Table of Contents
COVER
INTRODUCTION
Trading as a Process
Summary
CHAPTER 1: Options
Option Pricing Models
Option Trading Theory
Conclusion
Summary
CHAPTER 2: The Efficient Market Hypothesis and Its
Limitations
The Efficient Market Hypothesis
Aside: Alpha Decay
Behavioral Finance
High-Level Approaches: Technical Analysis and
Fundamental Analysis
Conclusion
Summary
CHAPTER 3: Forecasting Volatility
Model-Driven Forecasting and Situational Forecasting
The GARCH Family and Trading
Implied Volatility as a Predictor
Ensemble Predictions
Conclusion
Summary
CHAPTER 4: The Variance Premium
Aside: The Implied Variance Premium
Variance Premium in Equity Indices
The Implied Skewness Premium
The Implied Correlation Premium
1
Commodities
Bonds
The VIX
Currencies
Equities
Reasons for the Variance Premium
Insurance
Jump Risk
Trading Restrictions
Market-Maker Inventory Risk
Path Dependency of Returns
The Problem of the Peso Problem
Conclusion
Summary
CHAPTER 5: Finding Trades with Positive Expected Value
Aside: Crowding
Trading Strategies
Options and Fundamental Factors
Post-Earnings Announcement Drift (PEAD)
Confidence Level Two
The Overnight Effect
FOMC and Volatility
The Weekend Effect
Volatility of Volatility Risk Premia
Confidence Level One
Earnings-Induced Reversals
Pre-Earnings Announcement Drift
Conclusion
Summary
CHAPTER 6: Volatility Positions
Aside: Adjustment and Position “Repair”
Straddles and Strangles
Aside: Delta-Hedged Positions
2
Butterflies and Condors
Aside: Broken Wing Butterflies and Condors
Calendar Spread
Including Implied Volatility Skew
Strike Choice
Choosing a Hedging Strike
Expiration Choice
Conclusion
Summary
CHAPTER 7: Directional Option Trading
Subjective Option Pricing
A Theory of Subjective Option Pricing
Distribution of Option Returns: Summary Statistics
Strike Choice
Fundamental Considerations
Conclusion
Summary
CHAPTER 8: Directional Option Strategy Selection
Long Stock
Long Call
Long Call Spread
Short Put
Covered Calls
Components of Covered Call Profits
Covered Calls and Fundamentals
Short Put Spread
Risk Reversal
Aside: The Risk Reversal as a Skew Trade
Ratio Spreads
Conclusion
Summary
CHAPTER 9: Trade Sizing
The Kelly Criterion
3
Non-normal Discrete Outcomes
Non-normal Continuous Outcomes
Uncertain Parameters
Kelly and Drawdown Control
The Effect of Stops
Conclusion
Summary
CHAPTER 10: Meta Risks
Currency Risk
Theft and Fraud
Example One: Baring's Bank
Example Two: Yasumo Hamanaka, aka “Mr. Copper”
Example Three: Bernie Madoff
Index Restructuring
Arbitrage Counterparty Risk
Conclusion
Summary
CONCLUSION
APPENDIX 1: Traders' Adjustments to the BSM Assumptions
The Existence of a Single, Constant Interest Rate
The Stock Pays No Dividends
Absence of Taxes
The Ability to Trade and Short the Underlying
Nonconstant Volatility
Conclusion
Summary
APPENDIX 2: Statistical Rules of Thumb
Converting Range Estimates to Option Pricing Inputs
Rule of Five
Rule of Three
APPENDIX 3: Execution
Example
REFERENCES
4
INDEX
END USER LICENSE AGREEMENT
List of Tables
Chapter 1
TABLE 1.1 Statistics for the Short One-Year ATM Daily
Hedged Straddle With and W...
Chapter 3
TABLE 3.1 Thirty-Day Volatility Forecasts for the S&P
500 from 1990 to t...
TABLE 3.2 Thirty-Day Volatility EWMA Forecasts for the
S&P 500 from 1990 ...
Chapter 4
TABLE 4.1 Summary Statistics for the S&P 500 Variance
Premium
TABLE 4.2 Summary Statistics for the Dow Jones,
NASDAQ 100, and Russell 2000 Var...
TABLE 4.3 Summary Statistics for the VIX Sorted by
Quintiles
TABLE 4.4 The Size and Significance of the Variance
Premium in Commodity Options
TABLE 4.5 The Correlation of the Variance Premium
Within Commodity Sectors
TABLE 4.6 The Correlation of the Variance Premium
Between Commodity Sectors
TABLE 4.7 The Average Return to a Short 1-Month
Variance Swap for Stock Options ...
Chapter 5
TABLE 5.1 Postulated Risk and Behavioral Reasons for
the Smart Beta Factors
Chapter 6
TABLE 6.1 Summary Statistics for the Returns of a Fairly
Priced Short Straddle
5
TABLE 6.2 Summary Statistics for the Returns of a Fairly-
Priced Short Strangle
TABLE 6.3 Summary Statistics for the Returns of a
Mispriced Short Straddle
TABLE 6.4 Summary Statistics for the Returns of a Poorly
Priced Short Strangle
TABLE 6.5 Summary Statistics for the Returns of a Short
Straddle When Our Direct...
TABLE 6.6 Summary Statistics for the Returns of a Short
Strangle When Our Direct...
TABLE 6.7 Comparing Results for Straddles and Strangles
if the Underlying Has th...
TABLE 6.8 Comparing Results for Straddles and
Strangles When Hedging Daily
TABLE 6.9 Summary Statistics for the Returns of a Fairly-
Priced Butterfly
TABLE 6.10 Summary Statistics for the Returns of a
Fairly Priced Condor
TABLE 6.11 Summary Statistics for the Returns of a Badly
Priced Butterfly
TABLE 6.12 Summary Statistics for the Returns of a Badly
Priced Condor
TABLE 6.13 Summary Statistics of S&P 500 Returns from
1990 to 2018
TABLE 6.14 Summary Statistics of the PL Distribution for
&nb
sp; the Straddle Spread and...
TABLE 6.15 Summary Statistics of the PL Distribution for
the Straddle Spread and...
TABLE 6.16 Summary Statistics for the Returns of a
Strangle with an Implied Vola...
TABLE 6.17 The Results for Both the Flat Skew Condor
and the Skewed Case
TABLE 6.18 The Put Prices of the SPY June 2020
Expiration on July 30, 2019 (Down...
6
TABLE 6.19 The Summary Statistics from Selling $1000
Vega of the 210/360 SPY Str...
TABLE 6.20 The Dollar Premium of Options Over Their
Being Priced at the ATM Vola...
TABLE 6.21 The Summary Statistics from Selling $1000
Vega of 260/335 SPY Strangl...
TABLE 6.22 Prices and Strikes of Possible Hedging
Options for Our Short 260 Put ...
Chapter 7
TABLE 7.1 A Comparison of Risk-Neutral and Subjective
Option Prices
TABLE 7.2 Projected Performance Numbers for Long
Positions in Different Strike 3...
TABLE 7.3 Projected Performance Numbers for Long
Positions in Different Strike 3...
Chapter 8
TABLE 8.1 Summary Statistics for 100 Shares of a $100
Stock with a 20% Return (V...
TABLE 8.2 Summary Statistics of the PL Distribution for
a 1-Year ATM Call Option...
TABLE 8.3 Summary Statistics of the PL Distribution for
a 1-Year ATM/20-Delta Ca...
TABLE 8.4 Summary Statistics of the PL Distribution for
a Short 1-Year ATM Put O...
TABLE 8.5 Summary Statistics for BXM and the S&P 500
TABLE 8.6 Summary Statistics for BXY, BXMD, and the
S&P 500 from June 1988 ...
TABLE 8.7 Summary Statistics of the PL Distribution for
a Short 1-Year ATM/20-De...
TABLE 8.8 Summary Statistics of the PL Distribution for
a Short 1-Year ATM/20-De...
TABLE 8.9 Summary Statistics of the PL Distribution for
a 1-Year 20-Delta Risk R...
7
TABLE 8.10 Summary Statistics of the PL Distribution for
a 1-Year 20-Delta Risk ...
TABLE 8.11 Results for a Short Put–Long Call 20-Delta
Risk Reversal for Various ...
TABLE 8.12 Summary Statistics of the PL Distribution for
a 1-Year 20-Delta Risk ...
TABLE 8.13 The Risk Slide for the Single 241 Put
TABLE 8.14 The Risk Slide for the 258/266 One-By-Two
Put Spread
Chapter 9
TABLE 9.1 Summary Statistics for the Option Trade
TABLE 9.2 Fractional Schemes Corresponding to Various
Probabilities of Over-Bett...
TABLE 9.3 Fractional Schemes Corresponding to Various
Probabilities of Over-Bett...
TABLE 9.4 A Comparison of Trading at Quarter Kelly and
Trading Full Kelly in Sub...
Appendix 3
TABLE A3.1 The Order Book of All Bids and Offers for
UVXY (ProShares Ultra VI...
List of Illustrations
Chapter 1
FIGURE 1.1 The implied volatility surface for SPY on
September 10, 2019.
FIGURE 1.2 The terminal PL distribution of a single short
one-year ATM strad...
FIGURE 1.3 The terminal PL distribution of a single one-
year ATM straddle th...
FIGURE 1.4 The standard deviation of the terminal PL
distribution of a singl...
Chapter 3
8
FIGURE 3.1 The rolling 30-day close-to-close volatility of
Maximus, Inc.
FIGURE 3.2 Term structure of forecast volatility for SPY
using GARCH(1,1) (s...
Chapter 4
FIGURE 4.1 Profit from selling 1 front-month VIX future.
FIGURE 4.2 The VIX index from June 2015 to October
2019.
FIGURE 4.3 Profit from selling 1 front-month VIX future
when the term struct...
FIGURE 4.4 The VIX and the subsequent 30-day realized
S&P 500 volatility.
FIGURE 4.5 The S&P 500 variance premium (VIX minus
realized volatility).
FIGURE 4.6 The S&P 500 variance premium distribution.
FIGURE 4.7 Performance of the CNDR index.
FIGURE 4.8 Performance of the BFLY index.
FIGURE 4.9 The three different positive return paths.
FIGURE 4.10 The three different negative return paths.
FIGURE 4.11 The P/L for a short put, with a stock jump at
expiration.
FIGURE 4.12 The P/L for a long call, with a stock jump at
expiration,
Chapter 5
FIGURE 5.1 Results of the long straddle strategy.
FIGURE 5.2 Results of the short straddle strategy.
Chapter 6
FIGURE 6.1 The profit distribution of the short straddle.
FIGURE 6.2 The profits of the short strangle.
FIGURE 6.3 The returns of the short straddle when our
forecast was poor.
9
FIGURE 6.4 The returns of the short strangle when our
forecast was poor.
FIGURE 6.5 The returns of the short 100 straddle when
the underlying has the...
FIGURE 6.6 The returns of the short 85/134 strangle (10-
delta call and put) ...
FIGURE 6.7 The returns of the short straddle when
hedging daily.
FIGURE 6.8 The returns of the short 70/130 strangle
when hedging daily
FIGURE 6.9 Vega as a function of underlying price for the
straddle (solid li...
FIGURE 6.10 The profit distribution of the fairly priced
butterfly (long the...
FIGURE 6.11 The profit distribution of the fairly priced
condor (long the 70...
FIGURE 6.12 The profit distribution of the poorly priced
butterfly (long the...
FIGURE 6.13 The profit distribution of the poorly priced
condor (long the 70...
FIGURE 6.14 The P/L of the straddle spread at expiry of
the front-month opti...
FIGURE 6.15 The profit distribution of a strangle with an
implied volatility...
Chapter 7
FIGURE 7.1 Probability of the 3-month 150 strike call
expiring in the money....
FIGURE 7.2 Probability of the 3-month calls expiring in
the money when the r...
FIGURE 7.3 Ninetieth percentile of the profit of the 3-
month 100-strike call...
Chapter 8
FIGURE 8.1 The PL distribution for 100 shares of a $100
stock with a 20% ret...
10
FIGURE 8.2 The PL distribution for a 1-year ATM call
option on a $100 stock ...
FIGURE 8.3 The PL distribution for a 1-year ATM/20-
delta call spread on a $1...
FIGURE 8.4 The PL distribution for a short 1-year ATM
put option on a $100 s...
FIGURE 8.5 The payoff of the covered call as a function of
stock price at ex...
FIGURE 8.6 The performance of the CBOE BuyWrite
Index compared to that of th...
FIGURE 8.7 The total profit of the covered call and how
much comes from equi...
FIGURE 8.8 The PL distribution for a short 1-year
ATM/20-delta put spread on...
FIGURE 8.9 The PL distribution for a 1-year 20-delta risk
reversal on a $100...
FIGURE 8.10 The PL distribution for a 1-year ATM/20-
delta risk one-by-two ca...
Chapter 9
FIGURE 9.1 Growth rate as a function of f
(p1=0.55,p2=0.45,W1=1, ...
FIGURE 9.2 Growth rate as a function of f (P1 = 0.55, P2
= 0.44, P3 = 0.01, ...
FIGURE 9.3 The optimal investment fraction as a
function of skewness (return...
FIGURE 9.4 The approximate investment fraction as a
function of skewness (re...
FIGURE 9.5 The distribution of the option trade results.
FIGURE 9.6 The dependence of growth rate on the
fractional Kelly ratio.
FIGURE 9.7 The growth rate to drawdown ratio as a
function of the scaling fa...
FIGURE 9.8 The probability of reaching 200% before
being stopped out at 0% w...
11
FIGURE 9.9 The expected time to reach 200% before
being stopped out at 50% w...
FIGURE 9.10 The return distribution of our trading
strategy.
FIGURE 9.11 The hoped-for distribution when a stop has
been added.
FIGURE 9.12 The true distribution when a stop has been
added.
FIGURE 9.13 The return distribution of the simulated
trade when using a trai...
FIGURE 9.14 The distribution of the final account after
10,000 simulations o...
FIGURE 9.15 The distribution of the final account after
10,000 simulations o...
FIGURE 9.16 The distribution of the final account after
10,000 simulations o...
Chapter 10
FIGURE 10.1 The price of Bitcoin in USD in 2018.
Appendix 1
FIGURE A1.1 The daily VIX changes from 2000 to 2018.
FIGURE A1.2 The daily 1-year rate changes from 2000 to
2018.
FIGURE A1.3 The standard deviation pf the P/L for an
option hedged with an i...
FIGURE A1.4 S&P 500 30-day volatility from January
2000 through to the end o...
12
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13
POSITIONAL OPTION
TRADING
An Advanced Guide
Euan Sinclair
14
Copyright © 2020 by Euan Sinclair/John Wiley & Sons, Inc. All rights reserved.
Positional Option Trading (Wiley Trading) Page 1
