Arbitrage is the only trading model that works and is the model used by almost all market makers.
LTCM was a beta house and that is how the lost their money, they had loads of money in correlation trades especially in the bond areas, not pure arbitrage.
The Goldman Fund that melted down recently was another example of a Beta fund, tracking correlations between obsure unrelated securities. When the betas broke down, they lost a fortune.
Pure arbitragers consistently make money when properly managing their risk. The basis for the arbitrage model is the basic and expanded option pricing models.
"Options as a Strategic Investment" was my first options book but is more of a trading book for beginners then a real explanation of the arbitrage model, though it is brought up toward the end of the book.
"Option Pricing and Investment Strategies" by Richard M Bookstaber ,was the book that really turned on the light bulb for me.
For a deep math understanding, though a tough book and required reading when we were on the street, "Options, Futures, and Other Derivative Securities" by John Hull.
An easier and more readable book, "Black-Scholes and Beyond" by Neil A Chriss. A nice discussion of different models and limitations. It also has a toolkit that you can get to play with the models.
Comparison of different option models,
"From Black Scholes to Black Holes" from Risk/Finex.
For the pure Buying and Selling of volatility trading approach, this is what we use today mostly for longer-term market neutral vol plays on liquid issues, "Buying and Selling Volatility" by Kevin B Connolly is a good, simple book.
But you had better polish off one or two of the others first as it expects you to have a full understanding of the options model and greek-based risk management.
Once you have a basic understanding of Options, there are some great resources on the web that you can use for trade research and play. The first actaully can be useful for a starter.
http://www.cboe.com/
The CBOE has some tutorials. Under their Trading Tools in the Volatility Optimizer area is a nice option pricer ties into a volatility database. A really good site for the beginner and pro alike.
http://www.optionstrategist.com/
For Historical volatility data, McMillan, same as "Options as a Strategic Investment" fame, has a web site where you can down load them for free.
You can consistently make money with options if you study first and fully understand your risk, otherwise you can lose your money so fast you will scratch your head wondering what just happened.
Most option traders lose as they do not have the patience to fully learn or to follow the models, and instead of following a well-designed trading scheme, react to the stress of their own mishedged risk profiles.
It can take years off your life, there are not many older traders.
These days we mostly do longer-term long and short vol plays, and make some nice returns on cash invested with minimal stress.
If you follow through on your interest, I recommend you take a lot of time an study, trade on paper first, and you will have a nice new tool for investing.
