Backtesting the Covered Call Strategy with a Stop-loss
These are some backtest results from using a stop-loss on a covered call strategy. A systematic covered call strategy acts like a yield-generating strategy but suffers from occasional large drawdowns when the underlying asset increases past the strike price and expires ITM.
A community member suggested the use of a stop-loss to reduce the drawdowns, and so we tested a stop-loss at varying prices relative to the strike price to see whether it improved the strategy.
We tested executing the stop-loss when the price goes ITM(past the strike price), at 95% of the strike price and 90% of the strike price.
Backtest Settings
Backtest Period : 2019–4–4 ~ 2022–8–14 (1227 days)
Delta Setting : Low
Cycles : 175 weeks
No Stop-loss Results
Win Weeks : 169 (96.6%)
Loss Weeks : 6 (3.4%)
Win week average return : 1.17%
Loss week average return : -13.67%
Max Single Loss : -44.67%
Max Drawdown : -53.66%
Lifetime(3.4 years) Profit : 167%
Stop-loss @ ITM
Stop-loss is executed when the price of the underlying asset is above the strike price.
Win Weeks : 163 (93.2%)
Loss Weeks : 12 (6.8%)
Win week average return : 1.17%
Loss week average return : -27.77%
Max Single Loss : -76.80%
Max Drawdown : -95.13%
Lifetime(3.4 years) Profit : -93%
Stop-loss @ 95% of Strike Price
Stop-loss is executed when the price of the underlying asset is at 95% of the strike price.
Win Weeks : 151 (86.1%)
Loss Weeks : 24 (13.9%)
Win week average return : 1.19%
Loss week average return : -11.08%
Max Single Loss : -33.60%
Max Drawdown : -74.30%
Lifetime(3.4 years) Profit : -68%
Stop-loss @ 90% of Strike Price
Stop-loss is executed when the price of the underlying asset is at 90% of the strike price.
Win Weeks 116 (66.2%)
Loss Weeks 59 (33.8%)
Win week average return 1.28%
Loss week average return -3.68%
Max Single Loss -18.30%
Max Drawdown -60.94%
Lifetime(3.4 years) Profit -55%
Results Summary
Stop-loss is a common strategy used to reduce drawdowns in systematic trading strategies, but for covered calls it materially impairs the profitability of the strategy due to the reduced win rate and disadvantageous price conditions the options are executed in.
Also, it is important to note that prices occasionally surpass the strike price, but returned below it at the time of expiry. This would mean the strategy takes a relatively large loss despite not having needed to.
Over the 3.4 year backtest, after entering a position, BTC exceeded the strike price 12 times, but only expired ITM 6 times(50%)
Although these are slightly unintuitive results, we intend to continue to research ways to reduce losses and maximize returns for our covered call strategies.
