Introduction

Successful option trading can be difficult. Of that there can be no doubt. It does not take long for a new trader to realize that a “surefire” strategy is just a quick way to lose money. Moreover, the complexities of the option market often cause a prospective trader to become discouraged and simply give up in frustration.

This does not mean that success in option trading is an unattainable goal. But in order to reach that goal it is necessary to gain a full understanding of options, including the principles of option evaluation, strategy selection, risk management, and market dynamics. While this knowledge can be gained through actual trading experience, for a new trader with no foundation, mastering these principles simply by trading can be an extended, and perhaps costly, undertaking.

So where should a new trader begin? A good place to start is with a well-written text on options, of which there are many. It is important for a new trader to find a book with which he or she is comfortable. Some texts take a theoretical approach to options, with the expectation that the reader will have a solid grasp of advanced mathematics. Others take a more intuitive approach, but are still able to cover the most important aspects of option trading. Additionally, universities, exchanges, and brokerage firms may offer classes on options that are open to the public and can be a valuable tool in the educational process. Firms that trade options professionally—financial institutions, hedge funds, market-making firms—often have internal education programs to train their traders. These, unfortunately, are rarely open to the public.

Once a trader has the necessary foundation, the next step is to practice and become comfortable with what has been learned. This is the goal of this workbook. By completing the exercises contained herein a trader will achieve a working understanding of the important principles, as well as a comfort level that will enable him or her to enter the option market with increased confidence.

Finally, the aspiring trader must actually enter the option marketplace and apply in the real world what has been learned. While success can never be guaranteed, the efforts that have been made mastering the principles of option evaluation and risk management will give the trader the best chance of reaching his or her goal.

The exercises in this book cover a broad range of topics, from the very basic to quite advanced. A professional trader who needs a complete understanding of options should plan to complete all the exercises. Those with a specialized option application in mind—hedgers, speculators, portfolio managers—may find some exercises more valuable than others. And indeed, it may be reasonable to skip over some of the more advanced exercises.

Although this workbook was initially intended to accompany my book Option Volatility and Pricing, for most readers the workbook can probably stand alone. Many of the exercises are preceded with a brief discussion of the principles involved, and the answers and explanations to each exercise should be reasonably clear. Moreover, in the hands of a capable instructor, the exercises can form the basis for a complete course in option trading. The exercises can also be used as templates for additional exercises on the same topic.

For those exercises requiring computation, depending on whether the calculations are done by hand, with the aid of a calculator, or on a spreadsheet, there may be some rounding errors resulting in answers slightly different from those given in the in the answer section. However, these errors should be very small. Whether the answers are correct or not should be obvious.

Every effort has been made to avoid exercises and questions that are ambiguous or have multiple solutions. This is obviously necessary in a workbook of this type. Unfortunately in the real world of option trading there may not be one correct and unambiguous solution to every trading situation.