Trading options is perversely challenging for a myriad of reasons, yet that’s what keeps my attention. Whether your market perspective is bullish, bearish or neutral, you can speculate, invest, swing, box, chase and hedge. The ability to react to divergences across asset classes, markets, or prices make option trading an enormous puzzle with, if you’re
lucky smart, a little satisfaction when you close out. Finding a trustworthy trading reference, isn’t easy. McMillan on Options is one of the best.
I pull it off the shelf often, which is usually a good sign, and in fact that’s what prompted this little review. I should share something about this book, I thought. Yet every review should be critical of something, otherwise what’s the point in showering praise? In this case I’ll share my criticisms first.
Using Stock Option Volume as an Indicator is a section that I just couldn’t effectively use. Theoretically it’s masterfully done and the examples are clear. But it seems from a different time (1994-1995, 1997-1999). The insight on how an Arbitrageur or Market Maker might use options is insightful. But this insight is better communicated elsewhere. Keep this in mind, he says, while you’re looking at open interest and volume movement. I spent about 6 months looking for signals in volume, unsuccessfully. At least my successes felt edge-less.
The Put-Call Ratio is another indicator Mr. McMillan passes some quality-time on. He should put in bold print the following: Index options, for example, are quite useful- but not all of them. Whenever an index option is heavily traded by hedgers, or arbitrageurs, its usefulness as a contrary indicator wanes. This is understated. My feeling is that the current environment of QE ad infinitum, has made these indicators nearly obsolete. Identifying extremes and divergences in these ratios has become a fine art form better left to the algos. That’s my take, the next time I pull the McMillan off the shelve, I’ll revisit the question.
Now for the good stuff. One difference, when compared to other options trading books, which jumps out at you is his integration of futures contracts into his discussions of basic option strategies. And in turn some easily missed differences when trading futures. For example, defending against a limit move. This is great information, and well explained. A futures contract may help you flatten your delta, but changes your risk profile.
And that leads me to my favorite part of the book, Delta Neutral Trading. One of the hardest things about trading options isn’t mastering the basic strategies, it’s evolving those strategies (or getting out of them) as time moves forward. Considering evolution of an options position in terms of the Greeks is a great way to look at the evolution of your position. McMillan covers this superbly and is one of the reasons I open this book again and again. Where’s my gamma risk with this strategy, my delta risk, my volatility risk? What are my choices with expiration closing in? How might I flatten, evolve or take profits on this trade? And most importantly, how does this modification change my risk?
McMillan confers that taking profit is a bit of an art form with options, and learning different strategies to flatten or protect profits makes this a must-have for any options trader.