change is the Best Trade Management Technique

 The key reason is its superior Volatility control.

The following two charts illustrate the deltas from 1SD strangles since 2005 with 45 DTE. So there are 4000 occurrences.

No Trade Management

In the first chart, we do not manage the position at all.  

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You can see the longer the duration, the wider the delta range. The increasing delta toward the end of the cycle perfectly represents the growing portfolio volatility. As premium sellers, we prefer the trade delta stays in a tighter range. 

Using the Game Changer to Manage a Trade

We use the same strangles but manage them all by using the 21DTE approach. 

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The deltas were contained in a much tighter range, which implies lower volatility in our positions.

 To summarize, a good strategy should be able to achieve greater ROC (return on capital) but lower volatility.

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This is exactly what we found in managing with the 21 Day To Expiration methodology.

And that’s why managing at 21DTE is such a simple and brilliant idea!

Learn more about this management strategy by checking out this related content.

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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