by Roger Lee
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Suggested foundations for options and derivatives pricing and trading research and honest backtests. Specialist prerequisites vary by paper.
Build replication and risk-neutral probabilities in a tractable model.
Distinguish pricing probabilities from physical forecasts.
Use only information available at the simulated decision time.
Separate model selection from the final evaluation.
Connect the pricing equation, closed-form value and implied volatility.
Reconcile signals, executions, positions and P&L.
Include the costs that can erase a paper strategy.
Start in discrete time, move to Brownian motion, then read the original pricing argument and simulate it.
Choose a reproducible strategy, specify the trading rule, and test what remains after costs and estimation uncertainty.