Introduction p. 1
The Trading Process p. 3
Option Pricing p. 7
The Black-Scholes-Merton Model p. 7
Summary p. 14
Volatility Measurement and Forecasting p. 15
Defining and Measuring Volatility p. 15
Definition of Volatility p. 16
Alternative Volatility Estimators p. 22
Close-to-Close Estimator p. 26
Parkinson Estimator p. 26
Garman-Klass Estimator p. 27
Rogers-Satchell Estimator p. 27
Yang-Zhang Estimator p. 27
Using Higher-Frequency Data p. 27
Forecasting Volatility p. 31
Maximum Likelihood Estimation p. 36
Forecasting the Volatility Distribution p. 39
Summary p. 43
Implied Volatility Dynamics p. 45
Volatility Level Dynamics p. 48
Informal Definition p. 50
More Formal Definition p. 50
A Traders' Definition p. 50
Smile Dynamics p. 54
Summary p. 62
Hedging p. 63
Ad Hoc Hedging Methods p. 65
Hedging at Regular Intervals p. 65
Hedging to a Delta Band p. 65
Hedging Based on Underlying Price Changes p. 65
Utility-Based Methods p. 66
The Asymptotic Solution of Whalley and Wilmott p. 71
The Double Asymptotic Method of Zakamouline p. 74
Estimation of Transaction Costs p. 78
Aggregation of Options on Different Underlyings p. 83
Summary p. 85
Hedged Option Positions p. 87
Discrete Hedging and Path Dependency p. 87
Volatility Dependency p. 93
Summary p. 99
Money Management p. 101
Ad Hoc Schemes p. 101
The Kelly Criterion p. 103
Alternatives to the Kelly Criterion p. 113
Trade Sizing in a Continuously Changing Setting p. 118
A Simple Approximation p. 124
Summary p. 126
Trade Evaluation p. 127
General Planning Procedures p. 128
Risk-Adjusted Performance Measures p. 134
The Sharpe Ratio p. 135
Alternatives to the Sharpe Ratio p. 137
Setting Goals p. 140
Persistence of Performance p. 142
Relative Persistence p. 143
Absolute Persistence p. 144
Summary p. 147
Psychology p. 149
Self-Attribution Bias p. 151
Overconfidence p. 152
The Availability Heuristic p. 155
Short-Term Thinking p. 156
Loss Aversion p. 157
Conservatism and Representativeness p. 158
Confirmation Bias p. 160
Hindsight Bias p. 161
Anchoring and Adjustment p. 162
Summary p. 162
Life Cycle of a Trade p. 165
Pretrade Analysis p. 165
June 25, 2007 p. 165
June 26, 2007 p. 169
June 27, 2007 p. 169
June 28, 2007 p. 170
June 29, 2007 p. 170
July 2, 2007 p. 170
July 3, 2007 p. 170
Post-Trade Analysis p. 171
Summary p. 173
Conclusion p. 175
Execution Ability p. 176
Concentration p. 177
Product Selection p. 177
Model-Free Implied Variance and Volatility p. 179
The VIX Index p. 180
Spreadsheet Instructions p. 183
GARCH p. 183
Volatility Cones and Skew and Kurtosis Cones p. 184
Daily Option Hedging Simulation p. 184
Trade Evaluation p. 185
Trading Goals p. 185
Corrado-Su Skew Curve p. 185
Mean Reversion Simulator p. 186
Resources p. 187
Essential Books p. 187
Thought-Provoking Books p. 189
Useful Web Sites p. 190
References p. 193
About the CD-ROM p. 201
Index p. 203