In this post we’ll take a look at the backtest results of opening one SPY short call 45 DTE cash-secured position each trading day from Jan 3 2007 through July 10 2019 and see if there are any discernible trends. We’ll also explore the profitable strategies to see if any outperform buy-and-hold SPY
There are 20 backtests in this study evaluating over 62,300 SPY short call 45 DTE cash-secured trades.
Let’s dive in!
How to Trade Options Efficiently Mini-Series
AAPL – Apple Inc.
- AAPL Short Put 0 DTE Cash-Secured
- AAPL Short Put 45 DTE Cash-Secured
- AAPL Short Put 45 DTE Leveraged
- AAPL Long Day Trade
AMZN – Amazon.com, Inc.
BTC – Bitcoin
C – Citigroup Inc.
DIA – SPDR Dow Jones Industrial Average
- DIA Short Put 7 DTE Cash-Secured (coming soon)
- DIA Short Put 7 DTE Leveraged (coming soon)
- DIA Short Put 45 DTE Cash-Secured (coming soon)
- DIA Short Put 45 DTE Leveraged (coming soon)
DIS – Walt Disney Co
EEM – MSCI Emerging Markets Index
GE – General Electric Company
GLD – SPDR Gold Trust
IWM – Russel 2000 Index
- IWM Short Put 7 DTE Cash-Secured
- IWM Short Put 7 DTE Leveraged
- IWM Short Put 45 DTE Cash-Secured
- IWM Short Put 45 DTE Leveraged
- IWM Long Day Trade
MU – Micron Technology, Inc.
QQQ – Nasdaq 100 Index
- QQQ Short Put 7 DTE Cash-Secured
- QQQ Short Put 7 DTE Leveraged
- QQQ Short Put 45 DTE Cash-Secured
- QQQ Short Put 45 DTE Leveraged
SLV – iShares Silver Trust
- SLV Short Put 45 DTE Cash-Secured
- SLV Short Put 45 DTE Leveraged (coming soon)
SPY – S&P 500 Index
- SPY Long Put 45 DTE Optimal Hedging
- SPY Long Call 45 DTE
- SPY Long Call 730 DTE LEAPS
- SPY Short Put 0 DTE Cash-Secured
- SPY Short Put 0 DTE Leveraged
- SPY Short Put 0, 7, 45 DTE Leveraged Comparison
- SPY Short Put 2-3 DTE M,W,F “BigERN Strategy” (guest post)
- SPY Short Put 7 DTE Cash-Secured (coming soon)
- SPY Short Put 7 DTE Leveraged
- SPY Short Put 45 DTE Cash-Secured
- SPY Short Put 45 DTE Leveraged
- SPY Short Put 45 DTE Leveraged binned by IVR (coming soon)
- SPY Short Vertical Put Spread 0 DTE (coming soon)
- SPY Short Vertical Put Spread 45 DTE
- SPY Short Call 0 DTE Cash-Secured
- SPY Short Call 0 DTE Leveraged
- SPY Short Call 45 DTE Cash-Secured
- SPY Short Call 45 DTE Leveraged
- SPY Short Straddle 45 DTE
- SPY Short Strangle 45 DTE
- SPY Short Iron Condor 45 DTE
- SPY Wheel 45DTE
- Making Money in Your Sleep: A Look at Overnight Returns
- A Bad Case of the Fridays: A Look at Daily Market Returns
T – AT&T Inc.
TLT – Barclays 20+ Yr Treasury Bond
TSLA – Tesla, Inc.
USO – United States Oil Fund
VXX – S&P 500 VIX Short-Term Futures
- VXX Short Call 45 DTE Cash-Secured
- VXX Short Call 45 DTE Leveraged
- VXX Short Vertical Call Spread 45 DTE
VZ – Verizon Communications Inc.
- Symbol: SPY
- Strategy: Short Call
- Start Date: 2007-01-03
- End Date: 2019-07-10
- Positions opened: 1
- Entry Days: every trading day
- Timing: 4pm ET (EOD pricing)
- Strike Selection
- 5 delta +/- 1.5 delta, closest to 5
- 10 delta +/- 2.0 delta, closest to 10
- 16 delta +/- 2.5 delta, closest to 16
- 30 delta +/- 3.0 delta, closest to 30
- 50 delta +/- 3.5 delta, closest to 50
- Trade Entry
- 5 delta
- 10 delta
- 16 delta
- 30 delta
- 50 delta (ATM)
- Trade Exit
- 25% max profit or 21 DTE, whichever occurs first
- 50% max profit or 21 DTE, whichever occurs first
- 75% max profit or expiration, whichever occurs first
- Hold till Expiration
The initial portfolio size for this study is $100,000.
The options strategy seeks to open a position daily then close once the respective target(s) is(are) met. In a worst-case scenario the portfolio may see, on average, 35 concurrent positions. 100k is roughly the portfolio size needed to support 35 concurrent positions at the start of the study.
Days Till Expiration
Some studies look at ultra-short-duration option strategies while others explore longer durations. The nuances and range for each approach are summarized below.
0 DTE Strategies
Between 0 and 3, closest to 0.
The range is up to 3 days from expiration for two reasons: to allow opening positions on Friday that have a Monday expiration and to allow more opportunities for occurrences of strategies focused in the 10-40 delta range. As expiration nears, it becomes increasingly difficult to open positions in this range.
This visual from Options Playbook does a great job illustrating the concept. Notice how at 1 DTE delta jumps from .50 to .10 with a single dollar change in the underlying. Compare this to the 60 DTE scenario where the change in delta for a $1 change in underlying is much smaller. By allowing positions to be opened as far out as 3 DTE, delta sensitivity to $1 differences in strikes becomes muted.
7 DTE Strategies
Between 3 and 11, closest to 7.
The range is 4 days either side of 7 to ensure a position can be opened each trading day while remaining true to the duration target. For example, opening a position Wednesday will have either a 2 DTE horizon (next Friday) or a 9-DTE horizon (the Friday after next). In this scenario the 9-DTE position would be selected.
45 DTE Strategies
Between 28 and 62, closest to 45.
The range is 17 days either side of 45 to account for quadruple witching. As the end of each calendar quarter approaches, namely during the last 7-10 days of Mar, Jun, Sep and Dec, the expiration dates of option contracts widen significantly.
730 DTE Strategies (LEAPS)
Between 550 and 910, closest to 730.
The range is 180 days either side of 730 to account for underlying that have LEAPS expirations in 6-month increments.
Returns are calculated daily using notional returns. The change in daily values of the option is divided by the stock price at the time of order entry.
The formula for daily return is:
option profit / opening stock price.
For example, suppose we opened a XYZ short put at $1.10 on 1/3/2007 with a stock price of $50:
- On 1/4/2007, our option increased to $1.50. The notional daily return calculation would be ( $1.10 – $1.50 ) / $50 = -.008 which is -.8% daily return on 1/4/2007
- On 1/5/2007 our option decreased to $0.80. The notional daily return calculation would be ( $1.10 – $0.80 ) / $50 = .006 which is .6% daily return on 1/5/2007
By using notional returns on daily stock values when calculating returns we isolate the performance of the option strategy from the effects of leverage. This allows us to identify strategy performance in a non-margin context such as in a US-based retirement account.
By measuring strategy performance as a daily percentage change we abstract the strategy performance from absolute dollar gain/loss to a relative percentage value. This is a fancy way of saying the strategy becomes capital agnostic. In other words, think of an ETF that executes the respective option strategy. We can allocate $100 to the “option ETF” and $100 to the underlying and have an apples-to-apples, dollar-for-dollar comparison.
Monthly and Annual Returns
To identify the monthly and/or annual returns for an option strategy, the respective daily returns are summed.
Graphing Underlying and Option Curves
The underlying position derives its monthly performance values from Portfolio Visualizer. Portfolio returns are calculated in a compound fashion using this monthly data.
Option strategies derive monthly performance values from the backtesting tool by summing the respective daily returns. Portfolio returns are calculated using the following formula:
( backtest starting capital * monthly return ) + portfolio balance
Margin requirements and margin calls are assumed to always be satisfied and never occur, respectively.
In practice the option strategy may experience varied performance, particularly during high-volatility periods, than what’s depicted. Margin requirements may prevent the portfolio from sustaining the number of concurrent open positions the strategy demands.
Positions that become ITM during the life of the trade are assumed to never experience early assignment.
In practice early assignment may impact performance positively (assigned then position experiences greater losses) or negatively (assigned then position recovers).
The following commission structure is used throughout the backtest:
- 1 USD, all in, per contract:
- to open
- to close early
- expired ITM
- 0 USD, all in, per contract expired OTM / worthless
While these costs are competitive at the time of writing, trade commissions were significantly more expensive in the late 2000s and early 2010s.
In practice strategy performance may be lower than what’s depicted due to elevated trading fees in the earlier years of the backtest.
Slippage is factored into all trade execution prices accordingly:
- Buy: Bid + (Ask – Bid) * slippage%
- Sell: Ask – (Ask – Bid) * slippage%
The following table outlines the slippage values used and example calculations:
- A slippage % of .50 = midpoint
- A slippage % of 1.00 = market maker’s price
All values depicted are in nominal dollars. In other words, values shown are not adjusted for inflation.
In practice this may influence calculations that are anchored to a particular value in time such as the last “peak” when calculating drawdown days.
Calculating Strategy Statistics
Automated backtesters are generally great tools for generating trade logs but dismal tools to generate statistics. Therefore, I build all strategy performance statistics directly from the trade logs. Below is a breakdown on how I calculate each stat and the associated formula behind the calculation.
Trades that were closed at management targets (profit, DTE) as winners but became unprofitable due to commissions are considered non-winning trades. This phenomenon is typically observed when managing 2.5D and 5D trades early.
( count of trades with P/L > 0 ) / count of all trades
The standard deviation of all the monthly returns are calculated then multiplied the by the square root of 12.
STDEV.S(monthly return values) * SQRT(12)
Worst Monthly Return
Identify the smallest value among the monthly returns:
MIN(monthly return values)
Average P/L per Day
This measures changes in capital efficiency due to early management.
( average P/L per trade ) / average trade duration
Average Trade Duration
This measures the average number of days each position remains open, rounded to the nearest whole day.
ROUND ( AVERAGE ( trade duration values ) , 0 )
Compound Annual Growth Rate
This measures the compounded annual rate of return, sometimes referred to as the geometric return. The following formula is used:
Total P/L alone is not enough to determine whether a strategy outperforms. To get the complete picture, volatility must be taken into account. By dividing the compound annual growth rate by the volatility we identify the risk-adjusted return, known as the Sharpe ratio.
strategy CAGR / strategy volatility
Profit Spent on Commission
The following formula is used to calculate the percent of profits spent on commissions:
If a strategy is depicted as having percent greater than 100, this means the strategy is unprofitable due to commissions but would have been profitable if trades were commission free throughout the duration of the backtest.
If a strategy is depicted as “unprofitable” this means the strategy lost money even if trades were commission free throughout the duration of the backtest.
How much money is in the portfolio after the study? This stat answers that question and depicts it as a %
( portfolio end value / portfolio start value ) - 1
This study seeks to measure the performance of opening short call positions and will interpret the results from the lens of income generation relative to buy-and-hold SPY.
The utility of the short call strategy as a portfolio hedging tool or other use will not be discussed and is out of scope.
This study seeks to measure the performance of selling short calls.
If a SPY short call strategy is profitable on its own it can be interpreted that a SPY covered call strategy will outperform vanilla buy-and-hold SPY. Total return will be equal to the underlying SPY plus profits from selling calls against the underlying.
Conversely, if a SPY short call strategy is unprofitable on its own it can be interpreted that a SPY covered call strategy will underperform vanilla buy-and-hold SPY. Total return will be equal to the underlying SPY minus losses from selling calls against the underlying.
Early management did a better job of locking in gains and mitigating losses during market stress. In contrast, the 75% and exp strategies collected more absolute premium to offset the GFC losses and commissions.
Realized win rates for the strategies was lower than “expected” win rates in most scenarios.
Managing early lowered win rates in the 5D and 10D strategies and improved win rates in the 30D and ATM strategies.
Managing at 50% produced the lowest win rate in all strategies except 30D, in which case it was ~1% higher than hold-till-expiration.
Worst Monthly Return
Average P/L Per Day
Average Trade Duration
Earlier management results in shorter trade duration.
Positions opened with a high delta take longer to reach profit targets than positions opened with a low delta. 5D is a slight exception.
Compound Annual Growth Rate
Profit Spent on Commission
Commissions consume no less than half of all short call profits.
The “dividends” of covered calls? More than half of the revenue you receive is going to the broker in the form of dividends.
After 12.5 years of systematically selling short calls on SPY the best we could have done was make $2,490.
Given the buy-and-hold position has grown by $167,243, adding another 2.5k doesn’t move the needle much. In virtually all other scenarios we would have underperformed buy-and-hold SPY by the negative amount listed in the table.
While it’s technically correct to say selling 5D covered calls would have both lowered volatility while increasing returns – the so called holy grail – adding a 20 basis points to our total returns does not seem worth the time or risk involved.
Meanwhile, the broker has earned $1 for every hold-till-expiration trade earning a little over $3,100.
Said another way, commissions have consumed over 55% of our profits!
How did the individual trades compare to buy-and-hold SPY?
Systematically selling calls on SPY is unprofitable or generated so little return the activity could be considered unprofitable.
Covered calls supposedly only make money, right? It turns out that losses do indeed occur, but not in an obvious way. Let’s take a look.
Suppose stock XYZ is trading at $70 and a covered call is written with a strike of $80. $1 is collected in premium. Then, the XYZ eventually trades at $100 and shares are called away.
When the underlying exceeds the strike of the short call, yes, the long equity position makes money. In the example above, $30 is made on the long underlying. In the same breath we can also say that premium was received for writing the call option – $1. However, that call option is ITM and has a P/L of -$20 sans any extrinsic value.
The collective, total return of the trade is: Long Underlying Share Appreciation + Premium Received – ITM loss on call, or $30 + $1 – $20 = $11. This equation always yields a positive number when shares are called away. If the trade stops here, yes, we made $11/share in profit and the total portfolio value is indeed higher.
At this point we have a $19/share opportunity cost. Had a covered call not been written, the total portfolio value would be $19/share more. However, if this is one of many trades in a systematic covered-call strategy, we will “realize” – and I use this term loosely; loss was realized when the shares were called away – the $19 loss in a more tangible way. Specifically, it’s not until the next covered call position is opened that the loss is “realized” or felt.
In order to place another covered call trade on XYZ, on will take the $81/share in cash from the previous trade (70/share basis + 30/share appreciation + 1 in premium received – 20/share loss on ITM call) and buy XYZ for $100. One will need to deposit or otherwise pony up $19/share in order to establish the position.
While the 5D and 10D hold-till-expiration strategies were profitable according to the backtest, commission assumptions are generous at $1/contract. Prior to 2018, brokerages charges $5-$20 or more to place an option trade.
As mentioned in the SPY vertical put spread study, commissions can make or break strategy profitability. Quoting from the study:
In 2007 and for many years thereafter there were no (to my knowledge) retail brokers offering sub $2 round trip costs per contract. In fact, the cost to trade was far higher and would have hurt strategy performance even more.
The $1.00 trade fee per contract in the backtest is quite generous even by today’s standards and is a virtually unavoidable cost of doing business.
The best-case scenario was the 5D hold-till-expiration SPY covered call strategy. It generated $5,600 in revenue and spent $3,110 in commissions along the way at $1 per position for a total return of $2,490. If commissions were instead $2 the overall P/L would be negative ($5,600 in revenue – $6,220 in commissions).
Retail Broker Business Model
Why would retail brokers left, right and center be pitching covered calls? It’s great for their bottom line!
It’s a strategy that generates trade commissions and spreads on the option trades.
The covered calls strategy is “safe” in that:
- retail traders won’t be able to blow up their account implementing the strategy. Losses accrued from selling calls will be more than absorbed by the growth of the underlying SPY position.
- retail brokers experience lower customer attrition and lower customer acquisition costs since retail traders won’t be going broke or otherwise blowing up their account with this strategy
Retail traders experience muted returns while retail brokers collect the commissions on every trade.
Systematically selling calls on SPY is unprofitable for retail traders and serves as a revenue stream for retail brokers. After 12.5 years of trading the best we could do under [arguably unrealistically] optimal conditions is make $2,490 in profit.
In general, managing short call positions early:
- lowered win rate
- increased volatility
- lowered overall P/L
The optimal approach to selling calls on SPY to generate income is to not partake in the activity. If we absolutely must, sell 5D calls and hold till expiration – it has the best risk-adjusted return of all short call strategies.
Thanks for reading 🙂
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