Rolling Naked Puts (Part 1)

The motivation for this study comes from the Market Measures (MM) episode discussed here. Is rolling naked put losers a viable strategy for improving trade results?

Here are some important details from my study:

• All trading was done at 3:30 PM
• Used first strike with delta < 0.20
• Rolled put to next available expiration when 3x stop-loss hit
• Closed puts on expiration Thursday
• All trades subject to a $0.26/contract transaction fee

Here’s what I found:

Out of 509 trades, only 200 lose on the roll. This represents a 60% reduction in number of losers as shown in the third column. Rolling reduces net loss by about 15% and the average trade improves on the roll by the same amount (rows 4-5). That is the good news.

Bad news starts with row 6: the worst loss increases by over 400% with rolling. The standard deviation (SD) of trade results also increases over 650%. I have discussed many times how maximum drawdown (DD) and SD both represent risk (e.g. here, here, and here). If I position size based on max DD then I would have to trade five times smaller with rolling than without. A 15% improvement in PnL is hardly going to compensate for that.

Days in trade (DIT) is obviously larger with the roll. It more than triples, though, and this will dilute the PnL improvement. Three non-rolling trades could be done in the roughly 74 days it would take for one rolling trade. With a win rate over 84%, odds are the sum of three trades will better the PnL of the rolled trade.

Looking back to the MM presentation, the biggest difference between my analysis and theirs is what they did not present. I have detailed this critique elsewhere. Like the MM episode, I looked at success rate, average PnL, and DIT. I also discussed max DD and SD of results, though, where MM did not. As it turns out, these are the statistics I find to be most decisive and they are the biggest reason I believe rolling is not viable. MM arrived at the opposite conclusion.

I don’t believe the full picture of rolling can be understood without analysis of max DD and PnL SD. Without them you may be headed for an awful surprise when max rolling DD is experienced with real money! That would not make for a pleasant day.

I will continue next time.