Why Options Traders Lose Money (#1 Reason & the Fix)

Posted on February 2, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 12:46 pm

Why Traders Lose Money (#1 Reason)

Most active traders will never consistently make money in the markets. Whether it’s an equity day trader, options trader, or futures trader, many will struggle to extract profits from the markets on a regular basis.

But why?

While there are virtually unlimited reasons traders lose money in the markets, there’s one big reason (in our opinion) that stops traders from ascending to the land of consistent profitability.

In the video below, we’ll identify the reason we believe many traders (particularly options traders) struggle to profit consistently over time.

Long Call vs. Call Spread (Options Strategy Comparison)

Posted on February 2, 2022March 1, 2022 by Chris Butler

Last updated on March 1st, 2022 , 06:11 am

Buying call options and buying call spreads are both bullish options strategies with many similar characteristics.

However, both strategies have unique differences when it comes to profit/loss potential, exposure to changes in implied volatility, and probability of profit.

In the video below, you’ll learn the key differences between long calls and long call spreads as we compare the two strategies using real option contracts.

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Long Put vs. Put Spread (Options Strategy Comparison)

Posted on February 2, 2022March 1, 2022 by Chris Butler

Last updated on March 1st, 2022 , 06:11 am

Buying put options (long put) and buying put spreads (long put spread) are both bearish options strategies with many similar characteristics.

However, both strategies have unique differences when it comes to profit/loss potential, exposure to changes in implied volatility, and probability of profit.

In the video below, you’ll learn the key differences between long puts and long put spreads as we compare the two strategies using real option contracts.

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Additional Resources

Explaining Put Options (Short and Long) – CME Group

Iron Condor Options Strategy Explained | Trade Examples & Stats

Posted on February 2, 2022February 10, 2022 by Chris Butler

Last updated on February 10th, 2022 , 12:49 pm

The Iron Condor is one of the most popular options trading strategies, especially among income traders who prefer to have limited risk and a high probability of making money each month.

Here’s what you’ll learn in this guide:

✓ How Iron Condors are set up and how they profit (when buying or selling them).

✓ The historical profit/loss statistics for over 70,000 iron condor trades.

✓ Ways to adjust an iron condor when the stock price has moved against you.

Ready? Let’s get started.

The Long Iron Condor Options Strategy

Like all options strategies, the position can either be bought or sold. When you buy an iron condor, your position is called a “long Iron Condor.”

The long Iron Condor is set up by simultaneously:

➜ Buying an out-of-the-money Call Spread

➜ Buying an out-of-the-money Put Spread

The long Iron Condor is a limited-risk position that profits when the stock price makes a big move in either direction.

Conversely, the trade loses money when the stock price remains in-between the two spreads as time passes (no big movement in either direction).

Now that you know how the long Iron Condor strategy works, let’s talk about the more popular strategy of selling Iron Condors.

The Short Iron Condor Options Strategy

When an Iron Condor is sold, the position is called a “short Iron Condor.”

Traders with the goal of extracting monthly income from the markets love selling Iron Condors because they can make money when the market remains in a range, but have limited loss potential if the market makes a big move in either direction.

The Short Iron Condor is constructed by simultaneously:

➜ Selling a Call Spread

➜ Selling a Put Spread

All options need to be in the same expiration cycle. As long as the stock price remains between the short strikes of the call spread and put spread, the options will lose value as time passes, generating profits for the Iron Condor seller.

However, if the stock prices rises or falls significantly, the short Iron Condor seller will lose money. Fortunately, Iron Condors have limited risk, which means the maximum loss potential is known before entering the trade.

Iron Condor Management Results (Backtest)

We conducted an extensive backtest of selling Iron Condors on the S&P 500 ETF (ticker: SPY).

More specifically, we tested 16 different trade management combinations. For the key findings, watch the video below:

Short Iron Condor Adjustment Strategies

At some point, the stock price will move against your position after selling an Iron Condor.

What can you do to defend the position?

There are two common adjustments traders make when their Iron Condor positions get into trouble. When the stock price rises significantly, traders may “roll up” their short put spread to collect more option premium, neutralize their delta exposure, and effectively reduce the risk of the position.

Watch the video below to see how it works:

What about when the stock price falls significantly?

In that situation, traders will sometimes make the opposite adjustment and “roll down” the short call spreads.

Just like the first adjustment, rolling down the short call spreads collects more option premium, reduces delta exposure, and reduces the maximum loss potential of the position.

Watch the video below to see how the adjustment works

Nice job! You’ve made it to the end of the guide.

We’ve covered a ton of material here, and it might not all sink in at once. You’re encouraged to revisit this guide whenever you need a refresher.

Alternatively, you can watch the videos from above on our YouTube channel. Be sure to subscribe so you get notified when we upload new content!

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Additional Resources

Iron Condor Options Trading Strategy | tastytrade

How to Trade Options Calendar Spreads: (Visuals and Examples)

Posted on February 2, 2022February 28, 2022 by Chris Butler

Last updated on February 28th, 2022 , 02:36 pm

The calendar spread is an options strategy that consists of buying and selling two options of the same type and strike price, but different expiration cycles.

This is different from vertical spreads, which consist of buying and selling an option of the same type and expiration, but with different strike prices.

Here’s a visual representation of how vertical spreads and calendar spreads differ:

Please Note: The Buy/Sell positions in the above graphic could be switched to create a different vertical or calendar spreads. What’s important for now is that you understand vertical spreads are constructed with two strike prices (same expiration) while calendar spreads are constructed with two expiration cycles (same strike price).

Because calendar spreads are constructed with the same options in different expiration cycles, they are sometimes referred to as “time spreads” or “horizontal spreads.”

What is a Calendar Spread?

A calendar spread is an options strategy that is constructed by simultaneously buying and selling an option of the same type (calls or puts) and strike price, but different expirations. If the trader sells a near-term option and buys a longer-term option, the position is a long calendar spread. If the trader buys a near-term option and sells a longer-term option, the position is a short calendar spread.

The Long Calendar Spread

In this article, we’ll focus on the long calendar spread, which consists of selling a near-term option and buying a longer-term option of the same type and strike price.

Here’s a hypothetical long calendar spread trade constructed with call options on a $100 stock:

Sell the January 100 Call for $3.00 (30 Days to Expiration)

Buy the February 100 Call for $5.00 (60 Days to Expiration)

The trader will pay more for the long-term option than they collect for selling the near-term option, which means the trader will have to pay to enter the spread. In the above example, the trader would pay $2.00 for the call calendar:

$5.00 Paid – $3.00 Collected = $2.00 Net Payment

Let’s walk through a more specific example using real historical option data.

Long Call Calendar Example

Here are the details of the long call calendar spread we’ll analyze:

Stock Price at Entry: $171.98

Long Calendar Components

➜ Short 170 Call (39 Days to Expiration)

➜ Long 170 Call (74 Days to Expiration)

Calendar Spread Entry Price

➜ Sold the 39-Day Call for $5.50

➜ Bought the 74-Day Call for $7.75

➜ $7.75 Paid – $5.50 Collected = $2.25 Paid

When trading long calendar spreads, you want the stock price to trade near the strike price of the spread as time passes. If it does, the near-term short option will decay at a faster rate than the longer-term long option, which will result in profits on the position.

Let’s look at what happened to this calendar spread as time passed and the stock price changed:

As we can see, the stock price stayed close to the calendar’s strike price of $170 as time passed, and the calendar spread increased in value, but why?

Calendar Spread Components vs. Stock Price

Let’s compare the spread’s price changes to the prices of each call option in the calendar spread:

When we dig a little deeper, we find that the calendar spread’s price increased because the short option lost more value compared to the long option:

Since the short call experienced a larger price decrease than the long call, the long call trader experiences profits. More specifically, the short call lost $0.99 more than the long call over the period, which translates to a $0.99 profit ($99 in actual P/L terms per calendar spread) for the trader:

Summary

When a trader buys a calendar spread (sell a near-term option, buy a longer-term option of the same type and strike price), they are anticipating the stock price to trade near the strike price as time passes.

If the stock price hovers around the long calendar’s strike price over time, the short option will decay faster than the long option (all else equal), which will lead to an increase in the calendar’s price. This generates profits for the long calendar spread trader.

If the stock price moves significantly in either direction away from the calendar’s strike price, the worst loss that can occur is the price the trader paid for the calendar spread.

Long Calendar Spreads Are NOT Long Volatility Trades

Long calendar spreads are often said to be long volatility trades because the vega of the long option is greater than the vega of the short option, resulting in a positive vega position.

However, my opinion is that long calendar spreads are not long volatility trades.

Next Lesson

Additional Resources

What is a Calendar Spread Option? | tastytrade

Short Straddle Adjustment Results (11-Year Study)

Posted on February 2, 2022April 25, 2022 by Chris Butler

Last updated on April 25th, 2022 , 07:29 am

In this article, we’ll examine the historical performance of selling straddles on the S&P 500, and the impact of closing trades using profit targets and stop-losses.

What is a Short Straddle?

A short straddle is an options strategy constructed by simultaneously selling a call option and selling a put option with the same strike price and expiration date. Selling a straddle is a directionally-neutral strategy that profits from the passage of time and/or a decrease in implied volatility. A trader who sells a straddle is anticipating the stock price to stay close to the straddle’s strike price in the near future, as the options that were sold will experience the most extrinsic value decay as expiration approaches.

For instance, if a stock is trading at $100 and the trader wants to sell the 100 straddle with 30 days to expiration, they’d sell the 100 call option and 100 put option in the expiration nearest to 30 days.

The Risk of Selling Straddles

The most a trader can make when selling a straddle is the amount of option premium collected for selling the straddle, while the loss potential is virtually unlimited.

With so much loss potential, how have short straddles historically performed when sold against the S&P 500 ETF (ticker: SPY)?

Short Straddles on the S&P 500

Instead of just looking at the results of holding the short straddles to expiration, we’ll examine the usage of stop-losses as well to see if closing losing trades has improved the strategy’s performance over time.

NOTE: as opposed to a stop-loss order, a stop-limit orders guarantee a fill price.

Study Methodology

Product: S&P 500 ETF (SPY)

Expiration: Standard monthly cycle closest to 60 days to expiration (60 DTE).

Trade Setup: Sell the at-the-money call and put.

Management: None (hold to expiration), -50% loss, -100% loss, -150% loss.

Next Entry Date: First trading day after previous trades were closed.

Stop-Loss Example

To make sure you understand the stop-loss calculations, here are some examples:

Initial Straddle Sale Price: $10

-50% Loss: Straddle price increases by 50% to $15.

-100% Loss: Straddle price increases by 100% to $20.

-150% Loss: Straddle price increases by 150% to $25.

The stop-loss is just the percentage increase over the initial sale price that is used as a trigger to close the trade.

SPY Short Straddles: Taking Losses

Here are the results of the first study:

*Please Note: Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to the accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have been under or over compensated for the impact, if any, or certain market factors such as liquidity, slippage and commissions. Simulated trading programs, in general, are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risk.

Compared to holding to expiration, implementing a stop-loss that was not too tight helped smooth out strategy returns. By using the smallest stop-loss and closing trades when the loss reached 50% of the premium received, the returns were choppy and inconsistent over the test period.

Visually, the best-performing approach was to use a -100% stop-loss, which means the short straddles were closed if the price doubled from the initial entry price.

With that said, all approaches suffered significant losses in February of 2018, which highlights the importance of keeping risk in mind before selling straddles.

Here are some performance metrics related to each management approach:

Trade Results

As expected, the -50% stop-loss level had a lower success rate compared to the other approaches. If you’re wondering how the -100% stop-loss level had a higher success rate than not taking losses at all, it’s because closing trades early results in more overall trades, which can sometimes lead to higher percentages of profitable trades compared to the approaches with fewer trades.

Also, it’s worth noting that the losses were sometimes far more than the stop-loss levels in each category, which can be explained by the fact that sometimes trades will not be able to be closed at the exact stop-loss levels. The losses were sometimes much more than the stop-loss levels because the study uses end-of-day data, which means substantial one-day market movements can lead to a large change in the option prices by the time the market closes.

How many of the short straddles reached each loss level?

Not many of the straddles reached the -100% P/L level, but the same percentage reached the -100% and -150% P/L levels. The data shows us that almost all of the straddles that reached the -100% loss level also reached the -150% loss level. The data suggests that using a stop-loss of -100% is strategically better than using a slightly wider stop-loss of -150%.

SPY Short Straddles: Taking Profits

Now that we’ve explored the usage of stop-losses when selling straddles, let’s look at the historical performance implications of closing profitable straddles early. The preferred order type to do this is the limit order.

We’ll use the same methodology as before:

Sell an at-the-money SPY straddle in the expiration closest to 60 days.

Management: None, 10% Profit Target, 25% Profit Target, 50% Profit Target.

Next Entry Date: First trading day after previous trades were closed.

For instance, if a straddle was sold for $10, a 10% profit would be reached when the straddle’s price decreased to $9 (a 10% decrease from the entry price). A 25% profit would be reached when the straddle’s price decreased to $7.50 (a 25% decrease from the entry price).

Here were the results:

Taking profits at 10-25% of the maximum profit potential significantly increased the consistency of returns relative to not managing trades at all.

As expected, taking profits sooner resulted in higher success rates, fewer days held, yet larger losses than holding to expiration.

The reason the losses are larger in the profit-taking approaches is simply because there’s more overall trades, which means the straddle’s strike price is more often reset to the current market price.

I explain why this matters in this video:

Pros and Cons of Closing Profitable Straddles

There are numerous benefits of closing short straddle positions before expiration for profits.

Benefit #1

‘Reset’ the strike price higher during steadily rising markets. Results in more neutralized position deltas over time and reduces the probability of loss from market increases. The same concept holds true for steadily declining markets.

Benefit #2

Reduce P/L Volatility by avoiding the high gamma exposure short straddles can have close to expiration (if the stock price is near the strike price).

Benefit #3

Higher percentage of profitable trades, which can be beneficial from a psychological standpoint.

It’s not all good when it comes to closing short straddles early. Here are the downsides of closing profitable trades sooner.

Con #1

Resetting the strike price closer to the current stock price is also a bad thing. After selling a straddle, a quick drop in the stock price will lead to larger losses relative to a scenario where the stock price rises above the strike price and then falls through the strike price (which is more likely when holding positions longer because the market typically drifts higher). Refer to the video above for a more in-depth explanation

Con #2

More trades = more commissions. By exiting trades quicker, new trades are opened sooner as well, which leads to significantly more trades over time (and therefore more commissions).

Con #3

Higher required success rate when taking smaller profits. By closing trades for small profits, more profitable trades are required to recoup the losses from unprofitable trades, especially if the loss far exceeds the chosen stop-loss.

Selling Straddles on the S&P 500: Combining Profit & Loss Management

Hopefully, you’ve learned a great deal about how simple profit-taking and loss-taking approaches can potentially improve performance when selling straddles.

Now, we’ll examine the historical performance of combining profit targets and stop-losses on short straddle positions.

Study Methodology

Product: S&P 500 ETF (ticker: SPY)

Expiration: Standard monthly cycle closest to 60 days to expiration.

Trade Setup: Sell the at-the-money call and put. One straddle sold for all trades.

Management:

✓ 10% Profit OR 50% Loss

✓ 25% Profit OR 50% Loss

✓ 10% Profit OR 100% Loss

✓ 25% Profit OR 100% Loss

For example, if a straddle was sold for $10 and a trader used the 25% Profit OR 50% Loss management, they’d close the straddle if the price reached $7.50 (a 25% profit) or $15 (a 50% loss).

Here were the results of the four short straddle management strategies:

As we can see, all four of the management strategies performed well over the test period, though all strategies suffered major losses in February of 2018.

Consistent with previous findings, the 10% profit target approaches had the smoothest growth curves over time, as short straddles rarely get to higher profit percentages (since that requires the stock price to remain right on the straddle’s strike price as time passes).

As expected, taking profits earlier resulted in higher success rates and fewer days held, but larger drawdowns on the worst trades. The reason is partly because there’s more overall trades when taking profits sooner, but also because the strike price is reset more often.

How did the 10% profit-target approaches compare to not managing trades at all?

Holding short straddles to expiration had a period of outperformance between 2009-2012, but lagged behind the management approaches and was much less consistent during the 2012-2018 period.

During the 2009-2012 period, the VIX Index (implied volatility of S&P 500 options) was incredibly high and decreasing quickly in the years after the 2008 market collapse. A quickly decreasing VIX Index is a favorable environment for short premium strategies, as profits can occur very quickly. Consequently, taking small profits lagged behind letting the trades run until expiration.

However, during lower implied volatility environments (such as 2013 to early 2018), taking off profitable trades sooner led to much more consistent results compared to holding to expiration. It makes sense, as the market is typically grinding higher during low implied volatility environments (which is why implied volatility is low).

Here’s the same chart from above but with the VIX Index plotted against the strategies:

It’s important to note that while all of the above approaches show profits after the entire test period, all approaches suffered substantial losses at times, especially during February of 2018.

Over a long enough period of time, there will be market crashes worse than what was experienced in 2008, 2015 and 2018.

With that said, short straddles carry substantial risk and should be implemented with extreme caution (if at all). Undefined-risk strategies like short straddles and strangles are far riskier than what most traders are comfortable with, especially when increasing trade size.

Always think about risk before making any trades, and keep in mind that losses can become severe very quickly when selling naked options.

Short Straddle FAQs

How do you adjust short straddles?

Short straddles are typically adjusted by either rolling the options to a different expiration cycle or rolling the options to a different strike price. A combination of these two strategies is possible too.

Is short straddle always profitable?

The short straddle is a high probability trade that carries substantial risk. When markets turn volatile, a trader can have years of straddle selling profit wiped out in a single trade.

What is the risk of a short straddle?

Since the short straddle involves a short call option, ,the risk in this strategy is unlimited. A trader may use an alternate strategy, such as the iron condor, to mitigate risk.

Short Strangle Management Results (11-Year Study)

Posted on February 1, 2022February 28, 2022 by Chris Butler

Last updated on February 28th, 2022 , 02:20 pm

In this article, we’ll examine the historical performance of selling strangles on the S&P 500, and the impact of closing trades using profit targets and stop-losses.

What is a Short Strangle?

A short strangle is an options strategy constructed by simultaneously selling a call option and selling a put option at different strike prices (typically out-of-the-money) but in the same expiration. Selling a strangle is a directionally-neutral strategy that profits from the passage of time and/or a decrease in implied volatility. A trader who sells a strangle is anticipating the stock price to stay in-between the strangle’s strike prices in the near future, as the options that were sold will experience extrinsic value decay as expiration approaches.

For instance, if a stock is trading at $100 and the trader wants to profit from a scenario in which the stock price trades between $90 and $110 over the following 30 days, the trader could sell the 90 put and 110 call in the options closest to 30 days to expiration.

The Risk of Selling Strangles

The most a trader can make when selling a strangle is the total amount of option premium collected for selling the call and put, while the loss potential is virtually unlimited.

With so much loss potential, how have short strangles historically performed when sold against the S&P 500 ETF (ticker: SPY)?

Short Strangles on the S&P 500

Instead of just looking at the results of holding the short strangles to expiration, we’ll examine the usage of stop-losses as well to see if closing losing trades has improved the strategy’s performance over time.

Study Methodology

Product: S&P 500 ETF (SPY)

Expiration: Standard monthly cycle closest to 60 days to expiration (60 DTE).

Trade Setup: Sell the 16-delta call and 16-delta put.

Management: None (hold to expiration), -50% loss, -100% loss, -200% loss.

Next Entry Date: First trading day after previous trades were closed.

Stop-Loss Example

To make sure you understand the stop-loss calculations, here are some examples:

Initial Strangle Sale Price: $2.00

-50% Loss: Strangle price increases by 50% to $3.00.

-100% Loss: Strangle price increases by 100% to $4.00.

-200% Loss: Strangle price increases by 200% to $6.00.

The stop-loss is just the percentage increase over the initial sale price that is used as a trigger to close the trade.

SPY Short Strangles: Taking Losses

Here are the results of the first study:

Compared to holding to expiration, taking 50-100% losses on the short strangles helped avoid some massive losses, but all strategies still suffered substantial drawdowns in certain periods (especially the February 2018 crash).

The largest stop-loss of 200% was the worst-performing approach, which I suspect is due to the fact that the market has been on a bull run over the test period, which means any sharp declines that caused a 200% loss on the short strangles recovered very quickly. In other words, a lot of trades were stopped out at a 200% loss that later ended with profits or less-severe losses.

Here are some performance metrics related to each management approach:

As expected, the -50% stop-loss level had a lower success rate compared to the other approaches. If you’re wondering how the -100% stop-loss level had a higher success rate than the -200% stop-loss level, it’s because there were more overall trades in the -100% stop-loss approach, and the overall success rate happened to be slightly higher.

On a more important note, we can see that the worst losses experienced were far greater than the chosen stop-loss levels, which brings up a very important point to keep in mind when using stop-losses on undefined-risk strategies:

If the market moves significantly in a short period of time (usually that means a market crash), it can be very difficult to close trades at favorable prices because the bid-ask spreads of the options will widen significantly. Additionally, the study uses end-of-day data, which is one limitation of options backtests.

Let’s take a look at how many profitable trades would be needed to recoup the worst losses (based on the median closing P/L of the trades in each approach):

In regards to holding to expiration and not managing trades, we estimate that it would take 18.2 profitable trades to recoup the worst loss of $2,808. Of course, these are just estimations, but they show how sizable the losses can be relative to the potential reward.

How many of the short strangles reached each loss level?

Almost half of the strangles reached the 50% stop-loss level, which is incredibly high and likely a frequency that most traders would not prefer.

25% of the strangles reached the 100% stop-loss level and 16% of the trades reached the 200% stop-loss level. The data indicates that nearly 66% of the trades that reached a 100% loss also hit the 200% loss level.

Consequently, it may be logical to use the tighter 100% stop-loss as any strangle that reaches that loss level is likely to experience more severe losses.

SPY Short Strangles: Taking Profits

Now that we’ve explored the usage of stop-losses when selling strangles on the S&P 500, let’s look at the historical performance implications of closing profitable trades early.

We’ll use the same methodology as before:

Sell a 16-delta strangle on SPY in the expiration closest to 60 days away.

Management: None, 25% Profit Target, 50% Profit Target, 75% Profit Target.

Next Entry Date: First trading day after previous trades were closed.

For instance, if a strangle was sold for $3.00, a 25% profit would be reached when the strangle’s price decreased to $2.25 (a 25% decrease from the entry price). A 50% profit would be reached when the strangle’s price decreased to $1.50 (a 50% decrease from the entry price).

Here were the results:

Taking profits at 25-50% of the maximum profit potential significantly increased the consistency of returns relative to not managing trades at all.

As expected, taking profits sooner resulted in higher success rates, fewer days held, yet larger losses compared to holding to expiration.

When taking profits sooner, trades are held for fewer days, which means there’s a greater chance of seeing a substantial market decline shortly after entering a new trade. This matters because if the market is steadily rising, taking profits on a strangle and selling a new one typically means the short put’s strike price will be closer to the stock price. As a result, larger losses can be experienced.

Another downside of managing profitable strangles early is that the profits are smaller but significant losses are still possible, which can dramatically increase the number of profitable trades needed to recoup large losses: