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How to Price and Trade Options: Identify, Analyze, and Execute the Best Trade Probabilities, + Website



How to Price and Trade Options: Identify, Analyze, and Execute the Best Trade Probabilities, + Website

Al Sherbin

ISBN: 978-1-118-87122-5 March 2015 224 Pages


Select and execute the best trades—and reduce risk

Rather than teaching options from a financial perspective, How to Price and Trade Options: Identify, Analyze, and Execute the Best Trade Probabilities goes back to the Nobel Prize-winning Black-Scholes model. Written by well-known options expert Al Sherbin, it looks at the basis for probability theory in option trading and explains how to put the odds in your favor when trading options. Inside, you'll discover how anyone can "operate their own casino" if they know how through proper option strategies. Plus, a supplemental website includes videos that walk you through various probability scenarios, pre-formatted spreadsheets, and code.

All investors should have a portion of their portfolio set aside for option trades. Not only do options provide great opportunities for leveraged plays, they can also help you earn larger profits with a smaller amount of cash outlay. With the help of this book, traders, active investors, and self-directed investors of all stripes will learn how simple it can be to deploy probability-based trading strategies.

  • Teaches both defined and undefined risk strategies
  • Utilizes simple cost basis reduction strategies to enhance investment returns
  • Draws on unique research studies
  • Discusses volatility to include both historical (realized) and implied volatility: the interplay between the two is a key piece of information overlooked by option traders

If you're a trader of any level and want to make the best trades possible, this book has you covered.

Introduction xi

CHAPTER 1 Why Trade Options? 1

Strategic without Being Directional 2

A Word about Leverage 2

Options Are a Decaying Asset 5

Insurer or Insured? 6

Probability of Making Money 6

Market Efficiency 7

Tired, Worn]Out Metaphors 9

CHAPTER 2 What to Look for in a Broker 11

Brokerages versus Banks 11

Depth of a Broker’s Pockets 12

Trading Risk Management 13

Learning from Recent Events 14

Account Types 14

Commissions 16

Interest Rates 18

Stock Borrow and Loan 19

Trading Platforms 22

Conclusion 24

CHAPTER 3 Building the Foundation 25

Option Pricing Models 26

Option Pricing Model Inputs 27

Historical Data as Input into the Implied Volatility of an Underlying 29

Implied Volatility as a Predictor of Stock Movement and Probabilities 30

The Distribution Curve 31

Breakout Stocks 45

Actual versus Historical Distribution Curves 50

CHAPTER 4 Trade Probabilities: What to Look For 55

The Results 59

How to Calculate Option Probabilities 63

CHAPTER 5 Choosing Your Trades 67

Choosing Your Underlying 67

Making an Assumption 78

CHAPTER 6 Choosing a Strategy 83

Defined Risk Trades 85

Credit Spreads 85

Debit Spreads 88

Butterfly 89

Iron Condor 91

Calendar Spreads 92

Undefined Risk Trades 96

The Straddle 97

The Strangle 97

Short Naked Puts 98

Ratio Spreads and Back Spreads 100

What Time to Expiration Should My Trades Have? 103

Trading Earnings Announcements 105

CHAPTER 7 Exiting Trades 123

The Variables 123

The Kelly Criterion 125

Morning Routine 130

To Log Your Trades or Not to Log Your Trades 135

CHAPTER 8 Executing Your Trades 141

Order Types 142

CHAPTER 9 Portfolio Management 153

Two Types of Risk 154

The Goal: Diversification—Minimizing Unique Risk 155

The Methods: Correlation and Number of Positions 156

Identifying and Mitigating Systematic Risk 163

Trade Sizing 180

Early Exercise 183

Conclusion 189

About the Website 191

About the Author 193

Index 195