Fot 200809

September 2008 • Volume 2, No.
PROFITING FROM OPENING GAPS

at key price levels p. 6
CRUSHES AND CRUNCHES:

Implications for grain futures p. 12
STRATEGIC STOCK TRADING —

with options p. 24
HEDGING A PORTFOLIO
with bear put spreads p. 18
TRADING ICHIMOKU
signals with options
p. 28
CONTENTS
Trading stocks with short options . . . .24

Short options provide a useful alternative for
traders who want to enter the underlying market
at more advantageous price points.
By Mark D. Wolfinger
Options Trading System Lab

Ichimoku and vertical spreads . . . . . . . . . .28
By Steve Lentz and Jim Graham
Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .30

Momentum, volatility, and volume
statistics for futures.
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Option Radar . . . . . . . . . . . . . . . . . . . . . . . . . .31

Notable volatility and volume
Trading Strategies in the options market.
Fading the opening gap . . . . . . . . . . . . . . .6
This intraday system captures brief reversals Futures & Options Watch
that often follow extreme highs and lows. COT extremes . . . . . . . . . . . . . . . . . . . . . . .32
By Art Collins A look at the relationship between commercials
and large speculators in 45 futures markets.
From crunch to crush . . . . . . . . . . . . . . . .12
The credit crunch might be making its Options: Health care
presence felt in the unlikeliest of places — ETF components . . . . . . . . . . . . . . . . . . . . .32
the grain market. Traders should prepare
themselves for a volatile season.
By Keith Schap
Hedging with bear put spreads . . . . . . . .18

Adding a bear put spread to a stock portfolio
creates a more efficient hedge than simply
buying puts.
By Tristan Yates
continued on p. 4
2 September 2008 • FUTURES & OPTIONS TRADER

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registered trademark of Dow Jones & Company. ©2008 TradeStation Securities, Inc.
CONTENTS
News
CME shareholders approve
NYMEX acquisition . . . . . . . . . . . . . . . . . .34
The CME-NYMEX deal enters its final stages.
CBOE, CBOT reach settlement . . . . . . . .34

The settlement of the exchange-rights issue
opens doors for the CBOE’s future.
GLD options take off . . . . . . . . . . . . . . . . .35

New gold ETF options trade fast out of the gate.
New Products and Services . . . . . . . . . . . . .43
Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .36
References and definitions. Futures Trade Journal . . . . . . . . . . . . . . .44
Trying to squeeze a little more out of a pop in
Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 gold.
Futures & Options Calendar . . . . . . . . . . . .42 Options Trade Journal . . . . . . . . . . . . . . .45

Buying SPY calls on a 20-day high.
Have a question about something you’ve seen

in Futures & Options Trader?
Submit your editorial queries or comments to webmaster@futuresandoptionstrader.com.
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.
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OptionsMentoring The Wizard

Paris Trading Show TradeStation
PFGBEST.com

CONTRIBUTORS
CONTRIBUTORS
Art Collins (artcollins@ameritech.net) is the author of Beating The

Financial Futures Market: Combining Small Biases Into Powerful Money Making
Strategies (Wiley Publishing, 2006).
A publication of Active Trader ®

Mark Wolfinger (rookies@mdwoptions.com) has been in the options
For all subscriber services: business since 1977. After more than 20 years as a market maker, he left the
www.futuresandoptionstrader.com Chicago Board Options Exchange (CBOE) in 2000 and began helping indi-
vidual investors understand how to use options profitably (and safely). He
Editor-in-chief: Mark Etzkorn
metzkorn@futuresandoptionstrader.com has written three books and numerous magazine articles. As an educator, he
stresses the conservative methods detailed in his newest book, The Rookie’s
Managing editor: Molly Flynn Goad
Guide to Options (W&A Publishing, 2008). Wolfinger offers group seminars
mgoad@futuresandoptionstrader.com
and private consultation via telephone or e-mail. His Web site is
Senior editor: David Bukey http://blog.mdwoptions.com/options_for_rookies/.
dbukey@futuresandoptionstrader.com
Contributing editor: Tristan Yates researches and writes about enhanced indexing strate-
Keith Schap gies using derivatives for publications including Futures & Options Trader,
Associate editor: Chris Peters

SeekingAlpha, Investopedia, and Trader’s Journal. His articles are distributed
cpeters@futuresandoptionstrader.com through Yahoo! Finance, Forbes, Kiplinger, and MSN Money. He is currently
working on a book on enhanced indexing for the Wiley Trading Series.
Editorial assistant and
Webmaster: Kesha Green
kgreen@futuresandoptionstrader.com Keith Schap is a freelance writer specializing in risk man-
Art director: Laura Coyle agement and trading strategies. He is the author of numerous
lcoyle@futuresandoptionstrader.com articles and several books on these subjects, including The
President: Phil Dorman

Complete Guide to Spread Trading (McGraw-Hill, 2005). He was
pdorman@futuresandoptionstrader.com a senior editor at Futures magazine and senior technical mar-
keting writer at the CBOT.
Publisher,
Ad sales East Coast and Midwest:
Bob Dorman
Steve Lentz (advisor@optionvue.com) is a well-estab-
bdorman@futuresandoptionstrader.com
lished options educator and trader and has spoken all over the
Ad sales U.S., Asia, and Australia on behalf of the CBOE’s Options
West Coast and Southwest only:
Allison Chee Institute, the Options Industry Council, and the Australian
achee@futuresandoptionstrader.com Stock Exchange. As a mentor for DsicoverOptions.com, he
teaches select students how to use complex options strategies and develop a
Classified ad sales: Mark Seger
seger@futuresandoptionstrader.com consistent trading plan. Lentz is constantly developing new strategies on the
use of options as part of a comprehensive profitable trading approach. He
Volume 2, Issue 9. Futures & Options Trader is pub-
lished monthly by TechInfo, Inc., 161 N. Clark Street, regularly speaks at special events, trade shows and trading group organiza-
Suite 4915, Chicago, IL 60601. Copyright © 2008
TechInfo, Inc. All rights reserved. Information in this tions.
publication may not be stored or reproduced in any
form without written permission from the publisher.
The information in Futures & Options Trader magazine

is intended for educational purposes only. It is not Jim Graham (advisor@optionvue.com) is the product
meant to recommend, promote or in any way imply the
effectiveness of any trading system, strategy or manager for OptionVue Systems and a registered investment
approach. Traders are advised to do their own
research and testing to determine the validity of a trad- advisor for OptionVue Research.
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future
results.
FUTURES & OPTIONS TRADER • September 2008 5

TRADING STRATEGIES
Fading the opening gap

Instead of trying to identify long-term market reversals,
this intraday system trades the opening gaps that tend to accompany them.
BY ART COLLINS
S potting a market’s tops and bottoms seems

easy in hindsight, but it is nearly impossible in
real-world trading. One of the problems is
many false signals are generated before the
market eventually reverses direction. After hitting an all-
time high or low, the market will often continue in the same
direction, if only briefly.
this year, analysts knew it would peak at some point. But
when? Several turning points seemed to emerge as it
climbed 53 percent from Jan. 2 to July 11, but crude oil
futures kept surging higher.
Figure 1 shows a daily chart of August crude oil futures
(CLQ08) that highlights two all-time highs that closed
lower and seemed to act as reversals. First, crude oil hit a
Crude oil is a good example. As the price of oil surged record high at the open on May 22 before dropping to close
near its daily low. But the market exceeded that peak 10
Strategy snapshot days later. Then, oil climbed to another high on June 30, but
closed lower on the day. That high was exceeded the next
Strategy: Fading opening gaps.
day.
Market: Futures. A few days later, crude oil also formed an island top — a
day in which the low was higher than the highs of both sur-
Logic: Markets often reverse direction after opening
rounding days. These one-day patterns can act as reversal
much higher or lower than the previous close.
signals, but price hit a new high five days later. Clearly,
To exploit this pattern, buy markets that open at
price wasn’t going to surrender easily. How can you trade a
historic lows and sell those than open at historic
market like this?
highs.
One way is to trade in the opposite direction of opening
Timing: Exit at the close or within a few days of entering gaps. As markets reverse direction, price often opens at an
the market. Don’t expect the market to reverse extreme n-day high (or low) before dropping (or climbing)
its long-term trend. by the close. Instead of trying to identify major trend rever-
sals, this short-term strategy simply pin-
FIGURE 1 — WAITING FOR A REVERSAL – CRUDE OIL points the best times to fade extremely
large opening gaps and exit at the close.
Crude oil seemed to peak several times during its 53-percent climb from Jan. 2
to July 11. But each record high was exceeded within 10 days.
Behind extreme highs
and lows
Investors tend to panic when markets climb
to historic highs or drop to all-time lows.
And as emotions rise, markets become
volatile and bid-ask spreads expand as
even seasoned traders hesitate before tak-
ing a position. As a result, the daily range
(high-low) often widens.
In addition, markets tend to open at
extreme highs or lows and then pull back
by the end of the day. These moves seem to
be driven by nervous traders stampeding in
or out of a market they think is going to
continue to rise or plummet. Large opening
gaps often form after dramatic news hits
Source: TradeStation
the market before it opens.
By the close, however, the market has

often moved significantly away from its opening price. If the open, however, T-bonds and the S&P 500 reversed direc-
this move is big enough, it doesn’t matter where price tion by the close. Each of the opening gaps in Figures 2 to 4
closed in relation to its previous close. There are no more were reversed by the close, suggesting that you should fade
naïve traders to buy new highs or sell new lows, and the big these opportunities, not chase them.
news is all but forgotten. One simple idea is to trade in the opposite direction of an
opening gap if its open exceeds the last n days of highs or
Trade examples continued on p. 8
Figure 2’s daily chart shows
November soybean futures (SX93)
peaked in the summer of 1993, when FIGURE 2 — BEARISH REVERSAL — SOYBEANS
the market had been rallying sharply Soybeans opened limit up on July 19, 1993, but fell 20 cents by the close.
because of heavy flooding in the Selling soybeans after it gapped higher at the open would have been profitable.
Midwest. On July 19, the market That opening gap represented a major market top as soybeans didn’t climb
opened 30 cents higher, which was a back to July 19’s high for three years.
limit up move at the time. Soybeans
then fell 20 cents by the close. That
opening gap up represented a major
market top — soybeans didn’t climb
back to July 19’s high for three years.
Figure 3 shows a similar market top
in March T-bond futures (USH08) on
Jan. 22. The market opened 65 ticks
higher than its previous close — up
more than two full points. However, it
dropped 44 ticks by the close.
Meanwhile, Figure 4 shows the
March S&P 500 futures (SPH08)
opened 63 points lower before
rebounding 44 points by the close.
Both markets have tended to move
inversely at market extremes.
After setting multi-year extremes at Source: TradeStation
FIGURE 3 — ISLAND REVERSAL — T-BONDS
On Jan. 22, March T-bond futures (USH08) opened 65 ticks — more than two full points — higher than its previous close.
But the market fell sharply by the close. Again, selling this opening gap up would have been profitable.

TRADING STRATEGIES continued
FIGURE 4 — BULLISH REVERSAL — S&P 500 INDEX FUTURES

March S&P 500 futures (SPH08) opened 63 points lower on Jan. 22, but rebounded sharply by the close.
lows. Then, exit at the close. Let’s test this idea and deter- Test results — S&P 500 futures
mine if an opening gap’s size influences the results. The strategy tested opening gaps that exceeded previous
highs and lows of 10 different look-back periods. The tests
Trade rules ranged from 10 to 100 in 10-day increments from Jan. 1,
1. Go long if price opens below the lowest low of the 1990 to July 14, 2008. Table 1 lists the 10 sets of performance
past 10, 20, 30…100 days. results for the S&P 500 futures, ranked by return on account
(net profit / maximum drawdown * 100). All 10 look-back
2. Sell short if price opens above the highest high of the periods were profitable.
past 10, 20, 30…100 days. The most profitable technique was fading opening gaps
that rose to new 30-day highs or fell to new 30-day lows,
3. Exit at the close. according to Table 1. Return on account (ROA) represents
the percentage by which your account
would have increased if your startup cap-
TABLE 1 — PERFORMANCE RESULTS — S&P 500 FUTURES ital equaled the largest drawdown. The
For the S&P 500 futures (SP), the most profitable technique is fading opening 30-day example (first row) assumes your
gaps that rose to new 30-day highs or fell to new 30-day lows. The return on initial capital was $17,050 — the test’s
account is 764.44 percent. biggest intraday loss. Therefore, the net
profit of $130,337.50 represents a 764.44-
Max intraday Return on
Number Net Total % Avg. drawdown account percent increase of this initial amount.
of days profit ($) trades Profitable trade ($) ($) (%) Return on account is a better statistic
for comparison than simple net profit,
30 130,337.50 201 56.22 648.45 -17,050.00 764.44
because it shows relative performance. As
20 145,162.50 235 57.02 617.71 -19,400.00 748.26
you add criteria to a trading system, the
40 120,875.00 178 55.62 679.07 -16,525.00 731.47 number of instances drops, and its net
10 178,287.50 331 57.10 538.63 -27,200.00 655.47 profit often falls accordingly. But this isn’t
50 116,775.00 159 56.60 734.43 -23,175.00 503.88 a bad sign if the profit-to-drawdown ratio
60 112,950.00 149 57.05 758.05 -23,175.00 487.38 improves.
For example, a system that has a net
100 102,137.50 116 55.17 880.50 -23,050.00 443.11
profit of $25,000 with a $5,000 drawdown
80 95,787.50 125 55.20 766.30 -21,850.00 438.39 is preferable to one that has a net profit of
70 104,962.50 135 54.81 777.50 -24,075.00 435.98 $80,000 with a $45,000 drawdown. The
90 98,187.50 118 55.08 832.10 -22,950.00 427.83 first system should let you confidently
Source: TradeStation trade multiple contracts and still achieve
greater profit with less risk.

TABLE 2 — TESTING DIFFERENT MARKETS — 100-DAY HIGHS AND LOWS
The 100-day look-back period is profitable in all markets, except Japanese yen. In the stock-index futures, it earned average
per-trade profits of between $414 and $1,124 with minimal market exposure.
Net Total % Avg. Max intraday Return on
Market profit ($) trades Profitable trade ($) drawdown ($) account (%)
S&P 500 futures (SP) 105,963.00 118 55.93 897.99 -16,800.00 630.7
Nasdaq 100 futures (ND) 120,345.00 107 56.07 1,124.72 -23,300.00 516.5
Russell 2000 futures (RL) 107,750.00 147 52.38 732.99 -10,500.00 1026
Dow Jones futures (DJ) 20,730.00 50 66.00 414.60 -3,470.00 597.4
30-year T-bond futures (US) 10,906.00 124 57.26 87.95 -3,594.00 303.5
10-year T-note futures (TY) 8,375.00 139 56.83 60.25 -2,469.00 339.2
5-year T-note futures (FV) 8,570.00 152 53.95 56.38 -1,172.00 731.3
Japanese yen futures (JY) (525.00) 311 45.34 (1.69) -14,638.00 N/A
Euro futures (EC) 6,263.00 123 48.78 50.91 -4,375.00 143.1
Swiss franc futures (SF) 4,212.00 218 48.17 19.32 -7,163.00 58.8
Crude oil futures (CL) 3,360.00 172 48.26 19.53 -9,640.00 34.85
TABLE 3 — FILTERED TEST RESULTS
Adding a filter that waited for larger opening gaps improved performance in half of the markets shown.
Net Total % Avg. Max intraday Return on
Market profit ($) trades Profitable trade ($) drawdown ($) account (%)
S&P 500 futures (SP) 95,125.00 39.00 71.79 2,439.10 -5,350.00 1,778.00
Nasdaq 100 futures (ND) 48,600.00 32.00 62.50 1,518.75 -11,395.00 426.50
Russell 2000 futures (RL) 93,350.00 56.00 64.29 1,666.96 -3,750.00 2,489.00
Dow Jones futures (DJ) 12,550.00 16.00 75.00 784.38 -2,380.00 527.30
30-year T-bond futures (US) 8,719.00 47.00 59.57 185.51 -2,063.00 422.60
10-year T-note futures (TY) 10,906.00 68.00 69.12 160.39 -2,031.00 537.00
5-year T-note futures (FV) 5,672.00 76.00 57.89 74.63 -1,453.00 390.40
Japanese yen futures (JY) -1,500.00 274.00 45.62 -5.47 -13,963.00 N/A
Euro futures (EC) 6,800.00 95.00 49.47 71.58 -2,688.00 253.00
Swiss franc futures (SF) 963.00 172.00 48.26 5.60 -7,263.00 13.25
Crude oil futures (CL) 1,790.00 81.00 48.15 22.10 -5,500.00 32.55
in the markets less than one percent of the time. That is

Testing different markets more than enough to overcome commissions and slippage.
When you test this strategy in different markets, no single Each stock index gained about $6,000 annually.
look-back period will stand out as a consistent winner. Also, the stock-index futures’ ROA percentages are
Therefore, the challenge is to pick a value that is robust among the highest in Table 2. System equity climbed from
across a wide range of markets. 516.5 percent to 1,026 percent in 18 years in these four mar-
You don’t want to custom fit the best numbers to each kets.
market, because that increases the likelihood that those Finally, the system has a percentage of winners that is
results are random. A specific look-back period should per- higher than 50 percent most of the time. In the Dow futures
form similarly across all markets. (DJ), the strategy was profitable 66 percent of the time.
Gaps that exceed 100-day highs and lows Adding a filter

Table 2 lists the strategy’s performance with a 100-day look- To boost performance, let’s add the following filter: Enter a
back period in 11 futures markets in the past 18 years. The trade only if the distance between today’s open and yester-
system is profitable in all markets, except with the Japanese day’s close is at least 50 percent of the 20-day average range
yen (JY), which posted a total loss of $525. (high-low). The idea is that market tops and bottoms should
In the stock-index futures, the technique earned average be accompanied by relatively wide daily ranges. Also, such
per-trade profits of between $414 and $1,124, despite being continued on p. 10

markets outpace the lagging ones. For

TABLE 4 — WAITING TO EXIT — S&P 500 FUTURES
example, eight of 11 markets have
Holding S&P 500 trades up to seven days boosted the system’s net profit. ROA percentages of at least 253 per-
cent, while markets at the bottom of
Max intraday Return on
Number Net Total % Avg. drawdown account the list — crude oil and Swiss franc —
of days profit ($) trades Profitable trade ($) ($) (%) have ROA percentages of just 32.55
and 13.25 percent, respectively.
1 167,475.00 110 57.27 1,522.50 -20,550.00 814.96
Also, the average profit per trade
3 138,800.00 94 56.38 1,476.60 -29,250.00 474.53 improved in nine of the 11 markets
2 131,625.00 103 54.37 1,277.91 -29,250.00 450.00 shown. Without the filter, only the
4 98,387.50 89 47.19 1,105.48 -38,925.00 252.76 four stock-index futures have average
profits of at least $100. With the filter,
5 113,587.50 85 56.47 1,336.32 -64,925.00 174.95
six of the 11 markets exceed this
Source: TradeStation threshold. In addition, the percentage
of winning trades increased in 10 of
the 11 markets; the S&P 500 and Dow
TABLE 5 — WAITING TO EXIT — DOW FUTURES
futures have winning percentages of
Like the S&P 500, holding trades in the Dow futures a few more days improved 72 and 75 percent, respectively.
the system’s net profit.
Max intraday Return on Fine-tuning the exit rules
Number Net Total % Avg. drawdown account This intraday system simply exits at
of days profit ($) trades Profitable trade ($) ($) (%) the close, but most of these markets
2 26,100.00 47 61.70 555.32 -8,450.00 308.88 continued to move in the opposite
1 25,620.00 47 65.96 545.11 -12,250.00 209.14 direction as the opening gap, especial-
ly the stock-index futures.
3 19,180.00 44 54.55 435.91 -10,250.00 187.12
Tables 4 and 5 show the results of
4 23,090.00 40 55.00 577.25 -16,800.00 137.44 holding the filtered system’s trades
5 24,420.00 37 56.76 660.00 -19,700.00 123.96 from three to seven days in the S&P
Source: TradeStation 500 and Dow futures. Performances
are ranked by ROA percentages. These
large opening gaps suggest fairly volatile markets. numbers aren’t perfect, but they show that waiting for a
Table 3 lists the filtered system’s performance results for bigger reversal might improve profitability.
100-day highs and lows. The ROA percentages improved in
only half the markets, but notice how much the winning For information on the author see p. 5.
Related reading: Art Collins articles

“Morning reversal strategy”
“Turning systems upside down” Active Trader, May 2003.
Active Trader, February 2007. Historical tests reveal the tendency of the major stock
Inverting the rules of two popular trading techniques indices to revert to the previous day’s closing price in the
produces much better results than their standard early minutes of the trading session. This strategy takes
applications. its cue from that bit of market behavior.
“The six-signal composite indicator” “Twice as nice: The two-bar reversal system”
Active Trader, November 2006. Active Trader, March 2003.
Take a half-dozen trading rules, rate them as either buy or The simplicity and effectiveness of the two-bar reversal
sell signals, then add them together to create a market bias pattern prove that in the markets, as in the rest of life, good
for each day. things often come in small packages.
“Bottom or bounce?”
Other articles Active Trader, February 2002.
“Bottom fishing” tempts many traders who want to get in
“E-Mini morning reversal and afternoon at the absolute low, but it’s very dangerous. Here’s how
breakout patterns” to tell the difference between a real bottom and a temporary
Active Trader, January 2006. reversal.
Two simple ideas provide the basis for an intraday trading
approach. System analysis sheds light on how the strategies You can purchase and download past articles at
perform and what you can do to get the most out of them. http://store.activetradermag.com.

4
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TRADING STRATEGIES
From crunch to crush

Grain elevator credit issues could victimize soybeans — and soybean traders, if they’re not careful.
BY KEITH SCHAP
T he ongoing credit crunch that was

originally thought to be contained
in the sub-prime mortgage market
has spread to places the average
trader might not suspect. Although the seepage
from sub-prime to prime mortgages and the
problems with bank funding are now common
FIGURE 1 — NOVEMBER-JANUARY SOYBEAN SPREAD
The spread between the November 2008 and January 2009
soybean contracts is shown at the bottom of the chart.
knowledge, the way the credit situation can

affect the grain and oilseed markets is less well
known.
Because of the credit issues the grain elevator
commercials seem to be having, the unfolding
2008 harvest season could be a perilous time for
corn and soybean traders because the spread sig-
nals that ordinarily reflect the supply-demand
fundamentals could be misleading.
Further, the country elevator problem seems
likely to set off a chain reaction. Elevator activity
is likely to adversely affect the long-only com-
modity index funds, and the reactions of these
very large traders could make the markets dicey
for individual traders. Reactions through this
chain may temporarily override market funda-
mentals.
TABLE 1 — “CARRY” SPREADS SIGNAL PLENTIFUL TABLE 3 — BEWARE A FALSE SIGNAL

SUPPLIES OF SOYBEANS
For much of this summer soybean futures prices seem to
Intermonth usually offer a quick-and-easy way to gauge a
be indicating plentiful supplies: These positive spreads
market’s supply-demand situation. Successively higher
are at or near “full carry.”
prices produced the positive spreads shown here, which
is the futures market indicating supplies are plentiful. Contract Price ($/bu) Spread ($/bu)
November 11.8050
Contract Price ($/bu) Spread ($/bu)
January 11.9925 0.1875
January 6.0925
March 12.1375 0.1450
March 6.2450 0.1525
May 12.2700 0.1325
May 6.3625 0.1175
July 12.3975 0.1275
July 6.4625 0.1000
TABLE 2 — “INVERTED” SPREADS SIGNAL TABLE 4 — USDA NUMBERS INDICATE SOYBEAN

A SHORTAGE OF SOYBEANS SHORTAGE
Successively lower prices and negative spreads mean the In contrast to Table 3, the supply-demand data from
futures market is telling you a supply shortage — or fear the U.S. Department of Agriculture (USDA) indicated
of one — exists. soybeans were in very short supply.
Contract Price ($/bu) Spread ($/bu) 2007-08 2008-09
January 7.9775 Total supply 3,169 3,135
March 7.8400 -0.1375 Total usage 3,044 2,995
May 7.5000 -0.3400 Ending stocks 125 140
July 7.3150 -0.1850 Stocks/usage 4.1% 4.7%

TABLE 5 — WHEN FUTURES GAINS OVERCOME THE COST OF THE ROLL
Intermonth spreads usually A rising futures market often generates a large enough gain on the futures
indicate supply-demand position to overcome the cost of rolling over the position.
relationships
Month-to-month commodity spreads A. 2/28/90 Futures Contract No. of Position value
(the difference between the prices of price ($/bu) value ($) contracts ($ millions)
two different contract months) typical- Buy SK90 5.8075 29,037.50 6,000 174.225
ly provide a quick and easy way to
gauge a market’s supply-demand situ- 4/30/90
ation. Sell SK90 6.3250 31,625.00 6,000 189.750
Look at the soybean (S) futures
Buy SN90 6.4850 32,425.00 6,000 194.550
prices in Table 1. Successively higher
prices lead to the positive spreads in Roll result -4.800
this table, which is the futures market Futures result 15.525
telling you supplies are plentiful. The Net result 10.725
higher “deferred prices” of the more
distant back months prompt farmers B. 12/30/04 Futures Contract No. of Position value
and elevators to store soybeans against price ($/bu) value ($) contracts ($ millions)
future needs. Buy SH05 5.4725 27,362.50 6,000 164.175
At other times, you might see the
price relationships displayed in Table
2. When successively lower prices lead 2/28/05
to negative spreads such as these, the Sell SH05 6.1550 30,775.00 6,000 184.650
futures market is telling you a supply Buy SK05 6.2200 31,100.00 6,000 186.600
shortage exists, or there is the fear of Roll result -1.950
one. These higher nearby prices moti- Futures result 20.475
vate immediate delivery rather than Net result 18.525
storage for later delivery.
For much of summer 2008, soybean
futures prices were like the ones in This conflict between the two sets of
Table 1. Figure 1 shows November data calls for explanation.
2008 and January 2009 soybean
futures, along with the intermonth Credit blight hits the elevators
spread. In early August, futures prices Ordinarily, farmers sell grains or soy-
were similar to those in Table 3. The beans in increments throughout the
positive spreads were at (or close to) growing season. Grain elevators buy
“full carry,” which defines the limit for this grain and immediately go short
positive spreads. Full carry includes futures to protect against falling prices.
the costs of storage, taxes, insurance, Later, when the elevators sell the soy-
financing, and a shrinkage allowance. beans they have bought, they buy
Normally, spreads at full carry indicate these futures back to unwind their
the market believes soybean supplies hedges.
are adequate. A typical elevator line of credit
However, the supply-demand tables allows financing of approximately 84
issued by the U.S. Department of percent of these purchases; the eleva-
Agriculture (USDA) tell a different tor must pay cash for the other 16 per-
story about the soybean situation. cent. When soybeans are trading at
Table 4 abbreviates the information for $6.00 per bushel, this 16 percent
the 2007-2008 and 2008-2009 crop amounts to $4,800 per contract, or
years contained in the July USDA $960,000 for one million bushels. A
report. For practical purposes, any soybean price of $16.00 per bushel
“ending stocks” number under 200 boosts this working capital require-
million is effectively zero. ment to $12,800 per contract, or $2.56
These values are given in millions of million for one million bushels.
bushels, so the 3,169 total supply for Apparently, large numbers of coun-
2007-2008 indicates 3.169 billion try elevators lack this kind of working
bushels. Whether these figures are capital. As a result, banks, already suf-
completely accurate or not, soybeans fering from the credit crunch of the last
are in very short supply; the futures year, decline to lend to the elevators.
spreads of Table 3 result from some- The only way elevators can buy
thing other than just the supply- more soybeans (or corn or wheat) is to
demand dynamic. continued on p. 14

liquidate inventory. This response to the

TABLE 6 — THE ROLL COST CAN TURN A GAIN INTO A LOSS credit situation will tend to widen the
intermonth futures spreads. Also, as a
On rare occasions, the rollover cost will be greater than the futures gain.
delivery month approaches, the nearby-
The net result is then a loss.
first-deferred spread (e.g., during
2/28/95 Futures Contract No. of Position value October, this is the November-January
price ($/bu) value ($) contracts ($ millions) spread) will tend to reach full carry.
Buy SK95 5.6475 28,237.50 6,000 169.425 The strongly positive spreads of Table
3 most likely reflect the elevators’
4/28/95 response to tight credit and insufficient
Sell SK95 5.6700 28,350.00 6,000 170.100 working capital rather than an ample
Buy SN95 5.8000 29,000.00 6,000 174.000 supply of soybeans.
Roll result -3.900
Futures result 0.675 The plight of the long-only
Net result -3.225 index funds
A long-only commodity index fund goes
long all the contracts in whichever com-
TABLE 7 — THE ROLL COST CAN TURN A LOSS INTO A BIGGER LOSS modity index it tracks. Unlike stocks,
The combination of positive spreads and falling futures prices results in which you can hold practically without
negative rollovers and futures results — and an even larger negative net result. limit, futures contracts expire on a regu-
lar schedule — in soybeans, every two
A. 8/31/90 Futures Contract No. of Position value
months, except for the extra August con-
price ($/bu) value ($) contracts ($ millions) tract. This means a long-only fund man-
Buy SX90 6.1375 30,687.50 6,000 184.125 ager must periodically roll forward the
fund’s soybean futures positions — that
10/31/90 is, if the fund is long January soybean
Sell SX90 5.9200 29,600.00 6,000 177.600 futures, it must sell the January contracts
Buy SF91 6.0925 30,462.50 6,000 182.775 and buy March futures. It will usually do
this at or near the end of the month prior
Roll result -5.175
to the delivery month (in this case, on
Futures result -6.525 one of the last trading days in
Net result -11.700 December).
When the spreads are positive, as in
B. 12/30/05 Futures Contract No. of Position value Tables 1 and 3, the roll will be expensive,
price ($/bu) value ($) contracts ($ millions) because the fund will be selling low and
Buy SH06 6.1350 30,675.00 6,000 184.050 buying high. Of course, when the
spreads are negative, as in Table 2, the
roll will generate incremental income,
2/28/06
but this is a relatively rare situation in
Sell SH06 5.8025 29,012.50 6,000 174.075 the grain and oilseed markets.
Buy SK06 5.9400 29,700.00 6,000 178.200 A rising futures market often gener-
Roll result -4.125 ates a large enough gain on the futures
Futures result -9.975 position to overcome the cost of the roll.
Net result -14.100 Table 5 shows two such cases. Tables 5
through 10 assume 6,000-contract
futures positions and rollovers that
TABLE 8 — A ROLL GAIN CAN AMPLIFY A FUTURES GAIN occur on the last day of the roll month
(e.g., April for the May-July roll in Table
Positive rolls can augment a positive futures result, but they rarely occur. 5). The “Futures result” values are the
2/27/04 Futures Contract No. of Position value price differences between the relevant
price ($/bu) value ($) contracts ($ millions) contracts (in Table 8, the May and July
Buy SK04 9.3700 46,850.00 6,000 281.100 2004 contracts, SK04 and SN04) from the
last day in the prior roll month to the last
4/30/04 day of the current roll month, multiplied
Sell SK04 10.3400 51,700.00 6,000 310.200 by 30,000,000 bushels (5,000 bushels per
Buy SN04 10.1300 50,650.00 6,000 303.900 contract times 6,000 contracts). The
Roll result 6.300 6,000-contract position size, incidentally,
Futures result 29.100 is slightly less than the average long
Net result 35.400 index position based on the Commodity
Futures Trading Commission’s data

TABLE 9 — SUMMARIZING 20 YEARS OF SOYBEAN
ROLL RESULTS
from June through Aug. 5, 2008. During the 20-year review period, a long-only soybean
Only rarely does the roll cost overwhelm the futures position would not have been profitable. There were
gain. When it does, the net result is negative even though positive results for 38 of the 80 roll periods, and only
the futures result is positive, as illustrated in Table 6. Here, seven of 20 crop years were profitable. Only one five-year
positive spreads caused a loss on the roll, and rising May period (the last one) produced a net gain.
prices caused a small gain in the futures position. The com- Roll Futures Net Roll Futures Net
bination led to a loss for that two-month period. result result result result result result
Frequently, the combination of positive spreads and 1 - + + 41 - - -
falling futures prices causes negative roll and futures 2 - - - 42 + + +
results and, of course, an even larger negative net result, as 3 - - - 43 - + +
illustrated in the two examples in Table 7. The rare positive 4 - + + 44 + + +
roll results can greatly enhance a positive futures result, as 5 - + + 45 - + +
illustrated in Table 8. 6 - + + 46 - - -
No doubt, the situations of Tables 5 and 8 are what the 7 - + + 47 - - -
long-only managers hope for when they make these trades. 8 - + + 48 + - -
Unfortunately, the situation illustrated in Table 7 is more 9 - - - 49 - + +
common. 10 - + + 50 - - -
Table 9 distills 20 years of soybean rollovers: Each roll 11 - - - 51 - - -
result was either a cost (-) or a gain (+). The futures price 12 - - - 52 - + +
losses and gains are similarly denoted, as are the net results 13 - - - 53 - - -
combining roll and futures results. To avoid the complica- 14 - - - 54 - - -
tions surrounding old crop-new crop transitions, this study 15 - - - 55 - + +
analyzed only the November-January, January-March, 16 - + + 56 - + +
March-May, and May-July rolls for each crop year exam- 17 - - - 57 - - -
ined. 18 - - - 58 - + +
To summarize, 71 of the 80 rolls generated a cost, and 31 19 - + - 59 - - -
of those had a futures gain large enough to generate a net 20 - - - 60 - - -
gain (as in Table 5). Twice, the futures result was positive 21 - - - 61 - - -
but not large enough to result in a positive net result (as in 22 - - - 62 - - -
Table 6). 23 - + + 63 - + +
A negative roll result combined with a negative futures 24 - - - 64 - + +
result occurred 38 times (as in Table 7). Seven times both 25 - + + 65 - + +
roll and futures results were positive (as in Table 8). Two 26 - + + 66 + + +
times the roll result was positive, but the futures and net 27 - + + 67 + + +
results were negative. 28 - + + 68 - + +
During these 20 years, a long-only soybean position 29 - - - 69 - + +
would have been singularly unprofitable. Table 9 shows 30 - + + 70 - - -
positive results for 38 of these 80 roll periods. A search of 31 - - - 71 + + +
results for each crop year shows only seven of 20 generated 32 + - - 72 + + +
positive results, while looking at five-year intervals (1-5, 6- 33 - - - 73 - - -
10, 11-15, and 16-20) shows only the last one produced a net 34 - - - 74 + + +
gain. In dollar terms, a 6,000-contract position would have 35 - - - 75 - + +
lost $50.7 million for the entire 20-year period. 36 - + - 76 - - -
37 - + + 77 - - -
Implications 38 - + + 78 - + +
Among other things, this survey — which starts many 39 - - - 79 - - -
years before these long-only funds were even a twinkle in 40 - + + 80 - - -
anyone’s eye — demonstrates the difficulty of generating
consistently positive results using such a strategy.
The most recent five-year period includes the years dur- have netted $47.4 million and $87.975 million, respectively.
ing which these funds emerged and produced strongly pos- But consider what happened next. Table 10 shows the
itive results. This look at the past might constitute a cau- data for the May-July, July-September, and September-
tionary note about what to expect in the future, not only for November rolls (note, however, the early cutoff for the
fund investors but especially for individual traders in these September-November roll, which could still play out some-
markets. what differently). This is stormy weather indeed.
From the vantage points of any of the first three rolls of
the 2008-2009 crop year, 2008 would have looked like a very Looking ahead
good year. The November-January roll, based on the Most funds have some kind of exit rule. When the fund suf-
assumptions used throughout, would have netted $33.525 fers a drawdown greater than some specified magnitude, it
million, and the January-March and March-May rolls would continued on p. 16

TABLE 10 —A VERY GOOD YEAR OR STORMY WEATHER?
Related reading The first three rolls (Nov.-Jan., Jan.-March, and March-May) of the 2008-09
crop year might have made 2008 look like a good year, but the May-July, July-
“Speculators in crude oil? Where?” Sept., and Sept.-Nov. rolls tell a different story (although the Sept.-Nov. roll
Active Trader, October 2008. could still play out differently).
There’s been a lot of talk lately about
A. 2/29/08 Futures Contract No. of Position value
speculators in the crude oil market. It
takes more than a little digging to find price ($/bu) value ($) contracts ($ millions)
some useful numbers — but the even- Buy SK08 15.3650 76,825.00 6,000 460.950
tual implications are interesting.
4/30/08
“When value is uncertain, Sell SK08 13.0175 65,087.50 6,000 390.525
sell volatility” Buy SN08 13.1400 65,700.00 6,000 394.200
Active Trader, September 2008. Roll result -3.675
Wild conditions in commodity futures Futures result -70.425
open the door for option trades. Net result -74.100
“The liquidity crunch trade” B. 4/30/08 Futures Contract No. of Position value
Active Trader, August 2008. price ($/bu) value ($) contracts ($ millions)
A futures-spread strategy practiced by Buy SN08 13.1400 65,700.00 6,000 394.200
institutional traders can be used to take
advantage of gyrations in the credit 6/30/08
market. Sell SN08 16.0500 80,250.00 6,000 481.500
Buy SU08 15.8400 79,200.00 6,000 475.200
“The credit crisis: Roll result 6.300
Investor anguish, trader opportunity”
Futures result 87.300
Active Trader, April 2008.
Net result 93.600
Despite the actions taken by central
banks and other institutions, the sub-
C. 6/30/08 Futures Contract No. of Position value
prime mess and credit crisis might be
far from over. Astute traders might be price ($/bu) value ($) contracts ($ millions)
able to use spread relationships to prof- Buy SU08 15.8400 79,200.00 6,000 475.200
it from the market’s upcoming swings.
8/14/08
“A season for volatility trades Sell SU08 12.7750 63,875.00 6,000 383.250
in the grains” Buy SX08 12.8400 64,200.00 6,000 385.200
Futures & Options Trader, July 2007. Roll result -1.950
Implied volatility extremes help uncover Futures result -91.950
straddle and strangle opportunities in Net result -93.900
the soybean and corn futures.
Note: Some of the above articles are part remain sketchy. During the harvest season and for a
of “Keith Schap: Futures Strategy No one can know exactly how the short while afterwards, the soybean
collection, Vol. 1,” which is a discounted soybean situation will play out from and corn markets are unlikely to trade
set of articles in PDF format. harvest into 2009. One analyst head- in terms of fundamentals. The funda-
You can purchase past articles at lined a mid-August report, “Beans mental factors will still be there, but
http://store.activetradermag.com Need Good Finish.” A plentiful crop the credit-related phenomena may
could drive prices lower yet. A scanty override them. Traders approaching
crop could improve the situation these markets will need to exercise
must liquidate the position. The com- somewhat. great caution and have risk controls
bination of positive spreads and a But these fundamentals may not firmly in place.
plunging soybean market leads to very matter as much as they usually do. Sometime after the beginning of
large losses for the periods ending These falling futures prices and per- 2009, this furor should subside, and
with the May-July and September- haps misleading wide spreads could the grain markets should trade in
November rolls. These two results, conceivably lead a number of long- accord with the fundamentals once
taken in isolation, make it difficult to only commodity funds to have to, or again. For the short term, though,
believe such outcomes wouldn’t trip want to, liquidate their soybean posi- these are “trader beware” markets
the liquidation signal. In fact, this tions. This would widen the spreads because of the credit issues.
seems to have happened during the more and drive prices even lower than
first week in August, although details the usual post-harvest plunge. For information on the author see p. 5.

ads0908 7/15/08 1:28 PM Page 39
TRADING STRATEGIES
Hedging with
bear put spreads
Are you paying too much to hedge a long portfolio?
Find out why bear put spreads act as better hedges than long puts.
BY TRISTAN YATES
I nvestors have had a tough time so far in 2008 as the

S&P 500 index fell 18.3 percent from Jan. 2 to July 15.
You could have minimized the impact of this decline
by hedging a portfolio of stocks with long puts. But
buying puts can be expensive, especially during down-
trends when market volatility spikes. As the cost of buying
puts rises, their effectiveness as a hedge wanes, and poten-
declines, but a bear put spread is much cheaper because the
lower-strike put you sell helps offset the higher-strike put
you buy.
The trade-off is bear put spreads offer less downside pro-
tection than straight long puts. But as long as the market
doesn’t completely crash, these spreads offer several advan-
tages over buying puts.
tial profits from a stock portfolio can suffer.
Instead of buying puts for protection, you can add a bear Buying puts as a hedge
put spread (long put + short same-month, lower-strike put) To compare these two strategies, let’s track their hypotheti-
to your portfolio. Both strategies protect against market cal performance. The S&P 500 index closed at 1,375.93 on
May 23. For simplicity, let’s assume the long portfolio is
worth $137,593, or 100 times the index’s value.
Strategy snapshot One way to hedge this portfolio is to buy puts at slightly
Strategy: Hedging with bear put spreads out-of-the-money (OTM) strikes that expire in roughly one
year. For example, you could buy a 1,300-strike June 2009
Components: Long stock portfolio put for $91.60, or $9,160 in dollar terms ($91.60 * $100). Table
+
1 shows this trade’s details, and Figure 1 compares its
1 long put with a strike price 10 percent
below the market’s current value.
potential gains and losses at expiration (brown line) to the
+ unprotected index (pink line).
1 short put with a strike price 10 percent Figure 1 shows the hedged position’s (stock + long put)
below that. losses are limited to $16,600 if the S&P 500 drops to 1,300 or
below by expiration on June 19, 2009. But if the market
Logic: Protect a stock portfolio against 10- to
climbs, its upside breakeven point rises by the put’s cost;
30-percent losses for less than the cost of
any potential gains are reduced by the same amount. The
buying puts outright.
S&P 500 must jump 6.6 percent to 1,467.53 just to cover the
Best-case Market rallies sharply and spread’s cost put’s cost by expiration.
scenario: is a small percentage of overall portfolio
profits. The bear put spread advantage
Worst-case Market drops below bear put spread’s short You can reduce this cost by selling a same-month put at a
scenario: strike and spread protects against only a lower strike, which creates a bear put spread. After buying
portion of that loss (strike-price difference - a 1,300-strike put on May 23, you could then sell a 1,150-
spread’s cost). strike put for $47.10 ($4,710 in dollar terms). This step low-
Possible Exit spread after six months and replace it ers the protective position’s cost to $44.50 ($4,450 in dollar
adjustments: with higher-strike puts that expire in terms).
18 months. Table 1 shows this trade’s details, and Figure 2 compares
its potential gains and losses at expiration to the unhedged

FIGURE 1 — PORTFOLIO + LONG PUTS
Long puts will completely protect a portfolio below the strike price, but they can be
expensive. One 1,300 put cost $9,160 on May 23, which means losses are capped at
$16,600 if the S&P 500 drops sharply (brown line). However, the portfolio’s upside
breakeven point is raised to 1,467.53, and any potential gains are reduced.
index (green and blue lines,

respectively). Figure 2 shows the
spread’s maximum losses are lim-
ited to $12,210, but only if the mar-
ket trades between the two strike
prices at expiration.
Below the 1,150 short put, losses
continue to mount, but they are
105.5 points (150 strike-price dif-
ference minus 44.50 spread cost)
smaller than the unprotected
index.
In theory, a bear put spread is at
risk of early exercise, assuming
American-style options are used.
In reality, however, the short put
Source: OptionVue
holder is unlikely to exercise it
unless the underlying drops
TABLE 1 — LONG PUTS VS. BEAR PUT SPREAD
sharply and the put loses all of its time
value. Even if this happened, the long As a hedge, bear put spreads are cheaper than long puts. But they offer limited
1,300 put would retain its full intrinsic protection if the market drops below the short put’s strike.
value, so you could exercise it and the S&P 500 index closed at 1,375.93 on May 23.
spread would be worth 150 points — its
Hedge 1 - buy puts
maximum value.
Long or short? Strike Expiration IV Cost Dollar cost
Estimated costs and benefits Long 1,300 June 2009 24.51% -$91.60 -$9,160.00
Hedging with bear put spreads costs less
and offers more benefits than simply Hedge 2 - buy bear put spread
buying puts. To demonstrate, let’s first Long or short? Strike Expiration IV Cost Dollar cost
assume a hypothetical index trades at 100 Long 1,300 June 2009 24.51% -$91.60 -$9,160.00
that also represents a portfolio of stocks. Short 1,150 June 2009 27.07% $47.10 $4,710.00
As a hedge, you can buy 12-month puts
with a strike price of 90, or you can enter Total debit: -$44.50 -$4,450.00
a spread by buying 90-strike puts and
selling 80-strike puts.
Table 2 compares the costs and benefits of both positions er-strike ones, which helps lower the spread’s overall cost.
to the unprotected index. The expected returns and proba- Given Table 2’s assumptions, buying puts can help avoid
bilities of different-sized losses (i.e., at at least 5, 10, 15, or 20 an average loss of 0.57 points each year at a cost of 2.88
percent) are also shown. To estimate these values, the table points. If the index rises 10 points annually, the hedging
assumes the index climbs 10 percent annually with a 15-per- strategy earns a median 7.12 points and an average 7.69
cent historical volatility and uses a normal distribution of points. Therefore, this hedge’s cost is nearly 25 percent its
those returns; for simplicity, dividends are ignored. expected annual profits.
The bear put spread costs 1.77 vs. 2.88 points annually for By contrast, the bear put spread costs only 1.77 points
buying puts outright. The spread is less expensive because with an expected benefit of 0.49 points. In one year, the
selling a lower-strike put offsets the long put’s cost, and the index hedged with a put spread would earn a median 8.23
position offers limited downside protection. Also, lower- points and an average 8.72 points — much better than sim-
strike puts have higher implied volatilities (IVs) than high- continued on p. 20

ply buying puts, especially if this performance is applied to the underlying index has a five-percent chance of dropping
a large portfolio and compounded over five or 10 years. 15 percent in one year. The bear put spread reduces this
Adding a bear put spread doesn’t eliminate the likeli- possibility to about 1.5 percent in one year. Essentially, the
hood of catastrophic loss, it just reduces it. Table 2 shows spread cuts the probability of sharp losses in half.
FIGURE 2 — PORTFOLIO + BEAR PUT SPREAD Time decay and

rolling the spread
Adding a bear put spread to a stock portfolio limits the position’s maximum loss Table 3 lists the time decay of each
to $12,210, but only if the market trades between the two strike prices at expira-
position at 30-day intervals in a 12-
tion. Below the 1,150 short put losses continue to mount, but they are smaller
than if the index was unhedged.
month period and uses the same
assumptions as Table 2. Admittedly,
the passage of time and the underly-
ing’s steady gains take their toll on the
spread. However, the spread’s short
put decays faster than its long put,
which helps the spread maintain its
value.
After six months, the bear put
spread still retained 40 percent of its
value, even when the underlying ral-
lied significantly. The long 90 put was
worth $0.87, but the short 80 put was
worth only $0.17. The position still
had value as a hedge and could be
held until it expires in six months.
Or you can exit the spread and
replace it with options at higher
strikes that don’t expire for another 12
months, a technique called “rolling.”
Table 4 shows you can sell the 90-80
Source: OptionVue
spread for $0.70 and use the proceeds
to buy a 95-85 spread that expires six
TABLE 2 — WHICH IS THE BETTER HEDGE? months later.
The bear put spread costs 1.77 vs. 2.88 points annually for buying puts outright. The cost of rolling a spread depends
And the spread earns more than long puts, assuming the index climbs 10 on the underlying’s price and implied
percent each year. volatility. In general, it is better to roll
a position when volatility is low and
No hedge Bear put spread Long put
the market has dropped. However, it’s
Annual cost 0 1.77 2.88
tough to set solid rules, because all
Expected benefit 0 0.49 0.57
four puts have different volatilities
Expected loss (cost-benefit) 0 1.28 2.31
and strike prices.
Estimates show that the costs of
Expected annual return 10 8.72 7.69
rolling the original 90-80 spread up
Median return 10 8.23 7.12
five points and out 12 months ranged
Probability of >= 5% loss 16% 19% 21%
from $1.10 to $1.50; it cost $1.35, on
average.
Probability of >= 20% loss 3% 0.6% 0%
Different market scenarios
Assumptions: Market price = 100, long put strike = 90, short put strike = 80,
Table 5 shows how the 90-80 bear put
12-month bear put spread, 90-strike put IV =22%, 80-strike put IV = 22% (volatility
spread’s value is affected by the pas-
skew of 1%), expected annual return = 10 %, volatility = 15%, interest rate = 3.75%,
no dividends. sage of time, gains or losses in the
underlying, and changes in volatility.

The spread initially cost 1.77 and its largest possible TABLE 3 — TIME DECAY
value is $10, which represents a 660-percent gain.
The passage of time and the underlying’s steady gains take their
But you won’t capture the spread’s maximum gain toll on both hedging strategies. But after six months the spread still
unless the underlying falls 25 percent in 12 months retained 40 percent of its value.
and you wait until expiration to exit the trade.
However, you can still make money in a variety Days to Market Long Short Time
of situations. For instance, the spread gains ground expiration price put put Spread decay
if the underlying drops 10 percent or more or if 365 100.00 2.88 1.11 1.77
implied volatility rises. If the index drops 10 percent 335 100.80 2.53 0.92 1.61 8.7%
in the first six months, the spread could double in 304 101.60 2.18 0.73 1.45 18.0%
value as the OTM 90-strike put moves closer to the 274 102.41 1.84 0.56 1.27 27.8%
money. And when markets drop, implied volatility 243 103.23 1.50 0.41 1.09 38.2%
tends to rise, which also boosts the trade’s value.
213 104.05 1.18 0.28 0.90 49.0%
Bear put spreads often benefit from IV increases,
183 104.88 0.87 0.17 0.70 60.2%
because the long put’s value rises further than the
152 105.72 0.59 0.09 0.50 71.5%
short put’s value. But it doesn’t always work this
way. 122 106.56 0.35 0.04 0.31 82.3%
If, for example, the underlying falls sharply to 91 107.41 0.16 0.01 0.15 91.6%
trade near the short put’s lower strike, the spread 61 108.27 0.04 0.00 0.04 97.9%
becomes vega neutral, which means changes in IV 30 109.13 0.00 0.00 0.00 99.9%
no longer affect it. And if the market falls further, 0 110.00 0.00 0.00 0.00 100.0%
the position will lose value if implied volatility
increases. This happens because the short put’s Assumptions: Market price = 100, long put strike = 90, short put
extrinsic value rises, reducing the spread’s overall strike = 80, annual gain = 10%, 12-month bear put spread, 90-strike
value. put IV =22%, 80-strike put IV = 22% (volatility skew of 1%), expected
A scenario in which the underlying falls 20 points return = 10 % and volatility = 15%, interest rate = 3.75%, no
can be frustrating, because the bear put spread dividends.
might be worth only $5 or $6 instead of its maxi-
mum value of $10. In this case, the short put may
have a large amount of time value left. And the
TABLE 4 — ROLLOVER AFTER SIX MONTHS
short put will increase in value if volatility contin-
ues to rise, eroding the spread’s profit further. After six months you could have rolled the 90-80 spread to higher
Fortunately, this situation should only be tempo- strikes and later expirations for just $1.38.
rary, because the short put’s value will drop as time
passes and volatility declines. Original bear put spread
It’s tempting to try to time the market and hedge Value after
with a bear put spread only when you think stocks Type Expiration Entry cost six months
could decline. This approach might be profitable, Long 90 put June 2009 -$2.88 $0.87
but it misses the point of a hedge — security. By con- Short 80 put June 2009 $1.11 -$0.17
trast, the spread’s costs and benefits are more pre-
dictable if you maintain the position by rolling it Total debit: $1.77 $0.70
every six months. Index rises from 100 to 104.88 in six months.*
Which market to hedge? Rolling the spread

The strategy works best on broad and highly liquid Type Expiration Entry cost
indices such as the S&P 500 (SPX), Dow Jones Long 95 put December 2009 -$4.17
Industrial Average (DJIA), Nasdaq 100 (NDX), or Short 85 put December 2009 $2.09
Russell 2000 (RUT). On other indices, the bid-ask
spreads and transaction costs may be too large to Total debit: -$2.08
benefit from selling puts or from rolling the spread Total rolling costs: -$1.38
every six months. * The rest of Table 2's assumptions remain unchanged.
continued on p. 22

Related reading:
Tristan Yates articles
TABLE 5 — EFFECTS OF TIME, DIRECTION, AND VOLATILITY “Exploiting the fear factor”
The spread gains ground if the underlying drops 10 percent or more or implied Futures & Options Trader,
volatility rises. But you won’t capture its maximum value of $10 unless the index February 2008.
drops 25 percent and you wait until both puts expire in 12 months. What’s the best way to profit from
high-volatility forecast? Comparing
Scenario Today 3 months 6 months 9 months 12 months the performance of covered calls, dif-
later later later later ferent option spreads, and LEAPS
Flat 1.77 1.56 1.22 0.63 0.00 shines some light on the subject.
10% gain 0.86 0.65 0.37 0.08 0.00
25% gain 0.25 0.14 0.04 0.00 0.00 “Long-term diagonal call spreads”
10% loss 3.27 3.23 3.12 2.78 0.39 Futures & Options Trader,
25% loss 6.40 6.83 7.43 8.41 10.00 November 2007.
Higher volatility (IV=31) 2.76 2.56 2.20 1.49 0.00 This detailed look at diagonal
Lower volatility (IV=11) 0.41 0.30 0.17 0.03 0.00 spreads shows how to trade them
with a long-term perspective.
“Rolling leaps calls”

However, you can apply this strate- hedge’s cost multiple times (Figure 3).
Futures & Options Trader,
gy to liquid, but more volatile indices In addition, a 160-150 September 2008
September 2007.
such as distressed sectors or foreign bear put spread retained some value
Holding LEAPS calls instead of the
markets. The caveat is that these posi- because it didn’t expire for another six
underlying shares can pay off — but
tions cost more because implied months and the market’s volatility
only if you know when to roll them
volatility is higher and traders are was still elevated.
forward.
willing to pay more to protect against At that point, exiting the spread and
sharp declines. rolling it to higher-strike puts that
Other articles
In September 2007, for example, the expired later would have been a good
gold/silver producer index (XAU) idea. The gold/silver producer index
“Optionality: Why options
traded at an implied volatility of 38. At then fell 20.9 percent from March 14 to
are better than insurance”
those prices, a 10-point bear put May 1. If you had rolled the spread in
Active Trader, November 2007.
spread cost more than 3.5 percent of mid-March, that hedge would have
Getting the most out of an options
the index’s price, which seemed high. protected you from roughly half of
trade requires looking beyond the
But XAU jumped from 171 on Sept. 20, that loss.
clichés and understanding how these
2007 to 206 on March 14 — a 20-per-
tools really work.
cent gain that would have paid for the For information on the author see p. 5.
“Playing defense:
FIGURE 3 — HEDGING IN THE GOLD/SILVER PRODUCER INDEX Long puts vs. bear put spreads”
XAU jumped 20 percent from September 2007 to March 2008, but then gave back Futures & Options Trader, June
those gains within six weeks. But you could have made money if you entered a 2007. Protecting a portfolio from a
bear put spread back in September and then replaced it with higher-strike, later- market downturn doesn’t have to be
expiring puts in March. complicated. Find out which defen-
sive strategy offers the most bang for
your buck.
“The simplicity of debit spreads”

Options Trader, February 2006.
Using spreads instead of buying
options outright can reduce risk and
increase opportunity. This discussion
of "debit" spreads highlights their
versatility.
You can purchase and

download past articles at
Source: eSignal http://store.activetradermag.com.

ads1008 8/12/08 6:15 PM Page 47
TRADING STRATEGIES
Trading stocks
with short options
Shorting puts and calls can be risky, but if you want to own the underlying instrument,
it can help you trade more efficiently.
BY MARK D. WOLFINGER
I
FIGURE 1 — TRADE EXAMPLE
n the quest to learn complex
Instead of entering a buy limit order in the stock, you could sell August 165 puts
options strategies, newer traders
on Apple, which obligates you to buy the stock if it trades below the strike price
often miss some of their simple
at expiration.
and practical advantages. For
example, you can use options to buy or
sell stock at your target price — a tech-
nique that has certain benefits over sim-
ply entering a limit order in the stock
itself. You may need to wait a week or two
longer than usual, but the odds of execut-
ing orders at ideal prices are improved,
even when the stock never trades as low
or high as you wish.
The trick lies in selling options instead
Strategy snapshot
Strategy: Selling puts or calls.
Logic: Collect premium. Wait to buy
a stock at a reduced price
(short puts).
Source: eSignal
Criteria: Use front-month options when
IV is low. Use second-
or third-month options when TABLE 1 — SELLING PUTS ON APPLE
IV is high. When you sell August 165 puts on Apple, you collect 8.00 in premium,
Max. risk: Stock price – premium which lowers your purchase price to $157. But if the short puts aren’t
exercised and you don’t get assigned, you still keep that premium.
collected.
Best-case Puts — underlying drops Apple Inc. (AAPL) traded at $174 on June 24.
scenario: below short strike, stock Dollar amount
is bought and then climbs No. of Long or (price * 100
sharply. Calls — underlying puts short? Strike Expiration Cost multiplier)
drops to short strike at 3 Short 165 August 2008 $8.00 $800.00
expiration.
Worst-case Total premium: $24.00 $2,400.00
scenario: Underlying falls to zero. Net cost: $157.00

of buying them. When you buy an option, you purchase the each on June 24 (Table 1). You collect 24 in premium — a
right to buy or sell the underlying at the strike price before total of $2,400 — and wait. If you are eventually assigned
it expires. But when you sell an option, you accept the obli- that exercise notice, you pay $165 per share. If, however,
gation to buy or sell stock at the strike price. Selling options you subtract the 8.00 premium from each short put, your
can be risky, but if you already own the underlying shares net cost drops to $157 per share — lower than your target
— or plan to buy them — it can be a smart move. price of $158.
For example, if you want to buy a stock but think it’s
overpriced, you could sell a put with a strike price below Managing the trade
the current stock price. Then you buy the stock only if it is There are several issues to consider when using this strate-
below the strike price when expiration arrives. You always gy. For instance, you buy stock when you are assigned, and
keep the premium. that will happen only if it is below the 165 strike price at the
Alternately, if you own stock but want to sell it at a high- continued on p. 26
er price, you could sell a call with a
strike above its current value. Then, you
sell the stock only if it rallies and
remains above the strike at expiration;
again, you keep the short option’s pre-
mium.
Buying stock below the market

Figure 1 shows that Apple (AAPL) trad-
ed at $174 on June 24. Let’s assume you
want to buy 300 shares, but you don’t
want to pay more than $158 per share.
One method is to place a good till can-
celled (GTC) order with your broker,
bidding $158. If AAPL drops that far,
that order will be executed. But if Apple
never falls that low, the order won’t be
executed, and you will eventually can-
cel it.
Another approach is to sell AAPL
puts. On June 24, you could have sold
three AAPL August 165 puts that
expired in 38 days. By selling those puts
and collecting the cash premium, you
are accepting an obligation to buy 300
shares at the strike price. That obliga-
tion remains until the options expire or
you buy them back to close the position.
If Apple is below the strike price when
expiration arrives, you will receive an
exercise notice and be required to buy
300 shares.
How aggressive do you want to be
when buying the stock? This is an
important decision, because many
traders who use this strategy actually
hope to collect the option premium
rather than buy the shares.
First, let’s assume you are very bull-
ish and hope a brief drop will provide
an opportunity to buy stock at a lower
price. Aggressive buyers could sell three
August AAPL 165 puts for 8.00 ($800)
FUTURES & OPTIONS TRADER • September

TABLE 2 — SELLING CALLS ON APPLE

Selling calls can help you sell a stock you already own at an advantageous price.
When you collect 10.00 for selling each August 180 call, that premium helps you close of trading on the third Friday of
reach a target selling price of $190 even if Apple never trades that high. August. (Less-experienced traders
often believe you automatically buy
Apple Inc. (AAPL) traded at $174 on June 24.
stock if AAPL drops to 165 at any
Dollar amount time, but that’s not the case.)
No. of Long or (price * 100
You may repurchase the options
calls short? Strike Expiration Cost multiplier)
you sold at any time; you are not obli-
3 Short 180 Aug. 2008 $10.00 $1,000.00
gated to hold your position until expi-
ration. If you change your mind about
Total premium: $30.00 $3,000.00 the trade, you can buy back the puts
and cancel your obligation, although
you may lose money depending on
Mark D. Wolfinger articles: how much you pay for them. If the
short puts drop in value, it’s often a
“Synthetic solutions,” Futures & Options Trader, March 2008. good idea to buy them back cheaply.
Any options strategy has at least one other synthetic alternative, which could be This method contains some risks.
a better choice for a trade. Learn how to find an identical position with less risk The idea of buying Apple for $157
and greater profit potential.
might have been very attractive on
“Options for swing traders,” Options Trader, November 2005. June 24, but the stock might be trad-
New options traders must understand how leverage and time decay could affect ing lower by the time August expira-
a trade’s performance. We compare buying stock, buying calls, and selling tion rolls around and you would own
naked puts to illustrate how these two factors influence the outcome.
a losing position. Or, you could miss a
substantial profit. If AAPL drops to
Other articles: $158 before Aug. 16 expiration and
then rallies much higher, your profit
“Putting the put-write right,” Active Trader, August 2008. is limited to the $2,400 premium you
Unlike the venerable covered call strategy, short puts, despite their bad
collected for the three puts. However,
reputation, have a built-in advantage.
if you entered a buy limit order at
“Buying stocks at a discount with puts” $158, you would have bought Apple
Futures & Options Trader, July 2008. and been able to sell those shares at a
Attention discount shoppers: Puts and put ratio spreads can be used to buy
higher price.
stocks at reduced prices.
“Covered calls vs. cash-secured puts,” Futures & Options Trader, July 2007. A less-aggressive approach
These positions are similar, but one offers a slight edge. Let’s assume you are less bullish on
“Gad Grieve: Putting a premium on put premium” Apple. In this scenario, your main
Options Trader, November 2005. objective is to simply collect the pre-
This options trader’s expertise in selling premium has helped his Finvest Primer mium from selling puts. Your odds of
fund profitably navigate the U.S. options market — and outperform its peers — success will increase when you sell
since 2001.
puts with lower strikes that are fur-
“Naked puts: An option-income alternative” ther out-of-the-money (OTM). This
Options Trader, September 2005. tactic significantly reduces your
Although trading “naked” is rarely recommended, selling puts can be a way to chances of buying AAPL, but you
generate income if you pick the appropriate underlying market.
didn’t really want to buy it. If you do
“A new look at naked puts,” Active Trader, August 2002. buy stock, its price will be even lower.
Shorting puts can be a limited-risk strategy that behaves the same way as Instead of selling August 165 puts
selling a covered call — with potentially lower costs. for 8.00 each, you could sell August
“Selling naked puts,” Active Trader, April 2001. 160 puts for 6.00 or sell August 155
The average trader or investor may think of buying a call to profit from an puts for 4.50. Obviously, you collect
uptrending stock, but selling puts is an alternate technique with a number of less premium for these options, which
key advantages for traders who can manage risk. reduces your profit if they expire
You can purchase and download past articles at http://store.activetradermag.com. worthless. But if AAPL declines and
you are forced to buy it, your pur-

chase price also drops accordingly. With the
August 160 put, the purchase price falls to
$154 (160 strike - 6.00 premium), and with
the August 155 put, the purchase price
declines to $150.50 (155 strike - 4.50 premi-
um).
Selling OTM puts is an effective way to
collect premium or buy stocks at a reduced
price. But if the stock tanks, you could face
large losses. You may lose less money than
someone who simply buys 300 shares the
traditional way, but that’s not much conso-
lation.
Selling stock above the market

You can use a similar technique to sell stock
you already own at advantageous prices.
Let’s assume you own 300 shares of Apple
and your target selling price is $190. You
can enter a sell limit order at $190 with your
broker. Or you can sell three August
180 calls for 10.00 each — a total of $3,000
(Table 2).
If AAPL trades above 180 at expiration,
you will be assigned an exercise notice and
sell your shares. Add the 10.00 premium to
the $180 you will collect later, and the effec-
tive selling price rises to $190, even if Apple
never trades that high.
However, AAPL could drop in price and
your 180 calls would expire worthless. If
this happens, keep in mind you already col-
lected $10 per share, which lowers your tar-
get selling price to $180. After expiration,
you may decide to sell three September 170
calls or three October 175 calls, depending
on where Apple currently trades and how
much premium you can collect for those
calls.
The point is you already have earned
cash to apply toward the sale price. As you
continue to sell calls with strikes below
your target sale price and collect more pre-
mium, the chances of meeting your original
goal increase. There’s no guarantee you will
eventually sell the stock, but your chances
of doing so — and reaching the original
$190 target — are much better than when
you simply hold stock and hope it rallies to
your target price.
For information on the author see p. 5.
FUTURES & OPTIONS TRADER • September 2008

OPTIONS STRATEGY
OPTIONS TRADING SYSTEM
LAB LAB
Ichimoku and vertical spreads

Market: Options on the S&P 500 index (SPX). This strate-
gy could also be applied to other broad-based indices and Bull call spread:
stocks or ETFs with liquid options contracts. 1. Buy the call with the most time premium in the first
expiring month that has over 21 days remaining and
System concept: Ichimoku analysis is a Japanese chart- a strike price divisible by 25.
ing approach that combines trend-following and support- 2. Sell a same-month call with a strike 25 points higher.
resistance components. The method has been used in Japan 3. Hold until expiration.
for years and has caught on quickly in the West, especially
in the forex market. Its exotic terms mask common charting Bearish signal:
tools that are relatively easy to understand and analyze. 1. The S&P 500 crosses below the trendline (kijun).
In the following test Ichimoku analysis identifies trade 2. The index trades below the cloud (kumo).
signals and the system enters vertical debit spreads in the 3. The index trades below its value 26 days ago
direction of each trade. The system isn’t always in the mar- chikou confirmation).
ket, so there may be long periods of time between each sig-
nal. You can use software to scan for these entry signals; the Bear put spread:
definitions for this test were written in MetaStock code. 1. Buy a put with the most time premium in the first
When a bullish signal appears, the system enters a bull expiring month that has over 21 days remaining and
call spread. When a bearish signal emerges, the system a strike evenly divisible by 25.
enters a bear put spread. Each trade is held until the options 2. Sell a same-month put with a strike 25 points
expire, and no money management rules or stops are used. lower.
Figure 1 shows the potential
gains and losses of a bear put FIGURE 1 — RISK PROFILE: BEAR PUT SPREAD
spread entered on Feb. 4 when the
The 1350-1375 bear put spread has a 42-percent probability of profit and will make
S&P 500 index traded at 1380.80.
money if the SPX closes below 1366.02 by March 21 expiration.
Both puts expire in March and their
strikes are 25 points apart. The
spread has a reward-risk ratio of
1.75: Its maximum potential loss is
$892 (its cost) and its maximum
potential gain is $1,596. The trade
will be profitable if SPX trades
below 1366.02 by March 21 expira-
tion and it has a 45-percent proba-
bility of profit.
Trade rules:
Bullish signal:
1. The S&P 500 crosses above
the trendline (kijun).
2. The index trades above the
cloud (kumo).
3. The index trades above its
value 26 days ago (chikou
Source: OptionVue
confirmation).

FIGURE 2 — ICHIMOKU SYSTEM PERFORMANCE
The system gained 209 percent since January 2001.
3. Hold until expiration.
Starting capital: $5,000.
Execution: When possible

option trades were executed at
the average of the bid and ask
prices at the daily close; other-
wise, theoretical prices were
used. At-the-money (ATM)
options are defined here as the
Source: OptionVue
calls with the largest time value.
Each spread held one contract STRATEGY SUMMARY
per leg. Commissions were $5 base fee plus $1 per
contract. Net gain: $10,436.00
Percentage return: 209.0%
Test data: Options on the S&P 500 index (SPX). Annualized return: 29.3%
No. of trades: 23
Test period: Jan. 5, 2001 to March 21, 2008. Winning/losing trades: 15/8
Win/loss: 65%
Test results: Figure 2 shows the system’s per- Avg. trade: $453.74
formance, which gained $10,436 (209 percent) over Largest winning trade: $1,696.00
the seven-year test period. However, the system Largest losing trade: -$1,132.00
might perform better with added steps to manage Avg. profit (winners): $1,099.60
risk instead of simply holding each spread until it Avg. profit (losers): -$757.25
expires. Avg. hold time (winners): 39
The strategy’s largest winning trade ($1,696) is Avg. hold time (losers): 42
higher than its largest losing trade (-$1,132.00). Max consec. win/loss: 8/3
Combined with a win-loss ratio of 65 percent, the
statistics suggest this system has a
definite trading edge. LEGEND:
Net gain – Gain at end of test period.
— Steve Lentz and Jim Graham Percentage return – Gain or loss on a percentage basis.
of OptionVue Annualized return – Gain or loss on a annualized percentage basis.
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.

FUTURES SNAPSHOT (as of Aug. 27)
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). Price activity for CME futures
is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).
E- Pit 10-day move/ 20-day move/ 60-day move/ Volatility
Market symbol symbol Exchange Volume OI rank rank rank ratio/rank
E-Mini S&P 500 ES CME 1.91 M 2.40 M -0.19% / 29% -0.21% / 0% -6.93% / 33% .18 / 2%
10-yr. T-note ZN TY CME 885.4 1.70 M 1.03% / 63% 2.00% / 70% 1.99% / 44% .24 / 12%
5-yr. T-note ZF FV CME 583.1 1.47 M 0.87% / 42% 1.74% / 75% 1.05% / 28% .19 / 2%
E-Mini Nasdaq 100 NQ CME 390.3 323.9 -2.05% / 33% 2.45% / 30% -5.89% / 61% .37 / 76%
Eurodollar* GE ED CME 314.5 1.20 M 0.21% / 61% 0.33% / 55% 0.28% / 24% .21 / 25%
30-yr. T-bond ZB US CME 290.9 828.4 1.92% / 84% 3.49% / 81% 3.45% / 69% .33 / 20%
Crude oil CL NYMEX 276.1 239.0 1.85% / 67% -6.80% / 28% -3.39% / 17% .24 / 48%
2-yr. T-note ZT TU CME 265.4 846.9 0.13% / 42% 0.87% / 67% 0.87% / 36% .21 / 33%
Eurocurrency 6E EC CME 223.2 151.9 -1.42% / 10% -5.39% / 69% -4.78% / 72% .20 / 2%
E-Mini Russell 2000 ER2 CME 220.9 594.3 -2.13% / 0% 1.88% / 36% -1.56% / 25% .50 / 49%
Mini Dow YM CME 197.1 114.1 -0.22% / 0% -0.72% / 0% -7.31% / 31% .16 / 2%
Japanese yen 6J JY CME 114.4 172.4 -0.19% / 0% -1.53% / 33% -4.15% / 50% .19 / 27%
Natural gas NG NYMEX 89.0 81.7 1.80% / 100% -6.92% / 11% -30.46% / 76% .14 / 17%
British pound 6B BP CME 87.5 101.4 -2.03% / 30% -7.30% / 100% -6.31% / 97% .32 / 5%
Swiss franc 6S SF CME 64.8 57.1 -1.09% / 5% -4.99% / 66% -5.42% / 89% .17 / 2%
Gold 100 oz. GC NYMEX 60.5 81.1 0.30% / 0% -8.06% / 62% -6.08% / 59% .33 / 30%
Corn ZC C CME 58.5 231.1 7.12% / 14% -3.99% / 16% -5.03% / 39% .28 / 23%
Australian dollar 6A AD CME 49.2 83.2 -2.01% / 5% -8.76% / 73% -10.59% / 100% .22 / 22%
Sugar SB ICE 44.2 332.9 -1.88% / 20% 1.42% / 7% 39.96% / 99% .23 / 25%
Canadian dollar 6C CD CME 43.0 100.3 1.37% / 50% -2.28% / 55% -2.99% / 69% .35 / 37%
Wheat ZW W CME 40.3 106.5 -5.60% / 89% 1.90% / 6% 6.96% / 43% .53 / 87%
S&P 500 index SP CME 33.3 540.0 -0.19% / 38% -0.20% / 2% -8.77% / 51% .18 / 2%
Silver 5,000 oz. SI NYMEX 32.4 53.3 -9.26% / 45% -22.87% / 76% -20.48% / 89% .27 / 12%
Heating oil HO NYMEX 32.1 40.0 4.15% / 75% -7.35% / 29% -8.01% / 17% .22 / 28%
RBOB gasoline RB NYMEX 29.9 46.4 4.60% / 100% -2.17% / 17% -4.00% / 15% .33 / 85%
E-Mini S&P MidCap 400 ME CME 23.4 103.8 -0.42% / 29% -0.55% / 6% -7.44% / 56% .25 / 22%
Crude oil e-miNY QM NYMEX 23.1 6.7 1.85% / 67% -6.80% / 28% -3.39% / 6% .24 / 52%
Mexican peso 6M MP CME 21.6 99.6 0.38% / 20% -0.63% / 62% 1.58% / 19% .13 / 5%
Soybeans ZS S CME 17.3 26.7 5.53% / 17% -3.30% / 7% -0.84% / 10% .37 / 40%
Soybean oil ZL BO CME 14.9 24.7 3.34% / 20% -6.93% / 36% -11.17% / 55% .33 / 37%
Soybean meal ZM SM CME 14.5 27.0 3.52% / 0% -2.80% / 10% 6.05% / 34% .30 / 33%
Nikkei 225 index NK CME 13.3 76.7 -3.28% / 80% -3.90% / 48% -9.81% / 69% .20 / 2%
Copper HG NYMEX 12.7 44.8 3.57% / 20% -4.79% / 39% -2.07% / 17% .42 / 45%
Coffee KC ICE 12.6 72.8 9.26% / 100% 7.67% / 67% 11.77% / 78% .87 / 100%
Fed Funds** ZQ FF CME 10.4 137.1 0.02% / 5% 0.14% / 49% 0.05% / 17% .04 / 0%
Lean hogs HE LH CME 9.6 47.3 -7.51% / 58% -10.62% / 100% -7.27% / 88% .42 / 83%
Live cattle LE LC CME 8.8 38.0 0.58% / 18% 6.03% / 70% 10.02% / 78% .32 / 40%
Cocoa CC ICE 7.9 59.9 10.22% / 100% 5.63% / 37% 5.66% / 28% .64 / 100%
Gold 100 oz. ZG CME 6.8 3.2 0.31% / 0% -8.06% / 59% -6.29% / 61% .33 / 29%
U.S. dollar index DX ICE 6.3 33.9 1.06% / 5% 5.06% / 69% 5.02% / 80% .20 / 0%
Nasdaq 100 ND CME 4.2 30.1 -2.05% / 33% 2.45% / 30% -5.89% / 61% .37 / 77%
Dow Jones Ind. Avg. ZD DJ CME 4.1 31.4 -0.22% / 0% -0.72% / 0% -7.31% / 32% .16 / 2%
Natural gas e-miNY QG NYMEX 3.9 2.5 1.80% / 100% -6.92% / 11% -30.46% / 76% .14 / 20%
Mini-sized gold YG CME 2.6 2.1 0.31% / 0% -8.06% / 59% -6.29% / 61% .33 / 28%
Russell 2000 index RL CME 1.5 32.0 -2.13% / 0% 1.88% / 36% -1.56% / 25% .50 / 50%
Feeder cattle FC CME 1.4 6.8 -2.48% / 88% -1.16% / 45% -2.24% / 56% .19 / 41%
Silver 5,000 oz. ZI CME 1.3 2.0 -9.14% / 45% -22.70% / 74% -19.92% / 90% .27 / 12%
*Average volume and open interest based on highest-volume contract (June 2009). **November 2008
Legend day moves, 20-day moves, etc.) show the percent means the current reading is larger than
Volume: 30-day average daily volume, in centile rank of the most recent move to a cer- all the past readings, while a reading of 0 per-
thousands (unless otherwise indicated). tain number of the previous moves of the cent means the current reading is smaller than
same size and in the same direction. For the previous readings. These figures provide
OI: Open interest, in thousands (unless other-
example, the rank for 10-day move shows perspective for determining how relatively
wise indicated).
how the most recent 10-day move compares large or small the most recent price move is
10-day move: The percentage price move to the past twenty 10-day moves; for the 20- compared to past price moves.
from the close 10 days ago to today’s close. day move, the rank field shows how the most Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move recent 20-day move compares to the past term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. sixty 20-day moves; for the 60-day move, the prices) divided by the long-term volatility (100-
60-day move: The percentage price move rank field shows how the most recent 60-day day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. move compares to the past one-hundred- the percentile rank of the volatility ratio over
The “rank” fields for each time window (10- twenty 60-day moves. A reading of 100 per- the past 60 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 & 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.

OPTIONS RADAR (as of Aug. 27)
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 221.6 2.29 M -0.32% / 29% -0.20% / 2% 19% / 19% 19.9% / 23.5%
Russell 2000 index RUT CBOE 97.5 966.6 -1.97% / 0% 1.96% / 24% 24.2% / 22% 24.3% / 30.8%
S&P 500 volatility index VIX CBOE 86.1 1.02 M -8.31% / 47% -6.84% / 21% 137.2% / 95.8% 66.1% / 114.1%
Nasdaq 100 index NDX CBOE 30.7 252.6 -2.15% / 50% 2.56% / 42% 22.6% / 22.6% 24.5% / 26.9%
E-Mini S&P 500 futures ES CME 30.2 133.0 -0.19% / 29% -0.21% / 0% 18.8% / 21% 20% / 25.3%
Stocks
Apple Inc. AAPL 193.7 1.02 M -2.58% / 50% 9.25% / 81% 33.7% / 34.1% 38.2% / 51.4%
Kraft Foods KFT 168.5 1.47 M -2.37% / 100% 0.22% / 4% 21.7% / 20.8% 22.5% / 23.6%
Bank of America BAC 164.6 3.10 M 2.74% / 11% -11.78% / 11% 60.4% / 71.1% 72.3% / 133.2%
Citigroup C 155.3 3.83 M 1.74% / 20% -3.67% / 3% 58.1% / 66.2% 59.5% / 106.7%
Wells Fargo WFC 124.3 1.75 M -1.30% / 31% -7.34% / 12% 52.7% / 56% 55.1% / 95.2%
Futures
Eurodollar ED-GE CME 283.5 7.83 M 0.02% / 23% -0.01% / 0% 28.7% / 9.1% 30.6% / 19%
10-year T-notes TY-ZN CBOT 56.6 562.7 1.03% / 63% 2.00% / 70% 7.2% / 4.5% 6.4% / 7.7%
Corn C-ZC CBOT 51.5 633.7 7.12% / 14% -3.99% / 16% 37.9% / 50.1% 35.8% / 45.5%
Crude oil CL NYMEX 42.3 422.2 1.85% / 67% -6.80% / 28% 47.2% / 41.3% 44.6% / 44.3%
30-yr T-bonds US-ZB CBOT 38.4 364.8 1.92% / 84% 3.49% / 84% 8.9% / 6.7% 10.1% / 9.8%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
S&P 500 volatility index VIX CBOE 86.1 1.02 M -8.31% / 47% -6.84% / 21% 137.2% / 95.8% 66.1% / 114.1%
Japanese yen index XDN PHLX 1.7 45.9 0.05% / 0% -1.25% / 34% 10.6% / 8.4% 10% / 9%
British pound index XDB PHLX 1.2 18.1 -3.01% / 45% -7.05% / 97% 10.2% / 8.5% 8.6% / 6.1%
Mini Dow YM CBOT 1.7 7.4 -2.00% / 89% 0.34% / 17% 18.8% / 16% 18.8% / 16.6%
Eurodollar index XDE PHLX 1.5 45.3 -1.24% / 5% -5.44% / 66% 10.8% / 9.3% 7.8% / 7.4%
Indices - Low IV/SV ratio

Gold/Silver index XAU PHLX 4.0 38.0 1.46% / 0% -11.91% / 53% 43.2% / 59.3% 41.7% / 50.4%
Housing index HGX PHLX 4.9 68.2 4.05% / 25% 8.29% / 29% 45.3% / 57.1% 51.3% / 75.3%
Banking index BKX PHLX 4.4 99.4 0.00% / 0% -5.89% / 13% 52.5% / 61.9% 58.2% / 99.6%
Morgan Stanley Retail index MVR CBOE 4.8 67.1 1.63% / 24% 7.59% / 52% 37.9% / 42.5% 41.4% / 54.1%
E-mini S&P 500 futures ES CME 30.2 133.0 -0.19% / 29% -0.21% / 0% 18.8% / 21% 20% / 25.3%
Stocks - High IV/SV ratio

Anheuser Busch BUD 42.5 737.9 -0.19% / 0% 0.15% / 2% 17.1% / 4.2% 15.3% / 11.3%
Dendreon DNDN 26.2 1.59 M -1.04% / 67% 0.70% / 3% 168.3% / 52.8% 143.8% / 69.5%
Huntsman HUN 23.4 522.5 -7.68% / 100% -3.96% / 6% 105.2% / 42.7% 101.3% / 76.8%
Tivo Inc. TIVO 1.8 49.6 3.38% / 75% 3.65% / 20% 80.6% / 38.8% 71.1% / 59.1%
E-Trade Financial ETFC 6.3 298.7 -1.64% / 20% -0.33% / 0% 80.2% / 41.6% 92.4% / 159.1%
Stocks - Low IV/SV ratio

Ambac Financial ABK 29.8 351.3 32.99% / 32% 124.89% / 58% 116.8% / 253.8% 146% / 270.5%
Fording Canadian Coal FDG 4.1 93.7 2.96% / 25% 2.34% / 7% 15.4% / 25.4% 26.8% / 87.4%
Radian Group RDN 1.5 27.4 -2.17% / 100% 73.08% / 44% 157.8% / 254.7% 197.2% / 391.2%
Teck Cominco Ltd. TCK 2.5 40.8 3.60% / 20% -14.58% / 80% 48% / 76.9% 51.4% / 57.3%
Goodrich Petroleum GDP 1.7 33.2 8.00% / 42% 12.62% / 14% 82.8% / 131.6% 93.3% / 131.5%
Futures - High IV/SV ratio

Eurodollar ED-GE CME 283.5 7.83 M 0.02% / 23% -0.01% / 0% 28.7% / 9.1% 30.6% / 19%
5-year T-notes FV-ZF CBOT 27.6 229.2 0.87% / 42% 1.74% / 75% 5.6% / 3.4% 6.2% / 5.7%
10-year T-notes TY-ZN CBOT 56.6 562.7 1.03% / 63% 2.00% / 70% 7.2% / 4.5% 6.4% / 7.7%
Australian dollar AD-6A CME 1.3 6.9 -2.01% / 5% -8.76% / 73% 14.6% / 9.7% 9.2% / 7.5%
Japanese yen JY-6J CME 2.3 63.5 -0.19% / 0% -1.53% / 33% 10.2% / 6.8% 9.7% / 6.6%
Futures - Low IV/SV ratio

Silver 5,000 oz. SI NYMEX 5.8 41.8 -9.26% / 45% -22.87% / 76% 39.3% / 66.7% 31.8% / 39.3%
Sugar SB NYBOT 16.8 516.1 -1.88% / 20% 1.42% / 7% 40.6% / 58.9% 39.6% / 50.6%
Gold 100 oz. GC NYMEX 4.9 59.9 0.30% / 0% -8.06% / 62% 25.7% / 34.3% 23.4% / 26.1%
Corn C-ZC CBOT 51.5 633.7 7.12% / 14% -3.99% / 16% 37.9% / 50.1% 35.8% / 45.5%
Wheat W-ZW CBOT 7.7 86.6 -5.60% / 89% 1.90% / 6% 43.2% / 56.8% 38% / 35.4%
* Ranked by volume ** Ranked based on high or low IV/SV values.
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-
day moves) 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 most recent 20-day move compares to the past sixty 20-day moves.

FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
COT extremes The largest positive readings represent markets in which net commercial
positions (longs - shorts) exceed net fund holdings in August. By contrast,
The Commitment of Traders (COT) report is published each
the largest negative values represent markets in which net fund holdings
week by the Commodity Futures Trading Commission
surpass net commercial positions.
(CFTC). The report divides the open positions in futures
markets into three categories: commercials, non-commer-
cials, and non-reportable.
Commercial traders, or hedgers, tend to operate in the
cash market (e.g., grain merchants and oil companies, that
either produce or consume the underlying commodity).
Non-commercial traders are large speculators (“large
specs”) such as commodity trading advisors and hedge
funds — professional money managers who do not deal in
the underlying cash 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.
For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
Figure 1 shows the relationship between commercials
and large speculators on Aug. 19. Positive values mean net
Legend: Figure 1 shows the difference between net commer-
commercial positions (longs - shorts) are larger than net speculator holdings, cial and net large spec positions (longs - shorts) for all 45 futures
based on their five-year historical relationship. Negative values mean large spec- markets, in descending order. It is calculated by subtracting the
ulators have bigger positions than the commercials. current net large spec position from the net commercial position
In U.S. dollar index futures (DX), the difference between commercials and large and then comparing this value to its five-year range. The formu-
la is:
speculators is near a five-year low, a bearish relationship. However, in British
a1 = (net commercial 5-year high - net commercial current)
pound futures (BP), this relationship is near a five-year high, a bullish sign. These b1 = (net commercial 5-year high - net commercial 5-year low)
extremes don’t act as stand-alone trade signals, but they sometimes precede major
c1 = ((b1 - a1)/ b1 ) * 100
price reversals.
Last month, for example, gold futures (GC) generated a bearish signal on July a2 = (net large spec 5-year high - net large spec current)
b2 = (net large spec 5-year high - net large spec 5-year low)
22, and gold fell 18.4 percent by Aug. 15. Also, lumber futures triggered a bullish
c2 = ((b2 - a2)/ b2 ) * 100
signal on the same date, and lumber rallied 9 percent during the same period.
– Compiled by Floyd Upperman x = (c1 - c2)
Options Watch: Health Care ETF components (as of Aug. 25) Compiled by Tristan Yates
The following table summarizes the expiration months available for the top components of the health care exchange-traded fund (XLV). It also shows
each index's average bid-ask spread for at-the-money (ATM) August 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 Bid-ask spreads

Bid-ask
spread as %
Sept.
Aug.
Dec.
Nov.
Feb.
Jan.
Mar.
Jan.
Oct.
Closing of underlying
Stock Symbol Exchange price Call Put price
Pfizer PFE NA X X X X X X 19.51 0.02 0.02 0.09%
Bristol Meyers Squibb BMY NA X X X X X X 21.98 0.02 0.03 0.10%
Amgen AMGN NA X X X X X 63.96 0.07 0.09 0.12%
Johnson and Johnson JNJ NA X X X X X 70.80 0.10 0.09 0.13%
Abbott Laboratories ABT NA X X X X X X 57.76 0.11 0.09 0.17%
Genzyme GENZ NA X X X X 78.20 0.14 0.16 0.19%
Gilead Sciences GILD NA X X X X X X 53.21 0.10 0.11 0.20%
Baxter International BAX NA X X X X X X 68.15 0.14 0.14 0.20%
Medtronic MDT NA X X X X X X 55.43 0.13 0.10 0.20%
Eli Lilly LLY NA X X X X X 47.52 0.10 0.13 0.24%
Celgene CELG NA X X X X X 71.45 0.21 0.14 0.24%
WellPoint WLP NA X X X X X X 52.56 0.13 0.14 0.25%
Merck MRK NA X X X X X 35.00 0.09 0.09 0.25%
MedcoHealth Solutions MHS NA X X X X X 47.37 0.13 0.11 0.25%
Unitedhealth Group UNH NA X X X X X X 29.31 0.10 0.08 0.30%
Wyeth WYE NA X X X X X 42.25 0.11 0.15 0.31%
Covidien COV NA X X X X X 54.03 0.16 0.19 0.32%
Becton Dickinson BDX NA X X X X 87.53 0.18 0.58 0.43%
Schering-Plough SGP NA X X X X X X 19.40 0.09 0.10 0.48%
Thermo Fisher Scientific TMO NA X X X X X 60.01 0.33 0.33 0.54%
Healthcare Select SPDR XLV NA X X X X X X 32.77 0.14 0.24 0.57%
As of Aug. 25
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.
INDUSTRY NEWS
Moving forward
CME shareholders approve NYMEX acquisition
T he CME Group’s long-contested bid to acquire the

New York Mercantile Exchange (NYMEX) was
approved by shareholders on Aug. 18. The acqui-
sition completed on Aug. 22.
The merger will create a nearly all-encompassing futures
The integration, including integration of the NYMEX and
COMEX (the metals division of the NYMEX) trading floors,
is expected to complete by the third quarter of 2009. The
plan proposes to save $60 million through expected “cost
synergies.” Although there haven’t been any concrete num-
exchange, trading everything from stock indices, interest bers so far regarding exchange staffing, 380 people initially
rates, and currencies to energy, metals, and agricultural lost their jobs when the CME bought the CBOT last year.
commodities. In the first half of 2008, the two exchanges NYMEX members, however, did secure a pledge from the
averaged a combined 14.2 million contracts per day with CME Group to keep the NYMEX’s Manhattan trading floor
total revenue of 2.7 billion in 2007. open until at least 2012. Afterward, the CME Group claims
Through the merger agreement NYMEX shareholders they will “maintain a trading floor in the New York City
will receive cash, stock, or a combination of the two. metropolitan area as long as profitability and revenue
NYMEX stock (NMX), which was valued at $81.16 for the thresholds are met,” according to a customer Q&A sheet
deal, had traded as low as $64.34 in July, 48.3 percent lower released by the group.
than in July 2007.
Burying the hatchet

CBOE, CBOT reach settlement
FIGURE 1 — CME GROUP
I n August, members of the Chicago Board Options Exchange stocks have fared poorly in 2008. CME Group
Exchange (CBOE) and the Chicago Board of Trade, shares have fallen steadily throughout the year.
now part of the CME Group (CME), reached an agree-
ment over their two-year-old exercise rights issue. The
CBOT launched the CBOE in 1973, and through the years
some CBOT members have retained CBOE trading rights
— a benefit the CBOE in recent years (as it pursued the path
to demutualization and becoming a publicly traded com-
pany) has claimed is no longer valid.
After attempts to work out an agreement failed, the
CBOT sued the CBOE, claiming their trading rights repre-
sented ownership in the latter exchange. When the CME
bought the CBOT, however, the CBOE considered the claim
null and void. In January the SEC weighed in on the issue
and sided with the CBOE.
With the case still pending in the Delaware court system,
the two exchanges reached their agreement. A shareholder
vote to approve the agreement will be held on Sept. 17. The
new settlement awards former CBOT members who
claimed CBOE trading rights and who hold more than
10,251 shares in the CME Group an 18-percent stake in the
total common stock to be issued by the CBOE when it goes
public. This group will also share a $300 million cash pool
with a second set of former CBOT members who have Source: eSignal
CBOE trading rights but own fewer shares than those in the
first group. this year, however, exchange stocks haven’t fared well.
A CBOE membership traded at a record $3.3 million in From the beginning of 2008 through July 15, CME stock fell
June amid signs of a pending agreement. In July, the CBOE more than 50 percent (Figure 1), and had recovered little as
conducted 34.4 percent of all options volume in the U.S., of early September. The IntercontinentalExchange (ICE) fell
averaging 5.7 million contracts per day. 48 percent on the year through July, and NYSE Euronext,
The settlement now opens the way for the CBOE to offer thought to be a potential suitor for the CBOE, fell 46 per-
stock or pursue some form of acquisition or merger. So far cent.

There’s gold in them thar options
GLD options take off FIGURE 1 — SPDR GOLD TRUST

Options on the SPDR Gold Trust (GLD) rivaled
the volume of some of the CBOE’s key instru-
O nly two months after being released, the CBOE’s options

on SPDR Gold Shares (GLD) have established themselves
as a top trader. On Aug. 5, volume totaled 188,841 con-
tracts, or 3.7 percent of all contracts traded on the exchange that day.
By comparison, options on the CBOE’s Volatility Index (VIX) traded
ments after only two months. The ETF has fall-
en since hitting an all-time high in March.
99,138 contracts, while SPDR options (SPY) traded 243,700 contracts.

GLD options track the SPDR Gold Trust, which began trading on
the New York Stock Exchange in November 2004. Unlike other sim-
ilar exchange traded funds (ETFs), the GLD holds actual gold bullion
as opposed to securities. This has led to confusion over who has
jurisdiction rights over these instruments. Funds such as this one,
and issues surrounding instruments such as Credit Default Swaps,
prompted an agreement in March between the SEC and the
Commodity Futures Trading Commission (CFTC) to enhance their
cooperation and transparency. Previously, the agencies had entered
into a Memorandum of Understanding to deal with the oversight of
securities futures products. Following the agreement, the agencies
began the approval process for offering options and futures based on
the GLD fund.
GLD steadily gained 89 percent from 2005 through 2007. In 2008
the fund hit an all-time high of 100.44 on March 17, but fell 22.7 per-
cent to a nine-month low of 77.63 on Aug. 15 (Figure 1). Source: eSignal
MANAGED MONEY
Top 10 option strategy traders ranked by July 2008 return.

(Managing at least $1 million as of July 31, 2008.)
July YTD $ under

Rank Trading advisor return return mgmt.
1. Welton Investment (Alpha Leveraged) 10.05 25.19 4.0M
2. CKP Finance Associates (LOMAX) 9.51 29.89 6.2M
3. Aksel Capital Mgmt (Growth & Income) 9.02 109.00 11.6M
4. Golden West 6.01 13.64 1.5M
5. UNISystems Research (5D Option) 5.75 28.84 1.1M
6. Eickelberg & Associates (Option) 5.55 1.03 2.0M
7. Kingdom Trading (Short Option) 5.49 24.12 1.2M
8. Parrot Trading Partners 5.18 38.39 23.6M
9. Kawaller Fund 5.03 24.74 1.6M
10. Welton Investment (Alpha) 4.91 12.32 4.0M
Source: Barclay Hedge (http://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.

KEY CONCEPTS
The option “Greeks”
American style: An option that can be exercised at any
Delta: The ratio of the movement in the option price for
time until expiration.
every point move in the underlying. An option with a
delta of 0.5 would move a half-point for every 1-point
Assign(ment): When an option seller (or “writer”) is move in the underlying stock; an option with a delta of
obligated to assume a long position (if he or she sold a put) 1.00 would move 1 point for every 1-point move in the
or short position (if he or she sold a call) in the underlying underlying stock.
stock or futures contract because an option buyer exercised
the same option. Gamma: The change in delta relative to a change in the
underlying market. Unlike delta, which is highest for
At the money (ATM): An option whose strike price is deep ITM options, gamma is highest for ATM options
and lowest for deep ITM and OTM options.
identical (or very close) to the current underlying stock (or
futures) price. Rho: The change in option price relative to the change
in the interest rate.
Bear call spread: A vertical credit spread that consists
of a short call and a higher-strike, further OTM long call in Theta: The rate at which an option loses value each day
the same expiration month. The spread’s largest potential (the rate of time decay). Theta is relatively larger for
gain is the premium collected, and its maximum loss is lim- OTM than ITM options, and increases as the option gets
ited to the point difference between the strikes minus that closer to its expiration date.
premium.
Vega: How much an option’s price changes per a one-
percent change in volatility.
Bear flag: Flags are short-term consolidation patterns.
They are sometimes referred to as “continuation patterns”
because they are often pauses in price trends and imply the spread that contains puts with the same expiration date, but
continuation of those trends. Flags are essentially short- different strike prices. You sell an OTM put and buy a less-
term trading ranges that last approximately three to 15 bars expensive, lower-strike put.
(roughly one to three weeks on a daily chart), although
some people argue flags should consist of no more than 10 Calendar spread: A position with one short-term short
price bars. option and one long same-strike option with more time
A bear flag pattern represents a time when the market is until expiration. If the spread uses ATM options, it is mar-
taking a “breather” — pausing before resuming a down- ket-neutral and tries to profit from time decay. However,
trending move. OTM options can be used to profit from both a directional
move and time decay.
Bear put spread: A bear debit spread that contains puts
with the same expiration date but different strike prices. Call option: An option that gives the owner the right, but
You buy the higher-strike put, which costs more, and sell not the obligation, to buy a stock (or futures contract) at a
the cheaper, lower-strike put. fixed price.
Beta: Measures the volatility of an investment compared Carrying costs: The costs associated with holding an
to the overall market. Instruments with a beta of one move investment that include interest, dividends, the opportuni-
in line with the market. A beta value below one means the ty costs of entering the trade, and, in the case of physical
instrument is less affected by market moves and a beta commodities, storage.
value greater than one means it is more volatile than the
overall market. A beta of zero implies no market risk. Collar: An options spread with three components — an
underlying long position, a short call, and a long put that
Box spread: A hedged position in which the profit is expires in the same month. It is a conservative, flexible strat-
determined in advance. A box contains one long call and egy that profits if the underlying trades within a certain
one short put that share the same strike. Also, the spread range by expiration. The strategy’s goal is to improve a long
contains one short call and one long put that share a higher position’s odds of success by adding low-cost downside
strike price. All four options expire at the same time. protection without limiting potential upside profits exces-
sively.
Bull call spread: A bull debit spread that contains calls
with the same expiration date but different strike prices. The Commitments of Traders report: Published
You buy the lower-strike call, which has more value, and weekly by the Commodity Futures Trading Commission
sell the less-expensive, higher-strike call. (CFTC), the Commitments of Traders (COT) report breaks
down the open interest in major futures markets. Clearing
Bull put spread (put credit spread): A bull credit members, futures commission merchants, and foreign bro-

kers are required to report daily the futures and options that are very far above the current price of the underlying
positions of their customers that are above specific report- asset and put options with strike prices that are very far
ing levels set by the CFTC. below the current price of the underlying asset.
For each futures contract, report data is divided into three
“reporting” categories: commercial, non-commercial, and Delivery period (delivery dates): The specific time
non-reportable positions. The first two groups are those period during which a delivery can occur for a futures con-
who hold positions above specific reporting levels. tract. These dates vary from market to market and are deter-
The “commercials” are often referred to as the large mined by the exchange. They typically fall during the
hedgers. Commercial hedgers are typically those who actu- month designated by a specific contract - e.g. the delivery
ally deal in the cash market (e.g., grain merchants and oil period for March T-notes will be a specific period in March.
companies, who either produce or consume the underlying
commodity) and can have access to supply and demand Delta-neutral: An options position that has an overall
information other market players do not. delta of zero, which means it’s unaffected by underlying
Non-commercial large traders include large speculators price movement. However, delta will change as the under-
(“large specs”) such as commodity trading advisors (CTAs) lying moves up or down, so you must buy or sell
and hedge funds. This group consists mostly of institution- shares/contracts to adjust delta back to zero.
al and quasi-institutional money managers who do not deal
in the underlying cash markets, but speculate in futures on Diagonal spread: A position consisting of options with
a large-scale basis for their clients. different expiration dates and different strike prices — e.g.,
The final COT category is called the non-reportable posi- a December 50 call and a January 60 call.
tion category — otherwise known as small traders — i.e.,
the general public. European style: An option that can only be exercised at
expiration, not before.
Covered call: Shorting an out-of-the-money call option
against a long position in the underlying market. An exam- Exercise: To exchange an option for the underlying
ple would be purchasing a stock for $50 and selling a call instrument.
option with a strike price of $55. The goal continued on p. 38
is for the market to move sideways or
slightly higher and for the call option to
expire worthless, in which case you keep
the premium.
Credit spread: A position that collects

more premium from short options than
you pay for long options. A credit spread
using calls is bearish, while a credit spread
using puts is bullish.
Debit: A cost you must pay to enter any

position if the components you buy are
more expensive than the ones you sell. For
instance, you must pay a debit to buy any
option, and a spread (long one option,
short another) requires a debit if the pre-
mium you collect from the short option
doesn’t offset the long option’s cost.
Debit spread: An options spread that

costs money to enter, because the long side
is more expensive that the short side.
These spreads can be verticals, calendars,
or diagonals.
Deep (e.g., deep in-the-money

option or deep out-of-the-money
option): Call options with strike prices

KEY CONCEPTS continued
In the money (ITM): A call option with a strike price

Expiration: The last day on which an option can be exer- below the price of the underlying instrument, or a put
cised and exchanged for the underlying instrument (usual- option with a strike price above the underlying instru-
ly the last trading day or one day after). ment’s price.
Float: The number of tradable shares in a public company. Intrinsic value: The difference between the strike price
of an in-the-money option and the underlying asset price. A
Ichimoku analysis: The Ichimoku Kinko Hyo charting call option with a strike price of 22 has 2 points of intrinsic
technique was reportedly developed by Goichi Hosoda, a value if the underlying market is trading at 24.
Japanese newspaper writer, prior to World War II, although
he did not publish the method until 1968. The phrase loose- Leverage: An amount of “buying power” that increases
ly translates to “one-glance balance chart” or “equilibrium exposure to underlying market moves. For example, if you
chart at-a-glance technique.” Most traders refer to the buy 100 shares of stock, that investment will gain or lose
method simply as “Ichimoku.” $100 for each $1 (one-point) move in the stock.
The technique combines trend-following tools similar to But if you invest half as much and borrow the other half
moving averages with other calculations that define sup- from your broker as margin, then you control those 100
posed support and resistance areas. (See Table 1.) shares with half as much capital (i.e., 2-to-1 buying power).
First, chart the shorter-term tenkan sen, which is the “sig- At that point, if the stock moves $1, you will gain or lose
nal line,” and then the kijun sen, which is the longer-term $100 even though you only invested $50 — a double-edged
“base line.” Basically, the tenkan sen represents a short- sword.
term moving average, the kijun sen represents an interme-
diate-term moving average, and the kumo functions as a Limit up (down): The maximum amount that a futures
longer-term moving average, or support- resistance zone. contract is allowed to move up (down) in one trading ses-
The chikou span basically provides a convenient way to sion.
contrast today’s closing price to the closing price 26 bars
ago by comparing the end point of the chikou span to the Lock-limit: The maximum amount that a futures contract
close of the bar directly above or below it The senkou lines is allowed to move (up or down) in one trading session.
are the longer-term support-resistance pieces of the
Ichimoku puzzle. Long call condor: A market-neutral position structured
with calls only. It combines a bear call spread (short call,
Intermonth (futures) spread: A trade consisting of long higher-strike further OTM call) above the market and
long and short positions in different contract months in the a bull call spread (long call, short higher-strike call). Unlike
same market — e.g., July and November soybeans or an iron condor, which contains two credit spreads, a call
September and December crude oil. Also referred to as a condor includes two types of spreads: debit and credit.
futures “calendar spread.”
TABLE 1 — THE ICHIMOKU KINKO HYO CHARTING TECHNIQUE
Line name Calculation Comparable to: MetaStock formula

Tenkan sen (Highest high of past 9 bars A short-term moving average. (HHV(H,9) +
(signal line) + lowest low of past 9 bars) / 2 LLV(L,9))/2
Kijun sen (Highest high of past 26 bars + A medium-term moving average. (HHV(H,26) +
(base line) lowest low of past 26 bars) / 2 LLV(L,26))/2
Chikou span Today’s closing price plotted
(lagging span) 26 bars back
Senkou (Tenkan sen + kijun sen) / 2, Forward-adjusted moving average. Ref((( Fml( “Ichi Signal
span A offset 26 bars ahead Upper boundary of support area, Line”)+ Fml( “Ichi Trend
lower boundaryof resistance area Line”))/2),-26)
(cloud, or kumo).
Senkou (Highest high of past 52 bars Forward-adjusted moving average. Ref(((HHV(H,52) +
span B + lowest low of past 52 bars) / 2, Lower boundary of support area, LLV(L,52))/2),-26)
offset 26 bars ahead upper boundary of resistance
(cloud, or kumo).

Long-Term Equity AnticiPation Securities
(LEAPS): Options contracts with much more distant expi- Outlier: An anomalous data point or reading that is not
ration dates — in some cases as far as two years and eight representative of the majority of a data set.
months away — than regular options.
Out of the money (OTM): A call option with a strike
Market makers: Independent traders who attempt to price above the price of the underlying instrument, or a put
profit by trading their own accounts. They supply bids option with a strike price below the underlying instru-
when there may be no other buyers and supply offers when ment’s price.
there are no other sellers. In return, they have an edge in
buying and selling at more favorable prices. Parity: An option trading at its intrinsic value.
Moving average convergence-divergence (MACD): Physical delivery: The process of exchanging a physical
Although it is often grouped with oscillators, the MACD is commodity (and making and taking payment) as a result of
more of an intermediate-term trend indicator (although it the execution of a futures contract. Although 98 percent of
can reflect overbought and oversold conditions). all futures contracts are not delivered, there are market par-
The default MACD line (which can also be plotted as a ticipants who do take delivery of physically settled con-
histogram) is created by subtracting a 26-period exponen- tracts such as wheat, crude oil, and T-notes. Commodities
tial moving average (EMA) of closing prices from a 12-peri- generally are delivered to a designated warehouse; T-note
od EMA of closing prices; a nine-period EMA is then delivery is taken by a book-entry transfer of ownership,
applied to the MACD line to create a “signal line.” although no certificates change hands.
MACD = EMA(C,12)-EMA(C,26)
Signal line = EMA(MACD,9) Premium: The price of an option.
Naked option: A position that involves selling an unpro- Put option: An option that gives the owner the right, but
tected call or put that has a large or unlimited amount of continued on p. 40
risk. If you sell a call, for example, you are
obligated to sell the underlying instrument
at the call’s strike price, which might be
below the market’s value, triggering a loss.
If you sell a put, for example, you are obli-
gated to buy the underlying instrument at
the put’s strike price, which may be well
above the market, also causing a loss.
Given its risk, selling naked options is
only for advanced options traders, and
newer traders aren’t usually allowed by
their brokers to trade such strategies.
Naked (uncovered) puts: Selling put

options to collect premium that contains
risk. If the market drops below the short
put’s strike price, the holder may exercise
it, requiring you to buy stock at the strike
price (i.e., above the market).
Near the money: An option whose

strike price is close to the underlying mar-
ket’s price.
Open interest: The number of options

that have not been exercised in a specific
contract that has not yet expired.
Opportunity cost: The value of any

other investment you might have made if
your capital wasn’t already in the market.

KEY CONCEPTS continued
not the obligation, to sell a stock (or futures contract) at a “naked” options, which add upside or downside risk.
fixed price.
Rollover: The process of maintaining an open futures
Put ratio backspread: A bearish ratio spread that con- position beyond the expiration of the current contract
tains more long puts than short ones. The short strikes are month and into the next contract month. A position is
closer to the money and the long strikes are further from the “rolled forward” (or “rolled over”) by liquidating the posi-
money. tion in the current contract and simultaneously re-establish-
For example, if a stock trades at $50, you could sell one ing it in the new contract. For example, if you were long the
$45 put and buy two $40 puts in the same expiration month. September E-Mini S&P 500 futures and wanted to remain
If the stock drops, the short $45 put might move into the long past the expiration of the September contract, you
money, but the long lower-strike puts will hedge some (or would simultaneously sell the September contract and buy
all) of those losses. If the stock drops well below $40, poten- the December contract.
tial gains are unlimited until it reaches zero.
Simple moving average: A simple moving average
Put spreads: Vertical spreads with puts sharing the same (SMA) is the average price of a stock, future, or other mar-
expiration date but different strike prices. A bull put spread ket over a certain time period. A five-day SMA is the sum of
contains short, higher-strike puts and long, lower-strike the five most recent closing prices divided by five, which
puts. A bear put spread is structured differently: Its long means each day’s price is equally weighted in the calcula-
puts have higher strikes than the short puts. tion.
Ratio spread: A ratio spread can contain calls or puts and Strike (“exercise”) price: The price at which an under-
includes a long option and multiple short options of the lying instrument is exchanged upon exercise of an option.
same type that are further out-of-the-money, usually in a
ratio of 1:2 or 1:3 (long to short options). For example, if a Support and resistance: Support is a price level that
stock trades at $60, you could buy one $60 call and sell two acts as a “floor,” preventing prices from dropping below
same-month $65 calls. Basically, the trade is a bull call that level. Resistance is the opposite: a price level that acts
spread (long call, short higher-strike call) with the sale of as a “ceiling;” a barrier that prevents prices from rising
additional calls at the short strike. higher.
Overall, these positions are neutral, but they can have a Support and resistance levels are a natural outgrowth of
directional bias, depending on the strike prices you select. the interaction of supply and demand in any market. For
Because you sell more options than you buy, the short example, increased demand for a stock will cause its price
options usually cover the cost of the long one or provide a to rise, creating an uptrend. But when price has risen to a
net credit. However, the spread contains uncovered, or certain level, traders and investors will take profits and
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Location: Mandalay Bay Resort & Casino, Las Vegas Date: Nov. 19-22
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Dates: Oct. 23, Dec. 4
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short sellers will come into the market, creating “resistance” but different strike prices (e.g., a September 40 call option
to further price increases. Price may retreat from and and a September 50 call option).
advance to this resistance level many times, sometimes
eventually breaking through it and continuing the previous Volatility: The level of price movement in a market.
trend, other times reversing completely. Historical (“statistical”) volatility measures the price fluctu-
Support and resistance should be thought of more as gen- ations (usually calculated as the standard deviation of clos-
eral price levels rather than precise prices. For example, if a ing prices) over a certain time period — e.g., the past 20
stock makes a low of 52.15, rallies slightly, then declines days. Implied volatility is the current market estimate of
again to 52.15, then rallies again, a subsequent move down future volatility as reflected in the level of option premi-
to 52 does not violate the “support level” of 52.15. In this ums. The higher the implied volatility, the higher the option
case, the fact that the stock retraced once to the exact price premium.
level it had established before is more of a coincidence than
anything else. Volatility skew (“smile”): The tendency of implied
option volatility to vary by strike price. Although, it might
Time decay: The tendency of time value to decrease at an seem logical that all options on the same underlying instru-
accelerated rate as an option approaches expiration. ment with the same expiration would have identical (or
nearly identical) implied volatilities. For example, deeper
Time spread: Any type of spread that contains short in-the-money and out-of-the-money options often have
near-term options and long options that expire later. Both higher volatilities than at-the-money options. This type of
options can share a strike price (calendar spread) or have skew is often referred to as the “volatility smile” because a
different strikes (diagonal spread). chart of these implied volatilities would resemble a line
curving upward at both ends. Volatility skews can take
Time value (premium): The amount of an option’s other forms than the volatility smile, though.
value that is a function of the time remain-
ing until expiration. As expiration
approaches, time value decreases at an
accelerated rate, a phenomenon known as
“time decay.”
TRIX indicator: A percent rate-of-

change indicator of a triple smoothed expo-
nential moving average (EMA). The TRIX is
a momentum indicator that can identify
trend changes. The calculation is as follows:
1. Take an n-period exponential moving

average of price.
2. Take an n-period EMA of the value from
#1.
3. Take an n-period EMA of the value from
#2.
Positive values typically indicate an

uptrend, while negative values indicate a
downtrend. Traders also calculate a signal
line of the TRIX by taking a shorter-term
simple moving average of it. When its sig-
nal line crosses above the TRIX, market
conditions are bullish, and when the signal
line crosses below the TRIX, market condi-
tions are bearish.
Vertical spread: A position consisting

of options with the same expiration date

FUTURES & OPTIONS CALENDAR SEPTEMBER/OCTOBER
MONTH
September
Legend 1 FDD: September crude oil and natural equity options
gas futures (NYMEX); September sugar U.S.: Cattle on Feed report
CPI: Consumer price index futures (ICE)
ECI: Employment cost index
20
2 FDD: September copper, gold, silver,
FDD (first delivery day): palladium, and platinum futures
21
The first day on which deliv-
ery of a commodity in fulfill-
(NYMEX); September corn, rough rice, 22 LTD: October crude oil futures
oats, soybeans, soybean products, (NYMEX)
ment of a futures contract
T-bonds, silver, and gold futures (CME);
can take place.
September wheat futures (KCBT);
23
FND (first notice day): Also
known as first intent day, this
September wheat futures (MGEX) 24 FND: October cotton futures (ICE)
FND: September OJ futures (ICE) U.S.: Petroleum status report
is the first day a clearing-
house can give notice to a 3 FND: September gasoline and heating 25 LTD: September feeder cattle futures
buyer of a futures contract oil futures (NYMEX) (CME); September feeder cattle options
that it intends to deliver a (CME); October gold, silver, copper,
commodity in fulfillment of a 4 U.S.: EIA natural gas storage report
gasoline, heating oil, and natural gas
futures contract. The clear- 5 LTD: September live cattle options options (NYMEX)
inghouse also informs the (CME); October cocoa options (ICE)
seller. 26 LTD: September copper, gold, silver,
FOMC: Federal Open
6 palladium, platinum, and October
natural gas futures (NYMEX);
Market Committee 7
September gold and silver futures
GDP: Gross domestic
product
8 (CME); October wheat futures (KCBT);
October corn, rice, soybeans, soybean
ISM: Institute for supply 9 FDD: September gasoline and heating
products, wheat, and T-note options
management oil futures (NYMEX); September OJ
(CME); October wheat options (MGEX);
LTD (last trading day): The futures (ICE)
October wheat options (KCBT)
first day a contract may 10 LTD: September OJ futures (ICE) U.S.: EIA natural gas storage report;
trade or be closed out before U.S.: Petroleum status report hogs and pigs report
the delivery of the underlying
asset may occur. 11 U.S.: EIA natural gas storage report 27
PPI: Producer price index 12 LTD: September corn, oats, rough rice, 28
Quadruple witching Friday: soybeans, soybean products, and
A day where equity options, wheat futures (CME); September wheat
29 FND: October natural gas futures
equity futures, index options, (NYMEX)
futures (KCBT); September wheat
and index futures all expire. futures (MGEX); October coffee, cotton, 30 FND: October copper, gold, silver,
and sugar options (ICE) palladium, and platinum futures
U.S.: Crop production (NYMEX); October gold, silver, and
SEPTEMBER 2008 soybean products futures (CME);
31 1 2 3 4 5 6
13 October wheat futures (KCBT); October
7 8 9 10 11 12 13 14 wheat futures (MGEX)
LTD: September T-bond futures (CME);
14 15 16 17 18 19 20 15 LTD: September lumber futures (CME),
October gasoline and heating oil futures
21 22 23 24 25 26 27 September cocoa futures (ICE)
(NYMEX); October sugar futures (ICE);
28 29 30 1 2 3 4 16 FDD: September lumber futures (CME) October lumber options (CME)
FND: September lumber futures (CME)
October
OCTOBER 2008 17 LTD: October crude oil and platinum
1 FDD: October crude oil, gasoline,
28 29 30 1 2 3 4
options (NYMEX)
natural gas, palladium, platinum, cotton,
U.S.: Petroleum status report
5 6 7 8 9 10 11 gold, and silver futures (NYMEX);
12 13 14 15 16 17 18 18 LTD: September coffee futures (ICE), October gold, silver, and soybean
September index futures (CME), products (CME)
19 20 21 22 23 24 25
September equity options FND: October sugar futures (ICE)
26 27 28 29 30 31 1 U.S.: EIA Natural gas storage report U.S.: Petroleum status report
19 LTD: September index and T-bond 2 FND: October gasoline and heating oil
The information on this page is futures (NYMEX)
subject to change. Futures &
options (CBOE); September T-bonds
Options Trader is not responsible and E-mini index futures (CME); U.S.: EIA natural gas storage report
for the accuracy of calendar dates October OJ options (ICE); September
beyond press time. 3 LTD: October live cattle options (CME);
single stock futures (OC); September
November cocoa (ICE)
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FUTURES TRADE JOURNAL
Late to the party, but no harm done.
TRADE
Date: Thursday, Aug. 21, 2008.
Entry: Long December mini gold futures

(YGZ08) at $837.20, and short at $839.50.
Reasons for trade/setup (long trade):

Initial research conducted the day before the
trade had indicated that gold was ready for
a bounce after selling off from nearly $1,000
on July 15 to below $800 on Aug. 15. We did-
n’t expect the move to be so sudden and so
dramatic, however. Before we had a chance
to complete testing, the market (along with Source: TradeStation
virtually every other physical commodity)
was up big. original trade idea. The market failed to show much upside
The December gold contract hit $844.70 in the morning momentum after the long entry, even though it did move
but sold off steadily until a sharp down move brought it as higher overall. With other commodities (led by crude oil)
low as $836.40. Although we believed we had missed the flagging, it appeared the day might be setting up to be a
trade opportunity the analysis had indicated, we thought spike with a weak close. Given our longer-term bias was
the market had at least one more push in it as it had not yet bearish, anyway, we took profits early (at 838.40) and then
tested the day’s high. We entered as price stabilized after shorted at $839.50 (with a stop at $841.60).
the initial pullback to $836.40. The turnabout appeared to be the right move, as the mar-
This is intended only as a very short-term trade, as we ket soon pushed back below $837 again. We expected a
believe the market is, in the long term, headed lower. We down move, though, and didn’t take any profits. When the
will carry only part of the position overnight, and then only market crept higher again, we lowered the stop to just
if the market remains above the initial target price. below breakeven, and got taken out of the market shortly
thereafter.
Initial stop: $835.60. The chart shows the rest of the day was a somewhat
choppy trading range, so there were no big moves to cap-
Initial target: $844, a little below the intraday high. ture either way.
Although the trading was essentially fruitless, tight trade
management minimized risk and prevented either position
RESULT from losing money. (Gold did, however, move sharply
lower the next day, reaching $821.60.)
Exit: $838.40 (first trade); $839.30 (second trade).
Note: Initial targets for trades are typically based on things such as the
Profit/loss: +1.20 (first trade); +0.20 (second trade). historical performance of a price pattern or trading system signal.
However, individual trades are a function of immediate market behav-
ior; initial price targets are flexible and are most often used as points at
Trade executed according to plan? No. which a portion of the trade is liquidated to reduce the position’s open
risk. As a result, the initial (pre-trade) reward-risk ratios are conjec-
Outcome: These trades represented a reassessment of the tural by nature.
TRADE SUMMARY
Initial Initial
Date Contract Entry stop target IRR Exit Date P/L LOP LOL Length
8/21/08 YGZ08 837.20 835.60 844 4.25 838.40 8/21/08 1.20 (.14%) 3.00 -0.20 23 min.
839.50 841.60 827 5.95 839.30 .20 2.90 -1.40 30 min.
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

OPTIONS TRADE JOURNAL
A bullish trade turns profitable after a shaky start, but a clumsy exit leaves money on the table.
TRADE time decay shouldn’t be a problem. To capitalize on a bull-

ish move, we bought these calls for $6.25 each when SPY
Date: Wednesday, Aug. 6. traded around 129.00 at the Aug. 6 close.
Figure 1 shows the call’s potential gains and losses on
Market: Options on the S&P 500 tracking stock (SPY). three dates: trade entry (Aug. 6, dotted line), halfway to
expiration (Aug. 29, dashed line), and expiration (Sept. 20,
Entry: Buy one September 125 call at $6.25. solid line).
Reasons for trade/setup: SPY climbed to a 20-day Initial stop: Exit if call loses one-third of its value.
high on Aug. 6 and was poised to close within the upper 20
percent of its daily range. Historical testing shows the mar- Initial target: Exit if SPY climbs 1 percent within one
ket climbed roughly 1 percent in the week after this pattern week.
(see “Follow-through or fake-out: Testing 20-day highs and
lows,” Active Trader, April 2006). RESULT
September 125 calls are four points in-the-money (ITM)
with a delta of 68 and seem ideal for a short directional Outcome: Figure 2 shows SPY opened 0.9 percent lower
move. In addition, the calls won’t expire for six weeks, so the next day and dropped another 0.8 percent by the close.
At that point, the trade lost its
FIGURE 1 — LONG CALL RISK PROFILE validity, and we just hoped the
market would rebound so we
This long call has a delta of 68, so it will make money if SPY successfully breaks
above its 20-day high. could minimize losses.
The market bounced back and
posted a 2.2-percent gain on Aug.
8. We could have exited that after-
noon, but we waited to see if SPY
would push higher. Instead, we
exited the next morning as SPY
approached 130. The calls were
sold for $6.70 each — a profit of
$0.45.
The trade was profitable, but
mistakes were made. Figure 2
shows we exited too soon: SPY
climbed an additional 0.5 percent
to 131.50 before dropping in the
late afternoon. Instead of taking
such a small profit, we could have
placed a trailing stop to capture a
Source: OptionVue
continued on p. 46

OPTIONS TRADE JOURNAL continued
FIGURE 2 — TAKING PROFITS TOO SOON

The trade went negative immediately, but the market bounced back within a couple of days. After exiting with a small profit
on the morning of Aug. 11, SPY climbed an additional 0.5 percent by the close.
Source: eSignal
larger gain.
TRADE SUMMARY
In hindsight, we tied up unnecessary capital by buy-
ing September calls that didn’t expire for six weeks. By Entry date: Aug. 6, 2008
contrast, August 125 calls cost $1.70 less and gained the
Underlying security: S&P 500 tracking stock (SPY)
same amount ($0.45) during the trade. When buying
options, time works against you, but it wasn’t a factor Position: 1 long September 125 call
here because the trade lasted only five days. Initial capital required: $625
Initial stop: Exit if trade loses one-third of its value.
TRADE STATISTICS
Initial target: Exit if SPY rallies 1 percent in one week.
Aug. 6 Aug. 11 Initial daily time decay: -$4.41
Delta: 68.09 70.84 Trade length (in days): 5
Gamma: 3.93 3.82
P/L: $45 (7.2%)
Theta: -4.41 -4.97
LOP: $45
Vega: 16.44 15.11
LOL: -$140
Probability of profit: 42% 45%
LOP — largest open profit (maximum available profit during life of trade).
Breakeven point: 131.25 131.25
LOL — largest open loss (maximum potential loss during life of trade).

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September 2008 • Volume 2, No.

PROFITING FROM OPENING GAPS

CRUSHES AND CRUNCHES:

STRATEGIC STOCK TRADING —

Trading stocks with short options . . . .24

Options Trading System Lab

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .30

Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Option Radar . . . . . . . . . . . . . . . . . . . . . . . . . .31

Hedging with bear put spreads . . . . . . . .18

2 September 2008 • FUTURES & OPTIONS TRADER

Trade stocks for only

“I don’t need advice. Just give me the

CBOE, CBOT reach settlement . . . . . . . .34

GLD options take off . . . . . . . . . . . . . . . . .35

Futures & Options Calendar . . . . . . . . . . . .42 Options Trade Journal . . . . . . . . . . . . . . .45

Have a question about something you’ve seen

Looking for an advertiser?

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

OptionsMentoring The Wizard

4 September 2008 • FUTURES & OPTIONS TRADER

Art Collins (artcollins@ameritech.net) is the author of Beating The

A publication of Active Trader ®

Associate editor: Chris Peters

President: Phil Dorman

The information in Futures & Options Trader magazine

FUTURES & OPTIONS TRADER • September 2008 5

Fading the opening gap

S potting a market’s tops and bottoms seems

6 September 2008 • FUTURES & OPTIONS TRADER

FIGURE 3 — ISLAND REVERSAL — T-BONDS

FUTURES & OPTIONS TRADER • September 2008 7

FIGURE 4 — BULLISH REVERSAL — S&P 500 INDEX FUTURES

8 September 2008 • FUTURES & OPTIONS TRADER

TABLE 3 — FILTERED TEST RESULTS

in the markets less than one percent of the time. That is

Gaps that exceed 100-day highs and lows Adding a filter

FUTURES & OPTIONS TRADER • September 2008 9

markets outpace the lagging ones. For

Related reading: Art Collins articles

10 September 2008 • FUTURES & OPTIONS TRADER

Active Trader Online

From crunch to crush

T he ongoing credit crunch that was

knowledge, the way the credit situation can

TABLE 1 — “CARRY” SPREADS SIGNAL PLENTIFUL TABLE 3 — BEWARE A FALSE SIGNAL

TABLE 2 — “INVERTED” SPREADS SIGNAL TABLE 4 — USDA NUMBERS INDICATE SOYBEAN

12 September 2008 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • September 2008 13

liquidate inventory. This response to the

14 September 2008 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • September 2008 15

TABLE 10 —A VERY GOOD YEAR OR STORMY WEATHER?

16 September 2008 • FUTURES & OPTIONS TRADER

I nvestors have had a tough time so far in 2008 as the

18 September 2008 • FUTURES & OPTIONS TRADER

index (green and blue lines,

FUTURES & OPTIONS TRADER • September 2008 19

FIGURE 2 — PORTFOLIO + BEAR PUT SPREAD Time decay and

20 September 2008 • FUTURES & OPTIONS TRADER

Which market to hedge? Rolling the spread

FUTURES & OPTIONS TRADER • September 2008 21

“Rolling leaps calls”