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Trade Defense: Exit or Do Nothing?

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Part of being an active investor is putting in a little extra work to hopefully end each year with some extra returns and knowledge that we don’t get from passively buying funds. This extra work includes trade creation, profit management, and trade defense. Today’s study zeros in on the last of those – trade defense.

Tom and Tony look at the vanilla 1 standard deviation Strangle in the S&P 500, and filter historical results for the ones that have shown a tested breakeven at some point during the 45-day life of the option. They then test the following hypothesis: it’s better to do nothing than to exit the trade entirely when the stock moves past a short strike.

We found that since 2005, Strangles have performed better when we did not close out the losing trades prior to expiration. We will look to extend this research to further, more complicated defensive strategies in the near future here on Market Measures, so look out!