Trading Options in Turbulent Markets (2^nd Ed.)
Master Uncertainty through Active Volatility Management
Bloomberg Financial Series

Trading Options in Turbulent Markets, Second Edition skillfully explains the intricacies of options volatility and shows you how to use options to cope, and profit from, market turbulence. Throughout this new edition, options expert Larry Shover reveals how to use historical volatility to predict future volatility for a security and addresses how you can utilize that knowledge to make better trading decisions.

Along the way, he also defines the so-called Greeks?delta, vega, theta, and gamma?and explains what drives their values and their relationship to historic and implied volatility. Shover then provides effective strategies for trading options contracts in uncertain times, addressing the decision-making process and how to trade objectively in the face of unpredictable and irrational market moves.

• Includes a new chapter of the VIX, more advanced material on volatility suitable for institutional or intermediate options trader, and additional volatility-based strategies
• Answers complex questions such as: How does a trader know when to tolerate risk and How does a successful trader respond to adversity?
• Provides a different perspective on a variety of options strategies, including covered calls, naked and married puts, collars, straddles, vertical spreads, calendar spreads, butterflies, condors, and more

As volatility becomes a greater focus of traders and investors, Trading Options in Turbulent Markets, Second Edition will become an important resource for in-depth insights, practical advice, and profitable strategies.

Preface xiii

Acknowledgments xv

Introduction xvii

Part I: Understanding the Relationship Between Market Turbulence and Option Volatility 1

Chapter 1 Managing Risk and Uncertainty with Options 3

What Is Risk? 4

What Is Uncertainty? 4

Seven Lessons Learned from Market Volatility 5

Understanding Derivatives 7

The Six Benefits of Options 9

Chapter 2 Making Sense of Volatility in Options Trading 13

Volatility as an Asset Class 14

Analyzing Volatility with Implied Volatility 16

What Does Implied Volatility Reveal? 16

Making Trading Decisions Based on the Disparity between Historical and Implied Volatility 17

Appreciating Volatility for All It Is Worth 19

How Volatility Really Works on the Trading Floor 20

Volatility and Uncertainty: Lessons for the Irrational Option Trader 21

Varieties of Option Volatility Trading 23

Chapter 3 Working with Volatility to Make Investment Decisions 25

On Predicting the Future 25

Starting with Historical Volatility 27

Implied Volatility 32

Why Do Volatilities Increase as Equities Fall? 35

Implied versus Historical Volatility 36

Justification for the Disparity between Historical and Implied Volatility 37

Chapter 4 Volatility Skew: Smile or Smirk? 39

Considering Some Examples 40

A Primer on Random Walk and Normal Distribution 41

Dealing with the Higher Moments of the Normal Distribution 45

Skew Is High, Skew Is Low. So What? 47

Does a “Flat” or “Steep” Skew Predict the Future? 48

A Fair Warning about Thinking about Skew too Much 49

Chapter 5 Fixated on Volatility and the VIX: What Is Volatility, Anyhow? 51

What We (Think) We Know 52

Definitions of VIX 54

Grasping the VIX Index 54

VIX—A (Very) Brief History 55

VIX: Calculation and Interpretation with a Simple Calculator 56

Important Insights on the VIX Index 57

What Does the VIX Tell Us? 58

VIX and Perhaps the Biggest Misnomer of All! 59

Part II: Understanding Option Volatility and Its Relationship to Option Greeks, Personal Decision Making, and Odds Creation 61

Chapter 6 Extreme Volatility and Option Delta 63

The Misnomer of Delta and Probability of Exercise 63

Delta Defined 65

The Relationship Between Volatility and Delta 69

Higher Volatility and Delta 70

Lower Volatility and Delta 70

Delta, Time, and Volatility 71

Delta, Position Delta, Volatility, and the Professional Trader 72

Chapter 7 Smoke and Mirrors: Managing Gamma through Volatile Markets 75

Gamma and Volatility 78

Managing Positive Gamma during a High-Volatility Environment 79

The Bad News: There’s Always More than Meets the Eye 80

Practical Considerations for Managing Long Gamma in a High-Volatility Environment 81

Managing Negative Gamma in a High-Volatility Environment 82

Practical Considerations of Negative Gamma in High Volatility 84

Gamma and Volatility with Respect to Time Structure 85

Summary 86

Chapter 8 Price Explosion: Volatility and Option Vega 87

The Relationship between Implied Volatility and Vega 88

Implied Volatility: Price Analogy 90

Option Vega and Time 90

Option Vega and Its Greek Cousins 91

Option Vega Implications 91

Don’t Underestimate the Relationship between Volatility and Option Vega 91

Volatility and Vega Insensitivity 93

Important Concepts When Applying Option Vega in a Volatile Marketplace 94

Summary 97

Chapter 9 Sand in the Hourglass: Volatility and Option Theta 99

Balancing Time Decay with Volatility: Mistakes Traders Make 101

Volatility and Theta: What Every Investor Needs to Know 106

Chapter 10 The Nuances of Volatility: Interpreting the mix of Academics and the Study of Volatility 109

The Complication Surrounding Vega Risk in an Option Position 110

Implied Volatility Skew + Term Structure = Volatility Surface 111

Implied Volatility Term Structure 114

Did You Know Your Volatility Has Volatility? 115

The Normal Value of Volatility 117

Part III: Ten Proven Strategies To Employ In Uncertain Times 119

Chapter 11 Preparing for Trading Using Volatility Strategies 121

The Elements of a Sound Trading Decision 122

Developing an Approach to Options Trading 123

The Mind of a Successful Trader 126

Decision Making, Options versus Everything Else 128

Chapter 12 The Buy-Write, or the Covered Call 131

The Buy-Write (Covered Call) Defined 131

An Example of the Covered Call Strategy 132

The Theory and Reality of the Covered Call 133

Covered Call Writing and Implied Volatility 137

Implied Volatility in Practice 138

Managing Contracts in a Time of High Volatility or a Falling Market 142

Effective Call Writing in a Volatile Market 143

Chapter 13 Covering the Naked Put 145

Contemplating the Cash-Secured Put 147

Utilizing the Cash-Secured Put in a High-Volatility Environment 149

Cash-Secured Put and Volatility: Risks and Consequences 152

Income Strategy: Volatility as an Asset Class and Cash-Secured Puts 154

Position Management 155

Chapter 14 The Married Put: Protecting Your Profit 157

Volatility, Downside Risk, and the Case for Portfolio Insurance 157

Why Buy High Volatility? 158

The Married Put 159

How and When to Use a Married Put 161

Example of When to Use a Married Put 162

The Married Put: Limiting Loss, Neutralizing Volatility, and Unleashing Upside Potential 165

Married Put: A Real-Life Illustration 166

Chapter 15 The Collar: Sleep at Night 169

Collar Strategy 169

Types of Collars 173

Summary 177

Conclusions on the Collar Strategy 181

Chapter 16 The Straddle and Strangle: The Risks and Rewards of Volatility-Sensitive Strategies 187

The Buying or Selling of Premium 188

Properties of Straddles and Strangles 188

Comparing Straddles and Strangles 189

How to Compare Historical and Implied Volatility 192

The Impact of Correlation and Implied Volatility Skew 193

An Alternative to the Naked Volatility Sale via the Straddle/Strangle: The Strangle Swap 194

Chapter 17 The Vertical Spread and Volatility 201

Introduction to the Vertical Spread 202

A Trader’s Reasoning for Trading a Vertical Spread 203

Designing Your Vertical Spread 205

Vertical Spreads and Greek Exposure 208

Vertical Spreads as a Pure Volatility Play 211

Comparing Volatility’s Effect on Vertical Spreads 212

Summary: Comparing Vertical Spreads and Implied Volatility 213

Chapter 18 Calendar Spreads: Trading Theta and Vega 217

Calendar Spreading—Trading Time 218

Risks and Rewards of the Calendar Spread 219

A Calendar Spread with a Bullish Expectation 220

Considerations and Observations for Calendar Spreads and Volatility 222

Chapter 19 Ratio Spreading: Trading Objectives Tailor Made 227

How Back Spreads and Ratio Spreads Work 227

Back Spreads 229

Ratio Spreads 231

Greek Values and the Back Spread or Ratio Spread 232

Configuring and Pricing a Back Spread or Ratio Spread 236

Reconciling Volatility and the Back Spread or Ratio Spread 238

Chapter 20 The Butterfly Spread 241

Setting up a Butterfly 241

The Butterfly Spread as a Volatility Investment 245

Greek Values and the Butterfly 247

Structuring and Pricing a Butterfly 250

Trading Butterflies in a Volatile Market 250

Chapter 21 Wingspreads 253

Capturing Convergence and Divergence 253

Wingspreads: Risk/Reward 254

Wingspreads: Sensitivities 254

Wingspreads and the Greeks 255

Wingspreads: Various and Sundry Details 257

The Condor Spread 258

Conclusion 267

About the Author 269

Index 271

LARRY SHOVER has been a firm and proprietary options trader for more than twenty-five years and can be seen on networks such as Bloomberg, BNN, CNBC, CNN, FOX Business, Phoenix Television, and SKY. He is currently Chief Investment Officer and Portfolio Manager to Solutions Funds Group, Inc., a managed futures mutual fund. A large portion of his career has been dedicated to developing his own proprietary trading firm, and he has also served as director of education and senior vice president of trading at several commodities and options firms. Shover was a member of the CME and the Chicago Board Options Exchange (CBOE) and holds several Financial Industry Regulatory Authority (FINRA) licenses. He is also the author of the first edition of this title, published by Wiley.