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Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management

Name: Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management
Author: Larry Shover
ISBN: 9781576603604

by Larry Shover

August 2010

Intermediate to advanced

272 pages

6h 24m

English

Wiley

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Copyright
Acknowledgments
Introduction
1. Understanding the Relationship between Market Turbulence and Option Volatility
1. Managing Risk and Uncertainty with Options
1.1. What Is Risk?1.2. What Is Uncertainty?1.3. Seven Lessons Learned from Market Volatility1.3.1. Lesson One1.3.2. Lesson Two1.3.3. Lesson Three1.3.4. Lesson Four1.3.5. Lesson Five1.3.6. Lesson Six1.3.7. Lesson Seven1.3.8. Lessons Summary1.4. Understanding Derivatives1.4.1. Options Defined1.4.2. Futures Defined1.4.3. Understanding Options1.5. The Six Benefits of Options1.5.1. Benefit One: The Ability to Leverage1.5.2. Benefit Two: Creating Market Efficiency1.5.3. Benefit Three: Cost Efficiency1.5.4. Benefit Four: 24/7 Protection1.5.5. Benefit Five: Flexibility1.5.6. Benefit Six: Trading Additional Dimensions
2. Making Sense of Volatility in Options Trading
2.1. Volatility as an Asset Class2.1.1. How Does Volatility Work?2.2. Analyzing Volatility with Implied Volatility2.3. What Does Implied Volatility Reveal?2.4. Making Trading Decisions Based on the Disparity between Historical and Implied Volatility2.5. Appreciating Volatility for All It Is Worth2.6. How Volatility Really Works on the Trading Floor2.7. Volatility and Uncertainty: Lessons for the Irrational Option Trader2.8. Varieties of Option Volatility Trading
3. Working with Volatility to Make Investment Decisions
3.1. On Predicting the Future3.2. Starting with Historical Volatility3.2.1. Calculating Historical Volatility3.2.2. How Traders Have Calculated Volatility Has Itself Been Volatile over Time3.2.2.1. Method 1: A Piece of Paper and a Pencil3.2.2.2. Method 2: A Piece of Paper, a Pencil, and Excel3.3. Implied Volatility3.3.1. Calculating Implied Volatility3.4. Why Do Volatilities Increase as Equities Fall?3.5. Implied versus Historical Volatility3.6. Justification for the Disparity between Historical and Implied Volatility
4. Volatility Skew: Smile or Smirk?
4.1. Considering Some Examples4.2. A Primer on Random Walk and Normal Distribution4.3. Dealing with the Higher Moments of the Normal Distribution4.4. Skew Is High, Skew Is Low. So What?4.5. Does a "Flat" or "Steep" Skew Predict the Future?4.6. A Fair Warning about Thinking about Skew too Much
2. Understanding Option Volatility and its Relationship to Option Greeks, Personal Decision Making, and Odds Creation
5. Extreme Volatility and Option Delta
5.1. The Misnomer of Delta and Probability of Exercise5.1.1. Delta ≠ The Probability of Exercise5.1.2. Probability Does Not Actually Exist in Practice5.2. Delta Defined5.2.1. Running the Delta Numbers5.2.2. Portfolio Delta5.2.3. Cardinal Rules of Delta5.3. The Relationship between Volatility and Delta5.4. Higher Volatility and Delta5.5. Lower Volatility and Delta5.6. Delta, Time, and Volatility5.7. Delta, Position Delta, Volatility, and the Professional Trader5.7.1. Volatility and Its Effect on Position Delta

6. Smoke and Mirrors: Managing Gamma through Volatile Markets
6.1. Gamma and Volatility6.2. Managing Positive Gamma during a High-Volatility Environment6.3. The Bad News: There's Always More than Meets the Eye6.3.1. Point One6.3.2. Point Two6.4. Practical Considerations for Managing Long Gamma in a High-Volatility Environment6.5. Managing Negative Gamma in a High-Volatility Environment6.5.1. Scenario One6.5.2. Scenario Two6.6. Practical Considerations of Negative Gamma in High Volatility6.7. Gamma and Volatility with Respect to Time Structure6.7.1. The More Time You Have, the Less Gamma Your Option Will Have6.7.2. The Less Time You Have, the More Gamma Your Options Will Have6.8. Summary
7. Price Explosion: Volatility and Option Vega
7.1. The Relationship between Implied Volatility and Vega7.2. Implied Volatility: Price Analogy7.3. Option Vega and Time7.4. Option Vega and Its Greek Cousins7.5. Option Vega Implications7.6. Don't Underestimate the Relationship between Volatility and Option Vega7.7. Volatility and Vega Insensitivity7.8. Important Concepts When Applying Option Vega in a Volatile Marketplace7.9. Summary
8. Sand in the Hourglass: Volatility and Option Theta
8.1. Balancing Time Decay with Volatility: Mistakes Traders Make8.1.1. Mistake #1: When Traders Don't Fully Understand the Effect of Time Decay8.1.2. Mistake #2: When Traders Underestimate or Misinterpret Volatility and Its Effect on Theta8.1.3. Buying Options (Negative Theta) in a High-Volatility Environment8.1.4. If You Happen to Be in the Fortunate Position of Owning Options during an Upward Movement in Volatility, This Is What You Should Expect to Happen8.1.5. If You Happen to Be in the Unfortunate Position of Being Short Options during an Upward Movement in Volatility, This Is What You Should Expect to Happen8.2. Volatility and Theta: What Every Investor Needs to Know
3. Ten Proven Strategies to Employ in Uncertain Times
9. Preparing for Trading Using Volatility Strategies
9.1. The Elements of a Sound Trading Decision9.1.1. Risk Tolerance9.2. Developing an Approach to Options Trading9.2.1. The Day Trader9.2.2. The Short-Term Trend Trader9.2.3. The Position Trader9.3. The Mind of a Successful Trader9.3.1. Preparing to Win Big by Losing Well9.3.2. A Deer in the Headlights9.3.3. The Making of a First-Class Loser9.4. Decision Making, Options versus Everything Else
10. The Buy-Write, or the Covered Call
10.1. The Buy-Write (Covered Call) Defined10.2. An Example of the Covered Call Strategy10.2.1. Three Possible Outcomes10.3. The Theory and Reality of the Covered Call10.3.1. The Realities of the Covered Call10.3.2. Reality #110.3.3. Reality #210.3.4. Reality #310.3.5. Reality #410.4. Covered Call Writing and Implied Volatility10.5. Implied Volatility in Practice10.5.1. Writing Covered Calls10.5.2. Choosing Which Strike to Write10.5.3. In-the-Money Call10.5.4. At-the-Money Call10.5.5. Out-of-the-Money Call10.6. Managing Contracts in a Time of High Volatility or a Falling Market10.6.1. Rolling Down the Strike10.6.2. Doing Nothing10.7. Effective Call Writing in a Volatile Market
11. Covering the Naked Put
10.8. Contemplating the Cash-Secured Put11.1.1. Who Should Consider a Cash-Secured Put?11.1.2. Definition of the Cash-Secured Put11.2. Utilizing the Cash-Secured Put in a High-Volatility Environment11.2.1. Example of a Profitable Cash-Secured Put Trade11.2.2. Example of an Unprofitable Cash-Secured Put Trade11.3. Cash-Secured Put and Volatility: Risks and Consequences11.4. Income Strategy: Volatility as an Asset Class and Cash-Secured Puts11.5. Position Management11.5.1. For the Investor
12. The Married Put: Protecting Your Profit
12.1. Volatility, Downside Risk, and the Case for Portfolio Insurance12.2. Why Buy High Volatility?12.3. The Married Put12.4. How and When to Use a Married Put12.5. Example of When to Use a Married Put12.5.1. XYZ Shares Increase from $32 to $42 per Share, and an XYZ Put Is Purchased to Protect Unrealized Profits12.5.2. XYZ Shares Decrease from $50 to $35, and an XYZ Put Is Purchased to Protect from Further Decline12.6. The Married Put: Limiting Loss, Neutralizing Volatility, and Unleashing Upside Potential12.7. Married Put: A Real-Life Illustration12.7.1. Summary of the Married Put
13. The Collar: Sleep at Night
13.1. Collar Strategy13.1.1. What Is a Collar?13.1.2. Consider Three Potential Scenarios at Expiration13.1.3. XYZ Is above the Short Call Strike of $35 at Expiration13.1.4. XYZ Is below the Long Put Strike of $27.50 at Expiration13.1.5. XYZ Is Trading between $27.50 and $35 at Expiration13.1.6. Summary13.2. Types of Collars13.2.1. The Protective Collar13.2.2. The Appreciating Collar13.3. Summary13.3.1. The Flexible Collar13.4. Conclusions on the Collar Strategy13.4.1. The Flexible Collar Strategy13.4.2. The Reset Collar13.4.2.1. Benefits13.4.2.2. Costs13.4.3. The Revised Collar13.4.3.1. Benefits13.4.3.2. Costs
14. The Straddle and Strangle: The Risks and Rewards of Volatility-Sensitive Strategies
14.1. The Buying or Selling of Premium14.2. Properties of Straddles and Strangles14.3. Comparing Straddles and Strangles14.3.1. The Short Straddle14.3.2. The Short Strangle14.4. How to Compare Historical and Implied Volatility14.5. The Impact of Correlation and Implied Volatility Skew14.5.1. Possible Impact #1: Implied Volatility Spike14.5.2. Possible Impact #2: Skew of Implied Volatility14.5.3. Possible Impact #3: Winning Small and Losing Big14.6. An Alternative to the Naked Volatility Sale via the Straddle/Strangle: The Strangle Swap14.6.1. Comments Regarding Path-Dependent Outcome14.6.2. Comments Regarding a Rare Event with Both Volatility and Movement in the Underlying Share Price
15. The Vertical Spread and Volatility
15.1. Introduction to the Vertical Spread15.2. A Trader's Reasoning for Trading a Vertical Spread15.2.1. Reason #1: Lowering Your Net Cost, Qualifying Your Risk15.2.2. Reason #2: Flexibility15.2.3. Reason #3: Taking Advantage of Direction and Greeks are Contained by a Predefined Risk Profile15.3. Designing Your Vertical Spread15.3.1. Choosing a Debit Spread or Credit Spread15.3.2. Choosing the Right Strike Prices on the Contracts in Relation to the Underlying Asset Price15.3.3. Selecting the Strike Price Gap between the Contracts You Buy and the Contracts You Sell15.4. Vertical Spreads and Greek Exposure15.4.1. Delta15.4.2. Gamma15.4.3. Theta15.4.4. Vega15.5. Vertical Spreads as a Pure Volatility Play15.6. Comparing Volatility's Effect on Vertical Spreads15.7. Summary: Comparing Vertical Spreads and Implied Volatility15.7.1. Changes in Implied Volatility during the Trade
16. Calendar Spreads: Trading Theta and Vega
16.1. Calendar Spreading—Trading Time16.2. Risks and Rewards of the Calendar Spread16.3. A Calendar Spread with a Bullish Expectation16.4. Considerations and Observations for Calendar Spreads and Volatility16.4.1. 1. Time Value and Volatility in Calendar Spreads Are not Necessarily Connected16.4.2. 2. Implied Volatility Affects Calendar Spreads Mostly with At-the-Money Options16.4.3. 3. Avoid Assuming Too Much about Front-Month versus Back-Month Vega16.4.4. 4. At Extreme Prices for an Underlying Stock, Differences in Parity Appear16.4.5. 5. Pay Attention to Long-Term Trends in Volatility16.4.6. 6. Don't Put Too Much Emphasis on Greek Values
17. Ratio Spreading: Trading Objectives Tailor Made
17.1. How Back Spreads and Ratio Spreads Work17.2. Back Spreads17.3. Ratio Spreads17.4. Greek Values and the Back Spread or Ratio Spread17.4.1. Delta17.4.2. Gamma17.4.3. Theta17.4.4. Vega17.5. Configuring and Pricing a Back Spread or Ratio Spread17.5.1. Pricing a Back Spread or Ratio Spread17.6. Reconciling Volatility and the Back Spread or Ratio Spread
18. The Butterfly Spread
18.1. Setting up a Butterfly18.1.1. The Long Butterfly and the Ratio Spread18.1.2. The Short Butterfly and the Back Spread18.1.3. The Butterfly Spread as a Volatility Investment18.1.4. Butterfly Spreads and the Expiration Date18.1.5. Call and Put Butterfly Spreads Work the Same Way18.2. Greek Values and the Butterfly18.2.1. Delta18.2.2. Gamma18.2.3. Theta18.2.4. Vega18.3. Structuring and Pricing a Butterfly18.4. Trading Butterflies in a Volatile Market
19. The Iron Butterfly and the Condor
19.1. The Iron Butterfly19.2. The Condor19.3. The Iron Butterfly, the Condor, and a Volatile Marketplace

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Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management

by Larry Shover

Part 1. Understanding the Relationship between Market Turbulence and Option Volatility

Become an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
and much more.