How to Use Backtesting Software for Options Strategies
Introduction: Why Backtesting Is Crucial for Options Traders
Backtesting is the process of applying a trading strategy to historical market data to determine how it would have performed. For options traders, this step is indispensable. Options are complex financial instruments with multiple variables such as time decay, volatility, strike price, and moneyness—all of which can affect the strategy’s profitability.
Using robust backtesting software allows you to validate your ideas before risking real capital. It bridges the gap between theory and practice and helps aspiring self-sufficient traders reduce emotional decision-making by relying on data-driven strategies.
In this article, we’ll cover:
- How to choose the right backtesting software
- How to set up a comprehensive options backtest
- How to interpret and apply the results
Whether you’re experimenting with credit spreads, iron condors, or naked puts, this guide is designed to help you avoid the rat race and build toward financial freedom—one tested strategy at a time.
1. Software Options: Top Backtesting Tools for Options Traders
There are numerous platforms available for options strategy backtesting. Your selection should depend on your skill level, the depth of data available, and the complexity of your strategies.
1.1 ThinkOrSwim by TD Ameritrade
Strengths:
- Free platform with live and historical data
- Advanced charting and scripting through thinkScript
- PaperMoney account for simulated trades
Limitations:
- Options backtesting requires manual setups
- Limited automation for complex multi-leg strategies
🔗 More on ThinkOrSwim PaperMoney
1.2 OptionNet Explorer
Strengths:
- Specifically designed for options backtesting
- Tracks Greeks, P&L, and volatility
- Visual risk graphs and trade journaling tools
Limitations:
- Paid subscription required
- US markets only
1.3 ORATS (Option Research & Technology Services)
Strengths:
- Institutional-level backtesting engine
- Customizable testing windows and variables
- Access to over 20 years of data
Limitations:
- Steep learning curve
- Higher pricing tiers for advanced access
1.4 QuantConnect
Strengths:
- Algorithmic trading framework for coders
- C# and Python support
- Plug into global options markets
Limitations:
- Requires programming skills
- Steeper setup curve for beginners
🔗 Get started with QuantConnect
1.5 Excel or Google Sheets (Manual)
Strengths:
- Great for beginners
- Full control over data input and logic
- Good for journaling simple trades
Limitations:
- Manual and time-consuming
- Harder to simulate dynamic variables like IV crush
🔗 See example options trading journals
2. How to Set Up Backtests: Step-by-Step Workflow
Once you've selected your preferred platform, the next step is to create a robust and repeatable backtesting process. Below is a generalized workflow diagram for setting up an options backtest.
🖥️ Illustration: Workflow Diagram of Backtesting Setup
Now, let’s break it down.
2.1 Define the Strategy
Clearly state the rules of your strategy. For example:
- Strategy Type: Vertical Credit Spread
- Entry Conditions: Sell when RSI > 70 and IV percentile > 60%
- Expiration: 30 days
- Strike Selection: 1 SD away from ATM
- Exit Rule: Close at 50% max profit or 21 DTE
Avoid vague entries like "enter when market looks weak"—your rules should be programmable or easily repeated manually.
2.2 Choose the Historical Timeframe
You’ll want to test your strategy over multiple market environments:
- Bullish Trends (e.g., 2020–2021)
- Bear Markets (e.g., 2008, 2022)
- Sideways Periods (e.g., Q1 2023)
This ensures the robustness of your system under various conditions.
2.3 Collect Relevant Data
Look for:
- Historical options chains with implied volatility
- Underlying stock prices
- Interest rates and dividend adjustments
- Greeks (Delta, Theta, Vega, Gamma)
Platforms like ORATS and OptionNet Explorer provide full options chain history, which is critical for testing realistic fills and volatility decay.
2.4 Execute the Backtest
Whether manually in Excel or using automated software, simulate entries and exits according to your rules. Log each trade with:
- Entry/exit dates and prices
- Premium collected or paid
- Maximum risk and return
- Greeks at entry
- Market context (earnings, news, macro trends)
2.5 Record Metrics for Review
Capture metrics like:
- Win Rate
- Average Profit per Trade
- Max Drawdown
- Sharpe Ratio / Sortino Ratio
- Expectancy (Avg. gain x win rate – Avg. loss x loss rate)
All these contribute to the long-term viability of your options strategy.
3. Interpreting Results: What Makes a Backtest Valuable?
The backtest is only as good as your interpretation of the results. Misreading data can lead to overfitting or false confidence.
3.1 Avoiding Overfitting
If your strategy performs well on one specific period (e.g., 2020–2021 bull run) but fails elsewhere, it may be curve-fitted. This is a trap many traders fall into by “tweaking” a strategy until it fits historical data perfectly—but it fails in the real market.
Use Out-of-Sample Testing:
Split your data—optimize on one half, validate on the other.
3.2 Understand Volatility’s Role
Options are vega-sensitive. A strategy may work well when IV is high but fail in low IV environments. Study how your trades perform across different VIX levels or implied volatility percentiles of the underlying.
🔗 Learn more about IV and options here
3.3 Visualize Equity Curves
A rising equity curve with limited drawdowns indicates consistency. Look at:
- Slope of curve (indicates growth)
- Equity dips (frequency and magnitude)
- Recovery time (how fast it bounces back)
Use visuals to complement your findings.
3.4 Statistical Edge vs. Random Luck
Look for signs that your edge is repeatable:
- Strategies that rely on rare events (e.g., black swan spikes) may have good backtests but poor forward performance
- Sustainable strategies tend to have multiple small wins and controlled losses
3.5 Trade-By-Trade Breakdown
A detailed analysis of each trade—win or lose—helps you refine logic. Was the trade exited too early? Did earnings cause unexpected movement? Did time decay work in your favor?
This micro-review reveals improvement opportunities.
4. Real-World Example: Backtesting an Iron Condor Strategy
Let’s apply the workflow to a real-world strategy.
Setup:
- Underlying: SPY
- Strategy: Sell 1 SD Iron Condor
- Expiration: 30 DTE
- Entry Rule: Enter when IV Rank > 50%
- Exit Rule: 50% max profit or 21 DTE
Backtest Result (Using OptionNet Explorer):
- Time Period: Jan 2020–Jan 2024
- Total Trades: 72
- Win Rate: 78%
- Avg Return per Trade: +$112
- Max Drawdown: -$970
- Sharpe Ratio: 1.45
- Notes: High IV periods yielded better risk/reward
Conclusion: Strategy is viable but performs poorly in low IV and trending markets. Could filter trades using RSI or Bollinger Band ranges to improve.
5. Best Practices for Backtesting Success
To make the most out of your backtesting journey, follow these principles:
- Be Consistent: Use defined, repeatable rules.
- Start Small: Test one strategy thoroughly before juggling many.
- Review Regularly: Revise your hypothesis with each market phase.
- Document Everything: Maintain a journal or trade log.
- Transition to Paper Trading: Use backtest results to guide paper trades before going live.
🔗 How to transition from backtest to live trading
Final Thoughts: Your Data-Driven Trading Edge
Backtesting helps take the guesswork out of trading. In the options market, where variables are complex and risks are asymmetric, having confidence in your strategy can be a game-changer.
Remember: it’s not about predicting the market—it’s about preparing for different conditions with a tested, disciplined approach. Whether you're refining a wheel strategy, building a butterfly, or layering a diagonal calendar, the tools and methods shared here will help you make smarter decisions.
📣 Call to Action
At www.optionstranglers.com.sg we offer:
- ✅ In-depth live 1-1 sessions / group classes
- 📊 Real trade examples and breakdowns
- 🤝 Community mentorship and support
👉 Ready to upgrade your strategy and trade like a pro? Visit www.optionstranglers.com.sg and start your journey to financial freedom today.
Your future is an option. Choose wisely.
⚠️ Disclaimer:
Options involve risk and are not suitable for all investors. Always consult with a financial advisor before investing.