by Habib Badawi, Mohamed Hani, Taufikin Taufikin
Continue on SelfMadeQuant
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.