Euan Sinclair - Positional Option Trading

1 COVER

2 INTRODUCTION Trading as a Process Summary

3 CHAPTER 1: OptionsOption Pricing Models Option Trading Theory Conclusion Summary

4 CHAPTER 2: The Efficient Market Hypothesis and Its Limitations The Efficient Market Hypothesis Aside: Alpha Decay Behavioral Finance High-Level Approaches: Technical Analysis and Fundamental Analysis Conclusion Summary

5 CHAPTER 3: Forecasting Volatility Model-Driven Forecasting and Situational Forecasting The GARCH Family and Trading Implied Volatility as a Predictor Ensemble Predictions Conclusion Summary

6 CHAPTER 4: The Variance Premium Aside: The Implied Variance Premium Variance Premium in Equity Indices The Implied Skewness Premium The Implied Correlation Premium Commodities Bonds The VIX Currencies Equities Reasons for the Variance Premium Insurance Jump Risk Trading Restrictions Market-Maker Inventory Risk Path Dependency of Returns The Problem of the Peso Problem Conclusion Summary

7 CHAPTER 5: Finding Trades with Positive Expected Value Aside: Crowding Trading Strategies Options and Fundamental Factors Post-Earnings Announcement Drift (PEAD) Confidence Level Two The Overnight Effect FOMC and Volatility The Weekend Effect Volatility of Volatility Risk Premia Confidence Level One Earnings-Induced Reversals Pre-Earnings Announcement Drift Conclusion Summary

8 CHAPTER 6: Volatility Positions Aside: Adjustment and Position “Repair” Straddles and Strangles Aside: Delta-Hedged Positions Butterflies and Condors Aside: Broken Wing Butterflies and Condors Calendar Spread Including Implied Volatility Skew Strike Choice Choosing a Hedging Strike Expiration Choice Conclusion Summary

9 CHAPTER 7: Directional Option Trading Subjective Option Pricing A Theory of Subjective Option Pricing Distribution of Option Returns: Summary Statistics Strike Choice Fundamental Considerations Conclusion Summary

10 CHAPTER 8: Directional Option Strategy Selection Long Stock Long Call Long Call Spread Short Put Covered Calls Components of Covered Call Profits Covered Calls and Fundamentals Short Put Spread Risk Reversal Aside: The Risk Reversal as a Skew Trade Ratio Spreads Conclusion Summary

11 CHAPTER 9: Trade Sizing The Kelly Criterion Non-normal Discrete Outcomes Non-normal Continuous Outcomes Uncertain Parameters Kelly and Drawdown Control The Effect of Stops Conclusion Summary

12 CHAPTER 10: Meta Risks Currency Risk Theft and Fraud Example One: Baring's Bank Example Two: Yasumo Hamanaka, aka “Mr. Copper” Example Three: Bernie Madoff Index Restructuring Arbitrage Counterparty Risk Conclusion Summary

13 CONCLUSION

14 APPENDIX 1: Traders' Adjustments to the BSM AssumptionsThe Existence of a Single, Constant Interest Rate The Stock Pays No Dividends Absence of Taxes The Ability to Trade and Short the Underlying Nonconstant Volatility Conclusion Summary

15 APPENDIX 2: Statistical Rules of Thumb Converting Range Estimates to Option Pricing Inputs Rule of Five Rule of Three

16 APPENDIX 3: Execution Example

17 REFERENCES

18 INDEX

19 END USER LICENSE AGREEMENT

1 Chapter 1TABLE 1.1 Statistics for the Short One-Year ATM Daily Hedged Straddle With and W...

2 Chapter 3TABLE 3.1 Thirty-Day Volatility Forecasts for the S&P 500 from 1990 to t...TABLE 3.2 Thirty-Day Volatility EWMA Forecasts for the S&P 500 from 1990 ...

3 Chapter 4TABLE 4.1 Summary Statistics for the S&P 500 Variance PremiumTABLE 4.2 Summary Statistics for the Dow Jones, NASDAQ 100, and Russell 2000 Var...TABLE 4.3 Summary Statistics for the VIX Sorted by QuintilesTABLE 4.4 The Size and Significance of the Variance Premium in Commodity OptionsTABLE 4.5 The Correlation of the Variance Premium Within Commodity SectorsTABLE 4.6 The Correlation of the Variance Premium Between Commodity SectorsTABLE 4.7 The Average Return to a Short 1-Month Variance Swap for Stock Options ...

4 Chapter 5TABLE 5.1 Postulated Risk and Behavioral Reasons for the Smart Beta Factors

5 Chapter 6TABLE 6.1 Summary Statistics for the Returns of a Fairly Priced Short StraddleTABLE 6.2 Summary Statistics for the Returns of a Fairly-Priced Short StrangleTABLE 6.3 Summary Statistics for the Returns of a Mispriced Short StraddleTABLE 6.4 Summary Statistics for the Returns of a Poorly Priced Short StrangleTABLE 6.5 Summary Statistics for the Returns of a Short Straddle When Our Direct...TABLE 6.6 Summary Statistics for the Returns of a Short Strangle When Our Direct...TABLE 6.7 Comparing Results for Straddles and Strangles if the Underlying Has th...TABLE 6.8 Comparing Results for Straddles and Strangles When Hedging DailyTABLE 6.9 Summary Statistics for the Returns of a Fairly-Priced ButterflyTABLE 6.10 Summary Statistics for the Returns of a Fairly Priced CondorTABLE 6.11 Summary Statistics for the Returns of a Badly Priced ButterflyTABLE 6.12 Summary Statistics for the Returns of a Badly Priced CondorTABLE 6.13 Summary Statistics of S&P 500 Returns from 1990 to 2018TABLE 6.14 Summary Statistics of the PL Distribution for the Straddle Spread and...TABLE 6.15 Summary Statistics of the PL Distribution for the Straddle Spread and...TABLE 6.16 Summary Statistics for the Returns of a Strangle with an Implied Vola...TABLE 6.17 The Results for Both the Flat Skew Condor and the Skewed CaseTABLE 6.18 The Put Prices of the SPY June 2020 Expiration on July 30, 2019 (Down...TABLE 6.19 The Summary Statistics from Selling $1000 Vega of the 210/360 SPY Str...TABLE 6.20 The Dollar Premium of Options Over Their Being Priced at the ATM Vola...TABLE 6.21 The Summary Statistics from Selling $1000 Vega of 260/335 SPY Strangl...TABLE 6.22 Prices and Strikes of Possible Hedging Options for Our Short 260 Put ...

6 Chapter 7TABLE 7.1 A Comparison of Risk-Neutral and Subjective Option PricesTABLE 7.2 Projected Performance Numbers for Long Positions in Different Strike 3...TABLE 7.3 Projected Performance Numbers for Long Positions in Different Strike 3...

7 Chapter 8TABLE 8.1 Summary Statistics for 100 Shares of a $100 Stock with a 20% Return (V...TABLE 8.2 Summary Statistics of the PL Distribution for a 1-Year ATM Call Option...TABLE 8.3 Summary Statistics of the PL Distribution for a 1-Year ATM/20-Delta Ca...TABLE 8.4 Summary Statistics of the PL Distribution for a Short 1-Year ATM Put O...TABLE 8.5 Summary Statistics for BXM and the S&P 500TABLE 8.6 Summary Statistics for BXY, BXMD, and the S&P 500 from June 1988 ...TABLE 8.7 Summary Statistics of the PL Distribution for a Short 1-Year ATM/20-De...TABLE 8.8 Summary Statistics of the PL Distribution for a Short 1-Year ATM/20-De...TABLE 8.9 Summary Statistics of the PL Distribution for a 1-Year 20-Delta Risk R...TABLE 8.10 Summary Statistics of the PL Distribution for a 1-Year 20-Delta Risk ...TABLE 8.11 Results for a Short Put–Long Call 20-Delta Risk Reversal for Various ...TABLE 8.12 Summary Statistics of the PL Distribution for a 1-Year 20-Delta Risk ...TABLE 8.13 The Risk Slide for the Single 241 PutTABLE 8.14 The Risk Slide for the 258/266 One-By-Two Put Spread

8 Chapter 9TABLE 9.1 Summary Statistics for the Option TradeTABLE 9.2 Fractional Schemes Corresponding to Various Probabilities of Over-Bett...TABLE 9.3 Fractional Schemes Corresponding to Various Probabilities of Over-Bett...TABLE 9.4 A Comparison of Trading at Quarter Kelly and Trading Full Kelly in Sub...

9 Appendix 3TABLE A3.1 The Order Book of All Bids and Offers for UVXY (ProShares Ultra VI...

1 Chapter 1 FIGURE 1.1 The implied volatility surface for SPY on September 10, 2019. FIGURE 1.2 The terminal PL distribution of a single short one-year ATM strad... FIGURE 1.3 The terminal PL distribution of a single one-year ATM straddle th... FIGURE 1.4 The standard deviation of the terminal PL distribution of a singl...