Adam Warner's 'Options Volatility Trading: Strategies for Profiting from Market Swings'

[update below]

I have begun reading Adam Warner's new book Options Volatility Trading: Strategies for Profiting from Market Swings. For those of you who don't know, Adam writes the excellent and influential blog Daily Options Report. I started reading Adam's writing when he co-wrote the options column on Street Insight (part of the TheStreet.com family) from spring 2003 to spring 2005. He is currently Options Editor at Minyanville.com. You can read his profile at his About on his blog.

Readers should know that I correspond occasionally with Adam and have great respect for him. I have learned a tremendous amount from his articles and from his answers to my questions. Moreover, I admired his warning readers that they might wish to exercise caution when following Lenny Dykstra's options articles on The Street.com. His warnings were long before Dystra's problems became fodder for the mass media, including CNBC. Adam is a friend and thus I will likely be biased in my review of his book.

So far, I have just covered the Introduction, Chapter 1: Who Am I? Why Am I Here?, and Chapter 2: Know Your Greeks. The introduction is great because Adam sets out that the book will not be a cookbook with easy to follow recipes for success nor will it be steeped in heavy mathematics or formulas. Instead, the book will be focused on how to use information and data to manage an active account or portfolio with an ever changing set of circumstances. Adam provides his personal background in Chapter 1. I found knowing his background interesting for a couple reasons. First, I was amazed at how primitive the options markets were only a few years ago. And second, because of Adam's experience as a floor trader at the Amex Option Exchange, I know that Adam has a well honed intuitive feel for the markets and is able to think rapidly on his feet. In Chapter 2, Adam provides the reader with a high level overview of the major Greeks in options trading. As stated earlier, Adam skips over the mathematical treatments and provides the reader with the essential information.

If you are just starting out with Options, this book is not your best starting point. You should have a basic understanding of calls and puts. If you don't have that understanding, the free educational videos at Options New Network ONN.TV are a good resource. You don't require an in-depth understanding of options to read Adam's book. However, you should know what calls and puts are and understand their basic payoff diagrams.

So far, I am thoroughly enjoying Adam's book. After a few more chapters, I will provide another update.

Chapter 3: Understanding the VIX. This is a critical chapter because it serves as the backbone for the book. You learn what volatility is and how it is represented through VIX. VIX is how many investors and traders express fear and complacency. However, VIX is not perfect and this chapter explains why.

Chapter 4: Nuts and Bolts VIX. You learn that VIX represents the expected volatility of the SPX, the S&P 500. Notice that it is an expected volatility. For example, a VIX of 32 implies a roughly 2 percent range in the SPX on any given day. You also learn that volatility has two key components: volatility of individual S&P 500 component stocks and correlation among those stocks. That is, if stocks are extremely volatile but uncorrelated, then the VIX will be lower than when the stocks are undergoing the same volatility but are tanking in unison.

Chapter 5: Volatility Timing. With regard to buying and selling options, you learn that not every day is created equal. There are better days within the expiration cycle to either buy or sell options. And, there is seasonality to options as well.

Chapter 6: How Do Traders Trade Volatility. This chapter is where the real fun starts. Now, you are beginning to use your knowledge from the previous chapters to think about how you want trade. If you buy or sell options, what are your considerations with regard to volatility, delta, and gamma? Can a buyer and seller of the same options both make money, and if so, how? Do you prefer a high or low volatility environment, and why? What does volatility mean to options traders?

Update:

Chapter 7: Options and the Quarterly Earnings Report

Often you hear analysts say, "Stock ABCD is expected to move X%, either up or down, after the bell when it releases its earnings."

This chapter teaches you how you can determine for yourself how much the stock is expected to move. This knowledge is helpful whether you are an option or stock trader. If your expectations are different from that of the market, you can play accordingly. But, as Warner mentions, you have to be prepared to defend your position and take your medicine when the markets surprise you.

Chapter 8: Like the Weather--The Trader VIX and Why It Doesn't Do What You Think It Does

For those that don't understand them well, VIX, VIX futures, VIX Options on Futures, and VIX ETNs are complex and confusing. After reading this chapter, I have a clear understanding of how these instruments work. Consequently, I will take Warner's advice not to use them. Instead, as he suggests, I will keep it simple by using a different set of common indexes and ETFs.

With all the discussion in the media about VIX and fear index and how people might want to protect themselves against volatility, investors and traders should understand VIX. I suspect a surprising number do not.

Chapter 9: Ratio, Ratio

Put call ratios should be interpreted and used with caution, especially for individual stocks. By themselves, they could indicate any number of scenarios, and for you the trader, it is often difficult, if not impossible, to understand which scenario is at play.

Chapter 10: We're (Pin) Jammin'

Warner discusses the circumstances that make pins more likely. A pin is where a stock expires at a strike price. If you knew in advance where a stock would be pinned, then you could profit from this knowledge.

Chapter 11: Myth-Busting and Other Assorted Options- and Expiration-Related Stats

There are several urban legends related to options and options expiry. Warner examines a few of them and provides you with his analysis. For example, we often hear that expiration week is more volatile. Is that true, and if so, how can you profit from it?

Chapter 12: Buy-Write--You Bet

I found this chapter surprising because the results were exactly counter to my expectations. A buy-write is when an investor or trader buys a stock and sells a call. The call provides extra income while limiting potential capital gains. Under what circumstance is it advantageous to engage in buy-writes?

Chapter 13: Strategy Room

This is a great chapter because Warner provides his thoughts and analysis on some common strategies such as:

• Naked Put;
• Bull Call Spread;
• Bear Put Spread;
• Backspreads;
• Calendar Call Spread;
• Backspread and Calendar Spread Combined;
• Butterfly Spread;
• Iron Butterfly;
• Condor;
• Iron Condor;
• Synthetics; and
• Dividend Plays.

Armed with this knowledge, you are better equipped to think about which strategies you want to employ under various circumstances.

Chapter 14: Ultra and Inverse ETFs

I found this chapter surprising, because even though I am well versed in how double and triple exchange traded funds (ETFs) work, I didn't realize the size and scope of some of these ETFs. If you don't understand how ultra and inverse ETFs grind your results down over time, you definitely need to read and understand this chapter. And perhaps you'll be surprised too at how important these ultra and inverse ETFs have become to the markets.

Chapter 15: Chartin' Them Derivatives

Many investors have profited by using technical analysis. In this chapter, Warner cautions traders not to employ the same methodology to derivatives. Under certain circumstances, it might provide some additional guidance around the edges.

Chapter 16: Plus Ticks and Other Rules

The key theme in this chapter is that you must trade the market you're given, not the market you would like it to be. Whether you agree with the plus tick rule for shorting stocks is irrelevant. Trade the market with rules as they exist.

Disclosure: I am long TheStreet.com (TSCM) stock. And as part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.