Sunday, July 26, 2009

A simple way to Backtest Option Straddles

Here, I show how one could follow a simple approach to backtest the profitability of Option Straddles. Straddles are a way to get exposure to volatility of a stock. A Long Straddle means buying an AT-THE-MONEY CALL and PUT option of the same expiration date. Vice versa for a Short Straddle position.

TO profit from a straddle position, One should be able to calculate, historically, how many times did the stock move beyond the premium one would pay for the STRADDLE Position. For example, If a Straddle on a stock costs $4, It makes sense to check how many times in the past did the stock move more than $4, UP or DOWN. I.e if the option expires in 30 days, one needs to find out on any given 30 days in the past, how many times has the stock moved beyond $4. This is only one of the many things one needs to do before buying or selling straddles. This combined with the Volatility Cones and calculation of "Average" spread between Realized Volatility and Implied Volatility should give an investor some information to trade them. One can also look into "Strangle".

Here is a figure that shows a stocks historical movements over the past 3 years for a 30 day rolling window period.


One can see from the chart that in the past 3 years, CNH has moved beyond $5 only 50% of the time, 60% more than $3.8, 70% more than $2.66 etc. So if a straddle costs only $2.66, then Historically, 70% of the time it has moved more than $2.66 in 30 days. On the other side, there is still a 30% chance that it will not move beyond $2.66.




MATLAB CODE:

Backtest_Straddles.m

9 comments:

vJD said...

I would be interested in a more general option-strategy backtesting framework under MATLAB/Octave.

Do you have a hint where one can find one? Or do you plan to extend on this one?

Cheers,
Holger

jbr said...

Unrelated to this post but was wondering if you could help suggest a way to get free option/implied vol historical data? I use Matlab's datafeed toolbox to get stock quotes from quotes.yahoo.com but don't know where to get historical option data.

Thanks!

s said...

I see that you analyze lot of etf's and general stochastics such as vix etc. Is there a reason you do not do any stock specific scans? Is this something you tried and found it does not work or something you mean to?
Great blog.

I am very familiar with Matlab and use it often. I have been intending to use the financial toolbox and analyze stock charts. Your response might help my effort.

Thanks.

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Options Trading said...

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KLSE Stock Analysis said...

If it has moved beyond $5 only 50% of the time, in the past 3 years, then it is definitely be a profitable step for the investors as it would go more high.