k Trim Size: 6in x 9in Sinclair583516 bindex.tex V1 - 05/04/2020 9:51 P.M. Page 219 INDEX Bid-ask spreads (total cost component), 200 A Bitcoin, 172–173, 172f Acceleration, 60 Black-Scholes-Merton (BSM) Adjustment repair, 86 assumptions/equation/model, 2–4, 6, Alpha decay, 15–16 Anchoring, 19 108, 113, 115, 183, 192 Arbitrage counterparty risk, 178–179 Black-Scholes-Merton (BSM) PDE, 5, 116 Arbitrage pricing theory (APT), 63 Bonds, 49–50 Bonferroni’s correction, usage, 23 k ASPX option profits, taxation, 187 219 k Asymmetric implied volatility skew, 191 Broken wing butterflies/condors, 99–100 ATM, 104, 106t, 123, 131t, 137 Butterflies, 95–100, 96f, 98t At-the-money covered call, delta level, 135 BXMD/BXM/BXY, 133, 134t Autocorrelation, 73f, 91 Availability heuristic, 19 C Average return, calculation, 24 Calendar spread, 100–102 Calls, 55f, 129–136, 129f, 132f, 142 B call spread, 130f, 131t, 142f, 143t Back-tested rules, performer sample, 23 implied volatility, level (example), 140t Backwardation, 61, 62 put-call parity/relationship, 95, 115, 116 Badly priced butterfly, returns (summary strike call, 118f, 120f statistics), 98t Capital asset pricing model (CAPM), Badly priced condor, returns (summary development, 63 statistics), 98t Cash flows, taxation rate, 6 Bankruptcy, risk (increase),COPYRIGHTED66 Catastrophe MATERIAL theory, 20 Bayesian model, usage, 30 Chicago Board Options Exchange (CBOE), 16, Behavioral biases, inefficiency, 67–68 36, 45–46, 133, 134f Behavioral finance, 16–21 CNDR index, 45, 45f Best, defining (possibility), 121 Commissions (total cost component), 200 Beta, 67–68, 68t, 82, 196 Commodities, 47–49, 48t, 49t BFLY index, 45, 46f Condors, 95–100, 96f, 97f, 98t, 104t Biases, 18–20, 23, 30, 113 Confidence, 61–62, 71–75, 80 k k Trim Size: 6in x 9in Sinclair583516 bindex.tex V1 - 05/04/2020 9:51 P.M. Page 220 Conservatism, 19, 30 Expiration, selection, 109–111 Convergence strategy, 58 Exponentially weighted moving average Copper, price (decrease), 175 (EWMA) model, 22, 34–37, 38t Correlation effects, 99 Counterarguments, examination, 30 F Covered calls, 131–137, 132f, 136f Factor exposures/investing, 57, 51 Crowdedness, quantification, 58 Fairly priced butterfly, 96f, 97t Crowded, term (understanding), 58 Fairly priced condor, 96f, 97t Crowds/crowding, 36, 57–61 Fairly priced short straddle, returns (summary Cryptocurrencies, problems, 172 statistics), 87t Currencies, 25, 50, 171–173 Fairly priced short strangle, returns (summary statistics), 88t D Fama-French-Carhart, usage, 31 Daily hedging, usage, 94f, 94t Fat-tailed results, 71, 72 Data mining, 22, 23 Federal Reserve Open Market Committee Debt to equity (D/E) ratio, 63, 65 (FOMC), 76–77 Decision price, 200 FED funds rate, stability, 29 Delta, 5, 70–71, 93–95 Feedback, 58, 59 delta/gamma P/L, 141 Fees (total cost component), 200 delta-hedged option returns, 75 Fiat currency, risk, 171 performance, improvement, 136 Financial advisors, problems, 26 Directional anomaly, 76–77 Financial anomalies, data mining Directional forecast, problems, 91t (impact/traps), 23 Directional options, 113, 127 Financial forecasting, principles, 29–30 Distribution function, usage, 152 Financial options, real options (distinctions), k 220 Divergence strategy, 58 k 188–189 Diversifier, function, 101 Dollar premium, 106 First-order lagged terms, 34 Fixed commissions, absence, 15 INDEX Dow Jones 30, variance premia, 44 Dow Jones Industrial Average Flat skew condor, results, 104t (DJIA), 26, 44f Forecast, 35f, 37 Downside risk, 87, 140 Fractional Kelly ratio, impact, 159f Drawdown, 158–161, 159f Fraud, impact, 173–174 Drift, 69, 116 Front-month implied volatility, 102t Front-month options, straddle spread at expiry E (P/L), 101f Front-month VIX future/volatility, 40f, 101 Earnings announcements, 68–74, 81–82 Full Kelly, quarter Kelly (trading comparison), Earnings-induced reversals, 80–81 Earnings surprises, 31 169t Efficiency, conditions, 13 Fundamental analysis, 13, 21, 25–26 Efficient market hypothesis (EMH), 11–15, 18, Fundamental factors, 63–68 21–26, 68 Fundamentals, 136–137 Employment announcement, impact, 50 Futures, 4, 40 Ensemblle predictions, 36–37 Equities, 39, 42–46, 50–51, 136f G EuroSTOXX 50, composition, 178 Gamma, 6, 54 Event-driven trades, strengths, 32 Gann angles, 22 Excess kurtosis, 71, 72 GBM, 8, 85, 93, 163, 168f, 169f k k Trim Size: 6in x 9in Sinclair583516 bindex.tex V1 - 05/04/2020 9:51 P.M. Page 221 Generalized autoregressive conditional J heteroskedasticity (GARCH), 2, 24, Japanese candlesticks, 22 33–36 Jump risk, 52 Generalized Sharpe ratio (GSR), 122–127 Growth rate, 147–148, 150f, 151f, 159, 159f K H Kelly control/criterion, 147–149, 158–161, Half-Kelly, betting, 158 167–169, 169t Hedged option position, average PL, 7, 7f Kelly ratio, 127, 155, 160f, 161f Hedgers, insurance payment, 52 Knowledge, classification, 30 Hedging costs, presence/absence, 9t Know your customer (KYC) due diligence, 173 Hedging strike, selection, 107–109 Historical data, usage, 85 L Historical long-term average, 34–35 Liquidity providers, opportunities, 53 Historical returns, impact, 93t Long call, 54, 55f, 127, 129–131 Historical situations, examination, 29–30 Long-dated futures, expense, 61 Human nature, impact, 16–17 Long option, usage, 54 Long stock, 128, 133 I Long straddle strategy, results, 72f Implied correlation premium, 47 Long-term growth rate (maximization), Kelly Implied skew, 92, 141 criterion (usage), 147–148 Implied skewness premium, 46–47 Long volatility positions profits, Implied variance premium, 40–42 increase, 66–67 Implied volatility, 36, 46–47, 61–62, 76, 123, Loss aversion/size, 19, 71, 72 133 Losses (limitation), stops (usage), 165 k asymmetric implied volatility 221 k skew, 191 INDEX M example, 140t Market, 12, 16, 20, 52–53, 64 skew, 102–104, 103t impact (total cost component), 200 Implied volatility surface, 7f risk, reduction, 77 Index options, 78 Index restructuring, 177–178 Mean reversion, allowance, 34 Index variance swaps, sale, 47 Mean-reverting strategy, usage, 58 Industry beta, 82 Mean, weighted three-point estimate, 196 Inefficiencies, trader profit, 14–15 Median final underlying price, 119 Inefficiency-based strategy, half-life, 15 Meta risks, 171 Inflation, examples, 171–172 Mid-market prices, usage, 72 Information, 13–14, 70 Mispriced short straddle, returns (summary Information, price implications statistics), 89t (agreement), 13 Model-driven forecasting, 30–33 In-sample data sets, usage, 23 Model-free directional trading, 114 Interest rates, 183–186 Model-free volatility trading, 4 Interpolation, usage, 34–35 Modified BSM model, performance Intuition, 30, 36 (comparison), 192 Investment ratio, change effect (quantification), Momentum, behavioral roots, 67 160 Money put options, sell-out, 133 Investors, overconfidence/overreaction, Monte Carlo simulation, usage, 104 69–70, 81 Mutual funds, performance, 26 k k Trim Size: 6in x 9in Sinclair583516 bindex.tex V1 - 05/04/2020 9:51 P.M. Page 222 N Peso problem, 55–56 NASDAQ 100, variance premia, 44, 44f P/L, 54, 130, 141 Nikkei, drop, 174–175 dispersion, reduction, 100 No-good-deal theory (Cerny/Hodges), 189 standard deviation, 190f Noise traders, 13, 18 terminal distributions, 85 Nonconstant volatility, 190–192 PL distribution, 8, 9f, 100t, 102t, 128f Non-farm Payroll report, PPI release, 76 Poorly priced butterfly, profit distribution, 96f Non-normality, 149 Poorly priced condor, profit distribution, 97f Non-normal outcomes, 149–154 Poorly priced short strangle, returns (summary Non-normal return distribution, creation, statistics), 90t 190–191 Portfolios, 64–67 Normal backwardation, theory, 62 Post-earnings announcement drift (PEAD), 21, Notional exposure, maintenance, 59 68–75, 82 PPI announcement, impact, 50 O Pre-BSM pricing models, usage, 115 Occurrence rate, upper bound, 197 Pre-earnings announcement drift, 81–82 Offshoring, impact, 15 Pre-earnings anomalies, 82 Opportunity cost (total cost component), 200 Pre-earnings long straddles, profitability, 74 Option pricing models, 1, 4, 5 Price changes (total cost component), 200 Options, 3–10, 101f, 106t, 109, 113–118, Price-to-book (P/B) ratio, 63, 64, 66 157f, 157t Price-to-cash flow (P/CF) ratio, 63, 65 factors/dependencies, 63–68, 189 Price-to-earnings (P/E) straddle trading hedging, imperfectly correlated underlying results, 64 (inclusion), 190f Profitable trades, risk adjustment, 12 ProShares Ultra VIX short-term futures ETF k 222 non-redundancy, 52 k premia, ignoring, 107 (UVXY), 178, 201t, 202–203 pricing inputs, range estimates (conversion), Psychological explanations, problem, 17 195–196 Purchasing power parity, 58 INDEX real options, financial options (distinctions), Puts, 102, 105t, 133, 144t 188–189 put-call parity, 95, 116 returns, distribution (summary statistics), put-call relationship, 115 118–120 short put, 55f, 127, 131, 137–138, 141t risk-neutral option prices, subjective option p-value, defining, 24 prices (comparison), 117t value, factors, 188 Q Orders, fill-price, 202 Quarter Kelly, full Kelly (trading comparison), OTM calls/puts, 102, 130 169t Outperformance, determination, 24 Over-betting, 155, 158t R Overconfidence, 18 Range estimates, conversion, 195–196 Overnight effect, 75 Rational expectations hypothesis, 41 Overnight returns, volatility (reduction), 75 Rational expectations theory, 12, 41 Overoptimism, 19 Ratio spreads, 142–145 Realized skewness, 47 P Realized volatility, 86, 103f, 103t, 123t, 124t, Patterns, subjectivity, 22 140t Percentage-based trailing stop, usage, 168 Real options, 188–189 k k Trim