The tastytrade philosophy is founded on maximizing reward while minimizing risk in retail-oriented equity options trading. Careful management of your portfolio throughout the trade lifecycle is a key element in achieving those central principles.

For those that lean toward trading naked options, our tastytrade research team recently highlighted an optimal approach for managing these trades in such a way that return is maximized while risk is minimized.

On a May 2015 edition of Market Measures, Tom and Tony highlighted a study done by the tastytrade research team that examined the behavior of such trades in terms of timeline and profitability. The goal was to reveal optimal strategies for producing the highest possible return while exposing your capital to the lowest possible risk window when trading either naked calls or naked puts in short premium scenarios.

As is often the case, the tastytrade research team looked at 45 days to expiration trading windows as well as one standard deviation strike prices in both calls and puts. They then performed a regression analysis to extrapolate the optimal trade management points.

The results in both cases were quite compelling and indicate that a trade management strategy executed at 50% of maximum profit can drastically reduce the overall window of risk exposure when trading short, naked options.

For a one standard deviation short put with 45 days to expiration, the research revealed that the trades on average achieved 50% of maximum profit by the 14th day of exposure. This translates to only 31% of total days (14/45) risk exposure while achieving 50% of maximum profit, as shown in the graphic below.

Amazingly, the second half of the study revealed an almost identical theme. In the case of a one standard deviation short call with 45 days to expiration, the research similarly illustrated that the trades on average achieved 50% of maximum profit by the 14th day of exposure. Obviously, that translates to the same risk/reward equation in terms of trade management as the short put. The short call results are pictured below:

The primary takeaway from this study indicates that implementing a disciplined trade management strategy whereby a trader closes trades at 50% of maximum profit should on average allow a trader to drastically reduce the number of total days exposure to short premium naked options (calls or puts).

Such an approach allows traders to close risk exposure on average by the 14th day out of 45 possible days to expiration (31% of total days exposure).

Accruing 50% of maximum profit through only 31% of total days exposure certainly seems to fit the axiom of maximizing return while minimizing risk.

Additional information on trading naked options can be found here.


If you have any questions or comments on short premium naked options trade management, please leave them below.

And as always, thanks for being a part of the tastytrade community!