Options for Volatile Markets (2^nd Ed.) Managing Volatility and Protecting Against Catastrophic Risk Bloomberg Financial Series

Traditional buy-and-hold investing has been seriously challenged in the wake of the recent financial crisis. With economic and market uncertainty at a very high level, options are still the most effective tool available for managing volatility and downside risk, yet they remain widely underutilized by individuals and investment managers. In Options for Volatile Markets, Richard Lehman and Lawrence McMillan provide you with specific strategies to lower portfolio volatility, bulletproof your portfolio against any catastrophe, and tailor your investments to the precise level of risk you are comfortable with.

While the core strategy of this new edition remains covered call writing, the authors expand into more comprehensive option strategies that offer deeper downside protection or even allow investors to capitalize on market or individual stock volatility. In addition, they discuss new offerings like weekly expirations and options on ETFs. For investors who are looking to capitalize on global investment opportunities but are fearful of lurking "black swans", this book shows how ETFs and options can be utilized to construct portfolios that are continuously protected against unforeseen calamities.

• A complete guide to the increased control and lowered risk covered call writing offers active investors and traders
• Addresses the changing investment environment and how to use options to succeed within it
• Explains how to use options with exchange-traded funds

Understanding options is now more important than ever, and with Options for Volatile Markets as your guide, you'll quickly learn how to use them to protect your portfolio as well as improve its overall performance.

Preface xi

Introduction The “New Normal” in Equity Investing 1

Chapter 1 Option Basics 7

What Are Options? 7

Exercise and Assignment 14

Positions 17

How Options Are Traded 19

Options in Your Account 22

Chapter 2 Option Pricing and Valuation 25

Option Premium 25

Theoretical Value 27

Time Value 28

Volatility 31

Interest Rates 32

Dividends 32

Calls versus Puts 33

Option Skews and Anomalies 34

Chapter 3 The Basics of Covered Call Writing 37

Requirements for “Valid” Covered Writes 38

Risk/Reward of a Covered Write 39

Calculating Potential Returns 46

Major Factors Affecting Call-Writing Returns 48

Covered Writing as an Ongoing Strategy 54

Summing Up Covered Writing 57

Chapter 4 Implementing Covered Call Writing 59

Follow-Up Actions 59

Behavioral Issues 69

Differing Approaches 70

Selecting Calls to Write 77

Risks 80

Basic Tax Rules for Options 81

Summing Up Implementation 84

Chapter 5 Advanced Call-Writing Techniques 87

Writing Calls on “Hot” Stocks 88

Tax Deferral Strategies 89

Covered Writing on Margin 90

Covered Writing against Securities Other Than Stock 93

Partial Writing, Mixed Writing, and Ratio Writing 98

Put Writing 103

Expiration Games 106

Option-Stock Arbitrage 108

Chapter 6 Basic Put Hedging 111

Put Hedge Basics 111

Advantages 115

Disadvantages 116

Behavioral Implications 123

Put Hedge versus Covered Call 127

Hedging against Catastrophic Risk 129

Chapter 7 Advanced Hedging Strategies 131

Put Hedge Follow-Ups 131

Using Put Spreads to Hedge 137

Collars 145

Conclusions on Protective Option Strategies 151

Chapter 8 Options on ETFs 153

ETFs in a Nutshell 154

ETF Options 158

Covered Call Writing on ETFs 159

Our Put Hedge and Collar Study on SPY 162

Appendix: Partial List of ETFs with Listed Options 165

Chapter 9 Volatility and Volatility Derivatives 171

What Is Volatility? 171

Using VIX as a Market Indicator 173

Volatility Futures 179

Variance Futures 181

The Behavior of VIX Futures 183

VIX Options 191

VIX Option Strategies 199

The Future 204

Acknowledgments 205

About the Authors 206

Index 207

RICHARD LEHMAN is the founder of RHL Capital, a registered investment advisor, and a part-time instructor of behavioral finance and options at UC Berkeley Extension. He is also the author of Far From Random, and publishes an investment newsletter called the Channelist. Lehman's financial career spans more than thirty years in product management, marketing, sales, and investment management beginning with an eleven-year stint on Wall Street with E.F. Hutton & Co., Thomson McKinnon Inc., and the New York Stock Exchange.

LAWRENCE G. MCMILLAN is the founder and President of McMillan Analysis Corporation. He authors the Daily Volume Alerts, a unique daily service that selects short-term stock trades by looking for unusual increases in equity option volume. McMillan manages option-oriented accounts for individual investors and also publishes the Option Strategist, a derivative products newsletter covering equity, index, and futures options. McMillan's web site, www.optionstrategist.com, twice received a "Best of the Web" award from Forbes magazine. He is the coauthor, with Richard Lehman, of the first edition of this book and the author of McMillan on Options (Wiley) and Options as a Strategic Investment.