0 DTE Iron Condors (Part 3)

I want to spend some time reviewing the second-to-last bullet point from Part 2.

As a future direction for research, I suggested comparing mean realized loss in excess of stop-loss trigger on either side to study directional edge on a more granular level. What exactly do I mean by that?

I wrote a blog post in 2017 that spells out many of the points I wish to make here.

When done properly, I believe backtesting can provide a good idea how a strategy will perform in real-time. Particular attention must be paid to ensure the plan can be backtested accurately (this blog mini-series explores such facets). A big limitation is data granularity. OptionNet Explorer (ONE) is good to offer 5-minute intraday market data for the last several years, but in live trading stop orders are monitored much more frequently (e.g. every three seconds).

The 0 DTE trade presentation suggested buy stop-market or buy stop-limit orders to mange risk. Once the stop is triggered, the stop-market order will be filled at the next available price. Since I may not like the fill if the market gaps big at that point, a buy stop-limit order may be used to avoid high prices. This becomes a limit order when triggered but will not fill if price gaps beyond the limit value. For example, “buy at 3.00 stop limit 3.30” will be triggered when price hits or exceeds 3.00 but will not offer more than 3.30. If the price sequence is “2.90, 2.95, 2.98, 3.50,” then this stop-limit order will not fill.

ONE does not provide intrabar data, which would be necessary to determine if/when during the period a stop order would get filled. We can see the open, high, low, and close for each period, but we don’t know the sequence of prices in between. We must therefore look at the open or close (be consistent) to make that determination. As five minutes is 100x longer than three seconds, results from backtesting may differ significantly from live trading where stops are used because the market has much more time to run past the stop.

Whether such deviation is good or bad is discussed in the blog post linked above. Today I just highlight the difference.

If I am developing a strategy through backtesting, then I must trade like I backtest to get similar results: 5-minute monitoring of opens/closes and no stop-market/stop-limit orders.

From the top I mentioned the suggestion to compare summed excess losses between put and call sides. Over six months, I found a roughly equal number of losses on each side. If one side therefore generates a much larger excess loss than the other, then perhaps that side would make for a better trade in real-time since stops would mitigate the excess losses.

I now retract this suggestion for two reasons. First, I do not have a PnL comparison between call/put credit spreads since I backtested both together as IC’s. Second, if I don’t trade like I backtest then even comparing excess loss in a credit-spread backtest will not be meaningful because additional trades stopped out in live trading will not be reflected.