Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for April 2024 (Final)

Momentum Investing Strategy (Strategy Overview)

Allocations for April 2024 (Final)
1st ETF 2nd ETF 3rd ETF

A Few Notes on The Market Taker’s Edge

| | Posted in: Equity Options

In his 2011 book entitled The Market Taker’s Edge: Insider Strategies from the Options Trading Floor, author Dan Passarelli “offers lessons from the trading pits from the perspective of a professional trader turned options evangelist for the benefit of both aspiring professional traders and nonprofessional traders alike.” According to the book’s foreword: “What the trading industry has needed is a book that brings professional-trading experience and real-world know-how to the self-directed, individual trader; that is what Dan Passarelli’s book delivers.” Some notable points from the book are:

From Chapter 1, “My First Year in the Options Business” (Pages 2,13): “Mastery of the options game is about learning to exploit the nuances of a game of chance, not predicting the future. …Abstract thought is supremely necessary for an options trader, specifically in relation to the volatility component of option trading.”

From Chapter 3, “Spreading Risk” (Page 45): “Good option traders fit the trade to the outlook; amateurs fit the outlook to the trade.”

From Chapter 5, “The Zen of Trading” (Page 64): “Experienced traders…think like a casino; they don’t think like a gambler.”

From Chapter 8, “Using What You Know About Market Makers: Part 2” (Pages 108,110): “The strategy for middling the market [enticing the market maker to trade favorably off the bid or offer/ask] is to enter the order in such a way that one can assume the market maker is getting some edge. …When the bid and offer sizes are unbalanced (i.e., there’s a significantly greater number of contracts on one than the other), it sometimes indicates market makers’ preference as to whether they would rather buy or sell midmarket.”

From Chapter 9, “Using What You Know About Market Makers: Part 3” (Page 120): “Try to avoid trading opens and closes. It’s always best to trade in high liquidity.”

From Chapter 17, “The Symbiotic Relationship of Makers and Takers” (Pages 210-212): Market takers make a living selling options (or option positions) at a higher option premium than that at which they buy. Market makers make a living by selling at a higher volatility than that at which they buy. …Market makers typically know down to the tenth of a volatility point exactly what the volatility of the bid and the offer are as well as their theoretical value. …The volatility market is inefficient because of the number of market participants who…are not trading volatility.”

From Chapter 18, “Playing the Numbers” (Page 219): “…because volatility tends to revert to its mean, when volatility is above or below its mean–especially significantly–traders should try to figure out why.”

Some reservations regarding the advice in the book are:

  • The most specific examples of edges discussed in the book are those of market makers. Readers may be disappointed in the lack of specificity regarding edges for market takers. The book mostly addresses how equity options work, not statistical analysis of the profitability and reliability of option trading strategies.
  • Readers may find the author’s ambivalence about prediction frustrating. For example, from Page 216: “Analysis of volume and open interest is much like technical analysis using a stock chart and indicators. It doesn’t predict the future. It takes available data and helps its analyzer better understand what has been going on, so he or she can make more informed decisions about the future.” What is the difference between making “more informed decisions about the future” and prediction?
  • As noted in the book’s disclaimer, “examples may not include commissions, fees, margin, interest, taxes, or other transaction costs. These types of transaction costs will impact the outcome of all…trades…”

In summary, option traders may find the “casino” perspective of The Market Taker’s Edge useful as background on option market operations, but the book does not offer statistical analysis of strategies and tactics accessible to market takers.

Daily Email Updates
Filter Research
  • Research Categories (select one or more)