We normally discuss what to do with our winners when trading straddles. Today, Tom Sosnoff and Tony Battista examine possible trade exits when the position goes against us. Tom and Tony said that they have received many emails on the subject of closing straddles. Tom said, "We understand the managing winners side, now were going to discuss the managing losers side. When you sell a straddle, one side is going to be in the money right up front."
How much is our win rate affected when applying an exit rule for naked options?
How much room should we allow a losing trade to go against us?
Is there an optimal exit point for exiting a loser?
Selling straddles has benefits for the short volatility trader:
1) Positive Theta
2) Short Vega
3) Large Credit = Higher Potential Profit
4) Flexibility of Management
5) Less Commissions
But these benefits aren’t free. Here are the primary cons to selling straddles:
1) Higher BPR = Lower ROC
2) High Vega Risk
3) Possibility of large losses
Tom explained, "We've studied a lot about managing winners for the last three years. We've created a lot of statistics around managing winning trades. When it comes to losing trades we found that the optimal exit point on losers is 2X the max profit. We (Tom and Tony) have a tendency to not follow that rule because we carry a lot of positions and stay small. The difference between 1X, 2X,3X, 5X is not that much to us."
Tom added that their studies have shown that for strangles we "manage our winners" at 50%. On straddles we manage our winners at 25%. The net profit is larger using the same amount of buying power. That being the case, at what point do we take off a losing straddle?
The Study:
SPY, GLD, TLT, EWW, IWM, 2009 - Present
Sold ATM Straddle, 1st of the month Closest to 45 DTE
Exited trades at:
Expiration or Loss equal to 0.25x, 0.50x, 0.75x, 1x, 1.25x, 1.50x, or 2x of the credit received
Of the 378 occurrences, 186 (49% of the trades) never got to a 25% credit loss. Tom was amazed at this high percentage. Of those that did, how many reached or exceeded each of the pre-determined exit points?
Takeaways:
As we incrementally increased our loss limit, we saw a +15% win rate while only giving up 0.59% of profits
The highest win rate was seen by waiting the longest, 2x loss or expiration, but this also resulted in the largest loss as well
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