Trading Options in Turbulent Markets 2e – Master Uncertainty Through Active Volatility Management

<p>Preface xiii</p>
<p>Acknowledgments xv</p>
<p>Introduction xvii</p>
<p>PART I: UNDERSTANDING THE RELATIONSHIP BETWEEN MARKET TURBULENCE AND OPTION VOLATILITY 1</p>
<p>CHAPTER 1 Managing Risk and Uncertainty with Options 3</p>
<p>What Is Risk? 4</p>
<p>What Is Uncertainty? 4</p>
<p>Seven Lessons Learned from Market Volatility 5</p>
<p>Understanding Derivatives 7</p>
<p>The Six Benefits of Options 9</p>
<p>CHAPTER 2 Making Sense of Volatility in Options Trading 13</p>
<p>Volatility as an Asset Class 14</p>
<p>Analyzing Volatility with Implied Volatility 16</p>
<p>What Does Implied Volatility Reveal? 16</p>
<p>Making Trading Decisions Based on the Disparity between</p>
<p>Historical and Implied Volatility 17</p>
<p>Appreciating Volatility for All It Is Worth 19</p>
<p>How Volatility Really Works on the Trading Floor 20</p>
<p>Volatility and Uncertainty: Lessons for the Irrational Option Trader 21</p>
<p>Varieties of Option Volatility Trading 23</p>
<p>CHAPTER 3 Working with Volatility to Make Investment Decisions 25</p>
<p>On Predicting the Future 25</p>
<p>Starting with Historical Volatility 27</p>
<p>Implied Volatility 32</p>
<p>Why Do Volatilities Increase as Equities Fall? 35</p>
<p>Implied Versus Historical Volatility 36</p>
<p>Justification for the Disparity between Historical and Implied Volatility 37</p>
<p>CHAPTER 4 Volatility Skew: Smile or Smirk? 39</p>
<p>Considering Some Examples 40</p>
<p>A Primer on Random Walk and Normal Distribution 41</p>
<p>Dealing with the Higher Moments of the Normal Distribution 45</p>
<p>Skew Is High, Skew Is Low. So What? 47</p>
<p>Does a Flat or Steep Skew Predict the Future? 48</p>
<p>A Fair Warning about Thinking about Skew too Much 49</p>
<p>CHAPTER 5 Fixated on Volatility and the VIX: What Is Volatility, Anyhow? 51</p>
<p>What We (Think) We Know 52</p>
<p>Definitions of VIX 54</p>
<p>Grasping the VIX Index 54</p>
<p>VIX A (Very) Brief History 55</p>
<p>VIX: Calculation and Interpretation with a Simple Calculator 56</p>
<p>Important Insights on the VIX Index 57</p>
<p>What Does the VIX Tell Us? 58</p>
<p>VIX and Perhaps the Biggest Misnomer of All! 59</p>
<p>PART II: UNDERSTANDING OPTION VOLATILITY AND ITS RELATIONSHIP TO OPTION GREEKS, PERSONAL DECISION MAKING, AND ODDS CREATION 61</p>
<p>CHAPTER 6 Extreme Volatility and Option Delta 63</p>
<p>The Misnomer of Delta and Probability of Exercise 63</p>
<p>Delta Defined 65</p>
<p>The Relationship Between Volatility and Delta 69</p>
<p>Higher Volatility and Delta 70</p>
<p>Lower Volatility and Delta 70</p>
<p>Delta, Time, and Volatility 71</p>
<p>Delta, Position Delta, Volatility, and the Professional Trader 72</p>
<p>CHAPTER 7 Smoke and Mirrors: Managing Gamma through Volatile Markets 75</p>
<p>Gamma and Volatility 78</p>
<p>Managing Positive Gamma during a High–Volatility Environment 79</p>
<p>The Bad News: There s Always More than Meets the Eye 80</p>
<p>Practical Considerations for Managing Long Gamma in a High–Volatility Environment 81</p>
<p>Managing Negative Gamma in a High–Volatility Environment 82</p>
<p>Practical Considerations of Negative Gamma in High Volatility 84</p>
<p>Gamma and Volatility with Respect to Time Structure 85</p>
<p>Summary 86</p>
<p>CHAPTER 8 Price Explosion: Volatility and Option Vega 87</p>
<p>The Relationship between Implied Volatility and Vega 88</p>
<p>Implied Volatility: Price Analogy 90</p>
<p>Option Vega and Time 90</p>
<p>Option Vega and Its Greek Cousins 91</p>
<p>Option Vega Implications 91</p>
<p>Don t Underestimate the Relationship between</p>
<p>Volatility and Option Vega 91</p>
<p>Volatility and Vega Insensitivity 93</p>
<p>Important Concepts When Applying Option Vega in a</p>
<p>Volatile Marketplace 94</p>
<p>Summary 97</p>
<p>CHAPTER 9 Sand in the Hourglass: Volatility and Option Theta 99</p>
<p>Balancing Time Decay with Volatility: Mistakes Traders Make 101</p>
<p>Volatility and Theta: What Every Investor Needs to Know 106</p>
<p>CHAPTER 10 The Nuances of Volatility: Interpreting the Mix of Academics and the Study of Volatility 109</p>
<p>The Complication Surrounding Vega Risk in an Option Position 110</p>
<p>Implied Volatility Skew1Term Structure5Volatility Surface 111</p>
<p>Implied Volatility Term Structure 114</p>
<p>Did You Know Your Volatility Has Volatility? 115</p>
<p>The Normal Value of Volatility 117</p>
<p>PART III: TEN PROVEN STRATEGIES TO EMPLOY IN UNCERTAIN TIMES 119</p>
<p>CHAPTER 11 Preparing for Trading Using Volatility Strategies 121</p>
<p>The Elements of a Sound Trading Decision 122</p>
<p>Developing an Approach to Options Trading 123</p>
<p>The Mind of a Successful Trader 126</p>
<p>Decision Making, Options versus Everything Else 128</p>
<p>CHAPTER 12 The Buy–Write, or the Covered Call 131</p>
<p>The Buy–Write (Covered Call) Defined 131</p>
<p>An Example of the Covered Call Strategy 132</p>
<p>The Theory and Reality of the Covered Call 133</p>
<p>Covered Call Writing and Implied Volatility 137</p>
<p>Implied Volatility in Practice 138</p>
<p>Managing Contracts in a Time of High Volatility or a Falling Market 142</p>
<p>Effective Call Writing in a Volatile Market 143</p>
<p>CHAPTER 13 Covering the Naked Put 145</p>
<p>Contemplating the Cash–Secured Put 147</p>
<p>Utilizing the Cash–Secured Put in a High–Volatility Environment 149</p>
<p>Cash–Secured Put and Volatility: Risks and Consequences 152</p>
<p>Income Strategy: Volatility as an Asset Class and Cash–Secured Puts 154</p>
<p>Position Management 155</p>
<p>CHAPTER 14 The Married Put: Protecting Your Profit 157</p>
<p>Volatility, Downside Risk, and the Case for Portfolio Insurance 157</p>
<p>Why Buy High Volatility? 158</p>
<p>The Married Put 159</p>
<p>How and When to Use a Married Put 161</p>
<p>Example of When to Use a Married Put 162</p>
<p>The Married Put: Limiting Loss, Neutralizing Volatility, and</p>
<p>Unleashing Upside Potential 165</p>
<p>Married Put: A Real–Life Illustration 166</p>
<p>CHAPTER 15 The Collar: Sleep at Night 169</p>
<p>Collar Strategy 169</p>
<p>Types of Collars 173</p>
<p>Summary 177</p>
<p>Conclusions on the Collar Strategy 181</p>
<p>CHAPTER 16 The Straddle and Strangle: The Risks and Rewards of Volatility–Sensitive Strategies 187</p>
<p>The Buying or Selling of Premium 188</p>
<p>Properties of Straddles and Strangles 188</p>
<p>Comparing Straddles and Strangles 189</p>
<p>How to Compare Historical and Implied Volatility 192</p>
<p>The Impact of Correlation and Implied Volatility Skew 193</p>
<p>An Alternative to the Naked Volatility Sale via the Straddle/Strangle:</p>
<p>The Strangle Swap 194</p>
<p>CHAPTER 17 The Vertical Spread and Volatility 201</p>
<p>Introduction to the Vertical Spread 202</p>
<p>A Trader s Reasoning for Trading a Vertical Spread 203</p>
<p>Designing Your Vertical Spread 205</p>
<p>Vertical Spreads and Greek Exposure 208</p>
<p>Vertical Spreads as a Pure Volatility Play 211</p>
<p>Comparing Volatility s Effect on Vertical Spreads 212</p>
<p>Summary: Comparing Vertical Spreads and Implied Volatility 213</p>
<p>CHAPTER 18 Calendar Spreads: Trading Theta and Vega 217</p>
<p>Calendar Spreading Trading Time 218</p>
<p>Risks and Rewards of the Calendar Spread 219</p>
<p>A Calendar Spread with a Bullish Expectation 220</p>
<p>Considerations and Observations for Calendar Spreads and Volatility 222</p>
<p>CHAPTER 19 Ratio Spreading: Trading Objectives Tailor Made 227</p>
<p>How Back Spreads and Ratio Spreads Work 227</p>
<p>Back Spreads 229</p>
<p>Ratio Spreads 231</p>
<p>Greek Values and the Back Spread or Ratio Spread 232</p>
<p>Configuring and Pricing a Back Spread or Ratio Spread 236</p>
<p>Reconciling Volatility and the Back Spread or Ratio Spread 238</p>
<p>CHAPTER 20 The Butterfly Spread 241</p>
<p>Setting up a Butterfly 241</p>
<p>The Butterfly Spread as a Volatility Investment 245</p>
<p>Greek Values and the Butterfly 247</p>
<p>Structuring and Pricing a Butterfly 250</p>
<p>Trading Butterflies in a Volatile Market 250</p>
<p>CHAPTER 21 Wingspreads 253</p>
<p>Capturing Convergence and Divergence 253</p>
<p>Wingspreads: Risk/Reward 254</p>
<p>Wingspreads: Sensitivities 254</p>
<p>Wingspreads and the Greeks 255</p>
<p>Wingspreads: Various and Sundry Details 257</p>
<p>The Condor Spread 258</p>
<p>Conclusion 267</p>
<p>About the Author 269</p>
<p>Index 271</p>