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Decoding the 21 DTE Strategy: The Winning Approach to Rolling Option Trades

Updated: May 27, 2023

Today is Friday May 26th, 2023 and it's 21 days away from the regular June option expiration. What a great time to discuss a core principle of math-based options trading: why we typically roll our option trades at 21 Days to Expiration (DTE). I will be rolling a lot of my positions today!

You might be wondering, why 21 days? Is this some sort of magic number? Well, not exactly magic, but there is a method to the madness.

Several studies conducted have shown that the risk-reward profile of a trade changes significantly as we approach the expiration date. This shifting risk profile is primarily due to an increase in what we call 'tail risk.'

Tail risk, in "simple" terms (this sounds more complicated than it really is), represents the potential for an investment to move more than three standard deviations from its current price. If you aren't familiar with the Bell Curve here is an image:

As we get closer to the expiration date, the potential for large, sudden price swings increases, making the position riskier. Now, while we at GKT appreciate a good thrill now and then, we also value the importance of managing risk effectively in our trading strategy.

So, where does the 21 DTE come in? Well, these studies found that the tail risk starts to escalate significantly around 21 days before expiration. Essentially, the 21 DTE mark serves as a tipping point, where the risk of holding the position starts outweighing the potential rewards.

So, how do we manage this risk? That's where the art of 'rolling' options comes in. At 21 DTE, we typically make a choice: either we close the trade, or we roll it forward in time. This decision is based on a variety of factors, including the trade's current profitability and the overall market conditions. Remember to follow your trade plan, it keeps emotion out of this decision!

Rolling the trade technically involves closing the current position and opening a new one in a later expiration cycle. This allows us to reduce the risk associated with the current trade while maintaining a similar market position. This normally results in an additional credit so you continue to benefit from theta decay!

In essence, we are managing our trades and mitigating risk by adjusting our positions before the tail risk can bite us. It's all about staying one step ahead and proactively managing our trades, ensuring our portfolio remains healthy and robust.

Of course, like with all trading strategies, it's important to remember that there are no hard and fast rules here. The 21 DTE strategy is a guideline that works well for most of our trades, but every situation calls for its own unique assessment.

That's why at GKT, we encourage trading small, trading often, and trading mechanically. This approach gives us the flexibility to adapt our strategy based on the unique circumstances of each trade while sticking to our core risk management principles.

Remember, it's not just about making profitable trades, but about managing our risk along the way.

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