At tastytrade, we do our best to respond to feedback from viewers as quickly and comprehensively as possible. We’ve had a good number of comments and questions on a Market Measures episode aired during the summer and wanted to increase visibility of this show by featuring it on the blog.

The subject discussed on this particular Market Measures is straddles and how a trader can best manage these positions when in a winning or losing scenario. Managing winners is of course a philosophy and approach that tastytrade embraces and often features on the network.

Tom Sosnoff and Tony Battista, the long-standing hosts of the show, dive right into the heart of the matter by examining whether there is an equilibrium that can be achieved in managing straddle winners and losers that optimizes portfolio returns (maximum reward, minimum risk).

The data that the tastytrade research team analyzed in order to better understand optimal trading of these positions included five ETFs (first day of the trading month, January 2009 to present):

  • S&P 500 (SPY)
  • Russell 2000 (IWM)
  • U.S. Treasury (TLT)
  • Gold (GLD)
  • Mexico (EWW)

Using data from the above ETFs, the researchers then created five possible scenarios by which they could theoretically manage the straddle trades. These five strategies basically dictated at what level of profitability or loss a trade would be closed.

The five unique scenarios that were each run on ETF data are listed below:

  • 25% of maximum profit
  • 25% of maximum profit or 1x maximum loss
  • 25% of maximum profit or 1.25x maximum loss
  • 25% of maximum profit or 1.5x maximum loss
  • 25% of maximum profit or 2x maximum loss

After running these scenarios, the results indicated quite clearly that one of the strategies outperformed the other four:

mm061915straddles-managing-winners-and-losers_mstr-4.png

As you can see from the above slide, the trade management strategy that dictated closing positions at 25% of maximum profit or 1.5x maximum loss achieved the largest average profit/loss per day. The win rate and total profit/loss for this strategy also measured in at second and first, respectively. Implementing the winning strategy circled in red above theoretically reduced the average days each position was held from 45 day-to-expiration to 29.

The research conducted above compiles 6 years of data on well-known and highly liquid ETFs and clearly shows managing straddle trades according to specific parameters that can theoretically optimize a portfolio from a risk-reward standpoint.

Tom and Tony close the episode by pointing out that although holding losers may seem counter-intuitive, research done by tastytrade shows that doing just that increases the probability that these trades will ultimately mean revert and produce the expected average returns.

For a full account of this material, we encourage you to watch the full episode of Market Measures discussed in this post.

We also encourage you to contact us at support@tastytrade.com with any feedback or questions on this topic or any other related to options trading.