Questioning Butterflies

I feel like I could go on with BIBF discussion for quite some time but I think it may be time to change course altogether.

In the final paragraph of my last post, I laid out a solid plan for future research directions. I now have five degrees of freedom, which are multiplicative in trading system development. This could easily take years of manual backtesting.

I find it hard to accept this significant time commitment given the disappointing first impression for butterflies when compared to naked puts (NP). Consider NPs versus the BIBF:

These numbers somewhat confirm my NP worries about the potential for large downside loss. Max Loss / Avg Loss is 2.1x greater for the BIBF. Average win/loss metric is 2.52x greater for the BIBF. In both cases, advantage: butterflies.

But to get the BIBF looking this good, I had to significantly reduce transaction fees. I question whether I can reliably get these trades executed for so little slippage on each side. If not then up to 319 of the 4092 backtested trades [with MAE = 0] are at risk of going unfilled, which means the backtested performance is artificially high.

The BIBF performance is hardly compelling. A profit factor of 1.14 is just slightly into the profitable range. 1.58, for the NPs, is much more to my liking especially being saddled with a healthy amount of transaction fees at $26/contract. Whereas 1.14 may be optimistic, 1.58 may be pessimistic.

One other thing to notice is the much larger commission cost for butterflies over NPs. Trading NPs is dirt cheap: one or two commissions per position. Trading butterflies involves at least six commissions per position and possibly 7-8. All that and I get less profit? This is a soft poke in the eye.

If the real challenge is to limit potential for catastrophic downside risk then perhaps the better way to proceed is with put spreads or put diagonals.

Another idea is to consider a bearish butterfly as a hedge for trading NPs since the latter will be hurt by a down market whereas the former could benefit. I’d be interested to see how a bearish butterfly performs compared to this bullish one but I would be inclined to implement fixed width, which would mean two additional lengthy backtests.