Options for Volatile Markets
Richard Lehman and Lawrence G. McMillan · 2011 · 217 pages
This is a mechanics book, not a strategy book: it hands you the actual formulas for pricing a covered call, a put hedge, and a collar before you place the trade. The one speculative idea in it, a perpetually-long VIX call strategy, is backed by only four years of data and one crash.
The one idea
The book's real argument is that stockholders already have a full toolkit for managing risk sitting in the options chain, and most of them never price it out. Covered call writing, put hedging, and collars are not competing strategies so much as three settings on the same dial: how much upside are you willing to give up for how much downside protection, and what does that trade actually cost in dollars and percentage points, not vague terms like 'some protection.'
Lehman and McMillan walk through each piece with the same discipline: define the position, show the payoff diagram, then run the actual numbers on a hypothetical stock. A covered write is priced with two formulas, return if exercised and return if unchanged, both annualized so you can compare unlike expirations. A put hedge is priced by its time value alone, which the authors show varies with duration (as the square root of time, not linearly) and with volatility (linearly, for at-the-money puts). A collar combines both, selling a call to fund the put, and the book shows five different strike combinations on the same stock so you can see the risk/reward trade-off directly instead of guessing at it.
The last third of the book turns to volatility itself, treating VIX as a contrarian indicator (it moves opposite the market about 75 percent of the time, the authors report) and as a tradable instrument through VIX options and futures. The most interesting claim in the book is that buying out-of-the-money VIX calls every month, indefinitely, was profitable across the 2006-2010 period the authors tested, something they say they have not found to be true of any other underlying instrument when bought this way.
What it actually teaches
The book is organized as four distinct risk-management tools rather than a single sequential system, each with its own pricing math.
PRICE THE COVERED WRITE WITH RIE AND RU
Return if exercised (RIE) is the option premium plus any gain in the stock up to the strike, divided by the stock's cost, then annualized. On the book's own example, buying 100 shares of XYZ at $48 and selling a 60-day $50 call at 2 gives a raw RIE of 8.33 percent and an annualized RIE of 50.67 percent. Return if unchanged (RU) assumes the stock sits flat at expiration: on the same trade that is a raw 4.17 percent, or 25.37 percent annualized. The book has you run both before comparing any two covered writes, since RIE alone flatters out-of-the-money strikes that rarely get there.
COST THE PUT HEDGE BY TIME VALUE, NOT PREMIUM
The real cost of a put hedge is only its time value, the part you lose if the stock sits still, not the full premium. On a $50 stock at 25 percent implied volatility with 60 days to expiration, an at-the-money put costs $2.00, about 4 percent of the position's value for that period. Cost does not scale linearly with time (a 6-month put costs less than two 3-month puts back to back, because price moves with the square root of time) but does scale roughly linearly with volatility for at-the-money strikes. The book's own table shows a 30-day at-the-money put on a 30-volatility stock (their Boeing comparison) running 42 percent annualized, versus 12 percent for a one-year LEAPS put on the same stock.
FUND THE PUT BY SELLING A CALL: THE COLLAR
A collar sells a call to offset the cost of a protective put on the same stock. The book's worked example uses a $62 stock at 90 days and 25 percent volatility: a tight 65/60 collar risks a maximum of 3.6 percent of the position for a maximum gain of 4.5 percent, while a wider 70/55 collar risks 11.4 percent for a possible 12.7 percent gain. A 'no-cost' collar, where the call fully pays for the put, exists but pushes both strikes toward the current price, which caps the upside near zero. The authors cite a 2009 University of Massachusetts study (Szado and Schneeweis) that tested a passive 2 percent out-of-the-money collar on QQQ, using a 6-month put against monthly calls, across 122 months from March 1999 to May 2009: it beat buy-and-hold on a total-return basis and sharply cut standard deviation in every sub-period tested.
READ VIX AS A CONTRARIAN SIGNAL, THEN CONSIDER THE OVERLAY
VIX trades opposite the broad market's direction roughly 75 percent of the time, and a spike peak, not any fixed numeric level, marks a buy signal for stocks; the rule is to exit if VIX makes a new high after you enter, then wait for the next peak. Separately, the authors backtested buying one-month, out-of-the-money VIX calls every month from the start of VIX options trading in 2006 through mid-2010, three strikes out of the money, and found it produced roughly 30 points ($3,000 per call) of profit over the study, driven almost entirely by the 2008 crash and the May 2010 flash crash.
What it looks like Monday morning
A reader who already owns a stock or ETF portfolio starts running the RIE and RU math before selling any covered call, rather than picking the strike with the fattest premium, and starts pricing a collar's actual cost and cap on a core holding before an earnings date or a Fed meeting instead of just guessing that 'options would help here.'
That reader does not walk away with a new way to pick stocks or time entries. The book gives you the pricing tools for managing risk you already have, not a source of new returns, and the one part of the book that reads like a trading idea, the perpetual VIX call purchase, comes with an explicit warning from the authors that they cannot tell you in advance which months it will lose money.
| Collar | Net outlay | Max risk | Max gain |
|---|---|---|---|
| 60/55 | 58.46 | 5.9% | 2.6% |
| 65/60 | 62.21 | 3.6% | 4.5% |
| 65/55 | 60.74 | 9.5% | 7.0% |
| 70/60 | 63.38 | 5.3% | 10.4% |
| 70/55 | 62.11 | 11.4% | 12.7% |
Figures are for the 90-day period and are not annualized; wider strike spreads trade more downside risk for more upside room.
It's much the same logic as betting on the horse at 10-1 odds instead of the horse with 2-1 odds.Richard Lehman and Lawrence G. McMillan, Options for Volatile Markets
Where it fails
- The one 'always works' finding rests on four years and one crash. The perpetual long VIX call backtest runs only from the start of VIX options trading in 2006 through mid-2010. Nearly all of its profit came from the 2008 credit crisis and the May 2010 flash crash. The authors themselves write that whether the pattern continues is uncertain, and that they know of no other underlying instrument where buying calls every month, indefinitely, has ever produced this result.
- Every backtest in the book stops before this edition went to print. The BXM/BXY covered-write comparison runs 1988-2010, and the QQQ collar study cited runs March 1999 to May 2009. None of the book's evidence covers the 2018 volatility-product blowup, the 2020 COVID crash, or the 2022 rate-driven regime, all of which changed how VIX derivatives actually behave in a real crisis.
- It assumes you already have margin, options approval, and a screener. The covered-write comparisons in Chapter 3 are described as 'handily accomplished by a computer for all potential covered writes on all optionable stocks,' which presumes a funded margin account and scanning software. A reader without options approval or a paid data feed gets the formulas but not a way to apply them quickly.
- The duration advice is built on a market that barely had weekly options. The book notes that weekly options were, at the time of writing, 'available only on a dozen or so stocks and ETFs.' Its recommendation to write one-to-three month covered calls (Tables 3.3 and 3.4) was calibrated to that limited menu. Weeklies now exist on hundreds of names, which changes the annualized-return math the book uses to justify shorter durations.
- The VIX product landscape it treats as new has since been rebuilt. The book discusses VIX futures, VIX options, and volatility ETNs like VXX and VXZ as recent innovations worth learning. Several of the leveraged and inverse volatility products that followed the same design logic, most infamously the ones structured like the later-delisted TVIX and the 2018 XIV blowup, failed in ways this 2011 edition had no way to warn readers about.
Who it is for
Buy it if
Buy this if you already hold a stock or ETF portfolio and want the actual formulas for what a covered call, put hedge, or collar costs and pays before you place the trade, not just the payoff diagrams every other options book repeats.
Skip it if
Skip it if you are looking for a source of trading edge rather than a way to manage risk on positions you already hold, or if you do not yet have margin and options approval, since the book assumes both and spends no time on account setup.
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