In this post we’ll take a look at the backtest results of opening one SPX short call 7 DTE position each trading day from Jan 3 2007 through Aug 31 2021 and see if there are any discernible trends.
We will also explore the performance of the s1 signal. The s1 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 S&P 500 are most likely to be profitable at expiration. s1 is based on data from CBOE and S&P Global.
We know that s1 = TRUE has outperformed buy/hold SPY and daily-entry short put and short vertical put option strats. Will s1 = FALSE outperform for short call strats? Let’s find out!
The thesis is that if we limit order entry to only the days in which s1 is FALSE, we will be “swinging at only the best pitches.” On the days when s1 is TRUE, take no action. Existing positions will remain untouched and no new positions will be opened.
To test this thesis we will:
- limit order entry to only the days in which s1 = FALSE to see if the strategy outperforms daily entry in a statistically significant way
- limit order entry to only the days in which s1 = TRUE to see if the strategy underperforms daily entry in a statistically significant way
Performance of the s1 signal is explored in different contexts in other, non-paywalled s1 signal studies.
All this talk about signals is fine and dandy but a signal-based strategy in isolation isn’t helpful. Let’s compare it against the following benchmark and see how it performs:
- SPY buy/hold (total return) | 100% allocation, no leverage
There are 15 backtests in this study evaluating over 32,400 SPX short call 7 DTE leveraged trades.
Let’s dive in!
Short calls, as a systematic and continuous strategy (whether standalone or part of a multi-leg strategy such as straddles or iron condors), offer a limited value proposition.
3mo US treasuries outperformed all option strategies.
The s1 signal buffered total P/L losses by 87% vs “market-agnostic” 7 DTE, 30-delta, daily short call strats. The s1 signal was able to:
- realize up to 87% fewer total return losses
- by sitting out of the market 53% of the time
Neither the s1 signal – whether true or false – nor daily entry, outperformed buy/hold SPY with regard to:
- total return
- risk-adjusted return
- annualized volatility
- max drawdown
- max drawdown duration
The s1 = FALSE signal outperformed a comparable “market agnostic” daily short call strategy with regard to:
- total return (3 out of 5 strats)
- risk-adjusted return (all strats)
- annualized volatility (all strats)
- max drawdown (all strats)
- max drawdown duration (1 out of the 2 strats that recovered)
- win rate (all strats)
- premium capture (all strats)
- profit spent on commission (all strats that had a profitable benchmark)
- Symbol: SPX
- Strategy: Short Call
- Days Till Expiration: 7 DTE +/- 4, closest to 7
- Start Date: 2007-01-03
- End Date: 2021-08-31
- Positions opened per trade: 1
- Entry Days: each trading day in which s1 signal = TRUE; FALSE; and all trading days
- Entry Signal: s1 signal
- Timing 3:46pm ET
- Strike Selection
- 2.5 delta +/- 2.4, closest to 2.5
- 5 delta +/- 4.5, closest to 5
- 10 delta +/- 5, closest to 10
- 16 delta +/- 6, closest to 16
- 30 delta +/- 8, closest to 30
- Trade Entry
- 2.5D short call
- 5D short call
- 10D short call
- 16D short call
- 30D short call
- 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
- 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
- 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
Starting capital requirements of the s1 = FALSE strategies were lower than the daily-entry strategies. 2.5D and 10D were exceptions.
s1 = FALSE signal yielded a lower average margin utilization vs daily entry and s1 = TRUE. 30D was an exception.
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.
s1 = FALSE signal had higher rates of premium capture vs daily entry and s1 = TRUE
The higher the delta the lower the premium capture.
s1 = FALSE signal outperformed daily entry and s1 = TRUE with regard to win rate.
The higher the delta the lower the win rate.
s1 = FALSE signal outperformed daily entry and s1 = TRUE with regard to average monthly return. 2.5D and 5D were exceptions.
The lower the delta the greater the average monthly return.
Also displayed is the best and worst monthly returns for each strategy.
s1 = FALSE signal outperformed daily entry and s1 = TRUE with regard to max drawdown.
The higher the delta the greater the max drawdown.
Max Drawdown Duration
s1 = FALSE signal underperformed daily entry and s1 = TRUE with regard to max drawdown duration. 2.5D was an exceptions.
Max drawdown duration performance trended unfavorably as delta increased.
Average Trade Duration
The average trade duration for all strategies was 7 days.
Compound Annual Growth Rate
s1 = FALSE signal outperformed daily entry and s1 = TRUE with regard to compound annual growth rate. 2.5D and 5D were exceptions.
The higher the delta the lower the CAGR.
s1 = FALSE signal outperformed daily entry and s1 = TRUE with regard to annual volatility. 10D was an exception.
The higher the delta the greater the annual volatility.
s1 = FALSE signal outperformed daily entry and s1= TRUE with regard to sharpe ratio.
The higher the delta the lower the shark ratio.
The 2.5D s1 = FALSE signal strategy tied with daily entry for the greatest risk-adjusted return among the option strategies.
Profit Spent on Commission
5.42% – the average percent of profits spent on commission across profitable option strategies.
s1 = FALSE signal outperformed daily entry and s1 = TRUE with regard to total P/L. 2.5D and 5D, and 2.5D were exceptions, respectively.
Lower delta strategies yielded greater total P/L than higher delta strategies.
Two thirds of option strategies were eventually profitable.
Short calls, as a systematic and continuous strategy (or part of a multi-leg strategy such as straddles or iron condors), offer a limited value proposition.
Let’s take a look under the hood of the most profitable delta target to see what’s happening. We’ll look at:
- buy/hold SPY
- opening a 2.5D short call daily
- opening a 2.5D short call when s1 = True
- opening a 2.5D short call when s1 = False
Trading exclusively when the s1 signal = FALSE required more starting capital in order to successfully execute the strategy.
The s1 signal = FALSE strat had 47% ( 1515 / 3230 ) of the number of occurrences vs daily entry.
As per the methodology section, margin cash is held in 3mo US treasuries.
The daily entry strat generated $61,695 in income after accounting for slippage, minus $4,371 in commissions, for a total strat income of $57,324.
3mo US treasuries outperformed the option strat, yielding $57,551.
In fact, 3mo US treasuries outperformed every single strategy.
The 3mo US treasury rate is 0.17% (as of 2022-01-21) and a retail trader can get a 1.1% APY on cash holdings up to 500k courtesy of AMEX Business Checking accounts (individuals can sign up as sole proprietors). This is a 6.5x improvement.
For the sake of argument, let’s say individuals can conservatively and consistently access interest rates 2x the 3mo treasury rate. A quick gander at Dr Of Credit’s site lists over 40 online banks that offer rates in this range or better.
If we were to take the capital allocated to short calls and instead allocate it to a savings account, we would have made roughly what the most profitable option strat generated, without any risk or time commitment.
“…but I can trade short calls along side an existing short put strategy without any additional margin requirement.” This may be true, but I value my time (and the qualitative risk of an “unlimited loss” position) at more than that of a 3mo US treasury.
Sharpe ratios are quite high at 2.05. However, more than half the total return is attributed to risk-free interest income on the cash collateral. This skews strategy sharpe values higher. Take this value with a grain of salt.
Max drawdown when s1 = FALSE is shallower than daily entry or s1 = TRUE. Max drawdown duration is also materially shortened with s1 = FALSE.
The occurrences of s1 signal values is not evenly distributed throughout time. Here’s a breakdown of participation rate by year:
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