Synopses & Reviews
Volatility, by definition, is indicative of underlying randomness. But there are patterns within the noise that can be measured and exploited. No one knows this better than author Euan Sinclair, a highly successful options trader with a doctorate in quantum chaos.
But the Second Edition of Volality Trading isn't just about the numbers. Drawing upon his fifteen years as a professional trader, Sinclair provides a fully fleshed-out approach to trading that relies as much on the all-important "human element" and the psychological and emotional biases that drive trading decisions, as it does on quantitative analysis.
Ultimately, says Sinclair, trading is about having a coherent trading philosophy and developing a rigorous system. It's about setting a goal that can be clearly expressed in one sentence, and about finding trades with a clear statistical edge. And, finally, it's about capturing that edge and sizing each trade in a way that is consistent with your goal. Everything you do as a trader must be done within this framework.
Taking an accessible, straightforward approach, Sinclair provides you with the knowledge and tools you need to create just such a framework. He walks you through the basics of option pricing, volatility measurement, hedging, money management, and performance evaluation. And he develops a Black-Scholes-Merton-based quantitative model for measuring volatility that can easily can be adapted to trading virtually any type of financial instrument.
Responding to major changes in the markets since the first edition, Sinclair has expanded his scope in this Second Edition to include coverage of the many new opportunities available in VIX futures, ETNs, and leveraged ETFs. He also:
- Analyzes the benefits and shortcomings of an array of historical volatility measurements
- Clearly shows how volatility behaves in the real world and how it relates to returns on underlying assets
- Outlines methods for forecasting volatility over the lifetime of a trade
- Supplies proven techniques for knowing when to hedge and by how much
- Delivers strategies for aggregating positions so as to reduce the need to hedge
- Shares priceless tips on how to boost returns through trade sizingincluding techniques borrowed from the worlds of futures trading and professional gambling
- Arms you with powerful tools for evaluating the ongoing performance of your trading activity
- Fills you in on the latest research on cognitive and emotional biases that influence trading decisions and how to leverage them to your advantage
- Delineates time-tested strategies for trading VIX futures, ETNs, and leveraged ETFs
- Provides access to a companion website containing valuable spreadsheets, models for calculating volatility cones for different time periods, and simulation engines
Bringing volatility trading down to earth for even the most numbers-shy traders, as well as hard-nosed quants interested in acquiring a deeper understanding of options trading, Volatility Trading, Second Edition is an indispensable "tool of the trade."
Synopsis
Popular guide to options pricing and position sizing for quant tradersIn this second edition of this bestselling book, Sinclair offers a quantitative model for measuring volatility in order to gain an edge in everyday option trading endeavors. With an accessible, straightforward approach, he guides traders through the basics of option pricing, volatility measurement, hedging, money management, and trade evaluation. This new edition includes new chapters on the dynamics of realized and implied volatilities, trading the variance premium and using options to trade special situations in equity markets.
- Filled with volatility models including brand new option trades for quant traders
- Options trader Euan Sinclair specializes in the design and implementation of quantitative trading strategies
Volatility Trading, Second Edition + Website outlines strategies for defining a true edge in the market using options to trade volatility profitably.
Synopsis
Praise from experts for the Second Edition of
Volatility Trading"Benefitting from his experience as an option trader and his background as a physicist, Euan Sinclair gives a comprehensive and detailed treatment of theoretical and practical aspects involved in volatility trading. The style is to-the-point, focused, and honest. The book includes something rarer than a CD-ROM: humor. Heartily recommended for the practitioner, as well as the academic who wants to know."
JESPER ANDREASEN, Danske Markets, Copenhagen
"Over the last five years, this has become the classic work on practical options trading. It has been updated to cover innovations in markets as well as additional material on behavioral finance and capturing risk premium Everyone who trades options should read this book."
AARON BROWN, Risk Manager, AQR Capital Management, and author of Red-Blooded Risk
"Practical, engaging, and concise, Euan Sinclair's Volatility Trading remains the best book I have seen about options trading from the practitioner's standpoint. A far cry from the standard textbook treatment, Sinclair's discussion of practical topics such as trade sizing, exit criteria, and P&L managementpeppered with relevant trading anecdoteseducates while countering many of the trader myths and fallacies one hears over the years. New material on trading the VIX and volatility ETFs is particularly timely and useful."
STEVE CRUTCHFIELD, Head of U.S. Options, NYSE Euronext
About the Author
EUAN SINCLAIR is an option trader with fifteen years' 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.
Table of Contents
Acknowledgments xi
Introduction to the Second Edition xiii
CHAPTER 1 Option Pricing 1
The Black-Scholes-Merton Model 1
Modeling Assumptions 7
Conclusion 11
Summary 11
CHAPTER 2 Volatility Measurement 13
Defining and Measuring Volatility 13
Definition of Volatility 14
Alternative Volatility Estimators 20
Using Higher-Frequency Data 29
Summary 33
CHAPTER 3 Stylized Facts about Returns and Volatility 35
Definition of a Stylized Fact 35
Volatility Is Not Constant 36
Characteristics of the Return Distribution 40
Volume and Volatility 43
Distribution of Volatility 45
Summary 46
CHAPTER 4 Volatility Forecasting 49
Absence of Transaction Costs 50
Perfect Information Flow 50
Agreement about the Price Implications of Information 50
Maximum Likelihood Estimation 54
Volatility Forecasting Using
Fundamental Information 60
The Variance Premium 62
Summary 65
CHAPTER 5 Implied Volatility Dynamics 67
Volatility Level Dynamics 70
The Smile and the Underlying 80
Smile Dynamics 82
Term Structure Dynamics 90
Summary 91
CHAPTER 6 Hedging 93
Ad Hoc Hedging Methods 95
Utility-Based Methods 96
Estimation of Transaction Costs 109
Aggregation of Options on Different Underlyings 113
Summary 115
CHAPTER 7 Distribution of Hedged Option Positions 117
Discrete Hedging and Path Dependency 117
Volatility Dependency 123
Summary 129
CHAPTER 8 Money Management 131
Ad Hoc Sizing Schemes 131
The Kelly Criterion 133
Time for Kelly to Dominate 143
Effect of Parameter Mis-Estimation 144
What is Bankroll? 146
Alternatives to Kelly 148
Summary 161
CHAPTER 9 Trade Evaluation 163
General Planning Procedures 164
Risk-Adjusted Performance Measures 171
Setting Goals 178
Persistence of Performance 180
Relative Persistence 180
Summary 184
CHAPTER 10 Psychology 187
Self-Attribution Bias 191
Overconfidence 193
The Availability Heuristic 197
Short-Term Thinking 199
Loss Aversion 199
Conservatism and Representativeness 201
Confirmation Bias 203
Hindsight Bias 206
Anchoring and Adjustment 207
The Narrative Fallacy 208
Prospect Theory 209
Summary 212
CHAPTER 11 Generating Returns through Volatility 213
The Variance Premium 214
Reasons for the Variance Premium 220
Summary 222
CHAPTER 12 The VIX 223
The VIX Index 224
VIX Futures 225
Volatility ETNs 227
Other VIX Trades 229
Summary 230
CHAPTER 13 Leveraged ETFs 231
Leveraged ETFs as a Trade-Sizing Problem 234
A Long-Short Trading Strategy 234
Options on Leveraged ETFs 235
Summary 237
CHAPTER 14 Life Cycle of a Trade 239
Pretrade Analysis 239
Posttrade Analysis 245
Summary 247
CHAPTER 15 Conclusion 249
Summary 252
Resources 253
Directly Applicable Books 253
Thought-Provoking Books 256
Useful Websites 257
References 261
About the Website 273
About the Author 279
Index 281