- Paperback: 206 pages
- Publisher: Trading Insights, LLC (April 22, 2014)
- Language: English
- ISBN-10: 0692028293
- ISBN-13: 978-0692028292
- Product Dimensions: 6 x 0.5 x 9 inches
- Shipping Weight: 13.1 ounces (View shipping rates and policies)
- Average Customer Review: 49 customer reviews
- Amazon Best Sellers Rank: #218,723 in Books (See Top 100 in Books)
Enter your mobile number or email address below and we'll send you a link to download the free Kindle App. Then you can start reading Kindle books on your smartphone, tablet, or computer - no Kindle device required.
To get the free app, enter your mobile phone number.
Option Strategy Risk / Return Ratios: A Revolutionary New Approach to Optimizing, Adjusting, and Trading Any Option Income Strategy Paperback – April 22, 2014
|New from||Used from|
Frequently bought together
Customers who bought this item also bought
About the Author
Brian Johnson designed, programmed, and implemented the first returnsensitivity based parametric framework actively used to control risk infixed income portfolios. He further extended the capabilities of thisapproach by designing and programming an integrated series of optionvaluation, prepayment, and optimization models.
Based on this technology, Mr. Johnson founded Lincoln CapitalManagement's fixed income index business, where he ultimately managedover $13 billion in assets for some of the largest and mostsophisticated institutional clients in the U.S. and around the globe.
He later served as the President of a financial consulting and softwaredevelopment firm, designing artificial intelligence-based forecastingand risk management systems for institutional investment managers.
Mr. Johnson is now a full-time proprietary trader in options,futures, stocks, and ETFs primarily using algorithmic tradingstrategies. In addition to his professional investment experience, healso designed and taught courses in financial derivatives for both MBAand undergraduate business programs.
He is the author of two groundbreaking books on options: 1) Option Strategy Risk / Return Ratios, and 2) Exploiting Earnings Volatility.His recent in-depth (100+ page) article, Option Income Strategy Trade Filters, represents the culmination of years of research into developing asystematic framework for optimizing the timing of Option Income Strategy (OIS) trades.
He has also written articles for the Financial Analysts Journal, Active Trader, and Seeking Alpha and he regularly shares his trading insights and research ideas as the editor of traderedge.net/.
Mr. Johnson holds a B.S. degree in finance with high honors from the University of Illinois at Urbana-Champaign and an MBA degree with a specialization in Finance from the University of Chicago Booth Schoolof Business.
Try the Kindle edition and experience these great reading features:
Read reviews that mention
Showing 1-4 of 49 reviews
There was a problem filtering reviews right now. Please try again later.
According to its description on Amazon, this book “… includes a link to an Excel spreadsheet with macros designed to calculate all of the risk/return ratios introduced in the book.” The Excel spreadsheet will not produce any of the book’s tables and charts. Rather, it calculates one data point for each of three risk/return ratios (RRR). The calculation is based on the price of the underlying stock, the current and historical implied volatilities of that stock, the Greeks (Delta, Gamma, Vega, Theta and Rho ) of the spread that was developed from the stock options, and the risk-free interest rate. These data must be transferred from an outside source, such as a trading platform, to the spreadsheet in a Excel-compatible format. In return, the spreadsheet calculates a single data point for each of three RRRs: a reward that, in my opinion, is not worth the effort.
With a basic understanding of Excel, you can create a table that combines the spreadsheet’s inputs and outputs and looks like the tables in the book. The book’s tables, however, provide nine data points for each RRR while the spreadsheet that comes with the book calculates only one at a time. If your trading platform can calculate Greeks from different stock prices, and you are willing to spend several hours transferring these data to the spreadsheet, you can create a table that provides the same information as those in the book.
Figure 1 (attached to this review) includes a table that was created in the above manner. The table contains the risk return ratios of a double diagonal spread on the Dow-Jones Industrial Average or Diamonds (DIA). The spread comprises the sale of 20 near-term monthly option contracts (-10Jan17,15, 170.5 Puts and -10Jan17,15, 186 Calls) and the purchase of 4 longer-term weekly contracts (2Feb20,15, 183 Calls and 2Feb20,178 Puts. The graph above the table is a risk profile, at expiration, of the same spread. The table and graph cover DIA prices that range from 169.30 to 186.30.
The book emphasizes that the RRRs represent only the risks posed by an instantaneous change in the price of the underlying stock. The time it takes for these changes to occur is not considered. Consequently, the RRRs must be updated frequently, or they would quickly lose their validity. If a trading platform could be programmed to calculate RRRs in real time, I would say that Johnson has developed a useful strategy for the day to day management of delta-neutral option spreads. Unfortunately, this is not the case. Some more specific comments follow.
Page 18 – The text states, “The implied volatility line in Figure 1.7 is downward sloping indicating a higher level of implied volatility for RUT options with low strike prices and a lower level of implied volatility for Rut options with high strike prices.” As strikes go from low to high, the implied volatilities actually swing from high to low to high. This relationship is not a “vertical skew” but a curve that is often called the “volatility smile”. Figure 2 compares graphs of the vertical skew (Figure 1.7 in this book) versus the volatility smile (Investopedia).
Page 74 - The daily volatility of implied volatility (DVIV) is calculated from a “five-day average of the squared daily changes” in implied volatility. If “it is imperative to use a recent IV data sample” why does the Excel spreadsheet, which provides these calculations, use four years of IV data? Are the more recent data weighted?
Page 114 – A RRR of minus 4 is used as an arbitrary warning when risks become unfavorable. The text recommends that “trader-specific warning levels should be used to create consistent and objective adjustment points and/or exit triggers for all option income strategies.” I don’t think that it is possible to create warning levels that are “consistent and objective”. The attached Figure 1 includes a risk profile of a double diagonal spread at expiration. Note that the lower break-even point at 169.30 coincides with a Delta-Theta Risk Return Ratio (DTRRR) of -4.75 and upper the break-even point at 186.30 coincides with a DTRR of -10.55. A warning level -4.00 appears reasonable if the stock drops, but not if the stock rises.
Page 120 – The text states, “Longer-dated equity options typically have higher implied volatilities than shorter-dated equity options.” I have found the opposite. I often trade double calendar and double diagonal spreads where the implied volatility of the near-term options (which I sell) is at least 10% higher than the long-term options (which I buy). During earnings season, this volatility skew often exceeds 20%.
Page 128 – Figure 8.4 and similar tables show the risk return ratios (RRR) that correspond to nine different values for Implied Volatility (IV). The text states that the IV daily volatility is computed from the five-day average of the most recent (annual) IV. It is not clear why there would be nine different IV values when only one value could be derived from the recent, five-day average. Figure 8.4 also shows that when RUT is at 901.60 the IV daily volatility is 2.57%. The value “2.57%”, however, does not appear anywhere in the spreadsheet tab that calculates the IV daily volatility. My point here is that it is not clear where the Tables and Charts are getting IV values.
First of all, I did have some finance courses (mathematics of finance, financial administration and politics, and capital markets), but I did not learn much about options, only basic aspects. Therefore, as you can imagine, the language and concepts used in the book were new and complicated for me. Thus, after I started reading Mr. Johnson's book, I decided to give it a rest and rather dedicate my time to easier options books. After around two weeks of diving into other books and getting used to new concepts and ideas, I gave this book another try. Needless to say, this second read was much more informative and illuminating. Also, as stated by my 5 star score, I find it to be one of the best books I have read on the subject. I understand that my limited reading experience in terms of books about financial options might cause some people to discredit this review, but please let me enumerate the reasons for which I find this book to be excellent:
1) Innovative ratios for measuring and comparing risk and reward, which are applicable to different scenarios (in terms of factors & time periods, among other concepts) and markets
2) Includes and dedicates numerous sections of the book to refer to horizontal and vertical skew, and how they affect option strategies and therefore must be taken deeply into account
3) Gives several examples whilst applying new formulas and concepts, together with step-by-step explanations, before diving into how current option strategies can be improved
4) Dedicates a whole chapter to explaining how these revolutionary formulas and concepts can be applied through optimization software and the usage of programs such as Excel, so as to find the best possible outcome, and the be apply to constantly adapt it to changing market conditions
Overall, I found to book to be very consistent in terms of explanations. and I must admit that the optimization chapter is both essential and the main reason I rate this book with 5 stars. Not only does Mr. Johnson explain his reasoning for the application of these types of strategies, but he also gives numerous examples (whilst using software images to serve as a visual aid) and goes even further by establishing a draft model for designing an optimization platform.
In conclusion, this definitely is a book worth looking into if you are interested in financial options/market-neutral strategies/option strategy optimization and are willing to put in the time to take full advantage of the ideas, concepts and formulas introduced by this book. One last remark I want to make is that I have read some reviews mentioning that it is extremely difficult or even impossible to apply the concepts established inside this book. I heavily disagree, since the optimization chapter is specifically dedicated to that, and personally I am almost finished with my excel spreadsheet designed for option strategy optimization applied through Mr Johnson's concepts and formulas. Even though I have used both Excel and it's programming language VBA in the past, I am by no means an expert on the subject. And, even though the effort required is considerable and the process time consuming, the benefits from developing a very valuable optimization platform highly outweigh the lesser drawbacks.
As far as I know, this book is the first that has addressed the various payoffs (straddles etc) in the context of an actual edge: selling options to capture the index volatility premium.
Anyone, who says this idea is too complex to apply in practice probably shouldn't be trading options at all. The idea is actually where most of the edge in options trading comes from.