We often look to manage our winning trades for a number of reason. This allows us to increase our win rate and reduce our gamma risk. However by managing a winner at 50% of max profit, how much additional profit are we giving up?
Today, Tom Sosnoff and Tony Battista look at two different strategies of managing winning trades. First they look at managing winners at 50% and compare this to closing a trade when there are 15 days remaining until expiration. The guys then compare these management styles to holding the trade until expiration. They see that 94% of the profit seen at expiration came during the first 27 days of the trade. Another way to look at this is that for the same amount of risk, you can only make an additional 6% of profit not managing a trade at 50% of max profit!
Tony B: Thomas, I’m back my friend, Market Measures. We're talking about a reason to manage. Tom S: Yeah, we're way behind on emails. I'm behind. I haven't caught up for Monday, Tuesday, or Wednesday and I don't know if I'll catch up today. So I'm sorry. It's just we have a live show this afternoon ... Tony B: It's been a little hectic, yes. Tom S: We have a live show this afternoon. We've made 70 or 80 trades yesterday and it's just ... I can't catch up on email so I'll try my best but that's it. Twitter up 80 cents, I'm watching that, I'm watching you Twitter. Tony B: You were watching it, looking at the alarming rate. Tom S: I was. I'm so mad that they rallied it up before earnings tomorrow. I have to make some adjustments in there but Twitter's been great to us so I'm not mad. Tony B: Sure. Tom S: Whatever. Let's take a look at Twitter today. We're probably losing small in there. Yeah, we're going to lose small today, we're finally over the number where we're now short Twitter. Plus they're not going to take any premium out. Tony B: Right. It typically expands two weeks before earnings, you got earnings another day or so. Tom S: So on the difficult front today. Some of our stocks that we really needed to continue ... Obviously, the oil ones are not going to continue but US Steel is down today. And what else? Tony B: You have lot of calls in U. S. Steel yesterday? Took advantage of that, we got out of a lot of USO stock. We covered against that. We got a lot of emails from people who are like, "Why? Why now?" I don't know. Volatility was high, you had a larger than expected move. Tom S: Yeah. Tony B: You take advantage ... There's always going to be other trades to … Tom S: I'm trying to be more aggressive in 2015. Tony B: You mean more mechanical than aggressive? Because I would really think being aggressive would just mean standing naked long stock ... Tom S: I'm trying to be more aggressive with smaller positions and practice what we preach. It's hard for me so I'm trying. Tony B: You're not going to work with me today are you? Tom S: I'm trying. Nothing yet in CMG and nothing yet in GILD. We're out about ... Hang on one second. GILD we're out ... Tony B: In CMG, you going to roll that price up a little bit from ... Oh, you're up to 20 cents now, are you going to roll it up to 30 cents so you can get filled? Or are you going to ... Tom S: No. No, I'm making a freaking dollar fifty on that trade. Tony B: Okay, good. Tom S: Yeah. Tony B: Okay. All right, good. I'm glad. Tom S: We're doing okay in ... We're up more money in CMG than we're down in GILD ... Tony B: Yes. Tom S: But we can't cover Disney today. Tony B: No, no, no. (chuckles) The Disney loss is going to have to become a core position. Tom S: Yeah. It's not going to ... And I hate Disney too. God I hate Disney, I hate trading Disney, I hate everything about that stock. And we were up ... Tony B: You're looking at a stock with a 17% monthly implied volatility. Tom S: I'd rather trade the DOW Jones than Disney. Trust me, I know. I've been stuck in Disney positions many times in my life and ... Crazy. Tony B: We got to get the French rumors to come back in Disney. Remember when ... Tom S: Oh, yeah. When the stock's $24, absolutely. Anyway, so we spread off our short calls against 97 and a half puts and we'll see what happens, but I didn't go inverted yet. I don't know, probably not the right time to go inverted; 8:47 in the morning, it's Wednesday, February 4th. I can't believe I'm saying Wednesday, February 4th already. Tony B: I know, I know. Tom S: It's unbelievable. Have we missed winter? I know it was like ... we're digging out our ... Tony B: It's become the last couple of days, yes. Tom S: But, oh, my God. An amazing segment coming up for you. It's called, A Reason to Manage. A Reason to Manage. Let's see if we can get it up on our screen. Perfect. So, here's the question that came in from many of our viewers to our research team. Since managing winners is the backbone of our trading strategy and we does this for all of these different reasons, does it work? Is it right? Can we test this against other things? In other words, we do this for reasons, one of the reasons is gamma risk as you get closer to expiration, or the increased sensitivity of our positions to risk as we get closer and closer to trying to squeeze as much as we can out of our stuff. As expiration approaches in the theta decay of the out of money options slows, and gamma risk increases. Because of this, we'll look to exit, or roll, a trade with sufficient duration remaining. What this means is we're about to go against ... well we've been doing this for a while ... all industry convention when it comes to trading options. The industry conventions suggest that as you get closer to expiration, there is an acceleration of time decay and that is where you make the most money. That's the whole concept featuring trading weekly options, that's the whole idea between shortening the time frame, right? Tony B: Of Course. Tom S: We believed this our entire career. We knew that there was increased risk but we also knew that we made the most amount of money by taking the most amount of risk. So what we never really understood was managing early is the best approach because we did it ... Tony B: Instinctually? Tom S: ... like breathing. It was instinctual, right. What's crazy now, is that we've done the research to suggest that without any edge at all as an individual investor, it really doesn't make any sense to trade those ... that very short time frame. Let's show you. So is there a benefit to closing a trade solely based on the number of day left to expiration? Also, how does this compare to managing a trade at 50% of max profit or holding until expiration? Here we did a study in the SPX over the last almost 5 years, 2010 to present. One standard deviation strangle sold on the first day of the month, 45 days to expiration. We tested three scenarios that we managed at 50% of max profit we closed within 15 days remaining, or we held to expiration. Tony B: Now we used SPX as a case study here because it's clean and it's easy. There's no dividends and everything else like that. We would never hold an SPX position all the way through expiration ... Tom S: Probably not. Tony B: In monthly options because of the … Tom S: There's a reason we use SPX as one of the test examples. It's because it's cash settled so it's very ... it's easy, it's like you said, it's clean. So again, 50% or 15 days to go to expiration. First we look at closing a trade with 15 days to expiration compared to managing a winner at 50%. Again, we're starting with 45 days to go to expiration. We're switching this now to closing at 15 days to go or managing at 50%. The P&L is virtually the same. The number of wins, which is impressive, is obviously more when managing at 50%. I say obviously more because you have more control over 50% than you do 15 days to expiration. Average number of days held ... what's interesting here is the 50% number is actually lower. Average P&L per day, the 50% number is higher, and then even though the biggest loss managing 50% is higher as well. So the first interesting take away comes ... shorter, there is shorter management time, there is more P&L per day, higher percent of wins. Next one. Utilizing these two exit methods minimized our gamma exposure by closing the trades early. Next we compare these two methods to holding the trade through expiration. All right, this is kind of neat. Now what happens is if you hold the expiration ... your P&L ... because there's more time involved now, remember this is not talking about re-deployment of capital. You can re-deploy capital after 27 days as opposed to waiting 46 days, whatever the case is. Look at the average P&L per day, how much higher it is at managing 50%. Then look at the number of days held and the percent of wins. The first thing that jumps out at you is, I have a much greater chance of being successful if I manage at 50%. The amount of P&L is marginally different. The way you figure it out is you look at average P&er day. $13 versus $21. You hold it for almost twice as long and you make significantly less per day, a third less per day. Tony B: I see that. Tom S: It makes absolutely no sense because the thought was always the longer that you hold this towards expiration, the faster the rate of decay, so the more money you make in the last week. It's not true. Tony B: Right. And the risk is that they're 100%. Tom S: It's just not true. So many ask this for the study, but now look at this. Managing winners at 50% better win rate, that's a big number. Tony B: Sure., Tom S: 60% greater P and L per day. Tony B: Well you said 60% just eyeballing it, it was actually better. Tom S: Well I said 66. And only being in the trade for an average of 19 days less and only giving up marginal profit overall. This is why Tasty Trade is so important, this is why our research is what we call ever evolving because three years ago we couldn't have guessed any of these statistics to be even close. We're managing when it's at 50% compared to expiration which is ... could you imagine if everyone were 14% better by just understanding that you have to manage winners. But 60% greater P and L per day ... Tony B: That's a game changer. Tom S: ... That's insane. With 19 days left so you can obviously re-deploy the money everywhere else. But here's the nuttiest part of it all. The average time it took to manage a winner was 27 days. Holding the remaining 19 days to expiration made very little sense as the majority of money was made very early on as we can see below. Look at this statistic and then share it with everybody that has ever traded an option before because this is one of the most dramatic pieces of research we've done in a long, long time. The percentage of profit made on days 1 to 27 is 94% of the profits. Tony B: Unbelievable. You're looking at stop order type numbers that you talked about from yesterday, it's unbelievable. Tom S: You wasted half of my life playing gin and golf with you monkeys when we could've been ... Tony B: Half? Tom S: Half. Of my adult life. Tony B: Three quarters of it. Tom S: No, half of my adult life. We should have been doing this research because it would have changed the way we all traded ... I couldn't figure out for the life of me ... I used to think, "I'm a decent trader, there's a lot of decent traders around ... Tony B: "I'm a nice guy." (Chuckles) Tom S: "I'm a nice guy, I'm smart, I think I'm smart ... Tony B: Actually, I think you're brilliant. Tom S: Okay, whatever. Tony B: My peeps we're actually saying maybe I should go the other way; just start complimenting you on it. Tom S: I thought I was a smart trader. Tony B: I think you're brilliant. Tom S: I thought I was a good trader. Tony B: You're articulate, brilliant. Tom S: I lasted 20 years in the pits, as long as anybody. It's a tough ... Tony B: Yeah, it's a tough environment, only the strong survive. You were one of the strongest. Tom S: We made a lot of money ... Tony B: Yeah, sure ... Tom S: No complaints Tony B: Yeah, no complaints. I got more than I deserved. Tom S: I could have answered this the other way. I could have told you the exact opposite. Tony B: It's amazing. Tom S: How could we be that wrong? I understand that shows you what kind of edge we had an everything else but that shows you why there's almost no value to listen to these people just because their whole reason for being here, their whole legacy is that they were….. who cares? It doesn't matter. Tony B: You're right. Tom S: We're in a whole different world right now where research kills it. Look at this, percentage of profits made. Day 1 to 27, 94% of our profits. Tony B: It's crazy. Tom S: Days 28 to 46, 6%. Tony B: Unbelievable. Tom S: It really is. Tony B: Unbelievable. Tom S: When I saw this when the guy showed it to me before, I was like ... on the one hand I think this is an unbelievable piece of research. On the other hand, I kind of hate it, because I thought the exact opposite. Lately I've been coming around because I realize our own results ... Tony B: Right. Tom S: I can see what's happening. I can see the percentage of winner has gone up dramatically ... Tony B: So you're in that range right now, it's February with about 16 days to go until expiration. Tom S: Yeah, no, no. Well now you've just got risk left on the table. Apple is a perfect example. I was much more aggressive today in apple than I usually ever am. I'm on the dance floor and if I don't get my puts up to 18 or 19, my short puts, because my calls are way too deep in the money. I'm not making any more money on my calls. The tens have no more extrinsic premium and so I've got either roll to March, which is my next move. Tony B: Okay, sounds good. Tom S: Anyway Tony B: Good Study. Tom S: But hold on before you go .... Tony B: So are you going to be a little more aggressive with closing your trades with two weeks to go to expiration or somewhere inside that instead of one to ten days? Tom S: I just want to review these last three slides because I think they're so important and again, feel free to share them. It's important for us to get a word out there of what we do here and all this other kind of stuff. When you start to look at these numbers, you can eliminate close to 15 days because nobody would do that, that's just not .... To me that's something similar to a hard stop or something like that. We just eliminate the first one, close to 15 days, and for no other reason than because it doesn't give you enough flexibility. Managed at 50%, it becomes an absolute no-brainer when you look at average P and L per day. That's it. You look at the number of days, average P and L per days and you look at the percent winners. Nobody's going to choose 79% over 93%, no matter what. Tony B: Right. Tom S: Forget about the fact that it's a third better in P and L on top of that. So then we go to the next slide which just confirms it all. 14% better win rate, 60% better P and L, and 19 average less days. Then you look at this and it's going to blow you away. Percent of profits made, days 1 to 27 .... I don't even know why it took us three years to get here .... 94% of profits are made in days 1 to 27. I will never forget that statistic. It will be the first statistic I show at every event that I do. Tony B: And so it should be. There's nothing else really 94%. Tom S: Because when you start to look at this … I was so happy when we did the whole weekly option thing and we were like, "This is the greatest, we're going to change the whole industry, we're going to do all this .... " And now when I look at this I'm like .... And even the traders .... Tony B: This answers so many more questions to when you talk about rolling. When somebody says to me, "You know what, something's right in between my short strikes now and I'm back to even or I'm a really small loser, what should I do?" My answer now will change to something like, "You know what, If you don't want the delta risk, you really should think about rolling to the next month. Especially if you have high IV next month." Tom S: Even the floor traders, when we first came out with weekly options, the floor traders didn't want to trade them. They're like, "We're just going to get picked off." I was leaving the floor at that time so it didn't make any … Or, gone. It didn't make a lot of sense to me but I wasn't going to question them because I figured they understand. If they saw these statistics they'll go, "You know, we should just do the opposite of what anybody wants to do no matter what they want to do it doesn't make any difference at all. Tony B: [chuckles] Let's take a quick break, we'll come back. We've got a tastybites segment, we're talking about high return on capital. It's tastytrade Live.