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Backtesting with OptimalTrader
OptimalTrader (OT) provides a great deal of ability to test
your option strategy ideas. This article will show you how you might answer
the question of which strategy is best to do in a low implied volatility situation.
Using the knowledge gained by following this example, you can test one of your own hypothesis and develop it into
a trading system. This can be
used to greatly increase your confidence and eventually profits in your
option trades.
Step 1: Create a list of options that are very active
In order
to avoid large gaps between the bid and ask, it is a
good idea to use stocks that have a high open interest. Open Interest is the
total number of option contracts which are currently active for that symbol.
This is
done by navigating to the Technical Analysis page of OT and running a scan for
open interest.
In my
example, I also limit the Minimum Stock Price to stocks that are at least $10.
There is an entry field to put that in on the right hand side of the page. Once
I have selected the Pattern to Find, and Symbol List to Search, click on the
Find button and OT will begin running the scan.
The
results will be displayed on the screen. With this list we can create a symbol
list of those stocks with the highest open interest. Click on the Op Int Today so that the stocks with the highest open interest
are on top.
To create
the list, click on the “Create New Symbol List…” button on the bottom of this
page. Fill out the screen that appears similar to this example shown. Click on
Create List to create the list. This will complete Step 1.
Step 2. Scan for stocks which have low implied
volatility
In the
example we are trying to create a system which will allow us to find good
trades when a stock has low implied volatility (IV). For this example I am
going to test using January 14, 2003 as my test date. I chose this
date because the VIX was low on this date.
So you
need to set the System Date to January 14, 2003. Stay on the Technical Analysis
page and scan for stocks using the IV Range search, and select our new Top 100
Open Interest list as our list of symbols to use. For this scan I put the
Minimum Stock Price to 0 because it will be faster.
Click on
the Find button to begin the scan. Once the scan is finish, sort on the “% in
IV Range” column, with the lowest IV stocks on top. For this example I have
checked the checkboxes of the stocks with an IV Range of under
10 percent.
Step 3: Transfer these symbols to the MultiFind page
We want
to look for bearish trades for the purposes of our example, and we want to
search all of them at the same time. For the purposes of our search, we are
going to make some assumptions that the stock will go down 5 percent in the
next 30 days. So we click on the button on the bottom of the page called,
“Search For Trades…” and fill in the values.
Then we
click on the “Add the Symbols to the MultiFind Page” button. This will copy the
symbols to the MultiFind page and fill in the TargetPrice
and TargetDate fields.
Note: In
this example I actually excluded DIA because it caused the copy to MultiFind to
fail. I will have to fix this bug in the next release.
Step 4: Search for Trades
After
navigating to the MultiFind page, I see that the search parameters have been
entered. All that I have to do is click on the “Next Step” button.
For my
example I only select a few of the strategies which I think might work for a
bearish trade. After selecting my strategies I click on the “Begin the Search”
button.
Step 5. Reduce the Number of Trades
After
the search has completed, we will have a list of trades on the Search Results
page (no picture shown here). For our example, I am going to reduce the trades.
I am going to click the Trim Results and remove trades that either won’t make
enough profit for me to consider, and trades where it looks like the profit is unrealistic.
For this
example, the first trade (BBY Ratio Backspread) looks too high. And the risk is
less than zero. I am also going to remove every trade that won’t make 20%
profit. Again, this is a lesson on how to develop a system, and not necessarily
that we are going to find a good system here. When you build your system, you
might choose different trade situations, different strategies, etc…
After
removing those trades I don’t like I end up with 31 potential trades.
Step 6: See our results
Shortly
in this process we will see the fruits of our labor, to see how profitable we
would be in this situation. The goal of course is to learn what kinds of trades
work in each type of situation and then in the future apply those techniques so
that you can make a profit.
We are
going to move the System Date forward to January 27th and see our
results. I picked that day be cause it had high IV and would be the day when
our maximum profits should appear. After moving the date forward, click on the
Recalc button under the Search Results trades list. When the Recalc is
finished, a summary page will appear.
Our
results weren’t too bad. 18% profit in two weeks. If we could
do this every two weeks then… Well we can dream can’t we?
When I
look at my results I see that the butterfly trades which were at the top didn’t
do so well, and that the Bear Call Spreads and Bear Put Spreads did very well.
If I go back in the process and change the strategies to try, putting in only
those type trades, then I get different results.
Of course
hindsight is 20/20.
Step 7. Repetition
Keep
trying different scenarios using other technical patterns and try different
things. Taking this example, the next thing I would try would be to see if in a
low IV situation that the vertical spreads are always the best thing to do.
When you
find one that seems to work consistently, then you should try it with real
money, but not before.
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