Visual Quantitative Finance: A New Look at Option Pricing, Risk Management, and Structured Securities


“Michael Lovelady takes a very complex topic and explains it in basic, clear terms. Anyone interested in gaining insight about how the logic behind options pricing works needs to learn the visual quantitative finance skills in this book. This is the key to managing risk and to designing options strategies. The author has combined mathematical formulation with clarity of thought and expression.”
--Michael C. Thomsett, author of Options Trading ...
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Visual Quantitative Finance: A New Look at Option Pricing, Risk Management, and Structured Securities

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“Michael Lovelady takes a very complex topic and explains it in basic, clear terms. Anyone interested in gaining insight about how the logic behind options pricing works needs to learn the visual quantitative finance skills in this book. This is the key to managing risk and to designing options strategies. The author has combined mathematical formulation with clarity of thought and expression.”
--Michael C. Thomsett, author of Options Trading for the Conservative Investor, and co-founder of

Visual Quantitative Finance demystifies the complex mathematics of quantitative finance by moving from the abstract to the intuitive. Lovelady lays bare the mechanics of the Black-Scholes formula and then uses the framework to explain, both intuitively and visually, risk management and options-based structured securities. A crowning achievement in simplicity that will benefit investors and students alike!”
--Don DePamphilis, Ph.D., Clinical Professor of Finance, Loyola Marymount University, and author of Mergers, Acquisitions, and Other Restructuring Activities, 7th Edition

Modern Quantitative Finance Demystified! A simpler, visual approach for every investor, financial professional, and student.

Most investors today recognize the inadequacy of traditional strategies and instruments. However, they sensibly refuse to invest in securities they don’t understand. Unfortunately, alternative investments based on quantitative finance have been shrouded in confusion and advanced mathematics--placing them off limits to many investors who could profit from them. Now, Michael Lovelady cuts through the complexity, introducing a powerful visual approach to understanding options and related alternative investments.

Blending practice and theory, Lovelady illuminates and simplifies the core principles of modern quantitative finance. Lovelady introduces an intuitive, visual framework for understanding option pricing: foundational knowledge for managing risk and designing alternative strategies. Then, building on this framework, Lovelady presents a complete option-based model for tailoring risk/reward profiles, adjusting market exposure, generating income, and building creative portfolio structures.

Visual Quantitative Finance will be invaluable to retail and institutional investors contemplating alternative investments, to advisors who guide them, and to all students of finance.

Coverage includes:
• Random variables and option pricing
• Option pricing methods
• VaR and CVaR
• Black-Scholes models
• Investment profiles and model building
• Stock-only and option-based profiles
• Covered calls, condors, and SynAs
• Understanding price changes
• Greeks
• Position management
• Synthetic annuities, and more

Michael Lovelady makes quantitative finance more intuitive, visual, and accessible than ever before--giving investors the knowledge they need to confidently consider alternative strategies for controlling risk and increasing profit.

Lovelady introduces powerful visual techniques for analyzing options pricing, profit probabilities, virtual dividends, market risk exposure, and more. After introducing his visual approach, he applies it to one of today’s most important investing trends: lower-volatility, higher-income strategies.

Visual Quantitative Finance will be invaluable for everyone interested in quantitative finance, options, risk, structured securities, or financial model building--and for everyone who must explain these topics to nonspecialists.

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Product Details

  • ISBN-13: 9780132929196
  • Publisher: FT Press
  • Publication date: 5/1/2013
  • Edition number: 1
  • Pages: 324
  • Sales rank: 1,438,427
  • Product dimensions: 5.90 (w) x 9.10 (h) x 1.20 (d)

Meet the Author

Michael Lovelady, CFA, ASA, EA, works as an investment strategist and portfolio manager, where he specializes in blending traditional and quantitative styles, including reduced-volatility and yield-enhanced option strategies. Michael developed the synthetic annuity and is the author of Profiting with Synthetic Annuities: Options Strategies to Increase Yield and Control Portfolio Risk.

Prior to hedge fund management, Michael was a consulting actuary for Towers Watson and PricewaterhouseCoopers, where he worked with employers on the design and funding requirements of plans ranging from defined benefit and defined contribution to hybrid db/dc plans. His experience with retirement income strategies—both as an actuary from the liability side and as a fund manager from the asset side—gives him a unique perspective.

Michael has also been involved in teaching and creating new methods for making quantitative investing more accessible to students, trustees, and others interested in investment and risk management. He developed the investment profile—a graphical representation of risk and the basis of a simplified option pricing model, and visually intuitive presentations of structured securities.

During his career, Michael has served various organizations, including Hughes Aircraft, Boeing, Global Santa Fe, Dresser Industries, the Screen Actors Guild, The Walt Disney Company, Hilton Hotels, CSC, and the Depository Trust Company. He is a CFA charterholder, an Associate of the Society of Actuaries, and an ERISA Enrolled Actuary. He currently lives in Los Angeles.

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Table of Contents

Preface xi
Chapter 1 Introduction 1
Growth in Structured Securities 2
Growing Emphasis on Low Volatility and Dividends 3
Criticisms of Structured Securities 4
Demand for Quantitative Skills 5
Direction of Quantitative Finance 6
When I Realized It Might Be Easier 8
Try Again 10
The Spreadsheet 10
Visualizing the Result 14
What It Means and Why It Works: A Nontechnical Overview 17
It Doesn’t Get Too Complicated 18
An Integrated View of Risk Management 18
Endnotes 19

Chapter 2 Random Variables and Option Pricing 21
Random Variables 22
Building the Spreadsheet 28
Correcting the Mistake 36
Optional: Additional Resources 41

Chapter 3 An Overview of Option Pricing Methods 43
The Black-Scholes Formula 43
Black-Scholes Assumptions 48
The Binomial Option Pricing Method 49
Monte Carlo Methods 51
Putting Visual Quant in Context 52
Additional Reading, Advanced Topics, and Resources 57
Endnotes 60

Chapter 4 Value-at-Risk and Conditional Value-at-Risk 61
How Likely Is Something? 62
Value-at-Risk 66
Multiple Stock VaR 68
Stock and Option VaR 68
Conditional Value-at-Risk 69

Chapter 5 Full Black-Scholes Model 77
Adding Functionality to the Model 79
Stock Return Mean (Cell G3) 79
Stock Return Standard Deviation (Cell G4) 82
Discount Factor 84
Stock Price Median 85
Summary of New Formulas 88
Pricing Put Options 88
Effects of Assumption Changes 93
Endnote 96

Chapter 6 The Lognormal Distribution and Calc Engine 97
Definition of the Lognormal Distribution 98
The Forward Equation 99
Cross Reference: Stochastic Differential Equations 100
The Backward Equation 102
The Calc Engine 104
Assigning Probabilities 107
Setting the Stock Price Range 110
Visualizing Option Pricing As Normal or Lognormal 112

Chapter 7 Investment Profiles and Synthetic Annuities 115
What Is a Synthetic Annuity, and How Does It Work? 117
The Investment Profile 119
Assigning Probabilities Using Implied Volatility 120
Using Options to Reshape the Investment Profile 123
Adjusting the Profile for Behavioral Finance 125
Concentrated Stock Example 128
The Synthetic Annuity in Turbulent Markets 138

Chapter 8 Stock-Only Investment Profile 145
The Purpose and Context of the Model 145
The Stock-Only Investment Profile 146
The Calc Engine 151
The Stock-Only Profit Calculation 157
Adding the Chart 159
Test: Stock-Only Investment Profile 162

Chapter 9 Adding Options to the Model 167
Long Put Profit 168
Short Put 169
Expected Values 170
Black-Scholes Add-In 173
The Heading Formulas 175
Delta Formulas 176
Time Value and Total Premium Formulas 176

Chapter 10 Option Investment Profiles 179
Long Call Option Investment Profile 179
Short Call Option 190
Long Put Option 192
Short Put Option 194

Chapter 11 Covered Calls, Condors, and SynAs 197
Covered Call Investment Profile 198
Put–Call Parity 200
Iron Condor Investment Profile 205
Synthetic Annuity (SynA) Investment Profile 209
Adding a Customized Utility Function 223
Endnotes 225

Chapter 12 Understanding Price Changes 227
Investing in XYZ 227
Attribution: Explaining Why the Option Price Changed 238
Endnote 245

Chapter 13 The Greeks 247
The Option Greeks 248
Calculating Greeks: Formulas, Models, and Platforms 249
Delta 252
Theta 257
Vega 262

Introduction to Chapters 14, “Tracking Performance,” and 15, “Covered Synthetic Annuities” 265
Chapter 14 Tracking Performance 269
Tracking Template 270
TradeStation Platform 274
Putting It All Together: Synthetic Annuity Overview 282

Chapter 15 Covered Synthetic Annuities 285
Covered Synthetic Annuity (CSynA) 286
Example: Deere & Company 289
The Standard CSynA 304
Supplemental Material: The CBOE S&P 500 BuyWrite Index 311
BXM Study by Callan Associates 312

Index 315

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