SPX Short Put 7 DTE 2022 Options Backtest
Happy new year and welcome to 2023!
2022 was a notable year for volatility traders. There was no shortage of market participants feeling that it was a challenging time for short option trades. Is there any merit to those feelings? Let’s run some backtests targeting the 2022 trading year and find out.
In this post we’ll take a look at the backtest results of opening one SPX short put 7 DTE position each trading day from Jan 3 2022 through Dec 31 2022 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, published methodologies from S&P Global, and proprietary methodologies by spintwig.
Theses:
- if we open and hold-till-expiration a short put position on the S&P 500 on the days in which s1 is TRUE, and take no action on the days in which s1 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 S&P 500 on the days in which s1 is FALSE, and take no action on the days in which s1 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 s1 = TRUE signal, when levered, can outperform a 100% allocation (eg: no leverage) to buy-and-hold SPY 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 s1 = TRUE to see if the strategy outperforms daily entry
- limit order entry to only the days in which s1 = FALSE to see if the strategy underperforms daily entry
- compare performance of s1 = TRUE against a 100% SPY buy-and-hold portfolio with dividends reinvested (total return) to see if the strategy outperforms buy-and-hold
Performance of the s1 signal is explored in different contexts in other, non-paywalled s1 signal studies.
There are 15 backtests in this study evaluating over 2,400 SPX short put 7 DTE 2022 leveraged trades.
Let’s dive in!
Contents
Summary
The s1 signal yielded up to a 1200% / 13.0x improvement in capital efficiency over “market-agnostic” daily short put strats.
The s1 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 (5 out of 5 strats)
- max drawdown (5 out of 5 strats)
- max drawdown duration (5 out of 5 strats)
The s1 signal outperformed a “market agnostic” daily short put strategy with regard to:
- total return (5 out of 5 strats)
- risk-adjusted return (5 out of 5 strats)
- annualized volatility (5 out of strats)
- max drawdown (5 out 5 strats)
- max drawdown duration (5 out of 3 strats)
- win rate (5 out of 5 strats)
- premium capture (5 out of 5 strats)
- profit spent on commission (5 out of 5 strats)
Regarding the daily-entry strategies, when ignoring interest income on collateral and commission expense, only the 5-delta strategy was profitable.
The interest earned on margin collateral outperformed all daily-entry strategies.
The occurrences of losing trades when s1 = TRUE were fewer than what chance alone would suggest. Meanwhile, the occurrences of losing trades when s1 = FALSE were more frequent than what chance alone would suggest.
Losses were, on average, smaller per occurrence when s1 = TRUE vs when s1 = FALSE.
Limiting order entry to days in which the s1 signal = TRUE yielded 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.
The daily s1 signal email alert is available as a 7-day free trial. Start making data-driven trades today.
Methodology
Strategy Details
- Symbol: SPX
- Strategy: Short Put
- Days Till Expiration: 7 DTE +/- 4, closest to 7
- Start Date: 2022-01-03
- End Date: 2022-12-31
- Positions opened per trade: 1
- Entry Days:
- each trading day
- each trading day in which the s1 signal = TRUE
- each trading day in which the s1 signal = FALSE
- Entry Signal: s1 signal
- Timing 3:46pm ET
- Strike Selection
- 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
- 50 delta +/- 8, closest to 50
- Trade Entry
- 5D short put
- 10D short put
- 16D short put
- 30D short put
- 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 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, 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
Margin Utilization
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 by identifying the minimum amount of starting capital necessary to successfully complete (eg: avoid margin calls) the backtest.
Premium Capture
Win Rate
Monthly Returns
Max Drawdown
Max Drawdown Duration
Average Trade Duration
Average Trade Delta
Compound Annual Growth Rate
Annual Volatility
Sharpe Ratio
Profit Spent on Commission
Capital Efficiency
To calculate capital efficiency, the impacts of interest earned on margin collateral and commissions charged by the broker are excluded. Strictly the PnL of the options themselves are evaluated. The formula is:
( ( strat return / benchmark return ) / ( strat occurrences / benchmark occurrences ) -1 ) * 100
If we look at the 5D strat, we get:
- strat return = strat income / strat starting capital = ( 16,657 / 393,000 ) = 0.04238
- benchmark return = benchmark income / strat starting capital = ( 9,774 / 502,000 ) = 0.01947
When we plug in the numbers to the overall formula we get:
- ( ( 0.04238 / 0.01947 ) / ( 41 / 245 ) -1 ) * 100 = 1,200.70
s1 = True yielded a 1201% increase, or 13.0x improvement, in capital efficiency vs daily entry for the 5D strat.
Total PnL
Overall
Discussion
The results of opening positions only on the days in which the s1 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-and-hold SPY with dividends reinvested (eg: SPY total return), opening a 10-delta short put daily, opening a 10-delta short put only on days when s1 = TRUE, and opening a 10-delta short put only on days when s1 = FALSE.
Starting Capital and Leverage
Trading exclusively when the s1 signal = TRUE required less starting capital to successfully execute the strategy vs daily entry or when s1 = FALSE.
Win Rate Stats
The s1 signal = TRUE strat has roughly 17% ( 41 / 245 ) of the number of occurrences vs daily entry.
Two of the 41 trades when s1 = TRUE were losers. Meanwhile, s1 = False experienced 24, or 12x, more losing trades.
As we’ll see next, despite s1 = FALSE experiencing 4.6x ( 180 / 39 ) more winning trades than s1 = TRUE, the losses overwhelmed the gains.
Profit and Loss Stats
The s1 signal = TRUE strat yielded $44,994 more income vs daily entry while placing 83% fewer trades.
Interest rates experienced a material and historically-rapid increase in 2022.
Performance Stats
Risk Management and Drawdowns
Distribution of Wins and Losses Across Signals
One of the typical characteristics of a high-probability options trade is that the return profile is non-linear. Said another way, losses are often multiples – even orders of magnitude – larger than wins. The single best way to improve performance of such a strategy is not to increase occurrences, but to avoid the disproportionally-larger losing trades. Easier said than done.
From the perspective of [un]luck, the daily-entry strategy experienced 245 trades in 2022. 26 of the 245 trades were losers. If we reduce the number of occurrences by 83% (eg: trade only when s1 = TRUE), then we would expect to have 83% fewer losing trades ( 26 * ( 41 / 245 ) -1 ) or 3.35. s1 = TRUE experienced 2 loses, or 40% fewer loss occurrences than chance alone would suggest ( ( 2 / 3.35 ) -1 ). If we instead reduce the number of occurrences by 17% (eg: trade only when s1 = FALSE), then we would expect to have 17% fewer losing trades ( 26 * ( 204 / 245 ) -1 ) or 20.64. s1 = FALSE experienced 24 losses, or 16% more loss occurrences than chance alone would suggest ( ( 24 / 20.64 ) -1 ).
Of course, there aren’t enough occurrences for any of this to be significant. Let’s consider 16 years of s1 10-delta trades from Jan 5 2007 through Dec 31 2022 and see if the concept holds.
Using the same SPX short put 7DTE 10-delta dataset, we review the win rate statistics:
The daily-entry strategy experienced 3,698 trades. 182 of the 3,698 trades were losers. If we reduce the number of occurrences by 49.6% (eg: trade only when s1 = TRUE), then we would expect to have 49.6% fewer losing trades ( 182 * ( 1861 / 3698 ) -1 ) or 90.59. s1 = TRUE experienced 74 loses, or 18.3% fewer loss occurrences than chance alone would suggest ( ( 74 / 90.59 ) -1 ). If we instead reduce the number of occurrences by 50.4% (eg: trade only when s1 = FALSE), then we would expect to have 50.4% fewer losing trades ( 182 * ( 1837 / 3698 ) -1 ) or 89.40. s1 = FALSE experienced 108 losses, or 20.8% more loss occurrences than chance alone would suggest ( ( 108 / 89.40 ) -1 ).
Let’s also consider the magnitude of the losses.
The 74 losses that occurred when s1 = TRUE averaged -$2,350.44, with the median being -$1,427 and with the greatest loss being -$17,689.50.
The 108 losses that occurred when s1 = FALSE averaged -$4,370.70, with the median being -$1,904 and with the greatest loss being -$31,170.50.
Losses averaged 46% smaller per occurrence when s1 = TRUE vs s1 = FALSE.
Source of Outperformance
Outperformance of the s1 signal is predicated on its ability to evaluate the market and sit out when data suggests conditions are unfavorable for short put trades. On the days in which s1 = TRUE yet the position turns out to be a loser, the magnitude of the loss was attenuated. It outperforms by losing less often and by having smaller losses when it does lose.
The one-two punch of improved win rate and muted losses isn’t limited to just the 10-delta strats or 7DTE durations. If we review the win rate table from this and other s1 studies and the associated trade logs, we’ll see that the win rate when s1 = TRUE is greater and the average loss is smaller vs daily entry. We’ll also see that the win rate when s1 = FALSE is lower and the average loss is greater vs daily entry. This is true for all S&P 500 short-put out-of-the-money delta targets, and duration targets from 7 DTE to 180 DTE.
Experiencing fewer losing trades is good. Experiencing fewer losing trades when each loss is multiples or magnitudes greater than each win is great. Experiencing losses that are less severe is also great. Give the s1 signal a try for free. By avoiding just one losing trade a year (or by experiencing just one muted losing trade), it’ll pay for itself. The rest is gravy.
Distribution of s1 signals
The s1 = 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:
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Additional Resources
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Trade Logs
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January 29, 2023 @ 3:36 pm
Pretty impressive results! I’m curious, have you ever gotten someone else to independently audit your results?
January 29, 2023 @ 7:23 pm
Informally, yes. A few examples:
Dr. Karsten, CFA (BigERN) has allowed several guest posts. The raw data was provided with the content so he could generate the return series. No concerns were raised.
A client commissioned, and authorized publication of, a study that was based on prior work that quant researcher Corey Hoffstein had published. Corey’s methodology in that study uses theoretical pricing, while the methodology here at spintwig is purely empirical. The results were comparable. This particular example could be considered a “reverse audit”; backtest results were similar to an independent and unaffiliated researcher.
Less formally, when spintwig was just getting started, posts were made to a few sub Reddits (r/options, r/thetagang, etc.) which helped facilitate conversation and critique of the results and methodology. Each reddit post essentially became a micro dissertation. Most of the Reddit posts have since been taken down but a few remain. General improvements and clarifications were made throughout 2019 and at this point everything has been largely consistent. The methodology page outlines how calculations are derived, why backtest start dates are what they are, and related details. In 2023 a public version history has been introduced to provide visibility for any changes.
Over the years, readers have downloaded trade logs. No concerns have been raised to date.
Hope this helps!
January 30, 2023 @ 1:30 am
Thanks! I appreciate the detailed response.
February 22, 2023 @ 8:36 am
Wow fantastic! Selling options on S1=true is even more compelling when underlying treasuries give 5%
February 23, 2023 @ 8:05 pm
At a 1x leverage implementation (eg: 20% margin utilization at Reg-T margining), the collateral that’s held in treasuries compensates for the reduced premium received due to Rho’s effect on option pricing. A cash-secured implementation should generally be agnostic to the risk-free rate.
At anything in excess of 1x leverage, there is an implied interest expense.
Margin might be “free” to use in the sense that a trader doesn’t receive a bill from the broker to use it, but it’s still a form of leverage / borrowed funds and thus has an interest expense baked in. This “baked in” cost is in the form of receiving less premium.
The average margin utilization on the s1 = true configuration was less than 1x, so that was a small tailwind. Meanwhile, s1 = false and daily entry averaged around 3-4x leverage. Implied interest was less of a drag early in the year but became a greater influence as the risk-free rate started to get in the 300-400bps range.