Does Tastytrade Work

Does Tastytrade Work?

Tastytrade’s Love for the Short Strangle Shattered

The tastytrade network has created a lot of buzz around the short strangle.  A search on their site for “strangle” returns over 674 results.  They love it, teach it, market it to millions, but is this really a good strategy that they are so heavily marketing?

Tastytrade Quotes

“If there’s one thing we love discussing at tastytrade, it’s the good ole’ strangle! It has been a more popular topic of discussion lately so we wanted to curate for you, some of the best strangle content that we’ve produced, in one post (don’t say we never did anything for you)!”

more from the network…

“We are selling the strangle with the 16 delta call and 16 delta put so that it is a 1 standard deviation with over 70% POP, when factoring the credit.”

About the Short Strangle

The short strangle is high-risk trading method, which involves both naked calls and puts (nearly unlimited risk in both directions).  Traders who use this method usually trade a portfolio margin account.  This is a strategy that ends many trading careers.

Most traders will keep delta near flat and hope to make a profit from the theta decay of both uncovered options.  According to the tastytrade network website, they promote various formulas.

Tastytrade Strangle Formula, 16 Delta for Calls and Puts

One formula, per their own website, is to sell the 16 delta of the call and put 45 days to expiration (DTE) when IV Rank is from 50% to 100%.  They implement a rule of closing out winners when they reach 50% of the credit or stopping losses if the original credit doubles.  We could not find the exact amount of margin they recommend for trading a portfolio margin account, so we tried various amounts.  We back-tested this exact formula from 2005 to the beginning of 2016, 11 years and 1 month.

Tastytrade Strangle Performance

We performed multiple, 11-year back-tests to thoroughly test this formula.

In our first study, we used tastytrade’s exact formula and risk management rules.  In our second study, we modified the stop loss, giving the trades more wiggle room by extending stop losses to 4X the winners instead of 2X.

 

STUDY 1: Tastytrade’s Exact Short Strangle Formula Backtest

(Sell 16 deltas, manage winners at 50% of credit, stop loss when original credit doubles, 50% to 100% IV Rank only)

The following statistics are approximated since so many tests were performed:

  1. 65% winners
  2. Avg winner, 10%
  3. Avg loser, -24%

Test 1:  15% of portfolio margin used on average.

11-Year Portfolio growth, 2%

Yearly yield rate, 0%

Test 2: 25% of portfolio margin used on average.

11-Year Portfolio growth, -10%

Yearly yield rate, -1%

Test 3: 35% of portfolio margin used on average.

11-Year Portfolio growth, -61%

Yearly yield rate, -5.5%

Test 4: 50% of portfolio margin used on average.

11-Year Portfolio growth, -44%

Yearly yield rate, -4%

Test 5: 70% of portfolio margin used on average.

11-Year Portfolio growth, -93%

Yearly yield rate, Trading stopped in 2011 when account blew up.

 

STUDY 2: Stop Loss Modified to 4:1 Ratio of Winner

(Sell 16 deltas, manage winners at 50% of credit, stop loss when original credit triples, 50% to 100% IV Rank only)

  1. 84% winners
  2. Avg winner, 12%
  3. Avg loser, -36%

Test 1:  15% of portfolio margin used on average.

11-Year Portfolio growth, 33%

Yearly yield rate, 3%

Test 2: 25% of portfolio margin used on average.

11-Year Portfolio growth, -11%

Yearly yield rate, -1%

Test 3: 35% of portfolio margin used on average.

11-Year Portfolio growth, -15%

Yearly yield rate, -1.4%

Test 4: 50% of portfolio margin used on average.

11-Year Portfolio growth, -80%

Yearly yield rate, -7.3%

 

Noteworthy Problems with the Short Strangle

The inherent problem with trading the strangle on a portfolio margin account is that when the market moves, the trader’s account value drops quickly and margins increase simultaneously, sometimes by 200% or more.  For this reason, the portfolio margin trader should not use much of his capital.  If he does, he will be exposed to margin-call risk, which can include a forced liquidation by the broker, resulting in serious financial damages.  Note, in one video, Sosnoff states margins can increase 30% to 40%, but he is absolutely wrong about this.  Perform your own back-test over any serious market decline and make your own conclusions.

Tastytrade has interviewed a few traders that claim to have made 50% in a year using “the tastytrade method.”  That is highly hypocritical because the only way a portfolio margin trader could make as much is to violate the tastytrade rule of “trade small, trade often”, which means they are not actually trading the tastytrade way.  Traders using large amounts of portfolio margin capital with this method often run into margin problems and face large losses as the broker liquidates their strangles at market prices.  If you are not familiar with this process, please search online, and you’ll find many traders who have suffered devastating losses from this exact trading strategy.

Since the short strangle is such a high-risk trading method, traders must trade very small.  As in our back-test, trading 15% of the portfolio margin resulted in a small profit long-term.  However, this is not a good use of a portfolio margin account. The system only produced 3% a year, which is a very low amount for portfolio margin trading, and that assumes each trade was filled at the MID price – not likely.

Conclusion

Our multiple, 11-year back-test on SPX showed us that the beloved tastytrade strangle, the 16 delta version, underperforms the market long-term.  We followed their rules to the “T”.  Yes, it can produce very small profits, but is 3% a year really worth all the effort?  There are other methods which are much safer and consistently outperform this short strangle.

Tastytrade goes to extremes to market this trading method (nearly 700 videos already).  It appears they are trying to figure this strategy out by the number of classes they’ve hosted on the topic, but according to our back-tests, they have yet to do so.

Understanding Statistics of a Trading System

In the video I explain this a bit, but it’s very important to understand that just because a system has a high probability of profit (POP) and the average winners and losers look good,  that does not mean that the system will create a positive return.

The problem with strangles and other high-risk, low-reward trading systems, is a few large losses greatly reduce the net liquidation value of the account. When this happens, many consecutive, small winners, may never produce a profit on that account, ever. A system like this can produce misleading reports, such as 85% winners, average winning trade 10%, etc. and still create net losses when traded live. Clever advertises can take advantage of this information to make a system appear to be profitable when it’s not. That’s why when you look into a trading system, take a look at the equity curve and make sure it works long-term, not just for a few years only.

As always, best of luck with your trading, and if you seek a system that performs well for portfolio margin, then SJ Options and SJ Advisor is where you want to be.

Final Thoughts

A search for the term, “strangle” returns 674 results on the tastytrade network.

strangle

A search for the term, “strangle backtest” returns 0.

strangle backtest

It appears they have performed every test on the strangle except for the actual backtest.

 

 

 

 

Disclosure

We are not affiliated in any way with tastytrade.  Backtests were programmatically performed, and although we have attempted to produce accurate reports, we do not guarantee accuracy whatsoever.  We highly recommend everyone to perform their own backtesting duties and make the own conclusions about this trading system and others.  Any copyrighted materials by tastytrade are copyright of tastytrade.

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