How far out should you go when entering a new option trade? 10 day, 30 days, 60 days? Does it change based on the strategy you are using or the market situation you are in? All great questions we aim to answer and in today's newest case study we'll look at how options trading timelines and duration impacted the returns of this EEM straddle backtest. Plus, we'll cover some of the overall performance and variance metrics we ran on both strategy setups using our backtesting software that launches next week.
How Far Out Should You Place Trades?
- Of course, there is no 100% right answer; it is all subjective based on the strategy that you are looking at and the parameters that you set up.
EEM Straddle Strategy
- Major market ETF with a lot of liquidity.
Backtested a couple different variations of straddles in the underlying security.
The first test:
- Daily straddle entry in EEM.
- Looking to make a trade every single day if the parameters fit, with overlapping trades if needed.
- Tested a short straddle with an average time until expiration of 20 days.
- No IV rank filter, creating as many trading opportunities as possible.
- Overall allocation of 30% in both cases, profit taking at 25%, and no stop loss.
- The short strike deltas were the 50 deltas, which is on the money.
- A total return of 32%, but the sharp ratio was really low, at 0.08%, which means that we did not get the risk-adjusted returns that we were looking for.
- Won 77% of the time, partly because of IV's over expectation and from taking money off the table early.
- Max drawdown of 47%, which is high considering the large number of trades.
- Entered the trade 40 days out on average.
- Kept all other parameters the same.
- A total return of 82% versus the prior strategy of 32%.
- Had a compound annual growth rate of 8.03% and a sharp ratio of almost 1.
- The drawdown was 45%, so it remained relatively the same.
- The drawdown recovery time decreased from 275 days to 150 days.
- Overall, this strategy worked out really successfully.