SPY Short Put 7 DTE Leveraged Options Backtest
In this post we’ll take a look at the backtest results of opening one SPY short put 7 DTE leveraged position each trading day from Jan 10 2007 through Jun 3 2020 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 10 backtests in this study evaluating over 28,300 SPY short put 7 DTE leveraged trades.
Also, be sure to check out my guest post over on BigERN’s blog where I backtest his options strategy that mitigates sequence of returns risk.
Let’s dive in!
Contents
Summary
Systematically opening SPY short put 7 DTE leveraged positions was profitable no matter which strategy was selected.
All 30D and 50D strategies as well as 16D hold-till-expiration outperformed buy-and-hold SPY with regard to total return.
Methodology
Strategy Details
- Symbol: SPY
- Strategy: Short Put
- Days Till Expiration: 7 DTE +/- 4, closest to 7
- Start Date: 2007-01-10
- End Date: 2020-06-03
- 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 short put
- 10D short put
- 16D short put
- 30D short put
- 50D short put
- Trade Exit
- 50% 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 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 PnL 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
Early management has minimal impact since positions are held for, on average, 3 days.
Margin Utilization
Early management yielded a lower average margin utilization across all strategies when compared to holding till expiration.
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.
Premium Capture
Early management had lower rates of premium capture vs holding till expiration.
The higher the delta the lower the premium capture.
Win Rate
Managing trades early outperformed holding till expiration with regard to win rate.
The higher the delta the lower the win rate.
Annual Volatility
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Monthly Returns
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Max Drawdown
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Max Drawdown Duration
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Average Trade Duration
Managing trades at 50% max profit yielded trade durations roughly half the duration of hold-till-expiration.
Compound Annual Growth Rate
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Sharpe Ratio
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Profit Spent on Commission
13.27% – the blended average percent of profits spent on commission across all option strategies.
Total P/L
Early management underperformed holding till expiration with regard to total P/L.
Higher delta strategies yielded greater total P/L than lower delta strategies.
Overall
All option strategies were profitable.
All 30D and 50D strategies as well as 16D hold-till-expiration outperformed buy-and-hold SPY with regard to both risk-adjusted and total return.
Discussion
At face value it appears there may be some opportunities with 7 DTE options to outperform buy-and-hold SPY. Let me debunk those initial thoughts.
Timing Luck
I’ve referenced timing luck – P/L variance associated with sheer luck – on several occasions. A material risk and P/L variance can be observed by simply changing the day in which a position is opened, closed or rolled.
For example, a single 45 DTE short put can have the following outcomes:
A popular backtest approach is to open a position then roll (close then reopen a new position). One can get very lucky or unlucky based on when the strategy was started. In fact, it’s possible to have 30 different return profiles – one for each day of the month in which the backtest was started. If you’re pushing a narrative, simply select the return profile that best matches your message and no one’s the wiser.
To mitigate this potential “lying with data” opportunity, two approaches exist: open a position daily which essentially eliminates timing luck or publish a portfolio variance statistic that provides a +/- standard deviation against reported performance. I do the former.
Great, so what does any of this have to do with the backtest results? Glad you asked. Let’s take a look at the number of occurrences by year.
Time in the Market
Looking at the 50D strategy, there were only 91 trades in 2007; monthlies was the only option product that existed at this time for SPY. Consequently, the backtest avoided most of the 2007 global financial crisis. By “luckily” not participating in the market during this time the strategy had a great leg up on the buy-and-hold approach.
The options strategy experienced more occurrences as new options products came to market. On June 4 2010 CBOE released Friday-expiring weekly options on SPY.
Due to the lack of product availability during the first few years of the study and thus the inability to execute the option strategy (daily trades of short DTE positions) for more than 5 trading days per month during and after the GFC, we are forced to accept a material amount of timing luck in the performance results; take these numbers with a grain of salt.
Potential Workaround
What if we start the study at a time when timing luck isn’t a material factor – i.e. after June 4 2010?
We end up with the following P/L curves:
It could be argued that this is an unfair backtest since it both skips the largest SPY drawdown in recent history and compares a limited-upside strategy (short puts) against the longest bull market in history.
This also doesn’t take into effect the differences in margin utilization associated with skipping the GFC.
What is a researcher to do?
I intend to measure from late Feb 2018 through June 2020. This captures the Dec 2018 vol spike, 2019 strong +30% rally, and the March 2020 COVID-19 drop which resulted in a VIX value greater than what was observed during the GFC. Also, late Feb 2018 is when CBOE released Monday-expiring weekly options on SPY (see SEC release 34-82733). This product release is what allows the strategy to ensure a position is opened each trading day while remaining true to the duration target.
Stay tuned for a study that compares ultra-short (0 DTE), short (7 DTE), and standard (45 DTE) SPY short put strategies against a buy/hold total-return portfolio of SPY.
Update: the comparison study is now live!
Additional Resources
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June 29, 2020 @ 4:57 pm
So per prior comments from you here and on BigERN’s site, you mention you’ve just stuck to buy-and-hold the index as it’s so easy yet tough to beat. However, this study appears to be the holy grail of them all; something that isn’t tied to a single stock, yet beats the SPX both in absolute and risk-adjusted terms.
I get your point about time selection and the upcoming study based on a more limited time period; but if that study comes out agreeing with this one, wouldn’t we all be stupid not to just adopt this strategy?
Also, huge props on another great study, and on your site in general.
June 30, 2020 @ 10:19 am
Thats a good question. On paper, yes, if the data suggests short (7 DTE) and ultrashort (0-3 DTE) short puts outperform buy/hold SPY then we’re all better off adopting the strategy.
Two caveats come to mind: tax implications and why these option strategies outperform.
I intentionally don’t speak to tax drag since everyone’s scenario is unique and thus generalizations aren’t terribly helpful. For me personally, the ability to defer capital gains is substantial. Combine this with the ability to use margin loans as a form of tax arbitrage (https://spintwig.com/fire-taxes/#Margin_Loans) and there’s a material “intangible” advantage to the buy/hold approach.
As for why short-duration strategies outperform, my first thought is that these options are simply miss-priced. There’s very little [public] data on these strategies. Now that this info has been publicized, any edge on the strategy may fade away as retail and institutional players do their own due diligence and implement.
The counter argument is that market dynamics will work themselves out such that the strategy will almost always outperform, similar to how indexing almost always outperforms despite the massive shift to the strategy over recent years.
A happy medium might be to allocate 50% of one’s portfolio to the put writing strategy the other 50% to buy/hold.
Thanks! Happy to hear it’s helpful. Don’t hesitate to reach out with any ideas / suggestions for future studies.
July 3, 2020 @ 9:10 am
Thanks for the post. One question Ive got is when you are measuring the return on buy/hold SPY, are you accounting for dividends re-invested? On the compounded annual growth rate bar chart based on the SPY bar it looks like the return is around 8%. If this hasnt been accounted for over this same timeframe, how does this change the comparison between buy/hold vs the 50D, 7DTE, hold to expiration?
Thanks!
July 3, 2020 @ 10:18 am
Welcome! Yes, the buy/hold SPY numbers assume all dividends are promptly reinvested (total return).
July 27, 2020 @ 12:23 am
I’m having a lot of trouble following your curves. The summary here states All 30D and 50D strategies as well as 16D hold-till-expiration outperformed SPY, but it looks like only the dark green and light blue (50D) beat SPY based on the last P/L curve chart. Am I misinterpreting? Thank you.
July 29, 2020 @ 5:16 pm
The summary is based on the data in the section titled “Results.” This includes the overall P/L chart.
The P/L chart in the “Discussion” section is based on a crude review of changing the start date of the study so as to avoid timing luck.
November 24, 2020 @ 1:13 am
When you calculate the losses from immediately selling assigned shares, do you use the opening price of the next day?
This is because according to the The Options Clearing Corporation’s Characteristics and Risks of Standardized Options, Page 51, Section named “Assignment”:
“Assignments are ordinarily made prior to the commencement of trading on the business day following receipt by OCC of the exercise instruction”.
and
“It is possible that an option writer will not receive notification from its brokerage firm that an exercise has been assigned to him until one or more days following the date of the initial assignment to the Clearing Member by OCC”
I haven’t been assigned, I just need to know if the backtest accounts for it.
November 25, 2020 @ 8:30 pm
Great question! Losses are calculated on the day in which an option position expires ITM, not the day in which OCC logs an assignment event. Since price snapshots are taken only once daily at 3:46pm ET, the value of the option at 3:46pm is what’s used to calculate P/L. Price action of the underlying after 3:46pm ET the day of expiration is not accounted for and is an acknowledged gap in the methodology.
In other words, assignment events are calculated as a buy back of an ITM option 14 min before the option expires. If we ignore the 14 minutes of time value and subsequent price action of the underlying between 3:46pm and when OCC determines assignment price, the P/L is the same.
Rule of thumb: one can plan to realize ~80% of a backtest’s results in practice (not just mine, but anyone’s).
March 4, 2021 @ 1:22 pm
What do you mean that all strategies after March 23, 2020 did not recover? From the visual chart, it looks like all strategies bounced back. What did I miss here?
March 8, 2021 @ 8:39 am
If you’re referring to the observation that none of the strategies recovered from the max drawdown as of the end of the backtest, that’s indeed accurate. The max drawdown occurred on March 23 2020 and none of the strategies have reached or exceeded the high-water mark associated with the max drawdown.