Automated Backtester Research Plan (Part 9)

With digressions on position sizing for spreads and deceptive butterfly trading plans complete, I will now resume with the automated backtester research plan.

We can study [iron, perhaps, for better execution] butterfly trades entered daily from 10-90 days to expiration (DTE). We can center the trade 0% (ATM) to 5% OTM (bullish or bearish) by increments of 1% [perhaps using caution to stick to the most liquid (10- or 25-point) strikes especially when open interest is low*]. We can vary wing width from 1-5% of the underlying price by increments of 1%. We can vary contract size to keep notional risk as consistent as possible (given granularity constraints of the most liquid strikes).

An alternative approach to wing selection would be to buy longs at particular delta values (e.g. 2-4 potential delta values for each such as 16-delta put and 25-delta call). This could be especially useful to backtest asymmetrical structures, which are a combination of symmetrical butterflies and vertical spreads (as mentioned in the second-to-last paragraph here).

With trades held to expiration, I’d like to track and plot maximum adverse (favorable) excursion for the winners (losers) along with final PnL and total number of trades to determine whether a logical stop-loss (profit target) may exist. We can also analyze differences between holding to expiration, managing winners at 5-25% profit by increments of 5%, or exiting at 1-3x profit target by increments of 0.25x. We can also study exiting at 7-28 (proportionally less on the upper end for short-term trades) DTE by increments of seven.

As an alternative not previously mentioned, we can use DIT as an exit criterion. This could be 20-40 days by increments of five. Longer-dated trades have greater profit (and loss) potential than shorter-dated trades given a fixed DIT, though. To keep things proportional, we could instead backtest exiting at 20-80% of the original DTE by increments of 15%.

Trade statistics to track include winning percentage, average (avg.) win, avg. loss, largest loss, largest win, profit factor, avg. trade (avg. PnL), PnL per day, standard deviation of winning trades, standard deviation of losing trades, avg. days in trade (DIT), avg. DIT for winning trades, and avg. DIT for losing trades. Reg T margin should be calculated and will remain constant throughout the trade. Initial PMR should be calculated along with the maximum value of the subsequent/initial PMR ratio.

We can later consider relatively simple adjustment criteria. I may spend some time later brainstorming some ideas on this, but I am most interested at this point in seeing raw statistics for the butterfly trades.

I will continue next time.

* This would be a liquidity filter coded into the backtester. A separate study to see how open interest for
   different strikes varies across a range of DTE might also be useful.