Trading Options in Turbulent MarketsMaster Uncertainty through Active Volatility Management
Top options expert Larry Shover returns to discuss how to interpret, and profit from, market volatility Trading Options in Turbulent Markets, Second Edition skillfully explains the intricacies of options volatility and shows you how to use options to cope, and profit from, market turbulence. Throughout this new edition, options expert Larry Shover reveals how to use historical volatility to predict future volatility for a security and addresses how you can utilize that knowledge to make better trading decisions. Along the way, he also defines the so-called Greeks—delta, vega, theta, and gamma—and explains what drives their values and their relationship to historic and implied volatility. Shover then provides effective strategies for trading options contracts in uncertain times, addressing the decision-making process and how to trade objectively in the face of unpredictable and irrational market moves. Includes a new chapter of the VIX, more advanced material on volatility suitable for institutional or intermediate options trader, and additional volatility-based strategies Answers complex questions such as: How does a trader know when to tolerate risk and How does a successful trader respond to adversity? Provides a different perspective on a variety of options strategies, including covered calls, naked and married puts, collars, straddles, vertical spreads, calendar spreads, butterflies, condors, and more As volatility becomes a greater focus of traders and investors, Trading Options in Turbulent Markets, Second Edition will become an important resource for in-depth insights, practical advice, and profitable strategies.
Preface xiii Acknowledgments xv Introduction xvii Part I: Understanding the Relationship Between Market Turbulence and Option Volatility 1 Chapter 1 Managing Risk and Uncertainty with Options 3 What is Risk? 4 What is Uncertainty? 4 Seven Lessons Learned from Market Volatility 5 Understanding Derivatives 7 The Six Benefits of Options 9 Chapter 2 Making Sense of Volatility in Options Trading 13 Volatility as an Asset Class 14 Analyzing Volatility with Implied Volatility 16 What Does Implied Volatility Reveal? 16 Making Trading Decisions Based on the Disparity between Historical and Implied Volatility 17 Appreciating Volatility for All It is Worth 19 How Volatility Really Works on the Trading Floor 20 Volatility and Uncertainty: Lessons for the Irrational Option Trader 21 Varieties of Option Volatility Trading 23 Chapter 3 Working with Volatility to Make Investment Decisions 25 On Predicting the Future 25 Starting with Historical Volatility 27 Implied Volatility 32 Why Do Volatilities Increase as Equities Fall? 35 Implied versus Historical Volatility 36 Justification for the Disparity between Historical and Implied Volatility 37 Chapter 4 Volatility Skew: Smile or Smirk? 39 Considering Some Examples 40 A Primer on Random Walk and Normal Distribution 41 Dealing with the Higher Moments of the Normal Distribution 45 Skew is High, Skew is Low. So What? 47 Does a “Flat” or “Steep” Skew Predict the Future? 48 A Fair Warning about Thinking about Skew too Much 49 Chapter 5 Fixated on Volatility and the VIX: What is Volatility, Anyhow? 51 What We (Think) We Know 52 Definitions of VIX 54 Grasping the VIX Index 54 VIX—A (Very) Brief History 55 VIX: Calculation and Interpretation with a Simple Calculator 56 Important Insights on the VIX Index 57 What Does the VIX Tell Us? 58 VIX and Perhaps the Biggest Misnomer of All! 59 Part II: Understanding Option Volatility and Its Relationship to Option Greeks, Personal Decision Making, and Odds Creation 61 Chapter 6 Extreme Volatility and Option Delta 63 The Misnomer of Delta and Probability of Exercise 63 Delta Defined 65 The Relationship Between Volatility and Delta 69 Higher Volatility and Delta 70 Lower Volatility and Delta 70 Delta, Time, and Volatility 71 Delta, Position Delta, Volatility, and the Professional Trader 72 Chapter 7 Smoke and Mirrors: Managing Gamma through Volatile Markets 75 Gamma and Volatility 78 Managing Positive Gamma during a High-Volatility Environment 79 The Bad News: There’s Always More than Meets the Eye 80 Practical Considerations for Managing Long Gamma in a High-Volatility Environment 81 Managing Negative Gamma in a High-Volatility Environment 82 Practical Considerations of Negative Gamma in High Volatility 84 Gamma and Volatility with Respect to Time Structure 85 Summary 86 Chapter 8 Price Explosion: Volatility and Option Vega 87 The Relationship between Implied Volatility and Vega 88 Implied Volatility: Price Analogy 90 Option Vega and Time 90 Option Vega and Its Greek Cousins 91 Option Vega Implications 91 Don’t Underestimate the Relationship between Volatility and Option Vega 91 Volatility and Vega Insensitivity 93 Important Concepts When Applying Option Vega in a Volatile Marketplace 94 Summary 97 Chapter 9 Sand in the Hourglass: Volatility and Option Theta 99 Balancing Time Decay with Volatility: Mistakes Traders Make 101 Volatility and Theta: What Every Investor Needs to Know 106 Chapter 10 The Nuances of Volatility: Interpreting the Mix of Academics and the Study of Volatility 109 The Complication Surrounding Vega Risk in an Option Position 110 Implied Volatility Skew1Term Structure5Volatility Surface 111 Implied Volatility Term Structure 114 Did You Know Your Volatility Has Volatility? 115 The Normal Value of Volatility 117 Part III: Ten Proven Strategies to Employ in Uncertain Times 119 Chapter 11 Preparing for Trading Using Volatility Strategies 121 The Elements of a Sound Trading Decision 122 Developing an Approach to Options Trading 123 The Mind of a Successful Trader 126 Decision Making, Options versus Everything Else 128 Chapter 12 The Buy-Write, or the Covered Call 131 The Buy-Write (Covered Call) Defined 131 An Example of the Covered Call Strategy 132 The Theory and Reality of the Covered Call 133 Covered Call Writing and Implied Volatility 137 Implied Volatility in Practice 138 Managing Contracts in a Time of High Volatility or a Falling Market 142 Effective Call Writing in a Volatile Market 143 Chapter 13 Covering the Naked Put 145 Contemplating the Cash-Secured Put 147 Utilizing the Cash-Secured Put in a High-Volatility Environment 149 Cash-Secured Put and Volatility: Risks and Consequences 152 Income Strategy: Volatility as an Asset Class and Cash-Secured Puts 154 Position Management 155 Chapter 14 The Married Put: Protecting Your Profit 157 Volatility, Downside Risk, and the Case for Portfolio Insurance 157 Why Buy High Volatility? 158 The Married Put 159 How and When to Use a Married Put 161 Example of When to Use a Married Put 162 The Married Put: Limiting Loss, Neutralizing Volatility, and Unleashing Upside Potential 165 Married Put: A Real-Life Illustration 166 Chapter 15 The Collar: Sleep at Night 169 Collar Strategy 169 Types of Collars 173 Summary 177 Conclusions on the Collar Strategy 181 Chapter 16 The Straddle and Strangle: The Risks and Rewards of Volatility-Sensitive Strategies 187 The Buying or Selling of Premium 188 Properties of Straddles and Strangles 188 Comparing Straddles and Strangles 189 How to Compare Historical and Implied Volatility 192 The Impact of Correlation and Implied Volatility Skew 193 An Alternative to the Naked Volatility Sale via the Straddle/Strangle: The Strangle Swap 194 Chapter 17 The Vertical Spread and Volatility 201 Introduction to the Vertical Spread 202 A Trader’s Reasoning for Trading a Vertical Spread 203 Designing Your Vertical Spread 205 Vertical Spreads and Greek Exposure 208 Vertical Spreads as a Pure Volatility Play 211 Comparing Volatility’s Effect on Vertical Spreads 212 Summary: Comparing Vertical Spreads and Implied Volatility 213 Chapter 18 Calendar Spreads: Trading Theta and Vega 217 Calendar Spreading—Trading Time 218 Risks and Rewards of the Calendar Spread 219 A Calendar Spread with a Bullish Expectation 220 Considerations and Observations for Calendar Spreads and Volatility 222 Chapter 19 Ratio Spreading: Trading Objectives Tailor Made 227 How Back Spreads and Ratio Spreads Work 227 Back Spreads 229 Ratio Spreads 231 Greek Values and the Back Spread or Ratio Spread 232 Configuring and Pricing a Back Spread or Ratio Spread 236 Reconciling Volatility and the Back Spread or Ratio Spread 238 Chapter 20 The Butterfly Spread 241 Setting up a Butterfly 241 The Butterfly Spread as a Volatility Investment 245 Greek Values and the Butterfly 247 Structuring and Pricing a Butterfly 250 Trading Butterflies in a Volatile Market 250 Chapter 21 Wingspreads 253 Capturing Convergence and Divergence 253 Wingspreads: Risk/Reward 254 Wingspreads: Sensitivities 254 Wingspreads and the Greeks 255 Wingspreads: Various and Sundry Details 257 The Condor Spread 258 Conclusion 267 About the Author 269 Index 271
LARRY SHOVER has been a firm and proprietary options trader for more than twenty-five years and can be seen on networks such as Bloomberg, BNN, CNBC, CNN, FOX Business, Phoenix Television, and SKY. He is currently Chief Investment Officer and Portfolio Manager to Solutions Funds Group, Inc., a managed futures mutual fund. A large portion of his career has been dedicated to developing his own proprietary trading firm, and he has also served as director of education and senior vice president of trading at several commodities and options firms. Shover was a member of the CME and the Chicago Board Options Exchange (CBOE) and holds several Financial Industry Regulatory Authority (FINRA) licenses. He is also the author of the first edition of this title, published by Wiley.
While we continue to emerge from the rubble of the 2008 financial disaster, traders and investors still find themselves struggling to deal with markets and an economy besieged by uncertainty. Nobody understands this situation better than options expert Larry Shover. That's why he has returned with the Second Edition of Trading Options in Turbulent Markets. Updated to reflect current conditions—which may prevail for longer than anyone has expected—this book will help you think about options trading in terms of our modern world of randomness and volatility. Divided into three comprehensive parts, Part One of this expanded Second Edition further examines how volatility in options trading relates to today's stormy marketplace and shows you how to manage risk and take advantage of market volatility when investing in derivatives. It also skillfully addresses how to use historical volatility to predict future volatility for a security, or the implied volatility, and offers suggestions for dealing with that odd feature of options trading known as skew—in which the options market has, in recent decades, essentially developed its own consciousness and can respond to market conditions that defy all logic. Skew is uncertainty squared, and here, Shover describes how to work with or around it. Part One also contains new insights on the overwhelming fixation with VIX—the self-proclaimed fear gauge of the market. It breaks VIX down, providing you with important information on what VIX is, what it isn't, and how it can lead or even mislead you in making options trading decisions. Part Two digs into the tools for evaluating options trading decisions, the Greeks: delta, vega, theta, and gamma. Shover defines the values carefully and describes how each relates to volatility. This part of the new edition takes the discussion one step further with an in-depth look at some of the more intricate details of volatility—introducing you to various volatility terms such as realized volatility, term-structure "vol of vol", and correlations—which were once reserved for the institutional world. Rounding out this detailed discussion, Part Three outlines effective strategies for trading options contracts in uncertain times, addresses the decision-making process in broad terms, and discusses how to become a steel-nerved trader. Along the way, it looks at specific options trading strategies to offset risk and reach for profit. These include the covered call, the naked and married puts, collars, straddles, vertical spreads, calendar spreads, butterflies, and condors, along with other various wingspreads, which are new to this edition. You can prosper in options trading, even in the midst of uncertainty.Trading Options in Turbulent Markets, Second Edition will show you how to achieve this difficult goal.
ADVANCE PRAISE FOR THE SECOND EDITION OF TRADING OPTIONS IN TURBULENT MARKETS "Larry Shover brings to the reader twenty-five plus years of real-life experience trading options from the exchange floors of Chicago. Having experienced the crash of '87, the tech bubble burst in the early 2000's, and the most recent global financial crisis, all while actively managing sizable option positions as a professional trader, I do not feel that their is a better resource for enhancing your knowledge in managing risk than Mr. Shover. This book is a must for both professional and retail traders alike, who seek to better their understanding of the effects volatility has on the option markets." —GREG JENSEN, founder and CEO, optionsANIMAL.com PRAISE FOR THE FIRST EDITION "There are a myriad of 'Options 101' books for the beginning options investor and painfully lengthy and dry graduate-level books on advanced strategies. Larry has found the sweet spot in between, offering a great book on intermediate options strategies. I can heartily endorse Trading Options in Turbulent Markets as the book for investors seeking to enhance their knowledge of derivative trading and create a low-risk, high-return investment game plan." —JON "DOCTOR J" NAJARIAN, cofounder, tradeMONSTER.com "Shover's book offers valuable insights from his real-life experience in trading volatile markets." —JIM BITTMAN, Senior Instructor, The Options Institute at CBOE, and author of Trading Options as a Professional "Larry Shover was a successful options trader in his years at CRT and a valuable member of our team. His book is both accessible and informative, and its pages are filled with insights gained from many years of experience. Larry writes with passion and acumen, making this a book that will do more than just sit on your shelf." —JOSEPH RITCHIE, founder, Chicago Research and Trading Group (CRT); founder and Chairman, Fox River Financial Resources, Inc.; and CEO, Rwanda Development Board
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