October 28, 2022

RUT Short Put 7-365 DTE (LEAPS) s4 signal Options Backtest

spintwig.com Options 180 DTE, 365 DTE, 45 DTE, 7 DTE, 90 DTE, backtest, Hold Till Expiration, IWM/RUT, Leveraged, s4 signal, Short Put 0

4 min read

In this post we’ll take a look at the backtest results of opening one RUT short put 7 DTE through 365 DTE (LEAPS) position each trading day from Jan 3 2007 through Sep 27 2022 and see if there are any discernible trends.

We will also explore the performance of the s4 signal. The s4 signal is a boolean (TRUE / FALSE) daily indicator that attempts to identify the days in which short put and short vertical put positions on the Russell 2000 are most likely to be profitable at expiration. s4 is based on data from Cboe and S&P Global.

Methodology notes:

Weekly (7 DTE) options were introduced on:
- IWM circa May 2010
- RUT circa Mar 2011
The 7 DTE strat will use IWM as the underlying as there is more historical data available
- The start date will be Jun 3 2010
Greater historical data of IWM was prioritized over greater commission efficiency of RUT options
- Methodology on commission addresses differences in trading fees
Tables will have two “buy and hold” values for the IWM total-return benchmark: one that aligns with the start/end dates of the 7 DTE strat and one that aligns with all the other strats

Theses:

if we open and hold-till-expiration a short put position on the Russell 2000 on the days in which s4 is TRUE, and take no action on the days in which s4 is FALSE, we will outperform a strategy that opens and holds-till-expiration every trading day with regard to total return, risk-adjusted return, and max drawdown
if we open and hold-till-expiration a short put position on the Russell 2000 on the days in which s4 is FALSE, and take no action on the days in which s4 is TRUE, we will underperform a strategy that opens and holds-till-expiration every trading day with regard to total return, risk-adjusted return, and max drawdown
the s4 signal, when levered, can outperform a 100% allocation (eg: no leverage) to buy-and-hold IWM total return portfolio with regard to total return, risk-adjusted return, and max drawdown

To test these theses we will:

limit order entry to only the days in which s4 = TRUE to see if the strategy outperforms daily entry in a statistically significant way
limit order entry to only the days in which s4 = FALSE to see if the strategy underperforms daily entry in a statistically significant way
compare performance of s4 = TRUE and s4 = FALSE strats against an IWM buy/hold portfolio at 100% allocation, no leverage, with dividends reinvested (total return)

Performance of the s4 signal is explored in different contexts in other, non-paywalled s4 signal studies.

There are 15 backtests in this study evaluating over 36,400 RUT short put 7-365 DTE (LEAPS) s4 leveraged trades.

Let’s dive in!

Summary

The s4 signal yielded up to a 147% / 2.5x improvement in capital efficiency over “market-agnostic” daily short put strats.

The s4 signal outperformed a “buy and hold” strategy with regard to:

total return (5 out of 5 strats)
risk-adjusted return (5 out of 5 strats)
annualized volatility (4 out of 5 strats)
max drawdown (3 out of 5 strats)
max drawdown duration (5 out of 5 strats)

The s4 signal outperformed a “market agnostic” daily short put strategy with regard to:

total return (3 out of 5 strats)
risk-adjusted return (4 out of 5 strats)
annualized volatility (4 out of strats)
max drawdown (4 out 5 strats)
max drawdown duration (5 out of 5 strats)
win rate (5 out of 5 strats)
premium capture (5 out of 5 strats)
profit spent on commission (5 out of 5 strats)

The daily s4 signal email alert is available as a 7-day free trial. Start making data-driven trades today.

Methodology

Strategy Details

Symbol: RUT
Strategy: Short Put
Days Till Expiration:
- 7 DTE +/- 4, closest to 7
- 45 DTE +/- 17, closest to 45
- 90 DTE +/- 30, closest to 90
- 180 DTE +/- 45, closest to 180
- 365 DTE +/- 180, closest to 365
Start Date: 2007-01-03
End Date: 2022-09-27
Positions opened per trade: 1
Entry Days: each trading day in which s4 signal = TRUE
Entry Signal: s4 signal
Timing 3:46pm ET
Strike Selection
- 50 delta +/- 8, closest to 50
Trade Entry
- 50D short put
Trade Exit
- 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 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
Margin calls never occur (starting capital is set using hindsight bias so that max margin utilization never exceeds 100%)
Apply a 20% discount to displayed results. For example, if a strat depicts a CAGR of 10%, assume that it’ll yield 8% in practice.

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 PnL 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, RUT) 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
Positions that have an exit date beyond the backtest end date are excluded
For comprehensive details, visit the methodology page

Results

Starting Capital

Starting capital requirements of the s4 = TRUE strategies were lower than the daily-entry strategies. 7 DTE was an exception.

Margin Utilization

RUT Short Put 50D s4 max margin utilization table

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

Win Rate

Monthly Returns

RUT Short Put 7-365 (LEAPS) DTE s4 average monthly pnl

RUT Short Put 50D s4 average monthly pnl table

RUT Short Put 50D s4 monthly returns table

Max Drawdown

Max Drawdown Duration

Average Trade Duration

The average trade duration for all strategies was consistent across strategies.

Compound Annual Growth Rate

Annual Volatility

Sharpe Ratio

Profit Spent on Commission

Capital Efficiency

Total PnL

Overall

Discussion

The results of opening positions only on the days in which the s4 signal = TRUE is compelling. Let’s take a look under the hood and see what’s happening in a bit more detail. In the comparison we’ll look at buy/hold IWM, opening a 45 DTE 50-delta short put daily, opening a 45 DTE 50-delta short put only on days when s4 = TRUE, and opening a 45 DTE 50-delta short put only on days when s4 = FALSE.

Starting Capital and Leverage

Trading exclusively when the s4 = TRUE required less starting capital to successfully execute the strategy vs when s4 = FALSE or daily entry.

Win Rate Stats

The s4 = TRUE strat has just under 57% ( 2220 / 3899 ) of the number of occurrences vs daily entry.

Profit and Loss Stats

The s4 signal = TRUE strat yielded over 7% greater income vs daily entry [while placing roughly half as many trades as daily entry].

The s4 signal = FALSE strat managed to have a negative total PnL. Holding cash and not trading would have been more profitable.

Performance Stats

Risk adjusted return when s4 = TRUE is 209% greater (2.1x) than daily entry.

Risk Management

Max drawdown when s4 = TRUE is 52% shallower vs daily entry. s4 = TRUE also recovers from the max drawdown much faster.

Limiting order entry to days in which the s4 signal = TRUE yields a greater total return vs a daily-entry strategy while materially lowering max drawdown, annualized volatility, commission drag and consequently boosting premium capture and risk-adjusted return.

Think about it for a moment. An investor traded roughly half as often and generated a greater total return. There’s no need to swing at every pitch; open a position only when it’s worthwhile and avoid the days that were more likely to experience a drawdown event.

Distribution of s4 signals

The s4 = TRUE signal, while suggesting order entry on roughly half the trading days since 2007, is not evenly distributed throughout time. Here’s a breakdown of participation rate by year: