February 2010 • Volume 4, No. 2

February 2010 • Volume 4, No. 2

KELTNER CLASSIC futures system p. 6

THE REINSURANCEAPPROACHto option spreads p. 10

TRADING the butterfly effect p. 13

CHASING the crude oil rebound p. 28

BULL CALL SPREADgets slaughtered p. 29

LATEST COT ANALYSISp. 16

2 February 2010 • FUTURES & OPTIONS TRADER

Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Trading Strategies

Weekly Keltner channel system . . . . . . . . .6A longer-term trend-following system based on

a 50-year-old indicator produces surprisingly

robust results.

By Dion Kurczek and Volker Knapp

Option spreads:

The reinsurance approach . . . . . . . . . . . .10An analysis of the credit spread provides a

departure point for investigating the balance

between risk, reward, and probability of profit

in options trading.

By Don Fishback

Options Trading System Lab

The butterfly effect . . . . . . . . . . . . . . . . . . .13Butterfly spreads soar when applied to a simple

market timing system.

By Steve Lentz and Jim Graham

Futures & Options Watch:

COT extremes . . . . . . . . . . . . . . . . . . . . . . .16A look at the relationship between

commercials and large speculators in

45 futures markets.

Options Watch . . . . . . . . . . . . . . . . . . . . . .16Energy sector ETF components.

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .18Momentum, volatility, and volume

statistics for futures.

CONTENTS

continued on p. 4

The World of Forex Trading

Benefits 24-Hour Market Opportunities Unmatched Liquidity Flexible Leverage*

Our Commitment No Dealing Desk Competitive Spreads Exceptional Service

Test Drive Our Platform for FREE

Forex Capital Markets, Financial Square, 32 Old Slip, 10th Floor, New York, NY 10005 USA 1-866-851-8607WARNING: *Trading foreign exchange on margin carries a high level of risk and may not be suitable for all investors. Before deciding to trade foreign exchange, you should carefully consider your monetary objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your deposited funds, and, therefore, you should not speculate with capital that you cannot afford to lose. Please note, FXCM Micro, in its discretion, may or may not offset individual transactions unlike transactions in most FXCM Standard accounts.

www.fxcm.com/currency1-866-851-8607

Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .19Notable volatility and volume

in the options market.

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .20References and definitions.

Managed Money . . . . . . . . . . . . . . . . . . . . .24Top 10 option strategy traders ranked by

August 2009 return.

New Products and Services . . . . . . . . . . . . .26

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26

Futures & Options Calendar . . . . . . . . . . . .27

Futures Trade Journal . . . . . . . . . . . . . . .28Crude gets back to its high-flying ways.

Options Trade Journal . . . . . . . . . . . . . . .29Buying the dip feels like falling off a cliff.

Have a question about something you’ve seen

in Futures & Options Trader?

Submit your editorial queries or comments to [email protected].

Looking for an advertiser?

Click on the company name below for a direct link to the ad

in this month’s issue of Futures & Options Trader.

eSignal

FXCM

Paris Trading Expo

The World MoneyShow

CONTENTS


mailto:[email protected]

FUTURES & OPTIONS TRADER • February 2010 5

CONTRIBUTORS

Editor-in-chief: Mark [email protected]

Managing editor: Molly [email protected]

Senior editor: David Bukey [email protected]

Contributing writers: Keith Schap,Chris Peters

[email protected]

Editorial assistant andwebmaster: Kesha Green

[email protected]

Art director: Laura [email protected]

President: Phil [email protected]

Publisher,Ad sales East Coast and Midwest:

Bob [email protected]

Ad sales West Coast and Southwest only:

Allison [email protected]

Classified ad sales: Mark [email protected]

Volume 4, Issue 2. Futures & Options Trader is pub-lished monthly by TechInfo, Inc., 161 N. Clark St.,Suite 4915, Chicago, IL 60601. Copyright © 2010TechInfo, Inc. All rights reserved. Information in thispublication may not be stored or reproduced in anyform without written permission from the publisher.

The information in Futures & Options Trader magazineis intended for educational purposes only. It is notmeant to recommend, promote, or in any way implythe effectiveness of any trading system, strategy, orapproach. Traders are advised to do their ownresearch and testing to determine the validity of a trad-ing idea. Trading and investing carry a high level ofrisk. Past performance does not guarantee futureresults.

For all subscriber services:www.futuresandoptionstrader.com

A publication of Active Trader®

CONTRIBUTORS

� Volker Knapp has been a trader, system developer, and

researcher for more than 20 years. His diverse background

encompasses positions such as German National Hockey team

player, coach of the Malaysian National Hockey team, and

president of VTAD (the German branch of the International Federation of

Technical Analysts). In 2001, he became a partner in Wealth-Lab Inc.

(www.wealth-lab.com), which he still runs.

� Don Fishback has been a pioneer in the financial profes-

sion for more than 25 years. After first developing several mar-

ket sentiment models in the 1980s, Fishback then devoted his

research to options, culminating in the Fishback Option Pricing

Formula. That model is the first of its kind that takes into account actual mar-

ket movement, as opposed to theoretical probabilities. Fishback’s option

analysis software is available at www.oddsonline.com.

� Jim Graham ([email protected]) is the product

manager for OptionVue Systems and a registered investment

advisor for OptionVue Research.

� Steve Lentz ([email protected]) is a well-estab-

lished options educator and trader and has spoken all over the

U.S., Asia, and Australia on behalf of the CBOE’s Options

Institute, the Options Industry Council, and the Australian

Stock Exchange. As a mentor for DiscoverOptions.com, he teaches select stu-

dents how to use complex options strategies and develop a consistent trading

plan. Lentz is constantly developing new strategies on the use of options as

part of a comprehensive profitable trading approach. He regularly speaks at

special events, trade shows, and trading group organizations.

http://www.futuresandoptionstrader.com











http://www.wealth-lab.com

http://www.oddsonline.com



OPTIONS STRATEGY LABTRADING STRATEGIES


Weekly Keltner channel system

Note: A version of this article originally appeared in the February 2004 issue of Active Trader magazine.

Chester W. Keltner published his “KeltnerChannel” technique in the book How to MakeMoney in Commodities in 1960. Keltner Channelsare similar to Bollinger Bands, in that they con-

sist of a middle line and upper andlower bands that encompass mostprice action. Price moves above orbelow the bands indicate strongmomentum in that direction.

The middle line is a 10-bar simplemoving average (SMA) of the bar’s“typical price,” which is the sum ofthe high, low, and close divided bythree: (close + high + low)/3. Theupper band is the middle line plus the10-day moving average of the highminus low; the lower band is the mid-dle line minus the 10-day movingaverage of the high minus low. (Acommon variation of the indicatoruses an exponential moving averageinstead of a simple moving average,and true range instead of range.)

Keltner’s method for using hisbands was very simple: Buy whenprice closes above the upper band,and reverse and go short when pricecloses below the lower band. This is atrend-following approach that isalways in the market — a true stop-and-reverse system. The area betweenthe upper and the lower bands provides some space for prices to

move without generating numerous whipsaw signals.

The rules are:

1. Enter long and exit short when price crosses above upper Keltner channel.

2. Enter short and exit long when price crosses below lower Keltner channel.

Can a trading technique that was developed and published in 1960 still make money

in today’s markets? Simplicity — and a longer-term time frame — helps.

FIGURE 1 — EQUITY CURVE

Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com)

The system was profitable on both the long and short sides, with some moderate volatility and drawdown periods.

BY DION KURCZEK AND VOLKER KNAPP

http://www.wealth-lab.com


In this test, approximately two per-cent of account equity was risked pertrade, based on exiting trades at theopposite Keltner band value. Forexample, if prices cross above theupper band, the system goes long andthe initial exit price is the lower Keltnerband. The system buys the number ofcontracts that would result in a 2-per-cent loss of equity if the position isclosed out at that lower Keltner bandlevel. The starting equity was $500,000,with $20 deducted for slippage andcommission per round-turn trade.

The system was tested on weeklydata from September 1993 toDecember 2002 on a portfolio of 19futures contracts: corn (C), crude oil(CL), Eurodollar (ED), Euro currency(FX), gold (GC), copper (HG), Japaneseyen (JY), coffee (KC), live cattle (LC),lean hogs (LH), Nasdaq 100 (ND), nat-ural gas (NG), soybeans (S), sugar (SB),silver (SI), S&P 500 (SP), and 10 year T-Note (TY), DAX 30 (AX), German bund(DT). Later, we will compare theresults of the system using daily data.

Test resultsThe results reflect the Keltner system’strend-following nature. Trend-follow-ing systems typically produce morelosing trades than winners, but a goodsystem will offset the smaller losses bycatching major trends. This implies agood trend-following system shouldhold winning trades longer than losingtrades. In this case, winning tradeswere held for an average of 38.5 weeks(more than nine months), while losingtrades lasted only 12.4 weeks (aroundthree months). As expected, theKeltner channel system’s winning percentage was low(only 37.81 percent), but the average profit for winningtrades (14.7 percent) is much higher than the average lossfor losing trades (6.92 percent). This is reflected in the favor-able 2.12 payoff ratio.

By letting the profits run and cutting the losses short, thesystem delivered a very respectable annualized gain of18.78 percent during the 10-year test period. There weretwo losing years during the period, with losses of 3.4 per-

cent and 8.11 percent. In comparison, the two best years hadreturns of 59.21 and 40.10 percent.

Daily vs. weeklyA second test using the same system rules on the same timeperiod, but using daily instead of weekly price data, result-ed in a net loss of 80.24 percent. Why such a dramatic dif-ference? To help answer this question, let’s examine one of

continued on p. 8

FIGURE 2 — DRAWDOWN CURVE

The maximum drawdown of around 30 percent was significant, but the systemrecovered from all drawdowns relatively quickly.

FIGURE 3 — SAMPLE TRADES (WEEKLY)

The system catches and rides a long trend in crude oil.


the large winning trades on the weeklyscale and compare it to system’s per-formance during the same period ondaily data.

Figure 3 shows the system held a longtrade in crude oil for 75 weeks. The con-tract price during this period appreciat-ed nearly 100 percent, and a one-contractposition returned nearly $12,500. Ondaily data, however, the system traded atotal of 15 times (eight longs and sevenshorts) during the same period and onlyfive of the 15 trades were winners. Onecontract would have netted $3,380 dur-ing this period. By using a weekly timeframe, the system was able to catch along trend and avoid the noise andwhipsaws on the daily time frame.

Although it was published 50 yearsago, the Keltner system showed poten-tial as a long-term trend-following sys-tem on the weekly time frame. Considertesting your systems on weekly data.You will sometimes find this results inless noise and better performance.�

For information on the author see p. 5.

TRADING STRATEGIES

STRATEGY SUMMARY

Profitability Trade statistics

Net profit: $1,866,139.00 No. trades: 439

Net profit: 373.23% Win/loss: 37.81%

Exposure: 62.72% Avg. gain/loss: 1.25%

Profit factor: 1.36 Avg. hold time: 22.27

Payoff ratio: 2.12 Avg. profit (winners): 14.70%

Recovery factor: 3.01 Avg. hold time (winners): 38.50

Drawdown Avg. loss (losers): -6.92%

Max. DD: -33.39% Avg. hold time (losers): 12.40

Longest flat days: 140 Max. consec. win/loss: 8/11

LEGEND: Net profit — Profit at end of test period, less commission •Exposure — The area of the equity curve exposed to long or short positions,as opposed to cash • Profit factor — Gross profit divided by gross loss •Payoff ratio — Average profit of winning trades divided by average loss oflosing trades • Recovery factor — Net profit divided by max. drawdown• Max. DD (%) — Largest percentage decline in equity • Longest flatdays — Longest period, in days, the system is between two equity highs •No. trades — Number of trades generated by the system • Win/Loss (%)— The percentage of trades that were profitable • Avg. trade — The aver-age profit/loss for all trades • Avg. winner — The average profit for win-ning trades • Avg. loser — The average loss for losing trades • Avg. holdtime — The average holding period for all trades • Avg. hold time (win-ners) — The average holding time for winning trades • Avg. hold time(losers) — The average holding time for losing trades • Max. consec.win/loss — The maximum number of consecutive winning and losingtrades

PERIODIC RETURNS

Avg. Sharpe Best Worst Percentage Max. Max.return ratio return return profitable consec. consec.

periods profitable unprofitable

Weekly 0.38% 0.86 10.72% -13.05% 56.14% 8 9

Monthly 1.63% 0.87 16.80% -13.23% 59.09% 5 4

Quarterly 4.88% 0.86 27.38% -20.33% 56.76% 3 3

Annually 20.37% 0.94 59.21% -8.11% 77.78% 3 1

LEGEND: Avg. return — The average percent-age for the period • Sharpe ratio — Averagereturn divided by standard deviation of returns(annualized) • Best return — Best return for theperiod • Worst return — Worst return for theperiod • Percentage profitable periods — Thepercentage of periods that were profitable • Max.consec. profitable — The largest number of con-secutive profitable periods • Max. consec.unprofitable — The largest number of consecu-tive unprofitable periods

FIGURE 4 — DAILY TIME FRAME

Using daily price data on the same test period resulted in more frequentwhipsaw trades and negative returns.

http://www.WorldMoneyShowVancouver.ca

OPTIONS STRATEGY LABTRADING STRATEGIES


One of the biggest advantages of options istheir flexibility. With sufficient study, you cancreate a strategy that meets your personal cri-teria for risk, reward, and probability of suc-

cess. Understanding and managing the relationshipbetween these three factors is one of the most importantskills option traders must master. The following discussionillustrates this by analyzing a well-known option spread.

The credit spread is an option strategy that involves sell-ing an option while simultaneously purchasing the sametype of option, with the short option being more expensivethan the long option. A “vertical” credit spread indicates theoptions have the same expiration month.

For instance, a credit spread on stock ABC, which is trad-ing at 16, would consist of selling the June 12.50 put (bid at0.90) and simultaneously buying the June 10 put (offered at0.40). The June 12.50 put is more expensive than the June 10put, so the position provides a net credit of $0.50.

The maximum profit potential for this trade is the netcredit received, or $50 per spread. The maximum loss is $200per spread, which means the risk is quadruple the potential

reward. Why would anyone want totake on risk four times the maximumpossible reward? The answer is proba-bility — how frequently you get tomake the $50 profit vs. how frequentlyyou take the $200 loss. In this case, theprior historical price action of the stockindicated the probability of keeping the$50 — i.e., the strategy’s winning per-centage — was nearly 90 percent.

Implementing high-probabilitytrades such as this is the opposite ofwhat the majority of beginning tradersdo in the options market. When mostpeople speculate with options (asopposed to using them to hedge aposition in the underlying instrument)they tend to buy cheap options, hop-ing to hit a home run and make a hugeprofit with relatively small risk.

The credit spread strategy is a sub-stantially different approach. It’s notthat buying options outright is a badidea. But realistically, if you are simplybuying them hoping to hit the jackpot,you should know your odds of win-ning are about equal to playing thetables at a casino. And casinos don’t goout of business too often because ofgambling losses.

That’s because casinos (and even

Note: A version of this article originally appeared in the July 2004 issue

of Active Trader magazine.

BY DON FISHBACK

eBay (EBAY), daily

Profit zone

Loss zone

24 3 10 17 24 31 7 14 21 28 5 12 19 27 2March April May June

140

130

120

110

100

90

80

70

60

With the stock trading around $100 in June 2003, a trader could sell July 80puts because of the low probability of a 20-point drop in the next month.However, the risk on such a trade is unlimited. By also purchasing July 75 puts,the risk on the trade is dramatically reduced.

FIGURE 1 — SHORT PUT OR CREDIT SPREADS?

Source: Reuters Metastock

Option spreads:The reinsurance approachThe probabilities of options trading are not so different from those in

the insurance and gaming industries. To make money, it helps to play the odds

the way insurers and casinos do. Credit spreads are one way to do it.


state lottery commissions) know andmanage the risk, reward, and proba-bility of profit for the games of chancethey run. It’s similar to the insurancebusiness, although the risk, reward,and probability model in this area isfar more complex. However, individ-ual investors can use the same princi-ples in the options market.

Risk and reward:Naked optionsIn the insurance business, you makemoney when something does not hap-pen. Insurance companies collect pre-miums, which they get to keep if youdon’t get sick, you don’t get into anautomobile accident, your house doesnot catch fire, etc.

Individual traders can replicate thisconcept with the credit spread, essen-tially turning themselves into insur-ance companies, by selling an option,collecting a premium and keeping it aslong as the stock does not moveadversely.

Let’s look at what happens whenyou sell an option. Back in June 2003,prior to eBay’s stock split when theprice was $100, let’s say you sold 20 ofthe eBay July 80 puts at 0.85 (seeFigure 1). The net credit for the putsales was $1,700, which was the posi-tion’s maximum profit. You would getto keep that credit as long as the stockwas above the 80 strike price at expira-tion.

Based on the one-year historicalvolatility of the stock at the time (42percent), the odds of the stock beingbelow 80 at July expiration were less than 7 percent, whichmeans there was a 93-percent chance the stock would not bebelow 80. In other words, the odds were great a loss wouldnot occur.

The problem is the maximum risk on this trade is $80 pershare (the strike price of the put sold) multiplied by 100(number of shares each option represents) multiplied by 20(the number of puts sold): $160,000! So while this trade hasa great probability of profit, and a decent possible reward, itcarries with it potentially catastrophic risk (see Figure 2).

Selling “naked,” or uncovered, options in this mannerhas ruined more than one financial company in the pastseveral years. The centuries-old Barings Bank is one institu-tion that suffered the consequences of a solitary trader whosold a huge number of options in the expectation a bigmove would not occur in the Japanese market over a shortperiod of time. But it did, and Barings collapsed as a result.

In effect, selling a naked option (particularly a call) isvery similar to selling an insurance policy with no limit tothe size of the claim. Lloyd’s of London used to sell thiskind of policy. Unfortunately, all it takes is one bad claim tobring catastrophe. In the case of Lloyd’s, it was asbestos.

The reinsurance optionIf unlimited liability is the problem, then limiting the liabil-ity is the solution. Insurance companies have two ways todo that. First, they can set a limit on the amount the policywill pay. The second solution is to buy reinsurance.

With reinsurance, the company that wrote the policytakes a portion of the premium collected from the policy-holder and buys coverage for part of the policy’s risk.However, this seemingly simple and effective solution hasa downside: By capping the loss in this fashion, you also

continued on p. 12

Profit/loss of put sale(at expiration)

Pro

fit/

loss

($)

9 39 69 99 129 159 189

EBAY share price

20,000

0

-20,000

-40,000

-60,000

-80,000

-100,000

-120,000

-140,000

-160,000

Selling a put outright has fixed profit and potentially disastrous risk.

FIGURE 2 — NAKED PUT SALE

Source: chart — Excel; data — oddsonline.com

Profit/loss of credit spread(at expiration)

69.00 79.00 89.00 99.00 109.00 119.00 129.00EBAY share price

2,000

0

-2,000

-4,000

-6,000

-8,000

-10,000

Adding long options to the short put position creates a credit spread, which hasa smaller potential profit than a naked put, but also limits downside risk.

FIGURE 3 — CREDIT SPREAD


Pro

fit/

loss

($)


reduce the profit. That’s the trade-off.Traders can do the same thing with options. Returning to

the eBay example, taking $800 of the $1,700 premium andbuying 20 July 75 puts at 0.40 would establish a credit spreadand effectively reinsure the original naked put position. Thenet credit (and maximum possible profit) is now $900, butthe maximum risk is now much lower, as well. The long putoption provides coverage for the risk that eBay would tradebelow $75.

The total risk on a vertical credit spread is the differencein strike prices minus the net credit. In this case, the differ-ence in strike prices is 5. The net credit is 0.45 (0.85 - 0.40 =0.45). Thus, the trade’s maximum risk is 4.55 (5.00 - 0.45 =4.55), or $455 per spread. With this trade consisting of 20spreads, the total risk has dropped from $160,000 to just$9,100 (see Figure 3).

To some traders these numbers still might not look verygood. Comparing the put credit spread to the naked putsale, the profit potential on the spread dropped by almost

half — from $1,700 to $900. Andalthough the maximum risk is down to$9,100 — much lower than before —it’s still 10 times higher than the poten-tial reward. Figure 4 compares thenaked put sale directly to the creditspread.

The key to the success of this trade isprobability. The probability of any lossis less than 7 percent, and the probabil-ity of reaching the maximum loss isless than 3 percent. When you quanti-tatively balance these probability num-bers with risk and reward, you find thetrade has a positive expected outcome.(See “Gauging probability.”)

Games of chance:The probability factorThe options industry doesn’t like thecomparison, but the analytics ofoptions trading are not too far removedfrom the analytics of games of chance.

Casinos offer games that almostexclusively have expected outcomesthat are positive for the casino, nega-tive for the player. Nevertheless, for thecasino operator, the risk in each incre-mental game is substantially largerthan the rewards. With every pull ofthe slot machine lever, someone has theopportunity to win a jackpot. That’swhat keeps people coming back. Ifthere was no jackpot, there would beno players.

The question for the casino is, how many times doessomeone put money in the slot machine and lose it beforethey hit a winning combination?

Lottery commissions depend upon games where thereward potential to the lottery board is just $1, and thepotential risk could be a massive $80 million. The questionis, how many of those $1 lottery tickets are sold before aplayer collects the $80 million jackpot?

Insurance companies depend upon people makingclaims for losses. After all, if there were no losses, insurancewould be needless. For insurers, the questions are: Howmuch money can we collect before we have to pay a claim?How likely is it that a claim will be filed? How big will thatclaim be?

In the end, the analysis is the same with options. Howmuch can the spread trader collect? How likely is it that thetrader will lose? How big will the loss be? �

For information on the author see p. 5.

TRADING STRATEGIES

Gauging probability

The probability figures are derived from standard volatility models and the prob-ability assumptions in the Black-Scholes option pricing formula. Basically, if adistribution of values (such as prices or price changes over a period of time) is“normal,” it takes the shape of a bell curve, and one standard deviation will con-tain approximately two-thirds of all the values in the data set. Two standard devi-ations will contain 95 percent of all the numbers in the set. By definition, volatil-ity is equal to one standard deviation of an asset's price returns. As a result,because of the implications of the bell curve, volatility produces a standard devi-ation, which in turn produces a probability. For a more in-depth discussion ofthese issues, visit www.oddsonline.com/ probability.

Put sale vs. credit spread(at expiration)

Credit spread

Put sale

39 59 79 99 119 139 159EBAY share price

10,000

0

-10,000

-20,000

-30,000

-40,000

-50,000

-60,000

-70,000

-80,000

-90,000

Overlaying the profit/loss profiles of the naked put sale and the credit spreadhighlights the credit spread’s risk control — a form of “resistance” for the shortput position.

FIGURE 4 — SIDE-BY-SIDE COMPARISON


Pro

fit/

loss

($)

http://www.oddsonline.com/probability


OPTIONS STRATEGY LABOPTIONS TRADING SYSTEM LAB

Market: Options on the S&P 500 index (SPX).

System concept: Options traders often use but-terfly spreads as market-neutral strategies, but thissystem uses three-legged butterflies to make direc-tional bets.

Three years ago we tested this approach in S&P500 options (“Directional butterflies on the S&P500,” Options Trader, November 2006). Has thisstrategy performed as well in recent years as it didfrom 2001 to 2006?

Butterflies contain short options at one strikeprice with half as many long options at equidistantstrike prices above and below that price. All optionsshare the same expiration and type (calls or puts).

Figure 1 shows the potential gains and losses of abullish call butterfly placed on Oct. 13, 2009 andheld through Oct. 28, 2009. The spread inNovember options contained 10 short 1110 calls,five long 1070 calls, and five long 1150 calls.

The position would receive its maximum profit ifthe S&P 500 closes at the short strike (1110) on theNov. 20 expiration date. At this point, both the long1150 calls and short 1110 calls would expire worth-less, while the long 1070 calls will have an intrinsicvalue of $40. The position will be profitable at expi-ration if the S&P 500 closes anywhere between thetwo breakeven points of 1079.59 and 1140.38.

The appeal of a directional butterfly spread lies inits reward-risk ratio. Figure 1 shows this spreadcould potentially make $15,205 while risking nomore than $4,820, a reward-risk ratio of more than3:1. This favorable ratio occurs within the bound-aries of a one-standard-deviation move, so excep-tionally large underlying moves aren’t required.

The system uses a 50-day simple moving average(SMA) and a stochastic oscillator to find trade sig-nals. First, it enters bullish spreads when the S&P500 is above its 50-day SMA, while it places bearishspreads when the S&P is below its 50-day SMA.Also, the stochastic oscillator identifies when theindex’s momentum is accelerating. The systementers bullish spreads when the S&P 500’s relativeprice rises and enters bearish spreads when its rela-tive price declines.

Figure 2 shows a daily chart of the S&P 500 from February toJune 2008 labeled with bullish and bearish stochastic and mov-ing average crossovers.

Bullish and bearish conditions: Place a bullish butterflyspread when the following criteria are met:

1. Stochastic crossover: The %K line crosses above the %D line and the S&P 500 closes above its 50-day SMA. %K must be below 70, however, to avoid overbought situations.

2. Moving-average crossover: The S&P closes above its 50-day SMA while %K is above %D but still below 70.

A bearish butterfly spread is entered if the opposite scenariooccurs (i.e., %K must stay above %D but below 30).

Trade rules:

Bullish entry 1. Buy five calls of the lower strike that is at least three

OPTIONS TRADING SYSTEM LAB

The butterfly effectFIGURE 1 — BULLISH CALL BUTTERFLY

Butterfly spreads have attractive risk-reward ratios. This trade could earnup to $15,205 if the S&P 500 climbs to 1110 by Nov. 20. If not, losses arecapped at only $4,820.

Source: OptionVue

Not all of these signals were as well-timed as the bearish one in June2008. However, the signals generally preceded favorable price action.

FIGURE 2 — TRADE SIGNALS

continued on p. 14

Source: MetaStock


(3.00) points in-the-money (ITM).

2. Buy five calls of the upper strike with the first standard deviation (determined by the ATM call’s middle implied volatility [IV] — between bid and ask IVs).

3. Sell 10 calls at the middle strike — exactly in between the lower and upper strikes. Adjust the strike price to ensure all three strikes are equidistant. Execute all trades at the close.

4. Use the first expiration month with 30 or more days remaining.

Bearish entries use the exact same rules,except the butterfly is constructed with puts.

Exit when any of the following conditions occur:1. Both the stochastic and moving average signals an

opposite trend.2. The S&P 500 touches the short strike.3. If the spread is still open on the Friday that is one week

before options expiration, exit at the close.

Starting capital: $10,000.

Execution: Trades were executed at the average of the bidand ask prices at the daily close, if available; otherwise, theo-retical prices were used. The standard deviation was calculatedwith a probability calculator using the IV of the at-the-moneycall in the front month. Commissions were $5 per trade plus $1per option.

Test data: The system was tested on cash-settled S&P 500index (SPX) options at the CBOE.

Test period: Jan. 18, 2001 to Oct. 28, 2009.

Test results: Figure 3 shows the strategy’s performance,which gained $32,380 (327 percent) over the eight-year test peri-od. Overall, the system entered 91 trades since January 2001 and57 percent were profitable.

Since its publication in November 2006,the system, beginning with $10,000,earned $12,110 (121.1 percent), an annual-ized return of 41 percent. The strategy’s

average losing trade (-$1,399.49) was much less than its averagewinning trade ($1,678.00). In the original test, the average win-ing trade was 20 percent higher than the average loser, and thisdynamic has continued in recent years.

— Steve Lentz and Jim Graham of OptionVue

This profitable options strategy continued to make money after the original testwas published in November 2006.

Source: OptionVue

FIGURE 3 — SYSTEM PERFORMANCE

Option System Analysis strategies are testedusing OptionVue’s BackTrader module(unless otherwise noted).

If you have a trading idea or strategy thatyou’d like to see tested, please send thetrading and money-management rules [email protected].

LEGEND: Net gain — Gain at end of test period.Percentage return — Gain or loss on a percentagebasis.Annualized return — Gain or loss on a annualizedpercentage basis.No. of trades — Number of trades generated bythe system.Winning/losing trades — Number of winners andlosers generated by the system.Win/loss — The percentage of trades that wereprofitable.Avg. trade — The average profit for all trades.

Largest winning trade — Biggest individual profitgenerated by the system.Largest losing trade — Biggest individual lossgenerated by the system.Avg. profit (winners) — The average profit for win-ning trades.Avg. loss (losers) — The average loss for losingtrades.Avg. hold time (winners) — The average holdingperiod for winning trades (in days).Avg. hold time (losers) — The average holdingperiod for losing trades (in days).Max consec. win/loss — The maximum number ofconsecutive winning and losing trades.

OPTIONS TRADING SYSTEM LAB

STRATEGY SUMMARY

Since 1/17/2001 Since 11/15/2006

Initial capital: $10,000 $10,000

Net gain: $32,680 $12,110

Percentage return: 327% 121%

Annualized return: 37.2% 41%

No. of trades: 91 32

Winning/losing trades: 52/39 17/15

Win/loss: 57% 53%

Avg. trade: $359.12 $378.44

Largest winning trade: $7,755.00 $7,755.00

Largest losing trade: -$4,220.00 -$4,220.00

Avg. profit (winners): $1,678.08 $2,371.18

Avg. loss (losers): -$1,399.49 -$1,880.00

Avg. hold time (winners): 16 15

Avg. hold time (losers): 15 14

Max consec. win/loss: 7/3 4/3


http://www.salonat.com


FUTURES & OPTIONS WATCH

The Commitments of Traders (COT) report is publishedweekly by the Commodity Futures Trading Commission(CFTC). The report divides the open positions in futures mar-kets into three categories: commercials, non-commercials,and non-reportable.

Commercial traders, or hedgers, tend to operate in the cashmarket (e.g., grain merchants and oil companies that eitherproduce or consume the underlying commodity). Non-commercial traders are large speculators (“large specs”)such as commodity trading advisors and hedge funds — pro-fessional money managers who don’t deal in the underlyingcash markets but speculate in futures on a large-scale basis.Many of these traders are trend-followers. The non-reportable category represents small traders, or the general public.

Figure 1 shows the relationship between commercials and large speculators onJan. 26. Positive values mean net commercial positions (longs minus shorts) are larg-er than net speculator holdings, based on their five-year historical relationship.Negative values mean large speculators have bigger positions than the commercials.

In January, commercial positions hit short extremes in live cattle (LC) and copper(HG) futures. On the other side, the commercials reached long extremes in eurocur-rency (EC) and wheat futures.

Note: The CFTC recently improved this report, in part, by removing swaps deal-ers from the commercial category. The commission has also clarified the large spec-ulator category by highlighting the role of managed money vs. other participants.�

— Compiled by Floyd Upperman

In January, the commercial-speculator dynamic was bearish in livecattle (LC) and copper futures (HG). Meanwhile, this relationshipwas bullish in eurocurrency futures (FX) and wheat (W).

FIGURE 1 — COT REPORT EXTREMES

For a list of contract names, see “Futures Snapshot.” Source: www.upperman.com

Commercial traders sell live cattle, buy the euro

Legend: Figure 1 shows the difference between net commer-cial and net large spec positions (longs minus shorts) for all 45futures markets, in descending order. It is calculated by subtract-ing the current net large spec position from the net commercialposition and then comparing this value to its five-year range. The formula is:

a1 = (net commercial 5-year high - net commercial current)b1 = (net commercial 5-year high - net commercial 5-year low)

c1 = ((b1 - a1)/ b1 ) * 100

a2 = (net large spec 5-year high - net large spec current)b2 = (net large spec 5-year high - net large spec 5-year low)

c2 = ((b2 - a2)/ b2 ) * 100

x = (c1 - c2)

Options Watch: Energy sector components (as of Jan. 29) Compiled by Tristan Yates

The following table summarizes the expiration months available for the 20 top holdings of the S&P 500 energy sector exchange-traded-fund(XLE). It also shows each stock’s average bid-ask spread for at-the-money (ATM) February options. The information does NOT constitute tradesignals. It is intended only to provide a brief synopsis of potential slippage in each option market.

spread as %Stock of underlying

Stock Ticker price Call Put priceExxon Mobil Corp. XOM X X X X X X 64.43 0.04 0.04 0.06%Chevron Corp. CVX X X X X X X 72.12 0.03 0.06 0.06%Schlumberger Ltd. SLB X X X X X X 63.46 0.05 0.04 0.07%Conoco Philips COP X X X X X X 48.00 0.03 0.05 0.08%Halliburton Co. HAL X X X X X 29.21 0.03 0.03 0.10%Chesapeake Energy Corp. CHK X X X X X X 24.78 0.03 0.03 0.13%Apache Corp. APA X X X X X X 98.77 0.16 0.19 0.18%EOG Resources Inc. EOG X X X X X X 90.42 0.18 0.16 0.19%Noble Energy Inc. NBL X X X X X X 73.94 0.16 0.13 0.19%Occidental Petroleum Corp. OXY X X X X X X 78.34 0.15 0.18 0.21%Devon Energy Corp. DVN X X X X X X 66.91 0.14 0.15 0.21%Anadarko Petroleum Corp. APC X X X X X 63.78 0.11 0.18 0.23%Hess Corp. HES X X X X X X 57.79 0.11 0.15 0.23%Southwestern Energy Co. SWN X X X X X X 42.88 0.10 0.13 0.26%Baker Hughes Inc. BHI X X X X X X 45.28 0.14 0.13 0.29%National Oilwell Varco Inc. NOV X X X X X X 40.90 0.13 0.11 0.29%XTO Energy Inc. XTO X X X X X X 44.57 0.13 0.14 0.29%Marathon Oil Corp. MRO X X X X X X 29.81 0.10 0.11 0.36%Williams Cos. WMB X X X X X X 20.84 0.08 0.08 0.36%Spectra Energy Corp. SE X X X X 21.25 0.14 0.15 0.68%

Legend:Call: Four-day average difference between bid and ask prices for the front-month ATM call.Put: Four-day average difference between bid and ask prices for the front-month ATM put.Bid-ask spread as % of underlying price: Average difference between bid and ask prices for front-month, ATM call, and put divided by the underlying’s closing price.

Feb.

Mar

ch

Apr

il

May

June

July

Aug

.

Sep

t.

Jan.

Jan.

2010 2011 2012

Bid-ask spreads

Bid-ask

http://www.currencytradermag.com


LegendVolume: 30-day average daily volume, in thou-sands (unless otherwise indicated).OI: Open interest, in thousands (unless other-wise indicated). 10-day move: The percentage price move fromthe close 10 days ago to today’s close.20-day move: The percentage price move fromthe close 20 days ago to today’s close.60-day move: The percentage price move fromthe close 60 days ago to today’s close.The “rank” fields for each time window (10-

day moves, 20-day moves, etc.) show the per-centile rank of the most recent move to a certainnumber of the previous moves of the same sizeand in the same direction. For example, therank for 10-day move shows how the mostrecent 10-day move compares to the past twen-ty 10-day moves; for the 20-day move, the rankfield shows how the most recent 20-day movecompares to the past sixty 20-day moves; forthe 60-day move, the rank field shows how themost recent 60-day move compares to the pastone-hundred-twenty 60-day moves. A readingof 100 percent means the current reading is

larger than all the past readings, while a read-ing of 0 percent means the current reading issmaller than the previous readings. These fig-ures provide perspective for determining howrelatively large or small the most recent pricemove is compared to past price moves.Volatility ratio/rank: The ratio is the short-termvolatility (10-day standard deviation of prices)divided by the long-term volatility (100-day stan-dard deviation of prices). The rank is the per-centile rank of the volatility ratio over the past60 days.

This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & OptionsTrader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buyor sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.

FUTURES SNAPSHOT (as of Jan. 29)

The following table summarizes the most actively traded U.S. futures contracts. The information does NOT constitute trade signals. It is intendedonly to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the dif-ferent fields. Volume figures are for the most active contract month in a particular market and may not reflect total volume for all contract months. Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).

10-day move/ 20-day move/ 60-day move/ VolatilityMarket Symbol Exchange Volume OI rank rank rank ratio/rankE-Mini S&P 500 ES CME 1.67 M 2.43 M -6.53% / 100% -4.59% / 100% 3.03% / 2% .77 / 100%10-yr. T-note TY CME 706.7 1.23 M 1.56% / 69% 2.41% / 96% -0.09% / 14% .25 / 7%5-yr. T-note FV CME 333.5 793.4 0.88% / 62% 1.69% / 85% 0.02% / 2% .31 / 7%E-Mini Nasdaq 100 NQ CME 278.0 308.5 -7.89% / 100% -7.33% / 100% 4.21% / 8% .68 / 100%Crude oil CL CME 256.8 256.2 -8.19% / 44% -8.06% / 78% -8.43% / 100% .47 / 65%Eurodollar* ED CME 238.3 536.3 0.16% / 20% 0.49% / 80% 0.58% / 50% .17 / 5%Eurocurrency EC CME 234.4 153.2 -4.39% / 100% -3.27% / 75% -6.01% / 97% .47 / 68%30-yr. T-bond US CME 198.3 661.1 1.73% / 42% 2.59% / 88% -0.84% / 25% .27 / 10%2-yr. T-note TU CME 196.3 867.2 0.09% / 29% 0.22% / 63% 0.06% / 24% .30 / 3%Gold 100 oz. GC CME 149.9 289.8 -5.18% / 100% -0.80% / 15% 2.83% / 5% .33 / 72%Mini Dow YM CME 108.5 64.7 -5.17% / 86% -3.36% / 92% 3.09% / 1% .65 / 100%Corn C CME 105.2 488.3 -6.46% / 17% -13.83% / 95% -6.75% / 24% .17 / 12%Natural gas NG CME 103.7 95.2 -8.18% / 92% -10.12% / 79% 4.25% / 2% .33 / 72%E-Mini Russell 2000 TF CME 102.0 340.5 -5.59% / 86% -3.67% / 55% 6.54% / 41% .69 / 100%British pound BP CME 99.3 81.0 -2.07% / 100% -0.47% / 19% -2.42% / 82% .37 / 33%Japanese yen JY CME 97.7 106.5 0.76% / 25% 2.40% / 66% 0.11% / 2% .36 / 42%Soybeans S CME 75.3 176.0 -7.11% / 64% -11.79% / 100% -8.42% / 48% .34 / 50%Australian dollar AD CME 73.5 108.1 -4.80% / 100% -0.64% / 21% -1.83% / 67% .48 / 97%Canadian dollar CD CME 65.5 96.4 -4.37% / 100% -1.32% / 65% 0.87% / 14% .84 / 97%Swiss franc SF CME 46.8 35.3 -4.02% / 100% -2.27% / 64% -3.53% / 97% .65 / 90%Sugar SB ICE 44.2 312.7 8.25% / 89% 10.95% / 46% 24.74% / 46% .20 / 27%Heating oil HO CME 36.8 56.9 -8.16% / 45% -9.31% / 100% -7.73% / 100% .39 / 58%Wheat W CME 35.9 184.5 -10.16% / 58% -12.96% / 100% -8.25% / 23% .25 / 8%Soybean oil BO CME 35.2 99.5 -6.18% / 38% -8.46% / 100% -1.74% / 14% .18 / 2%RBOB gasoline RB CME 34.0 52.3 -7.73% / 78% -6.23% / 83% -4.35% / 51% .41 / 67%Silver 5,000 oz. SI CME 30.0 77.5 -13.21% / 100% -3.64% / 53% -1.52% / 40% 1.10 / 98%Soybean meal SM CME 26.5 60.8 -5.72% / 71% -13.41% / 100% -9.55% / 44% .41 / 88%E-Mini S&P MidCap 400 ME CME 25.4 100.7 -6.70% / 100% -4.47% / 100% 6.32% / 35% .64 / 100%Copper HG CME 23.1 106.4 -9.89% / 100% -8.74% / 100% 3.65% / 1% .58 / 100%S&P 500 index SP CME 21.0 323.7 -6.53% / 100% -4.61% / 100% 3.01% / 1% .77 / 100%Mexican peso MP CME 17.4 101.4 -2.72% / 75% 0.43% / 19% 1.77% / 31% .44 / 57%U.S. dollar index DX ICE 16.6 52.8 2.80% / 88% 1.83% / 50% 5.04% / 100% .55 / 80%Live cattle LC CME 13.7 68.8 -0.98% / 100% 0.88% / 10% -0.49% / 2% .41 / 35%Lean hogs LH CME 12.6 55.5 -3.69% / 100% 1.33% / 0% 15.20% / 9% .27 / 73%Coffee KC ICE 10.1 77.5 -8.76% / 100% -3.62% / 53% -7.48% / 41% .58 / 100%Mini-sized gold YG CME 9.5 3.9 -5.31% / 100% -1.05% / 29% 2.08% / 3% .32 / 68%Crude oil e-miNY QM CME 9.4 4.7 -8.19% / 44% -8.05% / 78% -8.43% / 100% .48 / 67%Nikkei 225 index NK CME 7.2 33.1 -6.61% / 100% -4.08% / 52% 4.28% / 25% .56 / 72%Cocoa CC ICE 7.2 68.2 -6.35% / 100% -3.19% / 75% -2.75% / 100% .84 / 100%New Zealand dollar NE CME 7.1 22.2 -5.29% / 100% -2.31% / 54% -1.85% / 54% .78 / 95%Fed Funds** FF CME 6.7 58.3 0.02% / 16% 0.11% / 51% 0.20% / 13% .05 / 3%E-Mini eurocurrency ZE CME 3.0 2.6 -4.39% / 100% -3.27% / 75% -6.01% / 97% .47 / 68%Mini-sized silver YI CME 2.7 2.9 -13.24% / 100% -3.61% / 47% -1.45% / 28% 1.08 / 98%Natural gas e-miNY QG CME 2.7 2.9 -8.18% / 92% -10.14% / 79% 4.25% / 2% .34 / 76%Nasdaq 100 ND CME 2.2 12.5 -7.89% / 100% -7.33% / 100% 4.21% / 8% .68 / 100%Feeder cattle FC CME 1.4 7.5 1.38% / 25% 3.94% / 76% 3.94% / 92% .27 / 58%Dow Jones Ind. Avg. DJ CME 0.8 10.6 -6.06% / 100% -4.51% / 100% 2.90% / 0% .63 / 98%*Average volume and open interest based on highest-volume contract (March 2011). **Average volume and open interest based on highest-volume contract (May 2010).


LEGEND:Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-daymoves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example, the “rank”for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows how the mostrecent 20-day move compares to the past sixty 20-day moves.

OPTIONS RADAR (as of Jan. 29)

MOST-LIQUID OPTIONS*Indices Symbol Exchange Options Open 10-day move / 20-day move / IV / IV / SV ratio —

volume interest rank rank SV ratio 20 days agoS&P 500 index SPX CBOE 161.6 1.30 M -6.49% / 100% -4.67% / 100% 21.5% / 13.1% 16.8% / 12.3%S&P 500 volatility index VIX CBOE 137.5 2.25 M 39.65% / 57% 23.35% / 86% 86% / 87.1% 158.6% / 92%Russell 2000 index RUT CBOE 46.0 402.1 -6.87% / 100% -4.95% / 76% 25% / 17.1% 22.9% / 17.7%E-Mini S&P 500 futures ES CME 24.1 120.1 -5.56% / 86% -3.74% / 87% 21.7% / 14.9% 16.5% / 15%Nasdaq 100 index NDX CBOE 20.3 193.3 -7.71% / 100% -7.32% / 100% 23% / 15.2% 17.7% / 15%

StocksCitigroup C 165.3 7.43 M -5.41% / 22% 0.00% / 0% 45.1% / 46.4% 49.3% / 46.4%Bank of America BAC 164.4 3.71 M -9.75% / 63% 0.73% / 0% 38.9% / 41.4% 36.8% / 30.4%AT&&T Inc T 135.2 495.4 -3.17% / 7% -10.45% / 100% 23.6% / 20.1% 19.2% / 18.1%Apple Inc AAPL 121.3 922.3 -8.29% / 100% -9.25% / 100% 36.4% / 26.1% 33.3% / 27.2%Verizon Comm VZ 102.4 336.2 -5.77% / 63% -11.97% / 95% 22.3% / 20% 18.2% / 19.3%

FuturesEurodollar ED CME 274.9 4.96 M 0.00% / 0% 0.07% / 30% 103.7% / 32.8% 107.2% / 57.8%10-year T-notes TY CME 77.7 707.2 1.56% / 69% 2.41% / 96% 6% / 4.8% 6.8% / 4.9%Corn C CME 39.1 497.6 -6.46% / 17% -13.83% / 95% 27.1% / 32.1% 33.1% / 34.4%30-year T-bonds US CME 27.2 156.4 1.73% / 42% 2.59% / 88% 10.2% / 7.7% 11% / 8.5%E-Mini S&P 500 futures ES CME 24.1 120.1 -5.56% / 86% -3.74% / 87% 21.7% / 14.9% 16.5% / 15%

VOLATILITY EXTREMES**Indices - High IV/SV ratio

S&P 500 index SPX CBOE 161.6 1.30 M -6.49% / 100% -4.67% / 100% 21.5% / 13.1% 16.8% / 12.3%S&P 100 index OEX CBOE 11.6 80.5 -6.52% / 100% -4.59% / 100% 20.9% / 12.9% 15.9% / 11.5%S&P 100 index XEO CBOE 4.0 36.4 -6.52% / 100% -4.59% / 100% 20.2% / 13% 15.3% / 12.1%Nasdaq 100 index NDX CBOE 20.3 193.3 -7.71% / 100% -7.32% / 100% 23% / 15.2% 17.7% / 15%Dow Jones index DJX CBOE 6.5 128.6 -6.01% / 100% -4.57% / 100% 18.8% / 12.5% 15.1% / 12.3%

Indices - Low IV/SV ratioS&P 500 volatility index VIX CBOE 137.5 2.25 M 39.65% / 57% 23.35% / 86% 86% / 87.1% 158.6% / 92%

Stocks - High IV/SV ratioBurlington Northern SF BNI 1.2 106.8 0.52% / 80% 1.01% / 53% 12.5% / 2.2% 13.4% / 2.5%Cell Therapeutics CTIC 15.2 215.0 -6.72% / 33% -3.48% / 10% 198.6% / 56.3% 155.2% / 70.6%InterMune ITMN 1.8 56.9 8.55% / 41% 20.54% / 76% 144% / 51.8% 103.4% / 43.5%Chimera Invest CIM 1.1 85.0 -5.31% / 100% 0.00% / 0% 61.1% / 25.6% 66.1% / 39.8%YRC Worldwide YRCW 46.8 529.6 -8.82% / 0% -6.06% / 13% 373.8% / 166.3% 351.2% / 158.4%

Stocks - Low IV/SV ratioCadbury PLC CBY 7.4 48.9 2.55% / 25% 4.17% / 57% 11.4% / 19.1% 24.8% / 12.7%Origin Agritech Ltd SEED 8.1 40.1 -18.15% / 57% -17.19% / 94% 77.8% / 113.4% 95% / 85.1%McMoRan Exploration MMR 11.8 119.0 4.46% / 0% 82.16% / 65% 66.8% / 95.1% 78.7% / 50.5%Taser Intl TASR 1.0 31.2 -11.74% / 100% 29.66% / 68% 62.6% / 84.7% 55.5% / 36.9%Zions Bancorp ZION 9.4 111.5 13.52% / 22% 48.20% / 92% 56.1% / 75.6% 54% / 38.8%

Futures - High IV/SV ratioEurodollar ED CME 274.9 4.96 M 0.00% / 0% 0.07% / 30% 103.7% / 32.8% 107.2% / 57.8%Cocoa CC ICE 1.3 10.4 -6.13% / 100% -1.94% / 52% 35.2% / 19.9% 37.6% / 25%5-year T-notes FV CME 7.5 74.8 0.88% / 62% 1.69% / 85% 4.1% / 2.6% 4.9% / 3.2%S&P 500 futures SP CME 12.7 63.1 -6.53% / 100% -4.61% / 100% 20.6% / 13.8% 16.8% / 12.2%Live cattle LC CME 5.0 149.1 -0.98% / 100% 0.88% / 10% 15.2% / 10.4% 14.3% / 12.8%

Futures - Low IV/SV ratioOrange juice OJ ICE 2.6 21.4 2.37% / 18% -0.58% / 14% 38.8% / 53.7% 48.6% / 37.4%Soybean oil ZL CME 2.9 69.4 -6.18% / 38% -8.46% / 100% 22.6% / 28.1% 24.7% / 24.6%Corn C CME 39.1 497.6 -6.46% / 17% -13.83% / 95% 27.1% / 32.1% 33.1% / 34.4%Wheat ZW CME 6.6 134.6 -10.16% / 58% -12.96% / 100% 32% / 36.9% 38.2% / 31.7%Silver SI CME 1.5 30.3 -13.21% / 100% -3.64% / 53% 31.9% / 35% 33.8% / 37.3%

* Ranked by volume ** Ranked based on high or low IV/SV values.


American style: An option that can be exercised at anytime until expiration.

Assign(ment): When an option seller (or “writer”) isobligated to assume a long position (if he or she sold a put)or short position (if he or she sold a call) in the underlyingstock or futures contract because an option buyer exercisedthe same option.

At the money (ATM): An option whose strike price isidentical (or very close) to the current underlying stock (orfutures) price.

Backspreads and ratio spreads are leveraged posi-tions that involve buying and selling options in differentproportions, usually in 1:2 or 2:3 ratios. Backspreads con-tain more long options than short ones, so the potentialprofits are unlimited and losses are capped. By contrast,ratio spreads have more short options than long ones andhave the opposite risk profile.

Note: These labels are not set in stone. Some tradersdescribe either position as option trades with long andshort legs in different proportions.

Bear call spread: A vertical credit spread that consistsof a short call and a higher-strike, further OTM long call inthe same expiration month. The spread’s largest potentialgain is the premium collected, and its maximum loss is lim-ited to the point difference between the strikes minus thatpremium.

Bear put spread: A bear debit spread that contains putswith the same expiration date but different strike prices.You buy the higher-strike put, which costs more, and sellthe cheaper, lower-strike put.

Bollinger Bands: Bollinger Bands are a type of trading“envelope” consisting of lines plotted above and below amoving average, which are designed to capture a market’stypical price fluctuations.

The indicator is similar in concept to the moving averageenvelope, with an important difference: While movingaverage envelopes plot lines a fixed percentage above andbelow the average (typically three percent above and belowa 21-day simple moving average), Bollinger Bands use stan-dard deviation to determine how far above and below themoving average the lines are placed. As a result, while theupper and lower lines of a moving average envelope movein tandem, Bollinger Bands expand during periods of risingmarket volatility and contract during periods of decreasingmarket volatility.

Bollinger Bands were created by John Bollinger, CFA,CMT, the president and founder of Bollinger CapitalManagement. By default, the upper and lower Bollinger

Bands are placed two standard deviations above and belowa 20-period simple moving average.

Upper band = 20-period simple moving average + 2 standard deviationsMiddle line = 20-period simple moving average of closingpricesLower band = 20-period simple moving average - 2 stan-dard deviations

Bollinger Bands highlight when price has become high orlow on a relative basis, which is signaled through the touch(or minor penetration) of the upper or lower line. However,Bollinger stresses that price touching the lower or upperband does not constitute an automatic buy or sell signal. Forexample, a close (or multiple closes) above the upper bandor below the lower band reflects stronger upside or down-side momentum that is more likely to be a breakout (ortrend) signal, rather than a reversal signal. Accordingly,Bollinger suggests using the bands in conjunction withother trading tools that can supply context and signal con-firmation.

Bull call spread: A bull debit spread that contains callswith the same expiration date but different strike prices.You buy the lower-strike call, which has more value, andsell the less-expensive, higher-strike call.

Bull put spread (put credit spread): A bull creditspread that contains puts with the same expiration date, butdifferent strike prices. You sell an OTM put and buy a less-expensive, lower-strike put.

KEY CONCEPTS

The option “Greeks”

Delta: The ratio of the movement in the option price forevery point move in the underlying. An option with adelta of 0.5 would move a half-point for every 1-pointmove in the underlying stock; an option with a delta of1.00 would move 1 point for every 1-point move in theunderlying stock.

Gamma: The change in delta relative to a change in theunderlying market. Unlike delta, which is highest fordeep ITM options, gamma is highest for ATM optionsand lowest for deep ITM and OTM options.

Rho: The change in option price relative to the changein the interest rate.

Theta: The rate at which an option loses value each day(the rate of time decay). Theta is relatively larger forOTM than ITM options, and increases as the option getscloser to its expiration date.

Vega: How much an option’s price changes per a one-percent change in volatility.


Butterfly: A non-directional trade consisting of optionswith three different strike prices at equidistant intervals:Long one each of the highest and lowest strike price optionsand short two of the middle strike price options.

Calendar spread: A position with one short-term shortoption and one long same-strike option with more timeuntil expiration. If the spread uses ATM options, it is mar-ket-neutral and tries to profit from time decay. However,OTM options can be used to profit from both a directionalmove and time decay.

Call option: An option that gives the owner the right, butnot the obligation, to buy a stock (or futures contract) at afixed price.

The Commitments of Traders report: Publishedweekly by the Commodity Futures Trading Commission(CFTC), the Commitments of Traders (COT) report breaksdown the open interest in major futures markets. Clearingmembers, futures commission merchants, and foreign bro-kers are required to report daily the futures and optionspositions of their customers that are above specific report-ing levels set by the CFTC.

For each futures contract, reportdata is divided into three “reporting”categories: commercial, non-commer-cial, and non-reportable positions. Thefirst two groups are those who holdpositions above specific reporting lev-els.

The “commercials” are oftenreferred to as the large hedgers.Commercial hedgers are typicallythose who actually deal in the cashmarket (e.g., grain merchants and oilcompanies, who either produce orconsume the underlying commodity)and can have access to supply anddemand information other marketplayers do not.

Non-commercial large tradersinclude large speculators (“largespecs”) such as commodity tradingadvisors (CTAs) and hedge funds.This group consists mostly of institu-tional and quasi-institutional moneymanagers who do not deal in theunderlying cash markets, but specu-late in futures on a large-scale basis fortheir clients.

The final COT category is called thenon-reportable position category —otherwise known as small traders —i.e., the general public.

Covered call: Shorting an out-of-the-money call optionagainst a long position in the underlying market. An exam-ple would be purchasing a stock for $50 and selling a calloption with a strike price of $55. The goal is for the marketto move sideways or slightly higher and for the call optionto expire worthless, in which case you keep the premium.

Credit spread: A position that collects more premiumfrom short options than you pay for long options. A creditspread using calls is bearish, while a credit spread usingputs is bullish.

Debit spread: An options spread that costs money toenter, because the long side is more expensive that the shortside. These spreads can be verticals, calendars, or diagonals.

Delivery period (delivery dates): The specific timeperiod during which a delivery can occur for a futures con-tract. These dates vary from market to market and are deter-mined by the exchange. They typically fall during themonth designated by a specific contract — e.g. the deliveryperiod for March T-notes will be a specific period in March.

continued on p. 22

www.esignal.com/offer/ot


Diagonal spread: A position consisting of options withdifferent expiration dates and different strike prices — e.g.,a December 50 call and a January 60 call.

European style: An option that can only be exercised atexpiration, not before.

Exercise: To exchange an option for the underlyinginstrument.

Exponential moving average (EMA): The simplemoving average (SMA) is the standard moving average cal-culation that gives every price point in the average equalemphasis, or weight. For example, a five-day SMA is thesum of the most recent five closing prices divided by five.

Weighted moving averages give extra emphasis to morerecent price action. Exponential moving average (EMA)weights prices using the following formula:

EMA = SC * Price + (1 - SC) * EMA(yesterday)where:SC is a “smoothing constant” between 0 and 1, andEMA(yesterday) is the previous day’s EMA value.

You can approximate a particular SMA length for an EMAby using this formula to calculate the equivalent smoothingconstant:

SC = 2/(n + 1)where:n = the number of days in a simple moving average of approximately equivalent length.

For example, a smoothing constant of 0.095 creates anexponential moving average equivalent to a 20-day SMA(2/(20 + 1) = 0.095). The larger n is, the smaller the constant,and the smaller the constant, the less impact the most recentprice action will have on the EMA. In practice, most soft-ware programs allow you to simply choose how many daysyou want in your moving average and select either simple,weighted, or exponential calculations.

Expiration: The last day on which an option can be exer-cised and exchanged for the underlying instrument (usual-ly the last trading day or one day after).

Extrinsic value: The difference between an option'sintrinsic value and it's current price(premium). For example, with theunderlying instrument trading at 50, a45-strike call option with a premium of8.50 has 3.50 of extrinsic value.

Front month (or “nearestmonth”): The contract month closestto expiration.

In the money (ITM): A call optionwith a strike price below the price ofthe underlying instrument, or a putoption with a strike price above theunderlying instrument’s price.

Intrinsic value: The differencebetween the strike price of an in-the-money option and the underlyingasset price. A call option with a strikeprice of 22 has 2 points of intrinsicvalue if the underlying market is trad-ing at 24.

Naked option: A position thatinvolves selling an unprotected call orput that has a large or unlimitedamount of risk. If you sell a call, forexample, you are obligated to sell theunderlying instrument at the call’sstrike price, which might be below the

KEY CONCEPTS



market’s value, triggering a loss. If you sell a put, for exam-ple, you are obligated to buy the underlying instrument atthe put’s strike price, which may be well above the market,also causing a loss.

Given its risk, selling naked options is only for advancedoptions traders, and newer traders aren’t usually allowedby their brokers to trade such strategies.

Naked (uncovered) puts: Selling put options to collectpremium that contains risk. If the market drops below theshort put’s strike price, the holder may exercise it, requiringyou to buy stock at the strike price (i.e., above the market).

Near the money: An option whose strike price is closeto the underlying market’s price.

Open interest: The number of options that have notbeen exercised in a specific contract that has not yet expired.

Out of the money (OTM): A call option with a strikeprice above the price of the underlying instrument, or a putoption with a strike price below the underlying instru-ment’s price.

Parity: An option trading at itsintrinsic value.

Physical delivery: The process ofexchanging a physical commodity(and making and taking payment) as aresult of the execution of a futures con-tract. Although 98 percent of allfutures contracts are not delivered,there are market participants who dotake delivery of physically settled con-tracts such as wheat, crude oil, and T-notes. Commodities generally aredelivered to a designated warehouse;T-note delivery is taken by a book-entry transfer of ownership, althoughno certificates change hands.

Premium: The price of an option.

Put option: An option that gives theowner the right, but not the obliga-tion, to sell a stock (or futures contract)at a fixed price.

Put ratio backspread: A bearishratio spread that contains more longputs than short ones. The short strikesare closer to the money and the longstrikes are further from the money.

For example, if a stock trades at $50,

you could sell one $45 put and buy two $40 puts in the sameexpiration month. If the stock drops, the short $45 putmight move into the money, but the long lower-strike putswill hedge some (or all) of those losses. If the stock dropswell below $40, potential gains are unlimited until it reach-es zero.

Put spreads: Vertical spreads with puts sharing the sameexpiration date but different strike prices. A bull put spreadcontains short, higher-strike puts and long, lower-strikeputs. A bear put spread is structured differently: Its longputs have higher strikes than the short puts.

Simple moving average: A simple moving average(SMA) is the average price of a stock, future, or other mar-ket over a certain time period. A five-day SMA is the sum ofthe five most recent closing prices divided by five, whichmeans each day’s price is equally weighted in the calcula-tion.

Stochastic oscillator: A technical tool designed tohighlight shorter-term momentum and “overbought” and“oversold” levels (points at which a price move has, theo-

continued on p. 24


retically at least, temporarily exhausted itself and is ripe fora correction or reversal).Calculation: The stochastic oscillator consists of two lines:%K and a moving average of %K called %D. The basic sto-chastic calculation compares the most recent close to theprice range (high of the range - low of the range) over a par-ticular period.For example, a 10-day stochastic calculation (%K) would bethe difference between today’s close and the lowest low ofthe last 10 days divided by the difference between the high-est high and the lowest low of the last 10 days; the result ismultiplied by 100.

The formula is:

%K = 100*{(Ct-Ln)/(Hn-Ln)}where:Ct is today’s closing priceHn is the highest price of the most recent n days

(the default value is five days)Ln is the lowest price of the most recent n days

The second line, %D, is a three-period simple movingaverage of %K. The resulting indicator fluctuates between 0and 100.

Fast vs. slow: This formula is sometimes referred to as

“fast” stochastics. Because it is very volatile, an additional-ly smoothed version of the indicator — where the original%D line becomes a new %K line and a three-period averageof this line becomes the new %D line –– is more commonlyused (and referred to as “slow” stochastics, or simply “sto-chastics”).

Any of the parameters — either the number of periodsused in the basic calculation or the length of the movingaverages used to smooth the %K and %D lines — can beadjusted to make the indicator more or less sensitive toprice action.

Horizontal lines are used to mark overbought and over-sold stochastic readings. These levels are discretionary;readings of 80 and 20 or 70 and 30 are common, but differ-ent market conditions and indicator lengths will dictate dif-ferent levels.

Straddle: A non-directional option spread that typicallyconsists of an at-the-money call and at-the-money put withthe same expiration. For example, with the underlyinginstrument trading at 25, a standard long straddle wouldconsist of buying a 25 call and a 25 put. Long straddles aredesigned to profit from an increase in volatility; short strad-dles are intended to capitalize on declining volatility. Thestrangle is a related strategy.

Strangle: A non-directional optionspread that consists of an out-of-the-money call and out-of-the-money putwith the same expiration. For example,with the underlying instrument trad-ing at 25, a long strangle could consistof buying a 27.5 call and a 22.5 put.Long strangles are designed to profitfrom an increase in volatility; shortstrangles are intended to capitalize ondeclining volatility. The straddle is arelated strategy.

Strike (“exercise”) price: Theprice at which an underlying instru-ment is exchanged upon exercise of anoption.

Time decay: The tendency of timevalue to decrease at an accelerated rateas an option approaches expiration.

Time spread: Any type of spreadthat contains short near-term optionsand long options that expire later. Bothoptions can share a strike price (calen-dar spread) or have different strikes(diagonal spread).

Source: Barclay Hedge (www.barclayhedge.com) Based on estimates of the composite of all

accounts or the fully funded subset method. Does not reflect the performance of any single account.

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

Top 10 option strategy traders ranked by December 2009 return.

(Managing at least $1 million as of Dec. 31, 2009.)

Nov. 2009 YTD $ underRank Trading advisor return return mgmt.

1. Kingsview Mgmt (Retail) 11.31% 12.45% 2.5

2. CKP Finance Associates (Masters) 10.63% 317.61% 8.5

3. LJM Partners (Aggr. Premium Writing) 7.35% 51.25% 28.7

4. ACE Investment Strategists (ASIPC) 7.01% 43.36% 3.3

5. ACE Investment Strat. (SIPC INST) 6.28% 37.33% 9.6

6. Kingsview Capital Ptnrs 5.26% 17.63% 1.6

7. Carter Road 5.00% 83.35% 1.3

8. Newport Private Capital (TEOW) 4.57% 25.88% 21.9

9. Reynoso Asset Mgmt. (Options Arb.) 4.47% 2.92% 2.0

10. LJM Partners (LJM Fund LP) 4.33% 28.70% 63.7

MANAGED MONEY


KEY CONCEPTS

http://www.barclayhedge.com

Time value (premium): The amount of an option’svalue that is a function of the time remaining until expira-tion. As expiration approaches, time value decreases at anaccelerated rate, a phenomenon known as “time decay.”

True range (TR): A measure of price movement thataccounts for the gaps that occur between price bars. Thiscalculation provides a more accurate reflection of the size ofa price move over a given period than the standard rangecalculation, which is simply the high of a price bar minusthe low of a price bar. The true range calculation was devel-oped by Welles Wilder and discussed in his book NewConcepts in Technical Trading Systems (Trend Research, 1978).

True range can be calculated on any time frame or pricebar — five-minute, hourly, daily, weekly, etc. The followingdiscussion uses daily price bars for simplicity. True range isthe greatest (absolute) distance of the following:

1. Today’s high and today’s low.2. Today’s high and yesterday’s close.3. Today’s low and yesterday’s close.

Average true range (ATR) is simply a moving average ofthe true range over a certain time period. For example, thefive-day ATR would be the average of the true range calcu-lations over the last five days.

Vertical spread: A position consisting of options withthe same expiration date but different strike prices (e.g., aSeptember 40 call option and a September 50 call option).

Volatility: The level of price movement in a market.Historical (“statistical”) volatility measures the price fluctu-ations (usually calculated as the standard deviation of clos-ing prices) over a certain time period — e.g., the past 20days. Implied volatility is the current market estimate offuture volatility as reflected in the level of option premi-ums. The higher the implied volatility, the higher the optionpremium.

http://www.currencytradermag.ir


� CME Group is expanding its international electronictrading fee incentive programs to provide clients outside ofNorth America with greater access to COMEX metalsfutures products. The programs include InternationalIncentive Program (IIP), the Asia Pacific Incentive Program(AIP), the South American Incentive Program (SAIP), theLatin American Commercial Incentive Program (LACIP),and the Latin American Fund Manager Incentive Program(FMIP). They will run through Dec. 31, 2010. The programsprovide traders at proprietary trading firms, arcades, banks,and fund managers outside of North America with feeincentives for electronically traded COMEX futures.Customers who participate in the international incentiveprograms will be subject to minimum volume and applica-tion requirements. Additional details can be found atwww.cmegroup.com/incentives.

� E*TRADE Securities has launched CNBC Plus on itsnewly redesigned premier desktop trading software foractive traders, Power E*TRADE Pro. CNBC Plus offerscommercial-free live streams of CNBC TV from the U.S.,Europe, and Asia. The CNBC Plus video-on-demandarchive provides the ultimate research library with morethan 150,000 interviews, analysis, and commentary, andmore than 100 new clips added each day. In addition toCNBC Plus, Power E*TRADE Pro now features a new lookand feel, new console header, improved windows manage-ment, RSS feed capability, and redesigned stocks andoptions order tickets. For more information aboutE*TRADE Securities products, services and educational ini-tiatives, visit www.etrade.com.

� CQG now provides access to real-time market datathrough the BlackBerry wireless platform. Data from morethan 100 exchanges worldwide is available to CQG Mobileusers, bringing real-time quotes on futures, stocks, fixedincome, options, indices, foreign exchange, and cash totraders on the go. CQG is an order execution, charting, andanalytics provider for global electronically traded futuresmarkets. CQG partners with more than 40 FuturesCommission Merchants and provides direct market accessto more than 35 exchanges through its worldwide networkof collocated CQG Hosted Exchange Gateways. For moreinformation about CQG, visit www.cqg.com.

� Alpari, a regulated foreign exchange company andglobal provider of online forex trading, has introduced spottrading of precious metals, gold and silver. These instru-ments are available to Alpari (U.S.) retail account holders.Both the gold and silver trading instruments can be locatedin the Market Watch window at the top left of the AlpariMetaTrader 4 platform. Gold is represented by the symbolpair XAUUSD, while silver is represented by the symbolpair XAGUSD. Those interested in trading with Alpari areencouraged to test out the spot trading of gold and silverthrough a demo account available on the company’s Website, www.alpari-us.com.�

Note: The New Products and Services section is a forum for industry businesses to announce new products and upgrades. Listings are adapted frompress releases and are not endorsements or recommendations from the Active Trader Magazine Group. E-mail press releases to [email protected]. Publication is not guaranteed.

NEW PRODUCTS AND SERVICES

EVENTS

Event: International Traders ExpoDate: Feb. 14-17Location: Marriott Marquis Hotel, New York, N.Y.For more information: www.tradersexpo.com

Event: 26th Annual Risk Management ConferenceDate: March 7-9Location: The Ritz-Carlton Golf Resort, Naples, Fla.For more information: Visit www.cboe.com/rmc

Event: 35th Annual International Futures Industry ConferenceDate: March 10-13Location: Boca Raton Resort & Club, Fla.For more information: Go to www.futuresindustry.org

Event: The 17th Forbes Cruise for InvestorsDate: March 18-30Location: Crystal Symphony, Sydney to AucklandFor more information: Go towww.moneyshow.com/events/Investment_Cruises.asp

Event: The 11th Free Technical Analysis ExpoDate: March 26-27Location: Paris, FranceFor more information: Go to www.salonat.com

Event: The World MoneyShow Vancouver 2010Date: April 6-8Location: Hyatt Regency VancouverFor more information: Go towww.moneyshow.com/events/World_MoneyShows.asp

Event: FIA/FOA International Derivatives ExpoDate: June 8-9Location: The Brewery, Chiswell Street, LondonFor more information: Go to www.idw.org.uk

Event: Los Angeles Traders ExpoDate: June 9-12Location: Pasadena Convention Center, Los AngelesFor more information: Go towww.moneyshow.com/caot/?scode=013721

http://www.cmegroup.com/incentives

http://www.etrade.com

http://www.cqg.com

http://www.alpari-us.com


http://www.tradersexpo.com

http://www.cboe.com/rmc

http://www.futuresindustry.org

http://www.moneyshow.com/events/Investment_Cruises.asp


http://www.moneyshow.com/events/World_MoneyShows.asp

http://www.idw.org.uk

http://www.moneyshow.com/caot/?scode=013721

February 2010 • FUTURES & OPTIONS TRADER 27

MONTH

Legend

CPI: Consumer price index

ECI: Employment cost index

FDD (first delivery day):The first day on which deliv-ery of a commodity in fulfill-ment of a futures contractcan take place.

FND (first notice day): Alsoknown as first intent day, thisis the first day a clearing-house can give notice to abuyer of a futures contractthat it intends to deliver acommodity in fulfillment of afutures contract. The clear-inghouse also informs theseller.

FOMC: Federal Open MarketCommittee

GDP: Gross domestic product

ISM: Institute for supply man-agement

LTD (last trading day): Thefirst day a contract may tradeor be closed out before thedelivery of the underlyingasset may occur.

PPI: Producer price index

Quadruple witching Friday:A day where equity options,equity futures, index options,and index futures all expire.

February

1 FDD: February crude oil, natural gas, gold, silver, copper, platinum, and palladium futures (CME)

2 FND: January heating oil and RBOB gasoline futures (CME)Weekly weather report

3 Petroleum status report

4 Natural gas storage report

5 LTD: February live cattle and pork bellies options (CME); March cocoa, cotton and U.S. dollar index options (ICE)

6 FDD: February heating oil and RBOB gasoline futures (CME)

7

8 FND: February live cattle and pork bellies futures (CME)

9 FDD: February pork bellies futures (CME)Weekly weather report, crop production, and world agricultural production

10 LTD: March coffee options (ICE)Petroleum status report

11 FDD: February live cattle futures (CME)Natural gas storage report

12 FND: March cocoa futures (CME)Crop value annual summary

13

14

15

16 LTD: March sugar options (ICE)

17 LTD: March crude oil and platinum options (CME)Weekly weather report

18 FND: March coffee futures (ICE)Petroleum status report, natural gas storage report, and U.S. Agricultural trade outlook

19 LTD: March corn, wheat, soybeans, soybean products, oats, rough rice, and T-bonds options (CME); March orange juice options (ICE); February single stock futures (OC); February index and equity optionsCattle on feed

20

21

22 FND: March cotton futures (ICE)LTD: March crude oil futures (CME)

23 LTD: February live cattle futures (CME); March natural gas, heating oil, RBOB gasoline, gold, silver, and copperoptions (CME) Weekly weather report

24 FND: March crude oil futures (CME)LTD: February natural gas, gold, silver,palladium futures (CME)Petroleum status report

25 FND: March natural gas futures (CME)Natural gas storage report

26 FND: March gold, silver, copper, platinum, palladium, corn, wheat, soybeans, soybean products, oats, rough rice, and T-bonds futures (CME)LTD: March heating oil and RBOB gasoline futures; February live cattle futures; March lumber options (CME); March sugar futures (ICE)Agricultural prices

27

28

March

1 FND: March sugar and orange juice futures (ICE)FDD: March crude oil, natural gas, gold, silver, copper, platinum, palladium, corn, wheat, soybeans, soybean products, oats, rough rice, and T-bonds (CME); March coffee, sugar, cocoa, and cotton (ICE)

2 FND: March heating oil and RBOB gasoline futures (CME)Weekly weather report

3 Petroleum status report

4 Natural gas storage report

5 LTD: March pork bellies options (CME); April cocoa; March U.S. dollar index options (ICE); March currency options

FEBRUARY/MARCH FUTURES & OPTIONS CALENDAR

The information on this page issubject to change. Futures &Options Trader is not responsiblefor the accuracy of calendar datesbeyond press time.

FEBRUARY 2010

31 1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 1 2 3 4 5 6

MARCH 2010

28 1 2 3 4 5 6

7 8 9 10 11 12 13

14 15 16 17 18 19 20

21 22 23 24 25 26 27

28 29 30 31 1 2 3


Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profitduring lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

TRADE

Date: Thursday, Dec. 17, 2009.

Entry: Long February crude oil (CLG10) at73.80.

Reason for trade/setup: This was a simple swing trade,based on an uptrending market turning up after a pullback.

After rallying back above $70 in October, front-month crudeconsolidated in November before swinging lower in earlyDecember. Nonetheless, as the economic panic has continued torecede in traders’ memories, commodities benefited enormouslyand there’s little in the way of resistance (other than a double-diprecession) for a longer-term up move in oil.

The March contract bottomed a little below $71 on Dec. 14,and after a couple of days of bullish price action, we entered alimit order to buy at 73.80 on Dec. 16 when the market was trad-ing around 74.40. Note: This was a paper trade.

Initial stop: 72.31. The recent swing low represents too-largea risk, and if our outlook is correct, the market shouldn’t pull backto that level before rallying. If it does, we don’t want to be in themarket anyway, so we will exit sooner rather than later.

Initial target: 76.35, just below the Dec. 8 high. Take partialprofits and raise stop to protect remainder of position.

Secondary target: 81.89, a little below the lower range of theOctober-November consolidation’s resistance level (which isaround the whole-number price of 82.00).

RESULT

Exit: 76.35 (first half); 81.89 (second half).

Profit/loss: +2.55 (first half); +8.09 (second half).

Outcome: After one more additional downswing (to 72.72) onDec. 22, the market closed strongly and jumped up to the initialprofit target on Dec. 23. The next several days brought an almostuninterrupted rally, and the stop was raised accordingly to protectthe remainder of the position.

Although oil traded even higher after hitting the second targeton Jan. 4 (trading as high as 83.95), the market turned lower onJan. 12. The target level did, in fact, act as resistance, although inthis case the market traded a little above the previous contracthigh rather than a little below it. However, it could easily havebeen the other way around; if we had set a target based on themarket exceeding that level by too much, we might have missedthe opportunity to exit.�

Note: Initial targets for trades are typically based on things such as thehistorical performance of a price pattern or trading system signal.However, individual trades are a function of immediate market behavior;initial price targets are flexible and are most often used as points at whicha portion of the trade is liquidated to reduce the position’s open risk. As aresult, the initial (pre-trade) reward-risk ratios are conjectural by nature.

Crude rebound follows chart levels.

FUTURES TRADE JOURNAL

Source: TradeStation

P/L

Date Contract Entry price Initial stop Initial target IRR Exit Date Point % LOP LOL Length

12/17/09 CLG10 73.80 72.31 76.35 1.71 76.35 12/23/09 +2.55 3.5% -1.08 9.72 4 days

81.89 1/4/10 +8.09 11% 11 days

TRADE SUMMARY


TRADE

Date: Friday, Jan. 22.

Market: Options on S&P 500 tracking stock (SPY).

Entry: Buy two February 110-strike calls for $3.25 each.Sell two February 115-strike calls for $0.75 each.

Reasons for trade/setup: The S&P 500 index dropped2 percent on Jan. 21 as President Obama revealed his plan toreign in U.S. banks. The market then slid another 1 percentthe next morning as several U.S. senators announced theiropposition to Federal Reserve Chairman Ben Bernanke’sreappointment.

Was this drop a brief interruption in a 10-month bull mar-ket, or did it signal a major reversal (Figure 1)? Historicaltesting suggests the stock market has tended to bounceback from such dips since the early 1990s, a pattern that hasbeen explored in Active Trader’s ongoing System Designseries.

After a three-day decline of 3.3 percent, the market ispoised to trigger the long pullback pattern discussed in this

series, which is why we are bullish, not bearish. Blackclouds may be forming over Wall Street, but the decline hasbeen fairly mild so far, suggesting that buying the dip couldbe profitable.

Although we typically buy in-the-money (ITM) calls toexploit a potential rally, options prices are too expensive;the CBOE Volatility Index (VIX) has climbed 42 percentwithin three days. To reduce costs and lower exposure toswings in implied volatility, we will buy ITM calls and sellhigher-strike calls in the same expiration month — a bullcall spread.

We bought February 110-115 bull call spreads for $2.50each when SPY traded at 111.36 at 12:40 p.m. ET. Figure 2

TRADE STATISTICS

Date Jan. 22 Jan. 29

Delta: 72.49 64.39

Gamma: -1.59 10.48

Theta: -2.77 -6.18

Vega: 4.35 13.78

Probability of profit: 39% 14%

Breakeven point: 112.50 112.50

OPTIONS TRADE JOURNAL

This February 110-115 bull call spread won’t profit unless SPY jumpsat least 1 percent to 112.50 by expiration. But the spread has limiteddirectional risk or exposure to changes in volatility.

FIGURE 2 — RISK PROFILE — BULL CALL SPREAD

Source: OptionVue

continued on p. 30

SPY fell 1.9 percent on Jan. 22, closingnear its low. Is the market poised to reboundor fall off a cliff?

FIGURE 1 — BUYING THE DIP

Source: eSignal

A bad signal and a lack of discipline wounds this bull call spread on SPY.

TRADE SUMMARY

Entry date: Friday, Jan. 22Underlying security: S&P 500 tracking stock (SPY)Position: Bull call spread

2 long February 110 calls2 short February 115 calls

Initial capital required: $500Initial stop: Exit after five daysInitial target: SPY jumps to 114 or momentum

signal triggersInitial daily time decay: $2.77Trade length: 5 daysP/L: -$264 (-53%)LOP: $0LOL: -$264LOP — largest open profit (maximum available profit during life of trade).

LOL — largest open loss (maximum potential loss during life of trade).

shows the trade’s potential gains and losses onthree dates: trade entry (Jan. 22, dotted line),halfway until expiration (Feb. 6, dashed line), andexpiration (Feb. 20, solid line).

This debit spread will remain underwater unlessSPY gains 1 percent and trades above 112.50 atexpiration. But with a total delta of only 72, thetrade’s directional risk is roughly two-thirds lowerthan buying an equivalent amount of stock. Andour total risk is capped at $2.50 per spread.

We will exit at a profit if SPY jumps 2.4 percentto 114 or if its momentum, which measures currentprice relative to the high-low range over the past32 days, hits a certain threshold (0.62). (Note: Thiswas a paper trade, although it tracks a real longtrade in the underlying ETF.)

Initial stop: Exit after five days.

Initial target: Exit if SPY climbs to 114 or if a momentumsignal is triggered.

RESULT

Outcome: Figure 3 shows the trade was a disaster as SPYdropped like a stone. Our big mistake was entering the

trade too early and not waiting until the close to go long. Ifwe simply followed the pullback system’s trade rules, wemight have had a chance to exit with a small profit.

SPY plunged 2.7 percent the following week. Instead ofexiting on Jan. 29 as planned, we held on, hoping for arebound. But despite its bad timing, the trade could havebeen worse as the spread still held roughly one-half itsvalue.�

The rebound we expected didn’t emerge, and SPY dropped 2.7 percentwithin a week. Instead of exiting, we dig in and hope for a bounce.

FIGURE 3 —PLAN FALLS APART

Source: eSignal


Click on these boxes

to link directly

to these advertisers’

Web sites

THIS MONTH’S ADVERTISERSTHIS MONTH’S ADVERTISERS

TRADING STRATEGIES

http://www.fxcm.com/fo

http://www.worldmoneyshowvancouver.ca



February 2010 • Volume 4, No. 2

Documents

Transcript of February 2010 • Volume 4, No. 2