December 2009 • Volume 3, No.

12

IMPROVING STRATEGY OPTIONS STRATEGIES:

PERFORMANCE Gamma scalping p. 12
with money
management p. 6 PLAYING RESISTANCE
in treasuries p. 28
BETTER BREAKOUT
trading p. 10 TRADING THE
parabolic SAR with
credit spreads p. 17
COMMERCIAL TRADERS
forego gold rush p. 21
 CONTENTS

Options Trading System Lab

Parabolic SAR with credit spreads . . . .17
Trading credit spreads when this indicator
changes direction.
By Steve Lentz and Jim Graham

Futures & Options Calendar . . . . . . . . . . . .19

Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 New Products and Services . . . . . . . . . . . . .20

Trading Strategies Futures & Options Watch:

Trading with maximum portfolio risk . . . .6 COT extremes . . . . . . . . . . . . . . . . . . . . . . .21
Using a dynamic position-sizing approach turns a A look at the relationship between
so-so system into a significant winner. commercials and large speculators in all
45 futures markets.
Tuning up the Turtle . . . . . . . . . . . . . . . . .10
After two decades, traders are still intrigued by Options Watch . . . . . . . . . . . . . . . . . . . . . .21
the trend-following strategy followed by the Vanguard Value ETF components
Turtles in the 1980s. Does it still work?
By Anthony Garner Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .22
Momentum, volatility, and volume
The options straddle battle . . . . . . . . . . .12 statistics for futures.
Can two traders succeed if they make completely
opposite bets on market volatility?
By Dan Keegan

continued on p. 4

2 December 2009 • FUTURES & OPTIONS TRADER

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 CONTENTS

Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .23

Notable volatility and volume
in the options market.

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .24

References and definitions.

Managed Money . . . . . . . . . . . . . . . . . . . . .25 Futures Trade Journal . . . . . . . . . . . . . . .28

Top 10 option strategy traders ranked by Resisting the temptation to fade resistance.
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4 December 2009 • FUTURES & OPTIONS TRADER

 CONTRIBUTORS
CONTRIBUTORS

 After Oxford University, Anthony Garner spent a few

formative years as a solicitor with Slaughter and May, a London
commercial law practice. He joined Swiss Bank Corporation
International in the mid-1980s and spent several years as an
investment analyst, with postings in Tokyo, Hong Kong,
A publication of Active Trader ® Singapore, and Zurich. He left conventional employment in 1995
and began working for himself. Garner now designs, tests, and trades simple
For all subscriber services: mechanical investment strategies. He recently published A Practical Guide to
www.futuresandoptionstrader.com ETF Trading Systems (Harriman House). Together with his colleague Roeland
Phillippe, Garner provides Zurich-based fund manager IFIT Advisory AG
with mechanical trading strategies. The firm uses Garner’s strategies in its
Editor-in-chief: Mark Etzkorn Cardio Angels Fund.
metzkorn@futuresandoptionstrader.com
 Dion Kurczek (dion@wealth-lab.com) is a private trader, software engi-
Managing editor: Molly Goad neer and trading system researcher. In 2000 he founded Wealth-Lab Inc. and
mgoad@futuresandoptionstrader.com launched an interactive trading system development laboratory on the Web
(www.wealth-lab.com). He is currently vice president of Wealth-Lab Product
Senior editor: David Bukey Development at Fidelity Investments.
dbukey@futuresandoptionstrader.com
 Volker Knapp has been a trader, system developer, and
Contributing writers: Keith Schap,
researcher for more than 20 years. His diverse background
Chris Peters
encompasses positions such as German National Hockey team
cpeters@futuresandoptionstrader.com
player, coach of the Malaysian National Hockey team, and
Editorial assistant and president of VTAD (the German branch of the International
webmaster: Kesha Green Federation of Technical Analysts). In 2001, he became a partner
kgreen@futuresandoptionstrader.com in Wealth-Lab Inc. (www.wealth-lab.com), which he still runs.

Art director: Laura Coyle  Dan Keegan is from Rochester, New York and earned an economics
lcoyle@futuresandoptionstrader.com degree from Marquette University in 1977. After graduation, Keegan moved
to Chicago and soon began working at the Chicago Board Options Exchange
President: Phil Dorman (CBOE). The CBOE was only four years old when Keegan began working at a
pdorman@futuresandoptionstrader.com
series of several jobs both on and off the trading floor. In 1982, Keegan began
trading on the CBOE floor with backing from legendary adventurer Steve
Publisher,
Ad sales East Coast and Midwest:
Fossett who made his fortune backing young traders like Keegan. After more
Bob Dorman than 20 years as an independent floor trader, Keegan has become an options
bdorman@futuresandoptionstrader.com educator and advisor. He frequently guest lectures in options at Marquette
University, is an advisor for i2i Analytics, and a regular contributor to finan-
Ad sales cial trade publications. Keegan is the co-founder and director of options for
West Coast and Southwest only: the Chicago School of Trading. He and his wife Lesly live in Hinsdale, Ill. with
Allison Chee their three children.
achee@futuresandoptionstrader.com
 Jim Graham (advisor@optionvue.com) is the product
Classified ad sales: Mark Seger manager for OptionVue Systems and a registered investment
seger@futuresandoptionstrader.com advisor for OptionVue Research.

Volume 3, Issue 12. Futures & Options Trader is pub-

lished monthly by TechInfo, Inc., 161 N. Clark St.,
 Steve Lentz (advisor@optionvue.com) is a well-estab-
Suite 4915, Chicago, IL 60601. Copyright © 2009 lished options educator and trader and has spoken all over the
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any U.S., Asia, and Australia on behalf of the CBOE’s Options
form without written permission from the publisher. Institute, the Options Industry Council, and the Australian
The information in Futures & Options Trader magazine Stock Exchange. As a mentor for DiscoverOptions.com, he
is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply teaches select students how to use complex options strategies
the effectiveness of any trading system, strategy, or and develop a consistent trading plan. Lentz is constantly
approach. Traders are advised to do their own
research and testing to determine the validity of a trad- developing new strategies on the use of options as part of a comprehensive
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future profitable trading approach. He regularly speaks at special events, trade
results. shows, and trading group organizations.

5 December 2009 • FUTURES & OPTIONS TRADER

 TRADING STRATEGY
OPTIONS STRATEGIES
LAB

Trading with maximum portfolio risk

A basic price pattern with mediocre results when tested on a single-contract basis takes off
when a dynamic money-management regime is introduced.

FIGURE 1 — SAMPLE TRADES

This cross section of long and short trades in natural gas (NG) illustrates how
the system rides short trends nicely, but exits at the first sign of a reversal.
Note: A version of this article origi-
nally appeared in the November 2003
issue of Active Trader magazine.

he two-bar breakout

T (2BB) system attempts to

capture short trends by
going long or short
based on the behavior of the two
most recent price bars. It trades fre-
quently and has a very brief aver-
age holding period — typically one
or two bars on average (six or
seven bars when a good trend
move materializes). Also, it uses a
very tight stop to limit losses.
Many traders would likely be
skeptical that such a basic price
pattern could produce useful
results. However, such traders
might overlook the role money
management — specifically, adjust- Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com)
ing the number of contracts accord-
ing to current account equity — can play in making the b. the high is greater than the previous bar’s high;
most of a strategy. c. the close is greater than the open.
The 2BB essentially looks for a reversal of the immedi- 2. Cover short using a trailing stop at the current
ate directional momentum, buying if price exceeds yester- bar’s high.
day’s high if yesterday was a down day, and selling if
price falls below yesterday’s low if yesterday was a down Figure 1 shows sample trades in natural gas (NG). The
day. The rules are: system was relatively active, triggering around 20 trades
during this roughly two-month period. Losing trades are
Long trades: stopped out quickly.
1. Go long with a stop order on the next bar To start, we’ll test the system trading only one contract
(at the current high plus one tick) if: per position, then evaluate other position-sizing strategies
a. the low is less than the previous bar’s low; later in the article. The initial account equity was set to $1
b. the high is less than the previous bar’s high; million, and $20 was deducted per round-turn trade for
c. the close is less than the open. slippage and commissions. Testing was conducted on
Exit long using a trailing stop at the current bar’s low. daily data on the following 19 markets: DAX30 (AX), corn
(C), crude oil (CL), German bund (DT), Eurodollar (ED),
Short trades: Eurocurrency (FX), gold (GC), copper (HG), Japanese yen
4. Go short with a stop order on the next bar (JY), coffee (KC), live cattle (LC), lean hogs (LH), Nasdaq
(at the current low minus one tick) if: 100 (ND), natural gas (NG), soybeans (S), sugar (SB), sil-
a. the low is greater than the previous bar’s low; ver (SI), S&P 500 (SP) and 10-year T-notes (TY). The test

6 December 2009 • FUTURES & OPTIONS TRADER

 FIGURE 2 — STATIC POSITION SIZE EQUITY CURVE
Trading one contract per market produced a very low-key equity curve.
spanned September 1993 until December However, both the long and short sides of the system were profitable.
2002.

Fixed position test results

The system returned a 45-percent profit over
the test period, but was somewhat hobbled by
the one-contract-per-trade position-sizing
rule and the large starting capital in the test
account. As a result, the system sat in cash for
most of the test period. Nonetheless, the equi-
ty curve showed steady increases in both the
long and the short sides of the system
(Figure 2).
Another interesting characteristic of the
equity curve is that on three occasions (1995,
1998, and 2002) the account ratcheted up
sharply, followed by longer periods of much
more moderate volatility. Because the system
traded one contract per trade, very large mar-
kets have a far greater impact on the overall
results than small ones.
Although the system’s annualized return
over the test period was a meager 3.93 per-
cent, the maximum drawdown was only -6.56
percent (Figure 3). Once again, the very con-
servative position sizing limited the system’s
potential during the test run. TABLE 1 — ADJUSTING THE RISK LEVEL
Let’s see if using a more dynamic position-sizing Reducing the risk per trade also decreased the
approach might extract more value from the trade rules. system’s maximum drawdown.

Dynamic position sizing Maximum APR Net Maximum

risk (%) (%) profit (%) drawdown (%)
with maximum portfolio risk
One of the most important aspects — some would argue the 1.00 28.65 1,052.00 -30.82
most important aspect — of futures trading is position siz- 0.75 22.82 635.00 -27.84
ing. Intelligent position sizing can produce much- 0.50 14.95 286.00 -23.89
improved returns even on simple trend-following systems.
0.25 5.65 70.00 -13.14
One approach is called “maximum portfolio risk,” which
establishes the position size so if the initial
stop-loss is hit, the amount of money lost will FIGURE 3 — DRAWDOWN
equal a certain percentage of the total account
The average drawdown was -3-percent and the maximum drawdown was
equity. only -6 percent.
A second test of the two-bar breakout sys-
tem used a maximum portfolio risk level of 1
percent, along with a filter that required the
number of contracts to not exceed 1 percent of
the total trading volume for that day. Finally,
two ticks of slippage were added to both the
entry and the exits for each trade. Figure 4
shows the results of this test. The difference
between it and Figure 2 is clear. The equity
curve’s ascent is much sharper, although also
more volatile, and the ending profit much
higher. However, in this case the increased
reward seems worth the higher risk.
continued on p. 8

FUTURES & OPTIONS TRADER • December 2009 7

 TRADING STRATEGIES

FIGURE 4 — DYNAMIC POSITION SIZE EQUITY CURVE

Table 1 shows the relationship
Normalizing the position size for all contracts by risking 1 percent of account
between maximum risk, annualized
equity increased returns significantly.
return, and maximum drawdown. Net
profit increased to an annual rate of 28.65
percent, but maximum drawdown also
increased dramatically to -30.82 percent.
However, the system still boasts a
healthy recovery factor (net profit/maxi-
mum drawdown) of 2.58. The draw-
down can be reduced by reducing the
maximum portfolio risk.

Sizing matters up
An intelligent position sizing strategy
can help minimize losses and extract the
full potential out of the strategy.
Although the trade setup only uses the
most recent two bars of market data, it
proved to be robust — and quite prof-
itable when combined with dynamic
position sizing. 

—Submitted by Vetri Vel

—Compiled by Dion Kurczek
and Volker Knapp of Wealth-Lab Inc.

For information on the author see p. 5.

STRATEGY SUMMARY
LEGEND: Net profit — Profit at end of test period, less commission •
Exposure — The area of the equity curve exposed to long or short positions, Profitability Trade statistics
as opposed to cash • Profit factor — Gross profit divided by gross loss •
Payoff ratio — Average profit of winning trades divided by average loss of
Net profit: $453,934.00 No. trades: 4,884
losing trades • Recovery factor — Net profit divided by max. drawdown • Net profit: 45.39% Win/loss: 38.74%
Max. DD (%) — Largest percentage decline in equity • Longest flat days Exposure: 1.86% Avg. gain/loss: 0.08%
— Longest period, in days, the system is between two equity highs • No.
trades — Number of trades generated by the system • Win/Loss (%) — The Profit factor: 1.21 Avg. hold time: 2.44
percentage of trades that were profitable • Avg. trade — The average prof- Payoff ratio: 1.77 Avg. profit (winners): 2.08%
it/loss for all trades • Avg. winner — The average profit for winning trades
• Avg. loser — The average loss for losing trades • Avg. hold time — The
Recovery factor: 4.67 Avg. hold time (winners): 3.78
average holding period for all trades • Avg. hold time (winners) — The Drawdown Avg. loss (losers): -1.18%
average holding time for winning trades • Avg. hold time (losers) — The
Max. DD: -6.56% Avg. hold time (losers): 1.60
average holding time for losing trades • Max. consec. win/loss — The max-
imum number of consecutive winning and losing trades Longest flat days: 388 Max. consec. win/loss: 10/14

STRATEGY SUMMARY (2% RISK)

LEGEND: Avg. return — The average percent-
Avg. Sharpe Best Worst Percentage Max. Max. age for the period • Sharpe ratio — Average
return ratio return return profitable consec. consec. return divided by standard deviation of returns
periods profitable unprofitable (annualized) • Best return — Best return for the
period • Worst return — Worst return for the
Weekly 0.08% 0.70 7.90% -3.11% 49.11% 7 6
period • Percentage profitable periods — The
Monthly 0.33% 0.77 7.02% -3.24% 55.93% 7 5 percentage of periods that were profitable • Max.
Quarterly 0.97% 0.76 10.42% -3.13% 65.00% 7 2 consec. profitable — The largest number of con-
secutive profitable periods • Max. consec.
Annually 4.01% 0.58 20.20% -2.68% 70.00% 6 2 unprofitable — The largest number of consecu-
tive unprofitable periods

8 December 2009 • FUTURES & OPTIONS TRADER

 TRADING STRATEGIES

Tuning up the turtle

After two decades, traders are still intrigued by the trend-following strategy followed by
the Turtles in the 1980s. This preview of an article in the February 2009 issue of Active Trader tests
their strategy and suggests how to improve it.
BY ANTHONY GARNER

o markets change? Is it necessary to TABLE 1 — MARKETS TRADED BY TURTLES

D undertake continued research and

development and adapt a trend-fol-
lowing system to maintain its prof-
itability over the years?
To attempt to answer these questions, the fol-
The original trend-following strategy traded by the Turtles included 21
futures markets. This test replaces the Deutsche mark and French franc
with the Euro and excludes the 90-day T-bill contract.

Bonds:
Market
30-year T-bonds (US), 10-year T-note (TY), Eurodollar
lowing study tracks the strategy of the “Turtles,” a (ED)
group trained by legendary traders Richard Softs: Coffee (KC), cocoa (CC), sugar #11 (SB), cotton (CT)
Dennis and Bill Eckhart in the 1980s. The Turtles Currencies: Swiss franc (SF), Euro (EC), British pound (BP),
were used to conduct an experiment about Japanese yen (JY), Canadian dollar (CD)
whether it was possible to teach people to become Stock indices: S&P 500 (SP)
successful traders. Metals: Gold (GC), silver (SI), copper (HG)
One trading system salesmen recently argued Energy: Crude oil (CL), unleaded gas (RB), heating oil (HB)
that it is “nonsense” and a “specious argument” to Source: Way of the Turtle: The Secret Methods that Turned Ordinary People into
suggest trend-following rules must adapt to Legendary Traders (McGraw-Hill, 2007).
changing market conditions.
Others argue a trend-following
system does not simply self-adapt FIGURE 1 — TRADE EXAMPLES — TURTLE SYSTEM
but needs continued monitoring The original Turtle strategy sold short in cocoa futures in January 1970 and exited at a
and refining. Some well-known profit in March.
trend-followers have indeed stated
they still trade the same system as
when they started out 30 or 40
years ago. But what do those man-
agers really mean?

Testing the Turtle

By back testing the original Turtle
strategy, we can ascertain whether
this one particular system, which
was highly profitable back in the
early 1980s, has stood the test of
time or needs updating.
At its core, the Turtle strategy is
a trend-following system that
attempts to capture short- and
medium-term trends in a portfolio
of futures markets (Table 1).
For example, Turtles bought the
market after 20-day highs and sold Source: Trading Blox
short after 20-day lows. Figure 1
shows trade examples in cocoa were entered short on Jan. 6 and 7, 1970, and all units were
futures (CC), which shows the effect of pyramiding: Units exited at the same time on March 5, 1970 as the market pen-

10 December 2009 • FUTURES & OPTIONS TRADER

 FIGURE 2 — EQUITY CURVE
After impressive growth in the 1980s, the equity curve flattened in the early 1990s,
etrated the 10-day high. suggesting the system has broken down.
We tested the Turtles’ strategy
on 21 futures markets from Table 1
from Jan. 1, 1970 to Sept. 23, 2009.
These were the markets traded by
the original Turtles. Note: French
francs and the 90-day U.S. T-Bill
were omitted from the original
portfolio, and the Euro was substi-
tuted for the Deutsche mark.
Figure 2 shows its equity curve.
The strategy was highly profitable
before and during the Turtle exper-
iment, which spanned from 1983 to
1988. Average trade length was rel-
atively short: 43 calendar days for
winning trades and 13 days for los-
ing trades.
However, since the early 1990s, Source: Trading Blox
the system has essentially been
unprofitable. Large drawdowns of up to 66 percent would (instead of 20-day thresholds). Similarly, wait to exit long
have made this system difficult to trade unless you had (short) trades at longer-term lows (highs) instead of just 10-
exceptionally strong nerves. The original Turtle system day extremes. These changes produce a longer-term system
needs considerable updating in the light of current market that is more likely to avoid some of the increased noise in
conditions. today’s markets.

Rethinking the strategy For information on the author see p. 5.

Let’s stick with the basic approach, but wait to buy the mar- Read the full article in the February 2010 issue of Active Trader,
ket at longer-term highs and sell short at longer-term lows on newsstands in January.
 TRADING STRATEGY
OPTIONS STRATEGIES
LAB

The options straddle battle

Traders on opposites sides of the market aren’t necessarily locked into a battle for success,
as this comparison of options straddles in corn futures shows.
BY DAN KEEGAN

an two traders both make money trading volatil- The long-short debate

C ity if one of them is short while the other is long? A common approach to trading volatility is the options
At first glance, that seems unlikely
because options trading is a zero-sum
game. When you place a trade, someone takes the
other side and only one of you will succeed at expi-
FIGURE 1 — DECEMBER CORN FUTURES
By entering a long options straddle on December corn futures,
you are betting corn either rallies above the upper breakeven
ration.
point or below the lower breakeven point by expiration. Traders of
However, both traders might be profitable if they the opposite position — a short straddle — will benefit if corn
adjust the position correctly. Establishing a trading trades in between these thresholds. However, either position can
position with an edge is always helpful, but proper- ultimately be profitable if adjusted correctly.
ly managing that position is more important. The
following examples use options straddles (same-
strike, same-month puts and calls) on corn futures
to demonstrate this point.

Historical and implied volatility

When deciding whether to buy or sell options,
traders often use the relationship between historical
and implied volatility (HV and IV) as a guide.
Historical volatility is the realized volatility of the
underlying over a given time period. Generally, this
measure is calculated by the standard deviation of
returns in a given period. HV is empirically based.
By contrast, implied volatility is the reverse engi-
neering process in which the current option prices
imply the underlying’s volatility.
A wide divergence between HV and IV can mean
one of two things. Either the relationship is out of
line with past levels, suggesting it might soon revert
back to normal, or the relationship has changed and Source: eSignal
may stay that way. For example,
implied volatility may increase before TABLE 1 — CORN STRADDLE DETAILS
an expected announcement while his-
Straddle buyers pay to enter this spread and will profit if December corn
torical volatility holds steady. Or IV
exceeds one of the breakeven points. Straddle sellers get paid to open the
may drop well below HV as traders spread and hope the underlying doesn’t move much.
anticipate a calm market. If you
believe extremely high or low IV will December corn (CZ09) traded at 372 on Oct. 16.
eventually move back toward HV, you Position Total price per bushel Dollar amount
could sell high-IV “expensive” options 10 December 3750-strike calls $1.78750 $8,937.50
or buy low-IV “cheap” options. 10 December 3750-strike puts $1.98750 $9,937.50
But the wide divergence could also
remain intact, and any attempts to Total cost (risk): $3.7750 $18,875.00
exploit a move toward their historical Lower breakeven point: 412.75
relationship could result in losses. Upper breakeven point: 337.25
Unfortunately, there is no crystal ball.

12 December 2009 • FUTURES & OPTIONS TRADER

 FIGURE 2 — LONG STRADDLE
straddle. If you believe the underlying is
poised to move sharply (in either direc- The easiest way to make money with a long straddle is with a large underlying
move in either direction. But there are other ways to profit if a significant move
tion), widening the spread between IV
doesn’t materialize.
and HV, you could enter a long straddle
by purchasing at-the-money (ATM) calls
and buying ATM puts in the same expi-
ration month. However, if you believe
the underlying will trade in a range, nar-
rowing the IV-HV spread, you could take
the opposite position by selling those
same calls and puts.
If one trader buys a straddle and
another sells the opposite position, only
one will make money if they don’t adjust
those positions before they expire. But if
both traders adjust the strategies based
on underlying moves, each lowers risk
and increases their odds of success.

Implied volatility in corn

The first step is to examine IVs of indi-
vidual options on corn futures. One corn
futures contract represents 5,000 bushels, Source: OptionVue
and a strike price of 3750 represents $3.75
per bushel.
Figure 1 shows December 2009 corn
futures closed at 372 on Oct. 16, and the
December 3750-strike call had a 41-per-
cent IV. By contrast, the March 2010 and
May 2010 3900-strike calls had IVs of 35
and 32 percent, respectively. And the
ATM call IVs for July, September, and
December 2010 and March 2011 were
roughly 32 percent.
Why was the highest IV at the nearest
month? This could mean traders expect
corn futures to break out in either direc-
tion. Over the past six months, near-term
IVs swung between 34 and 38 percent,
with a few exceptions touching 30 and 40
percent. If you believe corn futures could
move sharply in either direction, you
could buy a straddle in December ATM
options.

Straddling stalks of corn

To enter a long straddle on Oct. 16, you
could buy 10 December 3750-strike calls
for 17 7/8 ($0.17875 per bushel) each and
purchase 10 same-month, same-strike
puts for 19 7/8 ($0.19875 per bushel). At
expiration, you will be long 10 December
corn futures if the calls finish in-the-
continued on p. 14

FUTURES & OPTIONS TRADER • December 2009 13

 TRADING STRATEGIES

FIGURE 3 — SHORT STRADDLE money (ITM) or short 10 December corn

The short straddle can only lose money on one side of the market at expiration. futures if the puts finish ITM.
However, potential losses are large. This long-volatility position costs 37
6/8 ($0.3775 per bushel, Table 1). Figure
2 shows the trade’s potential gains and
losses on three dates: Trade entry (Oct.
16, dotted line), halfway until expiration
(Nov. 3, dashed line), and expiration
(Nov. 21, solid line).
There are three ways to make money
on this position. First, do nothing and
hope December corn finishes above 412
6/8 or below 337 2/8. Second, the uncer-
tainty surrounding the corn crop could
increase, inflating implied volatility. If
this happens, the straddle will climb in
value and you can exit the position.
But what if December corn never
breaches either of the straddle’s
breakeven points and implied volatility
stays flat or decreases? You still have
opportunities to make money on the
Source: OptionVue trade, but it won’t be easy.
If December corn drops lower, the
long puts are more likely to expire ITM,
boosting the odds of a short futures posi-
tion. (Long put holders have the right to
sell the underlying at the strike price.) In
response, you can buy the underlying
futures contracts to reduce the risk of
holding a short position. At that point, if
the underlying bounces back, you can
sell the underlying contracts at a profit.
If December corn rallies, the long calls
are more likely to expire ITM, which
could result in a long futures position.
(Long call holders have the right to buy
the underlying at the strike price.) You
can then sell the underlying to lower the
risk of holding a long position. And if
December corn slips, you can buy back
the underlying at a profit.
You will make money with this tech-
nique if the profit earned from these
underlying trades exceeds the decay in
the option’s time value. This “scalping”
approach works best when the underly-
ing is range-bound, not when it moves in
a straight line.

Short straddle example

Let’s compare a long straddle with a
short one in December corn options on
Oct. 16. The position includes the same

14 December 2009 • FUTURES & OPTIONS TRADER

options, but they were sold instead
of bought. FIGURE 4 — CORN VOLATILITY
The short straddle’s risk-profile Implied volatility of options on corn futures (blue line) climbed from Oct. 16 to Nov. 12.
graph is shown in Figure 3. Note
the risks and rewards are reversed:
By selling those options, the maxi-
mum profit is 37 6/8 and the total
possible loss is nearly limitless.
And unlike the long straddle, the
short one is profitable if December
corn trades within the upper and
lower breakeven points.
The short straddle can only lose
money on one side of the market at
expiration. If the short calls move
into the money, they will convert
into a short underlying position; if
the short puts move ITM, they will
convert into a long underlying
position.
If you do nothing until expira-
tion, and December corn never
Source: OptionVue
exceeds the upper or lower
breakeven points (412 6/8 and 337
2/8), the position will make money.
Another way to profit is to buy back the
position after the underlying trades side-
ways and the options’ time value drops.
But what happens if December corn
exceeds one of the breakeven points? As
the underlying declines, the short puts
will act more like long underlying
futures. To hedge against this directional
risk, you can sell the underlying after it
declines. This step essentially converts
the position’s short puts into short calls.
The position is now somewhat hedged
against market declines.
If December corn increases, then you
can buy futures contracts, which con-
verts the short calls into short puts and
mitigates the pain of further market ral-
lies. If the underlying market is choppy,
these trades may lose money. But that’s
fine as long as the short options’ daily
time decay exceeds the losses from trad-
ing the underlying.

Adjusting the position

Figure 4 shows implied volatility of
options on corn futures climbed from
Oct. 16 to Nov. 12 — two weeks before
expiration. The December 3750-strike call
continued on p. 16

FUTURES & OPTIONS TRADER • December 2009 15

 TRADING STRATEGIES TABLE 2 — AND THE VERDICT IS…
The straddle lost value since Oct. 16, suggesting straddle sellers made
money while straddle buyers lost money. However, a long straddle could
have been profitable if you traded the underlying futures against it, selling
after rallies and buying after declines.
IV increased to 47 percent. Does that
December corn (CZ09) traded at 390 4/8 on Nov. 12.
spell disaster for the short straddle? Not
Total price Dollar
necessarily.
Position per bushel amount
Those calls now trade at 19 5/8
($0.19625 per bushel) and have a 75-per- 10 December 3750-strike calls $1.96250 $9,812.50
cent chance of expiring ITM. The puts 10 December 3750-strike puts $0.46250 $2,312.50
now trade at 4 5/8 ($0.04625 per bushel)
with a 25-percent chance of finishing Short straddle gain (without adjustments) $2.4250 $6,750
ITM (Table 2). A position of 10 short calls Long straddle loss (without adjustments) -$2.4250 -$6,750
with a 75-percent chance combined with
10 short puts with a 25-percent chance
adds up to holding five short futures Related reading:
contracts at expiration [(10 * 75 percent)
+ (10 * 25 percent)]. To flatten those prob- Corn futures:
abilities, you could have purchased five “A season for volatility in the grains,” Futures & Options Trader, July 2007.
futures contracts along the way. Thus, Implied volatility extremes help uncover straddle and strangle opportunities in
you are now short 15 puts and five calls. the soybean and corn futures.
The overall short position has a -500
“Corn: The new crude oil?” Futures & Options Trader, April 2007.
delta; you could buy five futures (+100 Corn – it’s not just for dinner any more. This commodity’s expanding economic
deltas each) to lower its total delta to importance could make this an exciting year for the July-December futures
zero. spread trade.
If you had originally bought the strad-
dle for 37 6/8, it has since shrunk to 24 Options straddles:
2/8. To offset that unrealized loss, you “Searching for the short-straddle edge”
could trade the underlying. For example, Futures & Options Trader, December 2008.
December corn opened at 392 on Nov. 12 The difference between implied and actual volatility offers an advantage for
and hit a high of 398 2/8. Suppose you selling straddles on the S&P 500.
sell three futures at 395 before the under- “Straddling the COT report,” Futures & Options Trader, September 2007.
lying drops to a low of 382 4/8 and you Tracking shifts in large-trader sentiment can signal trade opportunities. This
buy them back. Then you buy another long straddle was triggered by an extreme reading in the S&P 500 futures.
futures contract at 383 and three more at
“Straddles vs. strangles, round two,” Options Trader, January 2007.
385. Finally, you sold this long underly- To choose between the two, calculate points at which both strategies generate
ing position at 390. The profit earned identical returns and compare them to your underlying price target.
from scalping corn futures combined
with a rise in corn above the 3750 strike “Seasonal straddles,” Options Trader, December 2006.
Long straddles can profit from a price move in either direction, assuming the
means you could have made money
market moves enough to overcome the trade’s cost. Finding low-implied
overall.
volatility markets with strong seasonal price tendencies may be your best bet
How frequently should you trade the for this trade.
underlying? The answer depends on
your risk tolerance, but some traders use “Long straddles and strangles,” Futures & Options Trader, July 2006.
the overall position’s delta as a guide. They are popular trades that offer limited risk and unlimited reward, but long
straddles and strangles require large underlying price moves in order to profit.
For example, the original short straddle
Learn the differences between these positions and discover when they are
had a basically flat delta (-38) at entry.
most appropriate to trade.
However, it fell to -500 after the underly-
ing gained 6.9 percent within a week. At “Long straddles: The importance of buying time”
that point, you could have bought five Options Trader, July 2005.
futures to bring delta back down to zero, Buying options has a bad reputation in some trading circles because you're
always fighting time decay. But knowing how to find options with the best
which lowers directional risk.
volatility characteristics and tapping into LEAPS can allow you to construct
But you don’t have to wait that long.
higher-probability long straddles.
Other traders might be more comfort-
able adjusting the position after delta “Straddles vs. strangles,” Options Trader, December 2005.
moves by 200 or 300 in either direction. It's the volatility-spread decision: Do you trade a straddle or a strangle? You
might be surprised by the clear advantages one strategy has over the other in
For information on the author see p. 5. most situations.

16 December 2009 • FUTURES & OPTIONS TRADER

 OPTIONS TRADING
TRADING SYSTEM
OPTIONS STRATEGY
OPTIONS SYSTEM
LAB LAB
LAB
FIGURE 1 — PARABOLIC SAR CHART
The parabolic SAR works best during strong trending periods, which

Parabolic SAR developer Welles Wilder estimated occur roughly 30 percent of the time.

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

System concept: The most profitable

options lab we have tested used the direc-
tional movement index, developed by Wells
Wilder in 1978. This lab tests another of
Wilder’s indicators — the parabolic SAR.
Sometimes known as the stop-and-
reverse system, the parabolic SAR is a calcu-
lation that acts as a stop-loss point under- Source: MetaStock
neath long trades and above short trades
(Figure 1). The parabolic SAR is often used FIGURE 2 — BULL PUT SPREAD RISK PROFILE
to determine the direction of an asset’s A November 1030-825 bear call spread was entered on Oct. 26, 2009 when
momentum and when momentum has a the market closed at 1067.
higher-than-normal probability of switching
directions.
If the parabolic SAR lies below the current
price, the market could be bullish, and if it is
above price, the market may be bearish. In
this lab, all transactions are placed when
price crosses the parabolic SAR calculation.
Bullish signals are triggered at the close after
price crosses above yesterday’s parabolic
SAR value. Bearish signals are triggered at
the close after price crosses below yester-
day’s parabolic SAR value. (Standard set-
tings were used: an acceleration factor of
0.02 with a maximum of 0.20.)
When signals appear, the system enters
credit spreads by selling an option (a put for
bullish signals, a call for bearish ones) at the
first strike beyond one standard deviation.
The system also buys a same-type option 10
Source: OptionVue
points farther OTM — far enough out-of-
the-money (OTM) to ensure the credit is suf-
ficient. Note: This distance varies depending on the under- Trade rules:
lying and current market conditions.
Ideally, credit spreads make money as time passes. If the Bullish signal
underlying’s price goes nowhere or moves away from the When price crosses above yesterday’s parabolic SAR
short strike, the spread’s value will decline toward zero as value, enter a bull put credit spread as follows:
the likelihood of the short strike finishing in-the-money
(ITM) decreases. 1. Sell five puts at the first strike that is beyond one
Figure 2 shows the potential gains and losses of a standard deviation.
November 1030-825 bear call spread entered on Oct. 26, 2. Use the first expiration month with 21 or more days
2009 when the S&P 500 index closed at 1067. The trade will remaining.
be profitable if the S&P 500 closes below 1130.89 at Nov. 20 3. Buy five puts at a strike price 10 points farther OTM.
expiration. continued on p. 18

FUTURES & OPTIONS TRADER • December 2009 17

 OPTIONS TRADING SYSTEM LAB
FIGURE 3 — SYSTEM PERFORMANCE
Exit: Let the spread expire worthless The parabolic SAR system gained 133 percent since January 2004.
unless a bearish trade is triggered.

Bearish signal
When price crosses below yester-
day’s parabolic SAR value, enter a
bear call credit spread as follows:

1. Sell five calls at the first strike

that is beyond one standard
deviation.
2. Use the first expiration month
with 21 or more days remaining,
3. Buy five puts at a strike price 10
points further OTM.

Exit: Exit if underlying touches the

Source: OptionVue
short option’s strike. Otherwise,
allow the credit spread to expire months, the winning percentage dropped to 70 percent,
worthless. reducing the overall win rate to 85 percent.

Starting capital: $10,000. — Steve Lentz and Jim Graham of OptionVue

Execution: All entries occur at the close when price cross- STRATEGY SUMMARY
es yesterday’s parabolic SAR value. The system may hold
both bullish and bearish positions at the same time. Initial capital: $10,000
However, duplicate signals are ignored until a position clos- Net gain: $13,250
es. Percentage return: 133%
Option trades were executed at the average of the bid and Annualized return: 22.6%
ask prices at the daily close, if available; otherwise, theoret- No. of trades: 82
ical prices were used. The standard deviation was calculat- Winning/losing trades: 70/12
ed with a probability calculator using the implied volatility Win/loss: 85%
(IV) of the at-the-money call in the relevant month. Each Avg. trade: $161.59
spread held five contracts per “leg.” Commissions were $5 Largest winning trade: $1,580.00
per trade plus $1 per option ($20 per spread). No commis- Largest losing trade: -$2,340.00
sions were included when a spread expired worthless. Avg. profit (winners): 447.93
Avg. loss (losers): -1,508.75
Test data: The system was tested using options on the Avg. hold time (winners): 36
S&P 500 index (SPX). Avg. hold time (losers): 19
Max consec. win/loss: 29/2
Test period: Jan. 12, 2004 to Nov. 20,
2009.
LEGEND:
Net gain — Gain at end of test period.
Test results: Figure 3 shows the per-
Percentage return — Gain or loss on a percentage basis.
formance of the system, which gained
Annualized return — Gain or loss on a annualized percentage basis.
$13,250 (133 percent) in six years, a 22.6-
No. of trades — Number of trades generated by the system.
percent annual return. In the test’s first four
Winning/losing trades — Number of winners and losers generated by the system.
years, the strategy had a winning percent-
Win/loss — The percentage of trades that were profitable.
age of 93 percent. But in the final 18
Avg. trade — The average profit for all trades.
Largest winning trade — Biggest individual profit generated by the system.
Option System Analysis strategies are tested Largest losing trade — Biggest individual loss generated by the system.
using OptionVue’s BackTrader module (unless
Avg. profit (winners) — The average profit for winning trades.
otherwise noted).
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 trad- Avg. hold time (losers) — The average holding period for losing trades (in days).
ing and money-management rules to
Max consec. win/loss — The maximum number of consecutive winning and losing trades.
Advisor@OptionVue.com.

18 December 2009 • FUTURES & OPTIONS TRADER

 FUTURES & OPTIONS CALENDAR DECEMBER/JANUARY
MONTH
December 21 FND: January crude oil futures
(NYMEX)
Legend
1 FDD: December crude oil, natural LTD: January crude oil futures
gas, gold, silver, copper, aluminum, (NYMEX); December T-bonds futures
CPI: Consumer price index
platinum, and palladium futures (CME)
(NYMEX); December corn, wheat,
ECI: Employment cost index soybean products, oats, and T-bonds 22 LTD: January sugar futures (ICE)
FDD (first delivery day): The futures (CME); December coffee, U.S.: Weekly weather report
first day on which delivery of cocoa, and cotton futures (ICE)
U.S.: Weekly weather report 23 FND: January sugar futures (ICE)
a commodity in fulfillment of a U.S.: Petroleum status report
futures contract can take 2 FND: December heating oil, RBOB
24 LTD: January soybeans, soybean
place. gasoline, and propane futures (NYMEX)
U.S.: Petroleum status report products, and rough rice options (CME)
FND (first notice day): Also U.S.: Natural gas storage report
known as first intent day, this 3 U.S.: Natural gas storage report
25
is the first day a clearing-
4 FDD: December propane futures
26
house can give notice to a (NYMEX)
buyer of a futures contract LTD: December live cattle options 27
that it intends to deliver a (CME); January cocoa and U.S. dollar
commodity in fulfillment of a index options (ICE); December currency 28 LTD: January natural gas, heating oil,
futures contract. The clearing- options RBOB gasoline, gold, silver, copper,
house also informs the seller. and aluminum options (NYMEX)
5
FOMC: Federal Open Market 29 LTD: January natural gas futures
Committee
6 (NYMEX); December gold, silver,
7 FND: December live cattle futures copper, aluminum, platinum, and
GDP: Gross domestic palladium futures (CME)
product (CME)
LTD: January sugar options (ICE) U.S.: Weekly weather report
ISM: Institute for supply man- 30 FND: January natural gas futures
agement 8 FDD: December heating oil and RBOB
(NYMEX)
gasoline futures (NYMEX)
LTD (last trading day): The LTD: December cotton futures (ICE) U.S.: Agricultural prices and petroleum
first day a contract may trade U.S.: Weekly weather report status report
or be closed out before the 31 FND: January gold, silver, copper,
delivery of the underlying
9 U.S.: Petroleum status report
aluminum, platinum, and palladium
asset may occur. 10 FDD: December live cattle futures futures (NYMEX); January soybeans,
PPI: Producer price index (CME) soybean products, and rough rice
U.S.: Crop production, world agricultural futures (CME)
Quadruple witching Friday: production, and natural gas storage LTD: January heating oil, RBOB
A day where equity options, report gasoline, and propane futures
equity futures, index options, (NYMEX); December live cattle futures
and index futures all expire.
11 LTD: January coffee options (ICE) (CME)
12 U.S.: Natural gas storage report
13
DECEMBER 2009 January
14 LTD: December corn, wheat, soybean
29 30 1 2 3 4 5 products, and oats futures (CME); 1 FDD: January crude oil and natural
December U.S. dollar index (ICE); gas futures (NYMEX); January sugar
6 7 8 9 10 11 12
December currency futures futures (ICE)
13 14 15 16 17 18 19
15 FND: December U.S. dollar index 2
20 21 22 23 24 25 26
futures (ICE) 3
27 28 29 30 31 1 2 LTD: December cocoa futures (ICE)
U.S.: Weekly weather report 4 FND: January orange juice futures
(ICE)
JANUARY 2010 16 FDD: December U.S. dollar index FDD: January gold, silver, copper,
(ICE); December currency futures platinum, and palladium futures
27 28 29 30 31 1 2 LTD: January crude oil and platinum (NYMEX); January soybean, soybean
3 4 5 6 7 8 9 options (NYMEX) products, and rough rice futures (CME)
U.S.: Petroleum status report
10 11 12 13 14 15 16
17 U.S.: Natural gas storage report
5 FND: January heating oil and RBOB
17 18 19 20 21 22 23 gasoline futures (NYMEX)
24 25 26 27 28 29 30 18 LTD: December coffee futures (ICE); 6 U.S.: Petroleum status report
December single stock futures (OC);
31 1 2 3 4 5 6 December index futures; January 7 U.S.: Natural gas storage report
orange juice and cotton options (ICE);
The information on this page is December index and equity options 8 LTD: January orange juice futures
subject to change. Futures &
U.S.: Cattle on feed (ICE); February coffee and U.S. dollar
Options Trader is not responsible index options (ICE); January currency
for the accuracy of calendar dates
beyond press time.
19 options
20
December 2009 • CURRENCY TRADER 19
 NEW PRODUCTS AND SERVICES

 Fidelity Investments (www.fidelity.com) has interactive trading tool; traders of all abilities are welcome
launched a new online stock research center to help to access the site with a valid email address. Visitors find
investors identify trading and investment ideas by deliver- valuable information, endorsed by major exchanges, and
ing independent expert insights about emerging opportuni- presented by veteran educators. Articles, research reports,
ties, popular stock screening strategies, stocks most fre- podcasts, live and archived Webinars, newsletters, blogs,
quently bought and sold online by Fidelity customers, and RSS news feeds, and special offers are regularly updated.
emerging topics on the Web. These new enhancements,
combined with Fidelity’s current research offering, allow  Trading software provider NinjaTrader has
customers to understand what is happening in real-time announced a partnership with Steve Nison’s
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cial blogs. The research center can be used to find emerging (www.ninjatrader.com) as his preferred trading platform
trends and opportunities among the most active stocks in for the Nison Candle Scanner (NCS). The scanner allows
the market; set predefined expert stock screening criteria traders to use NinjaTrader to uncover candlestick patterns
that customers can fine-tune, save, and use; read expert in real time in any market. NCS users can apply Nison’s
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track upgrades and downgrades; and search for investment erful Market Analyzer. NCS provides updated condition
topics on the Web. The stock research center is available to alerts to traders in real time to identify intraday and daily
all investors while expanded lists and intraday trading data trade setups. NinjaTrader makes it easy for traders to react
are available only to Fidelity customers. Fidelity offers quickly to these trade setups through its SuperDOM and
access to premium content on a subscription basis, and will chart-based order execution features. The orders can be sub-
be adding additional providers on an ongoing basis. mitted to NinjaTrader’s worldwide network of supporting
brokerages for futures, forex, and equities markets.
 CQG, the order execution, charting, and analytics
provider for global electronically traded futures markets,  TopCommodityBrokers.com — an interactive com-
has expanded its direct market access to include the modity/futures broker directory and educational and social
Australian Securities Exchange (ASX), an operator of elec- networking Web site — is now up and running. This Web
tricity and natural gas futures and options markets in site gives commodity brokers the ability to upload a profile
Australia and New Zealand. CQG customers will have photo and video, include a professional bio, connect
access to trade ASX’s Australian feed barley, Australian instantly with potential clients via Skype, link to their com-
sorghum, Australian milling wheat, and western Australian pany Web site and external blog, add detailed information
wheat contracts and the Mini S&P/ASX 50, 200, and 200 about their organization, services and specialties, upload
Property Trust indexes. These contracts are available on their company logo, and allow potential clients and fellow
both the CQG Trader and CQG Integrated Client advanced brokers to follow them on Twitter and Facebook. Registered
trading platforms. companies will be listed within the Top Commodity
In addition, CQG has launched a Certified API Partner Brokers searchable database. TopCommodityBrokers.com is
Program. CQG API Partner Certification provides program- targeted to commodity brokers as well as investors. The site
mers, developers, and vendors the opportunity to become also has a Community Blogosphere with a variety of topics
Certified API Partners with CQG. CQG certification indi- including interviews with commodity brokers, broker com-
cates the partner has demonstrated expertise in working missions, commodity broker trade shows, career classifieds,
with either the CQG Data API or the CQG Trading API. and weekly commentaries.
Certified CQG API Partners will enjoy a host of benefits
including joint marketing exposure, discounts on CQG sys-  United-ICAP — a leader in technical analysis-based
tems, membership in a private social network, and access to price risk assessment for institutional hedgers and profes-
Level III support and CQG developers. For more informa- sional energy traders — has launched new product offer-
tion, visit www.cqg.com. ings and a revamped Web site (www.united-icap.com). The
new site offers a suite of customizable tools and technical
 Futures Truth Magazine and Chicago-based analysis including daily, weekly, and monthly reports and
Trader Kingdom have partnered, sharing viable content emails, larger in-depth topical reports, live daily and week-
such as access to Webinars, articles, newsletters, podcasts, ly Webcasts, and full analyst support to discuss any of the
and blogs to enhance subscriber experiences. Futures Truth report contents, investment ideas, or methodologies.
Magazine subscribers are now able to access Trader
Kingdom Webinars from the Futures Truth Web site Note: The New Products and Services section is a forum for industry
businesses to announce new products and upgrades. Listings are adapted from
(www.futurestruth.com). Systems trading experts now
press releases and are not endorsements or recommendations from
have greater reach to present strategies to education seek- the Active Trader Magazine Group. E-mail press releases to
ers. Trader Kingdom (www.traderkingdom.com) is an editorial@futuresandoptionstrader.com. Publication is not guaranteed.

20 December 2009 • FUTURES & OPTIONS TRADER

 FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
Is gold hot? The commercials in November were overwhelmingly short in gold futures (GC).
The commercials think not
The Commitments of Traders (COT) report is published
each week by the Commodity Futures Trading
Commission (CFTC). The report divides the open posi-
tions in futures markets into three categories: commer-
cials, non-commercials, 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-fol- For a list of contract names, see “Futures Snapshot.” Source: www.upperman.com
lowers. The non-reportable category represents small
traders, or the general public. Legend: Figure 1 shows the difference between net commer-
Figure 1 shows the relationship between commercials and large speculators on cial and net large spec positions (longs minus shorts) for all 45
Nov. 24. Positive values mean net commercial positions (longs minus shorts) are futures markets, in descending order. It is calculated by subtract-
ing the current net large spec position from the net commercial
larger than net speculator holdings, based on their five-year historical relation- position and then comparing this value to its five-year range.
ship. Negative values mean large speculators have bigger positions than the The formula is:
commercials. a1 = (net commercial 5-year high - net commercial current)
In November, commercial positions in gold futures (GC) were overwhelming- b1 = (net commercial 5-year high - net commercial 5-year low)
ly short, a bearish dynamic that has recently intensified. Similar relationships c1 = ((b1 - a1)/ b1 ) * 100
existed in platinum (PL) and palladium (PA) futures. On the other side, com- a2 = (net large spec 5-year high - net large spec current)
mercial long positions have outnumbered speculator long holdings in natural b2 = (net large spec 5-year high - net large spec 5-year low)
gas futures (NG) for several months.  c2 = ((b2 - a2)/ b2 ) * 100
— Compiled by Floyd Upperman x = (c1 - c2)

Options Watch: Vanguard value ETF components (as of Nov. 30) Compiled by Tristan Yates
The following table summarizes the expiration months available for the 20 top holdings of the Vanguard Value ETF (VTV). It also shows each
stock’s average bid-ask spread for at-the-money (ATM) December 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

2009 2010 2011 2012
Bid-ask
March

spread as %
June
April
Dec.

Feb.
Jan.

July

Jan.

Jan.
May

Stock of underlying
Stock Ticker price Call Put price
Exxon Mobil Corp. XOM X X X X X X 75.07 0.03 0.03 0.04%
Coca Cola Co. KO X X X X X X 57.20 0.03 0.03 0.05%
Proctor & Gamble Co. PG X X X X X X 62.35 0.03 0.03 0.05%
Chevron Corp. CVX X X X X X X 78.04 0.03 0.05 0.05%
Verizon Communications Inc. VZ X X X X X X 31.46 0.02 0.02 0.06%
Johnson & Johnson JNJ X X X X X X 62.84 0.03 0.05 0.06%
JP Morgan Chase JPM X X X X X X 42.49 0.03 0.03 0.07%
Goldman Sachs Group Inc. GS X X X X X X 169.66 0.10 0.14 0.07%
ConocoPhilips COP X X X X X X 51.77 0.04 0.04 0.07%
AT&T Inc. T X X X X X X 26.94 0.02 0.03 0.08%
Wells Fargo & Co. WFC X X X X X X 28.04 0.02 0.02 0.08%
Intel Corp. INTC X X X X X X 19.20 0.02 0.01 0.08%
Bank of America BAC X X X X X X 15.85 0.01 0.02 0.09%
Merck & Co. MRK X X X X X X X X 36.21 0.04 0.03 0.09%
Pfizer Inc. PFE X X X X X X 18.17 0.02 0.02 0.10%
General Electric Co. GE X X X X X X 16.02 0.02 0.02 0.11%
United Technologies UTX X X X X X X 67.24 0.10 0.09 0.14%
3M Co. MMM X X X X X X 77.44 0.13 0.11 0.15%
Walt Disney Co. DIS X X X X X X 30.22 0.08 0.09 0.27%
Citigroup Inc. C X X X X X X 4.11 0.02 0.01 0.33%

Legend:
Call: Three-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.

FUTURES & OPTIONS TRADER • December 2009 21

 FUTURES SNAPSHOT (as of Nov. 27)
The following table summarizes the most actively traded U.S. 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 dif-
ferent fields. Volume figures are for the most active contract month in a particular market and may not reflect total volume for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity for CME futures is based on
pit-traded contracts.
10-day move/ 20-day move/ 60-day move/ Volatility
Market Symbol Exchange Volume OI rank rank rank ratio/rank
E-Mini S&P 500 ES CME 2.02 M 2.49 M -0.18% / 0% 5.47% / 89% 8.76% / 32% .17 / 24%
10-yr. T-note TY CME 863.5 1.20 M 2.31% / 100% 3.24% / 100% 2.55% / 85% .49 / 95%
5-yr. T-note FV CME 436.9 756.3 1.53% / 100% 2.43% / 94% 0.87% / 40% .41 / 73%
Crude oil CL CME 341.2 288.9 -0.39% / 0% -1.23% / 22% 11.90% / 32% .23 / 23%
E-Mini Nasdaq 100 NQ CME 310.4 323.5 -1.62% / 29% 5.63% / 86% 9.68% / 23% .23 / 58%
Eurodollar* ED CME 276.4 841.7 0.22% / 35% 0.53% / 84% 0.65% / 55% .18 / 10%
30-yr. T-bond US CME 268.8 690.8 4.03% / 100% 4.09% / 97% 1.66% / 34% .55 / 88%
Eurocurrency EC CME 262.1 166.4 0.65% / 36% 0.78% / 12% 4.82% / 52% .24 / 32%
2-yr. T-note TU CME 259.1 938.4 0.11% / 35% 0.86% / 93% 0.11% / 37% .33 / 50%
Gold 100 oz. GC CME 158.4 296.2 6.11% / 71% 12.14% / 97% 20.00% / 93% .29 / 33%
Mini Dow YM CME 152.3 64.6 0.49% / 7% 6.50% / 98% 9.29% / 40% .13 / 8%
E-Mini Russell 2000 TF CME 146.0 387.7 -2.00% / 25% 2.12% / 24% 1.04% / 6% .35 / 82%
Corn C CME 142.3 397.8 1.74% / 23% 4.69% / 30% 24.44% / 92% .25 / 43%
British pound BP CME 127.3 97.7 -0.46% / 40% -0.32% / 4% 1.31% / 17% .43 / 52%
Natural gas NG CME 113.1 115.2 18.21% / 80% 2.91% / 11% 90.32% / 98% .45 / 62%
Japanese yen JY CME 94.0 118.2 4.06% / 100% 5.44% / 100% 6.19% / 89% .40 / 82%
Australian dollar AD CME 93.6 113.9 -1.59% / 50% -0.93% / 100% 8.38% / 26% .20 / 43%
Soybeans S CME 91.9 194.4 6.36% / 64% 6.86% / 58% 10.73% / 30% .35 / 72%
Canadian dollar CD CME 76.9 90.2 -0.74% / 11% 0.33% / 5% 4.07% / 30% .31 / 47%
Swiss franc SF CME 55.4 53.1 0.92% / 30% 1.10% / 30% 5.33% / 64% .25 / 43%
Wheat W CME 51.2 128.9 3.20% / 8% 8.94% / 54% 12.97% / 80% .35 / 52%
Sugar SB ICE 43.9 361.1 0.35% / 25% -0.18% / 7% -3.84% / 40% .20 / 23%
Silver 5,000 oz. SI CME 39.9 73.0 6.01% / 38% 9.89% / 58% 19.11% / 57% .20 / 13%
E-Mini S&P MidCap 400 ME CME 38.8 107.2 -2.35% / 30% 3.56% / 64% 4.50% / 11% .29 / 67%
Heating oil HO CME 36.7 49.2 -0.20% / 6% -2.14% / 17% 13.10% / 38% .26 / 50%
RBOB gasoline RB CME 35.8 49.6 0.52% / 57% -1.70% / 12% 7.44% / 35% .21 / 13%
Soybean oil BO CME 35.2 77.4 4.51% / 47% 6.88% / 61% 16.91% / 92% .24 / 30%
Soybean meal SM CME 28.4 55.6 8.47% / 73% 10.57% / 93% 8.72% / 32% .31 / 78%
Copper HG CME 26.7 68.6 4.95% / 46% 2.11% / 17% 9.47% / 22% .23 / 68%
Mexican peso MP CME 23.8 84.0 2.08% / 54% 1.11% / 28% 5.39% / 82% .36 / 12%
S&P 500 index SP CME 19.4 387.8 -0.17% / 0% 5.47% / 87% 7.46% / 20% .17 / 24%
U.S. dollar index DX ICE 15.8 36.0 -0.51% / 17% -1.88% / 75% -4.00% / 42% .24 / 38%
Live cattle LC CME 14.5 65.8 0.42% / 17% -3.56% / 61% -4.12% / 71% .23 / 13%
Lean hogs LH CME 13.3 53.0 8.40% / 92% 3.19% / 13% 20.89% / 71% .31 / 88%
Coffee KC ICE 12.5 59.4 5.30% / 80% 1.88% / 9% 14.28% / 84% .14 / 0%
Crude oil e-miNY QM CME 11.2 5.2 -0.39% / 0% -1.23% / 21% 11.81% / 34% .23 / 27%
Mini-sized gold YG CME 9.6 5.1 6.59% / 82% 12.33% / 97% 20.05% / 93% .29 / 30%
Nikkei 225 index NK CME 9.3 31.6 -5.73% / 94% -8.26% / 98% -10.00% / 88% .55 / 87%
Cocoa CC ICE 8.2 50.5 6.48% / 83% -0.76% / 14% 11.94% / 24% .40 / 82%
Fed Funds** FF CME 6.9 50.0 0.04% / 0% 0.19% / 73% 0.28% / 46% .07 / 13%
New Zealand dollar NE CME 5.6 22.6 -3.13% / 62% -3.45% / 92% 5.20% / 3% .32 / 90%
E-Mini eurocurrency ZE CME 3.5 2.5 0.45% / 33% 1.59% / 47% 4.55% / 46% .24 / 28%
Natural gas e-miNY QG CME 3.4 4.0 18.21% / 83% 2.91% / 11% 90.32% / 98% .43 / 60%
Nasdaq 100 ND CME 2.3 20.7 -1.62% / 29% 5.63% / 86% 9.68% / 23% .24 / 60%
Mini-sized silver YI CME 2.3 2.4 6.33% / 38% 9.77% / 57% 19.03% / 56% .20 / 14%
Feeder cattle FC CME 1.1 7.5 -0.48% / 8% -2.22% / 39% -6.19% / 46% .14 / 0%
Dow Jones Ind. Avg. DJ CME 0.7 14.4 1.01% / 7% 3.93% / 80% 10.94% / 60% .12 / 8%
*Average volume and open interest based on highest-volume contract (December 2010). **Average volume and open interest based on highest-volume contract (May 2010).

Legend
day moves, 20-day moves, etc.) show the per- larger than all the past readings, while a read-
Volume: 30-day average daily volume, in thou- centile rank of the most recent move to a certain ing of 0 percent means the current reading is
sands (unless otherwise indicated). number of the previous moves of the same size smaller than the previous readings. These fig-
OI: Open interest, in thousands (unless other- and in the same direction. For example, the ures provide perspective for determining how
wise indicated). rank for 10-day move shows how the most relatively large or small the most recent price
10-day move: The percentage price move from recent 10-day move compares to the past twen- move is compared to past price moves.
the close 10 days ago to today’s close. ty 10-day moves; for the 20-day move, the rank Volatility ratio/rank: The ratio is the short-term
20-day move: The percentage price move from field shows how the most recent 20-day move volatility (10-day standard deviation of prices)
the close 20 days ago to today’s close. compares to the past sixty 20-day moves; for divided by the long-term volatility (100-day stan-
the 60-day move, the rank field shows how the dard deviation of prices). The rank is the per-
60-day move: The percentage price move from most recent 60-day move compares to the past
the close 60 days ago to today’s close. centile rank of the volatility ratio over the past
one-hundred-twenty 60-day moves. A reading 60 days.
The “rank” fields for each time window (10- of 100 percent means the current reading is
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.
22 December 2009 • FUTURES & OPTIONS TRADER
 OPTIONS RADAR (as of Nov. 30)

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 143.4 1.74 M 0.20% / 0% 5.74% / 89% 21.6% / 17.1% 21.6% / 19.1%
S&P 500 volatility index VIX CBOE 142.2 2.40 M 4.92% / 14% -20.14% / 97% 105.5% / 112.5% 80.6% / 100.9%
Russell 2000 index RUT CBOE 43.0 524.9 -1.12% / 40% 3.01% / 40% 30.6% / 24.1% 29.1% / 25.3%
E-Mini S&P 500 futures ES CME 34.1 161.8 0.30% / 7% 5.98% / 93% 21.7% / 20% 21.9% / 21.3%
Nasdaq 100 index NDX CBOE 19.0 191.5 -1.18% / 14% 6.02% / 88% 23.2% / 17.6% 22.8% / 19%

Stocks
Bank of America BAC 135.7 4.20 M -0.81% / 0% 8.71% / 100% 43.1% / 39.5% 46.5% / 47.3%
Citigroup C 124.4 9.14 M 1.48% / 30% 0.49% / 9% 50.9% / 35.9% 51.7% / 53.2%
Apple Inc AAPL 83.3 998.0 -2.22% / 43% 6.05% / 42% 32.2% / 24.3% 29.9% / 29.9%
Microsoft MSFT 73.8 1.85 M -0.74% / 100% 6.06% / 53% 24.9% / 19.2% 24.8% / 25.5%
Research in Motion RIMM 72.7 792.7 -7.66% / 33% -1.43% / 2% 55.8% / 46.3% 45.1% / 35.8%

Futures
Eurodollar ED CME 190.1 4.94 M -0.01% / 0% 0.03% / 9% 115.7% / 51.8% 110.9% / 38.8%
10-year T-notes TY CME 58.5 665.8 0.84% / 39% 0.93% / 45% 6.4% / 4.5% 7.7% / 6%
Corn C CME 41.6 583.2 6.92% / 100% 14.04% / 79% 35.4% / 44.8% 40.2% / 50.3%
E-Mini S&P 500 futures ES CME 34.1 161.8 0.30% / 7% 5.98% / 93% 21.7% / 20% 21.9% / 21.3%
Sugar SB ICE 21.1 377.8 -0.35% / 7% -0.75% / 21% 43.4% / 39.6% 46.5% / 50.2%

VOLATILITY EXTREMES**
Indices - High IV/SV ratio
S&P 100 index OEX CBOE 11.0 92.1 0.52% / 0% 5.89% / 93% 21% / 15.9% 20.7% / 16.5%
Nasdaq 100 index NDX CBOE 19.0 191.5 -1.18% / 14% 6.02% / 88% 23.2% / 17.6% 22.8% / 19%
Russell 2000 index RUT CBOE 43.0 524.9 -1.12% / 40% 3.01% / 40% 30.6% / 24.1% 29.1% / 25.3%
S&P 500 index SPX CBOE 143.4 1.74 M 0.20% / 0% 5.74% / 89% 21.6% / 17.1% 21.6% / 19.1%
Dow Jones index DJX CBOE 5.5 205.7 0.73% / 7% 6.51% / 98% 19.3% / 15.6% 18.7% / 16.9%

Indices - Low IV/SV ratio

Mini Nasdaq 100 index MNX CBOE 5.8 223.6 -1.19% / 14% 6.02% / 88% 22.1% / 47.3% 22.6% / 42.2%
S&P 500 volatility index VIX CBOE 142.2 2.40 M 4.92% / 14% -20.14% / 97% 105.5% / 112.5% 80.6% / 100.9%

Stocks - High IV/SV ratio

Fed Home Loan Bank FRE 1.3 284.8 -8.85% / 67% -16.26% / 49% 298.1% / 68.6% 48.8% / 113.1%
Burlington Northern BNI 5.3 175.2 0.34% / 6% 30.51% / 100% 11.4% / 5% 31.6% / 32.5%
Chimera Invest CIM 1.1 96.1 4.13% / 43% 15.47% / 100% 77.5% / 34.5% 81% / 43.5%
Apollo Group APOL 8.1 170.8 5.96% / 100% -0.05% / 0% 57.3% / 29.7% 49.2% / 49.4%
Fannie Mae FNM 2.8 682.1 -12.00% / 89% -18.52% / 53% 98.7% / 57.3% 117.7% / 108.1%

Stocks - Low IV/SV ratio

3Com COMS 4.7 46.2 -1.86% / 14% 43.39% / 100% 15.2% / 22.2% 54.8% / 45.5%
LDK Solar Co. LDK 5.3 174.6 22.07% / 11% 15.04% / 93% 74.4% / 106.2% 81.4% / 54%
Ambac Financial Group ABK 2.6 149.6 0.00% / 0% -33.04% / 76% 152.1% / 195.8% 138.2% / 92.4%

Futures - High IV/SV ratio

Eurodollar ED CME 190.1 4.94 M -0.01% / 0% 0.03% / 9% 115.7% / 51.8% 110.9% / 38.8%
2-year T-notes TU CME 2.2 54.1 -0.65% / 100% 0.04% / 15% 1.5% / 0.8% 2% / 1.1%
5-year T-notes FV CME 4.4 86.7 0.68% / 21% 0.81% / 39% 4.1% / 2.5% 5% / 3.4%
Japanese yen JY CME 1.0 12.9 3.94% / 95% 4.30% / 85% 16% / 11.1% 13.9% / 13.3%
10-year T-notes TY CME 58.5 665.8 0.84% / 39% 0.93% / 45% 6.4% / 4.5% 7.7% / 6%

Futures - Low IV/SV ratio

Corn C CME 41.6 583.2 6.92% / 100% 14.04% / 79% 35.4% / 44.8% 40.2% / 50.3%
Soybean meal SM CME 2.8 60.8 4.68% / 56% 6.13% / 70% 29.1% / 36% 30.4% / 37%
Wheat W CME 9.7 135.2 9.20% / 77% 19.10% / 97% 38.8% / 44.4% 37% / 55.6%
Soybean oil BO CME 4.0 111.2 5.10% / 47% 11.48% / 90% 29% / 30.4% 29.7% / 29.6%
30-year T-bonds US CME 13.5 132.0 2.59% / 92% 1.82% / 75% 11.4% / 11.7% 13.2% / 12.2%
* 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 TRADER • December 2009 23

 KEY CONCEPTS
The option “Greeks”
Delta: The ratio of the movement in the option price for
American style: An option that can be exercised at any every point move in the underlying. An option with a
time until expiration. delta of 0.5 would move a half-point for every 1-point
move in the underlying stock; an option with a delta of
Assign(ment): When an option seller (or “writer”) is 1.00 would move 1 point for every 1-point move in the
obligated to assume a long position (if he or she sold a put) underlying stock.
or short position (if he or she sold a call) in the underlying
stock or futures contract because an option buyer exercised Gamma: The change in delta relative to a change in the
the same option. underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
At the money (ATM): An option whose strike price is 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.
Backspreads and ratio spreads are leveraged posi-
tions that involve buying and selling options in different Theta: The rate at which an option loses value each day
proportions, usually in 1:2 or 2:3 ratios. Backspreads con- (the rate of time decay). Theta is relatively larger for
tain more long options than short ones, so the potential OTM than ITM options, and increases as the option gets
profits are unlimited and losses are capped. By contrast, closer to its expiration date.
ratio spreads have more short options than long ones and
have the opposite risk profile. Vega: How much an option’s price changes per a one-
Note: These labels are not set in stone. Some traders percent change in volatility.
describe either position as option trades with long and
short legs in different proportions.
members, futures commission merchants, and foreign bro-
Bear call spread: A vertical credit spread that consists kers are required to report daily the futures and options
of a short call and a higher-strike, further OTM long call in positions of their customers that are above specific report-
the same expiration month. The spread’s largest potential ing levels set by the CFTC.
gain is the premium collected, and its maximum loss is lim- For each futures contract, report data is divided into three
ited to the point difference between the strikes minus that “reporting” categories: commercial, non-commercial, and
premium. non-reportable positions. The first two groups are those
who hold positions above specific reporting levels.
Bear put spread: A bear debit spread that contains puts The “commercials” are often referred to as the large
with the same expiration date but different strike prices. hedgers. Commercial hedgers are typically those who actu-
You buy the higher-strike put, which costs more, and sell ally deal in the cash market (e.g., grain merchants and oil
the cheaper, lower-strike put. companies, who either produce or consume the underlying
commodity) and can have access to supply and demand
Bull call spread: A bull debit spread that contains calls information other market players do not.
with the same expiration date but different strike prices. Non-commercial large traders include large speculators
You buy the lower-strike call, which has more value, and (“large specs”) such as commodity trading advisors (CTAs)
sell the less-expensive, higher-strike call. and hedge funds. This group consists mostly of institution-
al and quasi-institutional money managers who do not deal
Bull put spread (put credit spread): A bull credit in the underlying cash markets, but speculate in futures on
spread that contains puts with the same expiration date, but a large-scale basis for their clients.
different strike prices. You sell an OTM put and buy a less- The final COT category is called the non-reportable posi-
expensive, lower-strike put. tion category — otherwise known as small traders — i.e.,
the general public.
Calendar spread: A position with one short-term short
option and one long same-strike option with more time Covered call: Shorting an out-of-the-money call option
until expiration. If the spread uses ATM options, it is mar- against a long position in the underlying market. An exam-
ket-neutral and tries to profit from time decay. However, ple would be purchasing a stock for $50 and selling a call
OTM options can be used to profit from both a directional option with a strike price of $55. The goal is for the market
move and time decay. to move sideways or slightly higher and for the call option
to expire worthless, in which case you keep the premium.
Call option: An option that gives the owner the right, but
not the obligation, to buy a stock (or futures contract) at a Credit spread: A position that collects more premium
fixed price. from short options than you pay for long options. A credit
spread using calls is bearish, while a credit spread using
The Commitments of Traders report: Published puts is bullish.
weekly by the Commodity Futures Trading Commission
(CFTC), the Commitments of Traders (COT) report breaks Debit spread: An options spread that costs money to
down the open interest in major futures markets. Clearing enter, because the long side is more expensive that the short

24 December 2009 • FUTURES & OPTIONS TRADER

side. These spreads can be verticals, calendars, or diagonals. allowed by their brokers to trade such strategies.

Delivery period (delivery dates): The specific time Naked (uncovered) puts: Selling put options to collect
period during which a delivery can occur for a futures con- premium that contains risk. If the market drops below the
tract. These dates vary from market to market and are deter- short put’s strike price, the holder may exercise it, requiring
mined by the exchange. They typically fall during the you to buy stock at the strike price (i.e., above the market).
month designated by a specific contract — e.g. the delivery
period for March T-notes will be a specific period in March. Near the money: An option whose strike price is close
to the underlying market’s price.
Diagonal spread: A position consisting of options with
different expiration dates and different strike prices — e.g., Open interest: The number of options that have not
a December 50 call and a January 60 call. been exercised in a specific contract that has not yet expired.

Out of the money (OTM): A call option with a strike

European style: An option that can only be exercised at price above the price of the underlying instrument, or a put
expiration, not before. option with a strike price below the underlying instru-
ment’s price.
Exercise: To exchange an option for the underlying
instrument. Parabolic SAR (stop-and-reverse): The parabolic
stop is a trailing stop technique developed by Welles Wilder
Expiration: The last day on which an option can be exer- and explained in his book New Concepts in Technical Trading
cised and exchanged for the underlying instrument (usual- (Trend Research, 1978). It is the primary component of what
ly the last trading day or one day after). he called the “Parabolic Time/Price” trading system. The
basic principle behind the parabolic stop is a calculation
Extrinsic value: The difference between an option's that automatically raises (in the case of a long trade) or low-
intrinsic value and it's current price (premium). For exam- ers (in the case of a short trade) a stop-loss order that pro-
ple, with the underlying instrument trading at 50, a 45- tects existing profits in a trade.
strike call option with a premium of 8.50 has 3.50 of extrin- For simplicity, the following discussion is given in terms
sic value. of long trades. The rules are inverted for short trades. The
formula for calculating the parabolic stop level (P) for
Front month (or “nearest month”): The contract continued on p. 26
month closest to expiration.

In the money (ITM): A call option MANAGED MONEY

with a strike price below the price of
the underlying instrument, or a put
Top 10 option strategy traders ranked by October 2009 return.
option with a strike price above the
underlying instrument’s price. (Managing at least $1 million as of Oct. 31, 2009.)

Intrinsic value: The difference Oct. 2009 YTD $ under

between the strike price of an in-the- Rank Trading advisor return return mgmt.
money option and the underlying
asset price. A call option with a strike 1. CKP Finance Associates (Masters) 14.87% 256.69% 4.3
price of 22 has 2 points of intrinsic 2. Zephyr Investment (Defined Risk) 13.30% -9.71% 2.5
value if the underlying market is trad-
ing at 24. 3. Carter Road 12.00% 49.52% 2.1
4. ACE Investment Strategists (DPC) 9.86% 94.24% 24.2
Naked option: A position that
involves selling an unprotected call or 5. Financial Comm Inv (Option Selling) 7.45% 28.73% 12.8
put that has a large or unlimited
amount of risk. If you sell a call, for 6. Kingsview Capital Ptnrs 5.48% 8.76% 2.0
example, you are obligated to sell the 7. JPS Capital Mgmt (JPS Fund) 3.96% -14.11% 2.9
underlying instrument at the call’s
strike price, which might be below the 8. Oak Investment Group (Ag Options) 3.75% 57.29% 4.6
market’s value, triggering a loss. If you 9. Washington (Singleton Fund) 2.83% 35.99% 56.9
sell a put, for example, you are obligat-
ed to buy the underlying instrument at 10. Reynoso Asset Mgmt. (Options Arb.) 2.63% -4.42% 1.8
the put’s strike price, which may be
well above the market, also causing a
Source: Barclay Hedge (www.barclayhedge.com) Based on estimates of the composite of all
loss.
accounts or the fully funded subset method. Does not reflect the performance of any single account.
Given its risk, selling naked options
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
is only for advanced options traders,
and newer traders aren’t usually

FUTURES & OPTIONS TRADER • December 2009 25

 KEY CONCEPTS

tomorrow’s trading day (when using daily price bars) is:

Note that the acceleration factor increased from 0.02 to
Ptomorrow = Ptoday + AF(EPtrade - Ptoday) 0.04, and that the previous day’s parabolic value is now
where: used in the formula. The AF increases by 0.02 only for a bar
Ptoday = Today’s parabolic stop value. that establishes a new EP (high price) in the trade. If the
AF = Acceleration factor, the default value of which stock had not made a new high, the previous high of 26.50
begins at 0.02 and increases in 0.02 increments (for each would have been used as the EP and the AF would have
bar that establishes a new high during the trade) to a max- remained at 0.02.
imum of 0.20. The greater the acceleration factor, the more
“tightly” the stop follow prices. Parity: An option trading at its intrinsic value.
EP = The extreme price since the trade was initiated
(highest high if long, lowest low if short). Physical delivery: The process of exchanging a physical
commodity (and making and taking payment) as a result of
Assume a long trade was established yesterday in stock the execution of a futures contract. Although 98 percent of
XYZ at 25, with an initial stop-loss of 23 that is still in effect all futures contracts are not delivered, there are market par-
today. Today’s high of 26.50 was higher than yesterday’s ticipants who do take delivery of physically settled con-
high, which means it is the extreme price (EP in the previ- tracts such as wheat, crude oil, and T-notes. Commodities
ous formula) since the trade began. The calculations for generally are delivered to a designated warehouse; T-note
tomorrow’s parabolic stop level are then: delivery is taken by a book-entry transfer of ownership,
although no certificates change hands.
Ptomorrow = Ptoday + AF(Htoday – Ptoday)
where: Premium: The price of an option.
Ptoday = Today’s parabolic stop value
AF = Acceleration factor Put option: An option that gives the owner the right, but
Htoday = Today’s high (the extreme price) not the obligation, to sell a stock (or futures contract) at a
fixed price.
Because this is the first day of the calculation, there is no
parabolic stop level for today. This means we must use the Put ratio backspread: A bearish ratio spread that con-
initial stop for the trade (23) as Ptoday in the formula. tains more long puts than short ones. The short strikes are
Plugging in the hypothetical values results in: closer to the money and the long strikes are further from the
money.
Ptomorrow = 23 + 0.02(26.50 - 23) For example, if a stock trades at $50, you could sell one
Ptomorrow = 23 + 0.07 = 23.07 $45 put and buy two $40 puts in the same expiration month.
If the stock drops, the short $45 put might move into the
If tomorrow the stock rallies to a new high of 28, the par- money, but the long lower-strike puts will hedge some (or
abolic stop level for the following day would be: all) of those losses. If the stock drops well below $40, poten-
tial gains are unlimited until it reaches zero.
Ptomorrow = 23.07 + 0.04(28 - 23.07)
Ptomorrow = 23.07 + 0.1972 = 23.27 Put spreads: Vertical spreads with puts sharing the same

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26 December 2009 • FUTURES & OPTIONS TRADER

expiration date but different strike expiration. As expiration approaches, ied a market’s price changes from day
prices. A bull put spread contains time value decreases at an accelerated to day (or week to week, etc.), the more
short, higher-strike puts and long, rate, a phenomenon known as “time volatile that market is.
lower-strike puts. A bear put spread is decay.” A common application of variance in
structured differently: Its long puts trading is standard deviation, which is
have higher strikes than the short puts. True range (TR): A measure of the square root of variance. The stan-
price movement that accounts for the dard deviation of 8, 9, and 10 is: sq. rt.
Simple moving average: A sim- gaps that occur between price bars. 0.667 = .82; the standard deviation of 2,
ple moving average (SMA) is the aver- This calculation provides a more accu- 9, and 16 is: sq. rt. 32.67 = 5.72.
age price of a stock, future, or other rate reflection of the size of a price
market over a certain time period. A move over a given period than the Vertical spread: A position consist-
five-day SMA is the sum of the five standard range calculation, which is ing of options with the same expira-
most recent closing prices divided by simply the high of a price bar minus tion date but different strike prices
five, which means each day’s price is the low of a price bar. The true range (e.g., a September 40 call option and a
equally weighted in the calculation. calculation was developed by Welles September 50 call option).
Wilder and discussed in his book New
Straddle: A non-directional option Concepts in Technical Trading Systems Volatility: The level of price move-
spread that typically consists of an at- (Trend Research, 1978). ment in a market. Historical (“statisti-
the-money call and at-the-money put True range can be calculated on any cal”) volatility measures the price fluc-
with the same expiration. For example, time frame or price bar — five-minute, tuations (usually calculated as the
with the underlying instrument trad- hourly, daily, weekly, etc. The follow- standard deviation of closing prices)
ing at 25, a standard long straddle ing discussion uses daily price bars for over a certain time period — e.g., the
would consist of buying a 25 call and a simplicity. True range is the greatest past 20 days. Implied volatility is the
25 put. Long straddles are designed to (absolute) distance of the following: current market estimate of future
profit from an increase in volatility; 1. Today’s high and today’s low. volatility as reflected in the level of
short straddles are intended to capital- 2. Today’s high and yesterday’s close. option premiums. The higher the
ize on declining volatility. The strangle 3. Today’s low and yesterday’s close. implied volatility, the higher the
is a related strategy. option premium.
Average true range (ATR) is simply
Strangle: A non-directional option a moving average of the true range
spread that consists of an out-of-the- over a certain time period. For exam-
money call and out-of-the-money put ple, the five-day ATR would be the
with the same expiration. For example, average of the true range calculations
with the underlying instrument trad- over the last five days.
ing at 25, a long strangle could consist
of buying a 27.5 call and a 22.5 put. Variance and standard devia-
Long strangles are designed to profit tion: Variance measures how spread
from an increase in volatility; short out a group of values are — in other
strangles are intended to capitalize on words, how much they vary.
declining volatility. The straddle is a Mathematically, variance is the aver-
related strategy. age squared “deviation” (or differ-
ence) of each number in the group
Strike (“exercise”) price: The from the group’s mean value, divided
price at which an underlying instru- by the number of elements in the
ment is exchanged upon exercise of an group. For example, for the numbers 8,
option. 9, and 10, the mean is 9 and the vari-
ance is:
Time decay: The tendency of time
value to decrease at an accelerated rate {(8-9)2 + (9-9)2 + (10-9)2}/3 =
as an option approaches expiration. (1 + 0 + 1)/3 = 0.667

Time spread: Any type of spread Now look at the variance of a more
that contains short near-term options widely distributed set of numbers: 2, 9,
and long options that expire later. Both and 16:
options can share a strike price (calen-
dar spread) or have different strikes {(2-9)2 + (9-9)2 + (16-9)2}/3 =
(diagonal spread). (49 + 0 + 49)/3 = 32.67

Time value (premium): The The more varied the prices, the high-
amount of an option’s value that is a er their variance — the more widely
function of the time remaining until distributed they will be. The more var-

FUTURES & OPTIONS TRADER • December 2009 27

 FUTURES TRADE JOURNAL

Resistance fails to repel market.

TRADE

Date: Wednesday, Nov. 18.

Entry: Short December 10-year T-notes

(TYZ09) at 119-14/32.

Reason for trade/setup: This paper trade

was based on the simple premise of resistance
— in this case, the October high of 119-29. The
market came up just a couple ticks short of
that level on Nov. 17 before sagging intraday
on Nov. 18. We want to give the trade enough
room to pop above the prior high without get-
ting stopped out prematurely. Source: TradeStation
Although the market could ultimately move
higher, we look for a retracement into the pre-
vious congestion (below 119) before the con- mate level of the October high for a couple days after entry
tract rallies significantly. and closed down on Nov. 20 after trading to 120. The trade
looked okay until the market recovered intraday from the
Initial stop: 120-26. sharp drop on Nov. 23 to close near the top of the day’s
range. Strong follow-through the next two trading days
Initial target: 118-09. brought price to within a dozen ticks of the stop on Nov. 25.
Ultimately, though, the resistance was nothing more than a
Secondary target: 117-04. chart mirage — even though the market paused for a few
days around that level, price soon blasted through it on its
way to a new high above 121.
RESULT
Note: Initial targets for trades are typically based on things such as the
Exit: 120-26/32.
historical performance of a price pattern or trading system signal.
However, individual trades are a function of immediate market behavior;
Profit/loss: -1-12/32. initial price targets are flexible and are most often used as points at which
a portion of the trade is liquidated to reduce the position’s open risk. As a
Outcome: The market bumped up against the approxi- result, the initial (pre-trade) reward-risk ratios are conjectural by nature.

TRADE SUMMARY
P/L
Date Contract Entry price Initial stop Initial target IRR Exit Date Point % LOP LOL Length

11/182/09 TYZ09 119-14 120-26 118-09 .84 120-26 11/26/09 -1-12 -1.15% 10/32 -1-12 6 days

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).

28 December 2009 • FUTURES & OPTIONS TRADER

 OPTIONS TRADE JOURNAL

FIGURE 1 — MORNING JOLT

We bought ITM calls after SPY opened 1.2 percent higher on Nov. 23.
We exited at a small profit before the market cooled down.

Catching the last stage

of a bullish open with long calls.

TRADE

Date: Monday, Nov. 23.

Market: Options on the S&P 500 tracking

stock (SPY).

Entry: Buy two December 110 calls for 2.71

each.

Reasons for trade/setup: When SPY Source: eSignal

gapped higher by 1.2 percent on Nov. 23, it was
unclear where the market might be headed Figure 1 shows we bought two December 110-strike calls
(Figure 1). for $2.71 each at 9:35 a.m. ET when SPY traded at 111.07.
Historical testing shows opening gaps tend to be filled, Figure 2 shows the position’s potential gains and losses on
meaning price will likely drop to yesterday’s high. On the the entry date (Nov. 23). The trade’s risk profile is compa-
other hand, the stock market has been unusually bullish rable to 100 shares of SPY, but we can only lose $2.71 per
since March, and buying dips has been a profitable strategy. share.
SPY fell 2.4 percent in the four days before today’s gap The goal is to capture a quick, small gain, and we plan to
higher, so this bounce might continue, if only briefly. exit if SPY climbs 0.6 percent to its Nov. 16 high. Otherwise,
Moreover, the week surrounding the Thanksgiving has we plan to hold the trade up to a week.
been historically bullish as the S&P 500 gained a median 0.6 continued on p. 30
percent from 1983 to 2007. In 2008, the S&P jumped 11.6
percent on Thanksgiving week as the financial panic began TRADE SUMMARY
to subside.
Buying in-the-money (ITM) calls is one of the easiest Entry date: Monday, Nov. 23, 2009
ways to take a bullish stance. Their directional exposure,
Underlying security: S&P 500 tracking stock (SPY)
measured by delta, is similar to buying the underlying out-
right. If SPY climbs, ITM calls should increase in value Position: 2 long December 110 calls
accordingly and time value is less of a problem, especially Initial capital required: $542
with short-term trades. Initial stop: Exit if SPY drops below 110.71.
Initial target: Hold one week or until SPY hits 111.69.
TRADE STATISTICS Initial daily time decay: $8.62
Time: 9:25 a.m. 9:50 a.m. Trade length: 1 day
Delta: 117.5 126.6 P/L: $28 (5.2%)
Gamma: 15.52 14.9 LOP: $28
Theta: -8.62 -8.55
LOL: $0
Vega: 23.4 23.2
LOP — largest open profit (maximum available profit during life of trade).
Probability of profit: 39% 42%
LOL — largest open loss (maximum potential loss during life of trade).
Breakeven point: $112.71 $112.71

FUTURES & OPTIONS TRADER • December 2009 29

 TRADING STRATEGIES

Initial stop: Exit if SPY falls below FIGURE 2 — RISK PROFILE — LONG CALLS
today’s low of 110.71. Buying ITM calls is an easy and cheap way to exploit brief rallies.

Initial target: Hold over

Thanksgiving week unless SPY hits
its Nov. 16 high of 111.69.

RESULT

Outcome: Figure 2 shows SPY con-

tinued to rally after we entered, but
we had second thoughts as the mar-
ket climbed above Nov. 19’s high.
SPY stalled around 111.50 last week,
and holding a long position near this
resistance level made us nervous.
We sold the calls at a per-share
profit of 0.14. In hindsight, the trade
didn’t make much sense, but exiting
early helped us avoid losses. Source: OptionVue

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30 December 2009 • FUTURES & OPTIONS TRADER