Challenges to Option Backtesting (Part 1)
Posted by Mark on January 12, 2016 at 05:18 | Last modified: November 13, 2015 15:28I had an exchange with another trader some months ago about option backtesting. I wanted to copy and paste parts of my last response because they are good things to keep in mind:
“Greeks do lie sometimes… I was just on the phone
with OptionVue (OV) discussing a position I was
studying… between 10:30 AM and 11 AM yesterday.
Greeks suggested a market rally and volatility
contraction would increase cash flow when cash
flow significantly decreased. The back month
option in the spread had no volume change over
that 30 minutes so without any volume that may
have been a stale quote. This is another
potential contaminant to accurate backtesting…
One thing that has frustrated me over the years
with OV is that I can open a matrix and get
identical prices but different greeks simply by
refreshing the data, which I suppose forces the
program to recalculate modeled values. If I’m
looking to sell nothing greater than a 10 delta,
for example, then a 10.4 versus 9.8 delta
simply as a result of refreshing the data means
the backtest is not reliable: one option may
land a winner and the other a loser. This is
another argument in favor of a large sample
size because if small then the difference
between a winning trade and a losing one can
be very significant in the totality of results…
Just this morning I was reading a trading forum
and I found this post:
> I have found backtesting options strategies
> to be very difficult mainly due to the large
> bid/ask spread.
> If, in your backtest, you always use the
> worst price, the strategy will never
> make money. If you use the best price
> then your probability of success is
> artificially inflated.
> Backtesting options strategies is very
> hard, and the results given by most
> websites and/or software seems to always
> show the best case scenario. Most of the
> time this is not happening
This really hit home. I’ve encountered this for
years and I totally agree.”
I’ll finish up with the next post.