Look-ahead Bias in Option Trading Backtests

Numerous option trading studies report finding strategies with remarkably high mean returns and Sharpe ratios. Are these findings too good to be true? In their October 2023 paper entitled “Too Good to Be True: Look-ahead Bias in Empirical Option Research”, Jefferson Duarte, Christopher Jones, Mehdi Khorram and Haitao Mo investigate the extent to which look-ahead bias drives extraordinarily high average returns and Sharpe ratios in two distinct option strategies: one based on stock characteristics (January 2012 through June 2020), and the other associated with liquidity provision in the options market (January 1996 through April 2016). They first replicate the strategies as published, and then recast the strategies with careful attention to what information is reliably available before trading. Using data over the above sample periods required to replicate and correct the original studies, they find that: (more…)