From the May 2013 issue of Futures Magazine • Subscribe!

Trading Options in Turbulent Markets

“Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management”
By Larry Shover
John Wiley & Sons, Inc., 2013
The first edition of “Trading Options in Turbulent Markets” was published by Bloomberg Press in 2010.
$46.29, 277 pages

Larry Shover — options trader, investment officer, portfolio manager and television commentator — opens his book stating his first objective is the management of risk while taking advantage of market volatility, including historical and implied volatility. His second purpose is to explain everything options: skew, Greeks (delta, vega, theta, and gamma), risk tolerance and trading strategies (covered call, naked and married puts, collars, straddles, vertical spreads, calendar spreads, butterflies, and wingspreads). The chapters that follow fill out the descriptions and strategic uses of each of those topics, plus the VIX volatility index.

Because trading derivatives is by and large a risky business, it is interesting to see how Shover applies the trading techniques in an effort to conquer uncertainty. He states that “we still face a stunning amount of uncertainty in the markets as in life” and “addressing this uncertainty as options traders is what this book is all about.” The book’s subtitle includes another of the author’s objectives: “I sought to write this second edition uniquely combining options trading and volatility in a universe that is beyond control and sometimes terrifying.”

Shover’s book assumes that the reader has a relatively advanced knowledge of options trading and theoretical pricing models. At the same time, each trading strategy and theoretical subject such as skew, volatility and probability is covered in detail so that they immediately are useful to both new and experienced options traders.

However, along with an experienced and knowledgeable presentation, there are several questionable points. For example, early on Shover states that probability “can be determined by using either the practical observance of the frequency of past events or theoretical forecasting models,” while later we are informed that “probability does not actually exist in practice” and that “probability is a magnificent yet dangerous concept.” Of course, these thoughts do not impede the use of probabilities and measurable risk in every trading strategy and the description of a trading plan as “a high-probability strategy.” 

The level of options trading experience and knowledge assumed is indicated by several discussions in the book. In the concepts of volatility and theta, “As volatility increases, so does theta,” and “In any option class there will eventually be a ‘crossover’ effect wherein theta becomes more of an issue than vega.” These statements are followed by the warning that “It is absolutely crucial to be able to delineate the difference, in your position, between vega and theta.”

In many instances the book will make the reader want to look at options charts to see if the author’s ideas are really true and useful. Thus, it may indirectly result in a much larger store of knowledge of trading techniques and variables such as Greeks and volatility. For example, do out-of-the-money options have a “propensity to pick up more gamma as volatility increases?”  Because gamma is the speed of change in delta (slope), and option price curves become less steep with increased implied volatility, this would seem to be counterintuitive. Time to get busy with options charts to check this out!

Assuming that the trading strategies and pricing relationships are accurate — an easy assumption in view of Shover’s extensive experience —the only error in the book (calculating the S&P 500 30-day return by VIX) is calling 3.464 the standard deviation of 12, when it is the square root of 12.

The book includes three parts: 1. Understanding the relationship between market turbulence and option volatility; 2. Understanding option volatility and its relationship to option Greeks, personal decision making and odds creation and 3. Ten proven strategies to employ in uncertain times.

Part 3 is really a book in its own right, containing five types of spread trades, including vertical and calendar spreads, backspreads and ratio spreads, butterflies, condors and wingspreads. The initial chapter in Part 3 prepares the trader in terms of sound trading decisions, approaches to options trading and “the mind of a successful trader.” Then, before starting on spread trades, Shover describes the covered call, covering the naked put, the married put and collar strategies. In several Part 3 chapters, the trades are shown in relation to all of the Greeks, assisting a trader to visualize the important connections between implied volatility and other pricing elements.

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