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Volatility

Book Description

Gain a deep, intuitive and technical understanding of practical options theory

The main challenges in successful options trading are conceptual, not mathematical.  Volatility: Practical Options Theory provides financial professionals, academics, students and others with an intuitive as well as technical understanding of both the basic and advanced ideas in options theory to a level that facilitates practical options trading.  The approach taken in this book will prove particularly valuable to options traders and other practitioners tasked with making pricing and risk management decisions in an environment where time constraints mean that simplicity and intuition are of greater value than mathematical formalism.

The most important areas of options theory, namely implied volatility, delta hedging, time value and the so-called options greeks are explored based on intuitive economic arguments alone before turning to formal models such as the seminal Black-Scholes-Merton model.  The reader will understand how the model free approach and mathematical models are related to each other, their underlying theoretical assumptions and their implications to level that facilitates practical implementation.

There are several excellent mathematical descriptions of options theory, but few focus on a translational approach to convert the theory into practice. This book emphasizes the translational aspect, while first building an intuitive, technical understanding that allows market makers, portfolio managers, investment managers, risk managers, and other traders to work more effectively within—and beyond—the bounds of everyday practice.

  • Gain a deeper understanding of the assumptions underlying options theory
  • Translate theoretical ideas into practice
  • Develop a more accurate intuition for better time-constrained decision making

This book allows its readers to gain more than a superficial understanding of the mechanisms at work in options markets. Volatility gives its readers the edge by providing a true bedrock foundation upon which practical knowledge becomes stronger.

Table of Contents

  1. Cover
  2. Preface
  3. Acknowledgments
  4. About the Author
  5. CHAPTER 1: Volatility and Options
    1. 1.1 WHAT IS AN OPTION?
    2. 1.2 OPTIONS ARE BETS ON VOLATILITY
    3. 1.3 OPTION PREMIUMS AND BREAKEVENS
    4. 1.4 STRIKE CONVENTIONS
    5. 1.5 WHAT IS VOLATILITY?
    6. 1.6 TRADER'S SUMMARY
  6. CHAPTER 2: Understanding Options Without a Model
    1. 2.1 VANILLA OPTIONS
    2. 2.2 MAKING ASSUMPTIONS
    3. 2.3 UNDERSTANDING WITH ECONOMIC ASSUMPTIONS
    4. 2.4 DELTA AND DELTA HEDGING
    5. 2.5 THE VALUE FUNCTION
    6. 2.6 DEFINING DELTA
    7. 2.7 UNDERSTANDING DELTA
    8. 2.8 DELTA AS THE PROBABILITY OF AN IN‐THE‐MONEY EXPIRY
    9. 2.9 APPLYING DELTA AS THE PROBABILITY OF AN ITM EXPIRY IN PRACTICAL TRADING
    10. 2.10 CONSTRUCTING
    11. 2.11 OPTION DELTAS
    12. 2.12 A NOTE ON FORWARDS
    13. 2.13 PUT–CALL PARITY
    14. 2.14 TRADER'S SUMMARY
  7. CHAPTER 3: The Basic Greeks: Theta
    1. 3.1 THETA,
    2. 3.2 TRADER'S SUMMARY
  8. CHAPTER 4: The Basic Greeks: Gamma
    1. 4.1 GAMMA,
    2. 4.2 GAMMA AND TIME DECAY
    3. 4.3 TRADERS' GAMMA,
    4. 4.4 GAMMA–TIME DECAY TRADE‐OFFS IN MORE DETAIL
    5. 4.5 PnL EXPLAIN
    6. 4.6 DELTA HEDGING AND PnL VARIANCE
    7. 4.7 TRANSACTION COSTS
    8. 4.8 DAILY PnL EXPLAIN
    9. 4.9 THE GAMMA PROFILE
    10. 4.10 TRADER'S SUMMARY
  9. CHAPTER 5: The Basic Greeks: Vega
    1. 5.1 VEGA
    2. 5.2 UNDERSTANDING VEGA VIA THE PDF
    3. 5.3 UNDERSTANDING VEGA VIA GAMMA TRADING
    4. 5.4 VEGA OF AN ATMS OPTION ACROSS TENORS
    5. 5.5 VEGA AND SPOT
    6. 5.6 DEPENDENCE OF VEGA ON IMPLIED VOLATILITY
    7. 5.7 VEGA PROFILES APPLIED IN PRACTICAL OPTIONS TRADING
    8. 5.8 VEGA AND PnL EXPLAIN
    9. 5.9 TRADER'S SUMMARY
  10. CHAPTER 6: Implied Volatility and Term Structure
    1. 6.1 IMPLIED VOLATILITY,
    2. 6.2 TERM STRUCTURE
    3. 6.3 FLAT VEGA AND WEIGHTED VEGA GREEKS
    4. 6.4 FORWARD VOLATILITY, FORWARD VARIANCE, AND TERM VOLATILITY
    5. 6.5 BUILDING A TERM STRUCTURE MODEL USING DAILY FORWARD VOLATILITY
    6. 6.6 SETTING BASE VOLATILITY USING A THREE‐PARAMETER GARCH MODEL
    7. 6.7 VOLATILITY CARRY AND FORWARD VOLATILITY AGREEMENTS
    8. 6.8 TRADER'S SUMMARY
  11. CHAPTER 7: Vanna, Risk Reversal, and Skewness
    1. 7.1 RISK REVERSAL
    2. 7.2 SKEWNESS
    3. 7.3 DELTA SPACE
    4. 7.4 SMILE IN DELTA SPACE
    5. 7.5 SMILE VEGA
    6. 7.6 SMILE DELTA
    7. 7.7 TRADER'S SUMMARY
  12. CHAPTER 8: Volgamma, Butterfly, and Kurtosis
    1. 8.1 THE BUTTERFLY STRATEGY
    2. 8.2 VOLGAMMA AND BUTTERFLY
    3. 8.3 KURTOSIS
    4. 8.4 SMILE
    5. 8.5 BUTTERFLIES AND SMILE VEGA
    6. 8.6 TRADER'S SUMMARY
  13. CHAPTER 9: Black‐Scholes‐Merton Model
    1. 9.1 THE LOG‐NORMAL DIFFUSION MODEL
    2. 9.2 THE BSM PARTIAL DIFFERENTIAL EQUATION (PDE)
    3. 9.3 FEYNMAN‐KAC
    4. 9.4 RISK‐NEUTRAL PROBABILITIES
    5. 9.5 PROBABILITY OF EXCEEDING THE BREAKEVEN IN THE BSM MODEL
    6. 9.6 TRADER'S SUMMARY
  14. CHAPTER 10: The Black‐Scholes Greeks
    1. 10.1 SPOT DELTA, DUAL DELTA, AND FORWARD DELTA
    2. 10.2 THETA
    3. 10.3 GAMMA
    4. 10.4 VEGA
    5. 10.5 VANNA
    6. 10.6 VOLGAMMA
    7. 10.7 TRADER'S SUMMARY
  15. CHAPTER 11: Predictability and Mean Reversion
    1. 11.1 THE PAST AND THE FUTURE
    2. 11.2 EMPIRICAL ANALYSIS
  16. APPENDIX A: Probability
    1. A.1 PROBABILITY DENSITY FUNCTIONS (PDFS)
  17. APPENDIX B: Calculus
  18. Glossary
  19. References
  20. Index
  21. End User License Agreement