Rolling Naked Puts (Part 2)

Last time I presented some data in an attempt to replicate the Market Measures (MM) episode from November 8, 2016.

The backtesting methodologies are different. MM started with 0.30-delta naked puts. They took assignment at expiration and sold a 0.30-delta call against it. I started with 0.20-delta naked puts and whenever a 3x stop-loss was hit, I rolled out to the next available expiration month.

My reason for rejecting the roll adjustment had to do with the larger max drawdown (DD) and standard deviation (SD) of returns. MM did not present these statistics.

The Tasty Trade mantra “trade small and trade often” alleviates the DD/SD concern. This is an effective means to cover their *ss because no one loss would ever be catastrophic. I feel this works for people trading part-time as a hobby who have an independent paycheck consistently coming in.

I do not believe “trade small and trade often” works for people trading full-time as a business, however. Unless capitalized with millions of dollars, one cannot trade “small” and still be able to cover living expenses. When position sized as a viable business, most traders do not have enough diversified strategies to avoid widespread portfolio devastation should a naked put max DD type of event occur. This is why I believe max DD and SD of returns are necessary to design a workable trading plan.

My backtest included 509 trades that hit a 3x stop-loss but excluded an additional 376 trades that hit the 2x stop-loss level. Naked puts that lose on the roll are those where the market does not recover or continues to tank lower. These are the most severe losses and are included in the present backtest. Backtesting trades hitting the 2x stop-loss that do not go on to hit 3x would therefore probably improve overall results.

I do not believe inclusion of the 2x stop-loss trades would be enough to save the rolling strategy, however. While I would expect to see more than a 15% improvement, even if PnL improves by up to 50% (for example), the 4x larger max DD realized when rolling would necessitate a decrease in position size by 80% to equate the DD’s and 80% >> 50%.