Recently I finished reading a book on options that doesn’t explain the basics of calls and puts. The Greeks are on almost every page, but never defined, and it’s assumed that the reader already knows options strategies and acronyms (e.g., butterflies, condors, ratio spreads, ATM, OTM).
Clearly the “The Option Trader’s Hedge Fund” is not for beginners. It targets serious traders that know the basics and want a full picture of what’s required to professionally trade options. Using the apt analogy of an insurance business Dennis Chen and Mark Sebastian construct the fundamentals of a well designed options trading business, including capital requirements, risk management, infrastructure needs, and recommended processes.
Within that framework they layer on a rich compendium of practical option advice. Some topics are strategy independent, for example:
- How the market interacts with market makers to establish option pricing
- Real vs theoretical pricing of OTM options
- “Card Game Risk” pricing
- Stages of skew
- VIX Index nuances
- Cash as a position
Other sections cover common strategies like vertical spreads, condors, butterflies, and calendars detailing the key parameters the authors evaluate and track including:
- Volatility requirements and expectations
- Skew parameters
- Recommended profit targets
- Margin requirements
- Trade time frames
- Typical trade duration
- Risk management / insurance
- Adjustment strategies
- Exit points
The trade selections that Dennis and Mark discuss are classic volatility trades—evaluating historical volatility, skew, and term structure in search of mispriced options. Target profit is 5% to 10% on many of the setups and the suggested initiations are 30 to 60 days before expiration. You won’t read about earnings plays or expiration week strategies in this book (check out Mark’s blog for that).
The Option Trader’s Hedge Fund bridges the gap between starter books and reference style books. It will challenge you, but I’d be surprised if you don’t come away with some valuable insights.
First posted: Tuesday, August 28th, 2012 | Vance Harwood