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Option Trading
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Table of Contents

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

About the Author

EUAN SINCLAIR is an option trader with fifteen years of professional trading experience. He specializes in the design and implementation of quantitative trading strategies. Sinclair is currently a proprietary option trader for Bluefin Trading, where he trades based on quantitative models of his own design. He holds a PhD in theoretical physics from the University of Bristol. Sinclair is also the author of the Wiley title Volatility Trading .

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