Musings on Put Credit Spreads (Part 5)

This post does have a subtle April Fool’s joke. Do you see it?

To finish up with my clarification of Part 2:

> Dream of the Holy Grail remains alive and demand to
> purchase the education in hopes of profitable trading
> is directly proportional to marketing efficiency.

If I have spent money to join a trading program or community then confirmation bias may predispose me to believe in it. As a consequence, I may search for evidence that it works and ignore any suggestion to the contrary. This could also involve future leaks (discussed in last post). Marketing efficiency (e.g. fallacy of the well-chosen example) may determine whether I become sold on the program in the first place.

Since I am completely disorganized in this series of blog posts, let me toss in a mention of Charles Cottle. In Parts 2 and 3 I discussed how complex spreads are often combinations of simpler units. Cottle talks a lot about this in his writing.

Now then, I will finally return to discussion about a methodology for backtesting put credit spreads. I will sell the first option under 9.90 delta or below to account for plasticity in the matrix greeks. The option to buy will be 10 points OTM. I will use $64 slippage per spread round turn.

Looking at two arbitrary dates, in 2010 at 637.55 with 46 DTE the vertical spread just described fetches $0.65 whereas in 2004 at 397.44 with 47 DTE this spread fetches $0.40. The differential between the two is not as much of a concern as the fact that slippage alone will completely negate the credit.

Houston, we have a problem!

One solution would be to decrease the slippage. Lately I have been finding $0.10 for a $3.00-$4.00 option is not unreasonable. On a spread that could be $0.20, which is $42 round trip (34% less).

A second solution would be to use the “last” prices instead of the “mid.” If the option traded at that price before then it seems reasonable I should be able to get that price again. One problem would be if I were selling (buying) a spread and the “last” quotes reflect purchase (sale) of that same spread, which would result in an artificially increased (decreased) price. I would never be able to tell what side the “last” was on. Another problem is that the “last” can be very stale if the option has low volume.

I will continue piecing together these backtesting guidelines in the next post.