Options as a Strategic Investment

Options as a Strategic Investment is widely regarded as the bible of options trading. First published in 1980 and now in its fifth edition, Lawrence G. McMillan's magnum opus runs over 1,100 pages and covers virtually every options strategy ever devised — from simple covered calls to complex volatility arbitrage. McMillan, a professional trader and former options market maker, writes with the authority of someone who has lived through every market cycle, and the book reflects decades of practical experience rather than academic theory.

The book's enduring appeal lies in its comprehensive yet accessible treatment of options. McMillan does not assume a mathematical background; he explains the Greeks, pricing models, and volatility concepts in plain English, then shows how to apply them through specific trade adjustments. The result is a reference work that beginners can grow into and that experienced traders return to for years.

Summary

The fifth edition is organised into eleven parts, each building on the previous. Part I covers the basics — what options are, how they trade, and the fundamental relationships between calls, puts, and the underlying stock. McMillan introduces put-call parity, the single most important concept in options pricing, and shows how arbitrageurs enforce these relationships. Parts II through IV present core strategies: covered calls, protective puts, straddles, strangles, and the full family of vertical, calendar, and diagonal spreads. Each strategy receives a full chapter with trade mechanics, breakeven analysis, profit-and-loss diagrams, and the specific market conditions under which it works — and, crucially, when it does not.

Part V covers volatility, the heart of modern options trading. McMillan distinguishes historical volatility (what the stock has done) from implied volatility (what the options market expects), explains how to calculate both, and provides a framework for assessing whether implied volatility is high or low relative to its own history. This section alone is worth the price of the book: it gives traders a repeatable edge that does not depend on predicting the direction of the underlying stock.

Parts VI through IX address advanced topics: index options and their cash-settlement mechanics, LEAPS (long-term equity anticipation securities), options on futures, and the unique characteristics of options on ETFs and currencies. Part X is a masterclass in risk management, covering position sizing, portfolio hedging, and the psychological discipline required to trade options profitably over the long term.

The final part, new to the fifth edition, covers practical trading — how to set up a trading plan, how to use technical analysis to time entries, and how to navigate the tax implications of options trading. An extensive appendix includes option symbols, margin requirements, and a glossary.

Key Takeaways

• Know your volatility regime: Before entering any trade, assess whether implied volatility is high or low. Buying options in low-volatility environments and selling in high-volatility environments is the closest thing to a free lunch in options trading.
• The Greeks are your dashboard: Delta measures directional risk, gamma measures acceleration, theta measures time decay, vega measures volatility sensitivity. Monitor all four, not just delta, to understand your true exposure.
• Adjust, don't just exit: McMillan advocates active management of positions. When a trade moves against you, consider rolling, hedging, or converting to a different strategy rather than taking the loss.
• Simple strategies outperform complex ones: Most of McMillan's personal trading uses covered calls, puts, and basic spreads. Exotic multi-leg strategies are often more profitable for the broker than the trader.
• Risk management trumps everything: No single trade should expose more than 2-3% of your capital to loss. Position sizing is the only variable you fully control.

Who Should Read

• Individual investors: The book teaches options as a strategic tool for income, protection, and speculation — not gambling.
• Professional traders: The depth of coverage on volatility, position adjustment, and advanced strategies is unmatched in any single volume.
• Students of finance: The practical treatment of options mechanics reinforces and contextualises academic pricing theory.
• Financial advisors: Understanding options helps advisors evaluate client portfolios that use or should use options-based strategies.

Who Should Skip

• Absolute beginners: Start with a shorter book like Understanding Options by Michael Sincere before tackling McMillan.
• Pure quantitative traders: If you want stochastic calculus and derivation of the Black-Scholes PDE, look to Hull or Wilmott.
• Passive investors: If you buy and hold index funds, options trading is unnecessary complexity.

Difficulty

Hard — Requires basic familiarity with stock markets and some comfort with numbers, but no advanced mathematics.

Reading Time

• Reading: 35-40 hours
• Listening: 30-35 hours

Related Books

• Option Volatility and Pricing
• Options, Futures, and Other Derivatives
• The Volatility Course
• Trading Options Greeks
• [Options as a Strategic Investment is the definitive reference — Natenberg is the definitive tutorial]

Final Verdict

Essential for anyone serious about options trading. McMillan's encyclopedic coverage, practical focus, and emphasis on risk management make this the single most valuable book on the subject. Own it, study it, and keep it on your desk.

The Foundation: Calls and Puts

Every options strategy, no matter how complex, is built from two basic instruments. A call option gives the buyer the right, but not the obligation, to purchase 100 shares of the underlying stock at a specified price (the strike price) on or before a specified date (the expiration date). A put option gives the buyer the right to sell 100 shares under the same terms. McMillan establishes these definitions in the first chapter and immediately moves to the pricing relationships that govern them.

The intrinsic value of an option is the amount by which it is in-the-money: for a call, the stock price minus the strike price; for a put, the strike price minus the stock price. Time value is everything else — the premium paid beyond intrinsic value, reflecting the possibility that the option will move further into the money before expiration. McMillan emphasises that time value decays at an accelerating rate as expiration approaches, a phenomenon known as theta decay.

graph LR
    A[Underlying Stock] --> B[Call Option]
    A --> C[Put Option]
    B --> D{In the Money?}
    C --> D
    D -->|Yes| E[Intrinsic Value + Time Value]
    D -->|No| F[Time Value Only]
    E --> G[Total Premium]
    F --> G
    G --> H[Breakeven: Strike + Premium for Calls]
    G --> I[Breakeven: Strike - Premium for Puts]

Put-Call Parity

McMillan devotes substantial attention to put-call parity, the fundamental relationship that links the prices of calls, puts, and the underlying stock. The relationship states that a synthetic stock position — long a call and short a put at the same strike — is equivalent to owning the stock. Any deviation from this relationship creates an arbitrage opportunity that professional traders will exploit, enforcing price consistency across the options chain.

The formula is: Call Price - Put Price = Stock Price - Present Value of Strike Price + Dividends

For the practical trader, put-call parity means that options prices cannot deviate too far from their theoretical values without triggering arbitrage activity. McMillan shows how to use this relationship to identify mispriced options, construct synthetic positions, and understand the implicit cost of early exercise.

The Greeks: Managing Risk with Precision

McMillan dedicates multiple chapters to the five primary Greeks, treating them not as academic abstractions but as practical tools for position management.

Delta measures the expected change in an option's price for a one-point move in the underlying. A call with a delta of 0.60 will rise roughly $0.60 if the stock rises $1.00. Delta also represents the approximate probability that the option will expire in-the-money. McMillan shows how to compute portfolio delta to understand overall directional exposure.

Gamma measures the rate of change of delta. High gamma means that delta itself changes rapidly as the stock moves, making the position difficult to hedge. Short options have negative gamma, which means the position loses delta as the stock moves against you — a phenomenon McMillan calls "getting run over by gamma."

Theta measures time decay. McMillan emphasises that theta is greatest for at-the-money options in the final weeks before expiration. Option sellers harvest theta; option buyers pay for it.

Vega measures sensitivity to implied volatility. McMillan argues that vega is the most misunderstood Greek — traders focus on delta while ignoring that a volatility collapse can destroy the value of long options even if the stock moves in the right direction.

graph TD
    subgraph "The Greeks"
        D[Delta - Directional Risk]
        G[Gamma - Acceleration Risk]
        T[Theta - Time Decay]
        V[Vega - Volatility Risk]
        R[Rho - Interest Rate Risk]
    end
    
    D -->|Hedging| P[Delta-Neutral Position]
    G -->|Adjustment| S[Gamma Scalping]
    T -->|Income| C[Theta Harvesting]
    V -->|Prediction| I[Volatility Trading]
    
    P --> M[Managed Option Portfolio]
    S --> M
    C --> M
    I --> M

Volatility Analysis

The single most important contribution of McMillan's book is its treatment of volatility. He distinguishes two types: historical volatility (HV), which measures the actual price movement of the underlying stock over a specified period, and implied volatility (IV), which is the market's forecast of future volatility derived from option prices themselves.

McMillan provides a detailed methodology for calculating HV using a 20-day or 50-day lookback period and annualising the result. He then compares HV to IV to determine whether options are cheap or expensive:

• IV \< HV: Options are cheap; consider buying (long premium strategies)
• IV > HV: Options are expensive; consider selling (short premium strategies)
• IV = HV: Options are fairly priced; no volatility edge exists

sequenceDiagram
    participant T as Trader
    participant M as Market
    participant O as Options Chain
    
    T->>M: Calculate Historical Volatility (HV)
    M-->>T: HV = 25% (from stock price data)
    T->>O: Check Implied Volatility (IV)
    O-->>T: IV = 32%
    Note over T: IV > HV → Options are expensive
    
    T->>T: Consider selling premium strategies
    Note over T: Credit spreads, iron condors, covered calls
    
    T->>O: If IV drops to 20%...
    Note over T: IV < HV → Options are cheap
    T->>T: Consider buying premium strategies
    Note over T: Long calls, long puts, long straddles

McMillan also introduces the concept of the volatility skew — the tendency for out-of-the-money puts to trade at higher implied volatilities than out-of-the-money calls, reflecting the market's persistent fear of downside crashes. He shows how to trade the skew through put spreads and risk reversals.

Core Strategies

McMillan organises strategies by market outlook, not by complexity. Each strategy is presented with entry criteria, breakeven analysis, maximum profit and loss, and adjustment rules.

Covered Calls: Buy 100 shares, sell one call. McMillan's preferred income strategy. Best when IV is high and the outlook is mildly bullish. The call premium provides downside protection of the premium received.

Protective Puts: Buy 100 shares, buy one put. Insurance against a decline. McMillan argues every concentrated stock position should have a protective put or collar.

Vertical Spreads: Buy one option, sell another at a different strike. Bull call spreads, bear put spreads, credit spreads. Limit risk and reduce capital at risk. McMillan emphasises that credit spreads (selling a higher-premium option and buying a lower-premium option) have a higher probability of success but limited upside.

Straddles and Strangles: Simultaneously buy (or sell) a call and put at the same or different strikes. Used when the trader expects a large move (long straddle) or no move (short straddle). McMillan provides detailed guidance on managing the gamma risk of short straddles.

Iron Condors: Sell an out-of-the-money put spread and an out-of-the-money call spread simultaneously. The quintessential low-volatility, range-bound market strategy. McMillan shows how to select strikes based on the probability of the stock staying within a defined range.

mindmap
  root((Options<br/>Strategies))
    Directional
      Long Calls
      Long Puts
      Bull Call Spreads
      Bear Put Spreads
    Income
      Covered Calls
      Cash-Secured Puts
      Short Strangles
      Iron Condors
    Hedging
      Protective Puts
      Collars
      Put Backspreads
    Volatility
      Long Straddles
      Short Straddles
      Ratio Spreads
      Calendar Spreads

Position Management and Adjustment

McMillan's most distinctive contribution is his framework for managing existing positions rather than simply entering and exiting. He identifies five adjustment techniques:

1. Rolling: Close the current option and open another at a different strike or expiration
2. Converting: Transform a directional position into a neutral position (e.g., converting a long call into a bull call spread)
3. Hedging: Add an offsetting position to reduce risk
4. Doubling: Add to a losing position at a better price (high risk, high reward)
5. Exiting: Take the loss when the trade thesis is invalidated

McMillan provides specific rules for when each adjustment is appropriate, tied to the Greeks and the volatility environment. The underlying philosophy is that options traders should not have binary win-lose outcomes; every position can be adjusted to improve the probability of success.

Chapter Insights

Part I: Basic Concepts

Establishes the language of options trading. McMillan covers option symbols, trading hours, margin requirements, and the mechanics of exercise and assignment. The critical concept is put-call parity, which he uses to derive synthetic positions.

Part II: Call Option Strategies

From covered calls to naked calls, McMillan covers every strategy using call options. The covered call receives the most attention as the foundation strategy for income-oriented traders.

Part III: Put Option Strategies

Protective puts, cash-secured puts, and naked puts. McMillan argues that cash-secured puts are the most attractive strategy for traders who want to own a stock at a discount.

Part IV: Combination Strategies

Straddles, strangles, spreads, and collars. McMillan introduces the concept of probability analysis — using delta as a proxy for probability of profit — to select strikes and expirations.

Part V: Volatility

The heart of the book. McMillan shows how to calculate HV, interpret IV, trade the volatility skew, and use volatility as a standalone asset class.

Part X: Risk Management

Position sizing, portfolio hedging, and psychological discipline. McMillan's risk management framework is worth studying independently of any specific strategy.

Real World Examples

McMillan illustrates each strategy with real-market examples from his own trading career. A typical example: in October 2008, during the financial crisis, implied volatility on the S&P 500 index options reached levels above 80% — more than double the historical average. McMillan shows how a trader who recognised this as extreme volatility would have sold premium through put credit spreads and iron condors, collecting rich premiums while maintaining defined risk. As volatility mean-reverted over the following months, these positions generated substantial profits.

Another example: a trader holding 500 shares of Apple at $150 who wants to generate income while protecting against a decline. McMillan constructs a collar: sell five call options at the $160 strike and buy five put options at the $140 strike. The call premium offsets the put cost, creating a low-cost hedge. If Apple stays between $140 and $160, the trader keeps the stock and collects any dividends. If Apple falls below $140, the puts provide full protection.

Practical Applications

For the income-focused trader, McMillan recommends starting with covered calls and cash-secured puts on high-quality stocks with liquid options markets. For the speculator, he recommends vertical spreads over naked options because they define risk. For the institutional investor, he provides a framework for using index options to hedge portfolio exposure without disrupting the underlying holdings.

Reading Guide

Sufficiency Assessment

This summary captures the core framework of McMillan's options trading methodology: the Greeks, volatility analysis, basic and intermediate strategies, and position management. It omits the encyclopedic coverage of every strategy variant and the detailed tax treatment.

Recommended Reading Path

| Reader Type | Time | What to Read | |---|---|---| | Casual | ~30 min | This summary + Part I of the book | | Interested | ~10 hr | Summary + Parts I-V + Part X | | Practitioner | ~40 hr | Full book, especially Parts V and X |

Chapters to Read in Full

• Part I — Fundamental concepts and put-call parity
• Part V — Volatility analysis (the book's best contribution)
• Part X — Risk management

Chapters to Skim or Skip

• Parts VI-IX — Exotic instruments (LEAPS, futures options) unless you trade those specific markets
• Tax appendix — Consult a tax professional; the law changes frequently

What You'll Miss by Not Reading the Full Book

Hundreds of worked examples, specific adjustment rules for each strategy type, and the accumulated wisdom of a professional trader who has navigated every market environment from 1980 onward.

Strengths

Encyclopedic Coverage

McMillan's book covers more options strategies than any other single volume. From the simplest covered call to the most complex ratio spread and volatility arbitrage, every strategy receives a full treatment with trade mechanics, breakeven analysis, risk parameters, and adjustment rules. The index alone runs over forty pages, reflecting the depth of coverage. For the professional trader, this comprehensiveness means the book serves as both a tutorial and a reference — you learn the strategies in order and return to specific chapters for refreshers on particular trade structures.

The fifth edition adds coverage of newer products including weekly options, ETF options, and VIX options, keeping the book current despite its long publishing history. McMillan also includes material on electronic trading platforms and the impact of high-frequency trading on market structure.

Practical Volatility Framework

The volatility analysis methodology is the book's single most valuable contribution. McMillan provides a concrete, repeatable process for calculating historical volatility, comparing it to implied volatility, and using the comparison to select appropriate strategies. This framework gives traders an edge that does not depend on predicting price direction — it exploits the mean-reverting nature of implied volatility, which is one of the few empirically validated anomalies in options markets.

McMillan's treatment of the volatility skew is equally practical. He shows how to read the skew to assess market sentiment, identify tail risk premiums, and structure trades that profit from skew normalisation.

Emphasis on Risk Management

Many options books teach strategies without adequately addressing what happens when they go wrong. McMillan devotes an entire section to risk management and integrates risk considerations into every strategy discussion. His position sizing rules, maximum risk guidelines, and adjustment frameworks are the practical tools that separate professional traders from amateurs.

The discussion of early exercise risk on American-style options is particularly valuable. McMillan documents the specific conditions under which options are likely to be exercised early and shows how to avoid being on the wrong side of an assignment.

Weaknesses

Sheer Length

At over 1,100 pages, the book is intimidating and difficult to read cover to cover. Many readers abandon it before reaching the most valuable sections on volatility and risk management. A condensed edition covering the essential strategies in 400 pages would serve most readers better.

The length also means the book is physically heavy and unwieldy. It does not fit in a briefcase easily, and the binding on some editions has been known to fail with regular use.

Limited Mathematical Rigor

McMillan explicitly avoids advanced mathematics, but this is also a weakness. He presents the Black-Scholes model as a black box without explaining the assumptions or limitations. Traders who want to understand why the model fails during market crises — precisely when understanding matters most — will not find the answer here.

The treatment of stochastic volatility models (Heston, SABR) is superficial. As these models become increasingly important for pricing exotic options and managing volatility risk, the book's omission is a growing gap.

Dated Examples

Some examples reference market conditions and tax rules from earlier editions that have changed significantly. The fifth edition updates much of this material, but legacy examples remain that can confuse readers who encounter them. The tax discussion, in particular, should be verified against current regulations rather than relied upon directly.

Criticism

Sheldon Natenberg

In Option Volatility and Pricing, Natenberg takes a more tutorial approach that complements McMillan's reference style. Natenberg has criticised McMillan's book for being too comprehensive — that it tries to cover every strategy and ends up overwhelming the reader. Natenberg's book is shorter, more focused, and better suited to the reader who wants to understand the principles rather than the complete catalogue.

John Hull

Hull's Options, Futures, and Other Derivatives covers the same subject from an academic perspective. Hull has noted that McMillan's treatment of pricing models is light on the assumptions and limitations of the models, which can lead traders to rely on them uncritically. Hull argues that understanding when a pricing model fails is as important as knowing how to use it.

Online Trader Community

The r/options subreddit and other trading forums frequently note that the book's tax advice reflects US regulations that may not apply internationally. Several forum posts document traders in the UK, Canada, and Australia who followed McMillan's tax guidance only to find their local treatment was different.

Counterarguments

Traders who prefer a more mathematical approach will find the book frustrating. The lack of derivations means that curious readers cannot verify the pricing relationships McMillan presents. This is a legitimate concern, but it reflects McMillan's audience: the book is written for practitioners, not quants. For the majority of options traders who do not need to derive the Black-Scholes formula but need to know when to use a bull call spread versus a bear put spread, the practical emphasis is exactly right.

Scientific Evidence

Academic research on options trading supports McMillan's core claims. Studies of the volatility risk premium confirm that selling options generates positive expected returns over time, consistent with McMillan's advice to sell premium when implied volatility is elevated. Research also confirms the empirical pattern of the volatility smile — out-of-the-money puts trade at higher IV than calls — which McMillan documents extensively.

The academic consensus on option seller profitability is strong: Bakshi and Kapadia (2003) found a significant negative volatility risk premium in S&P 500 index options, meaning option buyers pay a premium for protection that, on average, exceeds the realised volatility. This validates McMillan's bias toward premium-selling strategies for traders who can tolerate the tail risk.

However, the academic literature also reveals that the volatility risk premium is not constant — it varies with market conditions, investor sentiment, and the business cycle. McMillan's framework for assessing whether IV is high or low relative to HV captures some of this variation, but it does not account for regime changes in the volatility risk premium itself.

Historical Context

Published initially in 1980, Options as a Strategic Investment arrived as the listed options market was still maturing. The Chicago Board Options Exchange (CBOE) had launched only seven years earlier, and options were still viewed by many investors as dangerously speculative instruments. McMillan's book played a significant role in legitimising options as portfolio management tools.

The book's various editions track the evolution of the options market. The first edition covered basic equity options. Later editions added index options, LEAPS, weekly options, options on ETFs, and finally VIX options. This historical sweep makes the book a valuable document of how the options market developed.

Publication Context

The 2012 fifth edition was published in the aftermath of the 2008 financial crisis, when options trading volumes were surging and new products like credit default swaps and VIX options were transforming the derivatives landscape. The book reflects this post-crisis environment with expanded coverage of tail risk hedging and portfolio protection strategies.

Paradigm Shift

Before McMillan, most options books were either academic texts focused on pricing theory or simplistic primers on basic strategies. McMillan created a new category: the comprehensive practical reference that covers the entire strategic landscape without requiring a PhD. This approach has been widely imitated but never equalled.

Similar Books

Books This Builds On

• Option Volatility and Pricing by Sheldon Natenberg — The best tutorial on options pricing and volatility
• Options, Futures, and Other Derivatives by John Hull — The standard academic text
• The Options Playbook by Brian Overby — A quick-reference guide to basic strategies

Books That Challenge This

• Trading Options Greeks by Dan Passarelli — Argues for a more quantitative approach to position management
• The Volatility Course by George Fontanills — An alternative, more accessible introduction to volatility trading
• The Complete Guide to Option Pricing Formulas by Espen Gaarder Haug — A mathematical reference that goes deeper than McMillan

Long-Term Relevance

Initial Reception

The first edition was praised as revolutionary — the first book to treat options trading as a serious, systematic activity rather than speculation. It quickly became the standard reference for CBOE market makers and institutional traders.

Current Standing

The fifth edition remains the most comprehensive single-volume reference on options trading. No other book covers as many strategies with the same depth. However, it no longer stands alone — serious traders typically supplement McMillan with Natenberg for pricing theory and Passarelli for the Greeks.

Future Outlook

The core principles — the Greeks, volatility analysis, risk management, and strategic positioning — are timeless. The specific strategies and mechanics will evolve with the market, but the framework McMillan provides will remain relevant as long as options trade.

Final Assessment

Rating: 4.8/5 — The definitive reference on options trading. Essential for any serious options trader, indispensable for professionals, and a valuable long-term reference for intermediate traders. The length is the only significant drawback.

| Dimension | Assessment | |---|---| | Comprehensiveness | Excellent — unmatched coverage | | Practical Utility | Excellent — directly applicable strategies | | Readability | Good — clear prose, but daunting length | | Timeliness | Good — fifth edition is current | | Risk Management | Excellent — best in class | | Mathematical Rigor | Limited — intentionally non-technical |