Why do you do this...are you selling something?
Can you recommend some books on options?
TRADE SETUP
What option price do you use in your backtests, mid?
What is your trigger for trade entry?
What is your trigger for trade exit?
How do you select the strikes of your puts and call?
What is an 8 delta short strangle?
What is an 8 delta iron condor?
What is a short straddle?
What is an iron butterfly?
Do your backtests use weekly options?
Do you have multiple trades on at the same time?
TRADE RESULTS
Why don't you show compounded returns?
Why don't you show max drawdown numbers?
Do you account for commissions and slippage?
How are returns calculated?
BACKTESTING
What program do you use for backtesting?
Do you use historical data?
Why do you do this...are you selling something?
I'm not selling anything...software, training, mentoring, newsletters, trade signals...nothing.
I started running backtests for myself, involving complex options structures with multiple adjustments, and the results matched my own live trading performance...pretty poor! Almost as a joke, I thought I'd backtest one of the most common options structures, a balanced iron condor, but without adjustments...a "no touch trade". Surprisingly, it worked better than the more complex structures I was actually trading.
I thought I'd share the backtest results of these simple options structures on my blog. I hope this information will provide traders with a better understanding of how simple options structures work, and provide a sound staring point for more complex strategies. If I knew back then, what is on my blog today, I would have approached options trading very differently. So hopefully, my blog will save some traders from having to take as long to learn these lessons.
I started running backtests for myself, involving complex options structures with multiple adjustments, and the results matched my own live trading performance...pretty poor! Almost as a joke, I thought I'd backtest one of the most common options structures, a balanced iron condor, but without adjustments...a "no touch trade". Surprisingly, it worked better than the more complex structures I was actually trading.
I thought I'd share the backtest results of these simple options structures on my blog. I hope this information will provide traders with a better understanding of how simple options structures work, and provide a sound staring point for more complex strategies. If I knew back then, what is on my blog today, I would have approached options trading very differently. So hopefully, my blog will save some traders from having to take as long to learn these lessons.
What option prices do you use in your backtests, mid?
My historical options data provides bid prices and ask prices. My backtester uses these prices to calculate the mid price, and then uses this mid price for the entry and exit prices. In live trading sometimes I get better than mid, and sometimes I get worse than mid. In general, in terms of relative performance of the strategies backtested, the mid seemed to be a fair compromise.
What is your trigger for trade entry?
The trigger for backtester trade entry (in all of my blog posts) is only days-to-expiration (DTE). For example, the 66 DTE trades are entered at 66 days before expiration. On any given day, there are multiple options chains available for trading, with different DTE. The backtester monitors the options chains for the selected product (SPX, RUT, etc). At some point in time the backtester will see that the DTE for the chain matches the DTE for the entry criteria. The backtester would enter on this day and not consider any other criteria (i.e. market conditions).
The DTE for a particular set of backtests is listed in the title of each blog post.
The DTE for a particular set of backtests is listed in the title of each blog post.
What is your trigger for trade exit?
The exits are described at the start of each series of blog posts. An exit for a particular backtest run will either be:
RUT Iron Condor - Dynamic Exit Overview - Part 1
RUT Iron Condor - Dynamic Exit Overview - Part 2
Iron Condor Series - Higher Loss Thresholds
Option Strangle Series - Higher Loss Thresholds
- Based on a certain DTE (typically one week before expiration)
- At expiration
- Based on market movement relative to the strikes of the position
- Based on loss as a percentage of margin required for the position
- Based on loss as a percentage of credit received for the position
- Based on profit as a percentage of credit received for the position
RUT Iron Condor - Dynamic Exit Overview - Part 1
RUT Iron Condor - Dynamic Exit Overview - Part 2
Iron Condor Series - Higher Loss Thresholds
Option Strangle Series - Higher Loss Thresholds
How do you select the strikes of your puts and call?
For all of my published backtests, I am selecting strikes based on delta. For example, a 12 delta iron condor would sell the put at -12 delta, and the call at +12 delta. The corresponding longs options are based on the wing width defined in the trade setup, typically discussed in the introductory post for a series.
What is an 8 delta short strangle?
I define an 8 delta short strangle as a strangle where the -8 delta put is sold and the +8 delta call is sold. Many option platforms will display the -8 delta put as -0.08, and the +8 delta call as 0.08.
If you are unfamiliar with the short strangle strategy, the following links might be useful:
The Options Guide - Short Strangle (Sell Strangle)
Options Playbook - Short Strangle
If you are unfamiliar with the short strangle strategy, the following links might be useful:
The Options Guide - Short Strangle (Sell Strangle)
Options Playbook - Short Strangle
What is an 8 delta iron condor?
I define an 8 delta iron condor as a condor where the -8 delta put is sold and the +8 delta call is sold. Many option platforms will display the -8 delta put as -0.08, and the +8 delta call as 0.08.
If you are unfamiliar with the iron condor strategy, the following links might be useful:
The Options Guide - Iron Condors
Options Playbook - Iron Condor
If you are unfamiliar with the iron condor strategy, the following links might be useful:
The Options Guide - Iron Condors
Options Playbook - Iron Condor
What is a short straddle?
A short straddle is created by selling both a call and put at the same strike and expiration. The number of calls sold should be equal to the number of puts sold.
If you are unfamiliar with the short straddle strategy, the following links might be useful:
The Options Guide - Short Straddle
Options Playbook - Short Straddle
If you are unfamiliar with the short straddle strategy, the following links might be useful:
The Options Guide - Short Straddle
Options Playbook - Short Straddle
What is an iron butterfly?
An iron butterfly is constructed by selling both a call spread and a put spread, where the short strikes of both spreads occur at the same location...typically at-the-money (ATM).
If you are unfamiliar with the iron butterfly strategy, the following links might be useful:
The Options Guide - Iron Butterfly
Options Playbook - Iron Butterfly
If you are unfamiliar with the iron butterfly strategy, the following links might be useful:
The Options Guide - Iron Butterfly
Options Playbook - Iron Butterfly
Do your backtests use weekly options?
I do not use weekly options in the backtests shown on my blog, unless noted. I typically use only the monthly options that expire the third Friday of each month.
Do you have multiple trades on at the same time?
Yes, the backtester may hold multiple trades at the same time. For example, with 80 DTE "no touch" strategy variations, there may be up to 3 trades held at some points in time.
Why don't you show compounded returns?
Most options traders that I know do not allocate 100% of their portfolios to options trades. In fact many allocate only a percentage in terms of margin. Additionally, many traders that I know trade approximately the same size positions month after month and withdraw the profits...to use either for expenses or other investments. Compounding doesn't make sense in either of these scenarios.
It would be impossible for me to apply compounding in a generic way, or in a way that would be useful to different traders. I thought a non-compounded approach would be generic enough to provide solid information to all traders, and be useful in relative performance comparisons of strategies.
Lastly all of the returns are normalized to the largest margin requirement for a given backtest run. For example, if a backtest run contains 98 trades between the end of 2006 and the first quarter of 2015, then the denominator used in the percentage return calculations for each of the 98 trades would be the largest margin required out of all of the 98 trades.
It would be impossible for me to apply compounding in a generic way, or in a way that would be useful to different traders. I thought a non-compounded approach would be generic enough to provide solid information to all traders, and be useful in relative performance comparisons of strategies.
Lastly all of the returns are normalized to the largest margin requirement for a given backtest run. For example, if a backtest run contains 98 trades between the end of 2006 and the first quarter of 2015, then the denominator used in the percentage return calculations for each of the 98 trades would be the largest margin required out of all of the 98 trades.
Why don't you show max drawdown numbers?
Max drawdown numbers are a bit difficult to calculate based on many of the reasons mentioned in the compounded returns answer. The denominator in the max drawdown calculation is more subjective for options strategies than stock strategies. The denominator could be based on:
- The actual margin requirements for each trade
- The max margin required for the series of trades
- The actual portfolio margin required for each trade
- The max portfolio margin required for the series of trades
- The actual starting account size
- The rolling compounded value of the account size
- A percentage of the starting account size
- etc
Do you account for commissions and slippage?
I do not account for commissions or slippage. I am interested in comparing the relative performance of strategies.
With relative performance comparisons, it is not necessary to add in slippage and commissions since these components are present to the same degree across all strategies. By removing these common "terms" from the relative performance comparisons, I am simplifying the comparisons. Please read the following blog post for more information:
Thoughts on Options Strategy Backtests
With relative performance comparisons, it is not necessary to add in slippage and commissions since these components are present to the same degree across all strategies. By removing these common "terms" from the relative performance comparisons, I am simplifying the comparisons. Please read the following blog post for more information:
Thoughts on Options Strategy Backtests
How are returns calculated?
The denominator in the returns calculation differs between defined risk and undefined risk trades.
For the defined risk trades, the denominator is the max defined risk. For a balanced iron condor, the defined risk is the same on the call side and the put side. For a delta neutral iron condor, the defined risk will be larger on the put side than on the call side. For delta neutral iron condors, the denominator is the larger defined risk; the put side defined risk.
For undefined risk trades (straddles, strangles, etc), the denominator is the initial portfolio margin (initial PM). PM values vary with delta, DTE, and market conditions. For example, an 8 delta 80 DTE strangle will have a lower PM than a 38 DTE 8 delta strangle.
Additionally, for a single backtest run (for example an 80 DTE, 8 delta, SPX iron condor running from Jan-2007 to Apr-2015) the defined risk will change from trade to trade in the run. For each run, the largest max risk value in that run is selected and used as the denominator for each trade in that run.
What program do you use for backtesting?For the defined risk trades, the denominator is the max defined risk. For a balanced iron condor, the defined risk is the same on the call side and the put side. For a delta neutral iron condor, the defined risk will be larger on the put side than on the call side. For delta neutral iron condors, the denominator is the larger defined risk; the put side defined risk.
For undefined risk trades (straddles, strangles, etc), the denominator is the initial portfolio margin (initial PM). PM values vary with delta, DTE, and market conditions. For example, an 8 delta 80 DTE strangle will have a lower PM than a 38 DTE 8 delta strangle.
Additionally, for a single backtest run (for example an 80 DTE, 8 delta, SPX iron condor running from Jan-2007 to Apr-2015) the defined risk will change from trade to trade in the run. For each run, the largest max risk value in that run is selected and used as the denominator for each trade in that run.
I don't use a commercial application for backtesting options strategies. I wrote custom software in Java that I use for backtesting. The software accesses historical options data stored in a MySQL database and can run 8 years of 80 DTE trades in about 90 seconds. This might sound fast to some, and slow to others, but it is adequate for my testing.
Do you use historical data?
I use historical options data from three sources:
1) IVolatility.com
2) LiveVol
3) HistoricalOptionData
For most of my testing I use end of day (EOD) options data from IVolatility. I use the IVolatlity product defined as "Individual Options Contracts Volatilities (RawIV)". I have backtested with 15 minute data as well, but did not see a significant difference in results. I found the relative performance of two strategies based on 15 minute data to be nearly the same as the relative performance of the same two strategies using EOD data.
1) IVolatility.com
2) LiveVol
3) HistoricalOptionData
For most of my testing I use end of day (EOD) options data from IVolatility. I use the IVolatlity product defined as "Individual Options Contracts Volatilities (RawIV)". I have backtested with 15 minute data as well, but did not see a significant difference in results. I found the relative performance of two strategies based on 15 minute data to be nearly the same as the relative performance of the same two strategies using EOD data.
Can you recommend some books on options?
There are many options books out there...probably too many. Here is a short list that I think most options traders will agree on.
Level - Beginner
Options Made Easy: Your Guide to Profitable Trading (3rd Edition) (2013)
A good introduction to options, that has been read by some of my family members.
Level - Intermediate
Options as a Strategic Investment (2012)
This is a classic that you might want to have on your bookshelf...get the hard cover version.
Option Trading: Pricing and Volatility Strategies and Techniques (2010)
Level - Advanced
Option Volatility & Pricing: Advanced Trading Strategies and Techniques (1994)
There is a 2014 edition, but the reviews on Amazon don't seem too good...buy the original. Another classic that is required reading if you are serious...get the hard cover version.
Volatility Trading (2013)
Level - Beginner
Options Made Easy: Your Guide to Profitable Trading (3rd Edition) (2013)
A good introduction to options, that has been read by some of my family members.
Level - Intermediate
Options as a Strategic Investment (2012)
This is a classic that you might want to have on your bookshelf...get the hard cover version.
Option Trading: Pricing and Volatility Strategies and Techniques (2010)
Level - Advanced
Option Volatility & Pricing: Advanced Trading Strategies and Techniques (1994)
There is a 2014 edition, but the reviews on Amazon don't seem too good...buy the original. Another classic that is required reading if you are serious...get the hard cover version.
Volatility Trading (2013)
