There are a myriad of strategies that can be deployed in global financial markets that produce consistent, positive returns.

However, not everyone has access to the legions of software developers and quantitative engineers necessary to leverage niche opportunities in the marketplace.

In the absence of the those resources, one potential approach is to deploy and manage a portfolio that has a high probability of profit.

In a recent episode of Best Practices, hosts Tom Sosnoff and Tony Battista present and discuss four of the primary tenets of the tastytrade approach to capital/risk management, which are:

  1. Markets are Random

  2. The Law of Large Numbers

  3. Selling Premium

  4. Manage Winning Trades

This episode is a must-watch for any market participant seeking to optimize their approach - or simply to better understand options and volatility trading.

The tastytrade approach starts with the understanding that Markets are Random. It's indisputable that financial markets go up and down. As illustrated through a graph of the SPX from 1950 to present, the frequency of consecutive "up" days is only slightly higher than "down" days.

Markets move up and down, and picking the direction of the market on any given day or over a period of time is virtually impossible. That means that traders and investors may be better served deploying a higher probability approach.

Likewise, trading a high probability strategy is also founded on The Law of Large Numbers. The crux of this tenet is that as one deploys more trades, their results should approach the expected probability.

Imagine you flip a coin 50 times. Probability theory tells us that you have a 50% chance of getting "heads" or "tails" on any given flip. Now imagine that your first 5 flips results in "tails" - a somewhat skewed result as compared to the expected probability.

The Law of Large Numbers suggests that as the number of occurrences increase, the actual probability should get closer to the expected probability. In the case of the coin, this means that executing the remaining 45 flips should get one closer to an even result in terms of "heads" versus "tails." And flipping the coin another 1,000 times should get you even closer.

In trading a high probability strategy, this means that your results should get closer to the expected probability of profit as you deploy an increasing number of occurrences (trades).

This brings us to the next tastytrade tenet, which is Sell Premium. Data suggests that selling premium has a higher probability of profit than buying premium over time. As you can see in the slide below, the actual probability of profit exceeded the expected probability of profit when analyzing the sale of a 1 standard deviation strangle in the SPX over the last ten years:

 

This brings us to the fourth tenet of tastytrade discussed on Best Practices, which is that Managing Winning Trades can help enhance performance and decrease the likelihood of losses. One method of managing trades, as explained on the show, is to close positions when they reach 50% of potential profit.

The data illustrating the fourth tenet was presented more thoroughly on a previous episode of Market Measures, which can be accessed by following this link.

We hope you'll take the time to watch the entire episode of Best Practices focusing on “the tenets of tastytrade" when your schedule allows.

If you are looking for more information relating to the tastytrade approach we also suggest checking out the following: Twenty tastytrade Trading Commandments.

Lastly, don’t hesitate to hit us up with any questions or comments at support@tastytrade.com!
 


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.