At tastytrade, there are certain tenets that we believe you should adhere to in order to give yourself the best chance of success in the markets. Those tastytrade tenets are that markets are random, the “Law of Large Numbers”, selling premium is good and it’s best to manage winners.
We believe that markets are random. It’s also known as the “Random Walk Theory”. While the market does have positive drift, meaning it goes up over time, we are convinced the moves of the market day to day cannot be predicted. A bar graph of the frequency of consecutive days up or down displayed the classic bell curve. The movements are random. The “Law of Large Numbers” can help prove the randomness of the markets. The larger the number of occurrences there are to any observation in the markets the closer the actual probabilities will approach the expected probabilities. A small set of numbers of market movement may appear non random but a larger set will indicate otherwise. The larger the number of occurrences, the greater chance you have of expected results matching actual results. It’s why we preach, “trade small, trade often”.
The first two tenets explain why we believe in the third, selling premium. Since we can’t predict the market on a day to day basis and the larger are our number of occurrences the closer we get to expected results then a mechanical approach to selling premium should work. What makes selling premium even better is that Implied Volatility (IV) tend to overstate the expected move. Our studies consistently show this. A table of the results from one such study selling 1 Standard Deviation (SD) SPX Strangles demonstrated this. The expected Probability Of Profit (POP) was around 71% while the actual POP was 82.2%. The guys noted that by accepting defined probability for undefined risk you get this edge. What makes the edge even larger is the practice of managing winners. Numerous tastytrade studies, such as the one in the Market Measures from July 19th, 2016: Strangles: Visualized Performance, show that by, as in the case of Strangles, managing our wiiners at 50% of maximum possible profit we enhance performance.
For more on the Tenets of tastytrade see:
Market Measures from January 26, 2016: "Managing Winners | Exiting Based on Duration"
Market Measures from April 20, 2016: Manage Winners and Close Early?'
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the valuable takeaways and a quick explanation of the tenets of tastytrade; market randomness, the law of large numbers, selling premium and managing winning trades, that can help put the odds of trading on your side.
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