Volatility Trading / Edition 1

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Overview

Successful trading, says Euan Sinclair, is about developing aconsistent process. You must have a goal; you must find trades witha clear statistical edge; you must capture that edge and size eachtrade in a way that is consistent with your goal. Everything elseyou do must be done within this framework.

In Volatility Trading, Sinclair offers you a quantitative modelfor measuring volatility in or-der to gain an edge in your everydayoption trading endeavors. With an accessible, straightforwardapproach, he guides traders through the basics of option pricing,volatility measurement, hedging, money management, and tradeevaluation. In addition, Sinclair explains the often-overlookedpsychological aspects of trading, revealing both how behavioralpsychology can create market conditions traders can take advantageof—and how it can lead them astray. Psychological biases, heasserts, are probably the drivers behind most sources of edgeavailable to a volatility trader.

Your goal, Sinclair explains, must be clearly defined and easilyexpressed—if you cannot explain it in one sentence, youprobably aren't completely clear about what it is. The same appliesto your statistical edge. If you do not know exactly what your edgeis, you shouldn't trade. He shows how, in addition to the numericalevaluation of a potential trade, you should be able to identify andevaluate the reason why implied volatility is priced where it is,that is, why an edge exists. This means it is also necessary to beon top of recent news stories, sector trends, and behavioralpsychology. Finally, Sinclair underscores why trades need to besized correctly, which means that each trade is evaluated accordingto its projected return and risk in the overall context of yourgoals.

As the author concludes, while we also need to pay attention toseemingly mundane things like having good execution software, acomfortable office, and getting enough sleep, it is knowledge thatis the ultimate source of edge. So, all else being equal, thetrader with the greater knowledge will be the more successful. Thisbook, and its companion CD-ROM, will provide that knowledge. TheCD-ROM includes spreadsheets designed to help you forecastvolatility and evaluate trades together with simulationengines.

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Product Details

  • ISBN-13: 9780470181997
  • Publisher: Wiley
  • Publication date: 6/20/2008
  • Series: Wiley Trading Series, #331
  • Edition description: BK W/CD-ROM
  • Edition number: 1
  • Pages: 224
  • Product dimensions: 6.10 (w) x 9.10 (h) x 1.10 (d)

Meet the Author

Euan Sinclair is an option trader with over ten years of experience trading options professionally. He specializes in the design and implementation of quantitative trading strategies. Sinclair is currently a proprietary option trader for Bluefin Trading, where he trades based on quantitative models of his own design. He holds a PhD in theoretical physics from the University of Bristol.

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Table of Contents

Introduction.

The Trading Process.

Chapter 1. Option Pricing.

The Black-Scholes-Merton Model.

Summary.

Chapter 2. Volatility Measurement and Forecasting.

Defining and Measuring Volatility.

Definition of Volatility.

Alternative Volatility Estimators.

Using Higher-Frequency Data.

Forecasting Volatility.

Forecasting the Volatility Distribution.

Summary.

Chapter 3. Implied Volatility Dynamics.

Volatility Level Dynamics.

Smile Dynamics.

Summary.

Chapter 4. Hedging.

Ad Hoc Hedging Methods.

Utility Based Methods.

Estimation of Transaction Costs.

Aggregation of Options on Different Underlyings.

Summary.

Chapter 5. Hedged Option Positions.

Discrete Hedging and Path Dependency.

Volatility Dependency.

Summary.

Chapter 6. Money Management.

Ad Hoc Schemes.

The Kelly Criterion.

Alternatives to the Kelly Criterion.

Trade Sizing in a Continuously Changing Setting.

Summary.

Chapter 7. Trade Evaluation.

General Planning Procedures.

Risk-Adjusted Performance Measures.

Setting Goals.

Persistence of Performance.

Summary.

Chapter 8. Psychology.

Self-Attribution Bias.

Overconfidence.

The Availability Heuristic.

Short-Term Thinking.

Loss Aversion.

Conservatism and Representativeness.

Confirmation Bias.

Hindsight Bias.

Anchoring and Adjustment.

Summary.

Chapter 9. Life Cycle of a Trade.

Pretrade Analysis.

Post-Trade Analysis.

Summary.

Chapter 10. Conclusion.

Execution Ability.

Concentration.

Product Selection.

Appendix A. Model-Free Implied Variance andVolatility.

The VIX Index.

Appendix B. Spreadsheet Instructions.

GARCH.

Volatility Cones and Skew and Kurtosis Cones.

Daily Option Hedging Simulation.

Trade Evaluation.

Trading Goals.

Corrado-Su Skew Curve.

Mean Reversion Simulator.

Resources.

Essential Books.

Thought-Provoking Books.

Useful Web Sites.

References.

About the CD-ROM.

Index.

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