SPY Short Put 45 DTE Leveraged Options Backtest
In this post we’ll take a look at the backtest results of opening one SPY short put 45 DTE leveraged position each trading day from January 3 2007 through July 26 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 40 backtests in this study evaluating over 75,300 SPY short put 45 DTE leveraged trades.
Let’s dive in!
Contents
Summary
Systematically opening 45 DTE leveraged short put positions on SPY was profitable no matter which strategy was selected.
Hindsight suggests that for risk-parity and total return outperformance vs buy-and-hold SPY, implement the 30D 25% max profit or 21 DTE leveraged short put strategy.
Hindsight suggests that for a smoother ride and total return outperformance vs buy-and-hold SPY, implement the 16D hold-till-expiration 45 DTE leveraged short put strategy.
Methodology
Strategy Details
- Symbol: SPY
- Strategy: Short Put
- Days Till Expiration: 45 DTE +/- 17, closest to 45
- Start Date: 2007-01-03
- End Date: 2019-07-26
- Positions opened per trade: 1
- Entry Days: daily
- Entry Signal: N/A
- Timing: 3:46pm ET
- Strike Selection
- 2.5 delta +/- 2 delta, closest to 2.5
- 5 delta +/- 2 delta, closest to 5
- 10 delta +/- 2.5 delta, closest to 10
- 16 delta +/- 3 delta, closest to 16
- 30 delta +/- 3.5 delta, closest to 30
- 50 delta +/- 4 delta, closest to 50
- Trade Entry
- 2.5D short put
- 5D short put
- 10D short put
- 16D short put
- 30D short put
- 50D short put
- 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
- Max Margin Utilization Target (short option strats only): 100% | 5x leverage
- 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 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 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
- Starting capital for short option backtests is adjusted in $100 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 $100 increments such that max drawdown is between 80-100%, closest to 100%, of max drawdown target
- For comprehensive details, visit the methodology page
Results
Starting Capital
Early management allows a smaller starting portfolio value since the maxim number of concurrent positions is capped. Less capital is “turned over” faster than holding till expiration.
Margin Utilization
Early management yielded a lower average margin utilization.
Hindsight bias was used in to maximize Reg-T margin utilization for each strategy. This allows for a “best case” scenario, baring the limitations of backtesting such as no margin calls, for the option strategy to outperform relative to the benchmark.
Also displayed is the date in which each strategy experienced maximum margin utilization.
Premium Capture
The higher the delta, the lower the premium capture.
Early management yielded lower rates of premium capture than holding till expiration.
Win Rate
Managing trades early provided mixed results for the win rate and tended to perform better with higher-delta positions.
The riskier the trade the lower the win rate.
Annual Volatility
Volatility increases as delta increases.
Holding till expiration yielded lower volatility on the 50D strategies.
Monthly Returns
Early management improves average monthly returns in most scenarios.
The less risky the strategy the softer the best and worst months.
Max Drawdown
Managing at 75% max profit or expiration yielded the most severe drawdowns. Looking at the 10D strategy, there’s a 3.66x difference in max drawdown between managing at 25D & 21 DTE vs 75% & expiration.
Drawdown Days
Early management reduces the drawdown duration compared to holding till expiration. Managing at 75% max profit yielded the longest drawdown duration.
Average Trade Duration
Managing trades at 50% max profit or 21 DTE yielded trade durations less than half the duration of hold-till-expiration.
Compound Annual Growth Rate
Managing trades early outperformed holding till expiration for the 30D and 50D strategies.
Sharpe Ratio
The 2.5D @ 50% max profit or 21 DTE strategy had the greatest risk-adjusted return.
Profit Spent on Commission
8.95% – the blended average percent of profits spent on commission across all option strategies.
Total P/L
Higher delta strategies yielded more profit than lower delta strategies.
Holding till expiration yielded greater profits than managing early on the 2.5D, 5D, 10D and 16D strategies.
Overall
All option strategies were profitable.
Discussion
By applying leverage to the SPY short put 45 DTE trade one is able to generate total returns in excess of buy and hold. In contrast, the cash-secured SPY short put 45 DTE strategies were not able to achieve total returns in excess of buy-and-hold SPY.
While we’re talking about performance, let’s compare the Sharpe ratio between the leveraged and cash-secured strategies.
By applying leverage we experience a wider distribution of Sharpe ratios vs a cash-secured implementation.
Since SPY represents the market performance of the ~500 largest companies in the US, I hypothesize this phenomenon of wider Sharpe ratios for leveraged option strategies will manifest itself in backtests of other large-cap underlying.
The best news thus far is that the 16D hold-till-expiration strategy outperforms buy-and-hold SPY on both a risk-adjusted and total return basis AND the strategy is net profitable (not to be confused with USO, for example, which outperforms in both categories but is overall unprofitable). A runner up is the 30D 25% max profit or 21 DTE strategy, which matches risk-adjusted performance but outperforms on total return.
Additional Resources
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March 13, 2020 @ 6:00 am
Thanks for this study. One question/suggestion which I think could help leverage and simple strategy a lot. Selling only when price above SMA200. Can you do a backtest on this? A lot of trendfollowers and also big institutions use this and if you check back, biggest drawdowns always happen with price below SMA200 (or any similar number).. If one stops selling or / and immediately exits all open positions when price is below SMA200 or maybe when end of month it is below etc.. There are many variations but if you look at 2008 selloff for example, most of the carnage and VIX spike happened when price was already below SMA200 for quite some time…
Could you test something like that?
March 13, 2020 @ 2:14 pm
You’re welcome!
I could, but I think the results will be similar to selling IV is at or above/below “x” value. While working on this study I explored selling in various IV environments and no matter how I binned the results (note: manipulating the bins to yield a desired outcome is precisely why I avoid studies based on indicators – it’s curve fitting and enables manipulating results to match a narrative) there was no particular strategy that was above the rest.
I realize me stating this outcome is quite different from me publishing a study that shows the outcome. Once I’m able to produce and publish studies using automation, variations similar to what you mentioned might be on the roadmap.
March 13, 2020 @ 12:30 pm
I couldn’t figure out optimal leverage ratio from your research. Am I missing something?
March 13, 2020 @ 2:35 pm
I’d use the respective average margin utilization as the recommended leverage ceiling. For example, a 50% average margin utilization equates to 2.5x leverage; each position assumes the margin requirement is 20% of notional exposure.
The optimal leverage ratio in hindsight will be different depending on the point in time being evaluated. The average margin utilization values are the result of tuning each strategy such that it brushes up against a potential margin call but never breaches Reg-T limits (assumes no VIX expansion risk or broker policy changes during times of market stress).
March 17, 2020 @ 6:13 am
I have problems understanding leverage returns here too. 30 delta leveraged return vs unleveraged managed at 25 % or 21DTE show very different results, 56 % vs 247 % total return. But lets say you starti with 100.000 USD account and use unleveraged version. Because you open positions every day, would you not tap into leveraged with that too? I mean after 10 days you can have 10 short SPY positions open and on 100.000 account that is already using leverage, because you can only have 3-4 if you take 100.000$ account.
So my question would be ok normal version just sold 1 SPY 30 delta option each day. Leveraged version sold how many? 2-3 options each day? I know this can change how many options were opened at any different time because of closing at 25 % profit, but if I want to use this strategy of 30 delta with leveraged version, becuase is recovers 3x faster, has shallower drawdowns and better returns, how many options would I have to sell each day on 100.000 USD account? I think 100.000 USD is just barely enough for unlevered version if one sells option each day, let alone to use leveraged verison. But at your end grapf with leveraged and unleveraged both start at 100.000 USD.
maybe you can dumb this down for some of us readers that have problems understanding this. Also as you wrote for some other reader, margin is calculated as 20 % of notional and when I look at 30 delta option with 25 % profit target, it uses about 27 % which would again indicate no leverage most of the time. If you stay below 30 % average margin utilisation and 20 % is anyway used as soon as you open even 1 position, then I see no leverage usege. Or maybe just slight to get from 20 % to 27 % margin utilisation, but then how can returns be so different compared to “normal” version where also no leverage is used but returns are substantially less.. And if version one sells one option each day, how many does version 2 sell for 30 delta for example..
I think I am missing something here please help me out 🙂
March 25, 2020 @ 2:05 pm
If starting with a 100k portfolio and opening a position daily, yes, one will eventually become leveraged (and/or the account will fail to support additional positions). Similarly, suppose you have enough capital for “half” an option contract – do we calculate a return on idle cash or do we find a creative way to obtain exposure to half an option contract via delta hedging?
The solution to both of these issues is to calculate returns using a “daily average.” I speak to it in the methodology section of the cash-secured studies. The takeaway is that the results should be viewed as if you’re investing in an ETF that implements the given strategy. In practice, the larger the portfolio the closer the results will be to what’s shown in the calculations, and similarly, the smaller the portfolio the greater the potential variance from the depicted results.
Agree – at today’s prices 100k would only be able to support 3-4 positions at a time, at which point one would have cease opening new positions until the existing ones are closed due to leverage. Individually it may be difficult to mirror the strategy and consequently the results. I do have some institutional subscribers so they may be better positioned to realize the returns.
As for the 27% average margin utilization, that implies a 1.35x ( 27 / 20 ) leverage factor which is in the ballpark of TastyTrade research (see slides 4 and 5 for 1ST strangles at https://www.tastytrade.com/tt/shows/market-measures/episodes/pushing-the-limit-capital-allocation-05-17-2018).
Something to keep in mind is that 27% (1.35x) is the average utilization. It will dip lower as multiple positions close during an upswing / vol crush event and will be higher during times of market stress. In general we’re maintaining ~35% more exposure / returns and at times the margin utilization is 100% or 5x, so this is where the outsized gains come from vs a cash-secured strategy. Both strategies open a single position daily.
Hopefully this helps!
May 12, 2020 @ 12:03 pm
Hi there,
When you say ‘manage’ the trade at 21 DTE, what does this exactly entail? Closing the trade and opening a new one, or rolling further out or up/down strikes?
Thanks
May 12, 2020 @ 3:25 pm
“Managing” the trade means closing the position.
For order entry, the strategy opens a new position daily. For order exit, the position is closed when the respective criteria is met.
May 14, 2020 @ 9:35 pm
Wonderful analysis , thanks spintwig! If one were to remove the emotionality from the picture and acknowledge the higher volatility, would the 50D with 25% exit make the most sense from a CAGR perspective?
May 17, 2020 @ 12:18 am
Thanks, glad to hear it’s useful! It would (assuming short puts are your tool of choice to generate returns)!
Just keep in mind the backtest was run with highlight bias. During times of drawdowns the portfolio was within $100 or less of getting margin called.
May 19, 2020 @ 5:12 pm
Thank you, that is something to think about in these black swan event times. If I were to hazard a guess, would put spreads be a viable alternative? Those drawdown risks don’t exist albeit at a significant hit to maximum profit. Would you have any backtested wisdom about that?
May 22, 2020 @ 3:33 pm
There are a several ways to approach risk management.
One strategy is to start at order entry by selecting a delta that aligns with your risk profile. Another is to change the option strategy from short puts to spreads. In both scenarios, position sizing (number of open positions) as well as % of margin utilization is important. The margin collateral itself – whether it’s held in SPY or BIL positions – makes a material difference too.
There are a a lot of variables that go into optimizing a strategy. If the goal is total returns at the expense of an increase in volatility, have you considered a simple 1.25x leveraged play by purchasing SPY on margin or using futures such as /ES or MES? It will roughly match the CAGR of the 30D @ 25% max profit strategy while requiring significantly less time on your part as well as substantially lower amounts of leverage and consequently lower margin call risk. Tax efficiency will also be superior.