Volatility Trading: + Website

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 management—peppered with relevant trading anecdotes—educates 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

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

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.