Musings on Put Credit Spreads (Part 8)

Today I will continue to ramble on about some possibilities of backtesting the put credit spread.

I could stick with the naked put and buy a unit or two for a fixed percentage of the naked put premium. After backtesting a put spread I was thinking about including insurance like this as a ratio backspread. Maybe what I am really talking about here are two distinct backtests—naked puts and long options—that I overlay and sum to generate an equity curve. If this is valid then I would be killing two birds with one stone because the put spreads would not have to be backtested.

Alternatively, I could opt to buy the same number of longs as I short in the back month. The extra time could synthetically substitute for the additional contract especially because for any given series of shorts, two longs would be in place. I might not include this additional bonus for backtesting purposes since each trade would consist of the naked put plus a farther out-of-the-money option in the following month. Nevertheless, I feel a sense of comfort anytime I have reason to believe actual results would be better than those backtested.

Practically speaking, a problem here is the availability of deep-out-of-the-money strikes in the database. This is especially the case in the early years (2001-4). I should call OptionVue and ask why the strikes displayed are limited and what it would take to be able to see 5-10 more strikes automatically generated by the software.

As it is now, I need to add those strikes manually and then set the prices to fit some logical vertical skew. The skew I employ is 1.0%-1.2% IV per 10 underlying points or, in subjectively perceived crash conditions, 1.5%-2.0%. Of course, too, 10 points is much larger percentage of the underlying early in the database compared to later.

After the last eight posts, I’m not sure I have solved my problem with backtesting put credit spreads. I do think everything is on the table in front of me to mull over and consider, though. I will go forth in my writing from here.