How to Price and Trade Options: Identify, Analyze, and Execute the Best Trade Probabilities, + Website

CHAPTER 6 Choosing a Strategy

By now, we have chosen an underlying that is liquid and that we believe will give us an edge with respect to some kind of volatility assumption. I want to be clear that you do not have to think the same way I do to be successful. Many friends of mine who are accomplished and profitable traders look for other “setups” than those that I look for. In fact, there are few successful traders I know who think perfectly alike with any other trader. In many ways, that is what makes options trading so intriguing and fun for me. If you understand and respect the probability and math behind option pricing and trading, there is ample room for creativity as well. There were many times on the floor of the CBOE that I traded with other professional market makers (my peers) and we were both making money on the trade. They might have been closing a prior trade or mitigating risk, while I might have been taking on their risk for what I considered to be a price that gave me edge.

That being said, the biggest “variable” to be exploited is the implied volatility of the option. So it should come as no surprise that the comparative level of the implied volatility be used to choose not only an underlying but also a strategy. Some strategies will take advantage of an implied volatility we believe will rise, some take advantage of implied volatility we think will fall, and others are reasonably “volatility neutral.” Our assumption on the future movement of the stock and/or ...