OptionSmile is not an options backtesting platform in a conventional meaning. Its methodology has some key distinctions from the typical way of backtesting:
Options Fair Value disregards the views of options markets on how much an option contract should have worth in the past. The only data required to calculate this value is the underlying security returns distribution – as a probability measure. This feature provides for more solid options mispricing estimation when the volatility skew and time structure (vol surface) deviate from their historical averages.
OptionSmile can provide the options valuation based on the time periods when the options market was not liquid, not mature or did not even exist. That gives us more historical data points and more robust estimations of an options strategy efficiency.
Avoidance of a “Sequentiality” Trap
Fair Value calculation refrains from the “sequential” approach used in a standard simple backtesting when each trade opens after the closure of the previous one. Instead, the Fair Value calculation concentrates on the statistical properties of the underlying security and takes into account each day in history and does not accidentally miss any significant market moves, which can be easily “jumped over” by a sequential backtest.
In this post, we take a closer look at these key advantages of the OptionSmile approach.