Back to Library

McMillan on Options

by Lawrence G. McMillan (1996)

Quick summary -- an in-depth PhD-level extended summary (10-30 pages) for this book is coming soon.

McMillan on Options

Author: Lawrence G. McMillan | Categories: Options Trading, Technical Analysis, Volatility

Executive Summary

"McMillan on Options" by Lawrence G. McMillan, now in its second edition, is the practical, application-focused companion to his encyclopedic reference work "Options as a Strategic Investment." McMillan, widely regarded as the foremost authority on options trading and the publisher of "The Option Strategist" newsletter, shifts from comprehensive strategy definitions to real-world trading applications, backed by actual examples from his own trading experience. The book covers seven major chapters spanning basic definitions, option strategies in practice, special applications (stock equivalence, expiration effects, portfolio protection), the predictive power of options (volume analysis, put-call ratios), trading systems (seasonal patterns, intermarket spreads), volatility trading (neutral strategies, backspreads), and money management and trading philosophy.

Core Thesis & Arguments

McMillan's central thesis is that options are far more versatile than most traders realize, serving not only as speculative instruments but as powerful analytical and hedging tools. Key arguments: (1) Options can replicate virtually any stock or futures position with defined risk, making them superior in many situations; (2) Option volume and put-call ratios are among the most reliable contrary indicators available, signaling turning points in stocks, indexes, and futures markets; (3) Volatility trading - selling overvalued volatility and buying undervalued volatility - is a distinct and profitable discipline separate from directional trading; (4) The interaction between options, futures, and stock expiration creates predictable, tradeable patterns; (5) Intermarket spreads using options offer additional profit dimensions unavailable to stock or futures traders alone; (6) Money management and trading discipline, not strategy sophistication, ultimately determine long-term success.

Chapter-by-Chapter Analysis

Chapters 1-2: Definitions and Strategy Review

Establishes the framework including updated coverage of ETFs, electronic trading, single stock futures, and volatility futures. Reviews option strategies with real trading anecdotes that illuminate the practical realities of each approach.

Chapter 3: Special Applications

Covers synthetic positions and stock equivalence (using options to replicate stock positions), the effects of option and futures expiration on stock prices (including "pinning"), and portfolio protection strategies using options and volatility futures. The second edition adds the collar strategy and VIX-based hedging.

Chapter 4: The Predictive Power of Options

Perhaps the book's most distinctive contribution. Details how to use option volume to anticipate corporate events (takeovers, earnings surprises), and provides a comprehensive treatment of put-call ratios as contrary indicators across stocks, indexes, and futures. The second edition adds weighted put-call ratios and individual stock put-call ratio analysis.

Chapter 5: Trading Systems

Presents multiple trading systems with documented track records, including seasonal patterns, day-trading systems, and intermarket spreads using options for additional profit potential.

Chapter 6: Volatility Trading

Covers neutral option strategies (delta-neutral trading, selling overvalued volatility, buying undervalued volatility), with an extended backspread diary showing real-time decision making over six months. Addresses the common misconception that "neutral" means "risk-free."

Chapter 7: Money Management and Philosophy

Presents trading guidelines, money management rules, and McMillan's personal trading philosophy, supported by trading stories that illustrate both successes and failures.

Key Concepts & Frameworks

  • Synthetic Positions: Using options to create risk-equivalent stock or futures positions with defined risk
  • Put-Call Ratios as Contrary Indicators: When put volume is extreme relative to call volume (or vice versa), the market tends to reverse
  • Weighted Put-Call Ratios: Incorporating option prices with volume for more accurate sentiment readings
  • Volatility Trading: Treating implied volatility as a tradeable commodity, selling when overvalued and buying when undervalued
  • Expiration Effects: How option and futures expiration creates predictable price pressure and trading opportunities
  • Stock Pinning: The tendency of stocks to gravitate toward heavily traded strike prices near expiration

Practical Trading Applications

  • Monitor option volume surges in individual stocks as potential signals for upcoming corporate events
  • Use equity-only put-call ratios as intermediate-term market timing indicators
  • Construct synthetic positions to participate in stock moves with limited and defined risk
  • Trade volatility mean-reversion by selling options when implied volatility is elevated and buying when depressed
  • Exploit expiration-related price patterns through systematic calendar-based trading
  • Apply intermarket spreads with options to capture relative value opportunities between correlated markets
  • Use futures put-call ratios for commodity and index trading signals

Critical Assessment

Strengths: McMillan's decades of practical experience shine through in every chapter. The book fills a unique niche - it is neither a beginner's guide nor an academic treatise, but a practitioner's manual full of battle-tested insights. The put-call ratio work is genuinely original and has been adopted widely across the industry. The trading stories provide invaluable context that pure theory cannot.

Weaknesses: The book's organization is somewhat scattered, with chapters covering a wide range of loosely related topics. Some systems described in the first edition had become less effective by the time of the second edition, a problem McMillan acknowledges. The mathematical treatment is occasionally insufficient for readers wanting to implement strategies quantitatively. Some material overlaps with "Options as a Strategic Investment."

Key Quotes

  • "Options don't merely have to be treated as a speculative vehicle."
  • "While neutral trading can certainly be profitable, it is not the easy-money, no-work technique that some proponents seem to be extolling."
  • "The use of option volume to predict upcoming corporate events is one of the most valuable tools available to option traders."

Conclusion & Recommendation

"McMillan on Options" is essential reading for intermediate to advanced options traders who want to move beyond basic strategy definitions into practical, real-world applications. The book's treatment of put-call ratios, volatility trading, and expiration effects represents genuine intellectual contributions to the options literature. While some specific systems may have dated, the principles and frameworks remain robust. Recommended as a complement to McMillan's reference work and as a standalone guide for serious options practitioners.