Call Selling Strategy (3 year backtest results)

[lindq]

Maybe I misunderstood - but I think he's buying the ask and selling the bid (entries are on bid and the title of the thread is call selling). Should be reasonable to get filled there

OP says that his entries are based on bid price at 15:45 the afternoon BEFORE the entry. This makes no sense, at least to me. Because if the opening price the next morning is above that limit, which is common, actual trading would have him filled at the market open as a market order.

The same holds true, conversely, on exits based on prices the afternoon prior.

Thus, it seems likely that a trader is going to often experience serious spread issues on both sides of the trade.

 

[trend2009]

Wide bid/ask spread is common on illiquid OTM options. I am not as concerned about liquidity at the entry, as much as the probability of expiring worthless at the exit.

Unlimited risk is true, certainly with naked calls. The naked call could be spread into a long collar or bull vertical spread. But what is intriguing is that while naked OTM puts always blow up eventually, that has not been the case with calls, at least within this dataset.

did you say that you can win by selling otm call at bid regardless high spread of ask and bid price?

 

[Matt_ORATS]

This is a good test but has a couple of problems.
AAPL post split closing trades are valued at zero.
You should be exiting at expiration at parity. You are penalizing yourself for using the bid/ask. For example, SAM 3/19/21 closed ~1100 and you marked your 1500 calls that should have expired worthless at $10.
signalDate entryDate symbol shortStrike shortType expiration undPrice min max otmProb signalCost actualCost tgtCost exit exitUnd exitDate shortPnl
1/28/2021 1/29/2021 SAM 1500 CALL 3/19/2021 927.58 608.9905 1246.169 98.776 105 105 52.5 1000 1105.19 3/19/2021 -895
This should help your test a lot.
Your average stock price is $1400 which may account for the thesis that high priced stocks have higher than expected calls.
At ORATS we calculate a forecasted and smoothed theoretical value for each option. Mostly our values agree, ie very overvalued calls.

 

[newwurldmn]

This is a good lesson on understanding why a strategy works is really important even when developing a quant model.

All the pnl was made from q2-2020 through q1-2021. The reason was that there was a huge bid to call vol. Even the mainstream press was talking about softbank and RobinHood traders buying calls. This phenomena crescendo-ed in q3 of 2020 which was the biggest quarter for this strategy.

2018 and 2019 produced moderate gains. I suspect that this strategy will produce moderate gains going forward.

I appreciate the candor and intellectual honesty from the OP.

 

[newwurldmn]

Further, most of the trades are in AMZN. IN the 2nd half of january 2021 he is short about 40MM of notional of deep out of the money calls (about 130 calls). I have no idea what the margin would have been, but it probably would have been several hundred thousand if not a few million... all to make $28,000.

Again, credit to the OP for acknowledging that he didn't consider margin req as part of the strategy

 

[taowave]

Without looking at the spreadsheet and the market cap of what was traded,it appears you are a garbage call seller and would have to really lever up and trade big size to make a decent return..Thanks but no thanks.

As NWD pointed out you would have a big cap hit,even under PM,and dont expect the fat juicy premium paid for the 2020 tails yo come back anytime soon...

What were the returns you calculated and how were they calculated??

P.s. you know for margin purposes,brokers may shock the upside of some stocks as much as 50 percent..

 

[daytonabeach83]

OTM calls on single stocks are generally overpriced. Using 3 years of EOD options data, I ran the following backtest:

OTM call contract selection criteria

• Bid >= 0.15 and Ask >= 0.15
• Bid/Ask spread between 0.01 and 4
• Expiration between 11 and 75 days

I compute the 30, 45, 60, 75, 90-day variances (using the VIX formula) and calculate the EWMA(0.7) for the series after the maturity. e.g. if the call expires in 15 days, I use the 30 day variance.

Next, I filter out contracts where the IV is below the EWMA(0.7) variance.

Finally, I run a Monte Carlo simulation to generate 50,000 GBM price paths with varying step counts using the EWMA(0.7) volatility estimate. Iterating over each price path, I calculate the probability of touching the strike price target, and count the occurrences where it is <5%. 1 minus ITM probability over 50,000 is the probability of expiring OTM.

Contracts with a probability of expiring OTM >98% are selected to trade.

For the backtest, trading signals are generated after the close, so the entry date is the next trading day. Entries use the bid price at 3:45 PM, and exits use the ask at 3:45 PM. The bid must be at least 0.60 or the signal is ignored. The exit criteria is >50% profit. No stops are used.

Each trade is discrete and margin requirements are not considered. Assuming it were possible to enter the trade on the same day as the signal, profitability is slightly higher but not enough to justify the complexity of implementing this analysis on an intraday basis. Likewise, excluding days with zero volume did not affect the results much.


Excluding open trades:

7,064 total trades
7,031 were profitable (99.5%)

Total wins: $935,224
Total losses: -$11,160

stock where calls are overpriced is known as positive volatility skew (or call skew).. there are much, much, much better ways to take advantage of that besides just selling the calls..

instead of just selling a 35 delta call, also buy the 80-90 delta call, to form a vertical call spread.. IF the skew is there as you are saying, the long will hedge the short while giving you a positive expected return on the trade, with a breakeven below the current stock price..

if you're super concerned about a big down move, add a long OTM put to the trade

 

[Windlesham1]

Overpriced? Nothing is overpriced. You are dealing with prices generated by big players who are generally speaking not total idiots. Well, they may be but they would employ algo's that are not idiots. Single stock call options in the US? You'd get margin calls every 5 mins. I can show you 10 years of rock solid 95% wins with a put strategy on an index-means nothing if you don't take the trades. I don't always take the trades. (It makes about 15% a month on capital employed- ie margin)