SPY Long Put 45 DTE Options Backtest: Optimal Hedging

6 min read

In this post we’ll take a look at the backtest results of opening SPY long put 45 DTE positions from January 3 2007 through November 8 2019 and see if there are any discernible trends. We’ll also explore various bond and cash asset allocations to see which approach offers the best hedge.

There are 20 backtests in this study evaluating over 64,500 SPY long put 45 DTE trades.

Let’s dive in!

Summary

Systematically opening long put 45 DTE positions on SPY cost money no matter which strategy or management target was chosen.

Options provide a more effective hedge when markets drop. However, timing is everything.

If implementing a “continuous hedge,” an asset allocation of bonds or cash outperforms long put options with regard to total return.

Retail traders have a free lunch available in the form of high-yield online savings accounts, potentially tipping the scale in favor of cash over bonds.

Methodology

Strategy Details

• Symbol: SPY
• Strategy: Long Put
• Days Till Expiration: 45 DTE +/- 17, closest to 45
• Start Date: 2007-01-03
• End Date: 2019-11-08
• 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 long put
  • 10D long put
  • 16D long put
  • 30D long put
  • 50D long put
• Trade Exit
  • 10% max profit or expiration, whichever occurs first
  • 25% max profit or expiration, whichever occurs first
  • 50% max profit or expiration, whichever occurs first
  • Hold till expiration
• Max Margin Utilization Target (short option strats only): N/A
• 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
• Early assignment never occurs

Mechanics

• Prices are in USD
• Prices are nominal (not adjusted for inflation)
• Margin collateral is held as cash and earns no interest
• Assignment P/L is calculated by closing the ITM position at 3:46pm ET the day of expiration / position exit
• Commission to open, close early, or expire ITM is 1.00 USD per contract
• Commission to expire worthless is 0.00 USD per contract
• Commission to open or close non-option positions, if applicable, is 0.00 USD
• Slippage is calculated according to the slippage table
• For comprehensive details, visit the methodology page

Results

Win Rate

Managing trades early improved the win rate.

The higher the delta the higher the win rate.

Annual Volatility

Worst Monthly Return

Average P/L Per Day

Average Trade Duration

Managing trades at 10% profit on premium paid caused the strategy to cycle through capital roughly 2x faster than holding till expiration.

Compound Annual Growth Rate

Sharpe Ratio

Profit Spent on Commission

The buy and hold strategies were rebalanced monthly in order to keep the asset allocation as close to the target as possible.

Since larger hedges yield a lower total return due the cost of the hedge, the commission represents a greater percentage of remaining profits.

Total P/L

A portfolio of various buy-and-hold asset allocations outperforms a comparably hedged portfolio using options.

Managing option hedges early yielded greater total returns than holding long puts till expiration.

Overall

All long put 45 DTE strategies were profitable when married with a long SPY position.

Discussion

The idea of this study is to quantify the performance of different portfolio hedging tools. In particular, cash (defined as 3mo t-bills), bonds (defined as AGG ETF) and options (defined as SPY long put 45 DTE strategies) are the instruments evaluated.

As the size of the hedge relative to the size of the portfolio increases, a basic asset allocation increasingly outperforms on both a risk adjusted and total return basis relative to an option strategy. Said another way, a 5% hedge has roughly the same “cost” (opportunity or explicit) no matter the tool selected whereas a 50% hedge “costs” much more when options are used as the instrument of implementation.

Recall that options offered the softest worst month among bonds and cash. That is, they provided the most effective hedge during a market drop. This only paints half the picture though.

Let’s take a look at the max draw down of each strategy, measured from the most recent end-of-month high (Oct 2007) to the lowest end-of month before the next high (Feb 2009):

“But what about a collar option strategy?”, you might ask. It seems intuitive to sell an out-of-the money call to help pay for the long put hedge at the risk of capping potential gains.

The SPY short call 45 DTE strategy explores the short call half of the collar strategy. It is systematically unprofitable across all scenarios except the 5D hold-till-expiration strategy where a 0.2% CAGR is realized over 12 years. Not worth the time or risk.

Not depicted in the study is the free lunch retail traders have over institutional market participants: interest rate arbitrage. Consider online high-yield savings accounts. They are FDIC insured to not lose value (up to 250k per account) so they experience no interest rate risk or reinvestment risk and tend to have interest rates comparable the 10-year treasury note. Sometimes they even beat the 30-year treasury bond during seasons of flat yield or inverted yield curves. Parking money in such accounts can potentially outperform bonds – no price volatility and subsequently lower portfolio volatility, softer worst months, and CAGR may potentially be higher. Win win win.

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