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Option Volatility and Pricing: Advanced Trading Strategies and Techniques, 2nd Edition

Book Description


The bestselling Option Volatility & Pricing has made Sheldon Natenberg a widely recognized authority in the option industry. At firms around the world, the text is often the first book that new professional traders are given to learn the trading strategies and risk management techniques required for success in option markets.

Now, in this revised, updated, and expanded second edition, this thirty-year trading professional presents the most comprehensive guide to advanced trading strategies and techniques now in print. Covering a wide range of topics as diverse and exciting as the market itself, this text enables both new and experienced traders to delve in detail into the many aspects of option markets, including:

  • The foundations of option theory
  • Dynamic hedging
  • Volatility and directional trading strategies
  • Risk analysis
  • Position management
  • Stock index futures and options
  • Volatility contracts

Clear, concise, and comprehensive, the second edition of Option Volatility & Pricing is sure to be an important addition to every option trader's library--as invaluable as Natenberg's acclaimed seminars at the world's largest derivatives exchanges and trading firms.

You'll learn how professional option traders approach the market, including the trading strategies and risk management techniques necessary for success. You'll gain a fuller understanding of how theoretical pricing models work. And, best of all, you'll learn how to apply the principles of option evaluation to create strategies that, given a trader's assessment of market conditions and trends, have the greatest chance of success.

Option trading is both a science and an art. This book shows how to apply both to maximum effect.

Table of Contents

  1. Cover
  2. Title Page
  3. Copyright Page
  4. Dedication
  5. Contents
  6. Preface
  7. 1 Financial Contracts
    1. Buying and Selling
    2. Notional Value of a Forward Contract
    3. Settlement Procedures
    4. Market Integrity
  8. 2 Forward Pricing
    1. Physical Commodities (Grains, Energy Products, Precious Metals, etc.)
    2. Stock
    3. Bonds and Notes
    4. Foreign Currencies
    5. Stock and Futures Options
    6. Arbitrage
    7. Dividends
    8. Short Sales
  9. 3 Contract Specifications and Option Terminology
    1. Contract Specifications
    2. Option Price Components
  10. 4 Expiration Profit and Loss
    1. Parity Graphs
  11. 5 Theoretical Pricing Models
    1. The Importance of Probability
    2. A Simple Approach
    3. The Black-Scholes Model
  12. 6 Volatility
    1. Random Walks and Normal Distributions
    2. Mean and Standard Deviation
    3. Forward Price as the Mean of a Distribution
    4. Volatility as a Standard Deviation
    5. Scaling Volatility for Time
    6. Volatility and Observed Price Changes
    7. A Note on Interest-Rate Products
    8. Lognormal Distributions
    9. Interpreting Volatility Data
  13. 7 Risk Measurement I
    1. The Delta
    2. The Gamma
    3. The Theta
    4. The Vega
    5. The Rho
    6. Interpreting the Risk Measures
  14. 8 Dynamic Hedging
    1. Original Hedge
  15. 9 Risk Measurement II
    1. Delta
    2. Theta
    3. Vega
    4. Gamma
    5. Lambda (Λ)
  16. 10 Introduction to Spreading
    1. What Is a Spread?
    2. Option Spreads
  17. 11 Volatility Spreads
    1. Straddle
    2. Strangle
    3. Butterfly
    4. Condor
    5. Ratio Spread
    6. Christmas Tree
    7. Calendar Spread
    8. Time Butterfly
    9. Effect of Changing Interest Rates and Dividends
    10. Diagonal Spreads
    11. Choosing an Appropriate Strategy
    12. Adjustments
    13. Submitting a Spread Order
  18. 12 Bull and Bear Spreads
    1. Naked Positions
    2. Bull and Bear Ratio Spreads
    3. Bull and Bear Butterflies and Calendar Spreads
    4. Vertical Spreads
  19. 13 Risk Considerations
    1. Volatility Risk
    2. Practical Considerations
    3. How Much Margin for Error?
    4. Dividends and Interest
    5. What Is a Good Spread?
  20. 14 Synthetics
    1. Synthetic Underlying
    2. Synthetic Options
    3. Using Synthetics in a Spreading Strategy
    4. Iron Butterflies and Iron Condors
  21. 15 Option Arbitrage
    1. Options on Futures
    2. Locked Futures Markets
    3. Options on Stock
    4. Arbitrage Risk
  22. 16 Early Exercise of American Options
    1. Arbitrage Boundaries
    2. Early Exercise of Call Options on Stock
    3. Early Exercise of Put Options on Stock
    4. Impact of Short Stock on Early Exercise
    5. Early Exercise of Options on Futures
    6. Protective Value and Early Exercise
    7. Pricing of American Options
    8. Early Exercise Strategies
    9. Early Exercise Risk
  23. 17 Hedging with Options
    1. Protective Calls and Puts
    2. Covered Writes
    3. Collars
    4. Complex Hedging Strategies
    5. Hedging to Reduce Volatility
    6. Portfolio Insurance
  24. 18 The Black-Scholes Model
    1. n(x) and N(x)
    2. A Useful Approximation
    3. The Delta
    4. The Theta
    5. Maximum Gamma, Theta, and Vega
  25. 19 Binomial Option Pricing
    1. A Risk-Neutral World
    2. Valuing an Option
    3. The Delta
    4. The Gamma
    5. The Theta
    6. Vega and Rho
    7. The Values of u and d
    8. Gamma Rent
    9. American Options
    10. Dividends
  26. 20 Volatility Revisited
    1. Historical Volatility
    2. Volatility Forecasting
    3. Implied Volatility as a Predictor of Future Volatility
    4. Forward Volatility
  27. 21 Position Analysis
    1. Some Thoughts on Market Making
    2. Stock Splits
  28. 22 Stock Index Futures and Options
    1. What Is an Index?
    2. Stock Index Futures
    3. Stock Index Options
  29. 23 Models and the Real World
    1. Markets Are Frictionless
    2. Interest Rates Are Constant over the Life of an Option
    3. Volatility Is Constant over the Life of the Option
    4. Trading Is Continuous
    5. Expiration Straddles
    6. Volatility Is Independent of the Price of the Underlying Contract
    7. Underlying Prices at Expiration Are Lognormally Distributed
    8. Skewness and Kurtosis
  30. 24 Volatility Skews
    1. Modeling the Skew
    2. Skewness and Kurtosis
    3. Skewed Risk Measures
    4. Shifting the Volatility
    5. Skewness and Kurtosis Strategies
    6. Implied Distributions
  31. 25 Volatility Contracts
    1. Realized Volatility Contracts
    2. Implied Volatility Contracts
    3. Trading the VIX
    4. Replicating a Volatility Contract
    5. Volatility Contract Applications
  32. Afterword: A Final Thought
  33. A Glossary of Option Terminology
  34. B Some Useful Math
    1. Rate-of-Return Calculations
    2. Normal Distributions and Standard Deviation
    3. Volatility
  35. Index