Futures and Options Traders December 2008

December 2008 • Volume 2, No. 12

LATE-DAY FUTURES strategy p. 10

A NEW PHASE for gold traders?

A SHORT-STRADDLE trading edge p. 15

TRADING OPTIONS with the RSI p. 20 New energy futures p. 24

p. 22

CONTENTS

Futures Insight A new trend for gold? . . . . . . . . . . . . . . . . .22 Gold futures rocketed to an all-time high earlier this year, but surprised many market watchers by declining when the stock market imploded. By FOT Staff

News New energy contracts flood the major futures markets . . . . . . . . . . . . . .24 Contracts offering further access to crude,

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

coal, and electricity markets debut on CME Group and ICE platforms.

Market Movers . . . . . . . . . . . . . . . . . . . . . . . .6 Futures markets are down across the board

Options trade volume

as traders and investors divest themselves

falls in November . . . . . . . . . . . . . . . . . . . . .26 Options volume declines, but volatility

of holdings.

remains high in November.

Trading Strategies Trading the pit’s last trend . . . . . . . . . . . . .10 A short-term system triggers off the momentum at the end of the S&P 500 pit session.

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .28 Momentum, volatility, and volume statistics for futures.

By Boris Stein

Option Radar . . . . . . . . . . . . . . . . . . . . . . . . . .29 Searching for the short-straddle edge . . .15 The short straddle shows the potential for outperforming the underlying market in some

Notable volatility and volume in the options market. continued on p. 4

situations — especially on a risk-adjusted basis. By Tristan Yates

Options Trading System Lab Timing reversals with the RSI . . . . . . . . . .20 A credit-spread system tries to capture the maximum amount of premium just before the market reverses. By Steve Lentz and Jim Graham

2

December 2008 • FUTURES & OPTIONS TRADER

”Nobody tells me how to trade.“ They’re called “mavericks,” “individualists,” even “revolutionaries.” But they don’t care what they’re called, as long as they’re called “right.” These traders aren’t afraid to go it alone. Confident in their analysis, back-testing and rule-based trading. That’s why they’re also called something else: TradeStation Members.

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IMPORTANT INFORMATION: No offer or solicitation to buy or sell securities, securities derivative or futures products of any kind, or any type of trading or investment advice, recommendation or strategy, is made, given or in any manner endorsed by TradeStation Securities, Inc. or any of its affiliates. • Past performance, whether actual or indicated by historical tests of strategies, is no guarantee of future performance or success. • Active trading is generally not appropriate for someone of limited resources, limited investment or trading experience, or low-risk tolerance. • There is a risk of loss in futures trading. Options and Security Futures trading is not suitable for all investors. Please visit our Web site for relevant risk disclosures. • System access and trade placement and execution may be delayed or fail due to market volatility and volume, quote delays, system and software errors, Internet traffic, outages and other factors. • All proprietary technology in TradeStation is owned by TradeStation Technologies, Inc., an affiliate of TradeStation Securities, Inc. • Trading foreign exchange carries a high level of risk and may not be suitable for all investors. There is a possibility that you may sustain a loss equal to or greater than your entire investment; therefore, you should not invest or risk money that you cannot afford to lose. You should be aware of all risks associated with foreign exchange trading. Barron’s awards are based on a review of TradeStation’s brokerage products and services by a Barron’s journalist. Barron’s is a registered trademark of Dow Jones & Company. Leader in Rule-Based Trading tag line based on industry awards and reviews. © 2008 TradeStation Securities, Inc. All rights reserved.

CONTENTS

Futures & Options Watch COT extremes . . . . . . . . . . . . . . . . . . . . . . .30 A look at the relationship between commercials and large speculators in all 45 futures markets.

Options Watch: Consumer discretionary ETF components . . .30

New Products and Services . . . . . . . . . . . . .38 Futures Trade Journal . . . . . . . . . . . . . . .39

Futures & Options Calendar . . . . . . . . . . . .31

Short-term trades in stock-index futures pose risk-management challenge.

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .32 Options Trade Journal . . . . . . . . . . . . . . .40

References and definitions.

Betting on a market crash leaves this

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36

short trade in pieces.

Have a question about something you’ve seen in Futures & Options Trader? Submit your editorial queries or comments to [email protected].

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December 2008 • FUTURES & OPTIONS TRADER

CONTRIBUTORS CONTRIBUTORS

A publication of Active Trader ®

For all subscriber services: www.futuresandoptionstrader.com Editor-in-chief: Mark Etzkorn [email protected] Managing editor: Molly Goad [email protected]


Tristan Yates is the author of Enhanced Indexing Strategies: Utilizing Futures Senior editor: David Bukey [email protected] Contributing editor: Keith Schap Associate editor: Chris Peters [email protected] Editorial assistant and Webmaster: Kesha Green [email protected] Art director: Laura Coyle [email protected] President: Phil Dorman [email protected] Publisher, Ad sales East Coast and Midwest: Bob Dorman [email protected] Ad sales West Coast and Southwest only: Allison Chee [email protected] Classified ad sales: Mark Seger [email protected] Volume 2, Issue 12. Futures & Options Trader is published monthly by TechInfo, Inc., 161 N. Clark Street, Suite 4915, Chicago, IL 60601. Copyright © 2008 TechInfo, Inc. All rights reserved. Information in this 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 meant to recommend, promote, or in any way imply the effectiveness of any trading system, strategy, or approach. Traders are advised to do their own research and testing to determine the validity of a trading idea. Trading and investing carry a high level of risk. Past performance does not guarantee future results.

FUTURES & OPTIONS TRADER • December 2008

and Options to Achieve Higher Performance (Wiley, 2009). His articles on leveraged portfolio management and derivative strategies have been published and distributed through Investopedia, Yahoo Finance, Forbes, Kiplinger, and MSN Money and his research has been cited in the Wall Street Journal, Index Universe Europe, and Canadian Business. He has an MBA from INSEAD in Singapore, lives in Bethesda, Md., and can be reached at [email protected].
Boris Stein ([email protected]) is the president and sole owner of Stein Investment Management LLC (http://www.steininvestment.com) and Able World Trading LLC (http://www.ableworldtrading.com), which are registered with the National Futures Association as Commodity Trading Advisor and Introducing Brokerage firms, respectively. Stein holds master’s degrees in physics and computer science and has been developing trading systems and trading futures for 13 years. He used his mathematical background, knowledge of markets, and scientific methods of research to develop new technical trading ideas and systems as well as innovative asset-management approaches. Stein won second place in the futures division of the World Cup Trading Championship 2006 (sponsored by Robbins Trading Company), and he is a member of the WorldCupAdvisor.com team. Stein currently manages money of both institutions and private clients. Stein and his CTA have been featured in many professional publications.
Steve Lentz ([email protected]) is a well-established options educator and trader and has spoken all over the U.S., Asia, and Australia on behalf of the CBOE’s Options Institute, the Options Industry Council, and the Australian Stock Exchange. As a mentor for DiscoverOptions.com, he teaches select students how to use complex options strategies and develop a consistent trading plan. Lentz is constantly developing new strategies on the use of options as part of a comprehensive profitable trading approach. He regularly speaks at special events, trade shows, and trading group organizations.
Jim Graham ([email protected]) is the product manager for OptionVue Systems and a registered investment advisor for OptionVue Research.

5

MARKET MOVERS

Markets still sorting things out as volatility drops In early December exhaustion appeared to be getting the better of the futures markets, with most contracts solidifying relatively narrow trading ranges or jerking up and down in search of equilibrium in the aftermath of October’s sharp losses. For the most part the overall bias was still lower, although most markets seemed content to simply probe recent lows rather than blast through them. The chart of the Rogers TRAKRS (RCTY), which reflect the performance of the Rogers International Commodity Index, tells the tale: the relentless decline of the past several months and the recent stagnation, highlighted here by the sharp drop in the ratio of 20-day volatility to 125-day volatility. In November crude oil, OJ, and rice were weaker than most Source for all: TradeStation commodities, and there were also a few small, random gains toward the end of the month (e.g., cotton), but for the most part the recent theme has been congestion. Treasury futures were the one exception, posting a strong bull move in November and solidifying (somewhat belatedly) their safe-haven status.

Energy January crude oil (CLF09) dropped below $50/barrel for the second time in less than a week on Dec. 1, following through on the move the next day to trade below $45 on Dec. 4 — less than a third of the contract’s price in July. While gasoline (RB) and natural gas (NG) were merely flirting with their November lows in early December, January heating oil (HOF09) joined crude in setting fresh contract lows.

Metals Continuing its seesaw trading, gold (GC) closed November strong and recaptured some of its big October loss — only to lose $50/ounce on the first day of trading in December. February gold (GCG09) traded as low as 768.20 on Dec. 1 and dropped as low as 761 the next day — closing a little less than $100 above the October low but $150 below the October high of 938.80. See Futures Insight for more gold futures analysis. 6

Grains Grains were mostly quiet in November, extending the trading ranges they were building a month ago, with corn and rice showing the most weakness in late November and early December. December 2008 • FUTURES & OPTIONS TRADER

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MARKET MOVERS continued

Softs and fibers Coffee, sugar, and cocoa mostly traded sideways throughout November and the beginning of December, with cocoa showing — if not exactly strength — the least weakness. Two “auxiliary” softs, orange juice (OJ) and cotton (CT), were a little more active — OJ pushing to the downside at the outset of December, while cotton showed minor strength in late November.

Meats Pork appeared to have a hoof up on beef in November and early December, with bounces in pork bellies (PB) and especially lean hogs (HG) outshining the relatively flat live cattle (LC) market.

Currencies In November the March U.S. dollar futures (DXH09) contract topped its October high but for the most part bumped sideways into early December. Detailed coverage of the forex market is available in the current issue of Currency Trader magazine (http://www.currencytradermag.com).

8

Treasuries November’s least ambiguous move came in Treasury futures, which rallied as equities remained under pressure. March 10-year T-note futures (TYH09) traded to new highs in early December, along with 5-year (FV), 2-year (TU), and 30-year bond (US) futures.

Stock indices The trajectory of the decline became less severe, but stock-index futures nonetheless pushed to news lows in November before rallying into the end of the month — only suffering a huge down day on Monday, Dec. 1, the day the National Bureau of Economic Research “officially” announced the U.S. was in a recession and had been since December 2007. (Thanks for the heads up.) The December E-Mini S&P 500 futures (ESZ08) dropped more than 9 percent intraday and closed down nearly as much. Detailed coverage of the stock market and the financial crisis can be found in the current issue of Active Trader magazine (http://www.activetradermag.com). December 2008 • FUTURES & OPTIONS TRADER

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TRADING STRATEGIES

Trading the pit’s last trend Testing a short-term system that thrives on momentum in the last few minutes of the S&P 500 pit session. BY BORIS STEIN Strategy Snapshot

G

iven the amount of jockeying that occurs just before U.S. stock market closes each day, the closing price is arguably the most important price of the day. And the largest amount of volume in stock-index futures typically occurs during the last 15 minutes of pit trading — 3:00 to 3:15 p.m. CT. If the closing price is as important as it seems, the market’s trend just before the close should be worth following. The following short-term strategy is based on this premise. It enters in the direction of the last trend of the day and holds it overnight, if necessary. The system is designed for the pit-traded S&P 500 index

Strategy: Late-afternoon scalping technique Market: Any stock-index futures that trades in the pit. Logic: Market will continue in direction of today’s last trend. Timing: Enter at 3:10 p.m. CT and exit with a gain when the pit closes at 3:15 p.m. Otherwise, hold overnight and exit at 8:35 a.m. the next morning. Possible modifications: Add stop-loss and profit targets.

FIGURE 1 — QUICK SCALP By entering in the direction of the S&P 500 futures’ last trend, the system gained roughly five points ($1,250) within five minutes on Oct. 23. Luckily, the system exited by the close, because the market tanked overnight.

Source: TradeStation 8.3

10

December 2008 • FUTURES & OPTIONS TRADER

TABLE 1 — PERFORMANCE RESULTS

futures (SP), but it can also be applied to other pit-traded stock index futures, such as the Nasdaq 100 (ND), Dow (DJ), as well as the E-Mini contracts — E-Mini S&P 500 (ES) and E-Mini Nasdaq 100 (NQ).

This strategy gained 80.52 percent since November 2003 with a drawdown of 33 percent. All trades

Long trades

Short trades

Total net profit

$80,520.00

$47,055.00

$33,465.00

Gross profit

$352,140.00

$171,625.00

$180,515.00

Gross loss

-$271,620.00

-$124,570.00

-$147,050.00

Profit factor

1.3

1.38

1.23

Identifying late-afternoon trends

Total number of trades

1082

523

559

Percent profitable

78.93%

83.17%

74.96%

Although the U.S. stock market closes at 3 p.m. CT, stockindex futures trade in the pit for another 15 minutes before they shift to the electronic market. (The E-Mini futures also stop trading at 3:15 and restart at 3:30 p.m.) The idea behind this system is the S&P 500 futures will continue to move in the same direction as the last trend of the day, which is identified as the move from the day’s high or low — whichever appears last — to the S&P 500 futures’ closing

Winning trades

854

435

419

Losing trades

228

88

140

Avg. trade profit

$74.42

$89.97

$59.87

Avg. winning trade

$412.34

$394.54

$430.82

Avg. losing trade

-$1,191.32

-$1,415.57

-$1,050.36

Avg. win-to-loss ratio

0.35

0.28

0.41

Largest winning trade

$6,985.00

$6,485.00

$6,985.00

Largest losing trade

-$14,390.00

-$14,390.00

-$9,340.00

Largest winner as % of gross profit

1.98%

3.78%

3.87%

Largest loser as % of gross loss

5.30%

11.55%

6.35%

Net profit as % of largest loss

559.56%

327.00%

358.30%

Max. close-to-close drawdown

-$33,100.00

-$28,125.00

-$29,245.00

Drawdown as % of initial capital

33.10%

28.13%

29.24%

Net profit as % of drawdown

243.26%

167.31%

114.43%

continued on p. 12

Source: TradeStation 8.3

FIGURE 2 — HOLDING A LONG TRADE OVERNIGHT Holding this long trade overnight turned it into a winner as the S&P 500 futures opened roughly 10 points higher.

Source: TradeStation 8.3

FUTURES & OPTIONS TRADER • December 2008

11

TRADING STRATEGIES continued

FIGURE 3 — EQUITY CURVE

price at 3:10 p.m. (five minutes before the close). If the market rises to an intraday high most recently and then falls to the 3:10 p.m. close, the system sells short. If the market drops to an intraday low most recently and climbs to the 3:10 p.m. close, the system goes long. If profitable, the strategy exits the trade when the S&P 500 futures pit closes at 3:15 p.m. If not, it holds the trade overnight and exits at 8:35 a.m. — five minutes after the U.S. stock market opens. This system is a simple model that tries to predict the market’s direction for the last five minutes of today’s trading. Accordingly, it doesn’t use any stoplosses, profit targets, or optimization techniques, any of which could be used to augment the basic signal. Instead, the system uses a simple time stop, exiting within five minutes or shortly after tomorrow’s opening bell.

Despite the recent meltdown in financial markets, this short-term strategy was on a roll from April to October 2008 and hit a new equity high.

Source: TradeStation 8.3

TABLE 2 — TRADE ANALYSIS The system’s longest string of winning trades (19) lasted almost four times longer than its longest series of losing trades (5). All trades

Long trades

Short trades

Max. consecutive winning trades

19

23

16

Max. consecutive losing trades

5

3

5

1.45 1.3 2 $33,100.00 $16,230.00 80.52% 11.83% -17.84% 243.26% $978.62

1.41 1.29 2 $28,125.00 $7,845.00

1.48 1.31 2 $29,245.00 $8,385.00

Avg. bars in total trades Avg. bars in winning trades Avg. bars in losing trades Account size required Total commission Return on initial capital Annual rate of return Buy-and-hold return Return on account Avg. monthly return Std. deviation of monthly return Sharpe ratio Percent of time in market Longest flat period Source: TradeStation 8.3

12

$5,437.95 0.27 31.58% 6 days, 6 hours, 40 minutes

Trade rules: 1. Go long at 3:10 p.m. CT if the market’s daily low follows its daily high and the current price is higher than that day’s low. 2. Sell short at 3:10 p.m. CT if the market’s daily high follows its daily low and the current price is lower than that day’s high. 3. Exit at a profit when the S&P 500 pit closes at 3:15 p.m. Otherwise, hold the trade overnight and exit at 8:35 a.m. Figure 1 shows a chart of fiveminute bars in the December S&P 500 December 2008 • FUTURES & OPTIONS TRADER

TradeStation code The entry and exit strategies should be saved and verified in TradeStation as separate strategies, and then applied to the same @SP.P intraday 5-min chart. {Entry Strategy: Last Trend In The Pit. By: B.Stein Use on 5-min @SP.P chart.} var: BarsToOpen(0); if t=calctime(sessionendtime(0,2), -barinterval) {1 bar before the last bar of the day} then begin value1=(TimeToMinutes(SessionEndTime(0,2)) TimeToMinutes(Sess1FirstBarTime))/barinterval; BarsToOpen=Iff(FracPortion(value1)=0, value1, IntPortion(value1)+1); value2 = MRO(h=highd(0),BarsToOpen,1); {bars to latest high of day} value3 = MRO(l=lowd(0),BarsToOpen,1); {bars to latest low of day} if value2>0 and value3>0 {both extremes found} and d=d[value2] and d=d[value3] {both for the same day} then begin if c > lowd(0) and value3 < value2 {low happened after high} then buy("NTrendLE") next bar market; if c < highd(0) and value2 < value3 {high after low} then sellshort("NTrendSE") next bar market; end; end;

contract with $15 slippage and commissions per round-trip trade. Table 1 lists the system’s performance statistics. The strategy gained a total $80,520 with a maximum closeto-close drawdown of $33,100. The system traded every day for a total of 1,082 trades — 523 long and 559 short. The 78.93-percent winning percentage was quite high. Long trades were profitable slightly more often than short trades (83.17 percent vs. 74.96 percent, respectively). However, although most trades were winners, the average losing trade was nearly three times as large as the average winning trade. The strategy’s average trade was $74.42, and its profit factor (gross profit/gross loss) was 1.30. Table 2 shows the strategy’s trade analysis. The longest series of winning continued on p. 14

{Exit Strategy: Exit On Profitable Bar Close. By: B.Stein} input:BarsInTrade(1); if positionprofit > 0 or barssinceentry>= BarsInTrade then begin Sell("PTExitLong") this bar on close; Buytocover("PTExitShort") this bar on close; end;

futures (SPZ08) on Oct. 23 and highlights a profitable long trade that gained more than five points in the last five minutes of the day. Fortunately, the system exited with a profit at the close. If it hadn’t, the trade would have faced huge losses the next morning. Figure 2 shows a winning long trade that was held overnight on Oct. 6. After going long, the trade was in the red by the close at 3:15. However, the S&P 500 futures opened up more than 10 points the next morning, and the trade captured a roughly 6-point profit. You can use discretion when exiting a profitable trade at the open. If profits

are large enough, you can exit immediately. This tactic may produce better results, but is more difficult to back test. One weakness is the system trades almost every day and is vulnerable to large overnight moves, which may move sharply against it. However, overnight moves in the right direction could rack up profits.

Performance results The system was tested on five-minute bars in S&P 500 futures from Nov. 3, 2003 to Oct. 31, 2008. Overall, the strategy was profitable, even in the current volatile market, based on trading one

FUTURES & OPTIONS TRADER • December 2008

13

TRADING STRATEGIES continued

Related reading trades was 19, and the longest series of losing trades was five. Figure 3 shows the system’s equity curve during the five-year test period. The strategy’s most difficult period was Jan. 17 to April 8, 2008. After this drawdown, the system climbed to a new equity high during the recent market turmoil.

Ideas for further research Despite its simplicity, the system remained profitable in historical testing over the past five years. However, markets are always changing, so there is no guarantee this approach will be as successful in the future. Adding a stop-loss could improve performance by minimizing large losses. Another idea is to modify the time period used to define the final trend. Instead of waiting until 3:10 p.m., you might be able to enter the market immediately after the U.S. stock market closes. Also, a filter could be added to confirm trade signals. For example, you could decide to hold a trade overnight only if another signal or strategy pointed in the same direction.
For information on the author see p. 5.

“Night and day in stock index futures,” Active Trader, May 2008. Forget about whether the futures are up or down before the morning bell. Analyzing the entire range of the night session and putting this information in the context of the previous day’s price action sheds more light on what will happen in the upcoming day session. “Clashing closes: Index vs. Futures,” Active Trader, February 2007. Certain patterns emerge when analyzing what happens when the major stock indices and their futures close in opposite directions. “E-Mini morning reversal and afternoon breakout patterns” Active Trader, January 2006. Two simple ideas provide the basis for an intraday trading approach. These daytrading techniques were tested on the E-Mini Nasdaq 100 (NQ), E-Mini S&P 500 (ES), and E-Mini Russell 2000 (ER2) futures contracts. “Following through in the S&Ps,” Active Trader, December 2003. Strong closes and large ranges are often interpreted as signs of potential follow through, but this study shows another way to find out what today’s market action says about tomorrow’s — analyzing the NYSE up-down volume statistics at the close of the day to see if there is any consistent follow-through price action in the E-Mini S&P 500 futures the next day. “Getting in on follow-through days,” Active Trader, January 2004. In a follow-up to last month’s article discussing the odds of next-day followthrough in the S&P futures, a trader looks at the realities of basing entries on this price behavior. Several of these articles are included in the “Stock-index futures trading collection,” a 16-article set that covers a variety of techniques for analyzing and trading futures on benchmark stock indices such as the S&P 500, Nasdaq 100, Russell 2000, Dow Industrials, and others. The collection is now for sale at a 30percent discount in our online store. You can purchase and download past articles at http://store.activetradermag.com.

Three good tools for targeting customers . . .

— CONTACT — Bob Dorman Ad sales East Coast and Midwest [email protected] (312) 775-5421 14

Allison Chee Ad sales West Coast and Southwest [email protected] (415) 272-0999

Mark Seger Account Executive [email protected] (312) 377-9435

December 2008 • FUTURES & OPTIONS TRADER

TRADING STRATEGIES

Searching for the short-straddle edge The difference between implied and actual volatility offers an advantage for selling straddles on the S&P 500. BY TRISTAN YATES

W

ith the S&P 500 down 44 percent so far in you plan to sell a one-month, ATM straddle on a stock trad2008, traders are licking their wounds and ing at $100. Assume you sell one 100-strike call expiring in playing defense. They are focused on pro- 30 days for $3.10 and sell one same-strike 30-day put for tecting capital, not pursuing aggressive continued on p. 16 strategies such as selling naked puts and calls. TABLE 1 — SHORT STRADDLE EXAMPLE Selling a naked call or put entails a great deal of A short straddle is created by selling a put and a call with the same strike price and risk, because if the market expiration date. moves in the wrong direcPosition Expiration Long/short Credit tion when the option 1 100-strike call 30 days Short $3.10 expires, you may be forced 1 100-strike put 30 days Short $2.90 to buy or sell the underlying at an unfavorable price. Total credit: $6.00 However, one advantage of selling options is that Max. profit: $6.00 regardless of what happens Max. loss: Unlimited in the underlying market Upside breakeven point (at expiration): $106.00 you keep the premium, Downside breakeven point (at expiration): $94.00 which acts as a cushion against losses. Option premiums climb FIGURE 1 — SHORT STRADDLE RISK PROFILE in volatile markets as options sellers The short straddle’s $6 maximum profit occurs at the $100 short strike. Losses demand compensation for increased can mount if the underlying strays too far from the strike price. risk. Clearly, selling options is riskier in extremely volatile markets such as the current one, but the potential rewards are also much higher. Nonetheless, options strategies that appear risky have the potential to be safer than a simple buy-and-hold approach, especially over long periods. As evidence, let’s compare the historical performance of the short straddle, which contains one short at-themoney (ATM) call and one short ATM put, to the performance of the S&P 500 index tracking stock (SPY) over the past 16 years.

Short straddle mechanics A short straddle is created by selling a put and a call with the same strike price and expiration date. Suppose

Source: OptionVue

FUTURES & OPTIONS TRADER • December 2008

15

TRADING STRATEGIES continued

FIGURE 2 — SHORT STRADDLE PERFORMANCE The largest profits occur when SPY goes nowhere, while the biggest losses result from SPY moving sharply higher or lower.

FIGURE 3 — SHORT STRADDLES, 1993 TO 2008 With the VIX in the stratosphere, short-straddle performance has been volatile in 2008. The strategy lost 17.6 percent in October, its largest loss in more than 16 years.

Figure 1 shows the short straddle’s maximum profit of $6 occurs at the strike price. If the underlying rallies or falls significantly, losses mount on a point-for-point basis. For example, if the underlying either falls to $90 or climbs to $110, the short straddle will lose $4 ($6 premium - $10 loss). The short straddle’s breakeven points depend on the total premium collected. In Figure 1, the position loses ground if the underlying climbs or drops by more than $6 — below $94 or above $106. Because an option’s time decay accelerates in the last two weeks of its life, you need to hold a short straddle until expiration to capture its maximum profit. However, when volatility is climbing, as it was in October, to limit risk you should consider exiting the trade early. A practical limitation of the strategy is not all brokerage firms will let you sell short straddles because the short call faces theoretically unlimited upside risk (a short put’s risk is limited to the underlying dropping to zero). You may have to trade an iron condor instead by purchasing cheap out-of-the-money (OTM) puts and calls to reduce risk. You won’t collect as much premium, but the goal remains the same.

The importance of implied volatility

$2.90 — a total of $6.00 collected premium. Table 1 lists the trade’s details and Figure 1 shows its potential gains and losses on three dates: trade entry (dotted line), halfway to expiration (dashed line), and expiration (solid line). One advantage of a short straddle is either the put or call is guaranteed to expire worthless. If the underlying rallies, the call will have value and the put will expire worthless, but if the market drops, the call will expire worthless and the put will have value. 16

Implied volatility (IV) is the most important factor in an ATM straddle’s cost, influencing its potential gains and losses, profitability range, and breakeven points. This study measures changes in both the S&P 500 tracking stock (SPY) and the CBOE volatility index (VIX). To simulate a short straddle’s performance, the study tracked an ATM call and put each month from January 1993 to October 2008. The position’s gains or losses were based on SPY’s changes from one option expiration date to the next. Figure 2 compares the monthly performance of SPY to ATM short straddles over the past 16 years, according to low, medium, and high VIX readings (green, blue, and red dots, respectively). Transaction costs are excluded. The results form an upside-down v-shaped distribution that resembles Figure 1’s risk profile. Again, the largest December 2008 • FUTURES & OPTIONS TRADER

TABLE 2 — SHORT STRADDLES, 2008 Short straddles beat a simple buy-and-hold approach in the first 10 months of 2008, even if October’s dismal performance is included. SPY fell 28.8 percent from January to October, while a short-straddle technique lost just 6.9 percent overall.

profits occur when SPY Short straddles goes nowhere, while the Entry SPY percentage ATM ATM Percentage biggest losses appear date VIX SPY return call put gain/loss when SPY moves sharply 1/18/08 27.2 130.0 2.3 3.3 2.9 3.9 up or down. 2/15/08 25.0 133.0 -1.8 3.1 2.7 3.9 As volatility increases, 3/20/08 26.6 130.7 4.8 3.2 2.8 1.2 the trade’s potential risks 4/18/08 20.1 137.0 3.0 2.5 2.1 1.6 and rewards increase. When the VIX was below 5/16/08 16.5 141.1 -7.3 2.1 1.7 -3.5 18, the short straddle’s 6/20/08 22.9 130.8 -4.3 2.8 2.4 1.0 monthly performance was 7/18/08 24.1 125.3 3.3 3.0 2.5 2.2 relatively stable — from -3 8/15/08 19.6 129.4 -4.1 2.4 2.0 0.4 percent to 3 percent. 9/19/08 32.1 124.1 -24.9 3.9 3.5 -17.6 But when the VIX was above 18 (blue and red Total: -28.8 -6.9 dots), the position began to post 5- or 10-percent losses more often. As the VIX climbed to 89.53 in October, the short FIGURE 4 — EQUITY CURVE COMPARISON straddle lost 17.6 percent, its largest Overall, a short-straddle approach gained 37.7 percent more than SPY in the decline in the 16-year test period. past 16 years. Despite the risk, though, the strategy earned as much as 5 or 6 percent per month fairly often in volatile markets.

Bull vs. bear markets Figure 3 plots the short straddle’s monthly performance in chronological order. In 1997 the market’s volatility increased significantly, a situation that held until late 2003 (the green dots change to blue and red dots). When volatility was high, the short straddle’s gains and losses were larger than usual. The approach occasionally earned more than 5 percent, but it also lost ground during four consecutive months in 2002, two of which had losses of 6 and 8 percent. Take a look at the returns surrounding the technology-stock bust in 2000. Short-straddle performance became volatile in 1999 before the market downturn occurred, and the strategy’s returns remained volatile after the next bull market appeared in 2003. With the VIX in the stratosphere in 2008, shortstraddle performance, which includes October’s historic 17.6-percent loss, has also been volatile. Table 2 compares the monthly performance of SPY and short straddles from January to October 2008. Each position was entered at the close of a previous monthly options cycle and

Strategy Snapshot Strategy: Short straddle. Components: Sell one ATM call and one ATM put with the same strike price and expiration date. Logic: The premium collected from selling both options will exceed any losses that occur when the underlying climbs above or drops below the strangle’s strike price. Best-case The underlying goes nowhere, scenario: closing at the short strike at expiration. Worst-case The underlying rallies or falls sharply, causing large losses in one scenario: of the options that exceed the collected premium.

continued on p. 18

FUTURES & OPTIONS TRADER • December 2008

17

TRADING STRATEGIES continued

TABLE 3 — ANNUAL RETURNS, 1993 TO 2008 The short straddle’s yearly performance was more consistent than buy-and-hold, gaining ground in all but one year (2008 so far). Year *1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 *2008 Cumulative total

SPY 10.5 2.5 30.0 26.6 23.2 28.8 17.6 -5.5 -12.3 -17.5 25.7 4.6 9.9 14.2 -4.6 -28.8 125.0

Short straddle 15.3 17.3 2.9 2.6 24.1 6.6 23.1 21.6 0.0 6.5 19.4 11.0 5.9 11.4 1.9 -6.9 162.7

Difference 4.8 14.7 -27.1 -24.0 0.8 -22.3 5.5 27.2 12.3 24.1 -6.3 6.4 -4.0 -2.8 6.5 21.9 37.7

straddles only lost money in two of those months. Short straddles lost ground only when SPY dropped sharply — 7.3 percent in May and 24.9 percent in October. And those losses were smaller than SPY’s. As a comparison, in the summer of 2002, SPY dropped about 25 percent within two months. By contrast, the shortstraddle approach lost only 14.5 percent. Overall, short straddles were less risky than SPY over long periods, but the strategy was still vulnerable during short-term periods.

Beating the market

Figure 4 compares the equity curves of $100 invested in short straddles vs. SPY outright (blue vs. green lines, respectively) from 1993 to 2008 (assets not reinvested). In the 1990s the short straddle lagged SPY, although its cumulative performance was much more consistent than SPY’s, especially during the 2000 to 2003 downturn. When SPY fell sharply, short straddles still suffered, but they tended to recover quicker than SPY. Table 3 compares the yearly gains and losses for SPY and short straddles in the past 16 years. Both strategies’ cumulative and average performance is included, along with standard deviations and the largest annual gains and losses. Avg: 7.8 10.2 2.4 Overall, selling straddles earned 37.7 percent more than StDev: 17.8 9.2 -8.6 SPY during this period — 65 percent more if you had reinMin: -28.8 -6.9 21.9 Max: 30.0 24.1 -6.0 vested profits (not shown). In addition, the short straddle yearly performance was more consistent than buy-and*Partial year hold, as the strategy gained ground in all but one year (2008 so far). The short-straddle approach gained an average 10.2 percent annuTABLE 4 — THE VIX FACTOR ally compared to 7.8 percent for SPY. Short straddles worked best in medium-volatility environments, when the VIX Also, the short-straddle strategy was between 18 and 25. was less risky. Its standard deviation of annual returns was only 9.2 percent, SPY Short straddles compared to 17.8 percent for SPY. VIX levels VIX levels Moreover, SPY suffered doubleLow Med High All Low Med High All digit losses in three years — 2001, Avg: 0.66 0.04 1.83 0.66 0.57 1.20 1.12 0.87 2002, and 2008, but the short-straddle StDev: 3.30 4.82 7.53 4.78 2.01 3.17 4.96 3.08 technique hasn’t lost more than 6.9 Min: -10.16 -16.37 -24.90 -24.90 -6.11 -10.92 -17.58 -17.58 percent in any year since 1993. Indeed, if you sold straddles during the downMax: 7.28 9.74 14.12 14.12 3.98 5.14 6.58 6.58 turn from 2001 to 2003, you wouldn’t have lost money at all. held to the options expiration date. The first three columns list VIX and SPY closing values at the time of trade entry How volatility influences profits and SPY’s percentage return over the next month. The final Table 4 groups monthly performance of both short straddles three columns show the cost of the options and each strad- and SPY using the same VIX levels (low, medium, and high) dle’s subsequent gain or loss. as Figures 2 and 3. With 188 months of data, there are Selling straddles earned a cumulative 10.7 percent vs. a roughly 62 months in each category. loss of 3.9 percent for SPY in the first nine months of 2008. When the VIX remained low, short straddles earned Even if you include October’s large loss, the short straddle slightly less than SPY, on average (0.57 percent vs. 0.66 perstill outperformed the overall market — a cumulative loss cent, respectively). However, short straddles were also of 6.9 percent vs. 28.8 percent. much less volatile than SPY during these periods, with a The main reason short straddles performed better is they standard deviation of monthly returns of only 2.01 percent still gained ground when SPY fell moderately. For instance, vs. 3.3 percent for SPY. On a risk-adjusted basis, the short SPY fell in five of the 10 months shown in Table 2, but short straddle’s performance was superior, offering more down18

December 2008 • FUTURES & OPTIONS TRADER

TABLE 5 — WORST-PERFORMING MONTHS Although a short-straddle strategy is more correlated to the underlying in bad times, this is side protection; its largest more an exception than a rule. monthly loss was just 6.11 percent vs. 10.16 percent for SPY. Short straddles At medium and high VIX Entry SPY percentage levels, both risks and rewards date VIX SPY return Call Put Loss climbed for the short straddle 9/19/08 32.1 124.1 -24.9 3.9 3.5 -17.6 and SPY. But again, the short 8/17/01 23.8 103.7 -16.4 2.9 2.5 -10.9 straddles’ risk-adjusted re6/21/02 27.2 89.1 -14.7 3.3 2.9 -8.5 turns are higher than SPY’s. 10/15/99 28.8 108.9 14.1 3.5 3.1 -7.6 Historically, the best time to follow a buy-and-hold strate12/21/07 18.5 145.8 -10.8 2.3 1.9 -6.6 gy was in high-volatility mar2/16/01 22.1 115.2 -11.6 2.7 2.3 -6.5 kets, while short straddles 5/17/02 17.7 99.1 -10.2 2.2 1.8 -6.1 worked best in medium4/18/97 18.8 64.3 9.7 2.4 1.9 -5.5 volatility markets. Table 5 lists the eight worstCorrelation with SPY return: 0.62 performing months for SPY Correlation with SPY return (other 180 months): -0.16 and short straddles since January 1993. October 2008 tops the list, but both approaches lost nearly as much in the Related reading summer of 2002. The correlation, or beta coefficient, between the shortOther Tristan Yates articles: straddle and SPY returns for the worst “Hedging with bear put spreads,” Futures & Options Trader, September 2008. eight months is 0.62, meaning these Are you paying too much to hedge a long portfolio? Find out why bear put approaches had a moderate connecspreads act as better hedges than long puts. tion. However, there is virtually no correlation (-0.16) between the short “Exploiting the fear factor,” Futures & Options Trader, February 2008. straddle and SPY in the study’s What’s the best way to profit from a high-volatility forecast? Comparing the remaining 180 months.

No free lunch A short straddle in SPY earned higher risk-adjusted returns than simply holding the underlying because IV is somewhat higher than the S&P’s realized volatility over longer-term periods. When volatility was low, the short straddle performed in line with the underlying index, but its returns were more consistent. When volatility increased, so did both strategies’ potential risk and reward. Short straddles weren’t highly correlated with the underlying index. But when the market tanked and volatility climbed, the correlation between the straddle and the underlying increased, and the strategy sometimes suffered large losses. The technique beat a buyand-hold approach in 10 of the past 16 years, and in the five years SPY lost ground, it outperformed the index by an average of 18 percent.


performance of covered calls, different option spreads, and LEAPS shines some light on the subject.

“Long-term diagonal call spreads” Futures & Options Trader, November 2007. This detailed look at diagonal spreads shows how to trade them with a long-term perspective. “Rolling leaps calls,” Futures & Options Trader, September 2007. Holding LEAPS calls instead of the underlying shares can pay off — but only if you know when to roll them forward.

Other articles: “Klaus Schatz: Strangling the markets” Futures & Options Trader, November 2007. Trading short strangles isn't easy one big move can wipe you out. This options seller discusses how he emerged unscathed from the recent market pullback. “Short strangles,” Options Trader, May 2006. Selling out-of-the-money options above and below range-bound markets is risky, but it can be profitable if you follow a few important rules. “The conservative short strangle,” Options Trader, August 2005. Selling options always contains a certain amount of risk, but covering your shorts by owning the underlying stock can reduce exercise risk and boost income. Discover how long a position can enhance the profitability of a short strangle. You can purchase and download past articles at http://store.activetradermag.com.

For information on the author see p. 5. FUTURES & OPTIONS TRADER • December 2008

19

OPTIONS STRATEGY TRADING SYSTEM LAB OPTIONS LAB

Timing reversals with the RSI Market: Options on the Russell 2000 index (RUT).

potential yield of 10 percent (146 percent annualized). The position can lose up to $4,545 if the Russell 2000 climbs to 810 (or higher) at expiration — a 10:1 risk-reward ratio.

System concept: If you think the market is likely to reverse direction, you can sell options to collect a maximum amount of premium. The idea is to sell calls just before an Trade rules: uptrend ends or to sell puts immediately before a downtrend ends. One approach is to sell options one standard Bullish signal The underlying drops to a lower low than yesterday, but deviation out-of-the-money (OTM) in hopes it will reverse the RSI doesn’t. direction before reaching the strike price. To find potential reversal points, this Options Lab uses If the first rule is true, enter the trade at the close when the Relative Strength Index (RSI), a momentum oscillator the underlying posts its first daily gain. developed by J. Welles Wilder. The RSI compares the magnitude of a market’s recent gains and losses. Its values range from zero to 100 — low values represent possible Entering bull put spreads 1.Sell puts with a strike located one standard deviation oversold markets, and high values represent potential overbought markets. OTM. The strategy identifies divergences between the underly2.Buy puts at a strike 10 points below the short put. ing market and the RSI. A buy signal occurs when price 3.Use the first expiration month with more than 21 days drops to a new low, but the RSI doesn’t. A sell signal until expiration. appears when price rises to a new high, but the RSI doesn’t. 4.The spread’s yield must be at least five percent After a buy signal, the strategy enters a bull put spread (premium received/net margin required). (short put, long lower-strike put). After a sell signal, the sysBearish signal tem enters a bear call spread (short call, long higher-strike 1.The underlying climbs to a higher high than call). It holds each trade until the spread either expires yesterday, but the RSI doesn’t. worthless or an opposite signal appears. The system isn’t always in the market, but the signals tested were quite reliable. FIGURE 1 — RISK PROFILE — BEAR CALL SPREAD A vertical credit spread contains a short option with a strike that is The 800-810 bear call spread has an 85-percent probability of profit and will make closer to the money than the money if the Russell 2000 index closes below 800.89 at Oct. 17 expiration. option you buy as protection. The spread tries to exploit time decay and collects the most profit if the underlying doesn’t move beyond the short strike by expiration. Both options share the same expiration month, and when strikes are 10 points apart, the position requires a gross margin of $1,000 per contract. The spread is entered at a credit, which you keep if both options expire worthless. Figure 1 shows the potential gains and losses of an October 800/810 bear call spread entered on Sept. 22, 2008 when the Russell 2000 traded at 720.40. The trade will be profitable if the Russell 2000 closes below 800.89 by Oct. 17 expiration. The spread collected premium of $455, which repreSource: OptionVue sents its maximum gain and 20

December 2008 • FUTURES & OPTIONS TRADER

FIGURE 2 — RSI SYSTEM PERFORMANCE The strategy of selling vertical credit spreads with the RSI gained 96.6 percent since January 2005.

2.If the first rule is true, enter the trade at the close when the underlying posts its first daily loss. Entering bear call spreads 1.Sell calls with a strike located one standard deviation OTM. 2.Buy calls at a strike price 10 points above the short call. 3.Use the first expiration month with more than 21 days left until Source: OptionVue expiration. 4.The spread’s minimum yield must be at least five percent (premium received/net margin required). Exit Close either spread if the underlying touches the short strike. Otherwise, allow the position to expire worthless. Starting capital: $10,000. Execution: When possible, option trades were executed at the average of the bid and ask prices at the daily close; otherwise, theoretical prices were used. Standard deviation was calculated using the implied volatility of the atthe-money (ATM) call. Each spread held 5 contracts per “leg.” Commissions were $2 per contract. Test data: The system was tested using options on the Russell 2000 index (RUT). Test period: Jan. 25, 2005 to Oct. 17, 2008. Test results: Figure 2 tracks the system’s performance, which gained $9,660 (96.6 percent) since January 2005. The strategy’s average winning trade ($444.00) is lower than its average losing trade (-$1,440). However, the probability of price moving one standard deviation in a given time frame is roughly 25 percent. Thus, the strategy’s 96.6 winning percentage is higher than expected (75 percent), which suggests the system has a definite trading edge.

—Steve Lentz and Jim Graham of OptionVue

STRATEGY SUMMARY Net gain: Percentage return: Annualized return: No. of trades: Winning/losing trades: Win/loss: Avg. trade: Largest winning trade: Largest losing trade: Avg. profit (winners): Avg. loss (losers): Avg. hold time (winners): Avg. hold time (losers): Max consec. win/loss:

$9,660.00 96.6% 25.9% 26 25/1 96% $371.54 $780.00 $1,440.00 $444.00 -$1,440.00 37 6 25/1

Option System Analysis strategies are tested using OptionVue’s BackTrader module (unless otherwise noted). If you have a trading idea or strategy that you’d like to see tested, please send the trading and money-management rules to [email protected].

LEGEND: Net gain – Gain at end of test period. Percentage return – Gain or loss on a percentage basis. 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. Largest winning trade – Biggest individual profit generated by the system. Largest losing trade – Biggest individual loss generated by the system. Avg. profit (winners) – The average profit for winning trades. Avg. loss (losers) – The average loss for losing trades. Avg. hold time (winners) – The average holding period for winning trades (in days). Avg. hold time (losers) – The average holding period for losing trades (in days). Max consec. win/loss – The maximum number of consecutive winning and losing trades.

FUTURES & OPTIONS TRADER • December 2008

21

FUTURESSTRATEGY INSIGHT LAB OPTIONS FIGURE 1 — GOLD UP, STOCKS DOWN

A new trend for gold?

Until gold peaked in March, it had rallied while the stock market continued to retreat from last year's high.

Gold’s recent behavior might spell t-o-p, but few tendencies can be taken for granted in today’s market. BY FOT STAFF

E

arlier in the year the gold market was behaving pretty much according to script. Already entrenched in a multiyear bull market, gold futures pushed to a record high above $1,000 in mid-March as the stock market continued to slide off its 2007 record high (Figure 1). The story gets a bit murkier after that, though. Gold followed that seven-month surge by closing down in March and selling off sharply over the next several months — even as the stock market itself continued to decline. When equities unraveled in September and October, there were many cries that gold would jump to $2,000, maybe even $3,000, before all was said and done. Stories appeared in the media of people buying physical gold. The metal responded by dropping to its lowest level in more than a year in October — down some $372 from its March peak — and leaving some gold bugs scratching their heads. If gold couldn’t rally now, when could it? A modest bounce in November did little to sort things out. The current gold decline mirrors the collapse after the 1980 peak that established the market’s high for the next generation (Figure 2; prices are for continuous futures, so past prices do not reflect historical levels). That sell-off was a little more dramatic, though: Within three months the market had dropped around $435 from its record high; this time it took price approximately seven months to fall around $70 less, and from a higher price level, to boot, which Source: TradeStation means the move was smaller on a percentage basis. But it’s been a rough ride, nonetheless. FIGURE 2 — THEN AND NOW Gold was caught in the same wholesale liquidation that drove down prices in virtually all comThe recent gold sell-off is the largest since 1980, but it is notably smaller modities as the global market panic unfolded this on a percentage basis and has taken longer to unfold. year. (The collapse in crude oil has been much more severe.) The recessionary implications of the financial implosion erased the potential for a “gold rush” triggered by stock woes. Does that mean gold’s bull run is over?

Volatility and more

Source: TradeStation

22

Let’s look at where the market stood in early December. The huge monthly ranges in Figure 2 highlight the market’s extremely high volatility. Figure 3 shows a monthly gold continuous futures chart with the six-month/36-month volatility ratio below the price series. This line represents the sixmonth volatility of monthly closing prices divided by the 36-month volatility of monthly closing prices, and so offers a comparison of recent volatility to longer-term volatility. In October the ratio reached is highest level since 1980, but was still notably lower than the peak that year. It’s impossible to extrapolate much in the way of specific strategy from events that occur once a genDecember 2008 • FUTURES & OPTIONS TRADER

FIGURE 3 — COMPARING VOLATILITY The recent gold plunge pushed volatility to relatively high levels, but the eration. Although it might be tempting to say, short-term/long-term volatility ratio is much lower than it was in 1980. “Gold has posted its biggest sell-off since 1980, so it must be time for another bear market,” today’s market is much different from the one nearly 30 years ago. For starters, there was no all-encompassing financial panic in 1980 (although there was a bad recession) for starters, and if volatility is any indication, conditions were much more ragged in gold in 1980 than in 2008. In this light, the recent sell-off could be interpreted an independent event. However, gold is not likely to benefit from a recessionary environment, and although volatility could be higher, it is already plenty high. If it reverts to a more historically normal level, the combination of muted price movement and recessionary factors would give gold little room to shine. Ironically, a steady increase in equity prices (not that anyone one gives that much of a chance for a while) would also detract from gold’s supposed “safe harbor” attractiveness. Nonetheless, Figure 2 shows gold bounced sharply after the 1980 sell-off before trending lower. The market has yet to mount a similar Source: TradeStation rally. Even if a full-fledged return to the bull move is not in order, price is likely to stage a rebound. FIGURE 4 — SWING HIGH PATTERN

Monthly pull-up pattern Gold’s last protracted bear market spanned roughly 1980 to 2001. Although it would have been nice to know the market would decline for that long and employ a “shortand-hold” trade from the peak, it’s more practical to think in terms of finding repeated entry points within a trend. Figure 4 highlights monthly bars that share the following characteristics: they are at least $2 above the previous month’s high, have lower highs than the month six months prior, and follow months that closed higher than the previous month:

October 2008 (right) satisfied the criteria for a monthly swing pattern that marked advantageous selling points in gold’s last bear market (left). However, the pattern will produce false signals in a bull environment, as evidenced by the signals that occurred in 2004.

1. High[0] >= High[1] + 2 2. High[0] < High[6] 3. Close[1] > Close[2] The left side of the chart shows examples from gold’s bear-market phase in the 1990s; the right side shows examples from the recent bull market (the most recent month that qualified was October). One thing is apparent: If you used this pattern to go short, you would have had a chance to make some money in the bear market and most likely would have lost money in the bull market. No surprises there. If you operate on the assumption that a Source: TradeStation trend change has occurred, this type of pattern might be useful. The one described here, while not unique (it is repre- have been historic, and it would be unwise to forecast based on these extreme circumstances. When things return to “norsentative, not optimized), occurred 32 times since 1980. mal” — something few people expect to happen overnight — trading opportunities will be more manageable. If gold ultiLooking ahead Along with the rest of the financial world, the stock and com- mately shakes out to the downside, traders will need to modity futures markets are in disrepair. Recent conditions adjust to the new paradigm.
FUTURES & OPTIONS TRADER • December 2008

23

INDUSTRY NEWS

New energy contracts flood the major futures markets With volume slowing, futures markets look to energy markets for expansion.

T

he commodity boom/bubble of 2008 was a boon for volume on the major futures exchanges this year. Yearto-date volume through the end of November was up 20 percent compared to 2007 at the IntercontinentalExchange (ICE), which operates exchanges in the U.S., Europe, and Canada. Year-to-date average daily volume on the ICE’s U.S. futures exchange alone increased by 48 percent compared to the same period last year. The CME Group, which includes the Chicago Mercantile Exchange (CME), the Chicago Board of Trade (CBOT), and the New York Mercantile Exchange (NYMEX), experienced 7.1-percent year-to-date volume growth through November 2008 compared to 2007. However, in the aftermath of the global financial sell-off in September and October, trading has slowed. November volume assessments showed significant contraction, with the CME group trading 37.3 percent fewer contracts than in November 2007 and the ICE gaining only slightly. With crude oil leading the way, skyrocketing energy prices were one of the biggest stories of the futures markets this past summer, helping to fuel record volume at both the CME and the ICE. Even though prices have fallen dramatically since July, the two leading U.S. futures exchanges have new plans to offer even greater exposure to the energy markets through coal, electricity, and non-U.S. crude futures and options contracts. It may be an especially tough environment in which to get new contracts off the ground, however.

Oil The NYMEX wing of the CME now offers contracts for Russian export blend crude oil (REBCO) cash-settled futures (R2). The January 2009 contract began trading on Nov. 24. (REBCO con-

MANAGED MONEY Top 10 option strategy traders ranked by October 2008 return. (Managing at least $1 million as of Oct. 31, 2008.) October YTD $ under Rank Trading advisor return return mgmt. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Elk River Trading Harbor Assets Reynoso Asset Mgmt. (Options Arb.) Nantucket Hedge Fund - CTA Hyman Beck (Volatility) Eickelberg & Associates (Option) GrowthPoint Invest. (Index Condor) Singleton Fund Conservative Concept (Athena Ret) Welton Investment (Alpha)

39.63% 19.10% 17.12% 5.95% 1.74% 0.88% 0.84% 0.06% -0.31% -0.75%

79.58% 78.0 42.25% 3.0 30.90% 1.9 15.59% 6.5 5.21% 112.9 7.17% 2.0 33.38% 1.0 31.65% 52.4 9.39% 311.5 2.48% 4.0

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.

24

FIGURE 1 — DME OMAN CRUDE OIL Oman crude, which will begin trading on the CME Group’s electronic platform in Q1 2009, has lost 70 percent since its peak in July.

tracts for physical delivery (RE) have been trading since October 2006.) Contracts are available for 48 consecutive months, with settlement based on the Urals Primorsk assessment published by Argus Media. As of Dec. 2, though, the contract had yet to produce any volume. Also, the CME/NYMEX plans to begin trading Oman crude oil (OQ) futures in Q1 2009. Omanbased crude futures have traded on the Dubai Mercantile Exchange (DME) Source: eSignal since June 2007, with total volume exceeding 500,000 contracts. Figure 1 shows the monthly price action for the February 2009 DME Oman crude contract (OQG09) through Dec. 3. The contract peaked at 143.03 in July, about the same time as the equivalent CME/NYMEX crude oil contract (CLG09). It has since dropped 70.4 percent, approximately 3 percent more than CLG09. A cash-settled version of the DME Oman crude contract will also begin trading on the Globex platform under the symbol ZG. When the CME Group completed its acquisition of NYMEX in August 2008, it also acquired a 25-percent stake in the Dubai exchange, which has facilitated the transfer of the DME’s contracts onto its platforms.

Coal Coal has gained popularity recently as an energy source following the development of clean coal technologies, which reduce coal emissions. According to Energy Information Administration data, coal provides approximately 49 percent of electricity in the U.S., and globalCOAL estimates 40 percent of all the world’s electricity is produced by the commodity. The CME launched options on its Central Appalachian Coal futures contracts on Nov. 24 for trade on NYMEX’s ClearPort platform and the New York energy trading floor. The American-style contract will trade under the commodity code “C1” with its first listing for January 2009. Five strike prices will be available above and below the at-the-money strike price in increments of $2.50 per ton. The option contracts expire three business days prior to the expiration of its underlying contract. Central Appalachian Coal futures were not immune to the commodity price bubble previously this year. Figure 2 shows January 2009 Central Appalachian Coal futures (QLF09) peaked at 143.38 in June, 141.5 percent above the price at the end of 2007, but then fell 54 percent over the next several months to 65.50 by the end of November. The Appalachian Coal contract, along with the Eastern Rail December 2008 • FUTURES & OPTIONS TRADER

CSX Coal Swap Futures (QX) and the Western Rail Powder River Basin (PRB) Coal Swap futures (QP), are cash-settled contracts. ICE Futures Europe recently added a third coal futures contract to its energy complex based on the globalCOAL NEWC Index, which serves as a price benchmark for seaborne thermal coal in the Asia-Pacific region. The cash-settled globalCOAL ICE Newcastle Futures contract (NCF) joins their Rotterdam Coal Futures (ATW) and Richards Bay Coal Futures (AFR) based on the Argus/McClosky Coal Price Index reports for their respective regions. ICE Futures Europe and global coal also plan to launch the first physical-delivery coal futures contracts for the Amsterdam-Rotterdam-

Antwerp (ARA) region sometime in 2009.

Electricity Twenty-six new monthly PJM electricity futures contracts are slated to begin trading at the CME/NYMEX on Dec. 8. (PJM Interconnection provides wholesale electricity to more than 44 million customers across 13 states in the Midwest and Mid-Atlantic regions.) These financially settled contracts represent peak and off-peak hour swap futures prices relative to regional delivery hubs. (Peak-hour usage occurs from 7 a.m. to 11 p.m. local time Monday-Friday while off-peak hours continued on p. 26

FIGURE 2 — CENTRAL APPALACHIAN COAL Central Appalachian coal futures experienced an unprecedented level of volatility in 2008, gaining as much as 141 percent in the first half of the year, then dropping 65.5 percent from July to November.

Source: eSignal

FIGURE 3 — PJM MONTHLY PEAK ELECTRICITY Like most energy-related contracts, electricity futures have fallen significantly since peaking in July.

Source: eSignal FUTURES & OPTIONS TRADER • December 2008

25

INDUSTRY NEW continued include the rest of the day and weekends.) Contracts will be listed for five consecutive years, beginning with the January 2009 contracts. Year-to-date through the end of November, 37,176 PJM monthly peak contracts have traded, 10,185 more than the same period last year and the most since 2005. Before peaking in July, PJM monthly peak contracts reached its second highest monthly volume of 7,551 contracts in June 2008. February 2009 PJM

monthly peak electricity futures (JMG09) had fallen 48 percent from its all-time high of 128.4. Also, the ICE’s over-the-counter platform, which already includes more than 100 energy-related contracts, is about to gain 50 more contracts through the beginning of 2009. The exchange said it would kick off the new additions with a group of 21 swaps futures contracts linked to North American power and natural gas as well as global oil markets.


Options trade volume falls in November

O

ptions volume fell 21.2 percent in November 2008 year over year according to Options Clearing Corporation (OCC) data. Average daily volume for the month was 12,901,487 contracts, 3.5 million fewer than October and 1.9 million fewer than November 2007. Equity option volume alone dropped 21.1 percent year over year. “Retail investors are shell shocked right now,” says Keith Landsberg, executive vice president of business development for Ballista, a recently launched alternative trading system that facilitates block trading of equity options based in New York. “Speculators tend to speculate more when their returns are doing great. Now, with their portfolios down 30 percent, they’re not as apt to play around as they were in the past.”

Volatility The drop comes as the Chicago Board Option Exchange’s (CBOE) volatility index (VIX), the widely watched investor “fear gauge” that tracks the implied volatility of S&P 500 index options, traded at levels unheard of prior to the current economic crisis. Figure 1 shows the VIX began to move dramatically higher in September, when it jumped above 40 on Sept. 19, a level it hadn’t breached in six years. In October it rocketed to a record high of 89.53, and through Dec. 3 it had barely traded below 50. In November the index bounced around in a wide range between 44.25 and 81.48. Until November, option volume had continued to accelerate as equities fell into disarray. Despite November 2008’s volume FIGURE 1 — A VOLATILE SITUATION The VIX shot to record levels in October and has pulled back only moderately since.

Source: TradeStation 26

drop from a year ago, year-to-date volume through the end of the month was nonetheless 28 percent above the same period last year, with equity option volume up nearly 30 percent. Figure 2 shows total (cumulative) volume for 2007 and 2008 along with the month-to-month increases. October proved to be a record month for total contracts traded, with 376 million contracts changing hands, 1.4 million contracts more than the previous record set a month earlier. “Clearly [options buyers] love volatility, but they’re paying very large premiums in order to own that volatility,” Landsberg says. “On the institutional side, August through November saw huge volume — lots of block trades, especially hedge funds.” But with the increasing number of investor redemptions and massive consolidation in the hedge-fund market, many institutional traders had been forced to liquidate positions and beef up risk protection. “That was really the reason you saw big volume,” Landsberg says. “Those entities, with their positions already set, are basing their trading now on their new risk parameters, which have been tightened due to the instability.”

Institutional pullback Volume generated by the institutional sector is expected to continue to fall off in the coming months. “Merrill and Bank of America are merged, Bear Stearns and JP Morgan are merged, so that’s two desks off the street,” says FIGURE 2 — CBOE VOLUME Although 2008 total option volume through November was higher than in 2007, volume dropped notably in November 2008.

Source: Chicago Board Options Exchange December 2008 • FUTURES & OPTIONS TRADER

George Ruhana, CEO of Chicago-based options brokerage OptionsHouse. “On the buy side, these hedge funds are deleveraging, their capital base is much, much lower, so you would think there’s less trading.” Sentiment for the institutional side of the options market is a little mixed, especially considering the huge hit it’s taking as investors ask for their money back. “The [decreased] capital bases they’re going to work with will result in fewer trades,” Ruhana says. On the other hand, new risk considerations mean institutional traders who remain in the market will be more apt to use options to hedge their positions. “You will see a lot more option strategies in conjunction with whatever positions institutions are going to take on a pure equity play,” Landsberg says. Reduced liquidity has contributed to a volatile trading environment — too volatile for many traders. “You’re seeing large moves every day and a lot of that is because there’s not as much liquidity as there was in the past,” Landsberg says. According to some, prospects for the retail side of the option market are more positive — but not necessarily in the near future. “Long term, the demographics for retail options trading are great,” Ruhana says. “More people are getting educated, more people are becoming comfortable with the product, and more people are retiring and self directing. “2009 is probably a different story. There’s been massive dislocation in the market, and people have gotten hurt.”

Cheap stocks Whether option volume continues to contract or merely begins to level off, there are still certain aspects of the current turmoil that are shaping how options traders approach the market. “The one thing that will actually help options volume is that stocks have gotten hit so hard; if you want to put your money to work, you need to trade more shares,” Ruhana says. This translates into trading more options contracts. As investors gear up to take advantage of the greatly depreciated stock prices, options can offer protection for those who are afraid they may be jumping in a bit too early. “Someone who wants to buy a stock that has been severely beaten down in price [might implement] an option strategy [for protection],” Landsberg says.
FUTURES & OPTIONS TRADER • December 2008 27

FUTURES SNAPSHOT (as of Nov. 28) 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). Market Symbol Exchange Volume E-Mini S&P 500 ES CME 3.19 M 10-yr. T-note TY CBOT 548.9 E-Mini Nasdaq 100 NQ CME 439.4 5-yr. T-note FV CBOT 363.6 Mini Dow YM CBOT 292.3 Crude oil CL NYMEX 255.6 30-yr. T-bond US CBOT 218.2 Eurocurrency EC CME 198.5 Eurodollar* ED CME 189.4 2-yr. T-note TU CBOT 189.3 E-Mini Russell 2000 TF CME 175.0 Corn C CBOT 131.1 Gold 100 oz. GC NYMEX 116.6 Japanese yen JY CME 116.5 Soybeans S CBOT 69.5 British pound BP CME 67.8 Natural gas NG NYMEX 63.6 S&P 500 index SP CME 52.8 Wheat W CBOT 41.4 Sugar SB ICE 39.7 E-Mini S&P MidCap 400 ME CME 36.8 Swiss franc SF CME 35.2 Soybean oil BO CBOT 34.7 Canadian dollar CD CME 32.0 Australian dollar AD CME 29.0 Heating oil HO NYMEX 27.5 RBOB gasoline RB NYMEX 26.0 Soybean meal SM CBOT 25.6 Silver 5,000 oz. SI NYMEX 23.1 Nikkei 225 index NK CME 18.4 Copper HG NYMEX 14.4 Crude oil e-miNY QM NYMEX 14.0 Live cattle LC CME 12.8 Lean hogs LH CME 11.8 Fed Funds FF CBOT 10.6 Coffee KC ICE 8.2 Mini-sized gold YG CBOT 7.3 Cocoa CC ICE 5.6 U.S. dollar index DX ICE 4.8 Mexican peso MP CME 4.7 Nasdaq 100 ND CME 3.9 E-Mini eurocurrency ZE CME 3.6 Dow Jones Ind. Avg. DJ CBOT 3.5 Natural gas e-miNY QG NYMEX 2.2 Soybeans E-mini YK CBOT 1.3 Feeder cattle FC CME 1.2 New Zealand dollar NE CME 1.0 *Average volume and open interest based on highest-volume contract (June 2009). Legend Volume: 30-day average daily volume, in thousands (unless otherwise indicated). OI: Open interest, in thousands (unless otherwise indicated). 10-day move: The percentage price move from the close 10 days ago to today’s close. 20-day move: The percentage price move from the close 20 days ago to today’s close. 60-day move: The percentage price move from the close 60 days ago to today’s close. The “rank” fields for each time window (10-

OI 2.98 M 1.20 M 371.4 1.21 M 106.1 258.5 675.6 147.5 983.1 650.1 495.5 331.0 154.6 126.5 94.4 109.9 73.3 616.7 105.2 274.1 113.3 39.8 75.4 92.2 62.2 32.6 40.0 52.7 42.7 63.8 33.9 7.9 53.0 57.5 74.3 45.2 2.8 28.4 37.6 41.9 31.4 2.4 27.3 2.6 5.5 5.7 18.6

10-day move/ rank -1.38% / 8% 3.60% / 78% -3.93% / 15% 2.58% / 80% -0.10% / 0% -6.54% / 40% 8.67% / 100% 0.20% / 0% 0.15% / 31% 0.89% / 100% 5.58% / 80% -7.32% / 69% 15.77% / 100% 0.86% / 13% -1.23% / 18% 4.76% / 100% 3.04% / 13% -1.37% / 8% 0.78% / 22% 4.20% / 20% -2.41% / 8% -1.94% / 45% -0.70% / 7% -1.09% / 17% 0.80% / 13% -7.89% / 38% -7.13% / 5% -3.03% / 58% 15.74% / 100% -3.84% / 42% -0.03% / 0% -6.54% / 40% -3.51% / 36% 5.87% / 100% 0.07% / 11% 3.35% / 63% 15.68% / 100% 23.09% / 100% -0.28% / 33% -2.07% / 36% -3.93% / 15% 0.20% / 0% -0.10% / 0% 3.04% / 13% -1.23% / 18% -5.63% / 30% -2.37% / 13%

20-day move/ rank -6.89% / 36% 6.30% / 97% -11.82% / 41% 5.29% / 100% -4.39% / 27% -17.48% / 48% 11.45% / 100% -1.94% / 11% 0.38% / 46% 1.76% / 100% -11.89% / 46% -14.66% / 64% 10.52% / 81% 2.86% / 33% -5.46% / 21% -6.34% / 42% 1.23% / 7% -6.89% / 36% 0.82% / 0% 0.42% / 7% -8.18% / 34% -6.36% / 96% -5.51% / 12% -2.15% / 35% -3.26% / 14% -12.95% / 43% -17.55% / 35% -9.64% / 34% 4.09% / 33% -6.43% / 26% -14.12% / 38% -17.48% / 45% -4.46% / 41% 6.25% / 100% 0.24% / 17% 2.79% / 50% 10.49% / 85% 13.82% / 89% -0.10% / 0% -4.40% / 25% -11.82% / 41% -1.94% / 11% -4.39% / 27% 1.23% / 8% -6.36% / 27% -6.29% / 47% -7.13% / 56%

day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size and in the same direction. For example, the rank for 10-day move shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20day move, the rank field shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, the rank field shows how the most recent 60-day move compares to the past one-hundredtwenty 60-day moves. A reading of 100 per-

60-day move/ rank -27.60% / 80% 3.45% / 75% -33.21% / 84% 6.06% / 100% -21.24% / 79% -49.55% / 87% 6.83% / 91% -11.29% / 62% 1.01% / 51% 2.74% / 99% -34.32% / 78% -36.38% / 93% 2.11% / 45% 11.93% / 71% -28.44% / 57% -13.03% / 66% -11.09% / 6% -27.86% / 82% -28.18% / 70% -5.93% / 23% -34.33% / 82% -8.65% / 81% -34.22% / 60% -13.96% / 80% -20.22% / 55% -42.88% / 87% -55.86% / 88% -27.97% / 63% -17.36% / 21% -30.40% / 67% -50.76% / 91% -50.22% / 88% -15.42% / 90% -13.80% / 53% 1.63% / 85% -22.25% / 87% 1.95% / 22% -10.49% / 13% 10.00% / 66% -21.58% / 59% -33.21% / 84% -11.29% / 62% -21.24% / 79% -11.09% / 7% -28.50% / 57% -17.22% / 88% -18.33% / 81%

Volatility ratio/rank .25 / 7% .83 / 65% .16 / 0% .41 / 25% .28 / 22% .09 / 0% 1.13 / 90% .15 / 25% .20 / 10% .30 / 40% .26 / 5% .17 / 52% .50 / 65% .19 / 0% .09 / 15% .14 / 3% .14 / 58% .25 / 7% .12 / 12% .16 / 5% .23 / 7% .20 / 22% .07 / 2% .21 / 8% .14 / 10% .07 / 0% .09 / 2% .12 / 25% .15 / 35% .19 / 5% .05 / 3% .09 / 0% .28 / 47% .15 / 30% .04 / 2% .14 / 12% .48 / 63% .27 / 35% .22 / 28% .15 / 13% .16 / 0% .15 / 25% .28 / 23% .14 / 60% .09 / 12% .26 / 41% .16 / 3%

cent means the current reading is larger than all the past readings, while a reading of 0 percent means the current reading is smaller than the previous readings. These figures provide perspective for determining how relatively large or small the most recent price move is compared to past price moves. Volatility ratio/rank: The ratio is the shortterm volatility (10-day standard deviation of prices) divided by the long-term volatility (100day standard deviation of prices). The rank is the percentile rank of the volatility ratio over 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.

28

December 2008 • FUTURES & OPTIONS TRADER

OPTIONS RADAR

(as of Dec. 1)

MOST-LIQUID OPTIONS* Indices S&P 500 index Russell 2000 index S&P 500 volatility index E-mini S&P 500 futures Mini Nasdaq 100 index

Symbol Exchange Options volume SPX CBOE 202.8 RUT CBOE 67.5 VIX CBOE 53.7 ES CME 17.8 MNX CBOE 16.9

Open interest 1.50 M 514.0 441.5 89.9 365.6

10-day move / rank -6.54% / 43% -8.64% / 46% 3.32% / 13% -5.31% / 36% -7.49% / 38%

20-day move / rank -15.75% / 67% -22.41% / 76% 14.39% / 15% -15.66% / 69% -17.93% / 71%

IV / SV ratio 60.5% / 65.5% 70.4% / 76.3% 133.4% / 153.4% 59.9% / 50.5% 57.7% / 61%

IV / SV ratio — 20 days ago 48.4% / 84.6% 54% / 87.2% 159.1% / 307.2% 47.2% / 100.5% 50.3% / 86.8%

302.6 190.2 151.3 151.3 121.0

3.69 M 1.07 M 1.38 M 2.03 M 1.51 M

-32.25% / 63% -1.45% / 0% -3.25% / 20% -21.74% / 50% -24.22% / 69%

-52.75% / 93% -17.34% / 40% -20.55% / 71% -46.83% / 98% -36.68% / 97%

138.8% / 247.2% 80.3% / 72.6% 75.8% / 95.8% 131.2% / 146.2% 111.5% / 138.8%

87.7% / 132.8% 66.8% / 108.7% 67.1% / 94.6% 76% / 146.2% 65.6% / 110.2%

Stocks Citigroup Apple Inc General Electric Bank of America JPMorgan Chase

C AAPL GE BAC JPM

Futures Eurodollar 10-year T-notes Corn Crude oil 30-year T-bonds

ED-GE TY-ZN C-ZC CL US-ZB

CME CME CME NYMEX CME

246.2 45.9 35.5 34.3 26.0

8.31 M 344.2 449.3 208.3 199.4

0.15% / 40% 4.79% / 94% -12.52% / 100% -13.60% / 55% 10.20% / 100%

0.10% / 17% 8.36% / 100% -17.14% / 67% -27.33% / 78% 15.50% / 100%

78.6% / 58.8% 12.3% / 10.5% 41.6% / 41.8% 76.8% / 92.1% 21.9% / 16.2%

67% / 55.4% 10.1% / 10.2% 51.5% / 53.5% 84.1% / 90.2% 15.6% / 16.9%

Indices - High IV/SV ratio Euro index Japanese yen index E-mini S&P 500 futures Canadian dollar index Oil service index

XDE XDN ES XDC OSX

PHLX PHLX CME PHLX PHLX

1.2 2.2 17.8 1.9 1.3

13.1 15.8 89.9 15.5 16.3

0.10% / 0% 4.20% / 100% -5.31% / 36% -0.67% / 8% -13.84% / 58%

-0.99% / 11% 5.77% / 79% -15.66% / 69% -2.84% / 38% -24.50% / 68%

24% / 18.7% 22.6% / 18.4% 59.9% / 50.5% 26.5% / 25.4% 100.1% / 98.1%

26.7% / 20% 29.3% / 25.9% 47.2% / 100.5% 24.9% / 27.2% 79.8% / 155.6%

Indices - Low IV/SV ratio Morgan Stanley Retail index Gold/silver index S&P 500 volatility index Dow Jones index Russell 2000 index

MVR XAU VIX DJX RUT

CBOE PHLX CBOE CBOE CBOE

1.2 1.5 53.7 12.0 67.5

10.8 13.0 441.5 161.9 514.0

-6.80% / 15% 10.92% / 27% 3.32% / 13% -4.10% / 33% -8.64% / 46%

-26.18% / 70% 9.75% / 44% 14.39% / 15% -12.61% / 66% -22.41% / 76%

65% / 85.9% 90.5% / 114.8% 133.4% / 153.4% 54.9% / 59.8% 70.4% / 76.3%

64.9% / 96.3% 90.8% / 152.3% 159.1% / 307.2% 46.6% / 81.6% 54% / 87.2%

Stocks - High IV/SV ratio Tessera Tech Shanda Interactive Ent General Motors American Express XL Capital

TSRA SNDA GM AXP XL

2.3 1.9 84.4 46.3 2.1

49.5 56.8 1.38 M 548.6 46.1

-10.16% / 100% -12.96% / 89% 52.49% / 50% -1.75% / 0% -35.83% / 60%

-3.82% / 3% -23.76% / 100% -20.73% / 24% -28.58% / 73% -59.38% / 94%

133.3% / 92.5% 79.3% / 66.1% 284.2% / 237% 126% / 110.3% 220.5% / 194.5%

116% / 119.2% 81.3% / 96.5% 202% / 181.2% 79.3% / 139% 133.6% / 257.2%

Stocks - Low IV/SV ratio Citigroup Hartford Financial Svc CBS Corp B Gannett Lennar

C HIG CBS GCI LEN

302.6 17.0 2.9 3.1 3.0

3.69 M 115.6 183.0 91.0 236.6

-32.25% / 63% -47.75% / 67% -11.93% / 8% 0.37% / 0% 0.95% / 13%

-52.75% / 93% -35.95% / 34% -39.96% / 79% -25.64% / 61% -17.83% / 11%

138.8% / 247.2% 180.9% / 318.7% 95.5% / 156.9% 98.3% / 160.4% 147% / 239.2%

87.7% / 132.8% 168.5% / 316.3% 79.7% / 126.4% 85.1% / 131.4% 127.3% / 183.9%

Futures - High IV/SV ratio Japanese yen Swiss franc Eurocurrency 30-year T-bonds Eurodollar

JY SF EC US-ZB ED-GE

1.7 1.7 3.5 26.0 246.2

8.2 10.7 25.8 199.4 8.31 M

4.49% / 100% -1.37% / 25% -0.86% / 9% 10.20% / 100% 0.15% / 0%

5.72% / 76% -3.96% / 54% -0.57% / 5% 15.50% / 100% 0.10% / 0%

24.8% / 15.8% 18.9% / 13.2% 24.5% / 17.6% 21.9% / 16.2% 78.6% / 58.8%

32.2% / 17.1% 22.3% / 11% 28.4% / 16.2% 15.6% / 16.9% 67% / 55.4%

Futures - Low IV/SV ratio Cotton CT ICE 2.8 Sugar SB ICE 8.9 Wheat W-ZW CME 8.1 Natural gas NG NYMEX 2.1 Crude oil CL NYMEX 34.3 * Ranked by volume ** Ranked by high or low IV/SV values.

27.9 480.4 73.0 12.4 208.3

9.94% / 50% 0.00% / 0% -8.05% / 100% 4.63% / 22% -13.60% / 0%

1.85% / 100% -3.08% / 25% -4.96% / 13% -2.64% / 13% -27.33% / 0%

46.7% / 70.9% 38.4% / 52.7% 40.4% / 51.3% 59.6% / 71.8% 76.8% / 92.1%

43.6% / 76.9% 42.5% / 55.9% 47.3% / 48.6% 54.9% / 55.2% 84.1% / 90.2%

VOLATILITY EXTREMES**

CME CME CME CME CME

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 2008

29

FUTURES & OPTIONS WATCH FIGURE 1 — COT REPORT EXTREMES The largest positive readings represent markets in which net commercial positions (longs - shorts) exceed net fund holdings in November. By contrast, the largest negative values represent markets in which net fund holdings surpass net commercial positions.

COT extremes

The Commitment of Traders (COT) report is published weekly by the Commodity Futures Trading Commission (CFTC). The report divides the open positions in futures markets into three categories: commercials, non-commericals, 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 For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com general public. Legend: Figure 1 shows the difference between net commerFigure 1 shows the relationship between commercials cial and net large spec positions (longs - shorts) for all 45 futures and large speculators on Nov. 25. Positive values mean net commercial positions markets, in descending order. It is calculated by subtracting the (longs - shorts) are larger than net speculator holdings, based on their five-year current net large spec position from the net commercial position and then comparing this value to its five-year range. The formuhistorical relationship. Negative values mean large speculators have bigger posila is: tions than the commercials. a1 = (net commercial 5-year high - net commercial current) In the S&P 500 index (SP) and Japanese yen futures (JY), the difference between b1 = (net commercial 5-year high - net commercial 5-year low) commercials and large speculators is ranked lowest among all futures markets, c1 = ((b1 - a1)/ b1 ) * 100 which is a bearish sign. But in oats (O) and silver futures (SI), this relationship is a2 = (net large spec 5-year high - net large spec current) b2 = (net large spec 5-year high - net large spec 5-year low) near a five-year high, a bullish indication. These extremes aren’t trade signals, but c2 = ((b2 - a2)/ b2 ) * 100 they sometimes appear before price reversals.


– Compiled by Floyd Upperman

x = (c1 - c2)

Options Watch: Consumer Discretionary ETF components (as of Nov. 28)

Compiled by Tristan Yates The following table summarizes the expiration months available for the top components of the Consumer Discretionary exchange-traded fund (XLY). 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 2011

Jan.

Jan.

July

June

2010

May

Apr.

Mar.

Feb.

2009

Jan.

Dec.

2008

Bid-ask spreads Bid-ask spread as % of underlying price 0.16% 0.26% 0.33% 0.34% 0.46% 0.50% 0.51% 0.55% 0.61% 0.65% 0.67% 0.71% 0.72%

Closing Stock Ticker price Call Put Home Depot Inc HD X X X X X X 23.11 0.04 0.04 Target Corp TGT X X X X X X 33.76 0.09 0.09 McDonald's Corp MCD X X X X X X 58.75 0.21 0.18 Amazon.com Inc AMZN X X X X X X 42.70 0.14 0.15 Nike Inc NKE X X X X X X 53.25 0.21 0.28 Kohl's Corp KSS X X X X X X 32.66 0.18 0.15 Yum! Brands YUM X X X X X X 26.94 0.16 0.11 Apollo Group APOL X X X X X X 76.84 0.50 0.35 Lowe's Co LOW X X X X X X 20.66 0.14 0.11 Carnival Corp CCL X X X X X X 21.00 0.13 0.15 Walt Disney Co DIS X X X X X X 22.52 0.14 0.16 DIRECTV Group Inc DTV X X X X X X 22.01 0.16 0.15 Comcast Corp CMCSA X X X X X X 17.34 0.10 0.15 Select Sector SPDR Consumer Discretionary XLY X X X X X X 20.49 0.16 0.15 0.76% Omnicom Group Inc OMC X X X X X X 28.29 0.25 0.20 0.80% Time Warner Inc TWX X X X X X X 9.05 0.09 0.08 0.90% Staples Inc SPLS X X X X X X 17.36 0.18 0.14 0.90% Johnson Controls Inc JCI X X X X X X 17.66 0.18 0.16 0.96% TJX Cos TJX X X X X X X 22.82 0.29 0.29 1.26% News Corp NWS X X X X X X 8.19 0.16 0.16 1.98% Viacom Inc VIA X X X X 17.58 0.44 0.43 2.45% 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. 30

December 2008 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS CALENDAR December 1 FDD: December crude oil, natural gas,

Legend

gold, silver, copper, platinum, palladium, and aluminum futures (NYMEX); December corn, wheat, soy bean products, and oats futures (CME); T-bond futures (CBOT); December coffee, cotton, and cocoa futures (ICE)

FDD (first delivery day): The first day on which delivery of a commodity in fulfillment of a futures contract can take place. FND (first notice day): Also known as first intent day, this is the first day a clearinghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. The clearinghouse also informs the seller. LTD (last trading day): The first day a contract may trade or be closed out before the delivery of the underlying asset may occur. CPI: Consumer price index ECI: Employment cost index FOMC: Federal Open Market Committee

2

FND: December heating oil, propane, and RBOB gasoline futures (NYMEX)

3 4

U.S.: Petroleum status report

5

LTD: December live cattle options (CME); January cocoa options (ICE)

6

FDD: December heating oil and RBOB gasoline futures (NYMEX)

7 8 9 10 11

GDP: Gross domestic product

12

ISM: Institute for supply management PPI: Producer price index Quadruple witching Friday: A day where equity options, equity futures, index options, and index futures all expire.

13 14 15

DECEMBER 2008 30 1

2

3

7

9

10 11 12 13

8

4

5

6

2

3

JANUARY 2009 28 29 30 31

1

2

3

4

8

9

10

5

6

7

11 12 13 14 15 16 17

The information on this page is subject to change. Futures & Options Trader is not responsible for the accuracy of calendar dates beyond press time.

LTD: December corn, wheat, oats, and soybean products futures (CME); January coffee options (ICE); December wheat futures (KCBT); December wheat futures (MGEX)

25 26 27 28 29

FND: January crude oil futures (NYMEX) LTD: January gold, silver, copper, and aluminum options (NYMEX); January soybeans and soybean products options (CME) LTD: January natural gas options (NYMEX) U.S.: Petroleum status report and natural gas storage report LTD: January heating oil and RBOB gasoline options (NYMEX)

LTD: January natural gas and December gold, silver, copper, platinum, palladium, and aluminum futures (NYMEX)

30

FND: January natural gas futures (NYMEX)

31

FND: January gold, silver, copper, platinum, palladium, and aluminum futures (NYMEX); January rough rice, soybeans, and soybean products futures (CME) LTD: January heating oil, propane, and RBOB gasoline futures (NYMEX); December live cattle futures and January lumber options (CME) U.S.: Petroleum status report and natural gas storage report

January 1 FDD: January crude oil and natural gas futures (NYMEX)

LTD: December cocoa futures (ICE); January sugar options (ICE)

LTD: January platinum options (NYMEX) U.S.: Petroleum status report

18

LTD: December coffee futures (ICE); December index futures and options U.S.: Natural gas storage report

19

LTD: January crude oil futures (NYMEX); December T-bond futures (CBOT); January orange juice and cotton options (ICE); December single stock futures (OC); December equity futures and options U.S.: Cattle on feed report

25 26 27 28 29 30 31

24

U.S.: Natural gas storage report, crop production report, and world agricultural production report

17

18 19 20 21 22 23 24

22 23

U.S.: Petroleum status report

FDD: December live cattle futures (CME) LTD: January crude oil options (NYMEX); December T-bill options (CME)

21 22 23 24 25 26 27 1

FND: December live cattle futures (CME) LTD: December cotton futures (ICE)

16

14 15 16 17 18 19 20 28 29 30 31

FDD: December propane futures (NYMEX) U.S.: Natural gas storage report

DECEMBER/JANUARY MONTH

20 21

December 2008 • FUTURES & OPTIONS TRADER

2

3 4 5 6 7 8 9

FDD: January gold, silver, copper, platinum, palladium, and aluminum futures (NYMEX); January rough rice, soybeans, and soybean products futures (CBOT) FND: January orange juice futures (ICE) LTD: February cocoa options (ICE)

FND: January heating oil, propane, and RBOB gasoline futures (NYMEX) FDD: January propane futures (NYMEX) U.S.: Petroleum status report U.S.: Natural gas storage report FDD: January heating oil and RBOB gasoline futures (NYMEX); January orange juice futures (ICE) LTD: January orange juice futures (ICE); February coffee options (ICE) 31

KEY CONCEPTS The option “Greeks” American style: An option that can be exercised at any time until expiration. Assign(ment): When an option seller (or “writer”) is obligated to assume a long position (if he or she sold a put) or short position (if he or she sold a call) in the underlying stock or futures contract because an option buyer exercised the same option. At the money (ATM): An option whose strike price is identical (or very close) to the current underlying stock (or futures) price. Bear call spread: A vertical credit spread that consists of a short call and a higher-strike, further OTM long call in the same expiration month. The spread’s largest potential gain is the premium collected, and its maximum loss is limited to the point difference between the strikes minus that premium.

Delta: The ratio of the movement in the option price for every point move in the underlying. An option with a delta of 0.5 would move a half-point for every 1-point move in the underlying stock; an option with a delta of 1.00 would move 1 point for every 1-point move in the underlying stock. Gamma: The change in delta relative to a change in the underlying market. Unlike delta, which is highest for deep ITM options, gamma is highest for ATM options and lowest for deep ITM and OTM options. Rho: The change in option price relative to the change in the interest rate. Theta: The rate at which an option loses value each day (the rate of time decay). Theta is relatively larger for OTM than ITM options, and increases as the option gets closer to its expiration date. Vega: How much an option’s price changes per a onepercent change in volatility.

move and time decay. Bear put spread: A bear debit spread that contains puts with the same expiration date but different strike prices. You buy the higher-strike put, which costs more, and sell the cheaper, lower-strike put. Beta: Measures the volatility of an investment compared to the overall market. Instruments with a beta of one move in line with the market. A beta value below one means the instrument is less affected by market moves and a beta value greater than one means it is more volatile than the overall market. A beta of zero implies no market risk. Bull call spread: A bull debit spread that contains calls with the same expiration date but different strike prices. You buy the lower-strike call, which has more value, and sell the less-expensive, higher-strike call. Bull put spread (put credit spread): A bull credit spread that contains puts with the same expiration date, but different strike prices. You sell an OTM put and buy a lessexpensive, lower-strike put. Calendar spread: A position with one short-term short option and one long same-strike option with more time until expiration. If the spread uses ATM options, it is market-neutral and tries to profit from time decay. However, OTM options can be used to profit from both a directional 32

Call option: An option that gives the owner the right, but not the obligation, to buy a stock (or futures contract) at a fixed price. The Commitments of Traders report: Published weekly by the Commodity Futures Trading Commission (CFTC), the Commitments of Traders (COT) report breaks down the open interest in major futures markets. Clearing members, futures commission merchants, and foreign brokers are required to report daily the futures and options positions of their customers that are above specific reporting levels set by the CFTC. For each futures contract, report data is divided into three “reporting” categories: commercial, non-commercial, and non-reportable positions. The first two groups are those who hold positions above specific reporting levels. The “commercials” are often referred to as the large hedgers. Commercial hedgers are typically those who actually deal in the cash market (e.g., grain merchants and oil companies, who either produce or consume the underlying commodity) and can have access to supply and demand information other market players do not. Non-commercial large traders include large speculators (“large specs”) such as commodity trading advisors (CTAs) and hedge funds. This group consists mostly of institutional and quasi-institutional money managers who do not deal December 2008 • FUTURES & OPTIONS TRADER

in the underlying cash markets, but speculate in futures on a large-scale basis for their clients. The final COT category is called the non-reportable position category — otherwise known as small traders — i.e., the general public. Correlation: The correlation coefficient can tell us the type and strength of the relationship between two data series. The correlation coefficient ranges from +1, which indicates perfect, positive correlation between two data sets (i.e., they move in the same direction, in tandem) and -1, which indicates the sets are directly inverted; zero indicates no discernible relationship between the two data sets. Covered call: Shorting an out-of-the-money call option against a long position in the underlying market. An example would be purchasing a stock for $50 and selling a call option with a strike price of $55. The goal 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.

strike prices that are very far below the current price of the underlying asset. Delivery period (delivery dates): The specific time period during which a delivery can occur for a futures contract. These dates vary from market to market and are determined by the exchange. They typically fall during the month designated by a specific contract - e.g. the delivery period for March T-notes will be a specific period in March. Delta-neutral: An options position that has an overall delta of zero, which means it’s unaffected by underlying price movement. However, delta will change as the underlying moves up or down, so you must buy or sell shares/contracts to adjust delta back to zero. Diagonal spread: A position consisting of options with different expiration dates and different strike prices — e.g., a December 50 call and a January 60 call. continued on p. 34

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 premium 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 that are very far above the current price of the underlying asset and put options with FUTURES & OPTIONS TRADER • December 2008

33

KEY CONCEPTS continued

Double calendar spread: A calendar spread involves purchasing an option and selling a shorter-term, samestrike option of the same type (call or put) against it. Double calendars have two strikes: one put calendar spread below the current underlying price and one call calendar spread above it. The goal is to collect premium and capture theta from the shorter-term sold options as expiration approaches. Single calendars only profit in a fairly narrow range of underlying prices, so the double calendar widens this range and increases its chances of success. European style: An option that can only be exercised at expiration, not before. Exercise: To exchange an option for the underlying instrument. Expiration: The last day on which an option can be exercised and exchanged for the underlying instrument (usually the last trading day or one day after). Intermonth (futures) spread: A trade consisting of long and short positions in different contract months in the same market — e.g., July and November soybeans or September and December crude oil. Also referred to as a futures “calendar spread.” In the money (ITM): A call option with a strike price below the price of the underlying instrument, or a put option with a strike price above the underlying instrument’s price. Intrinsic value: The difference between the strike price of an in-the-money option and the underlying asset price. A call option with a strike price of 22 has 2 points of intrinsic value if the underlying market is trading at 24. Iron condor: A market-neutral position that enters a bear call spread (OTM call + higher-strike call) above the market and a bull put spread (OTM put + lower-strike put) below the market. Both spreads collect premium, and profit when the market trades between the short strikes by expiration. All options share the same expiration month. Logarithm: The exponent by which a certain base, such as 10, is raised to produce another number. For example, the logarithm of 10,000 is 4 because 10 to the 4th power 34

equals 10,000. Naked option: A position that involves selling an unprotected call or put that has a large or unlimited amount of 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 obligated 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 market’s price. Open interest: The number of options that have not been exercised in a specific contract that has not yet expired. Out of the money (OTM): A call option with a strike price above the price of the underlying instrument, or a put option with a strike price below the underlying instrument’s price. Parity: An option trading at its intrinsic value. Physical delivery: The process of exchanging a physical commodity (and making and taking payment) as a result of the execution of a futures contract. Although 98 percent of all futures contracts are not delivered, there are market participants who do take delivery of physically settled contracts such as wheat, crude oil, and T-notes. Commodities generally are delivered to a designated warehouse; T-note delivery is taken by a book-entry transfer of ownership, although no certificates change hands. Premium: The price of an option. Put option: An option that gives the owner the right, but not the obligation, to sell a stock (or futures contract) at a fixed price. December 2008 • FUTURES & OPTIONS TRADER

Put ratio backspread: A bearish ratio spread that contains more long puts than short ones. The short strikes are closer to the money and the long strikes are further from the money. For example, if a stock trades at $50, you could sell one $45 put and buy two $40 puts in the same expiration month. If the stock drops, the short $45 put might move into the money, but the long lower-strike puts will hedge some (or all) of those losses. If the stock drops well below $40, potential gains are unlimited until it reaches zero. Put spreads: Vertical spreads with puts sharing the same expiration date but different strike prices. A bull put spread contains short, higher-strike puts and long, lower-strike puts. A bear put spread is structured differently: Its long puts have higher strikes than the short puts. Ratio spread: A ratio spread can contain calls or puts and includes a long option and multiple short options of the same type that are further out-of-themoney, usually in a ratio of 1:2 or 1:3 (long to short options). For example, if a stock trades at $60, you could buy one $60 call and sell two same-month $65 calls. Basically, the trade is a bull call spread (long call, short higher-strike call) with the sale of additional calls at the short strike. Overall, these positions are neutral, but they can have a directional bias, depending on the strike prices you select. Because you sell more options than you buy, the short options usually cover the cost of the long one or provide a net credit. However, the spread contains uncovered, or “naked” options, which add upside or downside risk.

The formula is: RSI = 100 – (100/[1+RS]) where RS = relative strength = the average of the up closes over the calculation period (e.g., 10 bars, 14 bars) divided by the average of the down closes over the calculation period. For example, when calculating a 10-day RSI, if six of the days closed higher than the previous day’s close, subtract the previous close from the current close for these days, add up the differences, and divide the result by 10 to get the upclose average. (Note that the sum is divided by the total number of days in the look-back period and not the number of up-closing days.) For the four days that closed lower than the previous day’s close, subtract the current close from the previous low, add these differences, and divide by 10 to get the down-close average. If the up-close average was 0.8 and the down close average was 0.4, the relative strength over this continued on p. 36

Relative strength index (RSI): Developed by Welles Wilder, the relative strength index (RSI) is an indicator in the “oscillator” family designed to reflect shorter-term momentum. It ranges from zero to 100, with higher readings supposedly corresponding to overbought levels and low readings reflecting the opposite.

FUTURES & OPTIONS TRADER • December 2008

35

KEY CONCEPTS continued

period would be 2. The resulting RSI would be 100 (100/[1+2]) = 100 - 33.3 = 66.67. Simple moving average: A simple moving average (SMA) is the average price of a stock, future, or other market over a certain time period. A five-day SMA is the sum of the five most recent closing prices divided by five, which means each day’s price is equally weighted in the calculation. Straddle: A non-directional option spread that typically consists of an at-the-money call and at-the-money put with the same expiration. For example, with the underlying instrument trading at 25, a standard long straddle would consist of buying a 25 call and a 25 put. Long straddles are designed to profit from an increase in volatility; short straddles are intended to capitalize on declining volatility. The strangle is a related strategy. Strangle: A non-directional option spread that consists of an out-of-the-money call and out-of-the-money put with the same expiration. For example, with the underlying

instrument trading at 25, a long strangle could consist of buying a 27.5 call and a 22.5 put. Long strangles are designed to profit from an increase in volatility; short strangles are intended to capitalize on declining volatility. The straddle is a related strategy. Strike (“exercise”) price: The price at which an underlying instrument is exchanged upon exercise of an option. Time decay: The tendency of time value to decrease at an accelerated rate as an option approaches expiration. Time spread: Any type of spread that contains short near-term options and long options that expire later. Both options can share a strike price (calendar spread) or have different strikes (diagonal spread). Time value (premium): The amount of an option’s value that is a function of the time remaining until expiration. As expiration approaches, time value decreases at an accelerated rate, a phenomenon known as “time decay.”

EVENTS Event: Futures and Options/Series 3 Exam Course Date: Dec. 8-9 Location: Chicago Date: Dec. 17-18 Location: New York, N.Y. For more information: http://www.theifm.org Event: Intro to Exchange-Traded Futures & Options Date: Dec. 16 Location: New York, N.Y For more information: http://www.theifm.org

Event: 25th Annual Risk Management Conference Date: March 8-10 Location: The Ritz-Carlton, Laguna Niguel, Dana Point, Calif. For more information: http://www.cboermc.com Event: Live Trading Software and Trading Expos Date: April 5-7 Location: Miami Date: June 7-9 Location: Houston For more information: http://livetradingexpo.com

Event: The World Money Show Date: Feb. 4-7 Location: Orlando Date: March 17-19 Location: Hong Kong Date: May 11-14 Location: Las Vegas For more information: Go to http://www.moneyshow.com and click on “Events”

Event: The 15th Forbes Cruise for Investors Date: June 2-14 Location: Lisbon to Venice For more information: Go to http://www.moneyshow.com and click on “Events”

Event: International Trader’s Expo Date: Feb. 21-24 Location: New York, New York For more information: http://www.tradersexpo.com

Event: International Trader’s Expo Date: June 3-6 Location: Los Angeles For more information: http://www.tradersexpo.com

36

December 2008 • FUTURES & OPTIONS TRADER

Variance and standard deviation: Variance measures how spread out a group of values are — in other words, how much they vary. Mathematically, variance is the average squared “deviation” (or difference) of each number in the group from the group’s mean value, divided by the number of elements in the group. For example, for the numbers 8, 9, and 10, the mean is 9 and the variance is: {(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667 Now look at the variance of a more widely distributed set of numbers: 2, 9, and 16: {(2-9)2

+

(9-9)2

+

(16-9)2}/3

= (49 + 0 + 49)/3 = 32.67

The more varied the prices, the higher their variance — the more widely distributed they will be. The more varied a market’s price changes from day to day (or week to week, etc.), the more volatile that market is. A common application of variance in trading is standard deviation, which is the square root of variance. The standard deviation of 8, 9, and 10 is: .667 = .82; the standard deviation of 2, 9, and 16 is: 32.67 = 5.72.

of-the-money S&P 500 (SPX) calls and puts to make the index better represent the full range of volatility. At the same time the CBOE applied the new calculation method to the CBOE NDX Volatility Index (VXN), which reflects the volatility of the Nasdaq 100 index. The exchange still publishes the original VIX calculation, which can be found under the ticker symbol VXO. Figure 1 shows both indices: the VXO from May 19, 1993 to Sept 19, 2003 and the new VIX over the next four years. For more information about the VIX and its calculation, visit http://www.cboe.com/vix. Volatility: The level of price movement in a market. Historical (“statistical”) volatility measures the price fluctuations (usually calculated as the standard deviation of closing prices) over a certain time period — e.g., the past 20 days. Implied volatility is the current market estimate of future volatility as reflected in the level of option premiums. The higher the implied volatility, the higher the option premium.

Vertical spread: A position consisting of options with the same expiration date but different strike prices (e.g., a September 40 call option and a September 50 call option). VIX: The Volatility Index (VIX) measures the implied volatility of S&P 500 index options traded on the Chicago Board Option Exchange (CBOE). The VIX is designed to reflect the market expectation of near-term (in this case, 30-day) volatility and is a commonly referenced gauge of the stock market’s “fear level.” The original VIX, launched in 1990, was derived from eight near-term at-themoney S&P 100 (OEX) options (calls and puts) using the Black-Scholes options pricing model. The VIX underwent a major transformation in late 2003. The current index is derived from both at-the-money and outFUTURES & OPTIONS TRADER • December 2008

37

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program is a derivatives calculator that calculates trade profit/loss results and/or displays contract price specifications (point, minimum fluctuation, and daily limits) for both futures and futures options contracts. Contract information (exchange, contract code, and delivery month) is displayed for each selected market and links to exchange contract and holiday schedules are available.
Trading Technologies International’s X_TRADER derivatives trading platform is now connected to Spain’s Mercado Español de Futuros Financieros (MEFF) exchange. TT customers can trade a broad array of futures and options products listed on MEFF, including IBEX 35 Equity Index Futures, IBEX 35 Mini Futures and Options, and Single Stock Futures and Options. With the launch of its MEFF gateway, TT now offers connectivity to 23 markets in North America, South America, Europe, the Middle East, and the Asia/Pacific region.
CQG, Inc. and NH Investment & Futures have partnered, allowing CQG to provide trading connectivity to the CME Group, ICE U.S., KRX, NYMEX/COMEX, and SGX exchanges. This partnership allows NH Investment & Futures to offer CQG’s professional trading software to clients and traders in the U.S., Europe, Australia, and Asia. Customers clearing through NH Investment & Futures will have access to CQG’s decision-making tools, consolidated market data, and electronic trading via the CQG Trader and Integrated Client platforms.
TradeStation Securities launched TradeStation Scanner, a primary feature of TradeStation 8.4 that allows users to scan, sort, and rank thousands of symbols by price, volume, or any of more than 500 fundamental data indicators to create custom symbol lists. They can further screen symbols using their own custom EasyLanguage analytical techniques for a variety of time intervals, from tick-by-tick to monthly. Further functions include a “scan wizard” that walks users through the process of creating and saving the results of their scans; the ability to link scans run on a broad universe of symbols to those run on a smaller list of symbols using more precise scanning logic; an “Added/Dropped” tab that displays all symbols that have been added or dropped from the previous scan; and the ability to place orders from scan results.
Charles Schwab has enhanced its StreetSmart.com trading platform. The upgrades include bracket order technology, customizable trading alerts, and advanced charting tools. For more information about StreetSmart.com and the active trading services at Charles Schwab, visit http://www.schwabat.com.
TD AMERITRADE is offering mobile trading applications for the iPhone and the iPod Touch available in the Apple App Store. These applications link to TD AMERITRADE’s order routing and back-office management systems, allowing clients to access account details, real-time quotes, market data, news, and technical analysis tools from their iPhone or iPod Touch. iStockManager and iPTrader are available from Apple’s App Store at http://www.itunes.com/appstore. Note: The New Products and Services section is a forum for industry businesses to announce new products and upgrades. Listings are adapted from press releases and are not endorsements or recommendations from the Active Trader Magazine Group. E-mail press releases to [email protected]. Publication is not guaranteed. December 2008 • FUTURES & OPTIONS TRADER

FUTURES TRADE JOURNAL Is it better to stay out of the market during extreme conditions? TRADE Date: Wednesday, Nov. 26 and Thursday, Nov. 27. Entry: Short December Mini Dow futures (YMZ08) at 8,560 and 8,660. Reasons for trade/setup (long trade): On Nov. 21 the Mini Dow futures rallied 600 points off its intraday low of 7436 and gained nearly 600 more intraday the next day (Nov. 24) before trading quietly on Nov. 25. Even if this eventually turns out to be more than a bear-market bounce, the market is approaching resistance and is due for a pullback. Source: TradeStation Given the high volatility still in the market and the precarious nature of profits, we’re limiting risk on this trade to approximately three-quarters of the profit The market subsequently crawled higher on Nov. 28. It on the previous trade. went through the initial stop level (ultimately as high as 8,828 outside regular trading hours), but we pulled the stop Initial stop: 8,722. order because the market was trading quietly because of the curtailed holiday schedule and a runaway move Initial target: 8,312, just above the round-number price seemed unlikely. immediately above the Nov. 26 low. The gambit paid off — this time. The market tanked on Dec. 1. We lowered our stop to protect profits and got taken RESULT out of the market before price reached the initial target. Although these trades turned a net profit, there is someExit: 8,710 (first trade); 8,458 (second trade). thing to be said for staying out of the market during extreme conditions. The market had calmed down someProfit/loss: -150 (first trade); +202 (second trade). what from October, but volatility was still at historically high levels when these trades were executed. The result Trade executed according to plan? Yes (first); no (sec- was a classic Catch-22 situation: All trades needed extra leeond). way to avoid getting stopped out randomly, but that extra freedom increases the potential for very large losses when Outcome: The first short trade was impatient: We saw the you get caught on the wrong side of the market.
potential for a move above 8,750, but convinced ourselves this panicky market would repeat its pattern of sharp Note: Initial targets for trades are typically based on things such as the downturns sooner rather than later. historical performance of a price pattern or trading system signal. The first trade was exited a little below the planned stop However, individual trades are a function of immediate market behavprice because the market was closing and we didn’t want to ior; initial price targets are flexible and are most often used as points at hold the position overnight. Price subsequently pulled back which a portion of the trade is liquidated to reduce the position’s open a little during the shortened Thanksgiving session, and we risk. As a result, the initial (pre-trade) reward-risk ratios are conjectural by nature. re-entered the market on the short side at 8,660.

TRADE SUMMARY Date

Contract

Entry

Initial stop

Initial target

IRR

Exit

Date

P/L

LOP

LOL

Length

11/26/08

YMZ08

8,560

8,722

8,312

1.53

8,710

11/26/08

-150 (-1.8%)

20

-156

90 min.

8,660

8,777

8,312

2.97

8,458

12/1/08

+202 (2.3%)

302

-173

3 days

11/27/08

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). FUTURES & OPTIONS TRADER • December 2008

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OPTIONS TRADE JOURNAL A late-afternoon price breakout triggers a losing long-put trade. TRADE Date: Tuesday, Nov. 18.

FIGURE 1 — RISK PROFILE — LONG PUT This deep ITM long put will gain ground if the market continues to drop in the last hour of trading on Nov. 18.

Market: Options on S&P 500 tracking stock (SPY). Entry: Buy one November 90 put for $10.55. Reasons for trade/setup: Market volatility has surged over the last two months as U.S. stocks fell off a cliff in September and October. Some of the largest moves occurred just before the closing bell. For instance, the S&P 500 index dropped at least 1.8 percent in the last five to 10 minutes of trading on Oct. 24 and Oct. 27. And the Source: OptionVue market plunged 4.5 percent in the last five minutes of trading on market would slide further by the close. Oct. 29, following the Fed’s expected rate cut. The deep in-the-money (ITM) 90 put has a -76.26 delta, so A trading strategy in an upcoming issue of Active Trader tries to exploit the market’s tendency to climb to new daily it should gain ground if SPY continues to decline. Figure 1 highs or drop to new daily lows in the late afternoon (see shows the trade’s potential gains and losses on Nov. 18. “Trading late-day breakouts,” Active Trader, February 2009). The system goes long if stock-index futures such as the E- Initial stop: None. Mini S&P 500 and Mini Russell 2000 climb to a new high from 1:30 p.m. to 2:30 p.m. CT. It also sells short when price Initial target: Hold until close. dips to a new low in the same period. The idea is to catch a late-afternoon trend and exit by the close. Back-testing shows the system gained 187.85 perTRADE SUMMARY cent in E-Mini S&P futures (ES) over the past two years. When December E-Mini futures (ESZ08) slipped to a Entry date: Nov. 18, 2008 new intraday low at 1:50 p.m. CT on Nov. 18, we took Underlying security: S&P 500 tracking stock (SPY) this short signal by purchasing puts on the S&P 500 Position: 1 long Dec. 90 put tracking stock (SPY). We bought one December 90-strike put for $10.55 when SPY traded at $83.15, hoping the Initial capital required: $1,055 Initial stop: None TRADE STATISTICS Initial target: Hold until close Initial daily time decay: $8.44 Nov. 18, 2008 1:50 p.m. 2:30 p.m. Trade length (in days): 1 Delta: -76.26 -69.96 P/L: -$65 (6.2%) Gamma: 2.12 1.04 Theta: -8.44 -8.05 LOP: $0 Vega: 9.26 9.42 LOL: -$120 Probability of profit: 48% 41% LOP — largest open profit (maximum available profit during life of trade). Breakeven point: 83.26 83.22 LOL — largest open loss (maximum potential loss during life of trade).

40

December 2008 • FUTURES & OPTIONS TRADER

FIGURE 2 — FALSE BREAKOUT

RESULT

After dropping to a new daily low on Nov. 18, SPY rebounded sharply and we exited with a $0.65 loss. But the late-day breakout system triggered two successful short trades over the next two days.

Outcome: Selling short in a bear market seems easy, but stocks often rebound without warning, which can be painful. Figure 2 shows SPY bounced back and moved against us immediately. When the market jumped 2.3 percent within 30 minutes, it was obvious we were on the wrong side. We sold the 90 put for $9.90 — a $0.65 loss (6.2 percent) — when SPY traded at $84.20 at 2:30 p.m. In hindsight, several mistakes were made. First, we applied a futures strategy to stock options without paying Source: eSignal attention to all of its exit rules. And when we entered the bearish trade, SPY traded within 1 percent of a five-year low — a potential support level. However, Figure 2 shows the strategy triggered prof-

FUTURES & OPTIONS TRADER • December 2008

itable short trades over the next two days. After dropping to new lows on Nov. 19 and Nov. 20, SPY slid another 1.5 percent and 2.75 percent by the close, respectively.


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