Option Trader Handbook

GEORGE M. JABBOUR, PHD, is the Director of the Master of Science in Finance program at The George Washington University, as well as a professor of derivatives, financial engineering, and investments. Dr. Jabbour has published various articles in professional financial journals and regularly speaks at conferences in the United States and abroad regarding option pricing models, financial management, and risk management. He is also a managing director of Global Asset Investments, LLC, an asset management and derivatives consulting firm, and CEO of Global Finance Associates Inc., a financial training, consulting, and research company. Dr. Jabbour regularly conducts seminars in option trading and valuation, and is a very active equities and derivatives trader. PHILIP H. BUDWICK, MSF, is the Director of the Capital Markets Trading Room at The George Washington University School of Business and frequently writes articles on option trading strategies and investments. Mr. Budwick is a Managing Director of Global Asset Investments, LLC, an asset management and derivatives consulting firm, and is an active option and stock trader. He has a law degree and a master of science in finance and teaches classes in portfolio management.

• Preface to the First Edition xiiiPreface to the Second Edition xviiChapter 1 Trade and Risk Management 1Introduction 1The Philosophy of Risk 2Truth About Reward 5Risk Management 6Risk 6Reward 9Breakeven Points 11Trade Management 11Trading Theme 11The Theme of Your Portfolio 14Diversification and Flexibility 15Trading as a Business 16Start-Up Phase 16Growth Phase 19Mature Phase 20Just Business, Nothing Personal 21SCORE—The Formula for Trading Success 21Select the Investment 22Choose the Best Strategy 23Open the Trade with a Plan 24Remember Your Plan and Stick to It 26Exit Your Trade 26Chapter 2 Tools of the Trader 29Introduction 29Option Value 30Option Pricing 31Stock Price 31Strike Price 32Time to Expiration 32Volatility 33Dividends 33Interest Rates 33Option Greeks and Risk Management 34Time Decay 34Trading Lessons Learned from Time Decay (Theta) 41Delta/Gamma 43Deep-in-the-Money Options 46Implied Volatility 49Early Assignment 63Synthetic Positions 65Synthetic Stock 66Long Stock 66Short Stock 67Synthetic Call 68Synthetic Put 70Basic Strategies 71Long Call 71Short Call 72Long Put 73Short Put 74Basic Spreads and Combinations 75Bull Call Spread 75Bull Put Spread 76Bear Call Spread 77Bear Put Spread 78Long Straddle 78Long Strangle 79Short Straddle 80Short Strangle 81Advanced Spreads 82Call Ratio Spread 82Put Ratio Spread 83Call Ratio Backspread 84Put Ratio Backspread 85Long Butterflies 86Short Butterflies 87Long Calendar Spreads 88Short Calendar Spreads 89The Greeks and Spread Trades 90Delta/Gamma 91Vega 92Other Greeks and Spreads 93Valuable Derivative Traders Program 93Step 1: VEGA and Implied Volatility (IV) 94Step 2: Delta and Strike Selection 96Step 3: Theta and How Much Time to Expiration 97Putting the Program to Work 99Introduction to Trade Adjustments 100Chapter 3 Long Stock 105Introduction 105Protective Put 106Stock Moves Higher 109Stock Moves Lower 111Bear Put Spread 114Rolling from a Protective Put into a Bear Put Spread 116Rolling from a Bear Put Spread into a Protective Put 118Call Replacement 120Stock Moves Higher 121Stock Moves Lower 122Call Replacement versus Protective Put 123Sell Covered Calls 123Stock Moves Higher 125Strike Selection 127In the Money Calls 128Time to Expiration 131Scaling-Out Strategy 132Collars 134Opening Position—Regular Collar 134Stock Moves Higher—Profit Collar 137Ratio Write 139Opening Position 140Stock Moves Higher—Regular Ratio Write 143Stock Moves Higher—Variable Strike Ratio Write 149Stock Moves Lower—Ratio Write/Variable Strike Ratio Write 153Short Straddle/Short Strangle 156Opening Position—Short Straddle 156Opening Position—Short Strangle 160Stock Moves Higher—Short Straddle 163Stock Moves Higher—Short Strangle 168Stock Moves Lower—Short Straddle/Stock Repair 172Stock Moves Lower—Short Strangle 176Call Ratio Spread 179Opening Position 182Stock Moves Higher 186Stock Moves Lower—Stock Repair Strategy 191Call Calendar Spread 193Opening Position 195Stock Moves Higher 196Chapter 4 Short Stock 201Introduction 201Protective Call—Insurance 203Opening Position—Protective Call 203Opening Position—Protective Call Spread 208Short Stock + Protective Call = Long Put 210Stock Moves Lower—Protective Call 212Stock Moves Lower—Protective Call Spread 215Rolling between Protective Calls and Protective Call Spreads 219Stock Moves Higher 221Put Replacement 223Stock Moves Lower 224Stock Moves Higher 226Put Replacement versus Protective Call 227Covered Puts 228Stock Moves Lower 229Short Collars 234Opening Position—Regular Collar 235Stock Moves Lower—Profit Collar 237Put Ratio Write 239Opening Position 240Stock Moves Lower—Regular Ratio Write 243Stock Moves Lower—Variable Strike Ratio Write 248Put Ratio Spread 250Opening Position 250Stock Moves Lower 253Stock Moves Higher—Short Repair Strategy 256Chapter 5 Calls and Puts 259Introduction 259Long Call 260Protective Put—Stock Moves Higher 260Protective Put—Stock Moves Lower 262Call Replacement 264Rolling into a Bull Call Spread—Stock Moves Higher 267Rolling into a Bull Call Spread—Stock Moves Lower/Call Repair Strategy 269Rolling into a Bear Call Spread 271Short Stock 272Rolling into a Synthetic Straddle 274Rolling into a Calendar Spread 276Rolling into a Ratio Spread 278Stock Moves Lower—Call Repair Strategy 281Short Call 285Long Put 288Protective Call 288Underlying Stock Moves Lower 288Underlying Stock Moves Higher 290Put Replacement Therapy 292Rolling into a Bear Put Spread 294Underlying Stock Moves Lower 294Underlying Stock Moves Higher—Put Repair Strategy 295Rolling into a Bull Put Spread 297Long Stock/Synthetic Straddle 298Put Calendar Spread 302Put Ratio Spread 305Underlying Stock Moves Lower 305Underlying Stock Moves Higher—Put Repair Strategy 308Short Put 311Chapter 6 Spreads 317Introduction 317Bull Call Spreads/Bear Put Spreads 317Protective Puts/Protective Calls 318Bull Call Spread—Protective Put 318Bull Call Spread—Protective Put Spread 320Bear Put Spread—Protective Call 321Bear Put Spread—Protective Call Spread 322Convert to Ratio Spreads 323Bull Call Spread—Stock Moves Higher 323Bull Call Spread—Stock Moves Lower/Repair Strategy 326Bear Put Spread—Stock Moves Lower 330Bear Put Spread—Stock Moves Higher/Repair Strategy 332Convert to Butterflies 336Bull Call Spread 337Bear Put Spread 338Bear Call Spreads/Bull Put Spreads 340Calendar Spreads 340Call Calendar Spread 341Stock Moves Higher—Rolling into a Bull Call Spread 341Stock Moves Higher—Rolling into a Diagonal Ratio Spread 342Stock Moves Lower—Rolling into a Lower Strike Bull Call Spread 343Stock Moves Lower—Convert to a Calendar Strangle 344Put Calendar Spread 345Stock Moves Lower—Rolling into a Bear Put Spread 345Stock Moves Lower—Rolling into a Diagonal Ratio Spread 345Stock Moves Higher—Rolling into a Higher Strike Bear Put Spread 347Stock Moves Higher—Rolling into a Calendar Strangle 348Butterfly Spreads 348Long Butterfly to Long Condor 348Chapter 7 Combinations 353Introduction 353Long Straddle 353Straps/Strips 354Modified Straps/Strips 357Calendar Straddle 359Rolling a Long Straddle into an Iron Butterfly 361Diagonal Iron Butterfly 363Partial Iron Butterfly 363Long Call/Long Put Adjustments 365Long Strangle 365Diagonal Iron Butterfly 365Calendar Strangle 367Long Call/Long Put Adjustments 367Short Straddle/Short Strangle 368Short Straddle 368Rolling Short Straddle into Iron Butterfly 371Short Strangle 373Index 375