, CHAPTER 40 
Advanced Concepts 
As the option markets have matured, strategists have been forced to rely more on 
mathematics in order to select new positions as well as to discern how their positions 
will behave in fluctuating markets. These techniques can be used on simple strategies, 
such as bull spreads or ratio spreads, or on far more complex portfolios of options. 
First, the concept of implied volatility will be examined in more detail, prima­
rily as an aid in choosing new positions that have a positive expected return. Then, 
the concept of risk management will be explored. In effect, one can reduce his option 
position into several components of risk measurement that can be readily under­
stood. This chapter describes the techniques used to evaluate one's position, and 
shows how to use this information to reduce the risk in the position. The actual math­
ematical calculations required to perform these analyses are included at the end of 
the chapter. 
NEUTRALITY 
In many of the examples in previous chapters, it was generally assumed that one 
would take a "neutral" position in order to capture the pricing or volatility differen­
tial. Why this concentration on neutrality? Neutrality, as it applies to option positions, 
means that one is noncommittal with respect to at least one of the factors that influ­
ence an option's price. Simply put, this means that one can design an option position 
in which he can profit, no matter which way the underlying security moves. 
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