Backtester Logic (Part 9)

Having completed analysis of the first two, I now continue with the update_long and update_short branches.

The conditional skeleton for these two branches of program flow looks like this:*

As discussed in the third paragraph of Part 2, rather than follow trade entry criteria these branches just need to locate previous selections. L134 (for update_long) and L150 (for update_short) look to match strike price and expiration. Short and sweet.

Here are considerations with regard to historical date:

1. After find_short, historical date should be advanced to update the spread.
2. After update_long, historical date should not be advanced since two legs need to be updated on the same date.
3. After update_short, historical date should be advanced assuming the trade remains open.

(1) Near the end of find_short, the wait_until_next_day flag is set to True, but current_date has not yet been assigned. I have already discussed this oversight (near end of Part 3 and beginning of Part 4).

(2) update_long does nothing with the wait_until_next_day flag, and…

(3) In L145, update_short checks to make sure historical date has not advanced before progressing to update. If historical date has advanced, then an exception is raised. This should not happen if the data file is complete unless the short option has expired. Whether it be short option expiration or a predetermined DTE, I still need to build in time-stop logic to handle this.

When any branch of program flow finds a match, encoding from the data file assigns to variables shown in the key.

find_short and update_short include several lines devoted to variable reset. Variable reset prevents previous (stale) values to be used in current calculations. Variable reset will only be done as part of find_short if a short option is not found, which itself in an error. To do this effectively, I will make a list to ensure every variable involved in assignment is subsequently reset.

I will also decide whether a user-defined function to reset variables (as mentioned in Part 2 footnote) is indicated.

Is that the light at the end of the tunnel I might be starting to see?

Here are some other topics I still want to discuss:

• Printing to results file
• trade_status
• Rationale behind btstats
• L121 syntax
• Exit logic
• Encoding process

I will continue next time.

*—As discussed in the Part 6 footnote, I’ve used Atom’s folding feature for display purposes, which
     means the higher level (indented) lines are hidden from view.

Backtester Logic (Part 8)

Having tied up several loose ends in the last post, today I want to analyze logic for the find_short branch.

As with find_long (see here), find_short involves a multiple if statement:

The input variable (see key) from the top of the program is defined as follows:

      width = int(input(“Enter spread width (in monthly expirations): “))

L98 searches for a DTE between upper and lower bounds. The difference between bounds is 10 days. The upper bound is the long option expiration minus (28 * width). With 28 or 35 days between expiration cycles, (28 * width) is the highest value it should ever take. The extra 10 [days] should accommodate a 35-day cycle.

If the width covers two (or more) 35-day cycles then this may not work because 7 * 2 = 14 days is more than the 10 provided. Moving the 10 inside parentheses won’t work because width = 4 (the least required to get two 35-day cycles) would allow for a lower bound that is ((4 * 28) + 40) below the upper bound: enough to capture two potential options for the short leg (although the desired longer-dated option will match first if the data file is complete).

To better code L98, I should include the additional days for each three months of width:

      DTE > L_dte_orig – ((28 * width) + (10 * ((width + 2) // 3)))

Floor division ( // ) truncates the remainder for positive numbers. For one month, this is 3 // 3 = 1. For three months, this is
5 // 3 = 1. Only when I get to four months, which is 6 // 3 = 2, will 20 additional days be included.

I will make this modification, but for a couple reasons it’s not something I will use anytime soon. First, I really worry about liquidity and option availability for width > 3 because the long will then be very far from expiration and probably lightly traded. Practically speaking, I would only consider a max width of two months. Second, the lower bound seems unnecessary. Any option available in the long expiration should be available in the short as long as the data file is complete.*

If I want to clean the data files, which includes assessing completeness by searching for omitted and erroneous data, then I can create some simple Python scripts. That’s a topic for another post.

L99 looks to match strike price with the long option. One option per expiration cycle should match. I am okay with this line coming after L98 because the more restrictive if statement (see Part 4) may depend on how many expirations are available: a variable number over the years.

L99 also looks to match date with long option purchase. This is redundant because the previous if statement (not shown) checks for this and makes an entry in missing_s_s_p_dict if short not found.

I will continue next time.

*—This brings to mind another problem with 10-point multiples in find_long (see fourth paragraph Part 7).
     Far from expiration, I have sometimes noticed that only 25-point strikes are available (and only 50-point
     strikes going back many years). Requiring 10-multiple is actually constrained to 50-point strikes in that
     case. The difference between one 50-point strike and the next can be much more than 1% of the
     underlying in those earlier years, which is enough to make for a clearly directional trade.

Backtester Logic (Part 7)

Today, I want to tie up some loose ends related to multiple topics.

The issue of trading options farther out in time (see paragraphs 3-4 of Part 6) will resurface later when I discuss time spread width. For now it will suffice to say that if I want to increase width, besides trading a longer-dated long option I can also do a shorter-dated short option when slippage (open interest, volume, liquidity, etc.) is a concern.

L71 (see Part 4) filters for a 10-point strike by requiring the remainder of strike price / 10 = 0. Due to liquidity concerns, I would prefer to trade only 25-point strikes. My second choice would be 10-, and 5-point strikes would be last. I don’t have actual execution data to support this—it’s just gut feeling based on what I’ve anecdotally heard from other traders.

One potential issue with filtering for strike multiple is a strike density decrease with lower price of the underlying. The relative difference between one 10-point strike and another generally gets larger going back in time where SPX is valued lower. With SPX at 4000, 10 points is only 0.25%. With SPX at 1500, though, 10 points is 0.67%. I cannot say how significant a concern this is, but it would be 2.5x worse for 25-point strikes. The base strategy is not intended to be directional.

Going back to L70, I no longer need the lower bound with my proposed solution in the second paragraph of Part 6. The program will find the first option that has less than (((mte + 1) * 30 ) + 5) DTE. The extra five along with 30 (two more than the more common 28-day) will cover a 35-day expiration cycle, which happens once per quarter. The option I want will be that or the next-lower DTE option to match. The latter will be checked by the check_second flag.

Rather than nested ifs, I could code as an if-else block per fifth paragraph of Part 4, but I don’t see any real advantage. Additional logic in the else block may dictate that nothing be executed for the current iteration (only 0.4% of rows are used). I would have to include a pass (null) statement or two (as if-elif-else) since if-else forces execution of one branch or the other.

In the second paragraph of Part 4, I said the update_long logic avoids a subsequent match to options on the same date even though the same-date options are not being skipped. That logic is in L134:

This looks to match strike price and expiration date. Recall the third paragraph here. Once find_short is complete, same-date options are avoided despite the wait_until_next_day flag being circumvented because each strike/expiration combination only appears once per historical date. Is this more or less efficient?

Although I may be wrong due to “mitigating factors” (second-to-last paragraph of Part 4), I would hypothesize matching strike price and expiration date to be less efficient than skipping dates with wait_until_next_day. The latter requires one truth test to compare current_date and historical date whereas update_long’s and statement requires two.

Loose ends be gone!

Backtester Logic (Part 6)

Today I want to finish ironing out the logic from L70 shown here then continue to analyze that conditional skeleton.

As an example of my proposed solution at the end of Part 5, in 2015 (date 16448) we have options with 94 DTE followed by options with 66 DTE. Both pass L70, which means the latter is what I want. I can add a Boolean flag check_second that starts out as False. Once int(float(stats[2])) no longer equals L_dte_orig (see key), the flag gets changed to True. If this passes L70 then find_long continues in this DTE. If it fails L70, then change control_flag to find_short and continue (to the next iteration) without setting wait_until_next_day to True.

In addition to the 60 – 95 DTE range, I am also interested in studying longer-dated time spreads despite potential issues with slippage. Examples include 90 – 125, 120 – 155, and 150 – 185 DTE. Live trading is the best way to understand slippage. Unfortunately, I can’t go back and live trade in previous years. Common wisdom suggests slippage will be lower with higher volume and open interest, but the data files don’t allow me to test this. I could plot volume and open interest over time, but this may be a waste of time since I have no way to know how that might translate to slippage.

Another thing that may limit my ability to backtest longer-dated options is historical availability. Over the years, more expirations and more strike prices have come available coincident [I suspect] with higher-volume option trading. In 2015, 168 DTE is available followed by 105 DTE, which means I can’t do a time spread one month wide. Things change in 2020. In early Jan 2015, monthly expirations appear for the first four months. In early Jan 2020, monthly expirations appear for the first six months. This expresses my concern despite being anecdotal observation.

One thing I don’t see in the conditional skeleton is a continue statement at the bottom. Whether or not the backtester identifies the current row as the long option, it can then advance to the next iteration (row). Without a continue statement, the program will go on to unnecessarily evaluate control_flag three more times before advancing. “Continue” should conclude the first three branches. Completing the block, the last branch doesn’t need a continue statement as advancing to the next iteration will automatically take place.*

I will press forward next time.

*—Actually, I did remember this. The Atom text editor features folding to hide blocks of code as described
     here. With “continue” being the last line of the previously indented blocks, they were hidden.