Stop-Loss Orders: 10 Backtested Option Strategies Revealed (2024)

In most investing or online trading circles, it's common to hear people tout the need for "stop-loss" orders to theoretically protect your portfolio. And while there is no doubt that stop loss orders help mitigate large drawdowns from time to time, the question I never see asked is, "What am I giving up by implementing a stop-loss order as part of my trading system?" You see, all too often traders and financial educators are quick to harp on the "need" or "requirement" for having continuous and always present stop-loss order in place.

Still, we all accept this golden rule as an undeniable investing truth, because, well, it's always been something you're told to use. Today, I'll challenge this long-standing requirement for stop-loss orders when trading option strangles. Until now, nobody has built a system to backtest this variable on the scale and scope that we have here at Option Alpha. Sure, you've likely seen one-off backtesting research segments elsewhere, but nothing as specific and targeted as what we've created. It's just a small sample of the backtesting results we've been compiling over the last year that can help you make smarter, more profitable trades starting today.

SPY Short Strangle Strategies:

1. A 10 Day Expiration Cycle.

• Delta set at 10, giving an 80-90% chance of success, not including the credit received.
• Profit target set at 50%, closed out once 50% was reached.
• Did not use IVR filters for any of the strategies.

First strategy: Tested and exit stop-loss at 300% increase in premium. Ex: if you took in a premium of $1, would only buy it back once it has gone up by 3X.

Second strategy: No stop-loss, no matter what happens. Would go all the way to expiration, win, lose or draw.

Results:

• At the end of the cycle, the return on doing the short strangle without the stop-loss was 6,349%. Return with the 3X stop-loss was 4,420%, almost a 2,000% increase in your return by not having a stop-loss in place.
• Win rates for the stop-loss were 85.57% on the trades. Win rate for not having a stop-loss was 88.42%.
• Maximum drawdown without a stop-loss was 4.9%. With a stop-loss, the maximum drawdown was 4.47%.

2. 30 Day Expiration time, on average.

• Delta set at 15, with a 50% profit target.
• Stop-loss set at 25%, a tight stop-loss.

Results:

• For the 30 days, 15 delta, 50% profit target, no stop-loss, no IVR filter, the return was 3,140% at the end of the cycle.
• With a tight stop-loss, profitability went down to 1,489% over the period. The stop-loss creates a 2X difference in return.
• Win rate for stop-loss is decreased to 56.71% for this trading strategy. Without the stop-loss, the win rate was 90.40%.
• Maximum drawdown was 12.96% without a stop-loss in place. With the tight stop-losses added in, the drawdown was 5.92%.

3. 30 Day Expiration Cycle.

• Delta set to 20 on either side, profit target was taken at 25%.
• Kept tight stop-loss at 25%

Results:

• The strategy with stop-loss made 760%, and the strategy without the stop-loss in place generated 1,533% over the period.
• Win rate when taking profits early with stop-loss was 66.51% versus no stop-loss having a win rate of 92.94%.
• Maximum drawdown without a stop-loss was 16.66%, and with a stop-loss in place the maximum drawdown as 6.86%.

4. 50 Day Expiration Cycle.

• Deltas set at 30 on each side, and profit target is reset to 50%.
• Stop-loss set at 75%, no IVR filter.

Results:

• The strategy without the stop-loss generated 1,042% return over the testing period. The strategy with the stop-loss generated 464% over the course of the period, by far the lowest performing strategy of all tests.
• Win rate with a wider stop-loss was 65.91%, and without the stop-loss, the win rate was 74.36%.
• Saw a much bigger drawdown when there was no stop-loss in place. The biggest drawdown was 21.99%. With a stop-loss in place, your maximum drawdown was 13.3%.

5. 70 Day Expiration Cycle.

• Deltas were again set at 30, but no profit target was set in order to focus in on the stop-loss.
• The exit stop-loss was set at 100% or doubling the premium received.

Results:

• At the end of the cycle with a stop-loss in place, the return was 1,413%. Without a stop-loss in place, the return was 1,849%.
• The win rate was almost identical in both cases, 69.57% and 69.77%.
• The maximum drawdown with a stop-loss was 23.69%. Without the stop-loss, the maximum drawdown was 14.8%. The stop-loss created a lot more drawdowns that lasted for a longer period of time.

Summary:

1. There were fewer trades when there was no stop-loss in place, which increases profitability.
2. In almost every case, there was a higher drawdown when there was no stop-loss in place.
3. The average in annual return was 87% higher the entire period when there is no stop-loss in place.
4. When there was no stop-loss in place, there was a higher win rate in every situation that was tested.
   

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