Backtesting the Short Strangle Strategy: A 6-Month Performance Analysis with Insights

Disclaimer: Avoid applying this strategy directly in live markets, as it does not guarantee success. The results shared are purely based on historical backtesting, and no single strategy can assure financial gains.

In this blog, we will dive into the short strangle trading approach, implement it using historical data from the last six months, and review its performance metrics.

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A strangle strategy involves the simultaneous buying (or selling) of both a call option and a put option on the same underlying asset. These options have identical expiration dates but different strike prices.

Types of Strangles:

1. Long Strangle: This involves purchasing both a call and a put option. It works well in high-volatility conditions.
2. Short Strangle: This involves selling both a call and a put option. It is suitable for low-volatility environments where the asset price is expected to stay within a certain range.

In this discussion, we will focus on the short strangle strategy, which is an option-selling method.

For this approach, we sell out-of-the-money (OTM) call and put options based on the current spot price of Nifty, specifically two levels above and below the ATM strike price (ATM+2 or ATM-2). This method is commonly used due to its simplicity and effectiveness.

Example:

• If Nifty’s spot price is 19,500, the trades would include:
• Call Option: Strike price of 19,600 or 19,700
• Put Option: Strike price of 19,400 or 19,300

Underlying Logic:

• The strategy aims to capitalize on time decay (theta) while relying on the low probability that deep OTM options will be exercised.
• Selling OTM options reflects the belief that the market will stay within a specific range and avoid significant price movements before expiration.

1. Strike Price Selection:

• Choose strikes that are two levels away from the ATM price.
• For example, if Nifty’s spot price is 19,500:
• Sell a call option at 19,600 or 19,700.
• Sell a put option at 19,400 or 19,300.

2. Weekly Options:

• Weekly options experience accelerated time decay, making them ideal for this strategy to leverage theta.

3. Stop Loss:

• A 1.2% hard stop-loss is placed on capital to manage risks from unforeseen market movements.

Parameters:

• Initial Margin Requirement: ₹70,000 per lot.
• Options to Sell: OTM+/-2 CE and PE based on Nifty’s spot price.
• Stop Loss: 1.2% of the allocated capital.
• Trade Timing: Enter at 9:40 AM and exit at 3:15 PM each trading day.

Overall Results:

• Capital Required: ₹70,000
• Net Profit: ₹11,917.50
• Average Monthly ROI: 2.88%
• Total ROI Over 6 Months: 17.03% (124 trading days)

Win-Loss Analysis:

• Win Rate: 64.52% (80 out of 124 trading days were profitable).
• Average Daily PnL: ₹96.11.
• Average Profit on Winning Days: ₹597.27.
• Average Loss on Losing Days: ₹815.09.
• Highest Daily Profit: ₹2,443.75.
• Biggest Daily Loss: ₹1,540.00.

Risk Assessment:

• Maximum Drawdown: ₹4,152.50 (-5.09% of capital).
• Sharpe Ratio (Annualized): 1.96 (indicates solid risk-adjusted performance).
• Sortino Ratio (Annualized): 7.22 (excellent downside risk control).

Monthly Returns:

The strategy delivered consistent profits across the six months of backtesting, with every month closing positively.

Daily Returns:

While most trading days were profitable, Fridays tended to underperform, likely due to minimal time decay remaining before weekly expirations.

The short strangle strategy achieved a 17.03% ROI over six months with reasonable drawdowns and strong risk-adjusted metrics. The performance metrics, including the Sharpe and Sortino ratios, indicate that the strategy is well-suited for capturing steady returns while effectively managing downside risks.

Areas for Optimization:

While the strategy shows promise, adjustments could enhance results further. For instance:

• Modify the entry and exit times to target favorable market conditions.
• Experiment with different strike price selections to reduce drawdowns.