IWM Short Put 7 DTE Leveraged Options Backtest

7 min read

In this post we’ll take a look at the backtest results of opening one IWM short put 7 DTE leveraged position each trading day from Jan 3 2007 through Jun 30 2020 and see if there are any discernible trends. We’ll also explore the profitable strategies to see if any outperform buy-and-hold IWM.

There are 10 backtests in this study evaluating over 28,300 IWM short put 7 DTE leveraged trades.

Let’s dive in!

Summary

Systematically opening IWM short put 7 DTE leveraged positions was profitable no matter which strategy was selected.

All hold-till-expiration strategies, as well as 30D and 50D early-management strategies, outperformed buy-and-hold IWM with regard to total return.

Methodology

Strategy Details

• Symbol: IWM
• Strategy: Short Put
• Days Till Expiration: 7 +/- 4, closest to 7
• Start Date: 2007-01-10
• End Date: 2020-06-30
• Positions opened per trade: 1
• Entry Days: daily
• Entry Signal: N/A
• Timing: 3:46pm ET
• Strike Selection
  • 5 delta +/- 4.5 delta, closest to 5
  • 10 delta +/- 5 delta, closest to 10
  • 16 delta +/- 6 delta, closest to 16
  • 30 delta +/- 8 delta, closest to 30
  • 50 delta +/- 8 delta, closest to 50
• Trade Entry
  • 5D short put
  • 10D short put
  • 16D short put
  • 30D short put
  • 50D short put
• Trade Exit
  • 50% max profit or expiration, whichever occurs first
  • Hold till expiration
• Max Margin Utilization Target (short option strats only): 100% | 5x leverage
• Max Drawdown Target: 99% | account value shall not go negative

Assumptions

• Margin requirements are always satisfied
• Margin calls never occur
• Margin requirement for short CALL and PUT positions is 20% of notional
• Margin requirement for short STRADDLE and STRANGLE positions is 20% of the larger strike
• Margin requirement for short VERTICAL SPREAD positions is the difference between the strikes
• Margin requirement for short CALENDAR SPREAD positions is 20% of the short option (short option expires after the long option)
• Margin requirement for long CALENDAR SPREAD positions is the net cost of the spread (short option expires before the long option)
• Early assignment never occurs
• There is ample liquidity at all times

Mechanics

• Prices are in USD
• Prices are nominal (not adjusted for inflation)
• All statistics are pre-tax, where applicable
• Margin collateral is invested in 3mo US treasuries and earns interest daily
• Assignment P/L is calculated by closing the ITM position at 3:46pm ET the day of position exit if managed early or 4:00pm if held till expiration
• Commission to open, close early, or expire ITM is 1.00 USD per non-index underlying (eg: SPY, AAPL, etc.) contract
• Commission to open, close early, or expire ITM is 1.32 USD per index underlying (eg: SPX) contract
• Commission to expire worthless is 0.00 USD per contract (non-index and index)
• Commission to open or close non-option positions, if applicable, is 0.00 USD
• Slippage is calculated according to the slippage table
• Starting capital for short option backtests is adjusted in $1000 increments such that max margin utilization is between 80-100%, closest to 100%, of max margin utilization target
• Starting capital for long option backtests is adjusted in $1000 increments such that max drawdown is between 80-100%, closest to 100%, of max drawdown target
• For comprehensive details, visit the methodology page

Results

Starting Capital

Early management allows a smaller starting portfolio value since the maxim number of concurrent positions is capped. Less capital is “turned over” faster vs holding till expiration.

Margin Utilization

Early management yielded a lower average margin utilization vs holding till expiration.

Hindsight bias was used to maximize Reg-T margin utilization for each strategy. This allows a “best case” scenario for the option strategy to outperform the benchmark.

Also displayed is the date in which each strategy experienced maximum margin utilization.

Premium Capture

Early management had lower rates of premium capture vs holding till expiration.

The higher the delta the lower the premium capture.

Win Rate

Managing trades early outperformed holding till expiration with regard to win rate.

The higher the delta the lower the win rate.

Monthly Returns

Max Drawdown

Max Drawdown Duration

Average Trade Duration

Managing trades at 50% max profit yielded trade durations roughly half the duration of hold-till-expiration.

Compound Annual Growth Rate

Annual Volatility

Sharpe Ratio

Profit Spent on Commission

23.29% – the blended average percent of profits spent on commission across all option strategies.

Total P/L

Early management underperformed holding till expiration with regard to total P/L.

Higher delta strategies yielded greater total P/L than lower delta strategies.

Overall

All option strategies were profitable.

All hold-till-expiration strategies, as well as 30D and 50D early-management strategies, outperformed buy-and-hold IWM with regard to both risk-adjusted and total return.

Discussion

At face value it appears there may be some opportunities with IWM short put 7 DTE leveraged positions to challenge buy-and-hold IWM. Let me debunk those initial thoughts.

Timing Luck

Timing luck, P/L variance associated with sheer luck, is afoot with this study.

For example, a 45 DTE short put can have the following outcomes:

Similarly, by participating in or abstaining from the market through lucky or unlucky events can also yield material variances in backtest performance.

A popular backtest approach is to open a position then open a new position after the current position is closed – this is known as “rolling.” One can get very lucky or unlucky based on when such a strategy is started. In fact, with a 45 DTE strategy it’s possible to have ~32 different return profiles – one for each trading day in the roll cycle. If you’re pushing a narrative, simply select the return profile that best matches your message and no one’s the wiser.

To mitigate this potential “lying with data” opportunity, two approaches exist: open a position daily which essentially eliminates timing luck or publish a portfolio variance statistic that provides a +/- standard deviation against reported performance. I do the former.

Great, so what does any of this have to do with the backtest results? Glad you asked. Let’s take a look at the number of occurrences by year.

Time in the Market

Looking at the 16D strategy, there were only 100 trades in 2007; monthlies was the only option product that existed at this time for IWM. Consequently, the backtest avoided most of the 2007 global financial crisis. By “luckily” not participating in the market during this time the strategy had a leg up on the buy-and-hold approach.

The options strategy experienced more occurrences as new options products came to market. On June 4 2010 CBOE released Friday-expiring weekly options on IWM.

Due to the lack of product availability during the first few years of the study and thus the inability to execute the option strategy (open a new 7 DTE position daily) for more than 5 trading days per month during and after the GFC, we are forced to accept a material amount of timing luck in the performance results; take these numbers with a grain of salt.

Potential Workaround

What if we start the study at a time when timing luck isn’t a material factor – i.e. after June 4 2010?

We end up with the following P/L curves:

At a glance only the 50D strategies outperform buy/hold on a total return perspective. This however doesn’t take in effect changes in starting capital that occur by shifting the start date.

It could be argued that this is an unfair backtest since it both skips the largest IWM drawdown in recent history and compares a limited-upside strategy (short puts) against the longest bull market in history. This also doesn’t take into effect the differences in margin utilization associated with skipping the GFC.

However, working with the data that’s available should be ample to paint a “good enough” picture to gauge strategy performance and determine whether there are specific strategies worth diving into a little deeper. After all, broad backtests such as what this study contains is an activity of exploration. If something piques one’s interest then a closer look with more refined assumptions can be performed.

Additional Resources

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