Book Review: Positional Option Trading by Euan Sinclair

This is a review of Positional Option Trading by Euan Sinclair. 

Trading books set a low bar for the reviewer.

99% are full of facile feel-good advice (don’t fight the trend, always use a protective stop).

The 1% that are useful tend to either be dry technical treatments (quants who don’t trade), or sporadically helpful insights from traders who make money but don’t know why (traders who don’t quant.)

This book is a practical book by an experienced trader who writes clearly about what works, and why it works.

The first edition of Euan Sinclair’s Volatility Trading was a revelation for me as a trader. It’s a book written for the professional options trader. I was spreading futures when I read it and had barely traded an option contract. But it was an absolute revelation to me.

Why?

Because it did something much more valuable than teach me about volatility: it taught me how to think about trading.

Euan’s trading process and mental model of the market comes through strongly in this book. Reading this book will change the way you think about the markets and how to trade in a realistic, high probability way.

Positional Option Trading will be useful to all traders: not just options traders, and certainly not just professionals.

This book picks up where Option Trading (by the same author) left off. It assumes quite a lot of knowledge – so you should pick up Option Trading along with this if you haven’t already.

It starts with the basics of getting an edge and finishes with risk management. The material is advanced, but always practical. You will be well rewarded by repeated readings of this material – especially on sizing.

The material is intellectually honest. The author makes no attempt to draw firm conclusions when the data does not warrant it. Everything in trading is a trade-off made under immense uncertainty and the author makes no claim to the contrary. Valuable pointers are provided for the dedicated trader.

A Collection of Edges

A criticism of some serious trading books is that they don’t tell you exactly to trade. This book doesn’t either- but in Chapter 5 you are given a comprehensive list of quality edges backed by market intuition and empirical evidence. This is a valuable insight into what serious positional trading really looks like. Many retail traders will likely be surprised by the simplicity of these edges. (The author is careful to assert that these are edges and not rules.)

With a little work, you can include this stuff in your trading right away. It includes:

• The implied volatility forward curve as a predictor of variance premium returns
• Using fundamental factors (think Fama/French stuff) to predict cross-sectional equity option returns
• Trading the post-earnings announcement drift (PEAD) with vertical spreads
• Trading volatility over earnings announcements
• The tendency of the volatility risk premium to be concentrated overnight
• Trading pre-FOMC SPX trend effects, and selling volatility over the announcement
• The tendency for “time” to be mispriced on non-trading days (despite this sounding dumb)
• Timing the volatility risk premium at VVIX extremes
• Trading reversal effects on stocks that move big ahead of earnings
• Trading the pre-announcement drift in late reporting stocks.
• At times the book is hilarious. It’s a very easy read, despite the advanced subject matter.

Breakdown

Chapter 1 covers the basics of options pricing models. You probably won’t understand this if you don’t already understand it. So buy Euan’s Option Trading too.

Chapter 2 covers the Efficient Market Hypothesis in a practical and entertaining way. “The traders’ concept of the efficient market hypothesis (EMH) is ‘making money is hard’. This isn’t wrong, but it is worth looking at the theory in more detail.” This chapter makes a helpful distinction between inefficiencies and mispriced risk premia.

Chapters 3 and 4 look at volatility forecasting and the volatility risk premium. These are very good treatments if you are already familiar with the subject matter.

Chapter 5 gives you 10 edges to trade. I would have killed for this chapter when I was starting out.

Chapter 6 shows the P&L distribution of volatility positions. It’s a very useful reference.

Chapter 7 extends the BSM framework to incorporate directional views. This is eye-opening and gives the reader a simple framework for strike and strategy selection. The author is careful to point out that the utility of this is dependent on your ability to predict returns (which probably isn’t very good.)

Chapter 8 shows the P&L distribution of directional options structures.

Chapter 9 discusses trade sizing and the Kelly criterion. It incorporates estimation uncertainty, skew of returns, and stop losses in the treatment. As far as I am aware it is unique in doing so (especially the treatment of stop losses.) This is a challenging chapter – but will be extremely rewarding if you go through it carefully.

Finally, Chapter 10 covers non-obvious risks to the trader.

Summary

If you are serious about option trading, get this book and Option Trading by the same author.

If you’re a trader with no intention of trading options you’ll still get an enormous amount out of the book. It will teach you how to think about high probability trading.