Option trading pricing and volatility strategies and techniques


Sitemap Contact Us Login. This book aims to provide professional option traders with a solid understanding of the theory and practice of option trading. The typical reader would be an employee of a bank, a hedge fund or a market making firm that trades options, rather than an individual investor. There is no pretence that this will be an easy read for option trading pricing and volatility strategies and techniques 'average person'.

A solid knowledge of calculus, including partial derivatives, is assumed, especially in the early chapters on option pricing models. With these caveats, the book achieves its objectives, providing a good balance of theory and practical information.

The early chapters cover option contracts, and the mechanics of trades, all in considerable detail. The academic theory - the Black-Scholes-Merton and Binomial models - follows. These chapters take the discussion to a level far beyond that of many options books, which simply focus on using options for leveraged bets on stocks or commodities. The academic theory is important but it is only a starting point, as the assumptions that the academic models make are not always correct.

Often the trader's edge appears just where these theories break down. Accordingly, much of the rest of the book is devoted to a detailed analysis of these breaking points, such as lack of liquidity, hedging, scalping, limited market making and arbitrage, the risk of large price jumps, 'fat tail' price distributions, and many others. This may be the most valuable section of the book. In particular the descriptions of price formation and price discovery are very insightful and informative.

These chapters make this a marked improvement on earlier books on options trading such as Cox and Rubenstein's Options Marketswhich option trading pricing and volatility strategies and techniques to stop at the academic theory. Those who place excessive faith in these option trading pricing and volatility strategies and techniques can lose vast amounts of money or even wreak havoc in financial markets, as Long Term Option trading pricing and volatility strategies and techniques Management, run by Nobel Memorial Prize-winning economists, showed in Euan Sinclair has previously written on the topic of volatility-based strategies.

Consistent with this, Chapter 11 contains a strong section about estimating and pricing volatility, as well as strategies to exploit others' poor estimates of volatility.

Many members of the AIA will be individual investors and this book, while potentially very useful, is not really aimed at them. For an individual investor, two areas in particular stand out that the reader would need to cover in some other way.

The first is psychology. Sinclair is very dismissive of the role of psychology in investing: In large companies your risk management people ensure - or should ensure - that you keep your risks within reasonable limits and follow a plan. Without this organisational discipline, option trading pricing and volatility strategies and techniques scope for self-deception and ruinous losses, particularly when trading often highly leveraged derivatives, is unlimited.

An individual investor needs a strong understanding of his or her psychology and solid practices to ensure that these outcomes do not happen. There is a lot of material on trading psychology in books such as Stock Market Wizards by Jack Schwager. Ed Seykota, who has one of the most successful documented trading records of all time, devotes his Trading Tribe web site http: The second area is risk management.

Chapter 13 covers aspects of risk option trading pricing and volatility strategies and techniques, but is mainly concerned with adjusting hedges as prices move and as option expiration draws nearer. The question of position sizing is vitally important but only gets 5 pages of coverage in Chapter 9. Individuals typically overestimate their maximum safe position size by a factor of 20 or more.

This is one reason why so many traders "blow up" within the first couple of years. Jarrod Wilcox's book Investing By the Numbers has an excellent section on position sizing, and optimising multi-period returns, and the books mentioned above also cover this topic. In addition, there is not much discussion of options strategies popular with small investors, such as using options to make positional bets, selling covered calls, selling far-out-of-the-money options, and hedging exposures to underlying shares.

This reflects the book's focus on the market players who are probably taking the other side of the trade to the individual investor.

The book does point out that selling covered calls while owning the underlying stock is equivalent to selling naked put options and that selling out of the money options is similar to selling insurance. Depending on the degree of leverage involved, these can be a very dangerous things to do. Overall this book is a very useful potential addition to the library of anyone who wants to trade options in a serious way. Tim Josling This book aims to provide professional option traders with a solid understanding of the theory and practice of option trading.

Tim Josling is a member of the AIA and has been investing for almost 30 years. Brisbane website design Jellygnite.