We look at things somewhat differently than other option traders. Where else will you hear the concept of managing winners discussed? Unfortunately, when we sell premium using a strategy such as a Strangle we won’t always be right. Our studies have shown that a loss of twice the premium collected is a good general level to exit a trade but we also say trade small and trade often which leads to a large number of occurrences. Tracking each position for P/L can be difficult. Is there another system we could use to make things easier and still limit losses overall?
What about managing earlier based on time. Can this reduce the risk inherent in positions? Our first study was conducted in the SPY (S&P 500 ETF) from 2005 to the present. We sold a 1 Standard Deviation Strangle in the options closest to 45 days to expiration (DTE) and compared managing the position 3 weeks before expiration or managed the position if it reached 2x loss or held through expiration. The average P/L was higher when incorporating 2X losses but the win ratio, duration, and largest loss were worse.
Our second study had the same setup but since we believe in managing winners we added that to the study. We managed winners at 50% of max profit or 3 weeks before expiration, whichever came first and we compared that to managing winners at 50% or closing the losers at 2X point or if neither was possible the trade was held until expiration. A second results table showed that managing winners at 50% or exiting with 3 weeks to expiration had a much higher average P/L, a higher win rate, a shorter duration and the largest loss was more than 50% less.
For more on Managing Winners & Losers see:
Market Measures from June 19, 2015: "Straddles | Managing Winners and Losers"
Market Measures from September 1, 2015: "Short Puts | Managing Winners & Losers"
Market Measures from April 20, 2016: "Manage Winners and Close Early?"
Watch this segment of Market Measures with with Tom Sosnoff and Tony Battista for the important takeaways and the results of our two studies comparing exiting positions at three weeks to expiration versus a 2x loss the credit received and tested the strategies both with and without managing winners at 50%.
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