Table of Contents
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Copyright 2010 by Euan Sinclair. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Sinclair, Euan, 1969-
Option trading : pricing and volatility strategies and techniques / Euan Sinclair. p. cm. - (Wiley trading series)
Includes index.
ISBN 978-0-470-49710-4 (cloth)
1. Options (Finance) 2. Pricing-Mathematical models. I. Title.
HG6024.A3S5622 2010
332.632283-dc22 2010003139
To my parents
Preface
Traders tend to be a pragmatic group. They are largely interested in results. Actually some become so focused on results that it becomes a hindrance. This tendency can be a handicap, as the way to achieve good results is to focus on good processes and let the results take care of themselves. Good traders learn this.
But good traders are still intellectually parsimonious. They want to know what works, but seldom more than the minimum they need. When Im feeling uncharitable I regard this as characteristic of the uncurious, dull people I have had the misfortune to work with, and indeed some were like this. More realistically, however, this is less a reflection on the traders themselves, most of who were intelligent people with a wide range of interests, and more a reflection on the nature of trading.
Trading is complex, changeable, and potentially emotionally draining. Once a trader has learned a sensible, statistically valid, profitable method, he is better off concentrating on exploiting it rather than continuing to experiment.
So a perfectly valid question when told something is Why do I need to know this? As a general answer, in the case where everything else is equal, the trader with more knowledge will make more money. He will also be more easily able to adapt to new markets and opportunities.
It is possible to trade options successfully without knowing about the Black-Scholes-Merton model, or any other pricing model. But for the traders who do this, everything is a special situation. They have to individually learn every nuance with no organizing principle. It would be like trying to learn chemistry without knowing about the periodic table. Black-Scholes-Merton provides a simplifying framework. Traders who know this can then learn other things more easily, because they use less energy remembering the otherwise unconnected facts.
Throughout this book I will tell you things that are truly useful and not merely interesting. Trading is interesting only if it is profitable.
However I have no interest in, or intention of, making this an easy read for the average person. The reason for this is that the average person will not succeed as a trader, so I would be making things more difficult for myself by oversimplifying. The text would be longer and more boring. Trading is hard and options are complicated. Much of this book will require work and thought. It is not meant to be a light read; it is meant to be a thorough treatment.
I want this book to be the only book an intelligent, diligent person would need in order to go from knowing nothing about options to being able to trade professionally at a legitimate trading operation (a bank, a hedge fund, or a market making firm).
PROFESSIONAL TRADING
It is commonly believed that 90 percent of those attempting to trade will lose money. This is a difficult number to verify. First, the people in possession of the data needed to prove this are members of brokerages and clearing firms, and they have no interest in publicizing the fact that the vast majority of their customers fail. Second, we cannot learn much by interviewing traders as there is the problem of survivorship bias (the only people who will identify themselves as traders are those who have not gone bankrupt), and all people tend to exaggerate their successes and minimize their losses.
But even if this figure is somewhat exaggerated, its implications are startling. Most people will fail at trading. The normal excuses for this large-scale failure rate given in trading books or seminars (when it is even acknowledged) take one of two forms.
Traders do not know the correct techniques, where correct corresponds to whatever the particular expert is trying to sell.
Traders do not have the psychological discipline needed to stick with their plan. This is laughable. I know of no other field of endeavor where failure to perform a skill is routinely blamed on psychology. Would you seriously listen to a basketball coach who told you that the