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Options in Volatile Markets: Managing Volatility and Protecting Against Catastrophic Risk, 2nd Edition


Praise for Options FOR Volatile Markets, Second Edition

"Once again, McMillan and Lehman have created new and insightful updates into the world of derivatives trading. Every time you think you've mastered the game, these two industry titans prove you wrong. It's uncanny. In fact, let me put it this way: If you think you know options markets, think again."
Richard Bensignor, President and Chief Strategist at Bensignor Strategies, Inc.; Editor of New Thinking in Technical Analysis

"Highly recommended for serious investors aiming to protect their portfolios from the next 'black swan' event. It's not a question of 'if' but 'when.' Be prepared with the tactics in this book."
Donato A. Montanaro, Jr., Chairman and CEO, TradeKing

"Options for Volatile Markets provides the reader with time-tested option strategies for capital appreciation, income generation, and limiting losses. As discovered during the financial hurricane of 2008, asset diversification is not enough. Properly implemented, option strategies can be the difference between financial success and failure during volatile times."
Kenneth G. Winans, CMT, MBA, President and Founder, Winans International; award-winning author and columnist

"The 'new normal' post-2008 world involves more than just lower returns, it comes with an overhang of serious risk to boot. This book provides clear strategies to both boost returns and protect against 'fat-tail' risks that can destroy capital."
Stephen Savage, Managing Partner, Litman/Gregory Asset Management

"Successful investment management over time is not driven by how much one makes, but rather by how much one consistently does not lose. The best investors and traders of which I know focus first on risk management and secondly on profit maximization. After witnessing the financial market volatility of the last decade, absolute returns and consistency of those returns should be a key objective of institutional as well as retail investors going forward. Lehman and McMillan provide a roadmap of creative, intelligent, and purposeful options strategies for achieving exactly this."
Brian Pretti, CFA, CFP, Chief Investment Officer, Mechanics Bank

RICHARD LEHMAN is the founderof RHL Capital, a registered investment advisor, and a part-time instructor of behavioral finance and options at UC Berkeley Extension. He is also the author of Far From Random, and publishes an investment newsletter called the Channelist. Lehman's financial career spans more than thirty years in product management, marketing, sales, and investment management beginning with an eleven-year stint on Wall Street with E.F. Hutton & Co., Thomson McKinnon Inc., and the New York Stock Exchange.

LAWRENCE G. McMILLAN is the founder and President of McMillan Analysis Corporation. He authors the Daily Volume Alerts, a unique daily service that selects short-term stock trades by looking for unusual increases in equity option volume. McMillan manages option-oriented accounts for individual investors and also publishes the Option Strategist, a derivative products newsletter covering equity, index, and futures options. McMillan's web site,, twice received a "Best of the Web" award from Forbes magazine. He is the coauthor, with Richard Lehman, of the first edition of this book and the author of McMillan on Options (Wiley) and Options as a Strategic Investment.

Preface xi


The “New Normal” in Equity Investing 1


Option Basics 7

What Are Options? 7

Exercise and Assignment 14

Positions 17

How Options Are Traded 19

Options in Your Account 22


Option Pricing and Valuation 25

Option Premium 25

Theoretical Value 27

Time Value 28

Volatility 31

Interest Rates 32

Dividends 32

Calls versus Puts 33

Option Skews and Anomalies 34


The Basics of Covered Call Writing 37

Requirements for “Valid” Covered Writes 38

Risk/Reward of a Covered Write 39

Calculating Potential Returns 46

Major Factors Affecting Call-Writing Returns 48

Covered Writing as an Ongoing Strategy 54

Summing Up Covered Writing 57


Implementing Covered Call Writing 59

Follow-Up Actions 59

Behavioral Issues 69

Differing Approaches 70

Selecting Calls to Write 77

Risks 80

Basic Tax Rules for Options 81

Summing Up Implementation 84


Advanced Call-Writing Techniques 87

Writing Calls on “Hot” Stocks 88

Tax Deferral Strategies 89

Covered Writing on Margin 90

Covered Writing against Securities Other Than Stock 93

Partial Writing, Mixed Writing, and Ratio Writing 98

Put Writing 103

Expiration Games 106

Option-Stock Arbitrage 108


Basic Put Hedging 111

Put Hedge Basics 111

Advantages 115

Disadvantages 116

Behavioral Implications 123

Put Hedge versus Covered Call 127

Hedging against Catastrophic Risk 129


Advanced Hedging Strategies 131

Put Hedge Follow-Ups 131

Using Put Spreads to Hedge 137

Collars 145

Conclusions on Protective Option Strategies 151


Options on ETFs 153

ETFs in a Nutshell 154

ETF Options 158

Covered Call Writing on ETFs 159

Our Put Hedge and Collar Study on SPY 162

Appendix: Partial List of ETFs with Listed Options 165


Volatility and Volatility Derivatives 171

What Is Volatility? 171

Using VIX as a Market Indicator 173

Volatility Futures 179

Variance Futures 181

The Behavior of VIX Futures 183

VIX Options 191

VIX Option Strategies 199

The Future 204

Acknowledgments 205

About the Authors 206

Index 207