Review: The Option Trader’s Hedge Fund by Dennis A. Chen and Mark Sebastian

Fri, Jul 13, 2012 | Jared Woodard

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There is a well-established formula when it comes to books about options. The typical options book has sections that explain what puts and calls are, that review the different spread types, that explain the greeks, and that discuss implied and historical volatility.  One reason I liked The Option Trader’s Hedge Fund: A Business Framework for Trading Equity and Index Optionsis that it breaks that formula. Chen and Sebastian approach options trading through the metaphor of “The One Man Insurance Company,” (TOMIC) explaining how a portfolio manager focused on options strategies is analogous to a traditional insurance business. Where an insurance company prices and underwrites a policy, an options trader looks for overpriced options to sell. Insurers purchase reinsurance policies to protect themselves from risks that they don’t want to take, just as options traders hedge away unwanted risk exposure in order to isolate their volatility thesis. Where an insurer works to acquire new customers, options traders work orders in the market to add to their portfolio of desired risk. 

TOMIC is a great metaphor for what option traders do, and in Part I the authors use it as a framework to cover other important aspects of trading-as-a-business, like infrastructure, the psychology of risk management, and performance tracking. Instead of just telling you to keep a trading journal, they show you how with some concrete examples. Position sizing, portfolio insurance with unit puts, and other aspects of risk management are also covered in this section.

Where the book excels the most, I think, is in Part II. This part of the book is all about when and how to trade intermediate and advanced options spreads. Chapter 9, the heart of the section, covers vertical spreads, iron condors, iron butterflies, time spreads, and ratio/back spreads. The authors quickly remind you what each spread type consists of before getting on with the discussion of the conditions under which each position should be used, methods for adjusting threatened trades, and examples of each spread type. Exit and adjustment conditions and profit goals receive as much attention as entry criteria, which is a real plus. You can often tell a serious options trader by the tools he or she doesn’t use. The strategies presented here don’t rely on input from fundamental or technical analysis, but on the analysis of volatility and order flow.

Part III, “Lessons from the trading floor,” is a collection of some of Mark’s best work at Option Pit over the last few years. The chapters are composed of quick hits on important topics that arise for experienced traders. Here is a small sample of some of the topics covered:

  • Understanding weighted vegas in SPX options
  • Four tips when the VIX is depressed
  • How option time value decays over the weekend
  • When you should worry about assignment
  • A butterfly trading checklist

The Option Trader’s Hedge Fund is not written for novices – as the authors state, it should not be the first book you ever read about options. But if you’ve traded some option spreads before and are looking for new ideas or for methods to improve your trading, this really is a great resource.

Disclosure: Mark Sebastian and I are cofounders, with Bill Luby, of Expiring Monthly: The Option Trader’s Journal.


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  1. Friday links: trade the plan | Abnormal Returns Says:

    [...] A nice review of The Options Traders Hedge Fund: A Business Framework for Trading Equity and Index Options by Mark Sebastian and Dennis Chen.  (Condor Options) [...]

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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