Options Bry Boschan Spread Strategy

JHE YU LYU

July, 2017
 Outline
• The Strategy
• Data
• Backtest
• Improvement
• Conclusion

2
 The Strategy - Background
• Based on the findings of my thesis (Link):
• When the underlying asset S is bullish, the time value of put options decreases faster.
Underlying asset price Market price of OTM put options
62 120
60
100
58
56 80
54
60
52
50 40
48
20
46
44 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

• When the underlying asset S is bearish, the time value of call options decreases faster.
Underlying asset price Market price of OTM call options
56 120
54
100
52
50 80
48
60
46
44 40
42
20
40
38 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
3
 The Strategy - Background
• To take advantage of the time decay of the time value of options
• Based on daily data of options
• Securities traded: TXO (Taiwan index options)
• Focused on trading out of the money options

4
 The Strategy - Entry

Time value of Selling-put-

Bull Signal put options oriented Bull Put Spread
decreases faster strategies

Next trading day

Time value of Selling-call-

Bear Signal call options oriented Bear Call Spread
decreases faster strategies

5
 The Strategy – Defining Signals
• Three indicators
𝑆𝑡
• Past monthly return of the underlying assets: R𝑀
𝑡 = ln( )
𝑆𝑡−22
𝑆𝑡
• Past weekly return of the underlying assets: R𝑊
𝑡 = ln( )
𝑆𝑡−5
• Bry Boschan algorithm to define the market into bull or bear

1. R𝑀
𝑡 >0
2. R𝑊
𝑡 >0 Bull Signal
3. Bry Boschan is bull

1. R𝑀
𝑡 <0
2. R𝑊
𝑡 <0 Bear Signal
3. Bry Boschan is bear

6
The Strategy – Bry Boschan Algorithm

7
 The Strategy – Determination of Strike Price

• Bull Put Spread:

• at the money strike price – 100
• at the money strike price – 200
• Bear Call Spread:
• at the money strike price + 100
• at the money strike price + 200

8
 The Strategy – Example of Bull Put Spread

• If Bull Signal -> Bull Put Spread

• Sell Put 10,100 at 180
• Buy Put 10,000 at 121

9
The Strategy – Determination of Expiration of
Options Contract
• Monthly options due next month
• Higher premium income compared to weekly options

10
 The Strategy – Exit
• Stop Loss
• When the premiums of the selling position doubles, buy it back
and sell position with 200 points more out-of-the-money strike
price simultaneously
• E.g.: Assume, originally, the selling put 10,100 position of bull put
spread is selling at 180 points. When the index goes down and the
market price of that put increases to 360 points, buy it back to
stop loss, and sell put with a strike price of 9,900 simultaneously.
• Take Profit
• When the floating profit reaches 80% of initial net income
(Premium sold minus premium bought)
• No need to wait until the time value vanishes to zero
• To increase the turnover in order to build new position
11
 The Strategy – Position Sizing
• The margin of each spread position is set at 10% of the initial
deposit.
• Permitted to hold 5 spread position at most simultaneously
• Which means using only half of the initial deposit as margin
• E.g.: Assume initial deposit is 100,000. Margin requirement
of one spread is the difference of selling and buying strike
times contract multiples (100*50 = 5,000). 10% of the initial
deposit is 10,000. 10,000/5,000 = 2. So every spread position
is able to buy and sell 2 contracts respectively.

12
 The Strategy – Position Sizing
• For instance, there is a bull signal when t = 1, then construct
the first position to build a bull put spread (sell put*2, buy
put *2). When t = 2, there is also a bull signal, then construct
the second position to build another bull put spread (sell
put*2, buy put *2) until holding 5 spread positions at most
simultaneously.

13
 Backtest - Data
• Daily data from JihSunh

• R code (Link)

• Backtest Results (Link)

14
 Backtest – Output Table
• Backtest table - example
1 2 3 4 5 6 7 8 9 10
Type Date numeric numeric character character integer numeric numeric numeric numeric
Variable Date R_M R_W Bry Signal Position_count Floating_Profit Realized_Profit Margin_Requirement Cumulative_Return_%
1 2001-12-24
2 2001-12-25
… 2001-12-26
…
…
3725

11 12 13 14 15 16 17
Type numeric numeric numeric numeric integer integer integer
Variable Cumulative_Return_$ Risk_factor Sharpe_ratio Maximum_Drawdown Count_Bull_Put_Spread Count_Bear_Call_Spread Count_Options
1
2
…
…
…
3725

15
 Backtest – Output Table
• Open Position table - example
1 2 3 4 5 6 7 8 9 10 11 12 13

Type integer integer Date Date character integer character character numeric character numeric numeric numeric

Variable Order Order_Spread Date Entry_Date Type_Order Size Contract Due Strike Type_Option Entry_Price Close Floating_Profit

1 1 2001-12-24 2001-12-24 Buy 2 TXO 200201 4900 買權 170 180

2 1 2001-12-24 2001-12-24 Sell 2 TXO 200201 5000 賣權 70 80

1 2 2001-12-25 2001-12-24 Buy 2 TXO 200201 4900 買權 170 180

2 2 2001-12-25 2001-12-24 Sell 2 TXO 200201 5000 賣權 70 80

16
 Backtest – Output Table
• Account History table - example
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Type integer integer Date character integer character character numeric character numeric Date numeric numeric numeric numeric

Variable Order Order_Spread Entry_Date Type_Order Size Contract Due Strike Type_Option Entry_Price Exit_Date Exit_Price Commission Tax Profit

1 1 2001-12-24 Buy 2 TXO 200201 4900 買權 170 2001-12-26 180

2 1 2001-12-24 Sell 2 TXO 200201 5000 賣權 70 2001-12-26 60

3 2 2001-12-25 Buy 2 TXO 200201 4900 買權 170 2001-12-26 180

4 2 2001-12-25 Sell 2 TXO 200201 5000 賣權 70 2001-12-26 60

17
 Backtest – Parameters
• Test Period: Whole Sample or Latest 5 Years
• Delta Neutral: False, Using Futures, or Using Options
• K: (100, 200) or (200, 300) or (0, 100)
• Take Profit: 0.8 or 0.6
• Take into account tax, commission, and slippage: False or True
• Position Sizing: False or True
• Stop Loss: False or True
• How many scenarios?
• 2*3*3*2*2*2*2=288 in green: not yet finished
• Now only: 2*3*3*2*2*1*1=72

18
 Backtest – Without Position Sizing

Test Period:
Whole Sample

Without Delta Neutral Delta Neutral Using Futures Delta Neutral Using Options

K (100, 200) (200, 300) (0, 100) (100, 200) (200, 300) (0, 100) (100, 200) (200, 300) (0, 100)

Take Profit 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6

TCS: FALSE 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

TCS: TRUE 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36

Base

K: OTM Strike Price

TCS: Tax, Commission, and Slippage in red: to be tested
19
 Backtest – Without Position Sizing

Test Period:
Latest 5 Years

Without Delta Neutral Delta Neutral Using Futures Delta Neutral Using Options

K (100, 200) (200, 300) (0, 100) (100, 200) (200, 300) (0, 100) (100, 200) (200, 300) (0, 100)

Take Profit 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6 0.8 0.6

TCS: FALSE 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

TCS: TRUE 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72

K: OTM Strike Price

TCS: Tax, Commission, and Slippage in red: to be tested
20
 Backtest – Delta Neutral
• Example
• at-the-money strike price: 5900
• Bull Put Spread
• sell put 5800 (2002/2 due): 101 points
• delta of 5800 put: -0.3037426
• buy put 5700 (2002/2 due): 80 points
• delta of 5700 put: -0.1956767
• Delta neutral using futures
• sell put 5800: 1口
• buy put 5700: 1口
• Delta of spread = 0.3037426 - 0.1956767 = 0.1080659 => sell MTX 0.1080659口
• Delta neutral using options
• 0.3037426/0.1956767=1.5522676
• sell put 5800: 1口
• buy put 5700: 1.5522676 => rounding => 2口
• Set Threshold: If the absolute value of detla of the spread is smaller than 0.1, then
need not to delta neutral.
21
 Backtest – Tax, Commission, and Slippage

• Take tax, commissions, and slippage into account

• Tax (round to integer)
• Tax_options = 0.001 (e.g., 假設權利金24, 24*50*0.001=1.2, 四捨五入)
• Tax_futures = 0.00002
• Commission in NT$
• Commission_options = 18
• Commission_futures = 20
• Slippage of futures per entry and exit in NT$
• 250

22
 Backtest Result - Definition
• Initial Deposit = 2*MDD
• Cumulative_Return_%
• Cumulative_Return_$ / Initial Deposit *100
• Annualized Geometric Return
𝑖𝑒𝑛𝑑 −𝑖𝑏𝑒𝑔𝑖𝑛 +1
Cumulative_Return_%
• ( + 1 − 1) ∗ 252
100

• Risk_factor
• Annualized Standard deviation of daily return
• volatility of daily return
• 𝑠𝑡. 𝑑𝑒𝑣(Daily Return) ∗ 252
• Sharpe ratio
• (annualized daily return - risk free rate)/risk factor
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐷𝑎𝑖𝑙𝑦 𝑅𝑒𝑡𝑢𝑟𝑛 𝑋 252 − 0.01503
•
𝑅𝑖𝑠𝑘 𝑓𝑎𝑐𝑡𝑜𝑟 23
 Backtest Result – Good Spread

Backtest Result.xlsx (Link)

Each Spread Payoff Diagram (Link)

note: Base criteria, spread 205th

24
Backtest 13 – Base Criteria

25
 Backtest – To Be Tested
• Compare all delta neutral (whole sample)
• 13, 1, 25
• Compare whole sample and latest 5 years (all delta hedge)
• 13, 1, 25, , 49, 37, 61
• Compare 3 types of K (with delta hedge using futures)
• 13, 17, 21
• Compare 3 types of K (all delta hedge)
• 13, 17, 21,
• 1, 5, 9
• 25, 29 (Bug), 33 (Bug)
• Compare 2 types of Take Profit (with delta hedge using futures)
• 13, 15
• Compare 2 types of Take Profit (all delta hedge)
• 13, 15,
• 1, 3
• 25, 27
• Compare before and after tax for base criteria including Total profit, MDD, Total Profit/MDD,
annualized geometric return
• 13, 14
• Compare all
in red: Backtested but not yet summarized
26
 Backtest Result – Compare all delta neutral
(whole sample)
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
-
-1,000,000 Using Futures Without Delta Using Options
Neutral
Total Profit in NT$ MDD

27
Backtest Result – Compare whole sample and
latest 5 years (all delta hedge)

28
Backtest Result – Compare whole sample and
latest 5 years (all delta hedge)
4,500,000
4,000,000
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
-
-500,000 Using Futures Without Delta Neutral Using Options Latest 5 Years, Using Latest 5 Years, Latest 5 Years, Using
Futures Without Delta Neutral Options
-1,000,000
Total Profit MDD

29
Backtest Result – Compare 3 types of K
(with delta hedge using futures)

30
Backtest Result – Compare 3 types of K
(with delta hedge using futures)
Delta Neutral Using Futures
7,000,000.00
6,000,000.00
5,000,000.00
4,000,000.00
3,000,000.00
2,000,000.00
1,000,000.00
-
(1,000,000.00) (100, 200) (200, 300) (0, 100)

(2,000,000.00)
Total Profit MDD

31
Backtest Result – Compare 3 types of K (all delta hedge)

32
Backtest Result – Compare 3 types of K (all delta hedge)
7,000,000

6,000,000

5,000,000

4,000,000

3,000,000

2,000,000

1,000,000

-
K = (0,100) K = (100,200) K = (200,300) K = (100,200) K = (200,300) K = (0,100) K = (100,200)
-1,000,000 Using Futures Using Futures Using Futures Without Delta Without Delta Without Delta Using Options
-2,000,000 Neutral Neutral Neutral

Total Profit MDD

33
Backtest Result – Compare 2 types of Take Profit
(with delta hedge using futures)

34
Backtest Result – Compare 2 types of Take Profit
(with delta hedge using futures)
Delta Neutral Using Futures
4,000,000
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
-
-500,000 Take Profit = 0.8 Take Profit = 0.6
-1,000,000
Total Profit MDD

35
Backtest Result – Compare 2 types of Take Profit
(all delta hedge)

36
 Backtest Result – Compare 2 types of Take Profit
(all delta hedge)
5,000,000

4,000,000

3,000,000

2,000,000

1,000,000

-
Take Profit = 0.8 Take Profit = 0.8 Take Profit = 0.8 Take Profit = 0.6 Take Profit = 0.6 Take Profit = 0.6
-1,000,000 Using Futures Without Delta Neutral Using Options Using Futures Without Delta Neutral Using Options

-2,000,000
Total Profit MDD

37
Backtest Result – Compare before and after
Tax, Commission, Slippage for base criteria

38
 Backtest Result – Compare before and after
Tax, Commission, Slippage for base criteria
Delta Neutral Using Futures
4,500,000
4,000,000
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
-
-500,000 Before TCS After TCS
-1,000,000
Total Profit MDD

39
Backtest Result – Compare All

40
7,000,000
Highest
Profit:
606M
Backtest Result – Compare All
6,000,000

5,000,000

4,000,000
Highest
Profit/MDD: Highest
23.5 Annualized
3,000,000
Geometric
Return:
2,000,000
46%
1,000,000

-
K = (0,100) K = (100,200) K = (200,300) K = (100,200) K = (200,300) K = (0,100) K = (100,200) Latest 5 Latest 5 Latest 5 Take Profit = Take Profit = Take Profit = After Tax,
-1,000,000 Using FuturesUsing FuturesUsing Futures Without Without Without Using Years Years Years 0.6 0.6 0.6 Commission,
Delta Neutral Delta Neutral Delta Neutral Options Using Futures Without Using Using Futures Without Using Slippage
Delta Neutral Options Delta Neutral Options
-2,000,000

Total Profit MDD

41
The Ability of Signals to predict Future Market States
• Can bull and bear signals used in this strategy (including Bry Boschan
algorithm) predict future market states (e.g., future weekly or
monthly returns of S) ?
• By Regression
• Explanatory Variable
• Bull_Signal or Bear_Signal
• Response Variable
• Future_Weekly_Return: log(𝐶𝑙𝑜𝑠𝑒𝑡=5 /𝑂𝑝𝑒𝑛𝑡=1 )
• Future_Monthly_Return: log(𝐶𝑙𝑜𝑠𝑒𝑡=22 /𝑂𝑝𝑒𝑛𝑡=1 )

42
The Ability of Signals to predict Future Market States
Bry Boschan Algorithm

43
The Ability of Signals to predict Future Market States
Regression Result – Predict Future Weekly Return

Not Significant

44
The Ability of Signals to predict Future Market States
Regression Result – Predict Future Monthly Return

Not Significant

45
 Conclusion
• Best Parameters
• K = (0, 100)
• Reason of Good Performance
• Not from the ability of signals to predict the market trend
• Decaying Time Value of Options
• Safety of Spread Position

46