Basic Black-Scholes: Option Pricing and Trading [Paperback]

Timothy Falcon Crack (Author)

Book Description

Publication Date: April 7, 2009

THE AUTHOR: Dr. Crack studied PhD-level option pricing at MIT and Harvard Business School, taught undergraduate and MBA option pricing at Indiana University (winning many teaching awards), was an independent consultant to the New York Stock Exchange, worked as an asset management practitioner in London, and has traded options for over ten years. This unique mixture of learning, teaching, consulting, practice, and trading is reflected in every page. SUMMARY OVERVIEW: This revised second edition of Basic Black-Scholes gives extremely clear explanations of Black-Scholes option pricing theory, and discusses direct applications of the theory to option trading. The presentation does not go far beyond basic Black-Scholes for three reasons: First, a novice need not go far beyond Black-Scholes to make money in the options markets; Second, all high-level option pricing theory is simply an extension of Black-Scholes; and Third, there already exist many books that look far beyond Black-Scholes without first laying the firm foundation given here. The trading advice does not go far beyond elementary call and put positions because more complex trades are simply combinations of these. WHAT MAKES THIS BOOK SPECIAL OR UNIQUE?: -It contains the basic intuition you need to trade options for the first time, or interview for an options job. -Honest advice about trading: there is no simple way to beat the markets, but if you have skill this advice can help make you money, and if you have no skill but still choose to trade, this advice can reduce your losses. -Full immersion treatment of transactions costs (T-costs). -Lessons from trading stated in simple terms. -Stylized facts about the markets (e.g., how to profit from reversals, when are T-costs highest/lowest during the trading day, implications of the market for corporate control, etc.). -How to apply (European-style) Black-Scholes pricing to the trading of (American-style) options. -Leverage through margin trading compared to leverage through options. -Black-Scholes option pricing code for the HP17B, HP19B, and HP12C. -Two downloadable spreadsheets. The first allows the user to forecast T-costs for option positions using simple models. The second allows the user to explore option sensitivities including the Greeks. -Practitioner Bloomberg Terminal screenshots to aid learning. -Simple discussion of continuously-compounded returns. -Introduction to "paratrading" (trading stocks side-by-side with options to generate additional profit). -Unique "regrets" treatment of early exercise decisions and trade-offs for American-style calls and puts. -Unique discussion of put-call parity and option pricing. -How to calculate Black-Scholes in your head in 10 seconds (also in Heard on The Street: Quantitative Questions from Wall Street Job Interviews). -Special attention to arithmetic Brownian motion with general pricing formulae and comparisons to Bachelier (1900) and Black-Scholes. -Careful attention to the impact of dividends in analytical American option pricing. -Dimensional analysis and the adequation formula (relating FX call and FX put prices through transformed Black-Scholes formulae). -Intuitive review of risk-neutral pricing/probabilities and how and why these are related to physical pricing/probabilities. -Careful distinction between the early Merton (non-risk-neutral) hedging-type argument and later Cox-Ross/Harrison-Kreps risk-neutral pricing -Simple discussion of Monte-Carlo methods in science and option pricing. -Simple interpretations of the Black-Scholes formula and PDE and implications for trading. -Careful discussion of conditional probabilities as they relate to Black-Scholes. -Intuitive treatment of high-level topics e.g., bond-numeraire interpretation of Black-Scholes (where N(d2) is P*(ITM)) versus the stock-numeraire interpretation (where N(d1) is P**(ITM)).

Product Details

• Paperback: 256 pages
• Publisher: Timothy Crack; Revised 2nd edition (April 7, 2009)
• Language: English
• ISBN-10: 0970055242
• ISBN-13: 978-0970055248
• Product Dimensions: 11 x 8.2 x 0.5 inches
• Shipping Weight: 1.2 pounds (View shipping rates and policies)
• Average Customer Review: 4.8 out of 5 stars  See all reviews (9 customer reviews)
• Amazon Best Sellers Rank: #521,356 in Books (See Top 100 in Books)

Customer Reviews

Most Helpful Customer Reviews

7 of 7 people found the following review helpful:

5.0 out of 5 stars Quickly builds intuition for financial derivatives, September 10, 2007

By 

Brad B. (Columbus, OH USA) - See all my reviews

This review is from: Basic Black-Scholes: Option Pricing and Trading (Paperback)

Tremendously valuable book for its selection and excellent treatment of many rarely addressed aspects of financial derivatives and the care with which intuition for these aspects is developed.

Financial mathematics exists at the intersection of many different fields, yielding many possible perspectives from which to teach and learn about this discipline. Many of these perspectives bog down in the rigor of their respective fields. Such approaches render it difficult to absorb and apply core concepts without spending a great deal of time in first learning topics such as advanced probability theory and stochastic calculus.

Dr. Crack's approach seems to be to develop the intuition as a framework for understanding further advanced study, should it be warranted by the reader. At the same time, he includes many aspects of the underlying science to help bridge the gap between the academic world and the world of trading.

For example, his derivation of the solution to the Black-Scholes equation and subsequent analysis of the components of the solution leaves the reader fully prepared to quickly and intelligently grasp the impact of changes in assumptions. This is in contrast to many treatments that seem to stop at the solution, leaving the reader feeling as though the Black-Scholes solution is simply a black-box with no intuitive connection to the real world.

9 of 10 people found the following review helpful:

5.0 out of 5 stars Great Introduction to Option Pricing, September 6, 2005

By 

Everett Asher (Rochester, NY USA) - See all my reviews

This review is from: Basic Black-Scholes: Option Pricing and Trading (Paperback)

This is an excellent introduction to option pricing, with a great deal of both analytical and practical information. While there is a lot of mathematics (obviously), the logical progression of topics and easy to read text make it quite accessible. Intuition and reasoning are used in conjunction with the mathematics to help make somewhat abstract ideas more concrete. Although the focus of the text is on option pricing, several other facets of finance are explored to help illuminate general pricing/investment strategies. This is an easy to follow book with justifications at every step of the way - great for students as well as investors interested in option trading.

9 of 10 people found the following review helpful:

4.0 out of 5 stars A practical side of Black-Scholes, August 6, 2005

By 

Jim Gerdy "jjg" (Chicago, IL) - See all my reviews

Amazon Verified Purchase

This review is from: Basic Black-Scholes: Option Pricing and Trading (Paperback)

This is a good follow-up to Crack's "Heard On the Street" with more practical help for beginners in quantitative finance. It's basically a review of standard options pricing with a lot of Black-Scholes. For me the strength is a lot of conceptual reflection on how the formulas work, what individual terms mean, and how to apply with useful approximations. I was hoping for more case studies of options prices and looking at how stock and options prices interact in the market. This book really doesn't do that. But if you want a derivation of Black-Scholes and thoughtful discussion of terms and parameters this is excellent.