Weekly Bull Call Spread Backtesting Results for DIA

On this episode, we use our backtesting software to analyze the results of a weekly bull call spread in DIA, the Dow Jones Industrial Average ETF, and its performance compared to a monthly bull call spread in DIA.
Weekly Bull Call Spread Backtesting Results for DIA
Kirk Du Plessis
Jun 4, 2018

With the rising popularity of weekly option contracts, some investors are choosing to trade weekly bull call spreads as opposed to simply going long stock. The thought process is that by trading the weekly contracts, you can quickly adjust and profit from moves in the overall market. Naturally, this options buying case study will be very interesting for those investors who feel they have some sort of directional edge when markets are trending higher.

Introduction:

  • A concern with weekly options is that people are not using them the right away.
  • With option buying, you are still paying the premium that requires the market to make a huge move in the right direction, all the time. 
  • Weekly options start to lose their value very quickly — the gamma risk becomes really high. 
  • The rapid move in weekly options gives you no time to adjust to current market environments. 

Case Study: Bull call spread for DIA

Trade 1: 

  • 10 days to go until expiration.
  • No IV rank minimum.
  • Weekly trade frequency.
  • Overall allocation of 30%.
  • Profit exit of 50% and no stop-loss level.

$5 wide spreads were created around where the current price of DIA was trading. We tested creating a spread with a long strike of 60 Delta. Our long strike was slightly in-the-money, and our short strike was 5 strikes away, making it slightly out-of-the-money. We were trying to mimic a long stock position with frequent adjustments using options buying.

Results:

  • Over the 10 years tested, the strategy blew up early in the cycle. 
  • During this time period, the market experienced a crash.
  • Crashes happen--you don’t know when they will happen, so it’s fine the testing period included a crash.
  • The strategy had a -99.74% return. 
  • Annualized CAGR was -50% with a -0.85 Sharpe ratio.
  • The overall win rate was 52%. 
  • The average time in the trade was about 9 days.

Trade 2: Tweaking the strategy by 1 factor

If you have to buy options, you want to buy them a bit further out in time to give yourself the opportunity for the market to come back around. You also want to have time decay have a smaller impact on your option position. This is minimized by buying contracts further out in time. 

  • We changed the days until expiration targeted.
  • We still entered trades every week. 
  • Instead of targeting the weekly contracts, we targeted trades with about 60 days to expiration.
  • We kept everything else from the first test the same.

Results:

  • Over the 10 years tested, the test only lost 42%. 
  • Annualized CAGR was 10%, and Sharpe ratio was -0.18.
  • The overall win rate was 61%.
  • The average days in the trade were about 50 days.
  • We experienced multiple drawdowns of more than 20%.

The strategy performed well in 2010-2012 as the market rallied. The strategy started to fail as IV declined as we got into 2015 and 2016, the gamma risk became too great, and the market wasn't going as high. The market was slowly going higher, so the positions just continued to lose money. 

Conclusion:

  • Running these backtests can make a huge difference in your account.
  • Just as backtesting can show you when a strategy will be a loser, it can also show you which strategies will be winners. 

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