Systematic Options Trading: Evaluating, Analyzing, and Profiting from Mispriced Option Opportunities

350 Pages·2010·7.6 MB·English

by  Sergey

Systematic Options Trading

Evaluating, Analyzing, and Profiting from Mispriced
Option Opportunities

Sergey Izraylevich and
Vadim Tsudikman
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Printed in the United States of America

First Printing September 2010

ISBN-10: 0-13-708549-4

ISBN-13: 978-0-13-708549-1

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Library of Congress Cataloging-in-Publication Data

Izraylevich, Sergey, 1966-
Systematic options trading : evaluating, analyzing, and profiting from
mispriced option opportunities / Sergey Izraylevich and Vadim Tsudikman.
p. cm.
ISBN-13: 978-0-13-708549-1 (hardback : alk. paper)
ISBN-10: 0-13-708549-4
1. Stock options. 2. Options (Finance) 3. Investment analysis. 4. Portfolio
management. I. Tsudikman, Vadim, 1965-II. Title.
HG6042.I97 2011
332.63'2283—dc22
2010006153
This book is dedicated to Professor Uri Gerson, Hebrew University of
Jerusalem.
Contents

Introduction

PART I Criteria as the Basis of a Systematic Approach

chapter 1 General Presentation and Review of Criteria Properties

1.1 The Main Tool for Solving the Selection Problem

1.2 Formal Definition

1.3 Philosophy of Criteria Creation

1.4 Mission Fulfilled by Criteria

1.5 Forecast as a Key Element of the Criterion

1.6 Classification of Criteria

1.6.1 Universal Criteria

1.6.2 Specific (Nonuniversal) Criteria

chapter 2 Review of the Main Criteria

2.1 Criteria Based on Lognormal Distribution

2.1.1 Description of Lognormal Distribution

2.1.2 Expected Profit on the Basis of Lognormal Distribution

2.1.3 Profit Probability on the Basis of Lognormal Distribution

2.2 Criteria Based on Empirical Distribution

2.2.1 Description of Empirical Distribution

2.2.2 Expected Profit on the Basis of Empirical Distribution

2.2.3 Profit Probability on the Basis of Empirical Distribution

2.2.4 Simplified Calculation Algorithm

2.2.5 Modifications of Empirical Distribution

2.3 Criteria Based on the Ratio of Expected Profit to Loss
2.3.1 Basic Concept and Criteria Calculation Method

2.3.2 Criteria Calculation Example

2.4 Criteria Based on Expert Distribution

2.4.1 Basic Concept and Criteria Calculation Method

2.4.2 Set of Standard Distributions

2.4.3 Combining Separate Standard Distributions into a Unified
Probability Density Function

2.4.4 Criteria Calculation on the Basis of the Unified Probability
Density Function

2.4.5 Construction and Valuation of Complex Strategies Based on the
Unified Probability Density Function

2.5 Specific (Nonuniversal) Criteria

2.5.1 Break-Even Range

2.5.2 IV/HV Ratio

2.5.3 Relative Frequency Criterion

2.5.4 The Ratio of Normalized Time Value to the Coefficient of Absolute
Price Changes Distribution

chapter 3 Evaluation of Criteria Effectiveness

3.1 Introduction

3.2 Methods of Criteria Effectiveness Evaluation

3.2.1 Correlation Between a Criterion and Profit as the Main
Effectiveness Indicator

3.2.2 Transformation of the Criteria Effectiveness Indicator

3.2.3 The Dynamics of Transformed Effectiveness Indicators

3.2.4 Selection of the Averaging Period

3.3 Peculiarities of Criteria Effectiveness Evaluation

3.3.1 Number of Combinations Used in the Analysis

3.3.2 Expressing Profit
3.3.3 Expressing Effectiveness Indicators

3.4 Review of Criteria Effectiveness Indicators

3.4.1 Correlation Between Criterion and Profit Values

3.4.2 Correlation Between a Criterion and Profit Indexes

3.4.3 Correlation Between the Sharpe Ratios of Criterion and Profit

3.4.4 Areas Ratio

3.4.5 Other Effectiveness Indicators

3.5 Summary

PART II The Main Areas of Criteria Application

chapter 4 Selection of Option Combinations

4.1 Introduction

4.2 Analysis of Criteria Effectiveness in the Selection of Option
Combinations

4.3 Factors That Affect Option Combinations Selection

4.3.1 Absolute Values of the Criterion

4.3.2 Strategy and Underlying Assets

4.3.3 Simultaneous Analysis of Factors Affecting Combinations
Selection

4.4 Multistrategy, Long-Term Evaluation of Criteria Effectiveness

4.4.1 Methods

4.4.2 Results

4.5 Summary

chapter 5 Selection of Option Strategies

5.1 Introduction

5.2 Evaluation of Criterion Effectiveness by Ranking Analysis

5.2.1 Methods of Ranking Analysis

5.2.2 Results of Ranking Analysis
5.2.3 Generalized Ranking Analysis and Introduction of the Threshold
Parameter

5.2.4 Results of Generalized Ranking Analysis

5.2.5 Maximum Obtainable Values of the Criterion Effectiveness
Coefficient

5.3 Traditional Methods of Evaluating the Criterion Effectiveness

5.4 Synthetic Approach to Criterion Effectiveness Analysis

5.5 The Model for Optimizing the Threshold Parameter

5.6 Summary

chapter 6 Selection of Underlying Assets

6.1 Introduction

6.2 Analysis of Criteria Effectiveness in Selection of Underlying Assets

6.3 Multistrategy, Long-Term Evaluation of Criteria Effectiveness

6.3.1 Methods

6.3.2 Results

6.4 The Optimization Model for the Number of Underlying Assets

6.4.1 Utility Indicators

6.4.2 Utility Functions

6.4.3 Convolution of Utility Functions and Deriving Optima for
Different Strategies and Criteria

6.5 Summary

PART III Multicriteria Analysis

chapter 7 Basic Concepts of Multicriteria Selection as Applied to Options

7.1 Introduction

7.2 The Pareto Set

7.2.1 The Algorithm of Forming the Pareto Set

7.2.2 Widening the Pareto Set and the “Layer” Notion