INAUGURAL ISSUE MARCH 2010 | Vol. 1 No.

MONTHLY
THE OPTION TRADERS JOURNAL

AMERICAN STOCK EXCHANGE

THE RISE AND FALL OF THE

A Sit-Down
with Author

Sheldon
Natenberg
Plus, Market Insight & Commentary
From Five of the Top
Option Trading Bloggers
INAUGURAL ISSUE

MONTHLY
TABLE OF CONTENTS
03 Editor’s Note
Bill Luby
THE OPTION TRADERS JOURNAL
04 Q&A
The Expiring Monthly Team
07 The New Option Trader
Mark Wolfinger
09 Predicting Stock Returns With Implied Volatility
Jared Woodard
11 Expiring Monthly Feature:
The Rise and Fall of The American Stock Exchange
Adam Warner
13 Market Maker Trading Tips:
Understanding Fake Deltas
Mark Sebastian
15 Charting The Market
Bill Luby
17 “The Monthly Option Report”
Adam Warner
18 Follow that Trade
Mark Wolfinger
24 The VIX ETNs: VXX and VXZ
Bill Luby
26 An Interview with Sheldon Natenberg
Mark Sebastian
29 Floor Stories
Adam Warner
30 Back Page
Jared Woodard

Published By: Editorial: Contact Information:

Luby, Sebastian,Warner, Woodard, Adam Warner Editorial Comments: [email protected]
and Wolfinger Publishing Bill Luby Advertising and Sales
Jared Woodard Expiring Monthly President
Mark Sebastian Mark Sebastian: [email protected]
Mark Wolfinger Phone (773) 661 6620
Notes
Editor's

Bill Luby

Welcome to the inaugural edition of Expiring Monthly: Mark Wolfinger begins an ongoing series for traders
The Option Traders Journal. who are new to options; Jared Woodard discusses
the relationship between implied volatility and stock
I am delighted to join four other top options returns; and I weigh in on VXX, the VIX futures
bloggers to collaborate on a new type of magazine: exchange-traded note.
one that focuses on options and brings to bear five
very different experiences with options, approaches As a group, the five contributing editors firmly believe
to trading strategies and ideas about the investment there are many ways to successfully trade options.
universe. We intend to unleash this five-headed In these pages, we hope to spoon feed some readers
monster every Monday following options expiration and challenge others. Better yet, we will do our best
to tackle a wide range of timely issues relating to to avoid trying too hard to be fair and balanced;
options. instead, we will speak out when we have strong
opinions. After all, options are ultimately all about
The goal of this magazine is to be an educational understanding probabilities and cutting corners when
resource for the novice to advanced investor, focus- it makes sense to do so.
ing primarily on equity options, but encompassing the
full range of subjects that are found in the same orbit. In future issues we will introduce features which
will create more interaction among the contributing
In this issue, Mark Sebastian talks with Sheldon editors and also engage readers more directly. We
Natenberg about how the options world is changing encourage readers to join us in this discussion and
and what lies ahead;Adam Warner chronicles the rise to send questions and comments to
and fall of the American Stock Exchange; [email protected].

INAUGURAL ISSUE
SUE
I N A U G U R A L I S Ma
MARCH 2010 | Vol. 1
No. 1

Have a good expiration cycle,

MONTHLY
Und stan
rket Make

M O N er
r Tradin

ding Fake D
g Tips

THLY elta s
TABLE OF CONTENTS
03 Editor’s Note

Bill Luby
Mark Seba
stian Bill Luby
04 Q&A
THE OPTION TRADERS JOURNAL

The Expiring Monthly Team

07 The New Option Trader

Contributing Editor
Mark Wolfinger
09 Predicting Stock Returns With
TRADERS JOURNAL Implied Volatility
THE OPTION Jared Woodard
11 Expiring Monthly Feature:
The Rise and Fall of The American Stock
Exchange

E
AMERICAN STOCK EXCHANG
OF THE Adam Warner
THE RISE AND FALL 13 Market Maker Trading Tips:
Understanding Fake Deltas
Mark Sebastian
15 Charting The Market
Bill Luby
17 “The Monthly Option Report”
Adam Warner
18 Follow that Trade
Mark Wolfinger
24 The VIX ETNs: VXX and VXZ
Bill Luby
26 An Interview with Sheldon Natenberg
Mark Sebastian
29 Floor Stories
A Sit-Down
with Author

Sheldon
Adam Warner
30 Back Page
Jared Woodard

Natenberg
Published By:
Luby, Sebastian,Warner, Woodard,
Editorial:
Adam Warner
Contact Information:
and Wolfinger Publishing Editorial Comments: editor@expiring

ntary
monthly.com

Plus, Market Insight & Comme

Bill Luby Advertising and Sales
Jared Woodard Expiring Monthly President
Mark Sebastian Mark Sebastian: [email protected]
From Five of the Top Mark Wolfinger Phone (773) 661 6620
s
Option Trading Blogger

03 | www.expiringmonthly.com
Traders have questions; the Ex-Monthly Team has answers.

perts
Ask the

The Expiring Monthly Team

Each issue, we select some insightful questions 3) FYI, the ‘original call writer’ is out of the picture.
sent by our readers and answer them here. If Once an option is traded, the buyer and seller are
you have a question about options, contact us not connected. When an option owner exercises,
at [email protected]. the person assigned that exercise notice is chosen
randomly. When you buy (to close) and no longer
have any position in that option, your obligations are
I am sure this is a simple one question, but it

canceled. You cannot be forced to sell shares.

confuses me. If I buy a call at 50 cents and the
following day the same call is trading at 60 cents,
can I sell that call for profit? In doing so, do I -Mark W.
become responsible to deliver shares if the buyer
exercises, or is that the responsibility of the
I have lost my faith in calendars as an alternative
original call writer? This really confuses me
to low probability condors or butterflies. I have
because one book I read makes it seem as though
not witnessed an occasion in which calendars
I am now obligated to honor that call should it
be exercised. I was under the impression that if I outperformed a butterfly.
buy a call and then sell it, the position is simply Regards,
closed. Michelangelo
Thanks for the help. Michelangelo,

In my opinion, there is definitely a time and place

NC

NC, for a calendar spread. They have been rough trading

It’s important that everyone understand the sub- over the last year as implied volatilities have been,
tleties of trading options, and this is a good question. until recently, on strong a downward trend. In an
environment with smooth upward moves in implied
1) Yes, you can sell the call at a profit, but do not volatility, calendars can do exceedingly well. The key
ignore commissions. They are often high enough to is timing, and understanding how calendars make and
turn trades such as the one in your example into a lose money. Calendars quickly make money for the
losing proposition. owner when:
2) Your original impression is correct. The only time 1) Implied volatility rallies across the board (this is
you are obligated to ‘deliver shares’ occurs when you less common, but the more widely understood
receive an exercise notice. The only time you are function of calendars).
eligible to receive such a notice occurs when you are
net short that option at the end of a trading day. For 2) The relationship between the front month and the
that to happen you must sell options without buying back month changes to the benefit of the owner. This
them back; or you must sell more options than you is actually more common because the front month is
own. You did neither. more sensitive to changes than the back month.

04 | www.expiringmonthly.com
Ask the perts
The Expiring Monthly Team

As for the second part of your question, calendars 2. If you’re looking at an iron condor with forty days
can certainly outperform butterflies. I have seen to expiration, it wouldn’t make sense to abandon that
calendars make 10% in one day. I have never seen trade just because you think that volatility might start
that in a butterfly. In those cases, typically, the to increase many months from now. If your opinions
relationship between the short option in the front about the economy, or volatility, or whatever else
month and the long option in the back month aren’t pertinent to the next forty days, then you
temporarily changes. The trader enters the trade shouldn’t rely on those opinions for constructing a
when the temporary change happens (typically front short-term trade.
month gets bid up too high), and exits when the
What matters is whether the price and volatility
relationship reverts back to normal. One common
profile of a trade matches with your own
misconception about calendars is that they are
expectations for price and volatility over the period
simple. Just because a trade is easy to execute does
covered by the trade. I certainly wouldn’t choose
not mean it is not complex. Calendars are actually
option spreads based on whether we’re in a “bull”
far more complex than butterflies, in my opinion.
or “bear” market – it makes much more sense to
For example, butterflies do not have term risk, while
base those decisions on specific views you have
calendars do.
about the underlying over the relevant time frame.
-Mark S.
-Jared W

If you think the economy is fundamentally

I've heard from several people that the VIX is too
weak and that we might be in for a double-dip
easily manipulated and can give false readings
recession, wouldn’t you want to avoid trades that
and that a person is better off tracking the VXO
are short volatility, like vertical spreads and iron
for a truer gauge. What are your thoughts?
condors? In other words, shouldn’t you select
spreads to match the general type of market? Martin

Anonymous Martin,

Not necessarily. It depends on the time frame of the In short, yes, it is easier to 'manipulate' the VIX and
trade you are examining. Here are two examples: because one can buy VIX futures and options (unlike
1. If you’re considering whether to sell a put vertical VXO), there is also more of an incentive to manipu-
spread on an equity index and the options have ten late the VIX. That being said, the correlation between
or twelve months until expiration, that position might the VIX and VXO is so high (over 99%) that the two
be a poor fit if you also expect the market to decline are – for all practical purposes – interchangeable.
around that time, since the short put vertical will
Perhaps more importantly, there is a very limited
suffer if prices decline and/or implied volatility
reason to attempt to manipulate the VIX on any
increases. But notice that what makes the trade a
other day than VIX expiration, so for 20 out of every
poor fit is its relation to your forecast for the time
21 trading days, I suspect no one bothers. On that
period under review, not some general rule pairing
21st day,VIX options expiration, it is expensive but
different spreads with market types.
possible to manipulate the VIX.

05 | www.expiringmonthly.com
Ask the perts
The Expiring Monthly Team

There was indeed one dramatic instance of VIX as the short leg? This short leg is expected to rise
manipulation back in October 2008. in IV as earnings approaches. Is the trader at

If you are looking for an indicator of market volatility,

risk of selling low IV and buying it back when

watch the VIX. It is what everyone else is watching.

higher? Will the back-month leg (which you're

If you want to trade a volatility index, the VIX is

long) have an insufficient rise in IV to offset

one of only four that have options and/or futures

what your short leg experiences because it's

associated with it and it is hundreds of times more

not an earnings month?

liquid than the others – so it is once again the only Anonymous

realistic choice.
Anonymous,
Finally, I believe that most of the people who use
It depends on the specifics. Don't forget that the
VXO are those who built trading systems around
market generally knows which cycles contain the
VIX signals before the VIX became the VXO in 2003
earnings, so if it's XOM which has earnings in
(when a new VIX calculation was introduced). You
February, the February options will already reflect a
can watch both, but you will quickly realize that the
higher volatility for the earnings.The options will be
incremental information from watching a second
bid up along with the volatility as earnings aproaches,
volatility index is practically zero – at least in my
but it's really not going to hurt the trader much, if at
opinion.
all. If possible, it is best to wait on a calendar until
-Bill L. closer to earnings, but for a different reason, as the
near month short option may not compensate you
If a trader wanted to use a calendar (either OTM enough for the risk between when you initiate the
to express directional skew or ATM to express a trade and earnings day. In other words, if XOM
range-bound view) for an earnings play, would moves between the trade date and the earnings date,
this strategy be less likely to work effectively that's where you might get a small hit as your short
because you are using the earnings-month option will not get the full benefit of time decay.

-Adam W.

OPTIONPIT.COM
Specializing in Trade Structure, Risk Management and Capital Efficiency

LAUNCHING Q2, 2010

For Information Call 866.637.1430

06 | www.expiringmonthly.com
Many new traders do not respect the dollars and cents of risk. This is why they should.

New Option Trader

The

Mark Wolfinger

Money. It’s always about the money. The purpose of made or lost large sums when trading options. When you
investing or trading is to grow your capital. There is no hear about the winners, it is easy to get carried away and
denying that the faster it grows the better. However, feel an urge to begin trading options today. I encourage
expectations must be realistic. you begin with an education, then ease into trading.
When you hear sob stories from the losers, you may hear
Most newcomers to the options world recognize that how the ‘options game is rigged’ and that ‘the market
Questions

there is much to learn and it is only natural to ask ques- makers cheated me.’ Those are the laments of people
tions in order to accelerate that learning process. I en- who made big mistakes. They took big chances (a polite
courage those questions, but the following questions term for gambling) with their money by trading options
suggest that a new trader is not facing reality: before making an effort to understand how options work.
The truth is that options were designed as risk-reducing
• I have $1,000. How long will it take to turn that investment tools, but that is not how they are perceived
into $50,000? by the majority of the investing public. Too many traders
• I read that it’s easy to earn 10% per month with use options to place wagers on whether the market or an
this or that strategy? Can you teach me how to use individual stock is going to move higher or lower over the
that strategy? short term. Human nature often sends people down the
wrong path. If gambling, or placing such wagers, makes
Simple arithmetic tells you that $1,000, growing at you happy, so be it. When trying to earn money when
10% per month, requires only 12 years and two using options, you will have a much better chance of
months to become one billion dollars (ignoring achieving success if you use options to hedge (reduce
taxes). Surely you know that’s not going to risk), rather than to place bets.
happen, and those who state otherwise are not
telling the truth.
The purpose of this column is to help you learn to use
The New Option Trader

• I read an advertisement where one guy made 92 options with less risk. You may ask,‘less risk, compared
consecutive winning trades. Can I expect to do with what?’ That is a good question. You can use options
the same? to have less risk than when you adopt a buy and hold
investing philosophy.
On the other hand, the options rookie who asks ques-
tions of the following type demonstrates an understanding Learning the option business is no different from learning
that trading options is not the path to instant riches: any other business. People want your money and some
use deceptive practices to take it, while others are out
• Is it possible to make money consistently when in the open, selling expensive lessons for introductory
trading options? option courses. Save your money. You can learn the
• Can you estimate how long it will be before my trading basics from a quality beginners book or by getting free
becomes profitable? instruction from the Chicago Board Options Exchange
(CBOE) or the Options Industry Council (OIC). And be
You may have read or heard claims by individuals who sure to ask questions.

07 | www.expiringmonthly.com
The New Option Trader
Mark Wolfinger

It is fun and satisfying to earn profits when trading. be earned. You must always be aware of the possibility of
But there’s another side of the story – and it cannot be losing money, the chances of losing money, and especially
ignored. It is widely circulated that more than 90% of how much money is at risk (the maximum possible loss).
new traders lose money. While I cannot confirm the
validity of this number, I wonder how many of these In other words, the winning trader understands the risk
traders give up vs. how many go on to become successful and reward potential for a given trade – and the probability
traders. I have never seen any study on that issue. One of success. Only then can a reasonable decision be made
thing is certain: becoming a successful trader takes much about whether to make the trade or to pass. Sadly, too
more than desire. If you have the necessary skills and few bother to pay any attention to the risk side of trading
the patience to learn, you have a chance to succeed. because potential rewards are often so attractive (lottery
No guarantees are offered. tickets, anyone?) that the risk of losing all or a significant
portion of the investment is ignored.

Because trading is all about the money, there is nothing Successful traders do not operate when wearing blinders.
Risk vs. reward

wrong with being concerned with potential profits. It is In this writer’s opinion, the key to success depends on how
important that you understand what you have to gain, well you respect your money – and that’s defined by how
not only with options, but with any investment. carefully you manage risk when trading.

However, it is more important to be aware that profits are To request a specific topic to appear in this column, send
not being given to anyone who asks for them. Profits must e-mail to: [email protected]

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08 | www.expiringmonthly.com
Implied volatility can tell us more than price action alone.

Implied Volatility
Predicting Stock Returns with

Jared Woodard

Options traders are smarter than you might think. One coefficients (higher is better) and
of the implications of a recent study in the Journal of Asset goodness-of-fit from the volatility
Management is that the lagged implied volatility in options measures evaluated. If we take these results as is, it seems
prices is a more accurate predictor of asset returns than that implied volatilities have substantially more predictive
the historical volatility of stock prices. Options traders – power than information gleaned from price action alone
or at least options markets – seem to have a better grasp as summarized in historical volatility calculations.
on likely future returns than can be had by looking at
recent price action alone.
One intuitive explanation of these results comes to mind:
An Earnings Explanation
In their recent paper,“Do implied volatilities predict stock earnings cycles. Since the options being tested are individ-
returns?” Ammann,Verhofen & Süss survey a database of ual equity options, they will reflect investor expectations
individual equity options for the U.S. stock market from for earnings results in advance of the actual announce-
January 1996 to December 2005 and analyze the relation- ment. In the days prior to an earnings announcement,
ships among implied volatility, historical volatility, and stock stock volatility will often decline significantly as traders
returns. Their primary observation is that there is a adopt a wait-and-see approach, while implied volatility
“significant, highly positive relation between returns and over the same period will often rise considerably as
lagged implied volatilities.” On average, they find that an
sentiment about likely short-term moves is reflected in
1% increase in 3-month (91 calendar day) at-the-money
(ATM) call implied volatility in the lagged month leads to options prices. If, for example, Apple, Inc. beats earnings

91d IV 2.021
60d IV 1.734
30d IV 1.902
91d HV 0.337
60d HV 0.263
30d HV 0.506
>

R 2 0.008 0.008 0.0075 0.0085 0.0078 0.0062

an increase in returns of about 2% in the following month. estimates for a given quarter and the stock rises 5% over
In other words, a stock whose implied volatility rose last the next week or two, backward-looking comparisons will
month can be expected to show a higher return this certainly treat elevated implied volatility as more “telling”
month.This effect was much stronger for small capitaliza- than flat historical volatility.
tion stocks versus than those with high capitalizations;
the effect was about the same for growth and value This explanation, if true, would not actually diminish the
stocks.The authors also conclude that “implied volatility importance of the results above: a lift in implied volatility
carries some information beyond that implied by CAPM could just as easily have been found to coincide with
and the Carhart four-factor model.” lower average future returns.This earnings and news-
based interpretation of the results does not explain much.
What about historical volatility – surely recent price If it did, we should see the shorter-term implied volatility
behavior already reflects much of the same information? reading anticipate significantly better results than its
In fact, tested against historical volatilities of 30, 60, and 91
longer-dated counterparts. But notice that in the table
days, lagged ATM call option implied volatilities with the
same durations all proved more informative.The table above, returns following an increase in 30 day IV are no
below, constructed from data in the paper, shows the better than those following 60 and 91-day readings.

09 | www.expiringmonthly.com
Predicting Stock Returns with
Jared Woodard
Implied Volatility
Excluding Put Skew the stock due to simple short-term mean reversion. But the
The most interesting aspect of this research, to me, is fact that the authors studied ATM call implied volatility alone
something the authors do not discuss at all.The fact that excludes this (or any) explanation based on vertical skew.
they are only using price data from call options, instead of Two Implications
both puts and calls, precludes the most likely explanation for Covered call strategies are often critiqued for offering too
the observed relationship between implied volatility and little in the way of downside protection, and rightly so. But if
future returns: elevated put skew. Recall that there are two this research is correct, traders might also want to recon-
types of implied volatility skew: vertical and horizontal. sider selling calls against long stock if the call implied volatil-
Horizontal or calendar skew occurs when options in one ity has been rising: the premium received might not be
month reflect a different implied volatility than options with worth the opportunity cost of missing out on a stock with
the same strike in another month.Vertical skew occurs increased potential to run.
when put and call options in the same month reflect
different implied volatilities. Secondly, this study is neutral-to-positive for traders who
tend to be net short gamma at the index level and net long
Because equity investors tend overwhelmingly to be long gamma at the equity level. It may be counter-intuitive to buy
stock, in times of uncertainty they turn to put options for calls or straddles in names whose implied volatility has al-
protection.This increased demand for put options is ready been increasing, but hedging those equity positions
reflected in the prices of those options, so it is common to with long theta/short gamma index trades can help smooth
see the implied volatility for out-of-the-money (OTM) put returns.
options consistently higher than that of equidistant OTM
calls in the same expiration cycle. Given the conclusions Out-of-sample results were not as strong as those for the
of this research, it is tempting to think that the observed historical period tested, so the conclusions of this research
phenomenon is simply due to the presence of put skew – are not as compelling as they might have been. Even so, the
that is, as stock declines, increased put implied volatility contrarian bias with which many traders approach implied
might normally be expected to anticipate positive returns in volatility may be less warranted when it comes to options
on individual stocks.

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10 | www.expiringmonthly.com
For many years, the American Stock Exchange roared like a lion; since the new millennium, that roar has been quieted

MONTHLY FEATURE
The Rise and Fall of the American Stock Exchange
Adam Warner

them. I'm a kid and just starting out, it's a boatload of

money. Wtf was I thinking? But as you might remember,
Danny Manning played like the future superstar he'd have
been without all the injuries, Kansas won, and I learned
two valuable lessons. One was, don't gamble.The other
was, is there a better place in the world to work? I
doubt it.

Everyone always got the impression back then that all

exchanges resembled the orange juice pits in Trading
Places. Not quite. You had your occasional days with the
trading like that, but by and large it was a pretty collegial
So it's March 1988 and everyone on the floor has NCAA atmosphere. You stood in a trading crowd in front of a
Fever! March Madness is upon us. But it's the AMEX and specialist and took the other side of the public order flow.
we here scoff at your mere "brackets." No, we're traders. Another myth was that you were in violent competition
Instead of picking teams on a sheet of paper, we're going with the other traders in your crowd. Not so much. You
to buy and sell them. Here's how it works. Let's say I buy became kind of a club. You tended to work together and
1 Connecticut from you for $20. If Connecticut wins, you share and did not outbid or out offer each other, or the
owe me $400 less what I paid you, or $380. If Connecti- specialist. Your real competition was not on your floor, it
cut loses, I owe you the $20, payable the next business was the Evil Upstairs Trader. He saw every order before it
day in cash. Why $400? I’m not sure; no one thought it hit the floor. He could hedge. When the time was right
out that well I guess. But hey, who am I to argue. I'm a and the order finally hit the floor, the executing broker
scrawny 22-year-old just starting out in the business; I'm would do his best to protect the interests of the upstairs
happy to do anything to fit in. And at the time I loved trader. He would attempt to "cross" the trade and shut
college hoops. you out as best he could. If you, the crowd and specialist,
wanted to participate, you pretty much had to work as
This whole "market" started out with a few guys in the one. It was just business.
Phillip Morris crowd, one of the busier spots on the floor
at the time. Little did they know what they begat. By And by and large, the business worked. On one hand, you
that afternoon, trading in NCAA tournament teams had were a sitting duck. Many was a time that Goldman or
morphed into a crowd rivaling a busy futures pit in both Morgan would dump 1000 calls of something in your face.
size and noise level. Guys were literally getting off floor You had to short stock against it, but you can't get a plus
orders phoned in. And it was 1988, so it was not as if tick because everything still traded in eighths. When you
someone could go hit up Bodog for actual odds (though finally shorted your stock, you simply owned options
I'm sure guys had bookies on the line). I had my plan. gamma in a stock that magically never moved again.
The markets were not efficient. Obviously only one team
could win, while the others would all expire worthless. But the flip side was you got to do everything at your
And if you mentally summed up the price of the prime price. Busy options products today might have bid/ask
teams, they added up to over $400. So I sold a bunch, took spreads of a five cents or less. Bid/ask spreads in the 80s
in the $400 and basically had the "field" for free. I didn’t into the mid to late 90s were often as high as 1/4 or 3/8.
even need to win. My plan was that I would just ultimately Buy enough times on your bid and short enough on your
sell my "field" teams as the tournament goes on and offer and the clunkers would work out. My big theory
pocket way more than $400. Except it didn’t really work. on making money back then? Don't lose money. I'm
I'm short Oklahoma and they keep winning, so they keep totally serious. You had enough edge on the good trades,
ramping in price. I hate the odds at every juncture. especially the smaller ones, that if you could just defend
Finally we're at the end: it's Oklahoma vs. Kansas. I have the "pick-offs" well enough, you'd do fine.
no Kansas position, so I now have a de facto $400 bet on

11 | www.expiringmonthly.com
Monthly Feature
Adam Warner
The Rise and Fall of the American Stock Exchange
Another positive had to do with my timing. I started in instant execution.
1988 and the first few years were relatively lean. Volume The CBOE followed the ISE first into instant execution
was kind of light coming out of the crash, but you didn't and later into a hybrid structure where traders could still
get picked off quite as much then either, so business was congregate in a physical crowd at the same time as they
OK. But if you hung in there to the mid-90's, you were in could make markets from a remote location. The AMEX?
for a treat. Order flow tended to give you long volatility Not so much. One thing I discovered when I left the floor
positions as the "public" mostly sold you calls. But along in 2001 and began trading as a customer was that their fills
about 1995 or so, options volatility started to climb. Then were the slowest, even if you hit a bid or took an offer. In
you got to execute trades on your bids and offers more fact, that bid or offer you attempted to trade with may have
often than not AND you got left with winning positions. disappeared while an order was en route. The AMEX even-
Stocks and volatility rallied in unison. tually caught up to the other exchanges, but it was too little,
too late. Once a customer changes his or her trading habits
Like Greece and ancient Rome and the Chicago Bulls away from an exchange, it is notoriously tough to get that
dynasty of the 1990s, all things must come to end. So did customer back.
the physical options exchange as we knew it. Oh sure,
they all still exist in name, but it's a virtual shadow of a The AMEX’s "demise" only exists from certain perspectives.
bygone era. Volume on the exchange as measured in absolute terms has
done fine as a rising volume tide has lifted all boats. A total
A little over a decade ago, the AMEX was the 2nd busiest of of 3.6 billion options contracts changed hands across all
the four options marts in terms of volume, ranking below exchanges in 2009, compared to 507 million in 1999. That
the CBOE but ahead of the PHLX and the P-Coast. We can is roughly a 7-fold increase in a decade. But the AMEX now
blame automation, dual-listing, increased competition, et al. has a reduced share of a much larger pie In 1999, the
for the fact that today's AMEX is now essentially a quiet AMEX ranked 2nd in market share, with 25.53%. It actually
room on the NYSE. But more than a small part of the increased that number to over 26% in 2001, despite the
demise the exchange begat upon themselves. There were introduction of the ISE. In 2009, the AMEX ranked 5th in
proposed mergers that never happened (with the Philadel- volume market share with 6.87%, trailing the CBOE
phia Exchange and the P-Coast), there was a brief and (31.41%), the ISE (26.58%), the PHLX (16.79%) and the
ill-fated merger that did happen (with the NASDAQ) and NYSE (11.66%).
there was just a general inability to keep up with the pace
of innovation around the street. PERCENT OF AMEX TOTAL OPTIONS MARKET

If one asks others in the options business at the time to

30.00%

explain what happened to the AMEX, they will typically say

the culprit was our markets. Apparently we were called the
25.00%

"Scamex" around the street. Because? Well, I’m not sure 20.00%

we did anything worse than any other exchange. Believe it

or not, we had to honor the markets on our screens just 15.00%

like everyone else. If one must blame something for the

perceived poor markets, blame the pace of innovation, or
10.00%

lack thereof. The year 2000 saw the entry of the Interna-
tional Stock Exchange (ISE) into the business, followed in
5.00%

2004 by the Boston Options Exchange. What set these two

apart was that they took the same specialist (or Designated
0.00%

Market Maker) structure of the existing exchanges and

2000 2001 2002 2003 2004 2005 2006 2007 2008 2008

applied it to a "virtual" floor, where the "crowd" exists only

in cyberspace. The result was remote market making with

12 | www.expiringmonthly.com
Why delta isn’t always what it seems.

Understanding Fake Deltas

Market Maker Trading Tips

Mark Sebastian

In late December 2002 one of the stocks I was trading Options that have fake
was Home Depot (HD). Loews was just starting to really deltas typically have a few
dig into the company’s market share and for the first time things in common. They are out of the money, they have
they warned on profit. On Friday January 3rd, 2003, HD a long time to expiration and they are cheap. The typical
hit one of its all time lows and dropped 3.50, trading down action of an option with fake deltas is that the underlying
to about 21.32. This is when I learned one of my best will move in the direction that is favorable to the option,
lessons as a floor trader. I learned about how pricing according to its delta. But, the option gains little or no
models will break down and a position will have fake value, certainly less than what its delta predicts. In the
deltas. Here is what happened: case of the HD trade, I should have known that if the
stock didn’t rally quickly, my short stock was going to be
A customer was long several thousand February 27.5 calls. a loser – and it was.
The broker wanted to sell several thousand calls at 0.10.
I could buy as many or as few as I wanted. I thought to While hedging with stock is something only traders with
myself, “I'll take a shot!” I bought a 100 of them. The deep pockets do, the average trader can apply the concept
calls had a delta of 8 causing me to sell 800 shares of HD of fake deltas to his or her trading. If traders avoid fake
stock at around 21.35 against the position (I do not deltas when trading credit spreads, butterflies, or condors,
remember the actual fill price). My thinking was that if the trader will have far more predictable outcomes from
the stock rallied a little I could sell them at a profit. If it his or her positions. Here is an example of how simple
didn’t rally I was only out $1,000. Over the next two applying this concept can be:
weeks Home Depot rallied over 1.00. At this point most
novices would think that would be good for this position, Suppose on January 15th I want to sell 10 WMT call
but it wasn’t. My calls that I had bought for 0.10 were still spreads. With WMT trading 53.65 I can sell the February
worth 0.10. However, the 800 shares of stock I sold for 55 calls which have a 36 delta for 0.75. If I set up the
around 21.35 were now worth somewhere near 22.50. trade as a 5 point spread I would buy the February 60
I had actually LOST almost $1,000 on some cheap calls. They are trading 0.08 and have a 4 delta. If WMT
calls….AND THE STOCK WENT UP! I had been fooled rallies 1.00 over the next week, the model predicts that I
by “fake deltas”. would lose $280 from my deltas. My bet would be that I
will actually lose well over $300.

13 | www.expiringmonthly.com
Market Maker Trading Tips
Mark Sebastian
Understanding Fake Deltas
What if I set the trade up as a 2.5 point vertical instead? point vertical. However, many traders do not actually
I can buy the 57.5 calls that have a delta of 13 for 0.21. think about this when they are trading. Many retail
That is only 0.13 more than the 60 calls, yet my bet is that traders (and even professional traders) robotically trade 5
the credit spread will act far more predictably. If the stock point verticals every month, or set up a butterfly or
rallies 1.00 over the next week the model predicts that I will condor with wings at a specific width. Understanding fake
lose $230. I believe that is probably pretty close to accurate. deltas and using this knowledge BEFORE entering into

Comparing the two, for an extra $130 I have a position that trade and when evaluating position risk can help a trader
has a more predictable price action and has $2500 less risk. reduce risk, reduce the cost of a trade, and increase
As presented above, most traders would quickly conclude predictability of profit.
that the 2.5 point vertical is a smarter trade than the 5

[email protected] • 330.836.1600 ASK FOR TODD!

14 | www.expiringmonthly.com
Charting the Market
Options Graphics and Data

Bill Luby

Each month in this space, Expiring Monthly intends to now well below 30-day IV for the S&P 500 Index.
present a handful of graphics and data sets that will On the other hand, stocks have continued to trend
illuminate some of what is happening in the options world. upward, short straddles on the SPX and most other
Some of these are intended as regular features and others indices have lost money in the past month, as directional
are meant to shed light on developments which are movement has overwhelmed time decay.
specific the most recent month. For this reason, we
encourage reader feedback and suggestions. Both the CBOE Volatility Index (VIX) and recent equity
put to call activity on the CBOE indicate that options
For last Friday’s quadruple witching, we note active trading investors are aggressively bullish and more than a little
volumes in the financial and technology sectors, while the complacent.
stocks with the highest implied volatility (and prices of at
least 5.00) were overweight in technology, biotechnology Looking ahead to earnings options plays, one to keep an
and China. eye on is Oracle (ORCL), where several strong recent
earnings reports have generally favored the bulls. Oracle
The last month has seen several measures of historical is schedule to report earnings after the market closes on
volatility plummet to multi-year lows, with 20-day HV Thursday, March 25.

EXPIRING MONTHLY: OPTION DATA HIGHLIGHTS

MOST ACTIVE OPTIONS (3/19/10) OPTIONS WITH HIGHEST IV (3/19/10)
RANK UNDERLYING CLOSE OPT VOL (1000S) RANK UNDERLYING CLOSE(>5) IV
1 SPY 115.90 1,384 1 VHC 6.02 119.73
2 C 3.91 962 2 SMOD 6.67 110.06
3 IWM 67.28 691 3 CONN 6.15 108.83
4 QQQQ 47.47 476 4 MDCO 9.30 103.74
5 BAC 16.77 377 5 MNKD 7.50 102.75
6 F 13.31 319 6 MNTA 13.99 96.09
7 GLD 108.30 299 7 CAGC 27.00 93.93
8 EEM 41.23 267 8 RINO 23.12 91.74
9 PALM 3.97 252 9 SQNM 5.67 88.46
10 AAPL 221.75 171 10 WNC 7.65 85.63
11 XLF 15.66 156 11 SIGA 7.18 84.16
12 INTC 21.94 147 12 FUQI 11.92 83.37
13 PFE 16.92 125 13 XNPT 9.06 80.73
14 GE 17.99 123 14 PUDA 9.82 80.34
15 GOOG 559.89 115 15 ICXT 7.45 79.80
16 RIMM 73.20 112 16 IRE 6.99 77.86
17 EWZ 71.26 105 17 LDK 6.72 76.71
18 UNG 7.53 101 18 JAZZ 12.65 76.38
19 CHK 24.20 98 19 TLB 11.65 76.24
20 DIA 197.33 98 20 DNDN 36.16 75.40
21 QCOM 39.69 91 21 CLDA 21.34 75.38
22 FAS 92.00 85 22 OPTT 6.84 75.17
23 BBY 40.81 81 23 HEAT 12.03 74.36
24 MSFT 29.58 80 24 EDZ 44.97 74.30

15 | www.expiringmonthly.com
 Options Graphics and Data
Bill Luby
Charting the Market

PROFIT & LOSS FOR AN ATM SPX STRADDLE

SOLD AT THE OPEN ON FEBRUARY 22,2010
$200

$0

-$200
COMPARISON OF SPX 30-DAYLMPIED VOLATILITY AND
SPX 20-DAY HISTORICAL VOLATILITY (3 MONTHS)
-$400

-$600
P
-$800

-$1,00

-$1,200

-$1,400

-$1,800 2

-$2,000

-$2,200
FEB22 25 28 MAR3 6 9 12 15 18
10

C
2

CBOE OPTIONS EQUITY PUT CALL RATIO (3 MONTHS)

25$CPCE (CBOE OPTIONS EQUITY PUT/CALL RATION) INDX
19 MARK-2010 • $CPCE (DAILY) 0,610
• EMA (10) 0.545 • $VIX (DAILY) 16.97 • $SPX (DAILY) 1159.90 OPEN 0.610 HIGH 0.610 LOW 0.610 CLOSE 0.610 CHG +0.080 (+15.09%)
0.700
27.0
0.690
26.5
26.0 0.680

25.5 0.670
25.0
0.660 PRICE, STRADDLE AND IV HISTORY FOR RECENT ORACLE
24.5
0.650
24.0 (ORCL)EARNINGS REPORTING PERIODS
23.5 0.640
23.0 0.630
22.5
0.620
22.0
0.610
21.5
21.0 0.600
20.5 0.590
20.0
0.580
19.5
19.0 0.570

18.5 0.560
18.0 0.550
17.5
0.540
17.0
0.530
21 28 2010 11 19 25 FEB 8 16 22 MAR 8 15

16 | www.expiringmonthly.com
What does a low VIX really mean?

Monthly Option Report

The

Adam Warner

If I had a dime for every time some pundit or some stock What am I trying to say here? Well, run, don't walk, from
"tweeter" declared the VIX "cheap" I'd...well, I'd certainly anyone that looks at some absolute VIX on the board and
be able to buy many cheap options. declares it cheap as he likely knows not of what he speaks.
Different markets have different pulses. The VIX is only
The VIX attempts to be a proxy for the volatility for SPX “cheap” if SPX option implied volatility underprices real-
options. It averages about 20 over the course of time and ized volatility going forward. There is no way to know
that level looks like a magnet so far in 2010. But that says realized volatility going forward, so the best predictor is
literally nothing about cheap. We can only measure the realized volatility going backward. Unless the VIX is at or
"value" of VIX in relation to the volatility of the SPX itself. below that realized volatility, it's not accurate to call it
cheap.
How volatile is SPX? Not very. We see blips of action
here and there, but at the end of day, it's gone nowhere. Want an easy way to "snapshot" realized volatility? Take
Since June of 2009, the 10-day historical volatility of SPX the range of a given day in percentage terms and multiply
has spent the lion's share of the time fluctuating up and it by 16 (that's approximately the square root of 252, the
back between 10 and 20. That suggests 15 or so is a fair number of trading days in a year.) Thus, if SPX moved 0.5%
estimate for SPX index volatility. The VIX incorporates on a given trading day, multiply that by 16 and that day
OTM puts into its equation and given the natural skew in suggests that implied volatility is an 8. If a trader sees a
SPX options, those puts tend to trade at a higher volatility bunch of days like that, an 18 VIX won't seem so cheap.
than ATM options. Thus,“fair” VIX is about 3 points above
SPX volatility. That would put "fair" VIX roughly 18.
VOLTY VOLTY

In the past 9 months, the VIX has only gone below 18

S&P 500 INDEX CHART
SYMBOL: SPX DVO 695.6K SV[21] IV[27]
30% 30%

once, in mid-January. By the above definition, that was 28% 28%

the only time "cheap" aptly described it. But in reality,

even then the “cheap” label did not apply, because while
26% 26%

volatility is mean reverting, that mean is never static. The

24% 24%

10-day realized volatility in SPX from early to December

22% 22%

to the middle of January fluctuated between 10 and 12.5.

20% 20%

Even if a trader believes the VIX is entitled to an even

18% 18%

greater premium, it still suggests maybe a VIX of 16 is fair.

16% 16%

14% 14%

Of course that dip in both realized and implied volatility

12% 12%

preceded the rather swift and large January volatility

10% 10%
IMPLIED VOLTY

pop. Option sellers at those levels got smoked, but that

8% 8%
STATISTICAL VOLTY

is easier to see in hindsight than it was at the time of

6% 6%
A S O N D J F M
2009 2010

those sales.

17 | www.expiringmonthly.com
Putting the theory into practice (?)

That Trade
Follow

Mark Wolfinger

This month’s trade is an iron condor executed by The position: 10 RUT Feb 510/520P; 670/680C iron condors,
Mark D.Wolfinger Maximum profit: $2,650.
This occurs at expiration if RUT >520 and <670
Trade date: Thursday Dec 10, 2009; 70 days before
expiration. RUT (Russell 2000 Index) is at 597.22. Maximum loss: $7,350.
This occurs at expiration if RUT <510 or >680
The trade:
Buy 10 RUT Mar 510 puts
Sell 10 RUT Mar 520 puts Risk profile (figure 1).
Sell 10 RUT Mar 670 calls The black line shows profit and loss (scale at left), if RUT
Buy 10 RUT Mar 680 calls moves to the price (scale at bottom) today. NOTE:
net credit (cash collected); $2.65 per iron condor Real world conditions affect option prices. Thus, graph
Authors note: Commissions and other fees are ignored represents an estimate.

POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE EXPO VAR DELTA GAM VEGA THETA
ALL UNDERLYING -4,048 -7 -1 -156 28 -4,048 -7 -1 -156 28
RUT <CBEO> -4,048 -7 -1 -156 28 -4,048 -7 -1 -156 28
2010-02-18 -4,048 -7 -1 -156 28 -4,048 -7 -1 -156 28
RUT FEB 18 '10 500.00 PUT OPTION RUWNZ 6.60 0 0 0 0 0 6.65 0 0 0 0 0
RUT FEB 18 '10 510.00 PUT OPTION RUWNB 10 7.70 -88,237 -148 2 602 -157 10 7.85 -88,237 -148 2 602 -157
RUT FEB 18 '10 520.00 PUT OPTION RUWND -10 8.10 102.773 172 -3 -665 169 -10 9.25 102,773 172 -3 -645 169
RUT FEB 18 '10 530.00 PUT OPTION RUWNF 10.90 0 0 0 0 0 10.95 0 0 0 0 0
RUT FEB 18 '10 650.00 PUT OPTION RUYBJ 8.10 0 0 0 0 0 7.95 0 0 0 0 0
RUT FEB 18 '10 660.00 PUT OPTION RUYBL 6.00 0 0 0 0 0 5.90 0 0 0 0 0
RUT FEB 18 '10 670.00 PUT OPTION RUYBN -10 4.50 -84,929 -142 -4 -587 101 -10 4.35 -84,929 -142 -4 -587 101
RUT FEB 18 '10 680.00 PUT OPTION RUYBP 10 3.30 66,345 111 -3 494 -85 -10 3.20 66,345 111 -3 484 -85

RUT 510/520: 670/680IC. CREDIT $2.65

TRADE DATE 12/10/2009. RUT 597.22 RVX 29.74
PUT: 17.2 DELTA: CALL 14.2 DELTA
X10 3 TOTAL

0.0

-0.5

-1.0
PORTFOLIO VALUE CHANGE

-1.5

-2.0

-2.5

-3.0

-3.5

-4.0

-4.5

-5.0
4.7 4.8 4.9 5.0 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 6.0 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 7.0 7.1 7.2
UNDERLYING PRICE

FIGURE 1
DELTA GAM VEGA THET
-7 -1 -156 28
GREEKS FIG 1
NOTE:These graphs represent risk on the day the graph is drawn. Profits earned to date are ignored. Thus, all up and down moves for RUT
show that the position loses money. Cash earned prior to today has no effect on potential losses when considering what the future holds.

18 | www.expiringmonthly.com
Follow
Mark Wolfinger
That Trade
Rationale for trade:

If RUT remains within the boundaries set by the strike position becomes too uncomfortable (risky) to hold. If
prices (520 and 670), the options slowly erode and their that happens, preventive action (‘making an adjustment’)
prices move towards zero. At an appropriate time – to be will be taken.
determined – the plan is to close the position for a sub-
stantial profit ($2,650 less cost to exit). However, getting NOTE: RVX is the CBOE Russell 2000 Volatility Index
the timing right for exiting the position is often a difficult
task. As indicated in the graph, a substantial change in the
price of RUT wreaks havoc with those plans. Thursday, December 24, 2010 (56 days until expiration).
Update after 14 days:

The delta of the options sold are 17.2 and 14.2 (see figure RUT is higher, in a seemingly never-ending rally. It is
1).Thus, the probability is > 31% (sum of deltas) that one mid-morning and RUT is currently at 632. Figure 2
of these options expires in the money (ITM). There is represents a ‘real time’ snapshot of the iron condor
more to worry about than expiration. For instance, at any position. Risk has not increased sufficiently to warrant
time prior to expiration there is a possibility that the an early adjustment.

PORTFOLIO
THE GREEKS TOTALS MARKET SCENARIO (LIVE UPDATE) CUSTOM SCENARIO (LIVE UPDATE)
POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE EXPO VAR DELTA GAM VEGA THETA
ALL UNDERLYING -32,057 -51 -1 -161 36 -32,057 -51 -1 -161 3
RUT <CBEO> -32,057 -51 -1 -161 36 -32,057 -51 -1 -161 3
2010-02-18 -32,057 -51 -1 -161 36 -32,057 -51 -1 -161 3
RUT FEB 18 '10 510.0 PUT OPTION 10 2.45 -36,240 -57 1 285 -91 10 2.32 -36,240 -57 12 285 -9
RUT FEB 18 '10 520.0 PUT OPTION -10 2.70 43,189 68 -2 -326 101 -10 2.75 43,189 68 -3 -326 10
RUT FEB 18 '10 670.0 CALL OPTION -10 7.20 -157,0.. -248 -6 -784 145 -10 7.30 -157,0.. -248 -6 -784 14
RUT FEB 18 '10 680.0 CALL OPTION 10 4.90 38,027 187 5 665 -120 10 4.92 118,027 187 5 665 -12

PORTFOLIO RELATIVE P&L

PUTS: $0.25 CALLS $2.30 RUT <CBOE>
TOTAL
2000
1500
$1,000 LOSS
1000
5000
0
-500
PORTFOLIO VALUE CHANGE

-1000
-1500
-2000
-2500
-3000
-3500
-4000
-4500
-5000
-5500
-6000
-6500
-7000
500 510 520 530 540 550 560 570 580 590 600 610 620 630 640 650 660 670 680 690 700 710 720 730 740 750 760
UNDERLYING PRICE

DELTA GAM VEGA THET

FIGURE 2
-51 -1 -161 36

19 | www.expiringmonthly.com
Follow That Trade
Mark Wolfinger

If a trader eliminates risk by closing the 10 call spreads,

There are several points of interest: IMPORTANT NOTE:

1. Delta.The 670 call’s delta is 24.8. For conservative the trader should not ignore the put spreads. Many
traders, this may be a danger point. For others, it’s merely traders would hold the put position, hoping to earn a
a yawn. Current position delta is -51: I expect to lose small profit (from today’s price) to partially offset the loss
more than $500 if RUT rallies another 10 points. Delta on the call portion of the iron condor. That is generally
is not large enough to cause concern. Gamma (rate of not recommended. The put spread offers little profit
change of delta when RUT moves one point) is -1, potential and can result in a large loss. Experienced
confirming that the position is not in trouble. traders generally would not take that chance. When the
trader closes the calls, the savvy trader closes the puts.
2.The position shows a small profit (see graph for prices)
Making risk-reducing trades is often more profitable than
3.The true market for the put spread is $0.20 bid and exiting the position. The easiest adjustment is to reduce
$0.55 offered. The market for the call spread is a wide position size by closing one, two, or three call spreads.
$2.00 to $2.60. I am confident I could buy (to close) If a trader buys only a few call spreads, it is not necessary
this spread for $2.40. to buy the put spreads. For traders who prefer to reduce
size, I recommend buying two of the RUT 670/680 call
4. Figure 3 indicates a $1,000 loss from today’s prices if spreads for $2.90.
RUT moves to 650. A move of that magnitude would
represent another 18 points, or 3%. The rate at which I prefer to do nothing right now, but if RUT moves near
RUT has been moving higher provides no confidence that 645, then I will act. However, this Expiring Monthly
650 is out of reach. A nervous investor should seriously feature is meant to be educational as well as informative.
consider making a small adjustment (perhaps buying back I consider adjusting at this time to be a borderline
one or two of the call spreads) at this time. If the position decision. I am opting for the less risky approach. There
makes you nervous, it is not a good idea to do nothing. are many trades available, and I am selecting a method
The conclusion to hold without reducing risk is based on that works well (for me) under similar conditions.
my comfort zone.
Adjustment trade: Buy one call with a useful strike price
Decision: No adjustment needed. (it is ITM if RUT rallies and threatens the 670 calls). To
offset part of the cost, I sell an additional out of the
money (OTM) call spread. With the addition of one long
January 5, 2010 (44 days until expiration) call to the position, much of the upside risk disappears.
Update after 26 days:

A significant profit is possible if the rally is strong enough

Yesterday RUT rose more than 14 points to 640. The (figure 4).
Feb 670 calls are now 30 points (less than 5%) out of the
money; the delta is approaching 30. Conservative traders The RUT has advanced to 640.70; this is the risk graph
would already have adjusted their positions. At this stage, (figure 3):
some investors may elect to take a small loss by paying
less than $3.00 to exit the trade. (Remember, we
collected $2.65).

20 | www.expiringmonthly.com
Follow
Mark Wolfinger
That Trade
The RUT has advanced to 640.70; this is the risk graph (figure 3):

MARKET SCENARIO (LIVE UPDATE) CUSTOM SCENARIO (LIVE UPDATE)

POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE EXPO VAR DELTA GAM VEGA THETA
ALL UNDERLYING -40,835 -64 -1 -141 42 -40,835 -64 -1 -141 42
RUT <CBEO> -40,834 -64 -1 -141 42 -40,834 -64 -1 -141 42
2010-02-18 -40,834 -64 -1 -141 42 -40,834 -64 -1 -141 42
RUT FEB 18 '10 510.0 PUT OPTION 10 1.65 -25,992 -41 1 194 -85 10 1.50 -25,992 -41 1 194 -85
RUT FEB 18 '10 520.0 PUT OPTION -10 1.95 -31,228 49 -1 -225 95 -10 1.78 -31,228 49 -1 -225 95
RUT FEB 18 '10 670.0 CALL OPTION -10 7.70 -180,939 -282 -7 -753 183 -10 8.03 -180,939 -282 -7 -753 183
RUT FEB 18 '10 680.0 CALL OPTION 10 5.40 -134,869 211 6 643 -151 10 5.29 -134,869 211 6 643 -151

PORTFOLIO RELATIVE P&L

RUT 640.70; JAN 5, 2010 RUT <CBOE>
TOTAL
2000
1500
1000
5000
0
-500
PORTFOLIO VALUE CHANGE

-1000
-1500
-2000
-2500
-3000
-3500
-4000
-4500
-5000
-5500
-6000
-6500
-7000
500 510 520 530 540 550 560 570 580 590 600 610 620 630 640 650 660 670 680 690 700 710 720 730 740 750 760 770 780

Notice that the potential loss is ~

UNDERLYING PRICE

$4,300 if RUT moves to 700.

DELTA GAM VEGA THET
FIGURE 3
-64 -1 -141 42

Adjustment trade:

Buy one Feb 650 call; sell three Feb 670/680C spreads; cost $785.

Figure 4 shows the same position after the adjustment. The potential loss at RUT 700 is now ~ $1,800.

21 | www.expiringmonthly.com
Follow
Mark Wolfinger
That Trade

MARKET SCENARIO (LIVE UPDATE) CUSTOM SCENARIO (LIVE UPDATE)

POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE EXPO VAR DELTA GAM VEGA THETA
ALL UNDERLYING -25,882 -40 -1 -84 28 -25,882 -40 -1 -84
RUT <CBEO> -25,882 -40 -1 -84 28 -25,882 -40 -1 -84
2010-02-18 -25,882 -40 -1 -84 28 -25,882 -40 -1 -84
RUT FEB 18 '10 510.0 PUT OPTION 10 1.60 -25,835 -40 1 193 -85 10 1.48 -25,835 -40 1 193
RUT FEB 18 '10 520.0 PUT OPTION -10 1.90 -30,982 -48 -1 -224 94 -10 1.76 30,982 48 -1 -224
RUT FEB 18 '10 650.0 CALL OPTION 1 15.50 -28,059 -44 1 88 -23 1 15.84 28,059 44 1 88
RUT FEB 18 '10 670.0 CALL OPTION -13 7.55 -234,229 -366 -9 -977 238 -13 8.00 -234,229 -366 -9 -977
RUT FEB 18 '10 680.0 CALL OPTION 13 5.00 -175,140 273 8 835 -197 13 5.31 175,140 273 8 835

PORTFOLIO RELATIVE P&L

ADD; BUY 1 FEB 550C; SELL 3 ADDITIONAL FEB 670/680C SPREADS RUT <CBOE>
TOTAL
1,750
1500
1250
1000
750
PORTFOLIO VALUE CHANGE

500
250
0
-250
-500
-750
-1000
-1250
-1500
-1750
-2000
-2250
-2500
500 510 520 530 540 550 560 570 580 590 600 610 620 630 640 650 660 670 680 690 700 710 720 730 740 750 760 770 780
UNDERLYING PRICE

DELTA GAM VEGA THET

FIGURE 4
-40 -1 -84 28

Short delta was reduced from -64 to -40 thus improving the risk profile. The additional $785 of funds is a considerable
price to invest in this position. For less cash, the trader may consider buying back two of the 670/680 call spreads.

Update: January 15, 2010 (34 days until expiration) • Update after 40 days: January 19, 2010 (30 days until expiration)

FIGURE 5
POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE
ALL UNDERLYING -31,935 -50 -1 -122 41
RUT <CBEO> -31,935 -50 -1 -122 41
2010-02-18 -31,935 -50 -1 -122 41
RUT FEB 18 '10 510.0 PUT OPTION 10 0.55 -15,199 -24 1 108 -63
RUT FEB 18 '10 520.0 PUT OPTION -10 0.75 -18,546 29 -1 -127 70
RUT FEB 18 '10 650.0 CALL OPTION 1 10.35 -24,830 39 1 71 -23
RUT FEB 18 '10 670.0 CALL OPTION -13 4.30 -168,202 -264 -10 -705 205
RUT FEB 18 '10 680.0 CALL OPTION 13 2.60 -108,091 169 8 529 -149

JAN 15, 2010; RUT: 637.96

ORIGINAL IRON CONDOR IS $0.20 -$1.70 = $1.90; NO ACTION NECESSARY

22 | www.expiringmonthly.com
Follow That Trade
Mark Wolfinger

Adjustment trade: To eliminate all downside risk, I bought to close the 10 short 510/520 put spreads.
Cost: $0.15, or $150. At that price, there is too little to gain by holding the position.

FIGURE 6 CUSTOM SCENARIO (LIVE UPDATE)

POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE EXPO VAR DELTA GAM VEGA THET
ALL UNDERLYING -44,123 -68 -1 -109 38
COVERED FEB PUT SPREAD -40
-25,882 -1 -84
RUT <CBEO> -44,123 -68 -1 -109 38 @ $0.15 -25,882 -40 -1 -84
2010-02-18 -44,123 -68 -1 -109 38 REMAINING POSITION
-25,882 IN GOOD
-40SHAPE
-1 -84
RUT FEB 18 '10 650.0 CALL OPTION 1 12.10 29,046 45 1 73 -24 WITH 10
RUT @1.48
645, MID-MORNING
-25,835 -40 1 193
RUT FEB 18 '10 670.0 CALL OPTION -13 4.60 ,199,387 -309 -12 -745 228 1/19/2010
-10 1.76 30,982 48 -1 -224
RUT FEB 18 '10 680.0 CALL OPTION 13 2.60 126,218 196 9 563 -166 1 15.84 28,059 44 1 88
-13 8.00 -234,229 -366 -9 -977
PORTFOLIO RELATIVE P&L 13 5.31 175,140 273 8 835
RUT <CBOE>

Update after 42 days: January 21 (28 days until expiration)

RUT is 6 points lower this morning, at 633. I entered a bid of $0.80 to cover the 13 short 670/680 call spreads.
I will sell the one-lot Feb 650 call if filled.Position closed. Paid $0.80; sold Feb 650 call @ $5.80. RUT is now at 628.

Comment: I do not usually pay as much as 80 cents to exit, but there are still four weeks remaining before expiration,
the put portion of the iron condor has already been covered at a good price, the market has been down hard over the
past two days, and although I never predict market direction, I fear a rally. Under these circumstances, prudence dictates
closing the trade and taking the early profit.

FIGURE 7
POSIT PRICE EXPO VAR DELTA GAM VEGA THETA HEDGE POSIT PRICE
ALL UNDERLYING -28,0... -44 -2 -112 38 -
RUT <CBEO> -28,0... -44 -2 -112 38
2010-02-18 -28,0... -44 -2 -112 38
RUT FEB 18 '10 650.0 CALL OPTION 1 6.75 19,356 31 1 62 -22
RUT FEB 18 '10 670.0 CALL OPTION -13 2.20 -101,... -161 -8 -466 150
RUT FEB 18 '10 680.0 CALL OPTION 13 1.15 54,074 86 5 292 -91

PORTFOLIO RELATIVE P&L

RUT <CBOE>

Opening trades: Closing trades:

Results:

• Collected: $2.65 each for 10-lots of the iron condor • Paid $0.95 for iron condor
• Paid: $785 for one adjustment Bought puts early, @ 0.15
• Net cash collected: $1,865 Bought calls @ $0.80
• Sold adjustment position, collected $340
(NOTE adjustment lost $445)
• Net cost: $610

Net profit: $1,255

Many traders prefer to hold iron condor positions until the position decays even further, thus increasing profitability.
For long-term safety, my style is to exit early – when feasible.

There are no hard and fast rules to follow, but when Expiring Monthly follows a trade, the trading style of the writer
affects trade decisions. Each month a different writer will follow the trade, each with his own take, our hope is that it
will increase the amount of knowledge that can be attained by our readers.

23 | www.expiringmonthly.com
A detailed look at the ins and outs of the implied volatility ETNs.

VXX and VXZ

The VIX ETNs:

Bill Luby

In the course of my conversations with a broad cross- 20.00 level toward the end of 2009, investors decided
section of investors, I cannot help but conclude that the that the VIX had fallen too far relative to the breadth and
popular VIX ETN,VXX, is probably the most misunder- magnitude of the threats to the economy. Suddenly VXX
stood of all actively traded securities. In this article, I became the fashionable way to bet that volatility would
will attempt to look under the hood of VXX, explain how rise; retail investors flocked to the product, many com-
various factors impact the movement of VXX and offer pletely unaware of what they had purchased. Meanwhile,
some suggestions about how to approach trading VXX. the longer-term VIX ETN,VXZ, was relegated to obscurity
after investors tired of a product that typically moved less
First, a little history is in order. Launched in 1993, the than half as quickly as its short-term sibling.
CBOE Volatility Index, commonly known as the VIX, is an
index created by the Chicago Board Options Exchange What many VXX longs have failed to realize is that the
(CBOE) for the purpose of calculating the implied calculations which determine the value of this ETN are
volatility of options on the S&P 500 index for the next 30 based on the price of two different VIX futures: the front
calendar days. A source of frustration for many investors month and second month futures. In order to maintain a
is that for the entire history of the VIX, it has not been constant 30 day maturity,VXX rebalances the two near-
possible to trade this index directly. In 2004, the CBOE term VIX futures contracts on each trading day. The result
addressed the demand for volatility products by launching is that every day VXX converts approximately 1/22
the first VIX-based product: VIX futures. These were an (assuming 22 trading days per month) of its portfolio from
immediate success and paved the way for the launch of front month VIX futures to second month VIX futures.
VIX options in 2006. While VIX futures and options
changed how investors thought about trading volatility, Depending upon the VIX futures term structure, the daily
many retail investors were left out in the cold, due to the rebalancing can have a substantial impact on the value of
fact that they were not comfortable trading futures and the VXX ETN. During the first two weeks of March, for
options or did not have brokerage accounts that enabled instance, the front month (March) VIX futures hovered
them to do so. For this reason, a large number of retail around the 19.00 level, while the second month (April)
investors were unable or unwilling to trade volatility futures averaged about 22.00. As a result, on a typical day
products directly until the January 30, 2009 launch of two during early March,VXX was selling 1/22 of the portfolio
VIX Exchange Traded Notes (ETNs): the iPath S&P 500 with VX H0 futures at 19.00 and replacing it with VX J0
VIX Short-Term Futures ETN (VXX); and the iPath S&P futures at 22.00. This 3.00 loss on a basis of 19.00 trans-
500 VIX Mid-Term Futures ETN (VXZ). lates into a 15.8% loss for the 1/22 of the portfolio that
was rolled from front month to second month futures
In order to understand the VIX ETNs, it is essential to each day. Multiplying the 15.8% roll loss by the 1/22
have a basic grasp of VIX futures. Very briefly,VIX futures of the portfolio that is rolled on a daily basis, you can
are contracts that are based on the market expectation calculate that VXX was losing approximately 0.72% per
of the future value of the VIX at the time the futures day due to roll yield losses from the daily rebalancing
contract expires. Based on the number of emails I receive efforts. Over the course of a week, this is a 3.6% loss.
on the subject, it appears as if a surprisingly high percent- With VXX trading at about 24.00 during this period,VXX
age of investors mistakenly believe that VIX options are was losing an estimated 0.17 per day and 0.86 per week
based on the spot VIX (the index) when in fact they are due to negative roll yield.
priced off of VIX futures. As is the case with VIX options,
the value of the two VIX ETNs is linked not to the spot If some of this sounds familiar, this is the same futures
VIX, but to the VIX futures. So while the spot VIX is the contango problem which has plagued two other futures-
ubiquitous VIX seen in the media spotlight, all three VIX based ETFs: United States Oil Fund (USO); and United
products are based not on the spot VIX, but on the much States Natural Gas Fund (UNG). Simply stated, any ETF
lesser known VIX futures. which utilizes multiple futures positions to create a
portfolio with a constant maturity will have exposure to
Investors were relatively slow to warm up to the two VIX the slope of the term structure curve. When the futures
ETNs, but once the spot VIX began to drop below the are in contango (an upward sloping term

24 | www.expiringmonthly.com
The VIX ETNs:
Bill Luby
VXX and VXZ
structure in which the futures are more expensive than volatility, with negative roll yield akin to time decay. As
the spot price), the rolling from a nearer month to a more with options, it is important to understand the magnitude
distant month will have a negative impact on the value of of the daily time decay and the size of the volatility spike
the ETF. Conversely, when the futures are in backwarda- required in order to make long VXX positions profitable.
tion (downward sloping term structure in which the
futures are less expensive than the spot price), the rolling To sum up, investors who are interested in incorporating
process has a positive impact on the ETF price. long or short volatility positions in their portfolios should
give some thought to the following:
While contango, backwardation and roll yield are critical
aspects of VXX, it is vitally important not to lose sight of 1. Focus more attention on the underlying VIX futures
the fact that VIX futures prices reflect the direction and and less on the VIX ETNs
magnitude market participants believe volatility will move
in the future. This is because VIX futures have mean 2. Determine whether VIX futures are in contango or
reversion expectations built in to the term structure. backwardation
This also means that when there is substantial negative
roll yield, such as was the case in the first half of March, 3. Know the current VXX roll yield (differential between
the negative roll yield is a side effect of investor expecta- front month and second month VIX futures)
tions of an increase in volatility and suggests that investors
believe current volatility levels are a short-term aberra- 4. Understand the tug of war between roll yield and mean
tion. reversion expectations

In some respects, the VXX price action reflects a tug of 5. Consider trading VIX futures directly and avoid the
war between roll yield and volatility expectations. One complications of the roll yield
way of thinking about long VXX positions is to consider
them somewhat analogous to owning a call option on 6. Investigate an SPX/SPY straddle in order to have a ‘pure’
volatility position

THREE MONTH PRICE CHART

36

34

32

30

28

26

24

22
JAN 2010 FEB 2010 MAR 2010

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From the crash of ’87 to the new VIX products, Natenberg has seen it all.

Sheldon Natenberg
A Sit-Down with Author

Mark Sebastian

I still remember the day I found out I would be working Were you surprised by its success? Why do
for Group 1 Trading in New York City. Three things you think it has become the ‘trading manual’
happened. First, they told me that I had the job. Next, of many firms?
they told me when I was starting. Finally, they said,
I was surprised. Over time I’ve come to think that it was
“We are sending you a book called Option Volatility &
successful because it was written from the point of view
Pricing. Have it read before you start.” I did just that, thus
of the professional trader. At the time option books were
beginning my love affair with options. I later discovered
written for either retail traders or academics. The book
that most traders consider the book to be the bible of
was fortunate in that it was written for professional
professional option trading. I personally have read many
traders. It wasn’t academic, but it wasn’t overly simplified
of the chapters three or four times. I figured there would
either. What made it successful was it turned out a lot of
be no one better to interview for our inaugural issue than
other traders – besides market makers – liked reading the
the man who first introduced me to options, the author of
book as well. At one point I asked the editors what they
the aforementioned book, Sheldon Natenberg.
needed to make money.They said we needed to sell two
What inspired you to write printings of 2000-2500 copies to get their money back.
“Option Volatility & Pricing”? It’s now gone through over 30 printings.
When I started at the CBOE (Chicago Board Options
Exchange), I took a class taught by Marty O’Connell. I
Have you thought about a third edition? What

was fascinated by how he taught and I got it in the back

might you be looking to add?
I am thinking about doing a third edition of Option Volatility
of my head that I might enjoy teaching, despite having no
& Pricing. I am actually working on the edition; it might
teaching background at all. So I decided to take a crack
end up being a little more academic, although still from
at it. I put out notices that I was interested in teaching
the point of view of a trader. I will talk about volatility
some courses. I got one response; the firm was Chicago
skews and intermarket spreading. I might do a chapter
Research and Trading, so I taught there. Next, the CME
on volatility contracts.
(Chicago Mercantile Exchange) asked me to teach. I had
prepared some class notes for my students. I guess the What are your thoughts on the CFE (Chicago
notes were helpful because an individual suggested to me Futures Exchange) volatility futures and options
that that the notes could be the basis for a book on on volatility indexes, like the VIX and the RVX?
option trading. For retail traders, I think the value is mostly speculative.
For fund managers, volatility futures and volatility options
I began to look for an editing company and I called
give the ability to take an outright volatility position and
Dow Jones. They sent an editor. They said they weren’t
hedge it. Many managers actually have natural volatility
interested, but they had had three editors just leave and
positions and do not realize it. Let’s take a hedge fund
start their own firm. It was a small company called Probus
manager. The fund has a portfolio that needs to rebalance
Publishing. They were brand new to publishing and
every so often. When volatility goes up the cost of
decided to give the book a shot.
rebalancing is much higher.

26 | www.expiringmonthly.com
A Sit-Down with Author
Mark Sebastian
Sheldon Natenberg
He really has an indirect volatility position. A lot of hedge with an ETF in SPY or DIA. Another positive is that they
fund managers got hurt badly because they did not realize have driven down fund management fees.
their exposure to volatility. A manager could hedge away
some of the fund’s volatility risk with these products.
In 1987 you were on the CBOT (Chicago Board of
Trade) trading bond options. How does the 1987
Take a common way of using options to help manage a crash compare to what happened in 2008? If 1987
portfolio, the buy-write. If I am a portfolio manager I brought us skew, what will 2008 bring us?
want to do two things: I want to beat the market; and I I am convinced there was skew before 1987, but it
want to make money. If the market goes way up I will wasn’t as dramatic as after the crash. I traded agricultural
make money, but I won’t beat the market because my options; there was always a skew in those options, except
options will get called away. If the market goes down I in the other direction. For a few hours I thought the
will beat the market because I am selling call options, but market might collapse and our business might disappear.
I won’t make money because the market dropped. What I had just signed the mortgage on my house and I
is my volatility position? I am short volatility because I commented that I was hoping I could get a job as a ditch
want the market to stay relatively stable. A buy-write digger. Looking back, it turned out it was a one-time thing
will always do the best in low volatility conditions. I can and ended up being a localized event. By contrast, 2008
use futures from the CFE or volatility options to hedge had a much broader effect on the world. When you are
my volatility risk. standing in the middle of a crash you really don’t know
what to think. It is really hard to be objective when there
Here is another example: a market making firm. There is
is fire all around you.
a correlation between higher volatility and higher volume.
The market making firm wants more volume to take 2008 was interesting in that it seemed nobody
advantage of the bid-ask spread. Thus the market making did well into that market.
is indirectly long volatility. The market making firm could In 2008 it is likely that a lot of market making firms did
hedge its indirect volatility using CFE or CBOE volatility well. If a market making firm entered September of 2008
products. There is a whole group of funds and traders without a major position they did great because the
that aren’t really trading volatility and would never say bid-ask spread was so wide when the market got out of
they have a volatility position, yet because of the mechan- alignment. It was the firms that had major positions that
ics of the market they have a relatively large indirect had their bell rung.
exposure to volatility.
How is trading changing? Why are firms
How do you think the proliferation of ETFs
leaving the floor?
When I first started trading you borrowed money from
(exchange-traded funds) has changed the

your mom and dad,maybe an uncle,and leased a seat. The only

landscape of options?
I don’t think it has changed the landscape of the options
thing a trader really cared about was what the guy next to him
very much, but it has been a huge positive for the public.
would trade an option for. Now,the markets have become so
It’s great because the public that wants to be long the
big and there is so much capital required that it has become big
market can go in and buy ETFs. Before the ETF, the
business. On top of that the technology and modeling required
only way to go long the market was the S&P 500 futures
is so substantial. I don’t think any firm can survive without
contract which took a lot of work to get into and to
integrating trading,financial engineering and technology. Many
understand. Now the public can go in and buy the market
firms are leaving the floor because there is no money in it.

27 | www.expiringmonthly.com
A Sit-Down with Author
Mark Sebastian
Sheldon Natenberg
Market making is also getting more and more difficult Most firms don’t care about knowledge of derivatives.
because of information. It used to be as a market maker They figure they can teach you derivatives. Most firms
you had access to information that the public or retail want math and numerical skills. Firms will take anyone
traders didn’t have (in terms of orders that are being that they think can meld financial engineering, technology
shopped and in the book.) Now the tables have turned and trading. There are a lot of firms out there; door
and in many cases the retail traders and big banking knocking will still at least get your foot in the door.
customers may have more information than the market
maker.
Over the next few years, how do you think the
trading landscape will change?
What do you think about penny pricing? Are we I don’t have a crystal ball. One thing that seems to be
going to see the whole market in pennies? happening is trading for pennies and milliseconds. Firms
I think penny pricing has been a real problem for the are really interested in speed. CPU’s are being moved
industry. The concept sounds good but the markets closer and closer to the exchanges. Firms are researching
have turned into a free for all. There is a big difference and developing high frequency trading. Firms want as
between a free for all and a free market. But it looks like much speed as possible. If they can trade in 20 millisec-
that is the direction the industry is going. If you add the onds they want it down to 10 and so on and so on.
tightening of the bid-ask spread, with the availability of
information, market making has become very difficult. This
If you were to tell a new retail trader option

has contributed to the decline of big market making firms.

trader one thing, what would it be?
Even if you think you are trading directionally, you need
How should the next generation of trader get to understand the volatility component of options.
into the business?

28 | www.expiringmonthly.com
Sometimes no matter how high the implied volatility of a sale is, it is still a bad sale.

Worst Trade Ever

Floor Stories

Adam Warner

The time is February of 1999; the place is the American remotely near where it was trading now and you came close
Stock Exchange. It was perhaps right at the apex of the to locking in a winning trade. What could go wrong?
floor trading business. I made easily the worst series of
trades I ever made. Nothing before or since has ever come Well for starters, it was 1999. There was no penny trading
close. I left the AMEX 8 years ago last October and I'm not in stocks. You still needed a plus tick to short stock. And to
sure I've even had a year where I earned as much as I lost in say plus ticks were few and far between was an understate-
that one trading session. ment. We would sell a small quantity of puts at a silly price
and raise them to a sillier price. Then sell a few more.
The option that did me in that day? Pediatrix Medical
Systems. Frankly, I had never heard of it either until that day. By the end of the day everyone in the crowd got short a de-
They apparently don't exist anymore, at least as a stock. cent quantity of puts and a very small quantity of stock. And
remember, even if the trader could short stock 1:1, the
Back in 1999 I was a market maker on the AMEX. My job trader probably would not. The puts were ATM or OTM, so
was to provide liquidity to the options marketplace, i.e., take if the trader sold stock 1:1, he would have synthetically
the other side of public order flow. If Merrill wanted to buy shorted a bunch of ITM calls. Again though, moot point;
some calls in Caterpillar (CAT) and I was a market maker there was no way to short anywhere near that much stock.
trading CAT, I had to sell him some set amount on my offer-
ing price. In fact, I WAS a market maker in CAT and Ameri- Well, it was a Friday afternoon and over the weekend the
can Home Products (now Wyeth) and Fleet Bank (now part news hit the tape. I don't remember the story exactly, but
of BAC) and as a host of other stocks. as best I can recall, PDX owned medical facilities in Florida
and there was some sort of fraudulent book-keeping going
At the time, you physically stood in a "crowd" in front of on (imagine that).
specialist. That specialist typically had a "book" of several op-
tions. In general, the crowd made markets in his more liquid Come Monday or Tuesday (I believe it was President's Day
options, basically participating in every trade on the posted weekend), PDX re-opened at about half its Friday closing
bid or offer. The less liquid ones, however, we tended to just price. Ouch!!! Major ouch!!!! PDX was maybe 70 before
ignore. The specialist had to play them. that on Friday and now it was about 35. The puts had some
We did not…unless he asked us to. decent premium in them, but not anywhere close to the $20
or $30 intrinsic value ramp.
That is just what happened on that fateful February Friday.
Out of the blue, put buyers walked into PDX. It is notewor- Wah!!!!!!!!!!!!!!!!!!!!!
thy any time there is a bevy of put bids in any name when
there is nothing on the tape to explain why. (Yes, it was "the Now this wasn't the first or last one day hit I ever took. But,
tape" back then.) Traders had a handful of newswires they every other time, the hit was in a name I actively traded.
could see. It is particularly noteworthy when it is an option Much easier to get rocked in a name that's already paid me
that literally never trades. off. None were anywhere near the dollars involved in PDX.

Your first reaction when you see that sort of order flow is That's the sob story part. The good news? It was 1999. It
to raise the price. That's what our specialist, who I'll call was just a great time to be a market maker.The market was
"Bob" (because that is his name) did. Bob kept raising the exploding and volatility was actually going higher into the
volatility and the stock kept falling. It did not matter; the price lift. Despite taking my single biggest hit and withstand-
public kept buying PDX puts. Wash, rinse, and repeat. Bob ing the August onset of losing our exclusive listing of options,
got a bit sick of the drill and pointed out to all of us MMs I still had my best trading year ever. In fact I'm not even sure
that we got a lot of benefits trading the order flow over the I had a down month. Man those were good times.
years and this was one of those times we needed to step up
and provide some liquidity. I suppose if I learned one thing, it's that truly anything can
happen in this business. All the edge in the world means
After playing some small violins, we agreed. Besides, he about zero sometimes. The best way to make money is
had made all the early sales; these puts were fat now. I often simply avoiding losing money. In 1999, in the options
mean FAT. All a trader had to do was short stock anywhere world a trader could earn back almost anything he or she
lost. In 2010 with spreads of a penny…not so much.

29 | www.expiringmonthly.com
On Eating What We Kill
Back Page

Jared Woodard

The slogan, popular among many traders, that “we eat vintners will be needed to keep us fed and happy; and we
what we kill” isn’t just absurd, it’s dangerous. can think of similar explanations of the importance of
teachers, barbers, police officers, and so many others.
The cliché is absurd because every tick in profit and loss My claim is not that traders are useless to society; that’s a
that accrues to a trader’s account is the result of a series question for another time. But whereas the allocation and
of institutions, laws, practices, labor hours, and countless reallocation of capital to different assets is an activity so
other concrete relations of production without which utterly reliant on the strength of the material economy,
trading would be inconceivable.The chain of dependence boasts of carnivorous independence on the part of traders
that leads to a successful “predatory” financial transaction seem immediately not just false, but also in poor taste.
is, in fact, so much more protracted than the series typical Traders proud of their supposed predation are the anemic
of ordinary “agrarian” cubicle work that we might instead leonine aristocracy of a protected nature preserve,
regard trading as among the most tenuous, gossamer oblivious to the guards, gates, and smaller animals without
pursuits anywhere in Western culture. Recent hysterical whom they would quickly die.
outbursts among banks, hedge funds, and high-frequency
shops over the mere mention of the possibility of a Tobin Beyond the absurdity of bluster about “eating what we
tax on financial transactions illustrate the extreme fragility kill,” I’ve claimed that the slogan also represents a
of the business of trading. But an environment of perpet- dangerous attitude. If, instead of an attitude of humility
ual regulatory capture is just the most obvious in the long and circumspection, I approach markets with all the
chain of conditions necessary for presumably independent, maturity of a frat boy, I dramatically increase my chances
carnivorous traders to exercise their purported skills. of making serious errors.The conceptual mistake here, for
one, is in attributing any success I have to my own efforts,
Every financial instrument is a derivative, after all, of the rather than to luck; in the absence of statistically robust
work that goes on elsewhere in the material economy. performance data, any claim about my own trading
When that material world occasionally impinges on the prowess is just a swaggering invitation of future losses.
austere realm of finance – in interruptions natural, And even if we exclude discretionary traders, a healthy
political, workerist, and so on – it becomes clear just dose of overconfidence is a great way for a mechanical or
how entirely reliant the financial sector is on the people systems trader to fail to notice important changes in the
and relationships that it exploits for profit.The impetus market. In addition to being an obviously false description
for the slogan, I take it, is that whereas ordinary workers of reality, the mythology of self-reliance is a distraction
depend on bosses or consumers or other businesses for and a cognitive bias that we can all do without.
their livelihoods, traders have severed such ties and are
free to take profits wherever they find them. But this is A more accurate summary might be something like,“we
just irredeemable mythology, and it gets the relationship eat whatever we’re lucky enough to find.” I don’t expect
precisely backwards. Medicine will never be a useless that inelegant phrasing will ever catch on, but the best
profession as long as people get sick; farmers, chefs, and traders don’t tend to think in slogans, anyway.

30 | www.expiringmonthly.com
Expiring Monthly Team
About the

Adam Warner

Adam is the author of Options Volatility Trading: Strategies for Profiting from Market
Swings released in October 2009 from McGraw Hill. He co-wrote the options
column on Street Insight from spring 2003 to spring 2005, and is currently
Options Editor at Minyanville.com.

When not writing,Adam is a proprietary option trader with Addormar Co, Inc.
He traded as a member of the American Stock Exchange from 1988-2001, and
in several off-floor locations since then.

Adam Warner graduated Johns Hopkins University with a degree in Economics.

Bill Luby

Bill is a private investor whose research and trading interests focus on volatility, market
sentiment, technical analysis, and ETFs. His work has been has been quoted in the Wall
Street Journal, Financial Times, Barron’s and other publications. A contributor to Barron’s
and Minyanville, Bill also authors the VIX and More blog and an investment newsletter
from just north of San Francisco. He has been trading options since 1998.

His first book, Trading with the VIX, is scheduled to be published by John Wiley & Sons
in 2010.

Prior to becoming a full-time investor, Bill was a business strategy consultant for two
decades and advised clients across a broad range of industries on issues such as strategy
formulation, strategy implementation, and metrics. When not trading or blogging, he can
often be found running, hiking, and kayaking in Northern California.

Bill has a BA from Stanford University and an MBA from Carnegie-Mellon University.

Jared Woodard

Jared is the principal of Condor Options.With over a decade of experience

trading options, equities, and futures, he publishes the Condor Options
newsletter (iron condors) and associated blog.

Jared has been quoted in various media outlets including The Wall Street
Journal, Bloomberg, Financial Times Alphaville, and The Chicago Sun-Times.

In 2008 he was profiled as a top options mentor in Stocks, Futures, and Options
Magazine. He is also an associate member of the National Futures Association
and registered principal of Clinamen Financial Group LLC, a commodity
trading advisor.

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About the Expiring Monthly Team
Mark Sebastian

Mark is a professional option trader and option mentor. He graduated from Villanova
University in 2001 with a degree in finance. He was hired into an option trader training
program by Group 1 Trading. He spent two years in New York trading options on the
American Stock Exchange before moving back to Chicago to trade SPX and DJX options
For the next five years, he traded a variety of option products successfully, both on and
off the CBOE floor.

In December 2008 he started working as a mentor at Sheridan Option Mentoring. Currently,

Mark writes a daily blog on all things option trading at Option911.com and works part time
as risk manager for a hedge fund. In March 2010 he became Director of Education for a
new education firm OptionPit.com.

Mark Wolfinger
Mark grew up in Brooklyn and holds a BS degree from Brooklyn College and a PhD
(chemistry) from Northwestern University.After working as a research chemist for
Monsanto Company, in December 1976 he packed his belongings, left a career as a
research chemist behind, and headed to Chicago to become a market maker on the
trading floor of the Chicago Board Options Exchange (CBOE).

Over the next 23 years, he worked primarily as a market maker, and also held a
variety of positions in the industry.

After leaving the CBOE (2000), he became an options educator and stresses
conservative methods, as detailed in his newest book (The Rookie’s Guide to Options).

He currently resides in Evanston IL with his life-partner, Penny.

The information presented in this publication does not consider your personal investment objectives or financial situation; therefore, this publication does not make personalized recommendations. This information should not be
construed as an offer to sell or a solicitation to buy any security. The investment strategies or the securities may not be suitable for you. We believe the information provided is reliable; however, Expiring Monthly and its
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respective family members may directly or indirectly hold positions in the securities referenced in these materials.
Options transactions involve complex tax considerations that should be carefully reviewed prior to entering into any transaction. The risk of loss in trading securities, options, futures, and forex can be substantial. Customers
must consider all relevant risk factors, including their own personal financial situation, before trading. Options involve risk and are not suitable for all investors. See the options disclosure document Characteristics and Risks of
Standardized Options. A copy can be downloaded at http://www.optionsclearing.com/about/publications/character-risks.jsp.
Charts used with permission derived from Option Vue and Options Express Interactive Brokers, LiveVol Pro, Stockcharts.com and YAHOO.
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