The Option Trader Handbook: Strategies and Trade Adjustments / Edition 2

by George Jabbour, Philip H. Budwick

Overview

Strategies, tools, and solutions for minimizing risk and volatility in option trading

An intermediate level trading book, The Option Trader Handbook, Second Edition provides serious traders with strategies for managing and adjusting their market positions. This Second Edition features new material on implied volatility; Delta and Theta, and how these measures can be used to make better trading decisions. The book presents the art of making trade adjustments in a logical sequence, starting with long and short stock positions; moving on to basic put and call positions; and finally discussing option spreads and combinations.

• Covers different types of underlying positions and discusses all the possible adjustments that can be made to that position
• Offers important insights into more complex option spreads and combinations
• A timely book for today's volatile markets

Intended for both stock and option traders, this book will help you improve your overall trading skills and performance.

Product Details

ISBN-13:	9780470481615
Publisher:	Wiley
Publication date:	01/26/2010
Series:	Wiley Trading , #440
Edition description:	2nd ed.
Pages:	400
Product dimensions:	6.20(w) x 9.00(h) x 1.40(d)

About the Author

GEORGE M. JABBOUR, PHD, is the Director of the Master of Science in Finance program at The George Washington University, as well as a professor of derivatives, financial engineering, and investments. Dr. Jabbour has published various articles in professional financial journals and regularly speaks at conferences in the United States and abroad regarding option pricing models, financial management, and risk management. He is also a managing director of Global Asset Investments, LLC, an asset management and derivatives consulting firm, and CEO of Global Finance Associates Inc., a financial training, consulting, and research company. Dr. Jabbour regularly conducts seminars in option trading and valuation, and is a very active equities and derivatives trader.

PHILIP H. BUDWICK, MSF, is the Director of the Capital Markets Trading Room at The George Washington University School of Business and frequently writes articles on option trading strategies and investments. Mr. Budwick is a Managing Director of Global Asset Investments, LLC, an asset management and derivatives consulting firm, and is an active option and stock trader. He has a law degree and a master of science in finance and teaches classes in portfolio management.

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Table of Contents

Preface to the First Edition xiii

Preface to the Second Edition xvii

Chapter 1 Trade and Risk Management 1

Introduction 1

The Philosophy of Risk 2

Truth About Reward 5

Risk Management 6

Risk 6

Reward 9

Breakeven Points 11

Trade Management 11

Trading Theme 11

The Theme of Your Portfolio 14

Diversification and Flexibility 15

Trading as a Business 16

Start-Up Phase 16

Growth Phase 19

Mature Phase 20

Just Business, Nothing Personal 21

SCORE—The Formula for Trading Success 21

Select the Investment 22

Choose the Best Strategy 23

Open the Trade with a Plan 24

Remember Your Plan and Stick to It 26

Exit Your Trade 26

Chapter 2 Tools of the Trader 29

Introduction 29

Option Value 30

Option Pricing 31

Stock Price 31

Strike Price 32

Time to Expiration 32

Volatility 33

Dividends 33

Interest Rates 33

Option Greeks and Risk Management 34

Time Decay 34

Trading Lessons Learned from Time Decay (Theta) 41

Delta/Gamma 43

Deep-in-the-Money Options 46

Implied Volatility 49

Early Assignment 63

Synthetic Positions 65

Synthetic Stock 66

Long Stock 66

Short Stock 67

Synthetic Call 68

Synthetic Put 70

Basic Strategies 71

Long Call 71

Short Call 72

Long Put 73

Short Put 74

Basic Spreads and Combinations 75

Bull Call Spread 75

Bull Put Spread 76

Bear Call Spread 77

Bear Put Spread 78

Long Straddle 78

Long Strangle 79

Short Straddle 80

Short Strangle 81

Advanced Spreads 82

Call Ratio Spread 82

Put Ratio Spread 83

Call Ratio Backspread 84

Put Ratio Backspread 85

Long Butterflies 86

Short Butterflies 87

Long Calendar Spreads 88

Short Calendar Spreads 89

The Greeks and Spread Trades 90

Delta/Gamma 91

Vega 92

Other Greeks and Spreads 93

Valuable Derivative Traders Program 93

Step 1: VEGA and Implied Volatility (IV) 94

Step 2: Delta and Strike Selection 96

Step 3: Theta and How Much Time to Expiration 97

Putting the Program to Work 99

Introduction to Trade Adjustments 100

Chapter 3 Long Stock 105

Introduction 105

Protective Put 106

Stock Moves Higher 109

Stock Moves Lower 111

Bear Put Spread 114

Rolling from a Protective Put into a Bear Put Spread 116

Rolling from a Bear Put Spread into a Protective Put 118

Call Replacement 120

Stock Moves Higher 121

Stock Moves Lower 122

Call Replacement versus Protective Put 123

Sell Covered Calls 123

Stock Moves Higher 125

Strike Selection 127

In the Money Calls 128

Time to Expiration 131

Scaling-Out Strategy 132

Collars 134

Opening Position—Regular Collar 134

Stock Moves Higher—Profit Collar 137

Ratio Write 139

Opening Position 140

Stock Moves Higher—Regular Ratio Write 143

Stock Moves Higher—Variable Strike Ratio Write 149

Stock Moves Lower—Ratio Write/Variable Strike Ratio Write 153

Short Straddle/Short Strangle 156

Opening Position—Short Straddle 156

Opening Position—Short Strangle 160

Stock Moves Higher—Short Straddle 163

Stock Moves Higher—Short Strangle 168

Stock Moves Lower—Short Straddle/Stock Repair 172

Stock Moves Lower—Short Strangle 176

Call Ratio Spread 179

Opening Position 182

Stock Moves Higher 186

Stock Moves Lower—Stock Repair Strategy 191

Call Calendar Spread 193

Opening Position 195

Stock Moves Higher 196

Chapter 4 Short Stock 201

Introduction 201

Protective Call—Insurance 203

Opening Position—Protective Call 203

Opening Position—Protective Call Spread 208

Short Stock + Protective Call = Long Put 210

Stock Moves Lower—Protective Call 212

Stock Moves Lower—Protective Call Spread 215

Rolling between Protective Calls and Protective Call Spreads 219

Stock Moves Higher 221

Put Replacement 223

Stock Moves Lower 224

Stock Moves Higher 226

Put Replacement versus Protective Call 227

Covered Puts 228

Stock Moves Lower 229

Short Collars 234

Opening Position—Regular Collar 235

Stock Moves Lower—Profit Collar 237

Put Ratio Write 239

Opening Position 240

Stock Moves Lower—Regular Ratio Write 243

Stock Moves Lower—Variable Strike Ratio Write 248

Put Ratio Spread 250

Opening Position 250

Stock Moves Lower 253

Stock Moves Higher—Short Repair Strategy 256

Chapter 5 Calls and Puts 259

Introduction 259

Long Call 260

Protective Put—Stock Moves Higher 260

Protective Put—Stock Moves Lower 262

Call Replacement 264

Rolling into a Bull Call Spread—Stock Moves Higher 267

Rolling into a Bull Call Spread—Stock Moves Lower/Call Repair Strategy 269

Rolling into a Bear Call Spread 271

Short Stock 272

Rolling into a Synthetic Straddle 274

Rolling into a Calendar Spread 276

Rolling into a Ratio Spread 278

Stock Moves Lower—Call Repair Strategy 281

Short Call 285

Long Put 288

Protective Call 288

Underlying Stock Moves Lower 288

Underlying Stock Moves Higher 290

Put Replacement Therapy 292

Rolling into a Bear Put Spread 294

Underlying Stock Moves Lower 294

Underlying Stock Moves Higher—Put Repair Strategy 295

Rolling into a Bull Put Spread 297

Long Stock/Synthetic Straddle 298

Put Calendar Spread 302

Put Ratio Spread 305

Underlying Stock Moves Lower 305

Underlying Stock Moves Higher—Put Repair Strategy 308

Short Put 311

Chapter 6 Spreads 317

Introduction 317

Bull Call Spreads/Bear Put Spreads 317

Protective Puts/Protective Calls 318

Bull Call Spread—Protective Put 318

Bull Call Spread—Protective Put Spread 320

Bear Put Spread—Protective Call 321

Bear Put Spread—Protective Call Spread 322

Convert to Ratio Spreads 323

Bull Call Spread—Stock Moves Higher 323

Bull Call Spread—Stock Moves Lower/Repair Strategy 326

Bear Put Spread—Stock Moves Lower 330

Bear Put Spread—Stock Moves Higher/Repair Strategy 332

Convert to Butterflies 336

Bull Call Spread 337

Bear Put Spread 338

Bear Call Spreads/Bull Put Spreads 340

Calendar Spreads 340

Call Calendar Spread 341

Stock Moves Higher—Rolling into a Bull Call Spread 341

Stock Moves Higher—Rolling into a Diagonal Ratio Spread 342

Stock Moves Lower—Rolling into a Lower Strike Bull Call Spread 343

Stock Moves Lower—Convert to a Calendar Strangle 344

Put Calendar Spread 345

Stock Moves Lower—Rolling into a Bear Put Spread 345

Stock Moves Lower—Rolling into a Diagonal Ratio Spread 345

Stock Moves Higher—Rolling into a Higher Strike Bear Put Spread 347

Stock Moves Higher—Rolling into a Calendar Strangle 348

Butterfly Spreads 348

Long Butterfly to Long Condor 348

Chapter 7 Combinations 353

Introduction 353

Long Straddle 353

Straps/Strips 354

Modified Straps/Strips 357

Calendar Straddle 359

Rolling a Long Straddle into an Iron Butterfly 361

Diagonal Iron Butterfly 363

Partial Iron Butterfly 363

Long Call/Long Put Adjustments 365

Long Strangle 365

Diagonal Iron Butterfly 365

Calendar Strangle 367

Long Call/Long Put Adjustments 367

Short Straddle/Short Strangle 368

Short Straddle 368

Rolling Short Straddle into Iron Butterfly 371

Short Strangle 373

Index 375