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Trading Options at Expiration: Strategies and Models for Winning the Endgame Hardcover – March 22, 2009

ISBN-13: 978-0135058725 ISBN-10: 0135058724 Edition: 1st

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Product Details

  • Hardcover: 176 pages
  • Publisher: FT Press; 1 edition (March 22, 2009)
  • Language: English
  • ISBN-10: 0135058724
  • ISBN-13: 978-0135058725
  • Product Dimensions: 8.2 x 5.6 x 0.6 inches
  • Shipping Weight: 12 ounces
  • Average Customer Review: 3.7 out of 5 stars  See all reviews (35 customer reviews)
  • Amazon Best Sellers Rank: #429,535 in Books (See Top 100 in Books)

Editorial Reviews

About the Author

Jeff Augen, currently a private investor and writer, has spent over a decade building a unique intellectual property portfolio of databases, algorithms, and associated software for technical analysis of derivatives prices. His work, which includes more than a million lines of computer code, is particularly focused on the identification of subtle anomalies and price distortions.

 

Augen has a 25-year history in information technology. As a cofounding executive of IBM’s Life Sciences Computing business, he defined a growth strategy that resulted in $1.2 billion of new revenue and managed a large portfolio of venture capital investments. From 2002 to 2005, Augen was President and CEO of TurboWorx Inc., a technical computing software company founded by the chairman of the Department of Computer Science at Yale University. He is the author of three previous books: The Option Trader’s Workbook (FT Press 2008), The Volatility Edge in Options Trading (FT Press 2008) and Bioinformatics in the Post-Genomic Era (Addison-Wesley 2005).

 

Much of his current work on option pricing is built around algorithms for predicting molecular structures that he developed many years ago as a graduate student in biochemistry.

 

Excerpt. © Reprinted by permission. All rights reserved.

Introduction and Explanatory Notes

Praise Quotes

“Learn and profit from Jeff Augen’s book: It clearly explains how to take advantage of market inefficiencies in collapsing implied volatility, effects of strike price, and time decay. A must-read for individuals who are options oriented.”

Ralph J. Acampora, CMT, Director of Technical Analysis Studies,
New York Institute of Finance

“A fantastic, insightful book full of meticulously compiled statistics about anomalies that surround option expiration. Not only does Augen present a set of effective trading strategies to capitalize on these anomalies, he walks through the performance of each across several expirations. His advice is practical and readily applicable: He outlines common pitfalls, gives guidance on timing your executions, and even includes code that can be used to perform the same calculations he does in the text. A thoroughly enjoyable read that will give you a true edge in your option trading.”

Alexis Goldstein, Vice President, Equity Derivatives Business Analyst

“Mr. Augen makes a careful and systematic study of option prices at expiration. His translation of price behavior into trading strategy is intriguing work, and the level of detail is impressive.”

Dr. Robert Jennings, Professor of Finance, Indiana University
Kelly School of Business

“This book fills a gap in the vast amount of literature on derivatives trading and stands out for being extremely well written, clear, concise, and very low on jargon—perfect for traders looking to evolve their equity option strategies.”

Nazzaro Angelini, Principal, Spearpoint Capital

“Instead of considering macro-time strategies that take weeks to unfold, Jeff Augen is thinking micro here—hours or days—specifically the days or hours right before expiration, and harnessing grinding, remorseless options decay for profit. He builds a compelling case for the strategy here. The concept of using ratio spreads plus risk management for as brief a period as one day—open to close—to capture expiring premium is worth the price of admission alone. A superb follow-up to his first book. Must-read for the serious options student.”

John A. Sarkett, Option Wizard® software

Introduction and Explanatory Notes

Timing

This book was written during one of the most turbulent times in stock market history—the second half of 2008. During this time frame, trillions of dollars were lost by both bulls and bears as the world’s financial markets “melted down.” Investors who have never experienced a crashing market often believe that it is easy to generate profits in this environment with short positions. Unfortunately, nothing is ever that simple. The 2008 collapse included single-day bear market rallies as large as 11%—large enough to destroy nearly any short position. The answer lies in reducing market exposure and trading only when it makes sense.

Far too many investors have taken the opposite approach by remaining in the market with a portfolio of investments whether they were winning or losing. This approach has its own familiar vocabulary built around terms such as value investing and diversification. It hasn’t worked well for most investors. At the time of this writing, U.S. equity markets had just plunged to their 1997 levels, erasing 11 years of gains. Subtracting an additional 30% for inflation and dollar devaluation paints an even darker, but more realistic picture. As a group, long-term stock investors collectively lost an enormous amount of money—trillions of dollars.

Commodity traders faced similar problems. Oil prices climbed steeply from $27 in January 2004 to $134 in July 2008 before falling back to $50 in November. Long-term bulls actually suffered two significant setbacks during this time frame because the price fluctuated from an interim high of $70 in August 2006 to a low of $45 just five months later. Figure I.1 traces the price from January 2004 through the November 2008 decline.

As always, timing is everything. But the more important lesson is that blindly hanging on with a bullish or bearish view is a flawed strategy. Every investment has a window of opportunity; unless that window can be identified, leaving the money invested is somewhat like gambling. That said, the window can be relatively long—sometimes spanning months or years.

Option trading in turbulent times can also be difficult. Implied volatilities rise sharply, making simple long put or call positions unreasonably expensive, and the risks associated with naked short positions is simply too large for any conservative investor. Structured positions such as calendar spreads, ratios, vertical spreads, and the like, are difficult to trade because stocks frequently cross several strike prices in a single month—sometimes in both directions.


Figure I.1  Weekly U.S. spot price for crude oil 2004/01/02 to 2008/11/14. Price is displayed on the y-axis, key dates are noted on the chart. Source: U.S. Department of Energy, Energy Information Agency, http://www.eia.doe.gov.

These pitfalls can all be avoided by entering the market at very specific times and structuring trades that capitalize on well-characterized pricing anomalies. For option traders, the days preceding expiration represent the very best opportunity. During this time frame, traditional approaches to calculating the value of an option contract fail, and prices become distorted. One of the most significant forces, implied volatility collapse, can generate price distortions as large as 30% on expiration Thursday and 100% on Friday for at-the-money options. At the same time, strike price effects resemble the gravitational pull of planets, with stocks as their satellites. Heavily traded optionable stocks tend to hover around strike prices as large institutional investors unwind complex positions ahead of expiration. Option traders who structure day trades that take advantage of these forces can generate more profit in one day than most experienced investors realize in an entire month—sometimes an entire year.

Unlike other trading strategies that are linked—sometimes in subtle ways—to a specific set of market conditions, expiration trading focuses only on the underlying mathematics. It does not rely on any financial predictions, company results, or market direction. In this context, an expiration trader manages ticker symbols and strike prices because the name or business of the underlying stock is irrelevant. But nothing worth doing is ever easy. Trading subtle price distortions in the options market is a complex affair that requires an unusual blend of pricing knowledge and day trading skill. Expiration trading is a mathematical game distinctly different from stock picking. It will most likely appeal to day traders and other investors seeking to moderate risk by reducing market exposure. That said, this book should never be placed in the “get rich quick” section of the bookstore because success requires hard work, focused attention, and practice.

Some Notes About the Data

A relatively large amount of minute-by-minute stock and option data was used in the preparation of this book. This information, in its unprocessed form, was purchased from Tick Data of Great Falls, Virginia. Many specific criteria went into the decision to choose this particular data source.

First, and most significant, was accuracy. Because slight discrepancies can cause significant errors in implied volatility calculations, it is important that the data be both accurate and complete. Assembling complete and accurate datasets is not a trivial exercise, as options trade on several different exchanges, often at low liquidity levels. It is, therefore, necessary that the data vendor precisely align timestamps for the individual trades before creating a single sequence or time series. In addition, the large number of strike price and expiration date combinations adds a level of complexity that becomes apparent when a new series is introduced or a stock splits. This situation is further complicated by the enormous number of symbols used and reused by the options market. When creating data files of option prices, it is, therefore, crucial that old and new data or data from different equities not be mistakenly commingled despite the presence of overlapping symbols. In this regard, it is not unusual for a single stock in a given year to have more than 1,200 strike price/expiration date combinations. Multiplying by the number of stocks and years yields a very large number of permutations.

File format is another important criterion. Individual files should contain text delimited by commas, spaces, or some other readily identifiable marker so that the information can be imported into a database or spreadsheet. Filenames should follow a consistent set of conventions that make it simple to identify a particular series. For example, trade data for the Apple Computer $170 strike price call expiring on 2010/01/16 and having the symbol WAA_AN might be stored in a file designated WAA_C_20100116_170.00_AN. This file can easily be found using Excel’s import feature by...


More About the Author

Jeff Augen, currently a private investor and writer, has spent more than a decade building a unique intellectual property portfolio of algorithms and software for technical analysis of derivatives prices. His work includes more than one million lines of computer code reflecting powerful new strategies for trading equity, index, and futures options.

Augen has a 25-year history in information technology. As a co-founding executive of IBM's Life Sciences Computing business, he defined a growth strategy that resulted in $1.2 billion of new revenue, and he managed a large portfolio of venture capital investments. From 2002 to 2005, Augen was President and CEO of TurboWorx, Inc., a technical computing software company founded by the chairman of the Department of Computer Science at Yale University. He is author of The Volatility Edge in Options Trading (FT Press, 2008), The Option Trader's Workbook (FT Press, 2008), Trading Options at Expirations (FT Press, 2009), Day Trading Options (FT Press, 2009), and Bioinformatics in the Post-Genomic Era (Addison-Wesley, 2004). Much of his current work on options pricing is built on algorithms for predicting molecular structures that he developed as a graduate student.

Customer Reviews

3.7 out of 5 stars

Most Helpful Customer Reviews

129 of 135 people found the following review helpful By Christian Farman on April 13, 2009
Format: Hardcover
Before going into the details of my review I will quote some statements from the book:
"A relatively large amount of minute by minute stock and option data was used in preparation of this book....... First and foremost `in importance' was accuracy because slight discrepancies can cause significant errors in volatility calculations"

"It is certainly reasonable to study option expiration by studying the behavior of individual stocks that is one end of the spectrum . The other end involves development of custom data bases and software"
Before I buy any book, I usually look through the Table of Contents to get a glimpse of what the book covers. In this book the search inside feature was not available, so my decision to buy was based on the one review available at the time. Even though I am a successful options trader I could not resist the high potential profits in few hours mentioned in the review.
After reading the book, and based on the author's own assertions quoted above, an average option trader can use ideas qualitatively by studying the behavior of specific stocks and its effect on option premium at expiration. This may include volatility near expiration, open put call position lopsidedness, and distorted time value of the premium among others. While this information is available in other books , this book is useful in that it consolidates it in one small book together.
To quantitatively apply the concepts in this book you have to be able to: (1) obtain extensive and accurate stock and option data. (2) Be able to program and (3) be a full time dedicated option trader. Fortunately, I am a programmer and a full time option trader. I tried to get as accurate data as possible and generate option volatility decay charts for specific stocks I felt are good candidates.
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48 of 49 people found the following review helpful By Michael Orr on April 7, 2011
Format: Hardcover Verified Purchase
The book is VERY interesting, but in an academic sort of way. If you are looking for anything of practical value, look elsewhere.

The author has done a lot of work - he collected an extensive (and expensive) historical database of minute-by-minute option prices, and then did an impressive analysis of this historical data. He presents relatively clearly the results of this data mining.

The main finding are that "pinning" occurs routinely on expiration day (not a big surprise anyway, and you get no hint how to guess to WHICH strike
price the pinning will occur, which is THE whole point) and that there seems to be a pattern as to how an option's prices goes to its intrinsic value (if any)
over the course of Expiration Thursday and Friday.

However, this is about it.

There is some vague and general discussion how the results show that it SHOULD be possible to have some edge when trading on the day of expiration and 1 day previously, but no clear strategy emerges.

It sounds intuitively appealing that on the last two days before expiration options fair-pricing algorithms can get a little out of
focus - just enough for you to exploit. Sadly, this book does not show you how to get this edge.

It shows examples that purport to show how the author got an edge trading in the past, but does NOT even spell out clearly which strategies are used.

By reverse-engineering the examples given, I derived 6 strategies the author used:
- ATM short straddle
- Just-OTM Straddle
- Ratio-Call (2x and 3X)
- OTM ratio call (3x)
- Long Straddle).
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117 of 127 people found the following review helpful By Michael Benklifa on March 19, 2009
Format: Hardcover
I'm an options trader. That's how I make my living. I've read all the books, been to the seminars, and have the scars from experience. So believe me when I say this book is different. It's not the same options books with a different cover. It's not going to start all over from scratch about what are options. This little book is packed with an out-of-the box winning strategy that takes advantage of the institutional moves (for once!). The pinning of stocks on expiration day is a phenomena that has been noted for some time. How to make money from this is not so clear. Mr. Augen takes advantage of institutional trading behavior on expiration day and details not only which stocks to trade but which strategy and what time of day to apply each strategy. [read this last sentence again] This approach is not conjecture but a statistical study as to how certain stocks move. This is a genuine money making strategy that can earn 200%-300% or more in a few hours. Just recently a straddle purchased on a stock mentioned in the book could have been purchased for $1 and sold for $6 a few hours later. The beautiful thing is that institutions can't even take advantage of this strategy!

My previous favorite book on options was Mr. Augen's Volatility Edge which, again, is in a class by itself. His next book was the Options Trader's Workbook which will push your knowledge on options like no other. I don't know why Mr. Augen is disseminating this strategy that most people would jealously guard. I can only assume from the nature of his other books that he is one of those who loves to teach and sees success in other people's success. Thank you Mr. Augen!
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