Book Review: No-Hype Options Trading

No-Hype Options Trading: Myths, Realities, and Strategies That Really Work. 2011. Kerry W. Given.

The trading of options is quite mysterious to many investors. Some view the use of options as nothing more than gambling. One may place small bets with the potential for very large gains. Unfortunately, just like bets at a casino, the options trader who bets on a large move in the price of an asset is rarely the winner because most such bets expire worthless. As Kerry W. Given (a.k.a. Dr. Duke), founder of Parkwood Capital, points out in No-Hype Options Trading: Myths, Realities, and Strategies That Really Work, “The casino establishes a game where the casino holds a statistical edge. . . . Your model for trading options should be the casino owner, not the player at the tables.” His goal is to teach investors how to profit from the use of options while intelligently managing the risks involved.

Market professionals who do not trade options as part of their official duties are likely to be surprised by how little they actually understand about the intricacies of options trading. Most readers of the Financial Analysts Journal have studied options in their academic work or in preparing for the CFA exams. Consequently, they are well versed in the basics of options strategies, including bull and bear spreads, butterfly spreads, and straddles. Some may even have continued their studies to learn about the so-called Greeks: delta, vega, theta, and gamma. But studying options theory and implementing an options-trading strategy are two different things. In this book, Given, who holds a PhD from the University of Minnesota and whose firm offers educational services on stock and options investing, attempts to strip away the misconceptions associated with options and provides serious strategies for the inexperienced options trader.

Although the title smacks of a fly-by-night book about get-rich-quick schemes, No-Hype Options Trading is a carefully written manual that takes risk management seriously. For every strategy Given offers, he considers the situations in which investors should contemplate the strategy, the risks involved, and the techniques available for managing those risks.

Given begins with four chapters that establish the foundations of options trading. They include a brief introduction to options, a basic look at the concept of probability distributions, a review of options pricing, and the fundamentals of vertical spreads. Market professionals can skim or even skip this introductory material, which is probably included to enable the book to be marketed to a wide audience.

For the reader who has not recently dealt with statistical theory, the chapter on probability distributions provides a good review of the concepts necessary for understanding options trading. It includes a set of problems that will enhance the reader’s grasp of the subject. The problems allow the reader to estimate the probability that a stock will finish above or below the target price. They can be solved with a free spreadsheet program that is downloadable from the author’s website. In the spreadsheet, Given does a good job of highlighting the assumptions and limitations of the spreadsheet estimates. He does not, however, offer any insight into how the estimates are calculated. For that, the reader will need to dissect the formulas in the spreadsheet and perhaps brush the dust off an old statistics text.

In keeping with Given’s belief that the model of the options trader should be that of the casino owner, the second half of the book focuses on strategies for generating income. These delta-neutral strategies rely not on directional bets with potentially large gains but, rather, on trades that profit from time decay on the positions. From the basic covered call writing to the more esoteric iron butterfly, long-term iron condor, and double diagonal spreads, Given takes the reader through a multitude of strategies that can generate income under various circumstances.

Throughout the book, Given provides examples of the key strategies in a cookbook manner, laying out recipes that the trader should follow. This step-by-step approach requires some simplification, but Given attempts to sharpen the reader’s understanding by providing problems at the end of each chapter. The problems enhance would-be options traders’ intuition and challenge them to think carefully.

Perhaps the most important aspect of the book is Given’s emphasis on creating a plan for trading options and sticking to it. The key to Given’s plan is risk management. His risk management system consists of four parts: stop loss order, adjustment, profit stop, and time stop.

For Given, placing an actual stop loss order when establishing the trade is essential. All too often, traders use what Given refers to as a “mental stop loss order,” which is rarely implemented during times of duress.

Adjustment concerns changes in the position that may help extricate the investor from an adverse price move. Although the book provides a number of adjustments that can be made, Given points out that each change needs to be evaluated carefully because many changes in the position will require additional capital.

Setting a profit stop often causes the investor to close a position before the hypothetical maximum profit occurs. Nevertheless, setting a profit stop is invaluable because some trades (e.g., the butterfly spread) have a very wide range of profit outcomes before expiration. The intelligent options trader will realize that the odds favor this type of strategy over the long run.

Finally, a time stop specifies a date by which the investor is willing to admit that the trade did not work out as planned. At that point, the position is closed in a directional trade. Given generally recommends closing a delta-neutral position on the Friday before the expiration week.

In summary, No-Hype Options Trading is a thoughtful guide to sound options-trading strategies that can serve as a valuable reference for both money managers with high-net-worth clients and investors seeking to generate income in their investment portfolios.

More book reviews are available on the CFA Institute website or in the Financial Analysts Journal.