Put Diagonal Backtest (Part 1)
Posted by Mark on September 27, 2021 at 07:38 | Last modified: July 12, 2021 13:43Because the put diagonal fits together in a portfolio with this type of strategy, I spent a couple hours backtesting it. Today I begin discussion of related comments and impressions.
I will start with the strategy guidelines:
- Buy one ATM LEAPS LP in Dec of following year.
- Divide cost by total number of weeks to get TEV.
- Sell ITM put in shortest-term expiration available (M/W/F) at highest strike whose EV > TEV.
- At expiration, roll SP to the higher of strike determined via (3) or strike just closed.
- If the market has rallied 10% from LP purchase then then roll up and out to ATM Dec closest to two years thence.
- If one year has passed since LP purchase then roll LP out to ATM Dec closest to two years thence.
- Execute with midprices and charge $18/contract commission.
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My usual approach for dealing with slippage is described in the fifth paragraph here.
In live trading, I regularly deal in options priced $15-$35. I sometimes have to let the trade work for a few minutes, but I usually cave no more than $0.10 for two legs.
The current backtest should factor in more slippage because it:
- Trades options up to $200-$400 in price
- Trades options sufficiently DITM as to have little open interest and virtually no volume
- Includes 2020 crash conditions with fast-moving markets and wider bid/ask spreads to offset price uncertainty
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$18/contract, which includes $2 commission and $0.16 slippage, is significantly more than my average realized slippage of under $0.05/contract. Furthermore, I close out each option in the backtest because OptionNet Explorer (ONE) does not have an “Expire Options” button (another issue I have with the software). I am effectively charging $0.32/contract for each short option because in live trading, I could take assignment of ITM options at expiration with no transaction fee whatsoever. I would therefore be saving the $0.16 and, on the rare occasions when options are OTM, the remaining premium as well (ONE usually displays OTM options to be valued at $0.025 just before expiration).
Overall, I think I have done a decent job simulating slippage. I’m a bit light on the LP, but I believe most of these trades would not incur anything close to $0.32/contract. To satisfy the extreme naysayers, I could certainly increase slippage a bit more (e.g. to $0.20) and say “peace!”
I will start to discover the reality when I actually go live. For now, let’s move on.
Despite the guideline defined by (3), I was somewhat discretionary when choosing what strike to sell in the backtest. I sometimes took the fat premiums when IV kicked up and I could still remain seemingly DITM (e.g. 1.5 SD or more).
Why?
I will continue with this dilemma next time.