Options Trading Strategies – Book Review – Guy Cohen, The Bible of Options Strategies

Most of the trading literature on option strategies tends to lean towards mathematical formulas to define the construction of a spread. Guy Cohen has chosen to use pictorial logic, even with the unique Greeks in a particular strategy, to join the legs of a sheet with diagrams.

Diagrams that connect together are a much more intuitive way to learn for those less inclined to number formulas. Still, the logic of mathematics remains solid and intact.

The layout of the book makes it easy to navigate through the text. In addition to the strategies listed by chapter and page, there is a reference to the main strategy category with subcategories, which are:

• Competition: Beginner, Intermediate, Advanced and Expert Trader.
• Direction: Bullish, Bearish and Neutral Direction.
• Volatility: High Volatility and Low Volatility.
• Risk/Reward: Limited Risk, Unlimited Risk, Limited Reward, and Unlimited Reward.
• Type: Income and Capital Gain.

Guy Cohen has extensive experience in the US and UK equity and derivatives markets. He specializes in trading and analysis applications ranging from real estate to derivatives and has developed comprehensive business, trading and training models, all expressly designed for maximum ease of use.

There are proper reader reviews on Amazon and Google Book Search, to help you decide if you’ll get the book. For those who have just started or are about to read the book, I have summarized the basics in the larger, essential chapters to help you read them faster.

The number to the right of the chapter title is the number of pages contained in that chapter. It is not the page number. The percentages represent how much each chapter makes up out of the 302 total pages, excluding appendices.

1. The four basic option strategies. 20, 6.62%. 2. Income strategies. 68, 22.52%. 3. Vertical spreads. 30, 9.93%. 4. Strategies of volatility. 56, 18.54%. 5. Lateral strategies. 44, 14.57%. 6. Leveraged strategies. 20, 6.62%. 7. Synthetic Strategies. 54, 17.88%. 8. Taxation of Stock and Options Traders. 10, 3.31%.

Focus on chapters 2, 4, 5, and 7, which make up about 74% of the book. These chapters are relevant for practical business purposes. These are the key points of these focus chapters, which I am summarizing from the perspective of a retail options trader.

Chapter 2: Income Strategies. These strategies build spreads where part of the spread sells Theta as a premium on a shorter time frame (typically 30-45 days) to raise income. In its entirety, the strategy may result in a Net Debit or Net Credit spread. There are 13 types of spreads in this category: Covered Call, Short (Naked) Put, Bull Put Spread, Bear Call Spread, Long Iron Butterfly, Long Iron Condor, Covered Short Straddle, Covered Short Strangle, Calendar Call, Diagonal Call, Calendar Put , Diagonal Put and Covered Put (also known as Married Put).

Chapter 4: Strategies for volatility. These strategies use spreads that are indifferent to price direction, as long as the price shoots out of range. For a given price explosion, the volatility of the spread should increase for a Net Debit spread and decrease for a Net Credit spread. There are 11 spread types defined in this category: Straddle, Strangle, Strip, Strap, Guts, Short Call Butterfly, Short Put Butterfly, Short Call Condor, Short Put Condor, Short Iron Butterfly and Short Iron Condor.

Chapter 5: Lateral strategies. These strategies involve non-directional spreads, which require the price to move within a limited range. As the price remains within the range, the volatility of the spread should increase for a Net Debit spread and decrease for a Net Credit spread. There are 11 types of spreads in this category: Short Straddle, Short Strangle, Short Guts, Long Call Butterfly, Long Put Butterfly, Long Call Condor, Long Put Condor, Modified Call Butterfly, Modified Put Butterfly, Long Iron Butterfly and Long Iron Condor.

Chapter 7: Synthetic Strategies. Synthetic strategies mimic the risk profile of a stock, futures or other options position by combining calls, puts with or without shares. Typically, though, most synthetic positions are either long or short stocks. If you have a 401K or employee stock purchase plan that is a long stock, then it may make sense to consider synthetic strategies, since you already have a long Delta. There is unlimited risk for some synthetic spreads, regardless of whether the strategy involves stocks or not. There are disadvantages to using synthetics. 12 types of spread are defined in this category: Collar, Synthetic Call, Synthetic Put, Long Call Synthetic Straddle, Long Put Synthetic Straddle, Short Call Synthetic Straddle, Short Put Synthetic Straddle, Long Synthetic Future, Short Synthetic Future, Long Combo, Combo short and long box.

From a retail options trader’s point of view, I prefer to set positions without the use of stocks. The synthetic use of shares in a position makes each trade more capital intensive than necessary. Especially, if your trading account is below USD $50,000. The use of equities in the setup of these positions adds no material merit in risk control and there is no additional monetary benefit in tying up available trading capital in a synthetic equities-dependent position that could otherwise be achieved without the use of equities . As an options trader, you want to have as little equity participation as possible in the first place, apart from setting up the required option position around the underlying product, which can be substituted with a cash-settled index instead of a stock. Liquidated index.

From a total of 56 strategies covered in the book, I have narrowed the list down to 35 risk-limited types that do not need to include stocks as part of their original construction. Limited Risk means that there is a cap on the maximum loss – “Cap Risk” is the term used in the book. This should always be the starting point of any strategy you decide to build. Don’t just look at the unlimited profit (uncapped reward) side of the strategy without realizing that there is an unlimited loss (uncapped risk) side to the same strategy.

Limited risk spreads with “unlimited” reward and its directional perspective.

1. Long call. Bullish.
2. Long position. Bearish.
3. Put the retroactive relationship. Bearish; reverse bullish.
4. Reverse propagation of the calling relationship. Bullish; reverse bearish.
5. Astride. Indifferent/ – Neutral.
6. Strangle. Indifferent/ – Neutral. 7. Pull. Bearish.
8. Leash. Bullish.
9. Guts. Indifferent/ – Neutral. 1-9 are debit differentials: IV should increase.
10. Bull Put Ladder. Bearish. 10-11 are credit spreads: IV must fall.
11. Bear Call Ladder. Bullish.

Limited risk limited reward spreads and their directional perspective.

12. Spread Bear Put. Bearish.
13. Spread of bullish calls. Bullish.
14. Schedule of long calls. Bullish; Indifferent/ – Neutral.
15. Long Putting Calendar. Bullish; Indifferent/ – Neutral.
16. Butterfly long call. Indifferent/ – Neutral.
17. Long set butterfly. Indifferent/ – Neutral.
18. Long Box. Indifferent/ – Neutral.
19. Condor long call. Indifferent/ – Neutral.
20. Condor put long. Indifferent/ – Neutral.
21. Long iron butterfly. Indifferent/ – Neutral.
22. Long iron condor. Indifferent/ – Neutral. 12-22 are debit spreads: IV should increase.
23. Bear call propagation. Bearish. 23-35 are credit spreads: IV must fall.
24. Margin Bull Put. Bullish.
25. Short iron butterfly. Indifferent/ – Neutral.
26. Short iron condor. Indifferent/ – Neutral.
27. Diagonal call. Bearish.
28. Put diagonally. Bullish.
29. Modified butterfly call. Bearish to – Neutral.
30. Butterfly set modified. Bullish to – Neutral.
31. Short put (naked). Bullish.
32. Short butterfly call. Indifferent/ – Neutral.
33. Short call Condor. Indifferent/ – Neutral.
34. Short butterfly set. Indifferent/ – Neutral.
35. Condor put short. Indifferent/ – Neutral.

In addition to the 35 defined risk spreads that do not require stocks as part of your original construction for entry, there are 6 defined risk spreads that require stocks to set up your positions. The 6 positions I have deliberately excluded from the above list are Long Call Synthetic Straddle, Long Put Synthetic Straddle, Synthetic Call, Synthetic Put, Collar, and Covered Call.

In conclusion, for new and intermediate traders, don’t be overwhelmed by the 56 strategies in the book. It is titled the “Bible of Options Strategies” for a reason. What is critical is gaining a thorough understanding of buy long, sell long, buy short, sell short, vertical long buy/sell, vertical short buy/sell, and calendar long buy/sell. Those are the 4 basic options strategies, plus the vertical and the calendar, the only 2 strategies that floor traders define as true spreads. The other combinations are a mix of the basic ones with or without broth.