STT Backtesting Notes (Part 1)

Today I present miscellaneous notes based on observations seen doing manual STT backtesting in OptionNet Explorer (ONE).

I would like to give a disclaimer about level of sophistication. Someone recently looked at my blog and said, “I was completely lost after two sentences.” I have made particular effort in the past to explain things for an audience unfamiliar with trading concepts. I have cut back on this recently. Please realize my primary motivation for blogging is to organize my thoughts and to keep myself on track with my projects. I don’t need basic definitions because I’m immersed in this stuff every day. Should you have particular questions, always feel free to leave comments below or even contact me via website e-mail.

The backtest begins in Nov 2019 in order to be fully loaded for the March 2020 crash. This is primarily an income STT (BWB) backtested as 10 contracts (five tranches). I hedged starting with nakeds that become 40 LPs upon maturation. I sold the STT in the same month; next time, I will look to sell the STT one month farther out.

I tried to use some rudimentary technical analysis to guide whether I should lean positive or negative NPD. I looked at slope of 50-MA along with IV term structure.

If I’m going to trade this live, then I need to be very clear with technical criteria. Even if the criteria alone do not constitute a profitable strategy, they should at least filter out large contrary moves. I then need to make sure to lean directionally rather than letting NPD grow too large (especially in defensive periods where HV is high and big moves would not surprise).

I charged $20/contract to cover transaction fees. This should be sufficient as discussed here. All expiring contracts were BTC at 3:55 PM. This added expense may be considered to offset crash conditions where larger slippage would be expected.

Here are my general impressions:

• When things get crazy, look to peel back or exit because major adjustments moving around lots of contracts in market crash conditions may not be feasible. I totally forgot about this.
• I was usually short convexity although sometimes T+0 bottomed before reversing higher. I thought the idea with the tail hedge was to generally be long convexity, though.
• While I admit I did not add volatility stress to check convexity, never in 2020 did I see a T+0 smile. Neither was this realized when the underlying tanked despite tail hedges profiting handsomely.
• I did not harvest in this study, which could potentially remove risk for some added cost.

I will continue next time.