Wednesday, January 20, 2010

Saliba, Options Strategies for Directionless Markets

Some months ago I reviewed Anthony J. Saliba’s Option Spread Strategies. The book I’m looking at today has a more limited focus, as the full title indicates--Option Strategies for Directionless Markets: Trading with Butterflies, Iron Butterflies, and Condors (Bloomberg Press, 2008). The bonus is an interview with Saliba about the evolution of the options markets and how he traded butterflies.

The book is designed for someone who has a grasp of some of the fundamental building blocks of options trading—puts, calls, and vertical spreads. No knowledge of the Greeks is required because the author spends two chapters dealing with them. In the first chapter he provides an overview; in the second he shows how the Greeks impact butterflies.

The bulk of the book describes the structure of butterflies and condors and their variants such as iron butterflies and condors, broken-wing butterflies, pterodactyls, and iron pterodactyls. A single chapter is devoted to strategy application. Risk management is for the most part ignored.

This is a basic book that in its title purports to offer strategies for directionless markets. But, curiously enough, the strategy chapter analyzes not so much directionless markets as markets in transition. The summary statement reads in part: “The key to all of the butterfly (condor) strategies discussed in this chapter is capturing a transition, a particular change in market conditions that adds to the value of a long butterfly or condor position. By correctly anticipating a change in market conditions, whether it is the underlying’s price, time until expiration, or a decline in implied volatility levels, the trader may be able to realize a profit from a properly placed long butterfly or condor position.” (p. 143) This is a far cry from the common notion that butterflies and condors are appropriate for markets that are going nowhere. Even though we know that butterflies and condors are flexible positions that can easily be structured to reflect a directional bias and adjusted in response to a change in conditions, Saliba doesn’t devote enough space to this topic. The reader who is enough of a novice to need an introduction to the Greeks is going to be mighty confused by this chapter.

The book is beautifully laid out, with ample figures to illustrate the author’s points. It is designed for the student, with exercises, quizzes, and a final exam. In the final analysis, however, the reader is barely equipped to paper trade; no reader should consider himself ready to put his money on the line trading butterflies and condors until he’s done a lot more studying and practicing.

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