Volatility Trading by Euan Sinclair: Lessons About Risk for Many

by: Nick Gogerty

Volatility trading euan sinclair Volatility Trading is a good tool for learning about the ins and outs of volatility. Volatility Trading is accessible and informative in the same style as Ernest Chan's book, Quantitative Trading.

Both Quantitative Trading and Volatility Trading offer tutorials from helpful practitioner teachers. There is a mix of quantified academic rigor in the form of teaching about the tools of the trade and real world humility.

I don't trade options or volatility so why should I care?

One of the flaws of the financial system today is practitioners' belief that volatility is risk. This is a sad case of using the wrong metric to describe what is experienced by the investor or allocator. This failure occurs at the personal and billion $ pension fund portfolio levels where trustees from august institutions hold sway on allocation committees.

Volatility Trading begins explaining the basics of calculating Volatility and then launches into 6 separate ways to measure volatility. A risk manager's ears should perk up now. Portfolio Value at Risk VaR which is driven by volatility and co-variance can vary significantly depending on how things are measured.

Like the old joke about the accountant, engineer and lawyer goes. When asked what 2+2 equals, the accountant answers 4, the engineer answers 3.999 and the lawyer looks around and says, "what would you like it to be?". Most quantitative risk measurements are elastic and prone to subjective biases, ask Moody's or S&P about CDO ratings.

If you are on the receiving or delivering end of a VaR report or work with any derivative whose value is determined by path dependence you might want to perk up and take a look at this book as it is a good introduction to the field of volatility and indirectly hedging and risk.

If you have a deep background in mathematics etc, the Volatility Trading's math components may feel introductory and light. For math newbies, things are clearly articulated and laid out like a useful dummies guide to volatility, hedging and money management.

Living risk is very different from modeling it.

Sinclair does a good job of trying to explain what it is like to have a position on and go through drawdowns. Sinclair quotes Mike Tyson in the opening of one chapter, "Everyone has a plan, until they get hit."

Again for risk managers, learning to be more skeptical of volatility by reading someone who trades it for a living is useful.

The book also touches on Kelly money management techniques which can be a useful way to think about leverage, exposure and ultimate trading goals.

Volatility is a limited measure of risk that is detrimentally overused.

Volatility is simple to calculate, easy to apply across asset types and easy to understand. Unfortunately, that doesn't mean it is as worthwhile as it gets held up to be. Volatility tells you how much the car and driver have swerved in the past. Volatility doesn't tell you if the car or driver are going to get you where you want to go.