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The Option Trader’s Hedge Fund: A Business Framework for Trading Equity and Index Options by Mark Sebastian, Dennis A. Chen

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8. Understanding Volatility

You are probably aware of how the pricing model works. To fully understand how to trade options, potential hedge fund traders need a strong understanding of how options function.

All option pricing models are very different. The older ones like Black-Scholes and the Whaley model are somewhat antiquated, but much like automobiles or houses, even the most advanced models rely on a certain amount of fundamental information. All models need five factors: underlying price, strike price, time to expiration, cost of carry, and forward volatility. Four of the five are pretty simple...and then there is volatility. To a hedge fund trader (and all traders, for that matter), volatility is by far the number one determinant of success. ...

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