Option Volatility & Pricing
by Sheldon Natenberg
Options Volatility & Pricing is widely regarded as one the most important books in the Options trading industry. This book covers everything regarding options which makes this a great book for both beginners and advanced options traders. Some of the advanced topics do get pretty complex, but Natenberg explains them pretty clearly, so it’s not too hard to follow along.
The book covers more complex trading strategies that involve using several options at once—such as vertical, calendar, and diagonal spreads, along with my favorites - straddles and strangles.
Natenberg also shows simple ways to trade on changes in market volatility and advanced tips for managing risk, including building synthetic positions and finding arbitrage opportunities.
Here’s a breakdown of the main topics covered in Options Volatility & Pricing:
Trading Strategies
The majority of the book is dedicated to breaking down styles of advanced trading strategies and giving the data and statistics to back this approach up. Techniques including spreads, straddles, strangles, iron condors, and butterflies. Each strategy is analyzed in terms of risk/reward profiles, optimal market conditions, and potential pitfalls.
Volatility
Volatility, along with trading strategies, is the central theme in the book. Natenberg compares historical volatility, implied volatility, and volatility skew, highlighting how these concepts influence option pricing. He shows how traders can leverage this understanding to gain a tactical advantage in the market. High volatility increases the potential for significant price shifts, making options more expensive and attractive for traders seeking higher returns.
"All other factors being equal, in a high implied volatility market a hedger should buy as few options as possible and sell as many options as possible. Conversely, in a low implied volatility market a hedger should buy as many options as possible and sell as few options as possible." - Sheldon Natenberg, Options Volatility & Pricing
Dynamic Hedging
Natenberg goes into detail with dynamic hedging, which is all about making constant adjustments to keep your portfolio balanced in volatile markets. He shows how to use the Greeks to monitor and maintain your delta at the optimal level depending on your outlook for the market.
Risk Management and Trading Psychology
The importance of risk management can’t be understated in options trading. The book covers topics such as position sizing, stop-loss orders, and the psychological aspects of trading. In my opinion, this section is particularly important for newer options traders to fully understand.
"If one were to eavesdrop on conversations among traders, it would probably seem that no one ever made a losing trade. Disasters, when they do occur, only happen to other traders. The fact is every successful trader has had his share of disasters.
What separates the successful options trader from the unsuccessful one is the ability to survive such occurrences." - Sheldon Natenberg, Options Volatility & Pricing
Theoretical Pricing Models
Natenberg explains in a pretty easy to understand way, the foundational pricing models, particularly the Black-Scholes model. Factors such as strike price, time remaining, current stock price, interest rate, and volatility all go into how these models come up with a price for the option. He explains the assumptions underlying these models and discusses their implications for traders.
My Thoughts
Although I wouldn’t recommend this book to new options traders, it does have everything a new options trader would need to know. The topics get pretty advanced, but they are written with clear explanations that make some of the complex topics much easier to understand. If you can understand everything in this book, you will have an edge in the options market.
If you've made it this far, I highly recommend checking out my book summary and review of The Unlucky Investor's Guide to Options Trading. It's probably my favorite book on options trading and investing.
