7 DTE Strategy

Let's talk about 7 DTE strategy.

I shared this briefly in commenting someone's post. I'd like to share more details about what I found from backtesting 7 DTE strategy. I would like to address two points beforehand so you can understand backtest better.

Backtesting an early exit strategy (profit target and stoploss) is problematic because of intraday fluctuation and overnight gap up/down. If you only use EOD data your backtest result will be far off (which is basically the main problem for every backtest platform). The backtest platform I am using offers these two options: check execute vs open price (to include gap up/down) and check execution vs high & low (to be able to exit intraday). With these two options, the backtest result will be more reliable. One issue that is hard to verify is the daily high&low price. Since the daily high&low prices are based on actual transaction. So if a certain strike has a very low volume, the price would not be that reliable. That means the prices for low volume strikes don't move much with the stock price. I hope they can include theoretical price for high&low prices.

OK, let's see the result. The test condition is 7 DTE (+-1) SPY short 30 delta put vertical with $40 wide long leg, stopped at 100, 200, and 300% loss. The trade was entered everyday for the past 3 years. You might wonder why I only test for 3 year. It is because SPY has much less expiration to select from 2-3 years ago. You can't enter a trade everyday in older times. This is a profitable strategy for the past 3 years. However, there is a very strong psychological hurdle for this strategy as indicated. The drawdown in 2018 is too much. I would not want to see my one year worth profit go away in just several months. Imagine you trade this strategy for one year and your return is negative. How bad is that?

Interestingly, when I do 50% stoploss, the drawdown becomes much smaller. In exchange you get only 62% win rate but better ROC and total P/L. It is noted that in the worse period of time there is 15 consecutive losses (so are other stoplosses). Are you willing to stay engaged when you get more than 10 consecutive losses?

So, which is more important? Winning rate? P/L curve? or return on capital (ROC)? In my opinion, I would like to have high ROC, otherwise I can just buy SPY and leave it alone. SPY gives 34% ROC for the past 3 years and this strategy offers 81%. But you won't put just enough money to do short strategy, if you use 50% required capital the ROC becomes 41%, kind of similar to buy and hold SPY stock but you get a much smoother P/L curve using this strategy. I would like to see how this strategy performs in a recession but unfortunately there is not enough data in 2008 to test that out. Since I still have concern about high&low price data, I will trade it to figure out how reliable this backtest is.