Professional Documents
Culture Documents
10
FUTURES: T-BOND
System trading with seasonals p. 9
the %C filter p. 10
SHORT-TERM
calendar
spreads p. 15
FUTURES
SYSTEM LAB:
Bottom-catcher p. 26
THE MARKET’S
stress test p. 36
FUTURES BASICS:
Commodity
sectors p. 32
RATIO SPREADS
vs. BACK SPREADS
p. 20
CONTENTS
4
ra
-6
Del
New
Stock & ETF
Symposium
De
tails Online
”Nobody tells me
how to trade.“
TM
TM
2008
Rated Best for: Frequent Traders « Options Traders « International Traders « Trading Technology « Trade Experience
News
Financial panic tanks markets . . . . . . . .36
Financial turmoil in late September and early
October rocks markets around the world and
promises to usher in a new financial era, for
better or worse.
CBOE PFGBEST.com
eSignal RS of Houston
OptionsMentoring TradeStation
Editorial assistant and Jack F. Cahn, CMT has been involved in the financial mar-
Webmaster: Kesha Green kets since 1974. Over the years, he has worked as a technical market
kgreen@futuresandoptionstrader.com analyst for Stix & Co, Merrill Lynch, Sherson Loeb Rhodes, and R.
Rowland and Co. He was director of the Markets Technicians
Art director: Laura Coyle Association from 1990 to 1995 and is a member of the Australian
lcoyle@futuresandoptionstrader.com Technical Analysts Association and the International Federation of Technical
Analysts. Cahn has developed trading systems as president of Creative
President: Phil Dorman Breakthrough, Inc. (http://www.traderassist.com) since 1989.
pdorman@futuresandoptionstrader.com
Frederic Ruffy is the senior options strategist at
Publisher, http://whatstrading.com, a site dedicated to helping traders make
Ad sales East Coast and Midwest: sense of the complex and fragmented nature of listed options trad-
Bob Dorman ing. In addition to writing market commentary and trading-related
bdorman@futuresandoptionstrader.com books and articles, Ruffy has also worked as an instructor, educat-
ing investors on advanced topics such as volatility, the benefits of
Ad sales sector rotation, and trading around earnings. Ruffy is an active trader with more
West Coast and Southwest only: than 15 years experience in the industry. His market observations and analysis of
Allison Chee the options market are featured regularly in the financial press including Barron’s,
achee@futuresandoptionstrader.com
Reuters, The Wall Street Journal, Bloomberg, and Futures Magazine.
Energy
Crude oil consolidated between
$105 and $110 after bouncing
back from its mid-September
dive below the $100 mark —
only to plunge more than 10 per-
cent on Sept. 29. As of Oct. 3,
November futures (CLX09) had
turned down again and were
trading around $94.00.
Source for all: TradeStation
Metals
As might be expected, gold and
silver benefited from the financial
market’s jitters in September.
After falling below $740 on Sept. Grains
11, December gold (GCZ08) After a brief consolidation, grain
exploded nearly $200 to $926.40 futures renewed their sell-off in late
by Sept. 18. The market was trad- September and early October, push-
ing around $842.00 on Oct. 3. ing to new lows for the year.
Industrial metals did not enjoy November rough rice (RRX09)
the same bounce. December cop- futures, however, rallied more than
per futures (HGZ08) made a new 20 percent from their August low to
low for the year when they fell to 3.000 on Sept. 18, and have subsequently the Sept. 24 high before pulling back
fallen as low as 2.6030. with the rest of the complex.
Currencies
Meats For in-depth analysis of the FX mar-
Livestock futures have been relatively ket, go to http://www.currencytra-
robust, if characteristically volatile. dermag.com for a free subscription to
After trading as low as 83.600 in early Currency Trader magazine.
September, February 2009 pork belly
futures (PBG09) traded above 100.000
by Sept. 26 before dropping again to
below 95 as of Oct. 3.
Treasuries
Treasuries were definitely not the ben-
eficiary of the stock market’s woes —
at least initially. The December 10-year
T-note futures (TYZ08) fell from 119-
00 to around 114-00 between Sept. 17
and 25. They shot back up on Sept. 29
on a flight-to-quality move, however,
climbing as high as 118-00.
Stock indices
E-Mini Nasdaq 100 index futures
(NQZ08) took the biggest hit on Sept.
29, plunging as much as 10 percent (to
1,494) before rallying slightly into the
close. The Nasdaq 100 index (NDX)
fell to its lowest level since August
2006. The market challenged this low
with another sharp drop on Oct. 2.
TABLE 1 — BIGGEST S&P 500 ONE-DAY DECLINES, TABLE 2 — BIGGEST DOW ONE-DAY DECLINES,
1978-2008 1928-1978
As % Close Close As % Close Close
of to to of to to
Date Close Range midpoint low close Date Close Range midpoint low close
Close to close Close to close
10/19/1987 224.83 57.86 22.80% -20.47% -20.47% 10/28/1929 260.6 38.4 13.91% -14.74% -13.48%
10/26/1987 227.66 20.47 8.62% -8.45% -8.28% 10/29/1929 230.1 40.1 17.26% -18.53% -11.70%
9/29/2008 1117.85 96.53 8.32% -8.32% -7.88% 10/5/1931 86.5 6.6 7.43% -11.76% -10.73%
10/27/1997 876.97 64.91 7.14% -6.87% -6.84% 11/6/1929 232.1 23.8 9.90% -11.37% -9.93%
8/31/1998 957.55 76.05 7.64% -6.80% -6.79% 12/4/1933 89.9 9.5 10.04% -9.10% -9.10%
1/8/1988 243.39 18.13 7.19% -6.94% -6.77% 8/12/1932 63.1 6.6 10.03% -9.29% -8.42%
10/13/1989 333.64 22.72 6.60% -6.35% -6.12% 1/4/1932 71.6 3.2 4.41% -8.99% -8.09%
4/14/2000 1356.02 101.11 7.27% -7.02% -5.87% 7/21/1933 88.7 14.2 15.50% -12.25% -7.89%
10/16/1987 282.69 17.39 5.99% -5.56% -5.16% 9/29/2008 1117.85 96.53 8.32% -8.32% -7.88%
9/17/2001 1038.77 55.08 5.17% -5.04% -4.92% 6/16/1930 230.1 13.3 5.65% -8.33% -7.85%
Close to low Close to low
10/19/1987 224.83 57.86 22.80% -20.47% -20.47% 10/29/1929 230.1 40.1 17.26% -18.53% -11.70%
10/26/1987 227.66 20.47 8.62% -8.45% -8.28% 10/28/1929 260.6 38.4 13.91% -14.74% -13.48%
9/29/2008 1117.85 96.53 8.32% -8.32% -7.88% 7/21/1933 88.7 14.2 15.50% -12.25% -7.89%
4/14/2000 1356.02 101.11 7.27% -7.02% -5.87% 10/5/1931 86.5 6.6 7.43% -11.76% -10.73%
1/8/1988 243.39 18.13 7.19% -6.94% -6.77% 11/6/1929 232.1 23.8 9.90% -11.37% -9.93%
10/27/1997 876.97 64.91 7.14% -6.87% -6.84% 10/24/1929 299.5 40.5 13.84% -10.98% -2.09%
8/31/1998 957.55 76.05 7.64% -6.80% -6.79% 5/21/1940 114.1 9.9 8.57% -9.64% -6.78%
10/13/1989 333.64 22.72 6.60% -6.35% -6.12% 8/12/1932 63.1 6.6 10.03% -9.29% -8.42%
11/30/1987 230.3 14.56 6.25% -6.06% -4.17% 12/4/1933 89.9 9.5 10.04% -9.10% -9.10%
10/22/1987 248.25 15.38 6.14% -5.95% -3.92% 1/4/1932 71.6 3.2 4.41% -8.99% -8.09%
Daily range as % of the day’s midpoint Daily range as % of day’s midpoint
10/19/1987 224.83 57.86 22.80% -20.47% -20.47% 10/29/1929 230.1 40.1 17.26% -18.53% -11.70%
10/20/1987 236.83 29.15 12.62% -3.72% +5.34% 7/21/1933 88.7 14.2 15.50% -12.25% -7.89%
10/26/1987 227.66 20.47 8.62% -8.45% -8.28% 10/28/1929 260.6 38.4 13.91% -14.74% -13.48%
7/24/2002 843.43 68.64 8.47% -2.76% +5.73% 10/24/1929 299.5 40.5 13.84% -10.98% -2.09%
9/29/2008 1117.85 96.53 8.32% -8.32% -7.88% 10/6/1931 99.3 13 13.83% +1.16% +14.80%
10/21/1987 258.37 20.46 8.22% +0.83% +9.10% 10/30/1929 258.5 30 12.20% +0.35% +12.34%
8/31/1998 957.55 76.05 7.64% -6.80% -6.79% 12/18/1931 80.7 8.5 11.06% -1.63% +9.35%
10/28/1997 921.86 67.82 7.63% -2.47% +5.12% 7/20/1933 96.3 10.9 10.87% -8.49% -7.05%
4/4/2000 1494.72 110.04 7.48% -5.95% -0.75% 11/7/1929 238.2 24.3 10.57% -6.16% +2.63%
4/14/2000 1356.02 101.11 7.27% -7.02% -5.87% 8/3/1932 58.2 5.8 10.39% -0.56% +9.40%
The percent
contraction indicator
The %C indicator is designed to
identify a market’s condition and
when it might shift from one con-
dition to another. Like the Average
Directional Movement Index
(ADX), the indicator measures
trend strength, but it has less lag
and contains more information
Source: TradeStation
about the market’s condition. Also,
Inputs:lng(numericsimple);
Value1=TrueHigh;
Value2=TrueLow;
Value3=Value1-value2;
Value4=Summation(value3,lng);
Value5=Highest(Value1,lng);
Value6=Lowest(value2,lng);
If value5-value6>0 then Value7=value5-value6;
Value8=(value4/value7);
Value10=value9/log(lng);
Value11=Value10*100;
@PercentC=Value11;
Then Begin
Sell Short ( "DayTrader-SE" ) next bar at Filtered strategy #3:
OpenD(0) - ((HighD(1) - LowD(1)) * fac) stop ;
end; Inputs: fac(0.9),facs(.9);
Inputs: TrendExup(36),LChopEx(65),CDLF(16);
If EntriesLongToday(date)<1 Inputs: TrendExdw(36),SChopEx(65),CDSF(14);
Then Begin
Filtered strategy #2: If (time>0930 and time <1000 or time>1200 and time <1530) then
Sell Short ( "TON%CPlusA-SE" ) next bar at
OpenD(0) - ((HighD(1) - LowD(1)) * fac) stop ;
Inputs: fac(0.9),facs(.9);
end;
Inputs: TrendExup(36),LChopEx(65),CDLF(14);
Inputs: TrendExdw(36),SChopEx(65),CDSF(14);
If EntriesLongToday(date)<2
If EntriesshortToday(Date)<2
and ( PercentC(CDLF)<TrendExup and
PercentC(CDLF)>15 )
and (PercentC(CDSF)<TrendExdw and PercentC(CDSF)>15 )
or (PercentC(CDLF)>LChopEx )
or (PercentC(CDSF)>SChopEx )
Then Begin
If (time>0930 and time <1000 or time>1200 and time <1530)
Then Begin
then Buy ( "TON%CPlusA-LE" ) next bar at
Sell Short ( "TON%CPlus-SE" ) next bar at
OpenD(0) + ((HighD(1) - LowD(1)) * facs) stop ;
OpenD(0) - ((HighD(1) - LowD(1)) * fac) stop ;
End;
end;
tions 1 or 2). The strongest trends follow the most extreme the market remains in a range until the indicator hits an
indicator readings. However, the longer it stays above this extreme. When it climbs above 55, the trading range is con-
upper threshold, the more likely a weaker trend will devel- sidered overdone and ripe for change. On Aug. 8, the indi-
op. cator was above its moving average and closed at 59.57,
As the market starts to trend, the %C indicator’s value which suggests the E-Mini Russell 2000 could break out.
will drop as the tension between bullish and bearish traders Again, the longer the indicator remains above 55, the
dissipates. A trend is confirmed when the indicator falls more likely the ensuing trend will be weaker. The opposite
from a high extreme (such as 55) to below its seven-bar is also true; the less time %C remains above its upper
moving average. Finally, when the %C indicator drops threshold, the faster and stronger the subsequent price
below 25, the trend is potentially overextended. move will be. This is exactly what happened on Aug. 11 as
You can use the %C indicator either as a filter in an exist- the indicator dropped below 55 and below its moving aver-
ing trading strategy or as a portfolio management tool. As a age. These moves confirm that the breakout is underway.
filter, it can help identify trending markets, avoid losing Notice the indicator declined as the market rallied, and the
trades, and boost system performance. At the portfolio up trend lost steam after the %C indicator fell below 30 and
level, it can tell you which trading system to favor and bottomed out around 1 p.m.
when to increase a trade’s size. The market is in a trading range when %C is ascending
and between 15 and 65 while also above its moving aver-
Trade examples age. Figure 2 shows the E-Mini Russell 2000 futures on May
Figure 1 shows a 15-minute chart of the E-Mini Russell 2000 28, which is a good example of a trading range when it pays
futures (ER2) from Aug. 8 to 11. The %C indicator and its to buy low and sell high (condition 3). In this example, the
seven-bar moving average are plotted below it (red and breakout short trade failed because the market lacked direc-
dashed lines, respectively). Notice Aug. 8 was a dull trad- tion as %C moved higher from an extreme low.
ing-range day (condition 4). As the indicator’s value rises,
position’s value. Calendar spreads are flexible, which Calendar spread example
means you can make money even in a very short time peri- Figure 1 shows a daily chart of Google Inc. (GOOG) from
od, assuming you can profit from either changes in the Jan. 16, 2007 to July 31, 2007.
underlying’s price or implied volatility. Google dropped 7.1 percent on July 20 after its second-
Calendar spreads are created by selling an option in one quarter earnings were announced. After falling so sharply,
month and buying an option with the same strike price that GOOG was likely to trade sideways for a few days before
expires later. The spread typically profits from the differ- picking a direction — a good time to enter a short-term cal-
ence in the rate of time decay of the two options. The short- endar spread.
er-term option you sell will lose value faster than the Figure 2 shows Google’s 30-day historical volatility and
longer-term option you buy. its IV over the past 12 months (blue and yellow lines,
respectively). In early July, IV
jumped to 35 percent from 25
Strategy snapshot
percent before dropping to
Strategy: Short-term calendar spread. roughly 24 percent after Google’s
earnings announcement. At this
Market bias: Neutral.
point IV was near the low end of
Components: One short front-month option and one long same-strike option its 12-month range, so it was
with more time until expiration. Use at-the-money (ATM) options unlikely to drop further and had
for a neutral outlook (calls or puts). the potential to bounce back
slightly.
Logic: To benefit from short option’s time decay as it approaches
With GOOG trading at $518 on
expiration. Underlying will trade sideways, implied volatility may
July 31, a calendar spread was
increase, and time value will decrease.
entered by selling 10 August 520-
Looking for a 5-percent gain in less than a week.
strike calls and buying 10
Criteria: Use front-month options. You must believe that IV will hold or September 520 calls for a net cost
increase. of 8.80 ($8,800). Table 1 shows the
calendar spread’s details. The IV
Max. gain: The underlying closes at the strike price when the short option expires
of the September calls is slightly
and you keep its premium.
lower than August calls’ IV (23.9
Max. risk: The price paid for the spread. percent vs. 24.84 percent, respec-
tively).
Adjustments: If the underlying starts to move in one direction, exit half of original
Figure 3 shows the calendar
spread and add a second calendar spread with the proceeds.
spread’s potential gains and loss-
If market drops, use lower-strike puts. If market rallies, use
es on three dates: trade entry
higher-strike calls. continued on p. 16
Implied volatility
is important…
Figure 3 shows how the calendar
spread is affected by underlying
price moves and time decay, but it
doesn’t show the effect of IV
changes. Also, it only shows
potential gains and losses up to
Source: eSignal the August expiration. At that
point, you still own the September
FIGURE 2 — VOLATILITY VIEW 520 call that hasn’t expired yet.
You can’t afford to ignore IV when
Google’s implied volatility (yellow line) neared a 12-month low after dropping to
trading calendar spreads, because it
24 percent.
can dramatically impact their value.
The value of the September 520 calls
will fluctuate along with changes in
implied volatility.
Short-term calendar spreads are as
influenced by IV as by time. You
shouldn’t enter a calendar spread if
you think implied volatility will drop.
On the other hand, the position will be
helped immensely if IV increases.
Although an 80-percent gain is possible, it’s easier to wait for a 5-percent profit and
exit the trade before the underlying moves sharply or IV drops. place? One reason is to see which
direction Google may move before
you decide which way to adjust.
You may have to adjust multiple
times if the underlying keeps mov-
ing.
Figure 6 shows a daily chart of
Google through Aug. 2, 2007.
Fortunately, the stock cooperated
by trading sideways within the
spread’s profitable range. The dou-
ble calendar’s bid price was $15.50
and its ask price was $16.50, which
means you could have sold the
spread for $16.00 the next morning
— a $1 profit per contract ($500
overall). This represents a yield of
6.7 percent ($500/$7,500) in less
than four days. The key to small
and consistent gains is not to get
greedy.
Source: MarketGear Inc. If you waited another day, you
could have earned an additional 10
TABLE 2 — ADJUSTMENTS percent. By Aug. 6, the adjusted
spread’s value climbed to $17.50 as
After Google fell to $510, we made two adjustments. First, half the original trade
was sold at the same price. Then, a second calendar was bought using 500-strike the bid-ask spread rose to $17.40-
puts. The adjusted position became a double calendar spread that contained four $18.40. However, these gains can be
options with a cost of $15. fleeting, which is one reason to
limit your risk by limiting the time
Google fell to $510 on July 31, 2007. you hold a trade. For instance, the
Double calendar spread trade’s bid-ask spread fell to $14.80-
Dollar amount (price * $15.80 by Aug. 8 as Google climbed
Position Long/ no. of contracts * 1.8 percent to $519 and IV crashed.
short Price 100 multiplier)
Original spread:
Picking the right market
10 August 520 calls Short $11.30 $11,300 Short-term calendar spreads can be
10 Sept. 520 calls Long -$20.10 -$20,100 profitable if conditions are right.
Ideally, the underlying should be
Debit (max. loss): -$8.80 -$8,800 stable and implied volatility should
be likely to rise. These trades are an
Adjustment: attempt to capture changes in
1. Sell half the original position implied volatility as much as cap-
at same price. $8.80 $4,400 turing time value. If IV drops, the
strategy probably won’t work.
Finally, be ready to add addition-
2. Add a second spread al calendar spreads if the underly-
with a 500 strike. ing starts to move in one direction.
5 August 500 puts Short $6.43 $6,430 This adjustment lowers the
5 Sept. 500 puts Long -$12.63 -$12,630 spread’s maximum profit and
increases the profit zone.
Adjusted debit: -$6.20 -$3,100 Remember you’re just trying to
earn small gains in a few days.
Final cost: -$15.00 -$7,500
For information on the author see p. 5.
BY FREDERIC RUFFY
The SPDR Gold Trust (GLD) has been quite volatile lately,
dropping 14 percent from July 14 to Aug. 8. If you expect gold
to rally substantially in the next few months, entering a call
backspread might make sense.
The sooner GLD climbs, the more profitable this spread will be. Time decay will kill
this trade if GLD’s rally is gradual rather than dramatic. However, the trade has no
downside risk.
months later.
You could enter a 2:3 ratio
backspread by shorting 20
January 2009 calls with an 85
strike for 6.00 per contract and
buying 30 calls with an 89 strike
in the same month for 4.00 per
contract. As Table 1 shows, the
backspread didn’t cost money to
enter, because the premium from
the sale of 20 calls at 6.00 each
($12,000) completely offset the
cost of buying 30 contracts at
4.00 each ($12,000).
The position has no downside
risk. If GLD fails to climb above
$85 by expiration Friday on Jan.
16, 2009, the spread’s calls will
Source: OptionVue simply expire worthless. If you
had entered this spread with a
credit and gold went nowhere,
FIGURE 3 — RISK PROFILE: RATIO SPREAD
you would simply keep the pre-
A ratio spread’s potential gains and losses are the opposite of a backspread’s risk pro- mium.
file. The January 85-89 ratio spread’s maximum gain occurs at the long strike and losses However, the trade will per-
mount above $97.
form better if the underlying
jumps higher. Figure 1 shows a
daily chart of GLD from June 1 to
Aug. 8. Price fell 12.5 percent
from July 15 to Aug. 8. A
rebound is possible over the next
five months, but remember if
gold keeps falling, the spread
won’t lose money.
Figure 2 shows the back-
spread’s potential gains and loss-
es on three dates: trade entry
(Aug. 8, dotted line), halfway
until expiration (Oct. 28, dashed
line), and expiration (Jan. 17,
solid line). The sooner GLD
climbs, the more profitable the
spread will be. For example, if
gold rose suddenly in the next
few weeks, the trade will quickly
Source: OptionVue become profitable. On the other
Related reading
“Managing profitable trades”
Options Trader, August 2006.
Handling a profitable options trade
may seem easy, but it can be difficult
to decide whether to cash out or hold
on for further gains.
“A closer look at put backspreads”
Options Trader, July 2006.
Perfect on paper but still a trade you
may want to avoid.
“Ratio call spreads:
Leverage profits and reduce risk”
Options Trader, June 2006.
Ratio call spreads can enhance an
underlying position’s potential gains at
no extra cost, or in many cases, for a
net credit.
“Put ratio spreads:
Selling volatility to buy an option”
Options Trader, June 2006.
Put ratio spreads profit from slightly
bearish moves, but the trick is to
understand how implied volatility
affects these positions. We explore
several trade scenarios and discover
the best time to place these spreads.
You can purchase past articles at
http://store.activetradermag.com/
Market: Stock index futures. The system’s entry rule has two components: a series of
lower highs, lower lows, and lower closes, plus a 2-percent
Time frame: Daily. decline from the low two days ago to today’s low. Together,
the rules are designed to get into trades when the market
System concept: This system uses a pattern-based entry has strung together consecutive downtrending days, punc-
setup to buy pullbacks on the daily time frame. The goal is tuated by a large decline (the 2-percent drop) intended to
to find a signal that trades with moderate frequency and identify points at which the market is potentially oversold
has a high winning percentage. and likely to rebound.
The system uses a simple
momentum calculation as one of
PERFORMANCE SUMMARY
its exit rules. Signals are triggered
Test period when the current close is above the
1997-1999 1999-2001 2001-2003 close seven days ago and is in the
Total net profit $17,752.50 $18,425.00 $14,632.50 upper 25 percent of the high-low
Gross profit $24,437.50 $36,527.50 $24,245.00 range of the past seven days. This
Gross loss ($6,685.00) ($18,102.50) ($9,612.50) momentum calculation can be
fixed as:
Profit factor 3.66 2.02 2.52
Total number of trades 18 25 19
Seven-day momentum =
Percent profitable 83.33% 72.00% 73.68%
(close today-lowest(low,7))/
Winning trades 15 18 14
(highest(high,7)-lowest(low,7))
Losing trades 3 7 5
Avg. trade net profit $986.25 $737.00 $770.13 Essentially, if you think of this
Avg. winning trade $1,629.17 $2,029.31 $1,731.79 indicator as an overbought-over-
Avg. losing trade ($2,228.33) ($2,586.07) ($1,922.50) sold tool, a reading of 0.75 or high-
Avg. win/avg. loss 0.73 0.78 0.9 er represents a short-term over-
Largest winning trade $4,130.00 $7,130.00 $3,505.00 bought condition.
Largest losing trade ($3,370.00) ($6,982.50) ($4,220.00) Some of the system's
Largest winner as % of gross profit 16.90% 19.52% 14.46% parameters were selected through
Largest loser as % of gross loss 50.41% 38.57% 43.90% observation; others were the result
Max. consecutive winning trades 7 13 5 of optimization. The series of two
Max. consecutive losing trades 2 3 2 consecutive lower lows and lower
Total slippage $900.00 $1,250.00 $950.00 highs and three lower closes was
Total commission $360.00 $500.00 $380.00 selected by comparing different
Return on initial capital 35.50% 36.85% 29.27%
continued on p. 28
Annual rate of return 15.81% 16.28% 13.34%
Buy & hold return 19.41% -27.45% -5.47%
Avg. monthly return $1,183.50 $1,304.26 $1,045.18 LEGEND
Percent of time in the market 18.80% 24.29% 19.91% Profit factor: Gross profit/gross loss.
Time in the market 4 months, 5 months, 4 months, Avg. trade net profit: Dollar return for the
10 days 18 days 18 days average trade.
Longest flat period 118 days 65 days 105 days Longest flat period: Longest time between
new equity highs.
Max. equity run-up $24,817.50 $37,922.50 $20,060.00
Max. intraday drawdown: Largest equity
Max. intraday drawdown ($14,495.00) ($18,812.50) ($12,107.50) decline measured on a intraday basis.
Max. trade drawdown ($7,587.50) ($8,612.50) ($7,437.50) Max. trade drawdown: Largest equity
Source: TradeStation decline based on closed trades.
▲ ACCEPT NO SUBSTITUTE.
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics
and Risks of Standardized Options (ODD). Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options
Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. CBOE ®, Chicago Board Options Exchange ®, CBOE Volatility
Index ®‚ and VIX®‚ are registered trademarks of Chicago Board Options Exchange, Incorporated. All other trademarks and servicemarks are the
property of their respective owners. Copyright 2008, Chicago Board Options Exchange, Incorporated. All rights reserved.
OPTIONS
FUTURES STRATEGY
TRADING LAB
SYSTEM LAB continued
System concept: This Options Lab uses vertical credit Entering bull put spreads
spreads to trade signals generated by the commodity chan- 1. Sell puts with a strike located one standard
nel index (CCI) — a momentum indicator developed by deviation out-of-the-money (OTM).
Donald Lambert in 1980. The CCI incorporates a volatility 2. Buy puts at a strike 10 points below the short put.
component not found in many other momentum indicators. 3. Use the first expiration month with more than
The CCI generates buy and sell signals. When a buy sig- 21 days left until expiration.
nal appears, the system enters a bull put spread (short put, 4. The spread’s minimum yield must be at least five
long lower-strike put). When a sell signal emerges, the percent (premium received/net margin required).
strategy enters a bear call spread (short call, long higher-
strike call). It holds each trade until the spread either Bearish signal
expires worthless or an opposite signal appears. The system 1. CCI divergence: The underlying index climbs to a
isn’t always in the market, so there may be periods of inac- higher high than yesterday while the CCI doesn’t
tivity. rise to a higher high, and the CCI must be +100 or
When you enter a vertical credit spread, you short an more.
option with a strike that is closer to the money than the one 2. If the first rule is true, enter the trade at the close
you buy. The spread tries to exploit the short option’s time on the first day the underlying posts a loss.
decay and collects the most profit if the underlying doesn’t
reverse beyond the short strike’s price by expiration. Both
options share the same expiration month, and when the Entering bear call spreads
strikes are 10 points apart, the position requires a gross 1. Sell calls with a strike located
margin of $1,000 per contract.
The spread is entered at a net FIGURE 1 — RISK PROFILE: BULL PUT SPREAD
credit, which you keep if both
options expire worthless. This 620-630 bull put spread has a 78-percent probability of profit and will make money
Figure 1 shows the potential if the Russell 2000 index closes above 628.49 at Aug. 15 expiration.
gains and losses of an August
620/630 bull put spread entered
on June 27 when the Russell
2000 traded at 698.20. The trade
will be profitable if the Russell
2000 closes above 628.49 at Aug.
15 expiration. The spread col-
lected premium of $765, which
represents its maximum gain
and potential yield of 18 per-
cent (135 percent annualized).
The position can lose up to
$4,255 if the Russell 2000 drops
to 620 or below at expiration.
Trade rules:
Bullish signal
CCI divergence: The
underlying index drops to
a lower low than yesterday
Source: OptionVue
while the CCI doesn’t drop
Exit
Close either spread if the under-
lying index touches the short
Source: OptionVue
strike. Otherwise, allow the
position to expire worthless.
STRATEGY SUMMARY
Starting capital: $10,000
Net gain: $9,695.00
Execution: When possible, option trades were execut- Percentage return: 96.9%
ed at the average of the bid and ask prices at the daily
Annualized return: 26.8%
close; otherwise, theoretical prices were used. Standard
No. of trades: 27
deviation was calculated using the implied volatility of
the at-the-money (ATM) call. Each spread held 5 con- Winning/losing trades: 25/2
tracts per “leg.” Commissions were $10 per contract. Win/loss: 93%
Avg. trade: $359.07
Test data: The system was tested using options on the Largest winning trade: $870.00
Russell 2000 index (RUT). Largest losing trade: -$1,315.00
Avg. profit (winners): $464.60
Test period: Feb. 6, 2005 to Sept. 19, 2008.
Avg. loss (losers): -$960.00
Test results: Figure 2 tracks the system’s perform- Avg. hold time (winners): 40
ance, which gained $9,695 (96.9 percent) since February Avg. hold time (losers): 24
2005. The strategy’s average winning trade ($464.60) is Max consec. win/loss: 16/1
lower than its average losing trade (-$960.00). However,
given the high percentage of winning
trades, the statistics suggest this sys-
LEGEND:
tem has a definite trading edge.
Net gain – Gain at end of test period.
Percentage return – Gain or loss on a percentage basis.
—Steve Lentz and Jim Graham Annualized return – Gain or loss on a annualized percentage basis.
of OptionVue No. of trades – Number of trades generated by the system.
Winning/losing trades – Number of winners and losers generated by the system.
Win/loss – The percentage of trades that were profitable.
Avg. trade – The average profit for all trades.
Option System Analysis strategies are
Largest winning trade – Biggest individual profit generated by the system.
tested using OptionVue’s BackTrader
Largest losing trade – Biggest individual loss generated by the system.
module (unless otherwise noted).
Avg. profit (winners) – The average profit for winning trades.
Avg. loss (losers) – The average loss for losing trades.
If you have a trading idea or strategy that Avg. hold time (winners) – The average holding period for winning trades (in days).
you’d like to see tested, please send the Avg. hold time (losers) – The average holding period for losing trades (in days).
trading and money-management rules to Max consec. win/loss – The maximum number of consecutive winning and losing trades.
Advisor@OptionVue.com.
Financial Representative
futures markets Symbol
Stock indices E-Mini S&P 500
E-Mini Nasdaq 100
Russell 2000
ES
NQ
Futures
Mini Dow YM
Single-stock futures
Interest rates 10-year T-note
5-year T-note
TY
FV
sectors
2-year T-note TU
30-year T-bond US
Although there are such things as
Eurodollar ED
Fed Funds FF
commodity “sectors,” don’t think of
Currencies Eurocurrency EC them the same way you think of their
Japanese yen JY
British pound BP stock-market counterparts.
Swiss franc SF
Canadian dollar CD
Mexican peso MP1
U.S. dollar index DX
BY FOT STAFF
Commodity futures
Energy Crude oil CL
T
Heating oil HO he nice thing about the futures
Gasoline RB market is there are only a few
Natural gas NG dozen instruments to keep tabs
Metals
on, as opposed to thousands of
Precious metals Gold GC
individual stocks. Like equities, though,
Silver SI
futures (and specifically, commodity futures)
Platinum PL
are commonly divided into specific groups, or
Base/Industrial
sectors.
metals Copper HG
Aluminum AL First, let’s clear up some confusion about
the words “commodities” and “futures,”
Agricultural Grains Corn C which are often used interchangeably even
Wheat W though they don’t mean the same thing.
Rice RR Commodities are physical items — crude
Oats O oil, corn, gold — that are often traded on the
Soybeans S open market via “futures contracts,” which
Soybean meal SM allow people to buy or sell something at an
Soybean oil BO agreed-upon price at a future date.
In short, some commodities are futures, but
Softs Coffee KC not all futures are commodities. Stock indices
Sugar SB and T-notes aren’t commodities, but they have
Cocoa CC futures contracts. The reason the term “com-
Orange juice OJ modities” or “commodity futures” is some-
times applied to instruments such as the E-
Meats (Livestock) Live cattle LC Mini S&P 500 futures or 10-year T-note futures
Lean hogs LH is because, originally, all futures contracts
were based on physical commodities.
Wood and Fiber Cotton CT Financial futures are a relatively new develop-
Lumber LB ment (around 30 years old in an approximate-
Bill Greenwalt
After a rocky start, a fund manager learns the key to trading options
is keeping risk low. He explains his conservative strategy in this excerpt
from the December 2008 issue of Active Trader.
BY DAVID BUKEY
FOT: How does your current strategy work? FOT: What are the advantages of iron condors or credit
BG: The basic strategy is to sell option premium, a very spreads compared to the short strangle, or selling naked
widely known strategy. We sell OTM puts and calls on the options?
S&P 500 index. The strike prices are far enough out-of-the- BG: There’s nothing wrong with [selling uncovered
money that they are expected to expire worthless. It’s a sim- options] if the strikes are far enough out of the money and
ple strategy, but a lot of people blow up because they don’t you’re willing to take a loss or adjust your position. But if
manage risk closely. you don’t adjust a position and start losing ground, it’s hard
Entering the position is only five percent of the game; to recover. With an options spread, you have a long side
managing risk is the other 95 percent. We watch the posi- that can help you recover.
tions every minute of every day and we are ready to take In my experience, it’s easier to get out of spreads when
action if needed. When we enter a position, it has an 80 to the market is going against you than when you hold naked
90 percent probability of expiring worthless. But those short options. Years ago, however, we only sold naked
probabilities change right after you execute a trade. options and strangles.
We are prepared to take small losses in order to avoid the
potential of a large loss. We don’t often have to buy back An extended version of this interview appears in the December
sold options, but we err on the side of caution rather than 2008 issue of Active Trader magazine, on newsstands in
hoping it works out. Hope is not a strategy. November.
T
he IntercontinentalExchange (ICE) set new daily
volume records for Russell 2000 contracts traded
on the exchange on six different occasions in
September leading up to Sept. 19, when ICE’s exclusive
Source: TradeStation rights to list Russell-based contracts kicked in. Previously,
Russell contracts had
Wall Street’s assets to fund the recovery, and not taxpayer also traded on the TABLE 1 — CHANGING
dollars. The outcome was anything but certain. CME, which con- OF THE GUARD
On Sept. 25 Washington Mutual collapsed, marking the trolled most of the Sept. Dec.
biggest bank failure in history, and was seized by the FDIC. volume. Date E-Mini Russ mini Russ
JP Morgan then purchased their assets for $1.9 billion. This streak of 2000 (CME) 2000 (ICE)
Congressional leaders worked through the weekend to records included four
Sept. 2 216592 243
hash out a deal that would be acceptable to both parties, consecutive days of Sept. 3 230884 256
reassuring the public that an agreement was imminent. new records for the Sept. 4 232557 1442
mini Russell contract Sept. 5 248601 2127
Biggest drop since 1987 (TF) from Sept. 8 Sept. 8 288856 5898
However, on Monday, Sept. 29, the house failed to pass the through Sept. 11. Sept. 9 253664 12538
proposed legislation by just 12 votes, sending the stock On Sept. 8, ICE Sept. 10 250903 46317
traded a record of Sept. 11 174182 148744
FIGURE 3 — S&P 500 INDEX 22,553 mini Russell Sept. 12 120852 129782
The S&P 500 closed down more than 7 percent on Sept. 29. 2000 contracts. By Sept. 15 103173 247474
Sept. 11 the record Sept. 16 123807 331563
had increased to Sept. 17 77146 331824
272,756 contracts. On Sept. 18 79902 368896
Sept. 17, the record Sept. 19 1679 224457
increased to 500,394. Sept. 22 149371
Total open interest in Sept. 23 146549
the ICE mini and full- Sept. 24 131520
Sept. 25 155635
size Russell 2000 (TO)
Sept. 26 158333
contracts traded on
Sept. 29 231877
the exchange reached
Sept. 30 164392
828,426, an astound-
Oct. 1 124037
ing increase from the Oct. 2 165590
Jan. 1 combined open
interest of 1,377.
Table 1 compares the volume in the last E-Mini Russell
2000 contract to trade at the CME (September 2008) to the
volume in the December 2008 mini Russell contract (TFZ08)
traded on the ICE — the first contract month to which the
Source: TradeStation
ICE had exclusive rights.
— CONTACT —
Bob Dorman Allison Chee Mark Seger
Ad sales East Coast and Midwest Ad sales West Coast and Southwest Account Executive
bdorman@activetradermag.com achee@activetradermag.com seger@activetradermag.com
(312) 775-5421 (626) 497-9195 (312) 377-9435
FUTURES SNAPSHOT (as of Sept. 29)
The following table summarizes the trading activity in the most actively traded futures contracts. The information does NOT constitute
trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility.
See the legend for explanations of the different 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).
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 & Options
Trader 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 buy
or 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.
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 ago
S&P 500 index SPX CBOE 280.6 2.15 M -7.23% / 94% -13.75% / 100% 33.7% / 36.2% 20.8% / 17.9%
S&P 500 volatility index VIX CBOE 136.5 1.07 M 47.38% / 85% 126.25% / 100% 192.2% / 136.6% 80.2% / 86.4%
Russell 2000 Index RUT CBOE 107.6 787.2 -4.65% / 88% -11.06% / 93% 43.7% / 37.3% 25.3% / 22.9%
Nasdaq 100 Index NDX CBOE 48.0 225.8 -12.27% / 100% -20.10% / 100% 36.9% / 38.1% 25.2% / 21.7%
E-Mini S&P 500 futures ES CME 38.3 141.4 -4.01% / 72% -8.54% / 90% 39.5% / 40.6% 20.8% / 19.8%
Stocks
Citigroup C 299.9 3.80 M 16.47% / 100% -6.53% / 33% 95.6% / 117.8% 59.7% / 55.7%
Apple Inc. AAPL 270.8 1.05 M -25.01% / 100% -37.91% / 100% 88.7% / 73.5% 40.4% / 30.5%
Bank of America BAC 249.2 2.83 M 13.94% / 80% -2.86% / 13% 87.6% / 110.6% 57.6% / 62.7%
General Electric GE 202.1 2.02 M -6.10% / 55% -17.79% / 97% 61.1% / 83.6% 29% / 30%
Wachovia WB 156.3 1.12 M -99.91% / 100% -99.94% / 100% 292% / 273.1% 84% / 89.7%
Futures
Eurodollar ED-GE CME 579.5 7.49 M -0.61% / 83% -0.42% / 71% 58.3% / 47.1% 25.9% / 7.9%
Crude oil CL NYMEX 49.0 444.1 10.41% / 100% -8.27% / 37% 60.8% / 60.3% 45.4% / 46.8%
E-Mini S&P 500 futures ES CME 38.3 141.4 -4.01% / 72% -8.54% / 90% 39.5% / 40.6% 20.8% / 19.8%
10-year T-notes TY-ZN CME 35.9 231.9 -1.55% / 82% 0.89% / 31% 12.6% / 10.6% 6.5% / 4.4%
5-year T-notes FV-ZF CME 25.9 113.0 -0.75% / 33% 0.90% / 32% 9.3% / 6.1% 5.6% / 3.2%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
Mini Dow YM CME 1.7 5.5 -4.01% / 72% -8.54% / 90% 38.7% / 24.6% 21% / 15.3%
S&P 500 volatility index VIX CBOE 136.5 1.07 M 47.38% / 85% 126.25% / 100% 192.2% / 136.6% 80.2% / 86.4%
Banking Index BKX PHLX 3.8 68.9 -10.07% / 100% -11.43% / 61% 103.4% / 81.6% 53.8% / 53.8%
Russell 2000 Index RUT CBOE 107.6 787.2 -4.65% / 88% -11.06% / 93% 43.7% / 37.3% 25.3% / 22.9%
Eurodollar index XDE PHLX 2.2 39.3 1.34% / 14% -1.61% / 27% 16.1% / 14% 11.5% / 8.6%
Options Watch: Financial Sector ETF components (as of Sept. 29) Compiled by Tristan Yates
The following table summarizes the expiration months available for the top components of the Financial Sector exchange-traded fund (XLF). It also
shows each index's average bid-ask spread for at-the-money (ATM) September options. The information does NOT constitute trade signals. It is
intended only to provide a brief synopsis of potential slippage in each option market.
Option contracts traded
2008 2009 2010 2011 Bid-ask spreads
Bid-ask
spread as %
Dec.
Nov.
Feb.
Jan.
Mar.
Jan.
Jan.
Oct.
Apr.
May
Closing of underlying
Stock Symbol price Call Put price
Bank of America Corp. BAC X X X X X X 35.00 0.14 0.14 0.39%
Citigroup Inc. C X X X X X X 20.51 0.13 0.04 0.40%
CME Group Inc. CME X X X X X X 371.51 2.45 1.73 0.56%
Goldman Sachs Group Inc. GS X X X X X X 128.00 0.65 0.83 0.58%
JPMorgan Chase & Co. JPM X X X X X X 46.70 0.32 0.27 0.62%
Finance Select SPDR XLF X X X X X X 19.89 0.16 0.13 0.74%
U.S. Bancorp USB X X X X X X 36.02 0.40 0.16 0.78%
Wells Fargo & Co. WFC X X X X X X 37.53 0.38 0.28 0.87%
Chubb Corp. CB X X X X X X 54.90 0.74 0.51 1.14%
American Express Co. AXP X X X X X X 35.43 0.49 0.33 1.15%
PNC Financial Services Group Inc. PNC X X X X X X 74.70 1.40 0.53 1.29%
Travelers Cos. Inc. TRV X X X X X X 45.20 0.75 0.50 1.38%
Morgan Stanley MS X X X X X X 23.00 0.45 0.30 1.63%
Bank of New York Mellon Corp. BK X X X X X X 32.58 0.58 0.53 1.69%
BB&T Corp. BBT X X X X X X 37.80 0.81 0.66 1.95%
Allstate Corp. ALL X X X X X X 46.12 0.96 0.86 1.98%
Prudential Financial Inc. PRU X X X X X X 72.00 1.43 1.53 2.05%
MetLife Inc. MET X X X X X X 56.00 1.45 0.91 2.11%
AFLAC Inc. AFL X X X X X X 58.75 1.84 1.18 2.56%
State Street Corp. STT X X X X X X 56.88 2.39 2.55 4.34%
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.
At the money (ATM): An option whose strike price is Gamma: The change in delta relative to a change in the
underlying market. Unlike delta, which is highest for
identical (or very close) to the current underlying stock (or
deep ITM options, gamma is highest for ATM options
futures) price. and lowest for deep ITM and OTM options.
Average directional movement index (ADX): Rho: The change in option price relative to the change
Measures trend strength, regardless of direction. The high- in the interest rate.
er the ADX value, the stronger the trend, whether the mar-
ket is going up or down. The indicator can be applied to any Theta: The rate at which an option loses value each day
(the rate of time decay). Theta is relatively larger for
time frame, although it is typically used on daily charts.
OTM than ITM options, and increases as the option gets
Although the ADX concept is straightforward, its calcu- closer to its expiration date.
lation is rather lengthy. The indicator was designed by
Welles Wilder and is described in detail in his book New Vega: How much an option’s price changes per a one-
Concepts in Technical Trading Systems (Trend Research 1978). percent change in volatility.
Calculation:
1. Calculate the positive or negative directional move- sum of the true ranges.
ment (+DM and -DM) for each bar in the desired look-
back period. Bars that make higher highs and higher 5. Calculate the directional index (DX) by taking the
lows than the previous bar have positive directional absolute value of the difference between the +DI value
movement. Bars that make lower highs and lower lows and the -DI value, dividing that by the sum of the +DI
than the previous bar have negative directional move- and -DI values, and multiplying by 100.
ment.
If a bar has both a higher high and a lower low than 6. To create the ADX, calculate a moving average of the
the previous bar, it has positive directional DX over the same period as the lookback period used
movement if its high is above the previous high more throughout the other calculations.
than its low is below the previous low. Reverse this
criterion for negative directional movement. An inside Bear call spread: A vertical credit spread that consists
bar (a bar that trades within the range of the of a short call and a higher-strike, further OTM long call in
previous bar) has no directional movement, and nei- the same expiration month. The spread’s largest potential
ther does a bar whose high is above the previous high gain is the premium collected, and its maximum loss is lim-
by the same amount its low is below the previous low. ited to the point difference between the strikes minus that
premium.
2. If a bar has positive (negative) directional move-
ment, the absolute value of the distance between Bear put spread: A bear debit spread that contains puts
today’s high (low) and yesterday’s high (low) is added with the same expiration date but different strike prices.
to the running totals of +DM (-DM) calculated over a You buy the higher-strike put, which costs more, and sell
given lookback period (i.e., 20 bars, 30 bars, etc.). The the cheaper, lower-strike put.
absolute value is used so both +DM and -DM are pos-
itive values. Bollinger Bands: Bollinger Bands are a type of trading
“envelope” consisting of lines plotted above and below a
3. Calculate the sum of the true ranges for all bars in moving average, which are designed to capture a market’s
the lookback period. typical price fluctuations.
The indicator is similar in concept to the moving average
4. Calculate the Directional Indicator (+DI and -DI) by envelope, with an important difference: While moving
dividing the running totals of +DM and -DM by the average envelopes plot lines a fixed percentage above and
companies, who either produce or consume the underlying Trader, December 2001), “The CCI stochastic” (Active Trader,
commodity) and can have access to supply and demand September 2004), and “The CCI Ghost” (Active Trader, May
information other market players do not. 2004).
Non-commercial large traders include large speculators
(“large specs”) such as commodity trading advisors (CTAs) Covered call: Shorting an out-of-the-money call option
and hedge funds. This group consists mostly of institution- against a long position in the underlying market. An exam-
al and quasi-institutional money managers who do not deal ple would be purchasing a stock for $50 and selling a call
in the underlying cash markets, but speculate in futures on option with a strike price of $55. The goal is for the market
a large-scale basis for their clients. to move sideways or slightly higher and for the call option
The final COT category is called the non-reportable posi- to expire worthless, in which case you keep the premium.
tion category — otherwise known as small traders — i.e.,
the general public. Credit spread: A position that collects more premium
from short options than you pay for long options. A credit
The Commodity Channel Index (CCI): The CCI spread using calls is bearish, while a credit spread using
measures how much price (most often, the typical price of a puts is bullish.
bar) deviates from the average price over a specific look-
back period (e.g., five bars, 10 bars, etc.). Despite its name, Debit: A cost you must pay to enter any position if the
the commodity channel index has nothing to do with chan- components you buy are more expensive than the ones you
nels, nor is it limited to commodities. sell. For instance, you must pay a debit to buy any option,
The indicator fluctuates around a “zero line,” with a and a spread (long one option, short another) requires a
majority of its readings between -100 and +100. High read- debit if the premium you collect from the short option does-
ings mean the current price is unusually high relative to the n’t offset the long option’s cost.
average price over the look-back period.
1. Calculate the typical price for each bar, which is the Debit spread: An options spread that costs money to
sum of the high, low, and closing prices divided by enter, because the long side is more expensive that the short
three. side. These spreads can be verticals, calendars, or diagonals.
2. Calculate a moving average of the typical prices over a
desired look-back period (e.g., 10 bars). Deep (e.g., deep in-the-money option or deep
3. Calculate the difference between each typical price out-of-the-money option): Call options with strike
over the look-back period and the moving average of prices that are very far above the current price of the under-
the typical price for the respective bar. lying asset and put options with strike prices that are very
4. Sum the absolute value of all the differences from far below the current price of the underlying asset.
step 3 and divide by the look-back period.
5. Subtract the value calculated in step 2 from the last Delivery period (delivery dates): The specific time
bar’s value as calculated in step 1, and divide it by the period during which a delivery can occur for a futures con-
value calculated in step 4 times 0.015. (The factor 0.015 tract. These dates vary from market to market and are deter-
will force most readings to fall within +/- 100.) mined by the exchange. They typically fall during the
month designated by a specific contract - e.g. the delivery
Theoretically, there are no limits to how high or low CCI period for March T-notes will be a specific period in March.
values can go. Because of its construction, however, most
markets should have a large majority of their CCI values Delta-neutral: An options position that has an overall
between the +/- 100 levels, and very seldom should you see delta of zero, which means it’s unaffected by underlying
readings above or below 300. price movement. However, delta will change as the under-
The most basic way to interpret CCI is to look for a read- lying moves up or down, so you must buy or sell
ing above or below a significant level, as determined by shares/contracts to adjust delta back to zero.
past study of the indicator. Typically these levels are +/-100,
but other levels could be used, including “asymmetrical” Diagonal spread: A position consisting of options with
values (e.g., -150 and +200), depending on whether you use different expiration dates and different strike prices — e.g.,
the indicator to confirm breakouts or to look for tops and a December 50 call and a January 60 call.
bottoms, its two main uses.
For more information, see the following articles: Double calendar spread: A calendar spread involves
“Indicator Insight: The Commodity Channel Index” (Active purchasing an option and selling a shorter-term, same-
Expiration: The last day on which an option can be exer- Naked option: A position that involves selling an unpro-
cised and exchanged for the underlying instrument (usual- tected call or put that has a large or unlimited amount of
ly the last trading day or one day after). risk. If you sell a call, for example, you are obligated to sell
the underlying instrument at the call’s strike price, which
Intermonth (futures) spread: A trade consisting of might be below the market’s value, triggering a loss. If you
long and short positions in different contract months in the sell a put, for example, you are obligated to buy the under-
same market — e.g., July and November soybeans or continued on p. 48
September and December crude oil. Also
referred to as a futures “calendar spread.”
lying instrument at the put’s strike price, which may be well expiration date but different strike prices. A bull put spread
above the market, also causing a loss. contains short, higher-strike puts and long, lower-strike
Given its risk, selling naked options is only for advanced puts. A bear put spread is structured differently: Its long
options traders, and newer traders aren’t usually allowed puts have higher strikes than the short puts.
by their brokers to trade such strategies.
Ratio spread: A ratio spread can contain calls or puts and
Naked (uncovered) puts: Selling put options to collect includes a long option and multiple short options of the
premium that contains risk. If the market drops below the same type that are further out-of-the-money, usually in a
short put’s strike price, the holder may exercise it, requiring ratio of 1:2 or 1:3 (long to short options). For example, if a
you to buy stock at the strike price (i.e., above the market). stock trades at $60, you could buy one $60 call and sell two
same-month $65 calls. Basically, the trade is a bull call
Near the money: An option whose strike price is close spread (long call, short higher-strike call) with the sale of
to the underlying market’s price. additional calls at the short strike.
Overall, these positions are neutral, but they can have a
Open interest: The number of options that have not directional bias, depending on the strike prices you select.
been exercised in a specific contract that has not yet expired. Because you sell more options than you buy, the short
options usually cover the cost of the long one or provide a
Out of the money (OTM): A call option with a strike net credit. However, the spread contains uncovered, or
price above the price of the underlying instrument, or a put “naked” options, which add upside or downside risk.
option with a strike price below the underlying instru-
ment’s price. Simple moving average: A simple moving average
(SMA) is the average price of a stock, future, or other mar-
Parity: An option trading at its intrinsic value. ket over a certain time period. A five-day SMA is the sum of
the five most recent closing prices divided by five, which
Physical delivery: The process of exchanging a physical means each day’s price is equally weighted in the calcula-
commodity (and making and taking payment) as a result of tion.
the execution of a futures contract. Although 98 percent of
all futures contracts are not delivered, there are market par- Stochastic oscillator: A technical tool designed to
ticipants who do take delivery of physically settled con- highlight shorter-term momentum and “overbought” and
tracts such as wheat, crude oil, and T-notes. Commodities “oversold” levels (points at which a price move has, theo-
generally are delivered to a designated warehouse; T-note retically at least, temporarily exhausted itself and is ripe for
delivery is taken by a book-entry transfer of ownership, a correction or reversal).
although no certificates change hands. Calculation: The stochastic oscillator consists of two
lines: %K and a moving average of %K called %D. The basic
Premium: The price of an option. stochastic calculation compares the most recent close to the
price range (high of the range - low of the range) over a par-
Put option: An option that gives the owner the right, but ticular period.
not the obligation, to sell a stock (or futures contract) at a For example, a 10-day stochastic calculation (%K) would
fixed price. be the difference between today’s close and the lowest low
of the last 10 days divided by the difference between the
Put ratio backspread: A bearish ratio spread that con- highest high and the lowest low of the last 10 days; the
tains more long puts than short ones. The short strikes are result is multiplied by 100. The formula is:
closer to the money and the long strikes are further from the %K = 100*{(Ct-Ln)/(Hn-Ln)}
money. where
For example, if a stock trades at $50, you could sell one Ct is today’s closing price
$45 put and buy two $40 puts in the same expiration month. Hn is the highest price of the most recent n days (the
If the stock drops, the short $45 put might move into the default value is five days)
money, but the long lower-strike puts will hedge some (or Ln is the lowest price of the most recent n days
all) of those losses. If the stock drops well below $40, poten-
tial gains are unlimited until it reaches zero. The second line, %D, is a three-period simple moving
average of %K. The resulting indicator fluctuates between 0
Put spreads: Vertical spreads with puts sharing the same and 100.
Variance and standard deviation: Variance meas- etc.), the more volatile that market is.
ures how spread out a group of values are — in other A common application of variance in trading is standard
words, how much they vary. Mathematically, variance is the deviation, which is the square root of variance. The stan-
average squared “deviation” (or difference) of each number dard deviation of 8, 9, and 10 is: .667 = .82; the standard
in the group from the group’s mean value, divided by the deviation of 2, 9, and 16 is: 32.67 = 5.72.
number of elements in the group. For example, for the num-
bers 8, 9, and 10, the mean is 9 and the variance is: Vertical spread: A position consisting of options with
the same expiration date but different strike prices (e.g., a
{(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667 September 40 call option and a September 50 call option).
Now look at the variance of a more widely distributed set Volatility: The level of price movement in a market.
of numbers: 2, 9, and 16: Historical (“statistical”) volatility measures the price fluctu-
ations (usually calculated as the standard deviation of clos-
{(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67 ing prices) over a certain time period — e.g., the past 20
days. Implied volatility is the current market estimate of
The more varied the prices, the higher their variance — future volatility as reflected in the level of option premi-
the more widely distributed they will be. The more varied a ums. The higher the implied volatility, the higher the option
market’s price changes from day to day (or week to week, premium.
EVENTS
Event: The Options Intensive Two-day Seminars Event: Traders Expo Las Vegas
Dates: Oct. 23, Dec. 4 Date: Nov. 19-22
Location: CBOE Options Institute, Chicago Location: Mandalay Bay Resort & Casino, Las Vegas
For more information: http://www.cboe.com For more information: http://www.tradersexpo.com
Event: Regulation: Challenge or Business Event: The Options Initiative Two-day Seminars
Opportunity? Date: Nov. 20
Date: Oct. 24, 9 a.m. to 1 p.m. Location: CBOE Options Institute, Chicago
Location: Harvard Club, NYC For more information: http://www.cboe.com
For more information: Go to
http://www.thompsonhine.com and click on “Events” Event: TradeStation ETF Symposium
Date: Dec. 4-6
Event: SIFMA’s Annual Meeting Location: Delray Beach Marriott, Delray, Fla.
Date: Oct. 28 For more information:
Location: Marriott Marquis, NYC http://www.TradeStation.com/Strategy
For more information: http://www.sifma.org/events
Event: Dynamic Hedging of Long Volatility Strategies
Event: SIFMA’s OFAC Compliance Symposium Date: Dec. 4-5
Date: Nov. 6 Location: Sheraton Suites on the Hudson, New York
Location: AXA Equitable Conference Center, NYC For more information: http://www.marcusevans.com
For more information: http://www.sifma.org/events
Event: TradeTech Foreign Exchange 2009
Event: 23rd Annual Futures & Options Expo Date: Feb. 9-11
Date: Nov. 10-12 Location: Bridgewaters, NYC
Location: Hyatt Regency Chicago For more information:
For more information: Go to http://www.TradeTechForeignExchange.com
http://www.futuresindustry.org and click on “Conferences”
CME Group is launching E-mini S&P 500 futures and backtesting. Algorithmic traders have the ability to
denominated in Euros at the end of October. The contract access real-time economic release data in their own applica-
will provide access to the U.S. large-cap stock index com- tions for automated trading via the CQG Integrated Client
bined with exposure to the Euro currency. The Euro E-mini API. Traders can also employ trading strategies directly
S&P 500 will be offered exclusively on CME Globex, the from the CQG Integrated Client using alerts to monitor
exchange’s electronic trading platform. The value of the deviations between estimated economic reports and actual
contract will be Euro 50 times the S&P 500 Stock Index. release numbers. Need to Know News Economic Release
Trading hours will run from Sunday to Thursday 5 p.m. to Bullets include actual, estimated, and revised report data
3:15 p.m. the following day and then 3:30 p.m. to 4:30 p.m. for over 50 U.S. economic reports including employment
For more information, visit their Web site at: data, producer and consumer price data, housing data,
http://www.cmegroup.com/eurosp500. GDP, and more. Interfax Information Services
Group’s news services are also available to CQG users.
Mirus Futures has integrated live streaming data Customers using CQG’s news display will have access to
from EUREX with the Zen-Fire trading engine. Customers industry-specific news services and in-depth research
can request a real-time trading simulator from the Zen-Fire reports from 70 bureaus covering oil and gas, banking and
or Mirus Futures site. The new data-feed enhanced broad- finance, business and investment, energy, commodities,
cast solution (EBS) offers market data broadcasts for un-net- metals and mining, pharmaceuticals and health technolo-
ted public market data. The socket-based distribution gies, food and agriculture, and IT and telecom news in the
mechanism features, among others, an order book depth of emerging Eurasian markets.
10 for options, an enhancement of order book depth to 20
for benchmark futures, and a new subscription model, eSignal’s portal sites, Quote.com and
which allows members to select individual market data of RagingBull.com, now offer NYSE Euronext and NASDAQ-
all product groups relevant to their business. Along with listed stocks’ real-time last sale and quote market data from
the launch of EBS, the new data feed CEF ultra+ of BATS Trading. The BATS data feed is free to everyone visit-
Deutsche Börse Market Data & Analytics was started. CEF ing the Quote.com and RagingBull.com sites, and the infor-
ultra+ contains the same market depth as EBS but distrib- mation provided by BATS includes not only last sale, but
utes Eurex trading data to non-Eurex members. also full depth of book data.
Note: The New Products and Services section is a forum for
CQG has created an elementized news data feed detail-
industry businesses to announce new products and upgrades.
ing U.S. economic releases available on the CQG data line. Listings are adapted from press releases and are not endorsements
Need to Know News Economic Release Bullets are viewable or recommendations from the Active Trader Magazine Group. E-
in real-time through any of CQG’s quote displays. CQG mail press releases to editorial@futuresandoptionstrader.com.
includes historical economic report data for chart analysis Publication is not guaranteed.