Volatility Trading, Second Edition

298 Pages·2013·2.84 MB·english

by  Euan Sinclair(auth.)

V
OLATILITY
T
RADING
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V
OLATILITY
T
RADING
S E
ECOND DITION
Euan Sinclair
Copyright2013byEuanSinclair.Allrightsreserved.
PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey.
FirsteditionpublishedbyJohnWiley&Sons,Inc.in2008.
PublishedsimultaneouslyinCanada.
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LibraryofCongressCataloging-in-PublicationData:
Sinclair,Euan,1969–
Volatilitytrading/EuanSinclair.—Secondedition.
pagescm.—(Wileytradingseries)
Includesbibliographicalreferencesandindex.
ISBN978-1-118-34713-3(cloth/website);ISBN978-1-118-42044-7(ebk);
ISBN978-1-118-57487-4(ebk);ISBN978-1-118-41672-3(ebk)
1. Options(Finance). 2. Hedging(Finance). 3. Futures. 4. Financialfutures. I. Title.
HG6024.A3S56232013
332.64’5—dc23
2012047062
PrintedintheUnitedStatesofAmerica.
10 9 8 7 6 5 4 3 2 1
To Ann—
Sometimes a trader wins much more than he deserves.
CONTENTS
Acknowledgments xi
IntroductiontotheSecondEdition xiii
CHAPTER1 OptionPricing 1
TheBlack-Scholes-MertonModel 1
vii
ModelingAssumptions 7
Conclusion 11
Summary 11
CHAPTER2 VolatilityMeasurement 13
DefiningandMeasuringVolatility 13
DefinitionofVolatility 14
AlternativeVolatilityEstimators 20
UsingHigher-FrequencyData 29
Summary 33
CHAPTER3 StylizedFactsaboutReturns
andVolatility 35
DefinitionofaStylizedFact 35
VolatilityIsNotConstant 36
CharacteristicsoftheReturnDistribution 40
VolumeandVolatility 43
DistributionofVolatility 45
Summary 46
CHAPTER4 VolatilityForecasting 49
AbsenceofTransactionCosts 50
PerfectInformationFlow 50
AgreementaboutthePriceImplications
ofInformation 50
MaximumLikelihoodEstimation 54
VolatilityForecastingUsing
FundamentalInformation 60
TheVariancePremium 62
Summary 65
CHAPTER5 ImpliedVolatilityDynamics 67
VolatilityLevelDynamics 70
TheSmileandtheUnderlying 80
SmileDynamics 82
TermStructureDynamics 90
Summary 91
viii
CHAPTER6 Hedging 93
S
T
N AdHocHedgingMethods 95
E
T
N Utility-BasedMethods 96
O
C
EstimationofTransactionCosts 109
AggregationofOptionsonDifferentUnderlyings 113
Summary 115
CHAPTER7 DistributionofHedgedOptionPositions 117
DiscreteHedgingandPathDependency 117
VolatilityDependency 123
Summary 129
CHAPTER8 MoneyManagement 131
AdHocSizingSchemes 131
TheKellyCriterion 133
TimeforKellytoDominate 143
EffectofParameterMis-Estimation 144
WhatisBankroll? 146
AlternativestoKelly 148
Summary 161
CHAPTER9 TradeEvaluation 163
GeneralPlanningProcedures 164
Risk-AdjustedPerformanceMeasures 171
SettingGoals 178
PersistenceofPerformance 180
RelativePersistence 180
Summary 184
CHAPTER10 Psychology 187
Self-AttributionBias 191
Overconfidence 193
TheAvailabilityHeuristic 197
Short-TermThinking 199
LossAversion 199 ix
ConservatismandRepresentativeness 201
C
O
ConfirmationBias 203 N
T
E
HindsightBias 206 N
T
S
AnchoringandAdjustment 207
TheNarrativeFallacy 208
ProspectTheory 209
Summary 212
CHAPTER11 GeneratingReturnsthroughVolatility 213
TheVariancePremium 214
ReasonsfortheVariancePremium 220
Summary 222
CHAPTER12 TheVIX 223
TheVIXIndex 224
VIXFutures 225
VolatilityETNs 227
OtherVIXTrades 229
Summary 230
CHAPTER13 LeveragedETFs 231
LeveragedETFsasaTrade-SizingProblem 234
ALong-ShortTradingStrategy 234
OptionsonLeveragedETFs 235
Summary 237
CHAPTER14 LifeCycleofaTrade 239
PretradeAnalysis 239
PosttradeAnalysis 245
Summary 247
CHAPTER15 Conclusion 249
Summary 252
Resources 253
x DirectlyApplicableBooks 253
Thought-ProvokingBooks 256
S
T
N
E UsefulWebsites 257
T
N
O
C References 261
AbouttheWebsite 273
AbouttheAuthor 279
Index 281
ACKNOWLEDGMENTS
A
project like this invariably could not be accomplished without many
forms of help and support from many people. Although they had no
direct involvement in the writing, I need to first thank my parents, who
mademeappreciateeducationandtaughtmethatboredomisamortalsin.
I must also thank my wife for her patience as I wrote this instead of doing xi
variouschoresaroundthehouse.
Formoredirectprofessionalhelp,theregularsatwww.nuclearphynance
.com have been very generous with their time and knowledge. Their help
withfindingvariousresearchpapershasalsobeeninvaluable.
Finally,ChrisMerrill,JituPatel,andErinCallahangavedirecthelpwith
proofreadingandtechnicalassistance.Thankyou.