Musings on Put Credit Spreads (Part 4)

I begin by concluding some analysis of a Tasty Trade (TT) segment from February 9, 2016. I hope to take bits and pieces from this analysis and apply them to my backtesting methodology for put credit spreads.

Aside from mixing different strategies, a second problem I have with the TT research involves duration. All capital should be recycled in roughly 45 days. The tested trades were rolled for an average 35-day increase in duration. I therefore have to position size assuming 80 days in trade. This will significantly dilute returns.

Given a binary choice between diluted returns and win/loss then intuitively, I would choose the former. In addition to increased comfort, lower drawdown (DD) could mean increased position size to somewhat compensate for diluted returns. In backtesting this, I would have to be mindful of maximum DD since these positions are of the “unlimited risk” variety (the TT presentation did not include any DD data).

Continuing with the previous post’s clarification of Part 2, I also wrote this mouthful:

> This is partly why I believe the appeal to complex trade
> methodologies including multi-legged positions… is
> misguided. Large degrees of freedom significantly
> complicates backtesting: curve-fitting or small sample
> sizes muddle the interpretation.

This is called the “curse of dimensionality.” More parameters mean more categories for comparison. With a finite amount of data, this means fewer points in each category. These sample sizes may become insufficiently small and any identifiable conclusions may be curve-fit or fluke rather than representative of a large population.

> People think they are objectively backtesting while future
> leaks and free-range confirmation bias inconspicuously
> oppose them.

A future leak is when knowledge of the future contaminates calculation in the present. Realistically, this can never happen when trading live. I often hear about option traders backtesting trading strategies over recent months. They know exactly where the market is going so the guidelines are less likely to work when the market environment changes.

I see confirmation bias in much of the arrogant, ego-driven talk that I often write about. People present trading strategies that they are determined to defend as if their very lives depended on it. Why?

That’s a whole other blog post.