In this post we’ll take a look at the backtest results of opening one SPX short vertical put 7 DTE position each trading day from Jan 3 2007 through Sep 30 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.
The thesis is that if we limit order entry to only the days in which s1 is TRUE, we will be “swinging at only the best pitches.” On the days when s1 is FALSE, 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 = TRUE to see if the strategy outperforms daily entry in a statistically significant way
- limit order entry to only the days in which s1 = FALSE 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 33,000 SPX short vertical put 7 DTE trades.
Let’s dive in!
The s1 signal yielded a 86% improvement in capital efficiency over “market-agnostic” 7 DTE daily short vertical put strats. The s1 signal was able to:
- realize more total return
- with about half as many trades
- capturing up to 84% more premium per trade
- boosting sharpe ratio by up to 2.6x
The s1 = TRUE signals’s 10D-2.5D short vertical put 7 DTE strat outperformed buy/hold SPY with regard to:
- total return
- risk-adjusted return
- annualized volatility
- max drawdown
- max drawdown duration
The s1 = TRUE signal outperformed a comparable “market agnostic” daily short put strategy with regard to:
- total return (all strats)
- risk-adjusted return (all strats)
- annualized volatility (3 out of 5 strats)
- max drawdown (the 5D-1D strat)
- win rate (all strats)
- premium capture (all strats)
- profit spent on commission (all strats)
- Symbol: SPX
- Strategy: Short Put
- Days Till Expiration: 7 DTE +/- 4, closest to 7
- Start Date: 2007-01-03
- End Date: 2021-09-30
- Positions opened per trade: 1
- Entry Days: each trading day in which s1 signal = TRUE
- 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
- 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 arbitrarily set so that max margin utilization never exceeds 100%)
- Apply a 20% discount on displayed results. For example, if a strat depicts a CAGR of 10%, assume that it’ll yield 8% in practice. This is to account for hindsight bias being used when determining starting capital in the backtest.
- 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
Starting capital requirements of the s1 = TRUE strategies was roughly half of the daily-entry strategies.
s1 = TRUE signal yielded a higher average margin utilization vs daily entry. 50D-5D 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 = TRUE signal had higher rates of premium capture vs daily entry.
The higher the delta the lower the premium capture. 30D-16D was an exception.
s1 = TRUE signal outperformed daily entry with regard to win rate.
The higher the delta the lower the win rate.
s1 = TRUE signal outperformed daily entry with regard to average monthly return. 50D-5D was an exception.
The higher the delta the greater the average monthly return.
Also displayed is the best and worst monthly returns for each strategy.
s1 = TRUE signal underperformed daily entry with regard to max drawdown. 5D-1D was an exception.
The higher the delta the greater the max drawdown.
Max Drawdown Duration
Max drawdown duration performance was mixed between s1 = TRUE signal and daily entry.
The higher the delta the greater the max drawdown. 30D-16D was an exception.
Average Trade Duration
The average trade duration for all strategies was 7 days.
Compound Annual Growth Rate
s1 = TRUE signal outperformed daily entry with regard to compound annual growth rate.
The higher the delta the greater the CAGR.
s1 = TRUE signal outperformed daily entry with regard to annual volatility. 16D-5D and 30D-16D were exceptions.
The higher the delta the greater the annual volatility. 30D-16D was an exception.
s1 = TRUE signal outperformed daily entry with regard to sharpe ratio.
The higher the delta the lower the risk-adjusted return. 30D-16D was an exception.
The 5D-1D s1 = TRUE signal strategy had the greatest risk-adjusted return among the option strategies.
Profit Spent on Commission
9.98% – the average percent of profits spent on commission across profitable option strategies.
s1 = TRUE signal outperformed daily entry with regard to total P/L.
Higher delta strategies yielded greater total P/L than lower delta strategies. 30D-16D was an exception.
All option strategies were eventually profitable.
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/hold SPY, opening a 10D-2.5D short vertical put daily, opening a 10D-2.5D short vertical put only on days when s1 = TRUE, and opening a 10D-2.5D short vertical put only on days when s1 = FALSE.
Consistent with the methodology, since these positions are comprised of two option positions (short leg + long leg), commissions are $2.64.
At one or more points during the backtest, the strategy risked the entire account per the max margin use being near 100%.
The s1 signal = TRUE strat has 53% ( 1765 / 3332 ) of the number of occurrences vs daily entry.
Looking at strictly the strategy income/expense, 91% ( 186,121 / 204,531 ) of the profits were captured when s1 = TRUE vs daily entry. Meanwhile, when s1 = FALSE the strategy returned less than the interest earned on 3mo treasuries.
Capital efficiency is calculated as ( ( strat return / benchmark return ) / ( strat occurrences / benchmark occurrences ) -1 ) * 100.
When we plug in the numbers we get:
- ( ( 186,121 / 204,531 ) / ( 1765 / 3332 ) -1 ) * 100
- 72% increase in capital efficiency
Risk adjusted return when s1 = TRUE is 54% greater than daily entry.
Max drawdown when s1 = TRUE underperforms daily entry. The bulk of this was experiencing a poor sequence of returns shortly out of the gate in 2008 whereas daily entry experienced it’s max drawdown in March 2020.
Limiting order entry to days in which s1 signal = TRUE yields greater total return and lower annualized volatility vs both buy/hold and daily-entry while opening positions roughly 53% of the time.
Think about it for a moment. An investor trades roughly half as often and generates greater total return and lower volatility. There’s no need to swing at every pitch; open a position only when it’s worthwhile.
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:
Private, Custom Backtests
Visit the trade log store to download the data used in this and other backtests.
Trade S&P 500 options more efficiently using the s1 signal. Learn more.
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