i would very much like to read a book (or any resource) that can guide me in position adjustments, that is, after putting a trade on, what potential follow-ups can be considered when the spot moves against the view, etc. All books I have seen talk about initial trades or delta hedge nothing on trade lifecycle.
Best technical options books as of 2018
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I think we both “get it.” It’s not that Sinclair is a good or bad book—it’s probably a good book to go from classroom to professional level proficiency—but the proficiency Sinclair or Natenberg are trying to impart on the reader is really only relevant to the first year options market maker. So the retail trader’s take away is a better understanding of the Greeks and a bunch of party tricks about cones and stuff because going home flat and managing the Greeks the way an OMM does is not applicable to the retail vol trader.
I would still hazard Sinclair. It will give you a little more context and help you go from thinking about strategies as static per the above to dynamic. Topics of interest covered by Sinclair may be:
- delta hedging
- gamma scalping
- position repair
There’s a ton of literature out there on these matters. I don’t know how many academics have written papers about practical delta hedging that cover t-costs and the phenomenon where hedging your delta doesn’t actually minimize variance because of the difference in moments (I don’t know the name of this phenomenon but it’s a thing...).
If you don't mind I have two questions for you:
1. Market is efficient in that there is no arbitrage opportunity? Or is the option market efficient such that the expectancy of someone playing long enough without knowledge is zero?
2. How options are priced? MM are the one setting the prices and bid/ask. Armed with simple BSM, all I can see is in the IV number and really no visibility as to how they arrived at that IV. Based on about six months and hundreds if not thousands of trades (covered calls), I could see that their models were very good - I netted about zero minus commissions. If I netted zero, they also netted zero. So they must make money through hedging?
After six months, I realized there was no free lunch, covered calls won't generate "free premium" for me to spend. Unlike MM, for us retails making money in options will require us to have a correct opinion of the underlying movement or IV or some combinations.
Finally do you have any suggestion how I can find the equations MM use?
No problem, I don't want you to think I'm some super trader or something. Just a passionate fan of the markets. I'll give it a shot though.
I think if you observe the general performance of CTAs in the last 30 years we can see that the EMH is more or less not-totally-true. Arbitrage is sort of ambiguous here. If you mean is there a way to make a risk-free profit? I think so, if you're fast enough. For retails I don't believe there are many arbitrage opportunities you can capitalize on.
If you mean arbitrage as in Arbitrage Pricing Theory I certainly think there is significant utility in understanding APT. Even for retails.
Answering this part is relatively difficult because it's pretty opinionated and I do not possess a PhD in financial engineering or economics.
Under the assumption that the expectancy of any trade is zero your argument there is that the markets are approximately martingale. That is, the best estimate of today's return is yesterday's. I don't think this is totally true given the mean reverting properties of some portfolios.
This is an incredibly complicated and interesting question. I can tell you the basic theory of how options are priced but I couldn't tell you how MMs do it.
Options MMs make money primarily through the spread. So your net zero on a one sided trade probably netted them the difference of making that market. As for IV it is implied because it is determined by the market (and extracted by working backwards from the BSM). They didn't really arrive at the IV so much as the market "priced in" (for lack of a better term) the IV you saw.
Models aren't forced into the BSM world. For example, there is the Bjerksund-Stensland Model (also BSM funny enough) as well as the binomial options pricing model. There are also many jump diffusion models with the BSM. What I am trying to say is simply that we can't know what model the MM you're referring to is using for pricing. We can be almost certain it isn't the Black-Scholes model, however.
I hope this helps. Feel free to shoot me a private message if you want to talk more.
Is Options, Futures, and Other Derivatives by Hull still considered the general bible on options? 9th edition is a bargain compared to the newest one.
If I'm not mistaken, Hull have actual experience as a trader and running a fund, so that's a big plus.
If I'm not mistaken, Hull have actual experience as a trader and running a fund, so that's a big plus.
More like the bible on derivatives. it covers way, way more than options. It's basically a full Financial Engineering degree in book form. If your goal is to get into the industry it's up there on must-reads and it's mathematical rigor is refreshing compared to most books. If your goal is leisure reading to improve your understanding of derivatives pricing it's also very good. However, if your goal is to just trade using your retail broker I'm afraid it is not likely you will get a ton out of it that you can make money with as a retail. You didn't state your level of mathematical sophistication but assuming you've made it through the normal university calculus series, ODEs/PDEs, and at least a few calculus based probability theory and statistics courses you will find Hull enlightening.
Pro tip: If you're looking to save money buy the international version or get it from the used books section of Amazon. I prefer international versions when available. They are cheaper because the publishers know they can't twist the knife on non-American students (amazing how the market adjusts to zero risk to lender student loans...) and are generally printed on cheaper paper (sometimes in black and white) so they mark them down sometimes nearly a full order of magnitude. Don't ever pay full price for university "gotta get mine" book markup. Additionally if you live near a university offering a Financial Engineering degree you could contact the school to put up an ad on the bulletin board (usually costs not much...) looking to purchase a 10th edition Hull for whatever you're willing to pay for it.
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Thanks, @gaussian! 
I've always wanted to read that book and it seems like it's precisely what I need now. My goal is mostly leisure reading and expanding my knowledge about derivatives. I currently day trade futures directionally, so don't plan on doing any business yet, but increased understanding of the marketplace is always good.
I'm an engineer, so know basic calculus. Hopefully, it's not too dense. Thank you for the tip on getting a good bargain.
I've always wanted to read that book and it seems like it's precisely what I need now. My goal is mostly leisure reading and expanding my knowledge about derivatives. I currently day trade futures directionally, so don't plan on doing any business yet, but increased understanding of the marketplace is always good.I'm an engineer, so know basic calculus. Hopefully, it's not too dense. Thank you for the tip on getting a good bargain.
Amazon has Options as a Strategic Investment: 5th Edition by Lawrence G. McMillan. I bought it few months ago and love it. He indeed describes what you're after. What you need to do when the trade moves against you. He calls it follow up and lists various fixes one can try. He shows several ways of repair for each strategy and explains which is better and from what point of view.
With a 25 VIX, that's feasible.
Try it with VIX of 10. Or 9. Or 8.
Best keep an eye on things, cuz "rolling for a credit" is a door that *can*close.*