From the February 01, 2012 issue of Futures Magazine • Subscribe!

The Market Taker’s Edge

“The Market Taker’s Edge”
By Dan Passarelli
McGraw Hill, 2011
$35.00, 235 pages

Describing his beginning as a runner and then a clerk on the floor of the Chicago Board of Trade (CBOT), which is now a part of CME Group, Dan Passarelli provides detailed and colorful views of trading in this action-packed environment. Professional traders, originally on the exchange floor but now primarily engaged in providing prices and liquidity to the market online electronically, are disciplined and committed to trades that are quickly and efficiently hedged. Their ultimate goal is to avoid being out of balance in terms of delta – the measure of an option’s price movement relative to the change in price of the underlying asset.

As stated by Passarelli, these traders like to have lots of activity each day, managing risk with hedging and spreads with the objective of being flat delta. Of course, there are too many distracting influences for this goal to be achieved easily. This book is really about how market makers are able to control profit and loss (P&L) through multiple trades, by continually watching and adjusting the Greeks – delta, gamma, theta, vega and rho – that measure the risks and profit opportunities in market prices.

In a number of trading examples and market situations, Passarelli gives clear and detailed instructions on how to combine the Greeks successfully for minimum risk and maximum profit. Some examples cover several pages, but most are brief enough to be described in a page or less. The history of options pricing models is presented. Examples of trades along with their Greek metrics shown in this book seem to be based on the Black-Scholes pricing model, the first complete theoretical model, which was developed in 1973.

Although the author does not present a pricing model to follow, readers may want to access the Black-Scholes model that is available as a free Excel download worksheet at futuresmag.com. By changing the input values of variables such as time to expiration, interest rate and volatility, the effects of changes may be noted on option prices and delta values. In fact, Passarelli says that part of his early knowledge of theoretical price models was gained by experimentally testing the effects of changing variables on computer programs available at the options exchange.

Unless you are already well-versed in the methods of pricing and trading by market makers, there will be a learning curve involved with the actual trading examples presented by the author. Like a student who is thankful for interesting stories that a teacher intersperses within difficult-to-understand lectures, you will appreciate Passarelli’s tales from his own experiences as a professional market maker. These stories show that market professionals are committed and focused on making money, and also help in understanding how non-professional retail traders – the market takers – may take advantage of several means to achieve their own edge in trading and pricing.

The author makes good on the promise implied by the book’s title, “The Market Taker’s Edge,” by showing ways that do not require complex calculations how individual retail traders can improve trading results.

For example, both the market maker and market taker can come out ahead by thoughtful splitting of bid-ask price spreads. There are several methods for improving the edge by having better knowledge of market maker trading and pricing procedures.

Various types of buy and sell orders are described, with reasons why some have advantages over others. Other features include instructions on putting together synthetic spreads, and a discussion of synthetic relationships that are useful for options traders. Volatility trading is another topic that is fully developed under the subtitle “Volatility: the Real Commodity.” One goal of market makers is to eliminate volatility risk.

The overall conclusion is that this book contains much information that will benefit a non-professional trader. Passarelli has conducted mentoring sessions on the same topics. A reader will feel that this is the next best thing to having the author as a coach.

Paul Cretien is an investment analyst and financial case writer. His e-mail is PaulDCretien@aol.com.

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