1countertrend moves, 101coupons, as options, 77Cox-Ross-Rubenstein model, 108criteriafor endplay trades, 244–245for non-seasonal trades, 109–113for ratio-spread application, 213–214for riding the bear, 191–192for roll-out or flip defense, 134for straddles, 173–174crude oil, 103, 209, 246distribution study of, 285historical gross movement studyof, 269cumulative normal densityfunction, 53
Index
currencies, national, 83currency markets, 113, 227data analysis, tools for, 91–92databases, 90debit put spread, 228decimalization of prices, 9defensebear market strategies, 202–203bull market strategies, 223delta/gamma-neutral, 140diagonal, 140endplay strategies, 246–247flip, 133–139hedge, 123–132market conditions and, 138mini-bull strategies, 233–234move-the-goalpost, 141–143parabolic bull market strategies,229–231ratio-spread, 218–220, 223roll-out, 133–139runaway bull market strategies,235–236spread trading, 139–141straddle, 160–164strangle, 168, 171–189types of, 123deferred bid-ask spread, 8delta, 60, 62–63delta/gamma-neutral defense, 140derivatives, 34diagonal defense, 140Diamonds, 38Disraeli, Benjamin, 39distribution curves, 51–53, 52, 53distribution study, market highs andlows, 280–281, 282–295diversification, of tradingpositions, 50Dow Jones Industrial Average, 14Dunbar, Nicholas, 117electronic trading, 9El Toro Grande, 227–231endplay strategy, 238–251preconditions for, 244–245
299energy marketsendplay strategy in, 241–244event risk in, 106Enron, 43entry conditions. See preconditionsevent risk, 40–43banking and, 18–20bookmaking and, 12–15energy markets and, 106gambling and, 5–7governmental, 38–40non-seasonal trading and, 115–116regulations and, 12self-induced, 19–20stock markets and, 82, 258exchangescounterparty risk and, 10–11event risk and, 14fraud and, 11expectationapproximating, 51–54calculation of, 46definition of, 45, 46examples of, 55, 56, 107model of, 51–54options and, 45–70risk and, 115expectation tables, values of, 54,55, 56expiration dates, 28experts, 93–94trading and, 87–88fadeaway strategy, 252fair value, 57, 58Federal Reserve, 15purpose of, 19Federal Reserve Regulation T, 92–93financial media, 27flexibility, trading and, 47–48flip defense, 133–139preconditions for, 134Fly-By-Night Trading Partners, 259Food and Drug Administration(FDA), 157forecasting, 100forex markets, 83, 215
300forum.ino.com, 210fraudin banking, 17–18in insurance, 11trading and, 30–31free market, definition of, 36–37futures, single-stock, 38futures contracts, late-in-life, 80futures marketscapital requirements of, 35event risk and, 41–43governmental risk and, 39–40information risk and, 27leverage in, 32, 35–36myths about, 85–87purpose of, 86symmetry of, 37, 38futures options, bid-ask spreads in, 48futures trading, SPAN® and, 35–36, 37“gambler’s ruin,” 32gambling, 3–7, 9–10event risk and, 5–6games, 1–2game theory, trading and, 24, 86gasoline, unleadeddistribution study of, 294expectation of writing, 107historical gross movement studyof, 278seasonal buy study of, 103GLOBEX®, 83goalpost defense. See move-thegoalpost defensegold, 83, 119distribution study of, 286good will, risk and, 6governmental event risk, 38–40heating oil, 58, 246distribution study of, 287historical gross movement studyof, 270non-seasonal strategy and, 117–118hedge, 123–132definition of, 123principles of, 128, 129
Index
historical databases, 90historical gross movement, studies of,263–264, 265–279historical volatility (HV), 55hogs, live/leandistribution study of, 288historical gross movement studyof, 272statistical volatility of, 61hype, 64–70illiquidity. See liquidityimplied volatility (IV), 58–63delta and, 60, 62–63inflation of, 220–222indenture, 39, 40indexes, safety of, 82inflation risk, 40informationcurrent, 90–91effects on trading of, 25–26evaluation of, 25historical, 90impact of, 256–257requirements, 90–99information risk, 24–28hard data and, 27non-seasonal trades and, 111options trading and, 71–88reduction of, 26–27initial risks, 46–47insurance companiesas bookmakers, 7, 8reinsurance of risk by, 14securitization of risk by, 14insurancecounterparty risk and, 11–12event risks of, 13–14fraud and, 11profit possibilities of, 9–10spread and, 8interest-rate markets, 113, 226–227interest rates, 76interest rate spread, 17interim dollar risk, 115–116Internetas information source, 91
Index
301
as training source, 96–97use of, 30–31Inventing Money, 117investing, vs. trading, 22It’s a Wonderful Life, 19
loss limit, risk and, 29lumberdistribution study of, 289historical gross movement studyof, 272
Japanese yen, 83–84distribution study of, 287historical gross movement studyof, 271seasonal buy study of, 181
margindefinition of, 35minimum, 50margin account, 34–35margining policy, 50margin requirement, 33–34, 204setting, 50–51margin traders, contest risk and, 35marketdefinition of, 190conditions, defense and, 138discontinuities, 73–74equilibrium, 161market makers, 8, 9, 224market report, straddle and, 162–164marketsasymmetry of, 36–38futures, 188–206governmental event risk and, 38–40leverage and, 34–36minimum value of, 189movement of, 152–154, 153news vacuums and, 239–240orange juice, 152–154, 153retail, 23seasonal tendencies of, 101selecting, 34–36strangle and, 176–178volatility, 55–64market value, 58Martian ratio-spread strategy. See bullmarket strategiesMcDonough, William, 33McMillan, Larry, 57, 67, 78, 96, 146, 221McMillan on Options, 96media, financial, 27Merrill Lynch, 14Merton, Robert, 35, 73methodologysubjectivity of, 72technical, 89
knowledge risk, 28–29, 108late-in-life futures contracts, 80LEAPS, 33, 96Lehrer, Tom, 72leverageavailability of, 34–36, 37capacity risk and, 15–16, 31–32calculating, 34markets and, 32maximizing, 33liquidity, 8, 17, 19, 48, 136bid-ask spreads and, 48bond options and, 41content risk and, 23, 24Long-Term Capital Managementand, 33straddles and, 150loansdefault and, 16–17“five Cs” of, 17–18as options, 76–77sovereign, 20lognormal distribution curve, 52–54,53, 57–58lognormal model, application of, 108long position notice period, 80–81Long-Term Capital Management(LTCM), 33, 73, 83–84, 117lossexternal factors and, 5–6gambling and, 4–5illustration of, 45, 46probability of, 4self-induced, 5–6
302methodology, (cont.)of trading, 89–99Microsoft Corporation, 39mini-bull market, 231–234minimum value, 189modelsbear markets and, 203–206failure risk of, 75, 113future price distribution, 72, 73market discontinuities and, 73–74myths about, 72–76purpose of, 73money, 2–3gambling and, 3–7moneylending, “five Cs” of, 17–18money supply, event risk and, 18–19Moore, Stephen, 91Moore Research, Inc., 91move-the-goalpost defenseexamples of, 142–143types of, 141movement, studies of, 263–264,265–279mythsabout models, 72–76about options, 76–78about unlimited risk, 78–80about wealth creation, 85–87naked options, risks of, 78–80Natenberg, Sheldon, 78, 96, 186national currencies, 83natural gasdistribution study of, 289historical gross movement studyof, 272margin requirements and, 243–244seasonal sell study of, 177networking, 93–94New York Federal Reserve Bank, 33New York Stock Exchange (NYSE),as bookmaker, 7news vacuums, 239–240non-seasonal strategy, 102–121, 171–189example of, 102–106model failure risk and, 113volatility and, 116
Index
non-seasonal tendency, 102non-seasonal tradescriteria for, 109–113examples of, 265–279exiting, 117normal distribution, expectation and,51–52, 52NYMEX energy markets, 119oatsdistribution study of, 290historical gross margin study of, 274offensive strategies, spread, 139–141one-tick rule, 242opportunities, evaluation of, 255option, definition of, 76option prices, time and, 97Optionetics, 98Option Pricing and Volatility, 186optionsexpiration dates of, 28flexibility and, 47–48hedging with, 125–127loans as, 76–77myths about, 76–78naked, 78–80types of, 76–78Options as a Strategic Investment, 67,96options exchanges, market makerfunctions and, 8options markets, risk reductionand, 41option strikes, ratio spreads and,216–218options tradingevaluation of, 45–70profit possibilities in, 9Options Volatility and Pricing, 96option-writing strategies, 100–145orange juicedistribution study of, 290gross movement of, 153historical gross movement studyof, 273May 1, 2002 snapshot of, 159straddle and, 158–160, 159
303
Index
orderschanging, 154–155ratio-spread and, 224overvaluation, 207PC-SPAN®, 92–93perceived advantage, gambling and, 5perceived risks, in bookmaking, 10performance bond, futures marketsand, 35permanent strangle, 182–186, 252Philip Morris, 42–43physical futures marketsbear markets and, 188–206shortages and, 227–231Picador strategy, 227–231Pinnacle Data, 90Pit Bull, 87Poincaré, Jules–Henri, 66policyholders, as gamblers, 10portfolio insurance model, 73portfolio margining, 35–36, 92–93position size, 144–145preconditionsfor bear market strategies, 194–195for endplay strategies, 244–248for mini-bull market strategies,231–234for parabolic bull market strategies,229for ratio-spread strategies, 213–214price, movement of, 157–158prices, information and, 256–257price discovery, 189, 190–191price distribution model, applicationof, 54–55price inelasticity of demand, gasolineand, 105pricingmodels of, 51–54volatility of, 238–239profitbookmaking and, 7gambling and, 4–5, 7illustration of, 45, 46principles of, 21spread and, 7, 8
profitabilitydiscipline and, 122strategies for, 146–167threats to, 197–199profitability curve, 47–48, 48profit expectationgambling and, 5risk and, 5–6proposition betting, 3–4pure assets, 47–48put spread, 228QQQs, 38quadratic models, 108randomness, options and, 256–258ratio-spread strategybull markets and, 208–210mini-bull markets and, 232–233parabolic bull markets and, 229–230preconditions for, 213–214recommendations, for training, 94–97REFCO, Inc., 90, 224Regulation T, 34, 92–93regulatory risk, 12banking and, 18definition of, 14reinsurance, definition of, 14replacement cost, as counterpartyrisk, 11retail markets, pricing in, 23return on capital (ROC), 70margin requirements and, 114non-seasonal trades and, 114–115strangle and, 172–173R. F. Lafferty & Co., 146riskaccidental counterparty, 30avoidance of, 21, 32–33in banking, 16–20bid-ask, 24capacity, 15–16, 31–34, 74–75collateralization of, 16–17contest, 23–24counterparty, 6–7, 10–12, 17–20,29–31event, 5–7, 12–15, 18–19, 40–43
304risk, (cont.)endplay strategies and, 240–241gambling and, 5–7governmental, 38–40good will and, 6hedging and, 123–132inflation, 40information, 24–28, 71–88insurance against, 9–10interim dollar, 115–116knowledge, 28–29loss limit and, 27mini-bull markets and, 235model failure, 113myth of unlimited, 78–80options and, 258perceived, 10position and, 79reduction, 41, 48–51regulatory, 12, 18reinsurance and, 14self-induced, 19–20securitization of, 14slippage, 24SPAN® and, 35–36, 37structural, 40taxation, 40trading, 22–44, 46–47unlimited, 78–80volatility and, 121weather, 40–41wiggle, 29, 115–116ROC. See return on capitalRockefeller, Barbara, 215roll-out defense, 133–139vs. flip defense, 138preconditions for, 134roll-out strategy, 193–194Roth, Harrison, 33–34, 96Rothschild, Baron Edmond de, 211Rubenstein, Mark, 73Rubenstein-Leland model, 73runaway bull marketdefense in, 235–236See also bull marketrunaway parabolic market, 227–231
Index
seasonal analysis, straddle and,155–157seasonal buy study, 103seasonal sell study, 120seasonal trade, example of, 102–108,103serial months, 192, 193–194Salomon Smith Barney, 90Samuelson, Paul, 66–67Scholes, Myron, 35, 73Schwartz, Marty, 22, 87securitization, 14selling short, 38Shartsis, Jay, 146short-dated options, theta and, 108short positions, 81silver, 126, 222–223distribution study of, 291historical gross movement study of,270, 274single-stock futures, 38, 92–93skill, definition of, 3slippage, 24definition of, 23sovereign loans, 20soybean mealdistribution study of, 292historical gross movement study of,275soybean oildistribution study of, 291historical gross movement study of,275soybeansdistribution study of, 292historical gross movement study of,276risk periods of, 119SPAN® (Standard Portfolio Analysis ofRisk®), 35–36bear markets and, 204SPDRs, 38specialists, 8, 9sports bookmaking, 8, 9counterparty risks and, 10event risk and, 13
305
Index
spread, 139–141bookmaking and, 7bid-ask, 8, 9deferred bid-ask, 8definition of, 139insurance companies and, 8interest rate, 17spreadsheets, 91–92square root of time calculation, 67Standard & Poor’s 500 Index (S&P500), 15Standard Portfolio Analysis of Risk®.See SPAN®statistical volatility (SV), 55–64calculating, 57illustrations of, 60, 61, 62step-in strangle, 179–182straddle, 146–167, 168–171, 170, 263ATM December markets and,169, 170defense of, 160–164definition of, 147preconditions for, 173–174strangle, 168, 171–189, 239–293permanent, 183–186, 252strategybookie, 253bear market, 189–206bull market, 207–225defensive, 122–145endplay, 238–251evaluation of, 254fadeaway, 252flip defense, 134gambling, 3–4hedge, 127–128Martian ratio-spread, 209–225move-the-goalpost, 141–142non-seasonal, 102–121, 171–189parabolic bull market, 229–231permanent strangle, 182–186Picador, 227–231ratio-spread, 208–210roll-out defense, 134, 193–194seasonally based, 101–121straddle, 146–167
strangle, 168, 171–189“Voice From the Tomb, The,” 101stock indexes, naked put optionsand, 82stock markets,asymmetry and, 82event risk and, 41–43, 258governmental risk and, 39information risk and, 27leverage and, 32myths about, 85–87stock options, long-term, 33–34structural risk, 40sub-event, 5–6sugardistribution study of, 293historical gross movement studyof, 276suicide seasonal, 118–119straddle and, 155–157SV (statistical volatility). , 55–64calculating, 57illustrations of, 60, 61, 62Swiss francdistribution study of, 293historical gross movement studyof, 277statistical volatility of, 62taxation risk, 40technical methodology, 89theoretical fair value, 57, 58theta, 108, 164, 190Thorp, Edward O., 238time, 97–98time premiums, 201time spread, 140time-spread defense, 246time value of money, 76timing, 117bull markets and, 207defense and, 143–144mini-bull markets and, 232–233Toro poco markets. See mini-bullmarketTrade Like a Bookie, 96
306trade, definition of, 22trading“at the market,” 23experts and, 87–88flexibility and, 47–48fraud in, 30–31as game playing, 2hype and, 64–70information risk and, 24–28, 71–88initial risks of, 46–47vs. investing, 22mechanical errors in, 30methodology, 22–44principles of, 21risk profile of, 22–44risk reduction and, 46–47, 48–51risk events and, 14–15success factors of, 43–44tools for, 89–99time and, 1training and, 94–97training, 94–97Treasury marketsbonds, statistical volatility of, 6110-Year Notes, distribution studyof, 29310-Year Notes, historical grossmovement study of, 27730-Year Bonds, distribution studyof, 29430-Year Bonds, historical grossmovement study of, 278trigger event, 192, 199
Index
unleaded gasolinedistribution study of, 294expectation of writing, 107historical gross movement studyof, 278seasonal buy study of, 103“Voice From the Tomb, The,” 101volatility, 55–64, 60, 61, 62bear markets and, 204bull markets and, 209calculating, 57causes of, 238–239implied (IV), 58–63profit opportunities and, 59straddle and, 154–157strangle and, 175–178wagering games, rules of, 1–2wealth creation, myths about, 85–87Whaley quadratic model, 108wiggle risk, 29, 115–116wheatdistribution study of, 279historical gross movement studyof, 279Wriston, Walter, 20WorldCom, 43
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