Tuesday, April 29, 2008

Option Volatility & Pricing by Sheldon Natenberg (Book review)

"Option Volatility & Pricing: Advanced Trading Strategies and Techniques" by Sheldon Natenberg presents straightforward, practical concepts valuable for both equity and derivative trading. Understanding derivative mechanics leads to deeper insight of the underlying securities, this book explains the why’s and how’s.

Some reasons you should learn option trading

1. Selling out-of-money Covered-Calls allows for potentially significant enhancement to long term underlying stock investments.

2. If you want to short a stock, but it is not available due to various reasons. You can still pull it off with options, via a “synthetic position” where you long a Put and short a Call of the same strike price.

3. Option pricing involves volatility of the underlying security. Understanding how volatility works remains a key to optimizing “trend following” stock trading systems.

4. Arbitrage, gaining profit regardless of underlying market movement or volatility, becomes possible coupling options with stock trading. Though still not entirely risk free due to issues with liquidity, price impact, etc., returns via arbitrage present consistently positive returns if applied diligently.

Some helpful points from the book

1. Basic option details

2. Volatility defined (without too much advanced mathematics so that you can understand it even if you have had nothing but basic algebra)

3. Forecasting underlying security movements via volatility

4. Option strategy payoffs

5. Strategy payoff comparisons as regards to underlying market conditions

6. Arbitrage strategies with options and underlying securities

Read it

Out of a sea of speculative, reiterated content, Option Volatility & Pricing gives some unbiased and actually-useful information without the car sales-pitch. You might even find it at the library (like I did at school). So take a seat, with your favorite beverage at arm’s reach, and go through it.

0 Reflections: