Some thoughts on back testing Super trader Karen's portfolio entries

In the last couple of weeks, our study group started some back-tests on Super-trader Karen's strategy. I worked on the entry rules as a beginning. Although major rules are described in my original post, there are some details or flexibility that need further explorations regarding the opening of the monthly portfolio.

Since all positions are not opened on day 56 to expiration, we need to have a range of opening days first. Then we should have some rules on when (conditions) to open options within the opening day ranges. Next we will need to figure out how many more puts to sell if necessary.

Personally, I prefer to test the opening of positions around 56 DTE +/- 7 days, because some of my recent studies showed far OTM option decay with a good rate starting around 2 to 2.5 month to expiration.

So, what are possible conditions for entering new trades in these 2 weeks? I tested the following rule briefly today, using an up-trending period from late October to November last year.

o   Before half positions are entered around 56 days to expiration (56 DTE + 7 days)

§  Sell put if market drops for 1 day and sell call if market rises for 1 day

o   After half positions are entered around 56 days to expiration (56 DTE - 7 days)

§  Sell put if market drops for 1 day and sell call if market rises for 3 days

DTE	Date	Option	Strike	Price	SumPremium
58	10/23/2013	S Put	151	0.265
57	10/24/2013	S Call	184	0.4	0.665
52	10/29/2013	S Call	186	0.35	1.015
51	10/30/2013	S Put	154	0.245	1.26

The December expiration monthly portfolio P&L chart is shown below. In the rising market, the short call strike at $184 got approached but not violated near the end of the option expiration. The 50% profit target worked well for this month as shown by the green bubble. The yellow bubbles named C1Back, P1Back and C2Back were located approximately 1 month after their corresponding entries.

In this example, holding positions longer than 30 days caused maximum profits for the portfolio. It was a surprise that this cycle would end in profits as the original thoughts were trying to find a tough period for the back test in the up-trending days (I'll provide an update if my script is found to have a bug). Due to the multiple entry dates and the fact that SPY never ended above the lowest upper short strike, the P&L of this cycle was not challenged at all.

Portfolio entry tests are a beginning of the back tests. We need to test various entry rules on different types of market conditions. After that, the adjustment rules will need to be back-tested. This may be the most complicated part of the strategy. Later on, exit rules will need some tests as well. Finally, we will put the rules together for comprehensive back-tests and finalize all the rules of the strategy.

The back-tests use end of day data only, as explained in the prior post. We will have to perform and analyze some paper trading which will give us real time trading experiences for this strategy before going on live accounts in the future.