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Naked Put Backtesting Methodology (Part 1)

I’ve run into a buzzsaw with regard to my naked put (NP) backtesting so I want to review the development of my methodology to date.

I started with a generalized disdain for the way so much option backtesting is done regarding fixed days to expiration (DTE). Quite often I see “start trade with X DTE.” I believe this is a handicap for two reasons. First, I can only backtest one trade per month. This limits my overall sample size. Second, I don’t believe anything is special about X DTE as opposed to X + 1, X + 4, X – 5, etc. Since they should be similar, why not do them all? This is similar to exploring the surrounding parameter space and would also solve the sample size problem.

To this end, I backtested the NP trade by starting a new position on every single trading day. This is not necessarily how I would trade in real life because I might run out of capital. However, the idea was to see how the trade fares overall. This would give me over 3500 occurrences and that is a very robust sample.

From the very beginning, my aim was to keep position size fixed to ensure drawdowns were being compared in a consistent manner. In the first backtest I therefore sold a constant contract size of naked puts with defined premium (first strike priced at $3.50 or less).

This large sample size gave me a healthy set of trade statistics. I had % wins (losses). I had average win (loss) and largest win (loss: maximum drawdown). I had average days in trade (DIT) for the winners (losers). I had standard deviation (SD) of the winners (losers) and of DIT for both. I had the profit factor. I was also able to compare these statistics to a long shares position by creating a complementary shares trade over the same time interval. I then calculated the same statistics and the NP strategy seemed clearly superior.

The analysis thus far was done to study trade efficacy rather than, as mentioned above, to represent how the trade would be experienced live. To further develop the latter guidelines I would need to generate and study an equity curve. Thankfully I already had a fixed-position-size backtest so I could at least compare the drawdowns throughout the backtesting interval.

Upon further review, however, I discovered some problems that I will describe in the next post.

Comments (1)

[…] Last time I began to describe my naked put (NP) backtesting methodology. I thought I implemented constant position sizing—important for reasons described here—but such was not the case. […]

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