Option Trading

An A to Z options trading guide for the new millennium and the new economy

Written by professional trader and quantitative analyst Euan Sinclair, Option Trading is a comprehensive guide to this discipline covering everything from historical background, contract types, and market structure to volatility measurement, forecasting, and hedging techniques.

This comprehensive guide presents the detail and practical information that professional option traders need, whether they're using options to hedge, manage money, arbitrage, or engage in structured finance deals. It contains information essential to anyone in this field, including option pricing and price forecasting, the Greeks, implied volatility, volatility measurement and forecasting, and specific option strategies.
* Explains how to break down a typical position, and repair positions
* Other titles by Sinclair: Volatility Trading
* Addresses the various concerns of the professional options trader

Option trading will continue to be an important part of the financial landscape. This book will show you how to make the most of these profitable products, no matter what the market does.

Preface xi
Professional Trading xii
The Role of Mathematics xiv
The Structure of this Book xvi
Acknowledgments xix
CHAPTER 1 History 1
Summary 6
CHAPTER 2 Introduction to Options 7
Options 9
Specifications for an Option Contract 9
Uses of Options 11
Market Structure 14
Summary 20
CHAPTER 3 Arbitrage Bounds for Option Prices 21
American Options Compared to European Options 25
Absolute Maximum and Minimum Values 25
Summary 39
CHAPTER 4 Pricing Models 41
General Modeling Principles 42
Choice of Dependent Variables 45
The Binomial Model 48
The Black-Scholes-Merton (BSM) Model 55
Summary 61
CHAPTER 5 The Solution of theBlack-Scholes-Merton (BSM) Equation 63
Delta 67
Gamma 72
Theta 76
Vega 80
Summary 88
CHAPTER 6 Option Strategies 89
Forecasting and Strategy Selection 89
The Strategies 93
Summary 116
CHAPTER 7 Volatility Estimation 117
Defining and Measuring Volatility 119
Forecasting Volatility 129
Volatility in Context 132
Summary 136
CHAPTER 8 Implied Volatility 137
The Implied Volatility Curve 138
Parameterizing and Measuring the Implied Volatility Curve 142
The Implied Volatility Curve as a Function of Expiration 145
Implied Volatility Dynamics 146
Summary 151
CHAPTER 9 General Principles of Trading and Hedging 153
Edge 154
Hedging 156
Trade Sizing and Leverage 158
Scalability and Breadth 163
Summary 164
CHAPTER 10 Market Making Techniques 165
Market Structure 166
Market Making 169
Trading Based on Order-Book Information 181
Summary 189
CHAPTER 11 Volatility Trading 191
Hedging 192
Hedging in Practice 193
The P/L Distribution of Hedged Option Positions 203
Summary 213
CHAPTER 12 Expiration Trading 215
Pinning 215
Pin Risk 219
Forward Risk 221
Exercising the Wrong Options 221
Irrelevance of the Greeks 223
Expiring at a Short Strike 224
Summary 225
CHAPTER 13 Risk Management 227
Example of Position Repair 228
Inventory 232
Delta 234
Gamma 234
Vega 238
Correlation 240
Rho 242
Stock Risk: Dividends and Buy-in Risk 242
The Early Exercise of Options 243
Summary 248
Conclusion 249
APPENDIX A Distributions 253
Example 253
Moments and the "Shape" of Distributions 254
APPENDIX B Correlation 263
Glossary 271
Index 285