Considering Something Simple:
Sample Variance*

 or why I wrote the new Option Wizard® Simplified Options Strategy (SOS) Backtester



By John A. Sarkett

Designer, Option Wizard®




"  I like this new software.  Has some real trading applicability.  Easy to use, lightning fast.  Since markets cycle and things change, I especially like the customizability of the time frame studied.  Good addition to the toolbox of the delta neutral or directional trader. "

Dan Harvey

20 year veteran of successful options trading
Called "supertrader of index condors" by SFO magazine, and
Instructor, Sheridan Options Mentoring



Instructional notes




Success in options, as in life, requires lots of things, but three things hit me as I write this:


·        A competitive edge

·        Stamina

·        Confidence


In the last five to ten years, delta neutral trading has taken center stage in the options world, favored because it is a (relatively) low-risk, high reward enterprise.  Some consider it their “edge,” but it is not an edge, it is an approach, a concept, that itself requires an edge.


It only works for those who know what their edge is, exploit it, and come back month after month to collect their earnings, even if the last month, or two have been losers.  They can come back, because they haven’t confidence in their research, their historicals.


So the “easy money” here is not that easy.  Takes work.  You have to do your homework.  Just putting the same trade on every month without knowing your edge is not a winning strategy.


Calls to mind the old saw about the poker game.  If you look around the room, and don’t know who the patsy is ---- you’re the patsy.


Options are probabilities.  There is no sure thing.  The question is always:  what is the likelihood?  No one knows the future, but the past is prelude, and even if history doesn’t repeat itself, it does tend to rhyme.


Here are some questions options traders ask themselves every day.


  • I think the market will go sideways here.  I want to put on a condor.  

  • But which stock moves more than 5 percent most often in any 17 day period, over the last five years:  IBM or MSFT. ?

  • Which index or ETF moves less than 5 percent most often, DIA (DJ30), QQQQ (Nasdaq 100) SPY (SP500), IWM (Russell 2000).


The answers:

To:  "But which stock moves less than 5 percent often?"


Using Option Wizard® Simplified Options Strategy (SOS) Backtester, we ran the numbers.  Over the last five years, these stocks have moved 5 percent (or more) in a 17-day period::


  • IBM – 30.13% of the time

  • MSFT  – 40.36%


IBM may be a better bet for a delta neutral strategy.


And the broader indices, how did they fare?


  • DIA – 20.46%

  • QQQQ – 35.08%

  • SPY – 22.86%

  • RUT – 37.88%


Does this sort of thing matter?


It does.


We know empirically quite a few options traders trade the Russell 2000 as a condor vehicle each month, not realizing it is nearly twice as volatile as the SP500.  (One might ask then, do the premiums compensate?  Short answer:  sometimes yes, sometimes no.  Pays to look.)


A quick study of variance would tell them that.  It should not come as a surprise, then, that for many, the results have not been good.


That’s the competitive edge – but here working against them.


A second example, you have in mind to earn some income with a calendar spread on Big Pharma.  Until recently MRK retained much of its luster, while PFE was looked down upon.  Which stock is more stable?


Using the same measure as above, incidence of > 5% moves up or down in 17 days, we find:


MRK – 40.36%




PFE – somewhat less at 34.20%


But how about a stock that gets less media attention than either MRK or PFE, then:


LLY – 26.45%.



That might be the one.


Or, if one does choose MRK, or PFE, for reasons fundamental or technical or other, they should be prepared for quicker and more meaningful adjustments, e.g. turning a calendar into a double calendar.


Option Wizard® Simplified Options Strategy (SOS) Backtester shows one other important thing, especially for those who like to dig in their heels and “take the heat.”  Prices that move outside of 5% or 7% or 10% bands “x” days ago, are often breaking out, either to the upside or downside.  Pays to exit at breakeven, or adjust, and play again another day, and protect one’s options principal.  Bodies in motion tend to stay in motion.  Bodies at rest tend to stay at rest.


Caveat emptor.


One other aspect bears mention:  time.  That ol’ debbil.


Go out one more expiration and there is only a 42% chance that MRK will stay within the 5% borders set here by the options strategist.  That might then suggest another strategist, in this case, if volatilities were sufficiently low, buying a straddle, and expecting MRK to follow its historical precedent and, in fact, move out of its 5% bounds.



Everyone has to do their own due diligence, everyone has to come to their own conclusions.  Tools like this will help one do just that.


At least this quick study of variance provides either confirmation of additional fundamental and technical research, or the jumping off point for same.


Perhaps the most important part of the whole enterprise here, then, is not any one calculation, any one trade, but putting a year’s worth of probabilities in your favor.  If you know that a given options strategy should be successful 9 out of 12 months, and you undertake it, and lose the first month, get discouraged, and don’t return for months 2 and 3 and 4, where you would have likely been profitable, well…..your probability of failure becomes 100%.


And no one wants to undertake that probability.



Speed:  one click per day or one click per 5 years data?


One last point:  speed.  Many of us have spent hundreds of hours clicking day-by-day data in options programs with a backtest capability or a certain broker's "thinkback" function, again, clicking day by day.  Time consuming and daunting.  We built Option Wizard® Simplified Options Strategy (SOS) Backtester because, like Tom Cruise in Top Gun for a long time we have felt the "need for speed."  There's a lot this new package for Excel doesn't do, e.g. provide for options volatility, or price spikes (or their counterparts regression) or risk management skill on the part of the trader, most notably.  But for a fast, one-click, 5-year data look that can jump from MRK to PFE to LLY in seconds, and then go from SPX to SPY to DIA to QQQQ to NDX in under a minute -- well, several among the options cognoscenti have told us that we have something very valuable for the options community here.


Now, the most important member of that community, you, can decide right here and now with a free and easy trial.



* Using the term "variance" here as "simple variance," i.e. The variance is a parameter describing in part either the actual probability distribution of an observed population of numbers, or the theoretical probability distribution of a not-fully-observed population of numbers. In the latter case a sample of data from such a distribution can be used to construct an estimate of its variance: in the simplest cases this estimate can be the sample variance — that is, the variance of the sample data.  Source:  Wikipedia.  Emphasis here on the word "simple" -- we know there are other and more complex measures of the concept known as variance.  JS

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