Ep49 - The Problem with Backtesting

Dan takes a critical but balanced look at backtesting and why it often leads traders astray, especially when it comes to strike and expiration selection for covered calls and cash-secured puts. Drawing on decades of experience and firsthand work with traders and developers, Dan explains why backtesting tools have structural limitations, how those limitations create misleading conclusions, and why discretion, objectives and real-world market structure still matter far more than “optimal” backtested metrics.

Key Topics

• What backtesting is—and what it’s actually good for
• Why strike and expiration selection matter so much for edge
• The hidden limitations of backtesting platforms
• Why support and resistance can’t be meaningfully backtested
• The subjectivity of fundamental analysis and valuation models
• Common backtesting strike rules: delta, % moneyness and standard deviation
• Why no single delta or strike distance can be “best”
• Rounding errors and incomplete option-chain data
• Entry/exit limitations caused by expensive market data
• Unintentional data fitting based on test time horizons
• How backtesting can create false confidence and bad habits
• Using objectives (skate vs. trade) to guide real-world strike selection
  

Key Takeaways

• Backtesting is useful—but incomplete. It can inform strategy behavior, but it cannot capture discretion, context or market structure.
  
  
• Strike “optimization” is often an illusion. Apparent outperformance by a specific delta or distance is usually the result of rounding, data constraints or time-period bias.
  
  
• Markets don’t reward mechanical precision. If one delta were objectively superior, the options pricing model itself would be broken.
  
  
• Support, resistance and fundamentals matter but can’t be coded cleanly. These human-driven factors provide real edge but resist automation.
  
  
• Objectives should drive decisions. Use technical levels for skate trades and fundamentals for trade-objective setups.
  
  
• You’ll never get it perfectly right—and that’s OK. Adjustments and rolling are part of the wheel, not failures.
  

Connect

• Learn more about host Dan Passarelli and Market Taker Mentoring: MarketTaker.com
• Get exclusive content including video trade walk-throughs, Dan's actual trades, monthly AMA webinars and more: wealthbuildingpodcast.com
• Subscribe on your preferred platform and leave a review to help more traders discover the show.

Disclosure:

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, investors must read Characteristics and Risks of Standardized Options (ODD) which can be found at https://www.theocc.com/company-information/documents-and-archives/options-disclosure-document

Don’t trade with money you are not prepared to lose. Anything discussed on this show is intended to be generalized information and not intended to be a recommendation to buy or sell any security. The host and guests are not familiar with listeners’ specific situations. For trading information relevant to your specific needs, speak with a licensed broker or advisor.  

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