The term "managing winners' refers to a closing a position before expiration. It is one of the "Early Exit" conditions you can specify on eDeltaPro Options Backtesting Software. Typically, you would exit a trade when it reaches a percentage of the maximum profit - for example 40% of Max Profit.
Managing Winners is considered a good trading practice as it:
- Reduces the "days held" and thus the time exposed to market risks
- Improves the risk-reward ratio (Once you reached your target profit, there is simply less money to be made for essentially carrying the same risk)
- Improves the win ratio
We did a backtest study to verify these claims.
We started with a 1 Standard Deviation Strangle, that is:
- Short 16 Delta PU
- Short 16 Delta CALL
- 45 DTE
- SPY
- 10+ Years (Jan 2005 to June 2018)
We compared letting the trade close at expiration and with an early exit condition of 50% of Max Profit. When a trade was closed because it reached that profit target we immediately placed a new trade.
The early exit at 50% provided a greater total return. It also improved the trade in others aspects. While the average P/L for each trade was about the same, the daily P/L was substantially better ($2.04 vs $1.18).
The risk profile - as measured by the Standard deviation - also shows improvement for the early exit backtest.
In this study managing winners, - by an early exit at a specified target - did improve results. It increased the profit per day and reduced the average duration of each trade. As a result, an early exit increased the total return on the strategy. All while maintaining, or even slightly decreasing, the risk profile.
We find the best option strategy to trade Microsoft [Backtest study]
Is it possible to use the insurance industry as a model to construct a low-volatility, non-correlated investment strategy using options?