FOT200903

March 2009 • Volume 3, No. 3

SELECTIVE TRADING:Can you identify yourstrategy’s best signals?p. 6

INTERMARKET SOYBEAN system p. 12

TRADING golden butterflies p. 16

THE GAIN/LOSSSPREAD:Trading options with a new volatility measure p. 22

ADJUSTING OPTIONS for stock splits and dividends p. 30

NEW COT REPORTp. 32

2 March 2009 • FUTURES & OPTIONS TRADER

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

Trading StrategiesUsing probability as a guide . . . . . . . . . . . .6Digging into a strategy’s historical statistics may

reveal how to enhance its performance. This test

explores variations of the Martingale rule, which

doubles position sizes after a loss based on the

notion that a winning trade is imminent.

By Lee Leibfarth

Intermarket soybean strategy . . . . . . . . .12Deciphering the relationships between

different markets offers a different way to

trade commodity futures.

By Markos Katsanos

Land softly with

butterflies and condors . . . . . . . . . . . . . . .16These low-risk options spreads can reap

profits even if your market forecast isn’t

perfect. An example in gold compares but-

terflies to condors, which boost your odds

of success in certain situations.

By Frederic Ruffy

Applying a simpler volatility measure . . . . . . . . . . . . . . . . . . . .22This new calculation demystifies volatility and

provides an easy way to compare the details of

two (or more) stocks. It also helps you uncover

opportunities that other options traders ignore.

By George Hoekstra

Options Trading System LabThe return of the short butterfly . . . . . .28These positions hit their stride in tough times.

By Steve Lentz and Jim Graham

Trading Basics

Option adjustments . . . . . . . . . . . . . . . . . . .30It’s not just about buying and selling: Traders

need to understand how dividends, stock splits,

and mergers change the terms of their options.

By FOT Staff

News

CFTC’s new monthly report dresses

up the weekly COT . . . . . . . . . . . . . . . . . . . .32Charged with the task of improving transparency

in the futures markets, the CFTC begins a six-

month trial for a new Commitments of Traders

report.

CONTENTS

continued on p. 4

ads0409 2/10/09 5:13 PM 7

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Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34

Futures & Options Calendar . . . . . . . . . . . .35

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .36Momentum, volatility, and volume

statistics for futures.

Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .37Notable volatility and volume

in the options market.

Futures & Options WatchCOT extremes . . . . . . . . . . . . . . . . . . . . . . .38A look at the relationship between commercials

and large speculators in all 45 futures markets.

Options Watch:Large-cap stocks . . . . . . . . . . . . . . . . . . . . . . .38

New Products and Services . . . . . . . . . . . . .39

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .40References and definitions.

Options Trade Journal . . . . . . . . . . . . . . .43A “bull”-headed put spread sees red during

options expiration week.

Have a question about something you’ve seen

in Futures & Options Trader?

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

Looking for an advertiser?

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

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

eSignal

Global Futures

Paris Expo

PFGBEST.com

RS of Houston

The Wizard

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CONTENTS


mailto:[email protected]

FUTURES & OPTIONS TRADER • March 2009 5

CONTRIBUTORS

Editor-in-chief: Mark [email protected]

Managing editor: Molly [email protected]

Senior editor: David Bukey [email protected]

Contributing editor:Keith Schap

Associate editor: Chris Peters [email protected]

Editorial assistant andwebmaster: Kesha Green

[email protected]

Art director: Laura [email protected]

President: Phil [email protected]

Publisher,Ad sales East Coast and Midwest:

Bob [email protected]

Ad sales West Coast and Southwest only:

Allison [email protected]

Classified ad sales: Mark [email protected]

Volume 3, Issue 3. Futures & Options Trader is pub-lished monthly by TechInfo, Inc., 161 N. Clark St.,Suite 4915, Chicago, IL 60601. Copyright © 2009TechInfo, Inc. All rights reserved. Information in thispublication may not be stored or reproduced in anyform without written permission from the publisher.

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

For all subscriber services:www.futuresandoptionstrader.com

A publication of Active Trader®

CONTRIBUTORS

� Markos Katsanos is the author of Intermarket Trading

Strategies published in February by John Wiley & Sons and has

been an active trader since 1995. He can be reached at

[email protected].

� Frederic Ruffy is the senior options strategist at

http://whatstrading.com, a site dedicated to helping traders

make sense of the complex and fragmented nature of listed

options trading. In addition to writing market commentary and

trading-related books and articles, Ruffy has also worked as an

instructor, educating investors on advanced topics such as volatility, the ben-

efits of sector rotation, and trading around earnings. Ruffy is an active trader

with more than 15 years experience in the industry. His market observations

and analysis of the options market are featured regularly in the financial press

including Barron’s, Reuters, The Wall Street Journal, Bloomberg, and Futures

Magazine.

� George Hoekstra is a research engineer in the petroleum

refining business. He started trading options 30 years ago while

studying under Myron Scholes who was his professor at the

University of Chicago. Hoekstra holds degrees in chemical engi-

neering from Purdue University and an MBA from the

University of Chicago. Hoekstra can be contacted via his Web site,

http://hoekstratrading.com/default.aspx.

� Lee Leibfarth ([email protected]) is an inde-

pendent futures trader and trading system researcher. He is an

affiliate of the Market Technicians Association and president of

PowerZone Trading, a company that provides a range of servic-

es for traders. His articles on technical analysis and market tech-

nology have been featured in a variety of publications.

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

lished options educator and trader and has spoken all over the

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

Institute, the Options Industry Council, and the Australian Stock

Exchange. As a mentor for DiscoverOptions.com, he teaches

select students how to use complex options strategies and develop a consis-

tent 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.

http://whatstrading.com

http://hoekstratrading.com/default.aspx





Using probability as a guideThis approach uses the Martingale rule in a conservative way to trade larger positions

after a string of losses without getting wiped out.


TRADING STRATEGIES

BY LEE LEIBFARTH

When evaluating the merits of a tradingstrategy, many arm-chair system develop-ers focus almost exclusively on its per-centage of profitable trades. If a trading

system has a high percentage of winning trades, it seemslogical it will withstand the rigors of real-world trading bet-ter than a system with a lower percentage of winners.

However, the percentage of winning trades doesn’t con-tain enough information to make a valid comparisonbetween two trading systems. You also need to know thetypical size of its winning and losing trades (among othermetrics). For example, most trend-following systems havewinning percentages of less than 50 percent, but the win-ners tend to be much bigger than the losers, which helpsgive these systems an edge.

The winning percentage can be an important clue of astrategy’s potential success, but it shouldn’t be measured inisolation from other performance statistics. Instead of sim-ply trying to boost a system’s winning percentage, the fol-

lowing discussion explores the concept of probability anduses it to strengthen an intraday trend-following strategy.

Intuitively, many traders feel after one (or more) losingtrade(s), their probability of winning has increased. At thatpoint, traders often increase their trade size to benefit fromthe next trade’s (perceived) higher odds of success. Or theymay also take a signal only after a series of paper losses. Isthis logic valid and can these tactics improve a trading strat-egy’s performance?

Probability as a trading toolIn trading, the probability of winning is calculated by divid-ing the number of winning trades by the total number oftrades for a given period; a probability of zero means alltraders were losers, and a probability of 100 percent meansall traders were winners.

To use probability to improve trading performance, youfirst need to establish a consistent set of strategy rules,grouped into three categories:

• Position sizing — how many shares/contracts to trade?

• Entry rules — when to enter the market (and which direction)?

• Exit rules — when to exit winners and losers?

This sounds obvious, but iso-lating just one of these factorslets you build a system that cantruly test the effects of probabili-ty. The following examples use astandard set of exit rules to testthe effects of different-sizedpositions.

Short-term trading strategiesare ideal for this experiment,because they trade more oftenand endure more price swingsthan longer-term ones, generat-ing more statistically significantresults. An intraday trend-fol-lowing strategy was tested onthe Mini Russell 2000 futures

This system uses the fast stochastic to identify short-term trends instead of reversals.Three of the five short trades made money on Jan. 22.

FIGURE 1 — PINPOINTING INTRADAY MOVES

Source: TradeStation


The intraday stochastics system was mildly profitable, but nothing special. It had a winning percentage of 54 percent, a profitfactor of 1.19, and a maximum drawdown of 6.3 percent.

TABLE 1 — BASIC SYSTEM STATISTICS

Total net profit $8,920.00 Profit factor 1.19Gross profit $55,880.00 Gross loss -$46,960Total number of trades 146 Percent profitable 54.11%Winning trades 79 Losing trades 67Avg. profit $61.10 Ratio avg. win / avg. loss 1.01Avg. winner $707.34 Avg. loser -$700.90Largest winning trade $800.00 Largest losing trade -$800Largest winning trade as percentage of gross profit 1.43% Largest losing trade as percentage of gross loss 1.70%Max. consec. winning trades 5 Max. consecutive losing trades 4Avg. bars in winning trades 44.15 Avg. bars in losing trades 37.21Avg. bars in total trades 40.97 Account size required $5,960Max. contracts held 1 Percent of time in market 15.53%Return on initial capital 8.92% Annual rate of return 37.46%Buy-and-hold return 13.25% Return on account 149.66%Avg. monthly return $2,230.00 Standard deviation of monthly return $5,188.85Max. drawdown (intraday peak to valley) -$6,310.00 Longest flat period 2 days, 20 hoursMax. drawdown as % of initial capital 6.31%


(TF) in the 60-day period from Nov. 19,2008 to Feb. 11, 2009. Instead of usingstandard time-based intervals, theapproach uses 610-tick bars — a moredetailed method that highlights priceaction and trade activity simultane-ously. Finally, the strategy tradesfutures, because it is easier to changethe size of futures contracts thanshares of stock.

Trade rulesThe strategy uses a 14-period fast sto-chastic oscillator to generate entry sig-nals. Instead of buying the marketwhen the fast %K line crosses below 25— a classic oversold signal — the sys-tem sells the market to exploit furtherweakness. And instead of selling shortwhen the fast %K line crosses above 75— a traditional overbought signal —the approach goes long to benefit from the market’s poten-tial strength. These signals are sometimes referred to as astochastic “pop” and trade in the direction of the intradaytrend.

The system trades from 8:30 a.m. to 3:00 p.m. ET andholds each trade until one of the exit conditions are met,even if a signal triggers in the opposite direction (i.e., tradesare not reversed).

Trade rules1. Go long if the 14-period fast %K line crosses

above 75.2. Sell short if the 14-period fast %K line crosses

below 25.3. Exit the trade if it earns $800 (profit target),

loses $800 (stop loss), or at the stock market’s close at 4 p.m. ET.

The Martingale rule doubles the next trade’s size after the previous trade losesmoney with the expectation that the odds of success increase. Applying this rule toa trading system may help it rebound from losses, but it can also wipe you outquickly.

FIGURE 2 — THE MARTINGALE CURSE


continued on p. 8

Figure 1 shows five short trades on Jan. 22, three of whichwere profitable. The approach earned $1,600 as the MiniRussell 2000 futures dropped roughly 4 percent in themorning. It gave back profits in the early afternoon beforemoving back into the black as it sold short when the marketfell apart again in the final two hours of trading.

Because the strategy’s profit target and stop loss amountsare identical, performance depends entirely on the percent-age of winning trades. In other words, the system earnsmoney if more than half of all trades are winners, and itloses money if more than half of all trades are losers. Thus,the strategy is basically a coin toss with the entry rules pro-viding the only hope of positive expectancy and potentialprofit.

Table 1 lists the system’s back-tested results, which weremodestly profitable when trading one contract (commis-sions are excluded). The strategy traded 146 times in the 60-day test period and gained ground 54 percent of the timewith a 1.19-profit factor (gross profit/gross loss). Its maxi-mum drawdown was $6,310, and it posted losses up to fourtimes in a row (more in a moment).

So far the strategy isn’t very impressive, as a good chunkof its average profit ($61.10) will likely be eroded by com-missions and slippage. Let’s try to improve performance byadjusting each trade’s size based on whether previoustrades gained or lost money.

Sizing positions the Martingale way In theory, you can sharpen a system’s performance by trad-ing larger positions after each losing trade, a tactic knownas Martingale betting. The idea is to successively double thesize of a previous losing trade until a single winner recoupsyour losses. The upside is you could quickly overcome any

drawdowns. The system’s winning percentage doesn’tchange, but it could earn significantly more money than ifyou simply traded one contract.

However, the Martingale rule magnifies risk. By tradingincreasingly larger positions, you could easily go brokebefore you have the chance to bounce back. Figure 2’s equi-ty curve shows how the Martingale rule can ruin a strategy:Drawdowns are steep as just one or two trades can wipeyou out. When the Martingale rule was applied to this sys-tem, equity fell from a $22,000-profit to a loss of more than$46,000 within 90 trades. You must have very deep pocketsto succeed with a Martingale system.

Clearly, this approach is too risky to trade, but you canadd elements of the Martingale rule to a system and stilltrade responsibly. One idea is to double the trade’s size acertain number of times before the system stops trading orresets, even if it hasn’t recovered. The goal, of course, is torecoup any losses before this limit is reached. This methodrelies on a system’s favorable winning percentage to keep itfrom shutting down.

Remember that the intraday stochastic system posted upto four consecutive losses. Instead of trading just one con-tract, let’s apply the Martingale rule and double the nexttrade’s size after a loss up to four times in a row. After fourconsecutive losses, the fifth trade should pull the systemout of its hole. If the strategy starts with one contract andposts a loss, the next trade will be two contracts; and if loss-es continue, the system will then trade four, eight, and final-ly 16 contracts. Ideally, a single 16-contract winning tradewill overcome the losses of the previous four trades — atotal of 15 contracts (1 + 2 + 4 + 8 = 15).

Table 2 shows the back-test results of applying theMartingale rule up to four times on the intraday stochastic


TRADING STRATEGIES continued

Doubling a trade’s size up to four times boosted performance, but it also magnified risk. The profit factor increased to 1.74 from1.19, total net profit climbed substantially, but the maximum drawdown nearly tripled.

TABLE 2 — MARTINGALE LITE

Total net profit $55,620.00 Profit factor 1.74Gross profit $130,580.00 Gross loss $74,960Total number of trades 146 Percent profitable 54.11%Winning trades 79 Losing trades 67Avg. profit $380.96 Ratio avg. win / avg. loss 1.48Avg. winner $1,652.91 Avg. loser $1,118.81Largest winning trade $7,840.00 Largest losing trade $6,400Largest winning trade as percentage of gross profit 6.00% Largest losing trade as percentage of gross loss 8.54%Max. consec. winning trades 5 Max. consecutive losing trades 4Avg. bars in winning trades 44.15 Avg. bars in losing trades 37.21Avg. bars in total trades 40.97 Account size required $10,300Max. contracts held 16 Percent of time in market 15.53%Return on initial capital 55.62% Annual rate of return 193.87%Buy-and-hold return 13.25% Return on account 540%Avg. monthly return $13,905.00 Standard deviation of monthly return $12,423.06Max. drawdown (intraday peak to valley) -$18,840.00 Longest flat period 2 days, 20 hoursMax. drawdown as % of initial capital 18.84%


strategy. Although the system’s win-ning percentage remained 54 percent,its profit factor increased to 1.74, andthe total net profit climbed substan-tially. However, this adjustment mul-tiplied risk as the maximum draw-down almost tripled to $18,840 from$6,310 — a harsh reality of this type ofposition-sizing technique.

Natural selectionConservative traders who can’t stom-ach additional risk can still benefitfrom the Martingale rule’s logic thatwinning trades tend to follow a stringof losing ones. Instead of increasingtrade size, you can monitor signalsand trade only the ones with a higherprobability of success. This methodaims to boost a strategy’s winningpercentage and profits (withoutincreasing risk) by taking significant-ly fewer trades.

To trade this approach, you need torun two strategies at the same time:the original system and one with a fil-ter that trades only after the originalplan loses a fixed number of times ina row. You just need to decide howmany consecutive paper losses willtrigger a real trade, keeping in mindthat skipping additional losses mayboost the system’s winning percent-age, but the number of trades willdrop.

Let’s track the original strategy, buttake trades only following two con-secutive losses per day, a limit select-ed after reviewing Mini Russell 2000futures chart during the test period.The revised strategy treats each dayseparately as the number of consecu-tive losses resets each morning.

Table 3 lists the performance statis-tics for this filtered strategy. Its win-ning percentage climbed to 64 percentfrom 54 percent, while the profit fac-tor rose to 2.12 from 1.19. Also, themaximum drawdown was only$1,590 (1.59 percent), meaning youcould trade more than one contract toboost performance (if you are com-fortable with additional risk).However, the system’s $2,720 (2.7


TradeStation EasyLanguage Code:

// =================================// Stoch Probability Strategy// Coded by: Lee Leibfarth 2009// =================================inputs:

StopLoss(800),ProfitTarget(800),Line1(25), Line2(75),StochLength(14),DoubleDSwitch(false), DoubleDLimit(4);

variables:oFastK(0), oFastD(0), oSlowK(0), oSlowD(0),count(0),PrevLosTrades(0),PrevWinTrades(0),NumContracts(1);

value1 = Stochastic( h, l, c, StochLength, 3, 3, 1, oFastK, oFastD, oSlowK, oSlowD);// ==== MONEY MANAGEMENT ====if DoubleDSwitch then begin

if PrevLosTrades <> numlostrades then beginif count <= DoubleDLimit or DoubleDLimit = 0 then NumContracts

= NumContracts * 2; if count > DoubleDLimit and DoubleDLimit <> 0 then

NumContracts = 1;count = count + 1;

end;if PrevWinTrades <> numwintrades then begin

NumContracts = 1;count = 1;

end;PrevLosTrades = numlostrades;PrevWinTrades = numwintrades;

end;//==== TRADE RULES ====if marketposition = 0 and time > 830 and time < 1500 then begin

if oFastK crosses under Line1 then sellshort (“ST_Sell”) NumContracts con-tracts next bar at market ;

if oFastK crosses over Line2 then buy (“ST_Buy”) NumContracts contractsnext bar at market ;end;if time > 1600 then begin

sell (“EOD_LX”) next bar at market;buytocover (“EOD_SX”) next bar at market;

end;setstopcontract;setexitonclose;setstoploss(StopLoss);setprofittarget(ProfitTarget);

You can copy this code athttp://www.futuresandoptionstrader.com/index.php/c/Strategy_Code

continued on p. 10

http://www.futuresandoptionstrader.com/index.php/c/Strategy_Code


percent) profit is relatively low because it traded only 11times during the 60-day test period.

Adding risk to a trading strategy shouldn’t be takenlightly. These adjustments were proposed to inspire creativ-ity — not to be traded without further research. That said,

exploring the role of probability is an important step indesigning a trading system and can be beneficial if doneproperly. ��

For information on the author see p. 5.


Trading the original stochastic strategy only after it posted two consecutive losses improved performance. But it traded only 11times in 60 days — far less often than the basic system.

TABLE 3 — FEWER TRADES, BETTER PERFORMANCE

Total net profit $2,720.00 Profit factor 2.12Gross profit $5,140.00 Gross loss -$2,420Total number of trades 11 Percent profitable 63.64%Winning trades 7 Losing trades 4Avg. profit $247.27 Ratio avg. win / avg. loss 1.21Avg. winner $734.29 Avg. loser -$605.00Largest winning trade $800.00 Largest losing trade $800Largest winning trade as percentage of gross profit 15.56% Largest losing trade as percentage of gross loss 33.06%Max. consec. winning trades 6 Max. consecutive losing trades 2Avg. bars in winning trades 32.00 Avg. bars in losing trades 60.5Avg. bars in total trades 42.36 Account size required $1,280Max. contracts held 1 Percent of time in market 0.95%Return on initial capital 2.72% Annual rate of return 11.76%Buy-and-hold return 19.50% Return on account 212.50%Avg. monthly return $680 Standard deviation of monthly return $1,555.46Max. drawdown (intraday peak to valley) -$1,590.00 Longest flat period 40 days, 23 hoursMax. drawdown as % of initial capital 1.59%


Related reading: Lee Leibfarth articles

“Improving the three-bar pullback pattern” Futures & Options Trader, August 2008.Getting in is only part of the story. This pullback strategy illustrates the crucial role exit rules play in profitability.

“Fibonacci pivot points” Futures & Options Trader, April 2008.Countertrend and breakout rules complement a Fibonaccipivot-point technique.

“Sharpening a countertrend strategy” Active Trader, October 2007.Designing a trading system involves more than just creatingprofitable signals. You also need to consider how to sizeyour trades.

“Intraday hybrid strategy” Active Trader, July 2007.Because simple trend-following methods can fall flat duringchoppy markets, this breakout system adjusts its exits to fitdifferent market environments.

“Forecasting techniques” Active Trader, October 2006.Predicting probable market action is a challenging task, buta handful of calculations make it possible to measure thereliability — and improve the accuracy — of price forecasts.

Other articles

“Trading System Lab: Martingale rule (futures)” Active Trader, December 2005.The Martingale rule is based on an old and simple rule oftenused by inexperienced gamblers: Start with one bet andeach time you lose, double the amount of your prior losingbet. If you win, bet again with the minimum amount. Thegoal is to recover all lost bets as well as gain additional profit. Although infallible in theory, the technique turns out tobe extremely dangerous in practice. It is a position-sizingmethod that tries to take advantage of the improbable natureof a very long losing streak.

“The ‘high probability’ myth” Active Trader, January-February 2001.“High probability.” It’s one of the biggest buzz terms in trad-ing. We all hear about it. We all want it — or think we do.But high probability and successful trading don’t necessarilygo hand in hand. Find out why.

“Probability vs. profitability” Active Trader, June 2000.It’s not the winning percentage of a trading system thatcounts, it’s how you manage positions and control losses.

You can purchase and download past articles athttp://store.activetradermag.com.

http://store.activetradermag.com

ads0908 7/15/08 1:28 PM Page 39


Intermarket soybean strategyAn intermarket system for soybean futures incorporates data

from markets inside and outside the grain sector.


TRADING STRATEGIES

BY MARKOS KATSANOS

Intermarket analysis, which studies the relationshipbetween different markets, is a neglected area ofresearch, but it offers the opportunity to develop asystem based on the divergences between two or

more highly correlated commodities, as well as avoidtrades against the prevailing direction of correlated mar-kets.

Soybeans (S), corn (C), and wheat (W) have always tend-ed to move in the same direction. The price of one market,however, does not move in a particular direction becausethe other is moving the same way; both markets are driven

by the same fundamentals. However, their correlation canbe used to exploit short-term inefficiencies because the fun-damentals might not be fully reflected in the price of all themarkets at the same time.

Other grains, however, are not the only markets thatshould be considered when designing an intermarket trad-ing system. Soybeans are denominated in U.S. dollars, sothe price of the dollar relative to other currencies can be animportant component. Also, the price of crude oil can havean effect, since more than 80 percent of estimated biodieselproduction in the U.S. comes from soybean oil.

The correlationsTo select the best markets for anintermarket system, we’ll start bycalculating the correlations of rawprices (Table 1) and percentagechanges (the last two columns ofTable 2) between soybeans andrelated markets — other commodi-ties, stocks, and the U.S. dollarindex.

The correlation coefficient variesbetween +1 and -1. A +1 value indi-cates a perfect positive relationship

TABLE 1 — MARKET CORRELATIONS (DEC. 1998-DEC. 2008)

S BO SM C W POT CRB DXY CLSoybeans (S) 1 0.95 0.92 0.83 0.87 0.80 0.79 -0.83 0.75Soybean oil (BO) 0.95 1 0.82 0.83 0.92 0.86 0.80 -0.88 0.78Soymeal (SM) 0.92 0.82 1 0.76 0.78 0.71 0.70 -0.63 0.68Corn (C) 0.83 0.83 0.76 1 0.84 0.65 0.57 -0.64 0.54Wheat (W) 0.87 0.92 0.78 0.84 1 0.86 0.79 -0.79 0.77Potash Corp. (POT) 0.80 0.86 0.71 0.65 0.86 1 0.87 -0.86 0.87CRB index (CRB) 0.79 0.80 0.70 0.57 0.79 0.87 1 -0.84 0.97Dollar index (DXY) -0.83 -0.88 -0.63 -0.64 -0.79 -0.86 -0.84 1 -0.82Crude oil (CL) 0.75 0.78 0.68 0.54 0.77 0.87 0.97 -0.82 1

Soybeans correlated well with the other commodities during the entire 10-year period.

TABLE 2 — CORRELATION ANALYSIS

Price 10-day yield

No. of years: 10 5 Fit line 10 5Soybean oil 0.95 0.93 Linear 0.73 0.77Soymeal 0.92 0.98 Linear 0.84 0.87Corn 0.83 0.86 Linear 0.56 0.59Wheat 0.87 0.80 Approx. L 0.33 0.36Potash Corp. 0.80 0.59 Linear 0.27 0.31CRB index 0.79 0.30 Approx. L 0.48 0.50Dollar index -0.83 -0.56 Parabolic -0.20 -0.18Crude oil 0.75 0.41 Non-linear 0.11 0.23

The correlations were volatile over time: Soybeans’ correlations with the CRB, crudeoil, dollar index, and Potash stock dropped significantly in the 2004-2008 period.


between the two variables — that is, two markets that aremoving precisely in tandem; a -1 value indicates a perfectnegative relationship between the two variables; a value ofzero means there is no linear relationship between the vari-ables. Values in between indicate the degree of positive andnegative correlation.

During the entire 10-year period, soybeans correlatedwell with all the other commoditiesin Table 1. However, Table 2 showsthe correlations with the CRB, crudeoil, dollar index, and Potashdropped significantly during themore recent five-year period (2004-2008). This indicates there is consid-erable correlation volatility overtime, which makes these instru-ments undesirable for a predictivetrading system. Also, the correla-tions with wheat, the dollar index,and crude oil broke down in termsof their 10-day percentage yields (inblue, Table 2).

Although the correlation with thedollar index is not as strong as it iswith some of the other commodities,it can increase dramatically duringperiods of rising volatility andsharp dollar declines (Figure 1).During the preceding seven years,there were three such periods, allresulting in strong, inverse correla-tions between soybeans and the dol-lar index. These coincided withsharp dollar declines: The dollarbecame the dominant price-movingfactor for soybeans.

Market selectionTo design an intermarket systembased on this analysis, we need todecide which market has the bestpredictive correlation for soybeans.However, the main purpose of apredictive model is not to select acommodity with the highest correla-tion value from a contemporaneouscorrelation analysis but to find apredictive market that produces dis-parities between forecasted andobserved values that warn you ofdangers and opportunities well

ahead of time. In other words, you want the predictor mar-ket to sometimes diverge from the predicted market. Thiscan only be revealed by a leading and lagging correlationanalysis, which is simply a list of related intermarket corre-lations displaced at specified time intervals (lags).

To determine which market was leading, the weekly soy-continued on p. 14

http://www.thewizard.com


bean price percent changes were shifted both forward andbackward in time, and the lagging or leading correlation torelated commodities was calculated.

In Table 3 the first column shows the number of days soy-bean data was shifted forward or backward in time: “+1”indicates yesterday’s soybean weekly price change was cor-related with today’s weekly price change in the other mar-ket, while “-1” indicates tomorrow’s soybean weekly pricechange was correlated with today’s weekly price change inthe corresponding commodity. Higher correlations withnegative lag numbers indicate soybeans are lagging the

other market (top half of thetable), while higher correla-tions with the positive lagnumbers indicate soybeansare leading the other market.

The table shows there wasno significant lead or lag rela-tive to soybean oil and soy-bean meal, but soybeanslagged corn considerably andled the dollar and wheat. Thelead on the dollar seemedcounterintuitive; a closer lookat Figure 1, however, confirmsthe correlation analysis, as itwas evident soybeans bot-tomed at least a week beforethe dollar peaked and toppedbefore the dollar bottomed.

The correlation analysisrevealed that except for soy-bean oil and soybean meal,

corn had the most consistent correlation during both timeperiods. Also, it was the only commodity that led soybeans.The second-best selection was soybean oil because of itshigher correlation with energy futures (Table 1), which hadthe potential to add new information influencing pricedynamics.

Having determined the most appropriate commodities,the next task is to develop a mechanical trading system toexploit divergences in their relationship. There are severalmethods for calculating the divergence between two corre-lated markets. This test used the regression equation to pre-

dict the likely values of the predict-ed market (soybeans) based on thevalues of a correlated market(corn). The divergence between thepredicted value and the actualvalue is then calculated; a buy sig-nal is triggered when the diver-gence reaches a certain extremevalue.

Because divergence values varyaccording to the market, theIntermarket Momentum oscillator(IM) was used to normalize themon a scale of zero to 100. The calcu-


The correlation with the dollar index increased dramatically during periods of risingvolatility and sharp dollar declines.

FIGURE 1 — SOYBEAN CONTINUOUS CONTRACT

Data source: Reuters

TABLE 3 — LEADING OR LAGGING?

Soybeans showed no significant lead or lag relative to soybean oil and soybeanmeal, but they lagged corn considerably and led both the dollar and wheat.

Lag (days) BO SM C W DXY

-3 0.302 0.339 0.249 0.117 -0.089

-2 0.442 0.510 0.354 0.176 -0.138

-1 0.578 0.668 0.450 0.233 -0.183

0 0.728 0.843 0.561 0.329 -0.201

+1 0.571 0.667 0.434 0.256 -0.186

+2 0.437 0.497 0.315 0.193 -0.145

+3 0.292 0.333 0.190 0.132 -0.109

Lag

Lead


lation of this indicator is similar to the stochasticoscillator, but it is designed to be applied to anindicator instead of price because it ignores intra-day extreme values. Buy signals are generatedwhen the indicator reaches a peak above a cer-tain level (usually 80-85) and subsequentlydeclines. Similarly, sell signals are triggeredwhen the indicator reaches a bottom below a cer-tain level (usually 10 to 15) and rises.

We tested a simple regression-divergence sys-tem, first using corn and then soybean oil. Thesoybean-corn combination produced slightlybetter results on a total profit basis but the soy-bean-soybean oil combination produced a higherprofit factor, so both commodities were used in acombined system.��


Note: The May issue of Active Trader magazine (http://www.activetradermag.com) has an expandedversion of this article that includes test results of atrading system based on this analysis.

Book:Intermarket Trading Strategies by Markos Katsanos (2009, Wiley Trading).Note: The proprietary indicators in this article are covered in greaterdetail in this book.

Articles:“Stock index spreads: S&P vs. Naz” Active Trader, May 2006.They aren’t often the subjects of spread trading, but the obvious con-nections and subtle differences of various stock index futures offeropportunities to play one market off the other. (Note: This article isalso part of two discounted article collections: “Keith Schap: FuturesStrategy collection, Vol. 1” and “Stock index futures trading collec-tion.”)

“Getting technical with John Murphy” Active Trader, September 2001.Noted analyst, author and money manager John Murphy discusseswhat he has learned about the technical approach to trading duringhis 30-plus-year career, including intermarket analysis.

You can purchase and download past articles at http://store.activetradermag.com

Related reading

Bob DormanAd sales East Coast and [email protected]

(312) 775-5421

Allison CheeAd sales West Coast and Southwest

[email protected](415) 272-0999

Mark SegerAccount Executive

[email protected](312) 377-9435

Three good tools for targeting customers

— CONTACT —

http://www.activetradermag.com


Land softly with butterflies and condors

Both positions are well-suited for volatile markets

because they have fairly wide profit ranges.


TRADING STRATEGIES

BY FREDERIC RUFFY

In times of economic uncertainty and market volatil-ity, investors have fewer places to turn. The DowJones Industrial Average was down roughly 44 per-cent year-to-date at its Nov. 21 nadir with daily

ranges around 5 to 6 percent. Mutual funds are gettinghammered and, in October, stock funds lost more than $1trillion, or 20 percent of their assets, according to theInvestment Company Institute.

Crude oil and other commodities have been in freefall.Bonds are performing well, but with the yield on 10-yearTreasuries at 2.4 percent on Dec. 16 and corporate bonds’default risk still high, the bond market also looks dicey.

Fortunately, investors can turn to the options market tocreate a variety of pre-defined risk-reward opportunities.Directional butterflies and condors are two option spreads

that risk a little for achance to earn a greatdeal if the underlyingmoves in the desireddirection.

Flying with a butterflyButterfly spreads arebest known as range-bound strategies, butthey also work well ifyou have an underly-

Strategy SnapshotStrategy: Call butterfly spread.

Components: Buy one call, sell two calls at a higher strike, and buy another call at an even higher strike.

Logic: Time decay erodes the short calls’ time value to a greater degree than the ITM long call’s value.

Criteria: Calls are spaced at equidistant strike prices. Short strike is placed at the underlying’s target price. Use options that expire in fewer than 45 days.

Best-case Underlying closes at the short strike scenario: at expiration. All short calls expire

worthless.

Worst-case Underlying moves beyond one of the scenario: long protective wings. The maximum

loss is the spread’s cost.

Possible Create a condor instead by selling two modifications: strike prices instead of just one.

Chances of earning maximum profit are increased.

By purchasing a December GLD 75/78/81 butterfly, you are risking $0.40 to make $2.60 if GLDclimbs from $74 to $78.

TABLE 2 — DISSECTING A BUTTERFLY

GLD traded at $74 on Nov. 19.Position Long/short Strike price Expiration month Credit/debit

Wing 1 call Long 81 December -$1.64Body 2 calls Short 78 December $4.82Wing 1 call Long 75 December -$3.58

Total debit: -$0.40Max. gain: $2.60Upside breakeven point: $75.40Downside breakeven point: $80.60

The trades executed on Nov. 19 have all the characteristics of a butterfly spread: They occurred at the same time, and thetrader sold the 78 strike and bought the 81 and 75 strikes in a ratio of 2:1.

TABLE 1 — SIGNS OF A GLD BUTTERFLY

Quantity Symbol Expiration month Strike Type Price Bid/ask side Exchange Time

278 GLD December 78 Calls $2.41 Bid side ISE 9:45:26

139 GLD December 81 Calls $1.64 Ask side ISE 9:45:26

139 GLD December 75 Calls $3.58 Ask side ISE 9:45:26

Source: Trade Alert

ing directional forecast. One drawbackis they require multiple trades, whichincreases commission costs. However,commissions have dropped in recentyears, meaning butterflies havebecome practical even for retailtraders.

Because a butterfly is an advancedstrategy, investors should practice onpaper before trading it with realmoney. The trade can be created withonly puts or calls or both (i.e., an“iron” butterfly).

A long call butterfly has three maincomponents: one long in-the-money(ITM) call, two at-the-money (ATM)short calls at a higher strike price, andan out-of-the-money (OTM) call at aneven higher strike. The two short callscreate the butterfly’s “body,” and theother two strikes form the “wings.”

Ideally, after entering a call butterflyspread, the underlying’s price will

continued on p. 18

If you were bullish on the SPDR Gold Trust on Nov. 19, you could enter a75/78/81 butterfly in December options, which could earn $2.60 per share ifGLD rallies to the $78 short strike within a month.

FIGURE 1 — GOLDEN OPPORTUNITY?

Source: eSignal

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move toward the short strike, and the short calls will expireworthless. However, the lower-strike long call will retainmost of its value. The trade generates profits, because timedecay erodes the short calls’ value to a greater degree thanthe long ITM call’s. The highest-strike call is merely ahedge, which expires worthless if the trade works asplanned.

Because butterflies exploit time decay, it makes sense touse shorter-term options. Options that expire sooner losetime value at a faster rate than options that expire later,because time decay is non-linear in nature. Many butterfly

traders prefer to focus on options withfewer than 45 days left until expira-tion.

A golden butterflyLet’s look at a specific example in theSPDR Gold Trust (GLD). Unlike mostexchange-traded funds (ETFs), GLDdoesn’t hold shares of individual com-panies. Instead, it holds the preciousmetal and allows you to bet directly ongold’s direction. Let’s assume you arebullish on the yellow metal and antici-pate price will gradually move higherfrom its Nov. 19 price of $735 an ounceto $775 in one month.

At that point, GLD traded at $74 —about one-tenth of gold futures (GC).Options on GLD are spaced at one-point strikes prices (84, 85, 86, etc.),which offers many choices for butter-flies. With a target price of $78 in theSPDR Gold Trust ($775 in goldfutures), the December 78 call will be

this butterfly’s short(center) strike.

Table 1 shows anoptions chain for selectDecember GLD callson Nov. 19. The day’sorder flow showsanother trader hasentered a butterfly. At9:45 a.m. ET, 278 GLDDecember 78 callstraded at the bid priceof $2.41 per contract.Meanwhile, half asmany (139) December81 and 75 calls tradedat the ask prices of$1.64 and $3.58,respectively.

The collective action has all the characteristics of a but-terfly spread: The trades occurred at the same time, and thetrader sold the 78 strike and bought the 81 and 75 strikes ina 2:1 ratio.

To calculate a butterfly spread’s cost (excluding commis-sions), add the long calls and subtract the short ones. Forexample, Table 2 shows the GLD December 75/78/81 but-terfly costs $0.40 (long strikes [$3.58 + $1.64] minus shortstrike [$2.41*2]). The butterfly’s maximum loss is $0.40 perspread, excluding any risk from dividends, which reduce acall’s value. Its maximum gain is $2.60 ($3 strike-price dif-



A condor is similar to a butterfly, but it has four strike prices instead of three. This condor risks$0.46 to earn a maximum profit of $2.54, and it is more likely to earn that amount than the butterfly from Table 2.

TABLE 3 — CONDOR DETAILS

GLD traded at $74 on Nov. 19.Position Long/short Strike price Expiration month Credit/debit

Wing 1 call Long 82 December -$1.52Body 1 call Short 79 December $2.23Body 1 call Short 78 December $2.41Wing 1 call Long 75 December -$3.58

Total debit: $0.46Max. gain: $2.54Upside breakeven point: $81.54Downside breakeven point: $75.46

This bullish December 75/78/81 butterfly gains up to $2.60 per share if GLDclimbs from $74 to the $78 strike by Dec. 20 expiration (solid line). But it will stillmake money if the SPDR Gold Trust trades between $75.40 and $80.60.

FIGURE 2 — RISK PROFILE — BUTTERFLY

Source: OptionVue

ference minus $0.40 cost), so you arerisking $0.40 to make $2.60.

Figure 1 shows a daily chart of GLDwith the butterfly’s highlighted strikeprices, and Figure 2 shows thespread’s potential gains and losses onthree dates: trade entry (Nov. 19, dot-ted line), halfway to expiration (Dec.5, dashed line), and expiration (Dec.20, solid line).

The GLD December 75/78/81 but-terfly has a very bullish bias. It willonly make money if the gold ETF ral-lies, and its largest profit occurs at $78— 5.4 percent above its entry price.The spread’s downside breakevenpoint is $75.40, so the trade will losemoney if GLD fails to climb that far.

However, the upshot is its wideprofit range, which makes the positionattractive in uncertain times. As longas GLD settles between $75.40 and$80.60 (its upside breakeven point) atexpiration, the butterfly will gainground.

Cruising with a condorInstead of trading a butterfly, you cantrade a condor, which offers a greaterchance of earning maximum profits. Acondor is similar to a butterfly, but ithas four strike prices instead of three.The difference is a condor’s body hastwo strike prices compared to only onefor a butterfly. However, the goalremains the same — wait for the shortoptions to expire worthless.

Let’s create a condor on GLD andcompare it to the butterfly example.Table 3 lists the condor’s fourDecember calls: short 78 and 79 strikesand long 75 and 82 strikes. The short78 and 79 calls form the condor’s body,and the long 75 and 82 strikes form theprotective wings.

To calculate a condor’s cost, subtractthe long calls’ cost from the short calls’collected premium. Table 3 shows thecondor costs $0.46 per spread ($1.52 +$3.58 - $2.41 - $2.23). It costs slightlymore to trade a condor, and the extracost also increases its risk. The condorrisks $0.46 to earn a maximum profitof $2.54.

Remember, the butterfly risked$0.40 to make it up to $2.60. Also, thecondor’s profit range is smaller thanthe butterfly’s ($75.46 to $81.54 vs.$75.40 to $81.60, respectively).

Figure 3 shows the condor’s poten-tial gains and losses, and Figure 4compares the condor’s risk profilewith the butterfly’s (red and blue lines,respectively). Admittedly, the butter-fly can earn slightly more and its prof-it range is wider.

But Figure 4 clearly shows the con-dor offers a better chance of extractingthe maximum possible profit of $2.54.The condor’s largest profit is betweenits two short strikes of $78 and $79.With a butterfly, however, you willearn significantly less if the SPDRGold Trust closes at $79.

Stops, assignment,and commissionsManaging risk is the key to success-fully trading butterflies and condorsover the long haul. If the underlyingfails to move within the profit range,all calls will likely expire worthless,and you will lose the spread’s cost.Even if that loss is small compared tothe potential profit, 100-percent lossescan mount over time.

Stop losses can lessen the risk of los-ing a spread’s entire cost. With a timed

stop, if the underlying doesn’t movewithin the profit range after a certaintime period (e.g., one week, two


The condor’s largest profit is between its two short strikes of $78 and $79.

FIGURE 3 — RISK PROFILE — CONDOR

Source: OptionVue

continued on p. 20

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Related reading: Frederic Ruffy article

“Backspreads and ratio spreads,” Futures & Options Trader, October 2007.Which options spread is preferable when you’re expecting an explosive underlying move?

Other articles:

“Directional butterfly spreads,” Options Trader, December 2006.Placing a butterfly spread near a price target establishes a wide, low-risk profit zone.

“Options Strategy Lab: Directional butterflies on the S&P 500” Options Trader, November 2006.This system uses butterfly spreads to make directional bets by placing the shortstrike near a price target.

“Option butterflies: A safer way to sell volatility” Options Trader, July 2005.Long butterfly spreads allow you to profit from time decay of short options — butwith the added benefit of providing a “safety net” around your position.

“Options Strategy Lab: Employment report iron butterfly”Futures & Options Trader, April 2007.Playing the monthly jobs report with an options spread.

“The butterfly in the iron mask,” Options Trader, November 2005.Does the iron butterfly have any advantage over its generic counterpart? We unmask this strategy to find out how it really works.

You can purchase and download past articles at http://store.activetradermag.com.

The butterfly can earn slightly more than the condor (blue and red lines, respec-tively) and its profit range is wider, but the condor has a better chance of earn-ing its largest gain of $2.54 per share.

FIGURE 4 — CONDOR VS. BUTTERFLY

Source: OptionVue

weeks, three weeks, etc.), you exit thetrade. Trailing stops can be set belowthe underlying, so the trade is closedif it falls, say, 5 percent from a previ-ous high. A third type of stop tracks aspread’s value. If, for example, youpay $1 for a spread and its value fallsto $0.50 (50 percent), then exit thetrade.

Understand the risks of assignmentat expiration as well. If the ITM calls(or puts) are held until expiration,they may be assigned, forcing you tobuy or sell the underlying and paycommissions. How will this affectyour account balance, and how willyour broker handle the assignment?

If the butterfly or condor is prof-itable, it might make sense to exit onexpiration Friday even if you leavesome money on the table. By side-stepping assignment, you also avoidany unexpected market movesbetween expiration Friday’s closewhen positions are exercised.Sometimes it might be optimal toexercise the deep in-the-money call toget the maximum profit from thetrade. If you aren’t sure, discuss itwith your broker and they can guideyou.

Finally, consider the commissioncosts of butterflies and condors. Somebrokers charge more for four-leggedstrategies (condors) than three-leggedstrategies (butterflies). Find out howmuch your broker charges per con-tract, and if you are serious aboutbecoming a spread trader, find a firmthat specializes in these types oftrades.

Trade with confidenceIn times of uncertainty, it’s importantto trade with confidence. Developinga trading plan with exit rules is agood start. Using options helpsbecause many strategies have clearlydefined risk-reward profiles that youcan study before entering a trade.��



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OPTIONS STRATEGY LABTRADING STRATEGIES


BY GEORGE HOEKSTRA

Applying a simpler volatility measure

In the wake of last year’s stock market collapse, every-one seems to be talking about volatility. However, fewinvestors really understand what volatility is and how

to calculate it. Volatility is typically measured by standarddeviation, a somewhat abstract concept for most investors.Luckily, there are more tangible ways to measure volatilityincluding a new calculation introduced by Professor JavierEstrada from the IESE Business School in Spain.

Professor Estrada’s volatility measure is called the gain-loss spread (GLS), which is easier to understand and isexplained in a recent issue of Active Trader (see “A simplervolatility measure,” April 2009). This discussion reviewshow the GLS is constructed and shows how it can uncover

subtle differences between the volatilities of two underly-ing markets that options traders focusing on standard devi-ation may overlook. In short, the gain-loss spread can helpyou uncover trading opportunities that the options-tradingcrowd neglect. (Estrada’s study can be downloaded fromhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1308103.)

Gain-loss spread basicsTo calculate the gain-loss spread for a stock, first select ahistorical time period — one year, for example. Next, breakthe time period into intervals of 52 weeks. Finally, ask foursimple questions:

1. In how many of the 52 weeks didthe stock go up?

2. In how many of the 52 weeks did the stock go down?

3. For the up weeks, what was the average percentage gain?

4. For the down weeks, what was the average percentage loss?

The weekly gain-loss spread is cal-culated directly from these four num-bers:

• The probability of gain is estimated as the number of up weeks divided by 52.

• The probability of loss is estimated as the number of down weeks divided by 52.

• The gain loss spread is the size of the average percentage gain times the probability of gain, minus the size of the average percentage loss times the probability of loss.

Flowers Foods ranged from roughly $23 to $33 over the past year, but moredefinitive conclusions about its volatility are hard to draw from this weekly pricechart.

FIGURE 1 — FLOWERS FOODS

A close look at the gain-loss spread demonstrates how it can pinpoint volatility patterns

that standard deviation might miss.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1308103

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1308103


Is the gain-loss spread useful?Figure 1 shows a weekly chart ofFlowers Foods, Inc. (FLO) for the 52-week period ending Jan. 30. Figure 2shows FLO’s weekly percentage pricechanges over the same period as wellas its average weekly percentage gain(green line) and loss (red line).

Flowers Foods increased in 23 of the52 weeks, and it dropped in 29 of thoseweeks. The average gain for the 23 upweeks was 4.0 percent, and the averageloss for the 29 down weeks was 4.2 per-cent. In calculating the GLS, the aver-age upside gain is weighted by thefraction 23/52, which is an estimate ofthe probability of gain; the averagedownside loss is weighted by the frac-tion 29/52, which is an estimate of theprobability of loss. The GLS is calculat-ed as follows:

Weekly GLS = 23/52 * (4.0%) -29/52 * (-4.2%) = 4.1%

Estrada’s article provides convincingevidence that the gain-loss spread is atleast as good — and in some ways bet-ter — than standard deviation as ameasure of stock-price volatility. One ofits big benefits is simplicity.

Using the GLS, Flowers Foods’volatility can be expressed as follows:In a typical week, Flowers Foods isexpected to vary by 4.1 percent (up ordown) from the prior week’s close. Thatis a simple, tangible statement aboutvolatility.

Using standard deviation, FlowersFoods’ volatility is harder to grasp: Thesquare root of the average quadraticdeviation from Flowers Foods’ arith-metic mean return is expected to be 36percent.

Painting a volatility pictureUnlike Figure 1, Figure 2 reveals a fin-gerprint of Flowers Foods’ volatility.What can be learned from studying thischart? First, the distance between green

continued on p. 24

The gain-loss spread for Flowers Foods indicates it is expected to vary by 4.1percent (up or down) in any given week.

FIGURE 2 — WEEKLY MOVES (FLO)

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and red lines is a simple indicator ofaverage volatility — the farther apartthese lines are, the higher the volatili-ty.

Figure 2’s individual bars representweekly percentage moves that lead toa certain level of volatility; they arethe spread’s sole components. Barsthat exceed the green line indicateunusually strong weeks. FlowersFoods had only two really strongweeks, one in July and one in October(8- and 13-percent gains, respective-ly).

Bars extending below the red lineshow losses exceeding the averageweekly loss of 4.2 percent. There were8 such weeks, all of them in the sec-ond half of 2008 (three exceeding 10percent).

A pattern of FLO’s volatilityemerges over time. Flowers Foodswas relatively stable in the first half of2008 as up and down weeks wereevenly distributed and mostly con-tained within the two average lines.By contrast, the second half of 2008was much more volatile, especially onthe downside.

Weekly GLS charts show priceaction through a new and differentlens. Instead of simply using a stan-dard deviation value for volatility,you are studying underlying informa-tion that drives option prices — adeeper level of detail.

Comparing volatilities of different stocksLet’s use weekly gain-loss charts tocompare the volatility of FlowersFoods with Raytheon (RTN), whichhas a one-year standard deviation of30 percent (similar to FLO). Figure 3shows RTN’s weekly gain-loss chart,and Figure 4 shows its weekly barchart.

If you compare Figures 2 and 4, youwill notice Raytheon has a much dif-


Raytheon had a bad year in 2008 as it plunged 34 percent from mid-Septemberto mid-October.

FIGURE 4 — RAYTHEON

Raytheon has a much different volatility pattern than Flowers Foods (Figure 2).In early 2008, RTN’s volatility was low, but it increased steadily during the year,climaxing with a 17-percent weekly loss in October and a 16-percent gain threeweeks later.

FIGURE 3 — WEEKLY MOVES (RTN)


ferent volatility pattern than FlowersFoods. In early 2008, RTN’s volatilitywas low, but it increased steadily dur-ing the year, climaxing with a 17-per-cent weekly loss in October and a 16-percent gain three weeks later.Meanwhile, FLO’s volatility was moreconsistent.

Figure 4’s weekly bar chart showsboth price trends and volatility — thetwo kinds of information are inter-mixed. Clues about volatility are oftenignored because your attention isdrawn to the stock’s directional move-ment. For example, the first thing youprobably notice about Figure 4 is thatRaytheon had a very bad year. ButFigure 3’s GLS chart helps you focussolely on volatility.

Comparing Tim Hortons (THI) toFlowers Foods makes more sense,because its stock moves and volatilitywere similar in 2008. Table 1 lists threemeasures of volatility for both stocks:100-day standard deviation, one-yearstandard deviation, and weekly gain-loss spread.

The 100-day standard deviations areessentially the same — 54 percent(FLO) and 52 percent (THI). These val-ues are based on 100 trading days andare sometimes used in theoreticaloption-pricing models. The one-yearstandard deviation values are smallerthan their 100-day counterparts, mean-ing the most recent 100 days have beenmore volatile than the entire previousyear. Both calculations show similarvolatilities.

Figure 5 shows a weekly gain-losschart for THI. The difference in GLSspread values for FLO and THI is rela-tively large (4.1 vs. 4.6 percent, respec-tively), a discrepancy that doesn’tappear in their standard deviations.

THI volatility was dominated byseveral explosive weeks in the fourthquarter of 2008, according to Figure 5.THI lurched at least 10 percent (up and

down) in half of those weeks duringthat period and moved more than 15percent at least once. This differssharply with the first half of the year,when THI often swung less than 3 per-

cent on a weekly basis. By contrast,Flowers Foods (Figure 2) showed amuch more consistent volatility pat-tern.

The difference in GLS percentage values for FLO and THI is relatively large (4.1vs. 4.6 percent, respectively), a discrepancy that doesn’t appear in their stan-dard deviations.

FIGURE 5 — TIM HORTONS

continued on p. 26




“A simpler volatility measure,” Active Trader, April 2009.Measuring volatility with standard deviation can be confus-ing for some traders. The gain-loss spread is a new volatilityformula that is easier to grasp.

“Who buys options?” Futures & Options Trader, November 2008.An academic paper analyzing who trades different types ofoptions strategies offers clues for successful trading.

“The quest for cheap options” Futures & Options Trader, August 2008.This option-buying strategy builds on a recent academicstudy that found a compelling edge in the options marketfrom 1996 to 2005.

“Getting a handle on volatility”Options Trader, September 2006.Want to understand volatility? Before you dive into option-pricing models and complex math, do some basic pricecomparison. You’ll be surprised how much you can learn.

“Focusing on volatility,” Options Trader, August 2005. To hone in on options with the most favorable odds, struc-

ture a search that focuses on a certain stock price, exerciseprice, and expiration date, and then use a simple analysisapproach to identify options that are the most underpriced.

“The option pricing edge” Options Trader, October 2005. Buying options at a 10- to 20-percent discount can be thedifference between making and losing money over time. Apopular trading approach is to buy options on a stock youexpect to have more volatility than the level implied by theprice of its options. Higher volatility translates into higheroption prices, so if your assessment of future volatility iscorrect, such options give you an advantage in that higheractual volatility increases the chance of a profitable trade.

“Bargain hunting options” Active Trader, January 2005. If you get the willies every time read “standard deviation,”take heart: This volatility analysis approach and option trad-ing strategy takes the mathematical sting out of finding inex-pensive options.

You can purchase and download past articles athttp://store.activetradermag.com/

The July calls for Flowers Foods and Tim Hortons have similar prices (if you examine their extrinsic values).

TABLE 2 — JULY OPTIONS DETAILS

Flowers Foods Inc. Tim Hortons Inc.

Stock price $21.50 $24.60

Amount in Option Extrinsic Amount in Option ExtrinsicOption Strike price the money price value the money price value

July 20 call $20.00 $1.50 $3.40 $1.90 $4.60 $5.70 $1.10

July 22.5 call $22.50 -$1.00 $2.10 $3.10 $2.10 $3.90 $1.80

July 25 call $25.00 -$3.50 $1.30 $0.00 -$0.40 $2.55 $0.00

July 30 call $30.00 -$8.50 $0.40 $0.00 -$5.40 $0.85 $0.00

Related reading: George Hoekstra articles

The next step is to show howoptions traders can use this dis-crepancy to find potential tradeopportunities.

Parsing options pricesBecause the standard deviationsand stock prices of Flowers Foodsand THI are similar, you would expect their options to bepriced about the same. Table 2 lists the details of severalJuly 2009 calls on FLO and THI and shows their extrinsic

values (price minus amount in the money) roughly match.Figure 6 plots both stocks’ July call prices (y-axis) against

the amount they are in the money (x-axis). The data fall

The standard deviations for Flowers Foods and Tim Hortons are about the same,but their weekly GLS percentages are wider apart.

TABLE 1 — MEASURING VOLATILITY – FLO VS. THI

100-day 1-year Weekly Stock standard standard gain-loss

Stock price deviation deviation spread

Flowers Foods, Inc. (FLO) $21.50 54% 36% 4.1%

Tim Hortons Inc. (THI) $24.50 52% 41% 4.9%

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along a single trend line, showingoption prices are equivalent for thesetwo stocks. This trend line crosses thex-axis at $2.50, which represents thecost of an at-the-money (ATM) Julycall for both stocks.

In short, the options market doesn’tcare about the difference in volatilitypatterns of FLO and THI. Optionprices reflect both stocks’ averagevolatility as measured by the stan-dard deviation. They are indifferentto the manner in which volatility haschanged over time.

Again, the weekly gain-loss chartsin Figures 2 and 5 highlight signifi-cantly different volatility patterns inFLO and THI, but their options arepriced identically. How can youexploit this situation? To answer thisquestion, dig deeper to diagnose theirvolatility patterns. Flowers Foods wasrelatively stable, but THI has beenmore sensitive to something going onin the market or in its business.Whatever the cause, is it likely to con-tinue in the next few months? If youbelieve it will, then you would wantto buy options on THI instead of FLO.

By examining recent news on astock, you can uncover reasons whyparticular large moves occurred whenthey did. First, find out what type ofnews broke when FLO and THI madeunusual weekly moves last year. Werethese moves driven by market orcompany-specific events? Also, deter-mine if other noteworthy eventsoccurred in the same week; if so, dothey tend to recur? Volume trends canalso pinpoint patterns of when largeprice moves occur.

The goal is to figure out what isdriving the volatility of these stocks.By answering these questions, youmay discover clues that reveal howvolatility may unfold in the future. Ifso, you can then enter an optionsposition to take advantage of thisforecast.��


The options prices of both stocks fall along a single trend line, showing theyare equivalent.

FIGURE 6 — OPTIONS PRICING — FLO VS. THI


OPTIONS STRATEGY LABOPTIONS TRADING SYSTEM LAB

Market: Options on the S&P 500 index (SPX). This strategycould also be applied to other equity indices, ETFs, andstocks with liquid options contracts.

System concept: Short butterflies are options spreads thattend to perform well in volatile mar-kets. These positions were first test-ed on the S&P 500 index back in2006, and they lost money in partbecause market volatility had driedup over the previous five years.Now that volatility has returnedwith a vengeance, let’s examinewhether short butterflies are effec-tive ways to exploit current volatileconditions. The following studycompares the original test’s results(2001 to 2006) to the overall per-formance from 2001 to 2008.

Short butterfly spreads containlong options at one strike price andhalf as many short options at equi-distant strike prices both above andbelow that strike. The spread resultsin a credit to your account, becausethe long options cost less than theshort ones. And the position is prof-itable only if the underlying movessubstantially (up or down) byoptions expiration.

A short butterfly resembles a longstraddle (long call + long same-strike put) because it profits from anunderlying move in either direction.However, short butterflies aren’t asexpensive as long straddles, so theycan profit from smaller underlyingmoves.

Figure 1 shows the potential gainsand losses of a short butterfly placedon the S&P 500 on Nov. 21, 2008 andheld until Dec. 19, 2008. The spreadcontained 10 long 800 Decembercalls, 5 short 780 December calls, and5 short 820 calls. It will make moneyif the S&P 500 finishes above thehigher short strike (820) or below thelower short strike (780) at expiration(Dec. 19).

The short butterfly has an unat-tractive risk-reward ratio. Figure 1shows the spread could lose up to$9,500, and it can earn only $500. The

trade doesn’t need a one-standard-deviation move to becomeprofitable, but time decay works against it. Thus, a number ofstop-loss rules were added to ensure the trade is closed if theS&P 500 index had not moved substantially (at least 10 pointsbeyond either short strikes) before options expiration.


Source: OptionVue

FIGURE 1 — SHORT BUTTERFLY SPREAD

This strategy’s win/loss ratio was significantly better over the past two years, and itgained 20 percent since January 2001.

Source: OptionVue

FIGURE 2 — SHORT BUTTERFLY PERFORMANCE

The return of the short butterfly

This short butterfly risks $9,500 to make $500 — a poor risk-reward ratio. However, thistrade will be profitable if the S&P 500 moves only 20 points (up or down) by expiration.

OPTIONS TRADING SYSTEM LAB


Trade rules:

Entry1. Buy 10 at-the-money (ATM) calls.

2. Sell 5 calls 20 points above the ATM strike and sell 5 calls 20 points below this level.

3. All options are in the second expiration month available in the S&P 500 index.

Exit on Friday before expiration if any of the following conditions occur:

1. The S&P 500 trades between the short strikes.

2. The S&P 500 is trading within 10 points of either short strike (i.e., not more than 10 points below the lower strike or 10 points above the upper strike).

3. If the SPX is outside this range on Friday before expiration, monitor the spread and close it if the S&P 500 hits either short strike. Otherwise, let the options expire.

4. Always open a new position on the same day as exiting the old trade.

Test details:• The test account began with $20,000.• Commissions were $5 base fee plus $1 per

option.• Prices executed between the bid and ask, when

available. Otherwise, theoretical prices are used.• Daily closing prices were used.

Test data: The system was tested oncash-settled S&P 500 index (SPX) optionsat the CBOE.

Test period: Jan. 18, 2001 to Dec 19, 2008.

Test results: Figure 2 tracks the shortbutterfly strategy’s performance, whichgained $4,005 (20 percent) over the eight-year test period. Overall, there were 95butterfly trades since January 2001 and 55percent were profitable. By contrast, thesame approach lost $2,755 (13.8 percent) inthe original test from January 2001 to May2006, a period in which the CBOE Volatilityindex fell below 10, an all-time low.

Overall, the strategy’s average loss ($1,258.37) was morethan its average gain ($1,117.60) since 2001. This approachperformed poorly when volatility (both IV and the actualvolatility of the asset) was low on a historical basis and con-siderably better when it was high. Incorporating this intothe trade rules might lead to a better success rate.

—Steve Lentz and Jim Graham of OptionVue

LEGEND: Net return – Gain or loss 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.

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].

STRATEGY SUMMARY

Orig. test Updated test1/18/01 to 1/18/01 to5/12/06 12/19/08

Net return: -$2,755.00 $4,005

Percentage return: -13.8% 20%

Annualized return: -2.4% 2.5%

No. of trades: 68 95

Winning/losing trades: 34/34 52/43

Win/loss: 50% 55%

Avg. trade: -$40.51 $42.16

Largest winning trade: $2,280.00 $2,280.00

Largest losing trade: -$2,870.00 -$2,870.00

Avg. profit (winners): $1,218.38 $1,117.60

Avg. loss (losers): -$1,299.41 -$1,258.37

Avg. hold time (winners): 33 33

Avg. hold time (losers): 27 27

Max consec. win/loss: 4/4 8/4


Option adjustmentsThe option you traded last week might be a different creature altogether

after a special dividend, stock split, or merger occurs.


TRADING BASICS

Dividend payments, stock splits, and mergersall affect stock prices. When dividends arepaid, the stock price drops by the sameamount, a split lowers a stock’s price because

more shares are issued, and mergers often result in a new,higher-priced stock.

Stock options are also affected by dividends, stock splits,and mergers, but the changes theyundergo aren’t as straightforward asthe ones in the underlying stockbecause option contract details aresometimes changed by the OptionsClearing Corporation (OCC) inresponse to these events.

Before trading options, it’s a goodidea to check if dividends, splits, ormergers are scheduled for the underly-ing stock. If so, you need to know howan option’s price will change, whetherthe contract’s terms may change, and when these changeswill occur. For dividends and splits, stock prices adjust onwhat is called the ex-dividend (“ex”) date; details are avail-able at http://www.theocc.com

DividendsWhen a company pays a dividend, its stock price drops bythat amount on the ex date. Both the dividend amount andthe ex date are usually announced well enough in advancefor the option premium to adjust accordingly. Call pricesdrop and put prices increase in response.

Companies sometimes issue special dividends — thosethat are larger than usual or occur at irregular times. Inthese cases the OCC may adjust an options contract’s terms.Recently the OCC decided to consider adjusting a contractonly if a special dividend is at least $12.50 per contract(0.125 per share). Previously, the OCC used a threshold of10 percent of the contract’s price to make this decision.

If a special cash dividend reduces the stock price in a one-eighth increment, the corresponding option strike priceswill be changed. For example, if the dividend is $1.375 (13/8) per share, then strike prices will drop by that amount— i.e., an option originally with a $30 strike price wouldhave its strike lowered to $28.625 ($28 5/8). The option’sticker symbol will change and a new code for the abnormalstrike price will be added.

Alternately, the OCC may add the dividend in cash uponexercise, leaving the rest of the contract’s terms untouched.

For example, if the dividend was $3.60, a $30 strike wouldneed to be reduced to $26.40, which can’t be expressed in aone-eighth increment. In this case, the cash difference ($3.60per share) would likely be added to the option’s premium.The contract’s symbol would be adjusted to reflect thischange, but the strike price codes (the symbol representingthe contract’s strike price) and the number of shares remain

the same. Sometimes companies will pay div-

idends by issuing additional shares ofstock, in which case the OCC willincrease the number of shares anoption contract represents. For exam-ple, if a company issues a 5-percentstock dividend, the options will nowrepresent 105 shares instead of theusual 100 shares. Again, the optionsymbols will change to reflect the newcontract terms.

Contract adjustments can be more complicated, such aswhen a firm distributes both stock and cash. In such situa-tions the OCC may increase a contract’s share size and adda cash payout upon exercise.

Stock splitsA company will typically announce a stock split after itsstock has rallied. The idea is to lower the stock’s price somore investors will be tempted to buy it. Let’s assume youown 100 shares of a stock trading at $100 — a $10,000 posi-tion. If the company splits its stock two for one (2:1), thestock will drop to $50 on the ex date and you will receiveanother 100 shares and still own the same dollar position($10,000).

For 2:1 or 4:1 splits, the OCC’s adjustment rules are quitesimple: The strike price drops and the number of optioncontracts rises. For example, a 4:1 split on a $100 stockmeans a $100-strike option becomes four $25-strike options.In these cases, option ticker symbols are usuallyunchanged.

Stock splits in irregular ratios of 3:2 or 4:3 result in theOCC adjusting an option contract’s share count, similar tothe way stock dividends are sometimes handled. After a 3:2split, strike prices remain unchanged, but each contract willcontrol 150 shares of stock. More complicated stock splitsmay prompt the OCC to add cash to a contract’s exercisevalue delivery to compensate for fractional shares.

If a stock’s price has been beaten down, the company

Before trading options,

it’s a good idea to check

if dividends, splits, or

mergers are scheduled

for the underlying stock.

BY FOT STAFF

http://www.theocc.com


may announce a reverse stock split thatincreases its price and lowers the number ofshares outstanding. If a stock traded at $1 andyou owned 100 shares, a reverse 1:10 splitwould drive the stock to $10, but you wouldnow own just 10 shares. At this point, all affect-ed options contracts would control just 10shares of stock.

Mergers and acquisitionsTwo companies can join in myriad ways,including transfers of stock, cash, or a mix ofboth. Each combination affects the stocks of themerging companies in different ways, which inturn impacts any options that are scheduled toexpire after the official merger date.

All-cash transactions convert the relevant in-the-money (ITM) options into cash when thedeals close; all-stock transactions change thenumber of shares (and the stock type) eachoption represents based on the merger’sdetails. For example, if concert promotersTicketmaster (TKTM) and Live Nation (LYV)merge in the first half of 2009, Ticketmasterinvestors might get 1.384 shares of Live Nationstock for each Ticketmaster share, and July2009 options on Ticketmaster would be con-verted to Live Nation options that control 138.4shares.

If merger transactions include both stockand cash, it could result in a combination of thetwo upon delivery. In any case, the contract’ssymbol will most likely be altered to reflect thechanges.

In the money or not?Many of these adjustments can alter how youcalculate whether a contract is in the moneyand by how far. Let’s assume a stock trades at$29, and a $30-strike call includes a $3.60 spe-cial dividend payment. In effect, this adjust-ment lowers the strike price to $26.40, so eventhough the $30 call is technically out of themoney (OTM), it has an intrinsic value of $2.60.

Finally, if a special dividend or stock splitprompts the OCC to issue a new contract, itmay not be available to trade immediately afterthe open on the ex date, and these new con-tracts may initially have large bid-ask spreadsthat make them difficult to trade.

The Options Industry Council’s Web site(http://www.888options.com) has plenty ofexamples of different options adjustments.Because each adjustment is unique, however,consult your broker or call the OIC if your con-tract has been altered or if you believe a changeis pending.��

http://www.888options.com

http://www.pfgbest.com/CMEF

O n Feb. 4, the Commodity Futures Trading Com-mission (CFTC) began a six-month trial of a newmonthly report meant to enhance transparency

in the futures markets. “This Month in Futures Markets”aggregates the previous month’s weekly Commitment ofTraders (COT) data into an easy-to-digest format, completewith graphs and commentary on commercial and non-com-mercial open interest for 22 different futures markets.

Commitments of tradersThe COT report is released each Friday and displays theprevious Tuesday’s levels of futures and options open inter-est in major markets. Broken down by exchange, the reportshows the number of open positions of commercial traders(hedgers), non-commercial traders (large speculators), andnon-reportables (small speculators). It also highlights long,short, and spread positions, as well as the number oftraders in each category, weekly changes, and the percent-age of open interest held by the largest four and eighttraders in the market.

Commercial traders represent companies and institu-tions directly involved in the production, storage, distribu-

tion, and/or other aspects of the markets themselves anduse the futures and options markets as a means to offsettheir risk. These traders are often referred to as the “smartmoney” because they are directly involved in the marketand should therefore have the best insight into where themarket is headed.

Non-commercials represent commodity trading advi-sors, hedge funds, and other large institutional investorslooking for investment opportunities. Non-reportables aretraders who are too small to need to report their positionsto the CFTC — generally, individual traders.

While the weekly report is fairly timely and contains a great deal of useful information, its presentation can be alittle off-putting. Consisting of basic tables in a text-onlyformat, digesting the information is easier said than done.

“It’s a little past due for a facelift,” says Jeff Harris, chiefeconomist for the CFTC. “One of the things we noticed last year was we were getting a lot of press calls and [they] would say ‘You’re doing this research and you’redoing these analyses, where are you finding this?’ So we pointed them to the [COT] reports, but that requires a lot of user intervention to download, graph, compile,

INDUSTRY NEWS


The House Committee on Agriculture, which over-sees the Commodity Futures Trading Commission(CFTC), approved the “Derivatives Markets

Transparency and Accountability Act of 2009” on Feb. 12,after holding two days of congressional hearings thatbrought more than 20 witnesses before the committee. Itwill soon be heading for a vote in the House.

The bill, sponsored by Minnesota Democrat and chair-man of the House Committee on Agriculture CollinPeterson, would broaden the authority of the CommodityFutures Trading Commission to include oversight of OTCderivatives, set stringent trading limits on deliverable com-modities, and would require OTC derivatives to be clearedon a CFTC- or (for financial derivatives) a SecuritiesExchange Commission (SEC)-regulated exchange. Amongfurther provisions, the bill would also require greater infor-mation sharing between international regulatory bodies,increased data reporting requirements, and would grantthe CFTC the ability to criminally prosecute violators of theact’s provisions.

Exchanges raised some opposition following the bill’sapproval for a House vote. The CME Group issued a statement which claimed that increased trade limits would

“divert trading in highly regulated commodity and energyfutures markets to less-regulated OTC and foreign marketsaccessible to U.S. investors but beyond the reach or jurisdiction of the U.S. government,” while forcing OTCderivatives onto regulated exchanges would drive tradeoverseas.

The Chicago Board Options Exhange (CBOE) also issueda statement saying that while they support the need forrevamped regulation, it should be through “a collaborativeprocess that includes the Obama administration, allCongressional Committees with relevant jurisdiction, themembers of the President’s Working Group on FinancialMarkets, and the private sector.”

Democratic Representative Barney Frank, chairman ofthe House Financial Services Committee, has also voicedopposition to the bill. His committee oversees the SEC andthe Federal Reserve, organizations that have also vied forregulatory authority in this area. Frank had proposed aSystemic Risk Regulator charged with assessing risk acrossall financial markets, along with a strengthening of theCFTC and SEC’s regulatory power. The proposed SystemicRisk Regulator would most likely be part of the FederalReserve.�

CFTC’s new monthly report dresses up the weekly COTThe CFTC has released a new monthly report based on COT data.

House derivatives bill faces opposition


On Feb. 13, The Commodity Futures TradingCommission (CFTC) approved limits proposedby the Chicago Board of Trade (CBOT) on the

number of delivery instruments, such as warehousereceipts and shipping certificates, that can be held by a non-commercial entity in the grain markets. The move is the lat-est effort to improve the convergence of grain futures andspot cash prices, a problem which first arose in early 2008 ascommodity prices skyrocketed.

The limit applies to corn, mini-sized corn, wheat, mini-sized wheat, oats, rough rice, soybean, mini-sized soybean,soybean oil, and soybean meal contracts. It brings the num-

ber of instruments that can be held by a non-commercialfirm in line with the spot month speculative limits alreadyin place.

“We will monitor the effectiveness of this and other graincontract changes to see if convergence remains an issuerequiring further action,” said acting CFTC chairmanMichael Dunn in the committee’s statement announcing theapproval. The commission believes this new rule will alsoreduce the grain market’s susceptibility to manipulation.

Non-commercial entities will have until May 31 to com-ply with the new rules, while soybean oil certificate holderswill have until Sept. 25.�

CFTC approves limit on grain delivery instruments

and do the analysis.”This Month in Futures Markets is the CFTC’s attempt to

provide a more accessible version of this information. It

covers six categories: energy, agriculture, softs, financials,metals, and livestock. The summary page graphs severalyears of open interest data for each category and breaksdown monthly and yearly changes for each tracked com-modity within each category for both futures open interest,and combined futures and options open interest. Figure 1displays the summary graph and figures from the Januaryreport (released on Feb. 4), showing the open interest graphfor corn along with data for wheat, soybeans, and soybeanoil.

Each of the six categories is then broken down on indi-vidual pages into their most heavily traded contracts. Forexample, energy is broken down into crude oil, natural gas,heating oil, and RBOB gasoline. Each page contains twotables compiling the major data from each of the previousmonth’s COT reports and eight sets of graphs displayingseveral years of data.

Further enhancements in the wings?While the report might seem to be just a shiny new packagefor already-available information, its reception could play arole in determining the nature of other reporting enhance-ments from the CFTC. Using commentary gained duringthe six-month trial, the new report could serve as a templatefor further attempts to increase transparency in the futuresmarkets.

Harris says that depending on how well it is received, thenew format could be expanded to cover all markets andcould possibly be released on a weekly basis. Reports suchas the CFTC’s quarterly staff report on commodity swapsdealers and index traders, first released in September 2008,could also be overhauled.

The CFTC also compiles information on specific hedge-fund participation for internal use, which could also beginto make its way to the public’s eye in some form. Harrissays there has been talk of providing price charts on theCFTC’s Web site as well. �

The CFTC’s new monthly report summarizes the previ-ous month’s COT report into an easily digestible format.This chart from the agriculture summary displays anopen interest chart for corn as well as weekly andmonthly changes for several other markets.

FIGURE 1 — THIS MONTH IN FUTURES MARKETS

Source: http://www.CFTC.gov

Open interest Change from last1/27/09 Month Year

Corn Futures 798.4 � -4.3 � -626.6Futures and options 1,227.5 � -11.5 � -777.3

Wheat Futures 278.9 � 31.5 � -176.0Futures and options 366.6 � 44.8 � -225.3

Soybeans Futures 322.5 � 43.7 � -247.7Futures and options 458.8 � 79.7 � -334.4

Soybean Futures 207.7 � -4.9 � -75.8oil Futures and options 249.6 � 4.5 � -82.5

http://www.CFTC.gov


The Chicago Futures Exchange(CFE), which is owned by theChicago Board Options Ex-

change (CBOE), announced mini-sizedversions of their VIX futures contractsto begin trading in March.

The new contracts, which will tradeunder the symbol “VM,” will track theCBOE’s volatility index (VIX), which

tracks the implied volatility of S&P 500index options. The contract will bepriced off the VIX using a $100 multi-plier, as opposed to the $1,000 multi-plier used for the larger VIX futurescontracts (VX).

This cash-settled contract will ini-tially be available for March, April,and May serial months, with a mini-

mum tick size of $5 and reduced mar-gin requirements compared to its larg-er counterpart.

The launch comes on the heels of aperiod of unprecedented volatility.Shown in Figure 1, the VIX, oftenreferred to as the “fear gauge,” hadjumped to record levels afterSeptember 2008. It has since settledsomewhat above 40, a level breachedonly a handful of times prior to thejump in September.�

The VIX jumped as high as 89.53 inOctober 2008, but in February droppedto a range between 40 and 50.

FIGURE 1 — VOLATILITY INDEX

Source: eSignal

CFE launches mini-VIX futures

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.

Top 10 option strategy traders ranked by January 2009 return.

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

January 2009 YTD $ underRank Trading advisor return return mgmt.

1. JPS Capital Mgmt (JPS Fund) 19.39% 19.39% 4.2

2. Oxeye Capital Mgmt. (FTSE 100) 10.62% 10.62% 9.7

3. Financial Comm Inv (Option Selling) 9.23% 9.23% 13.1

4. ACE Investment Strategists (DPC) 8.15% 8.15% 6.8

5. Financial Comm Inv (CPP) 7.10% 7.10% 1.6

6. HB Capital Mgmt (Diversified) 4.11% 4.11% 10.0

7. LJM Partners (Aggr. Premium Writing) 3.60% 3.60% 19.5

8. Harbor Assets 3.40% 3.40% 3.4

9. Crescent Bay Capital (BVP) 3.35% 3.35% 2.9

10. LJM Fund Ltd 3.00% 3.00% 4.4

MANAGED MONEY

INDUSTRY NEWS continued

EVENTS

Event: The World Money ShowDate: March 17-19 Location: Hong KongDate: May 11-14 Location: Las VegasFor more information: Go tohttp://www.moneyshow.com and click on “Events”

Event: 10th Free Annual Technical Analysis ExpoDate: March 20-21Location: Paris, FranceFor more information: http://www.salonAT.com

Event: Capital Markets Boot CampDate: March 25-26Location: New York CityFor more information: http://www.fmwonline.com

Event: Securities Operations World 2009Date: May 27Location: New York City For more information: http://www.fmwonline.com

Event: The 15th Forbes Cruise for InvestorsDate: June 2-14Location: Lisbon to VeniceFor more information: Go tohttp://www.moneyshow.com and click on “Events”

Event: International Trader’s ExpoDate: June 3-6Location: Los AngelesFor more information: http://www.tradersexpo.com

http://www.barclayhedge.com

http://www.moneyshow.com


http://www.fmwonline.com

http://www.fmwonline.com

http://www.moneyshow.com

http://www.tradersexpo.com


MONTH

Legend

CPI: Consumer price index

ECI: Employment cost index

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

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

FOMC: Federal OpenMarket Committee

GDP: Gross domestic product

ISM: Institute for supplymanagement

LTD (last trading day): Thefirst day a contract maytrade or be closed out beforethe delivery of the underlyingasset may occur.

PPI: Producer price index

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

March1 FDD: March crude oil and natural gas

futures (NYMEX); March sugar futures(ICE)

2 FND: March sugar and orange juice futures (ICE)FDD: March gold, silver, copper, aluminum, platinum, and palladium futures (NYMEX); March T-bonds, corn, wheat, soybeans, soybean products, oats, and rice futures (CME); March coffee, cocoa, and cotton futures (ICE); March wheat futures (KCBOT); March wheat futures (MGEX)

3 FND: March heating oil, gasoline, andpropane futures (NYMEX)U.S.: Weather and crop bulletin

4 U.S.: Petroleum status report

5 FDD: March propane futures (NYMEX)U.S.: EIA natural gas storage report

6 LTD: March live cattle and pork bellies options (CME); April cocoa options (ICE)

7 FDD: March heating oil and gasoline futures (NYMEX)

89 FND: March pork bellies futures

(CME)FDD: March orange juice futures (ICE)LTD: March cotton futures (CME)

10 FDD: March pork bellies futures (CME)U.S.: Weather and crop bulletin

11 LTD: March orange juice futures (ICE)U.S.: Crop production report, world agricultural production report, and petroleum status report

12 U.S.: EIA natural gas storage report

13 LTD: March corn, wheat, soybeans, soybean products, oats, rice, and lumber futures (CME); March wheat futures (KCBOT); March wheat futures (MGEX); April coffee options (ICE)

141516 FND: March lumber futures (CME)

FDD: March lumber futures (CME)LTD: March cocoa futures (ICE); April sugar options (ICE)

17 LTD: April crude oil options (CME)U.S.: Weather and crop bulletin

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

19 LTD: March coffee futures (ICE)U.S.: EIA natural gas storage report

20 LTD: April crude oil, March T-bond and index futures (CME); March single stock futures (OC); April orangejuice options (ICE); March index and equity optionsU.S.: Cattle on feed

21222324 FND: April crude oil futures (CME)

U.S.: Weather and crop bulletin

25 U.S.: Petroleum status report

26 LTD: March pork bellies futures (CME); April natural gas, heating oil, gasoline, gold, silver, copper, and aluminum options (NYMEX)U.S.: EIA natural gas storage report

27 LTD: April natural gas, gold, silver, copper, aluminum, platinum, and palladium futures (NYMEX); April T-bond, corn, wheat, soybeans, soybean products, oats, and rice options (CME); April wheat options (KCBOT); April wheat options (MGEX)

282930 FND: April natural gas futures (CME)

U.S.: Agricultural prices report

31 FND: April gold, silver, copper, aluminum, platinum, and palladium futures (NYMEX)LTD: April heating oil, gasoline, and propane futures (NYMEX); April lumber options (CME)U.S.: Weather and crop bulletin

April1 FDD: April crude oil, natural gas, gold,

silver, copper, aluminum, platinum, and palladium futures (CME)U.S.: Petroleum status report

2 FND: April heating oil, gasoline, and propane futures (NYMEX)U.S.: EIA natural gas storage report

3 LTD: April live cattle options (CME); May cocoa options (ICE)

MARCH/APRILFUTURES & OPTIONS CALENDAR

APRIL 2009

29 30 31 1 2 3 4

5 6 7 8 9 10 11

12 13 14 15 16 17 18

19 20 21 22 23 24 25

26 27 28 29 30 1 2

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

MARCH 2009

1 2 3 4 5 6 7

8 9 10 11 12 13 14

15 16 17 18 19 20 21

22 23 24 25 26 27 28

29 30 31 1 2 3 4


The following table summarizes the trading activity in the most actively traded futures contracts. The information does NOT constitutetrade 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 andmay 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 futuresis based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).

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

day moves, 20-day moves, etc.) show the per-centile rank of the most recent move to a cer-tain number of the previous moves of thesame size and in the same direction. Forexample, the rank for 10-day move showshow the most recent 10-day move comparesto the past twenty 10-day moves; for the 20-day move, the rank field shows how the mostrecent 20-day move compares to the pastsixty 20-day moves; for the 60-day move, therank field shows how the most recent 60-daymove compares to the past one-hundred-twenty 60-day moves. A reading of 100 per-

cent means the current reading is larger thanall the past readings, while a reading of 0 per-cent means the current reading is smaller thanthe previous readings. These figures provideperspective for determining how relativelylarge or small the most recent price move iscompared to past price moves.Volatility ratio/rank: The ratio is the short-term volatility (10-day standard deviation ofprices) divided by the long-term volatility (100-day standard deviation of prices). The rank isthe percentile rank of the volatility ratio overthe 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 & OptionsTrader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buyor sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.

FUTURES SNAPSHOT (as of Feb. 27)

10-day move/ 20-day move/ 60-day move/ VolatilityMarket Symbol Exchange Volume OI rank rank rank ratio/rankE-Mini S&P 500 ES CME 2.59 M 2.68 M -12.12% / 93% -12.87% / 93% -9.99% / 32% .36 / 90%10-yr. T-note TY CME 605.8 964.6 -3.26% / 92% -1.84% / 55% -1.77% / 91% .25 / 55%E-Mini Nasdaq 100 NQ CME 337.8 267.2 -10.30% / 90% -7.38% / 85% 2.06% / 27% .42 / 95%5-yr. T-note FV CME 316.9 861.0 -0.91% / 38% -0.76% / 39% -0.03% / 0% .20 / 58%Crude oil CL NYMEX 277.8 280.9 31.72% / 100% 8.01% / 46% -9.17% / 0% .24 / 100%30-yr. T-bond US CME 227.7 669.3 -4.63% / 71% -3.10% / 32% -5.45% / 100% .20 / 37%Eurodollar ED CME 225.8 1.26 M -0.09% / 29% -0.21% / 62% 0.57% / 9% .06 / 0%Mini Dow YM CME 214.9 72.2 -11.15% / 94% -13.07% / 98% -13.36% / 45% .36 / 90%Eurocurrency EC CME 199.6 142.8 -0.58% / 6% -1.98% / 23% 0.22% / 7% .21 / 45%2-yr. T-note TU CME 136.4 458.0 -0.67% / 38% 0.01% / 6% -0.77% / 50% .14 / 47%E-Mini Russell 2000 TF CME 129.2 407.7 -12.44% / 80% -12.22% / 95% -14.26% / 39% .42 / 93%Corn C CME 111.3 258.0 -1.97% / 12% -5.92% / 39% 7.94% / 100% .27 / 80%Gold 100 oz. GC NYMEX 100.3 207.0 -0.71% / 50% 3.97% / 22% 21.33% / 64% .27 / 17%Japanese yen JY CME 91.5 106.4 -7.60% / 88% -8.28% / 95% -4.67% / 100% .58 / 98%Soybeans S CME 85.0 120.5 -9.95% / 74% -10.14% / 62% 3.07% / 12% .44 / 88%British pound BP CME 78.1 80.6 0.94% / 0% 0.10% / 0% -3.93% / 4% .10 / 7%Natural gas NG NYMEX 63.7 91.0 -6.40% / 33% -8.26% / 20% -36.43% / 72% .13 / 18%Sugar SB ICE 46.2 213.5 4.57% / 65% 9.05% / 63% 17.85% / 89% .39 / 73%Soybean oil BO CME 39.0 87.9 -5.24% / 60% -3.89% / 31% 0.00% / 0% .36 / 90%Wheat W CME 36.5 100.1 -3.19% / 17% -9.79% / 76% 2.32% / 26% .20 / 55%S&P 500 index SP CME 35.6 544.4 -12.11% / 93% -12.89% / 93% -10.00% / 32% .36 / 90%Canadian dollar CD CME 33.9 62.7 -1.23% / 25% -3.72% / 71% -2.46% / 20% .21 / 75%Swiss franc SF CME 33.6 29.8 -0.15% / 6% -1.44% / 14% 2.87% / 67% .16 / 18%E-Mini S&P MidCap 400 ME CME 33.3 112.3 -12.53% / 92% -12.53% / 89% -6.54% / 16% .39 / 92%Australian dollar AD CME 32.3 45.1 -0.14% / 0% -1.35% / 21% -0.31% / 0% .25 / 73%RBOB gasoline RB NYMEX 29.7 37.4 9.08% / 82% 11.50% / 34% 23.52% / 100% .37 / 100%Soybean meal SM CME 29.4 46.8 -11.45% / 76% -12.60% / 84% 6.94% / 16% .40 / 88%Heating oil HO NYMEX 28.2 37.7 -4.11% / 21% -11.26% / 25% -21.52% / 2% .14 / 68%Silver 5,000 oz. SI NYMEX 19.8 47.3 -2.96% / 0% 7.95% / 20% 40.14% / 81% .34 / 78%Crude oil e-miNY QM NYMEX 14.2 7.3 31.72% / 100% 8.01% / 43% -4.68% / 0% .24 / 100%Copper HG NYMEX 14.0 46.2 0.26% / 0% 5.56% / 48% -5.67% / 3% .19 / 98%Nikkei 225 index NK CME 13.2 37.0 -5.51% / 63% -8.66% / 63% -4.90% / 9% .24 / 80%Live cattle LC CME 10.2 35.3 1.87% / 58% 5.95% / 95% 0.56% / 0% .61 / 100%Coffee KC ICE 9.6 46.3 -0.22% / 13% -7.90% / 81% -1.45% / 5% .35 / 85%Mexican peso MP CME 9.1 37.9 -3.17% / 74% -5.93% / 93% -10.27% / 39% .22 / 100%Lean hogs LH CME 8.7 35.8 -4.55% / 60% 6.84% / 53% 3.70% / 41% .60 / 83%Mini-sized gold YG CME 7.3 3.0 -0.73% / 50% 4.05% / 24% 21.34% / 64% .27 / 17%Cocoa CC ICE 6.9 33.7 -8.74% / 67% -13.85% / 89% 11.51% / 27% .51 / 95%Fed Funds FF CME 6.2 40.7 0.03% / 25% -0.01% / 16% 0.20% / 0% .04 / 57%U.S. dollar index DX ICE 4.7 18.2 2.11% / 73% 1.95% / 31% 1.13% / 9% .26 / 58%Nasdaq 100 ND CME 3.3 27.5 -10.30% / 90% -7.38% / 85% 2.06% / 27% .42 / 95%E-Mini eurocurrency ZE CME 2.6 2.4 -0.58% / 6% -1.98% / 23% 0.22% / 7% .21 / 45%Natural gas e-miNY QG NYMEX 2.2 3.0 -6.40% / 33% -8.26% / 20% -36.43% / 72% .13 / 17%Dow Jones Ind. Avg. DJ CME 1.8 19.7 -11.15% / 94% -13.07% / 98% -13.36% / 45% .36 / 90%Mini-sized silver YI CME 1.7 2.3 -2.74% / 0% 8.15% / 22% 40.16% / 81% .34 / 78%New Zealand dollar NE CME 1.5 12.1 -2.10% / 50% -1.76% / 10% -5.72% / 12% .15 / 35%Mini-sized soybeans YK CME 1.4 5.9 -9.95% / 74% -10.14% / 55% 3.07% / 15% .44 / 88%


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

OPTIONS RADAR (as of Feb. 27)

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

volume interest rank rank SV ratio 20 days agoS&P 500 Index SPX CBOE 217.1 1.63 M -11.99% / 93% -13.02% / 93% 40.9% / 39.3% 37.2% / 36.2%Russell 2000 Index RUT CBOE 71.0 514.1 -13.63% / 93% -14.17% / 88% 47.3% / 41.3% 47.1% / 45.1%S&P 500 volatility index VIX CBOE 55.4 748.4 12.36% / 67% 8.73% / 58% 84.4% / 124.7% 105.5% / 118.9%E-Mini S&P 500 futures ES CME 24.6 107.1 -12.12% / 93% -12.87% / 93% 41.8% / 25.7% 37.7% / 26.6%S&P 100 Index OEX CBOE 19.1 68.4 -11.52% / 94% -12.84% / 96% 37.1% / 37.7% 36.5% / 33.9%

StocksBank of America BAC 398.7 1.72 M -32.71% / 89% -41.74% / 62% 194.4% / 205.1% 136.4% / 157%General Electric GE 296.0 2.19 M -27.14% / 95% -33.10% / 98% 104.1% / 82.7% 64.7% / 73.4%Citigroup C 244.0 2.59 M -58.45% / 100% -61.54% / 98% 153.6% / 165.4% 131.7% / 172.4%Wells Fargo WFC 190.9 1.03 M -27.98% / 54% -35.57% / 76% 140.7% / 148% 106.6% / 119.9%Apple Inc. AAPL 165.1 844.0 -10.03% / 67% -3.97% / 19% 50.6% / 45.3% 43.5% / 49.4%

FuturesEurodollar ED CME 397.5 6.48 M -0.09% / 29% -0.21% / 67% 77.5% / 72.6% 90.5% / 99.4%10-year T-notes TY CME 58.0 247.8 -3.26% / 92% -1.85% / 55% 11.1% / 10.6% 10.7% / 11%Corn C CME 44.0 512.4 -1.97% / 12% -5.92% / 39% 41.1% / 33.7% 41.6% / 46.4%Crude oil CL NYMEX 31.8 264.4 31.72% / 100% 8.01% / 46% 69.6% / 74.1% 81% / 92.5%30-yr T-bonds US CME 28.7 138.8 -4.63% / 71% -3.10% / 32% 21.2% / 16.9% 19.4% / 17.8%

VOLATILITY EXTREMES**Indices - High IV/SV ratio

E-Mini S&P 500 futures ES CME 24.6 107.1 -12.12% / 93% -12.87% / 93% 41.8% / 25.7% 37.7% / 26.6%Japanese Yen index YUK ISE 1.2 17.0 7.36% / 88% 8.45% / 85% 17.8% / 13.6% 20.4% / 15.4%S&P 500 futures SP CBOE 12.6 78.9 -12.11% / 93% -12.89% / 93% 36.6% / 31.9% 34.1% / 31.4%Russell 2000 Index RUT CBOE 71.0 514.1 -13.63% / 93% -14.17% / 88% 47.3% / 41.3% 47.1% / 45.1%Gold/Silver Index XAU PHLX 1.0 14.4 -10.39% / 100% -5.08% / 80% 61.1% / 53.6% 59.7% / 70%

Indices - Low IV/SV ratioS&P 500 Volatility index VIX CBOE 55.4 748.4 12.36% / 67% 8.73% / 58% 84.4% / 124.7% 105.5% / 118.9%Banking index BKX PHLX 2.6 45.8 -12.37% / 47% -19.14% / 46% 91.3% / 114.4% 90.4% / 91.4%Oil Service index OSX PHLX 2.2 20.0 -7.80% / 56% -7.80% / 42% 61.8% / 75.7% 62.2% / 71.9%Housing index HGX PHLX 1.1 15.4 -12.91% / 67% -12.16% / 67% 66.1% / 77.7% 63% / 65.8%S&P 100 index OEX CBOE 19.1 68.4 -11.52% / 94% -12.84% / 96% 37.1% / 37.7% 36.5% / 33.9%

Stocks - High IV/SV ratioDendreon DNDN 4.8 128.9 -19.74% / 67% -8.68% / 53% 316% / 80.3% 225.8% / 67.6%Barclays BCS 2.0 33.9 -17.76% / 73% -8.87% / 17% 227.5% / 118.5% 178.1% / 152.4%Synta Pharm SNTA 4.4 66.4 -83.17% / 100% -83.57% / 100% 150.9% / 84.7% 142.7% / 81.4%Genentech DNA 43.4 532.1 1.85% / 33% 1.74% / 9% 36% / 20.8% 35.5% / 29.3%Omnicare OCR 1.5 11.5 -10.86% / 88% -9.43% / 47% 63% / 38.2% 54.9% / 50.6%

Stocks - Low IV/SV ratioDev Diversified Realty DDR 1.9 20.4 -20.49% / 33% -38.67% / 54% 82% / 156.7% 161.2% / 200.4%Marshall & Ilsley MI 2.6 36.7 0.88% / 0% -28.10% / 50% 124% / 216.9% 97.6% / 134.9%Time Warner Cable TWC 2.2 37.1 -1.51% / 31% -5.64% / 38% 42.5% / 67% 48.2% / 57.6%Fifth Third Bancorp FITB 10.4 90.9 -4.09% / 0% -30.82% / 47% 206.2% / 324.7% 156.7% / 175.4%Huntington Bancshares HBAN 2.1 18.9 -19.34% / 11% -57.43% / 69% 208% / 311.3% 116.8% / 165.7%

Futures - High IV/SV ratioSoybean oil BO CME 8.3 74.9 -5.24% / 60% -3.89% / 31% 366.8% / 36.8% 372.8% / 45.1%E-Mini S&P 500 futures ES CME 24.6 107.1 -12.12% / 93% -12.87% / 93% 41.8% / 25.7% 37.7% / 26.6%Japanese yen JY CME 2.8 10.1 -7.60% / 88% -8.28% / 95% 18.8% / 12.8% 20.5% / 20.7%Wheat W CME 12.9 97.6 -3.19% / 17% -9.79% / 76% 46.2% / 31.7% 44.3% / 40.4%Swiss franc SF CME 1.2 5.7 -0.15% / 6% -1.44% / 14% 15.2% / 11.5% 17.4% / 15.5%

Futures - Low IV/SV ratioAustralian dollar AD CME 2.2 7.9 -0.14% / 0% -1.35% / 21% 21.1% / 23.6% 28.3% / 23.6%Crude oil CL NYMEX 31.8 264.4 31.72% / 100% 8.01% / 46% 69.6% / 74.1% 81% / 92.5%Natural gas NG NYMEX 2.0 12.2 -6.40% / 33% -8.26% / 20% 56.9% / 59.1% 59.6% / 66.7%

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


Options Watch: Large-cap stocks (as of Feb. 26) Compiled by Tristan YatesThe following table summarizes the expiration months available for the 20 largest U.S. stocks, the large-cap S&P 100 index (OEX), and the S&P100 tracking stock (OEF). It also shows each ETF’s average bid-ask spread for at-the-money (ATM) March options. The information does NOTconstitute trade signals. It is intended only to provide a brief synopsis of potential slippage in each option market.

Option contracts traded

Bid-askspread as %

Closing of underlyingStock Ticker price Call Put priceWal Mart Stores WMT X X X X X X 48.25 0.03 0.02 0.05%AT&T Inc T X X X X X X 24.09 0.02 0.02 0.08%Exxon Mobil Corp XOM X X X X X X 70.95 0.07 0.04 0.08%Microsoft Corp MSFT X X X X X X 16.42 0.01 0.02 0.08%Verizon Communications VZ X X X X X X 28.48 0.03 0.02 0.09%Google Inc GOOG X X X X X X 337.18 0.30 0.30 0.09%Cisco Sys Inc CSCO X X X X X X 14.49 0.01 0.02 0.10%Pfizer Inc PFE X X X X X X 12.7 0.02 0.01 0.12%JP Morgan Chase & Co JPM X X X X X X 23.05 0.04 0.03 0.14%S&P 100 index OEX X X X X X X X X 357.22 0.58 0.50 0.15%Apple Inc AAPL X X X X X X 89.18 0.19 0.09 0.15%IBM IBM X X X X X X 88.97 0.13 0.15 0.15%Hewlett Packard HPQ X X X X X X 30.24 0.05 0.05 0.17%Proctor & Gamble PG X X X X X X 48.97 0.09 0.10 0.19%Abbot Labs ABT X X X X X X 50.58 0.10 0.10 0.20%Pepsico Inc PEP X X X X X X 49.42 0.10 0.10 0.20%Chevron Corp CVX X X X X X X 63.17 0.10 0.18 0.22%Philip Morris PM X X X X X X 34.21 0.08 0.08 0.22%General Electric Co GE X X X X X X 9.1 0.02 0.02 0.22%Coca Cola Co KO X X X X X X 41.07 0.10 0.09 0.23%Johnson & Johnson JNJ X X X X X X 52.44 0.11 0.31 0.41%S&P 100 tracking stock OEF X X X X X X X X 35.95 0.84 0.94 2.47%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.

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FUTURES & OPTIONS WATCH

2009 2010 2011 Bid-ask spreads

The Commitment of Traders (COT) report is published eachweek by the Commodity Futures Trading Commission (CFTC).The report divides the open positions in futures markets intothree categories: commercials, non-commericals, and non-reportable.

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

Figure 1 shows the relationship between commercials andlarge speculators on Feb. 24. Positive values mean net commer-cial positions (longs - shorts) are larger than net speculator holdings, based on theirfive-year historical relationship. Negative values mean large speculators have biggerpositions than the commercials.

In copper (HG), orange juice (OJ), and oats (O) futures, the difference between com-mercials and large speculators is ranked highest among all futures markets, which isa bullish sign. By contrast, this relationship is near a five-year low in the E-Mini S&P500 (ES), Japanese yen (JY), and platinum (PL) futures, a bearish indication.

These extremes aren’t trade signals, but they sometimes appear before price rever-sals.�

– Compiled by Floyd Upperman

The largest positive readings represent markets in which net commercialpositions (longs - shorts) exceed net fund holdings in February. By con-trast, the largest negative values represent markets in which net fundholdings surpass net commercial positions.

FIGURE 1 — COT REPORT EXTREMES

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

COT extremes

Legend: Figure 1 shows the difference between net commer-cial and net large spec positions (longs - shorts) for all 45 futuresmarkets, in descending order. It is calculated by subtracting thecurrent net large spec position from the net commercial positionand then comparing this value to its five-year range. The formu-la is:

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

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

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

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

x = (c1 - c2)

http://www.upperman.com


� The New York Institute of Finance (NYIF) hasformed a strategic partnership with the Chicago Board OptionsExchange (CBOE) that allows registered CBOE.com usersaccess to NYIF’s entire curriculum of instructor-led virtualclasses. Users can access more than 175 hours of online learning,covering more than 25 financial-area topics, including backoffice operations, derivatives, equities, credit, risk management,and corporate finance. In addition, the entire instructor-ledpublic courses curriculum is available both in New York and inChicago. All courses earn professional continuing educationcredits. Registered users receive a discount on NYIF courses,and can register directly through the CBOE site(http://www.theoptionsinstitute.com) or through NYIF’s Website for virtual, “e-learning,” and public instructor-led courses(http://www.nyif.com/cboe).

� optionsXpress announced three additions to its broker-age platform. The new myOX portal allows users to customizethe http://www.optionsXpress site to their specific interestsand preferences. myOX users design their own “control cen-ters” on the site by using the adaptable modular interface toselect the information they want to see, its location on thescreen, and even how it is displayed. Users can select from 16different preset myOX modules including account balances,watch lists, charts, positions, futures and options chains, andeven RSS feeds from financial news sites or blogs. Similarly, thenew Research Center provides a single access point for researchreports, breaking news, market commentary, quotes, and otherinformation. The Research Center allows users to read any fullreport or news item without ever leaving the page. The newEducation Center offers investors access to progressive invest-ment education courses, hundreds of free online learningevents, as well as a library of general investing information.

� CME Group announced 10 new natural gas basis swapfutures contracts, trading on the CME ClearPort electronicclearing and trading system. The new contracts and their com-modity codes are: Columbia Gulf Mainline (5Z); Florida Zone 2(8A); OneOk, Oklahoma (8X); Southern Star, Texas, Oklahoma,Kansas (8Z); Tennessee 800 (6Z); Texas Eastern West LA (8B);Texas Gas Zone 1 (9F); Transco Zone 1 (8E); Transco Zone 2 (8F);and SoCal Citygate (9A). The contracts are 2,500 MMBtus insize with a minimum price fluctuation of $0.0025 per MMBtu.Trading began with the April 2009 contract and is listed for thecurrent year plus the next five years. The CME Group alsoannounced the dual listing of Henry Hub natural gas financiallast day options, trading on CME ClearPort and the New Yorktrading floor. The new contract (commodity code: E7) is aEuropean-style option that is 10,000 MMBtus in size with a min-imum price fluctuation of $0.0001 per MMBtu. It began tradingwith the March 2009 contract and is listed for the balance of thecurrent year, plus consecutive months for the next five yearsthrough 2014. These contracts are listed with, and subject to, therules and regulations of the New York Mercantile Exchange.

� TradeKing (http://www.tradeking.com) has launched aneducation offering that is free to any TradeKing client andaccessible through its new Online Learning Center. TradeKing’snew learning center features the “Rookies Corner” with content

dedicated to beginning traders; a series of intelligence reports; aweekly and monthly online Webinar series; a strategies func-tion, which allows traders to sort choices by skill level and mar-ket outlook; and 35 hours of educational video content on stock,options, and fixed-income investing.

� Lightspeed Financial launched Lightspeed Spotlight,an online social networking community enabling its customersto interact with other Lightspeed customers and participate inonline educational courses and seminars. Members can partici-pate in group discussions; create groups and personal blogs;gain access to educational information and resources includingdiscussions and online Webinars from Lightspeed Trading,Options Industry Council, and the Chicago MercantileExchange; view and post videos, articles and events onSpotlight’s message boards, blogs, and calendar; and accessresearch and analyst Webinars from StreetBrains.com and chart-pattern recognition techniques provided by Recognia, Inc.

� Wolters Kluwer Financial Services’s GainsKeeper(http://www.gainskeeper.com) tax-lot accounting technologyhas been integrated with Firstrade Securities’(http://www.firstrade.com) online trading platform, offeringFirstrade customers new functionality and helping Firstradeprepare for requirements of the recently enacted cost-basisreporting law (http://www.costbasisreporting.com).GainsKeeper assists Firstrade customers with portfolio track-ing, adjusting cost basis, and gain/loss reports for wash salesand corporate actions, while its tax-trading tools help investorsmanage their portfolios in a tax-efficient manner and identifythe tax impact on their investment returns. Firstrade customersare also able to easily generate a Schedule D for tax filing usingGainsKeeper.

� Patsystems announced it is now a Certified ISV forBM&F, the derivatives segment of BM&FBOVESPA. Patsystemswill provide direct market access to the exchange for both localand international participants. As well as direct access,Patsystems also offers access to BM&F products via CMEGlobex, which allows existing CME customers to trade the mainBM&F derivatives contracts listed on the Globex platform. AllBM&F segment products will be available through Patsystems’front-ends, J-Trader and Pro-Mark, and risked by Patsystems’pre-trade System and Risk Administration (SARA) module.

� RTS Realtime Systems Group is offering connectivityto Nasdaq Dubai. Users are able to trade all of Nasdaq Dubai’slisted products, including equities, derivatives, and structuredproducts. RTS will offer direct market access through its entiretrading solutions portfolio, including its RTD-API, the front-end trading systems RTD and eRTD, as well as RTD Tango, itsautomated algorithmic trading solution. With the connectivityto Nasdaq Dubai, RTS now offers access to all three Dubai-based exchanges.

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

NEW PRODUCTS AND SERVICES

http://www.theoptionsinstitute.com

http://www.nyif.com/cboe

http://www.optionsXpress

http://www.tradeking.com

http://www.gainskeeper.com

http://www.firstrade.com

http://www.costbasisreporting.com


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

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

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

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

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

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

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

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

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

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

For each futures contract, report data is divided into three“reporting” categories: commercial, non-commercial, andnon-reportable positions. The first two groups are thosewho hold positions above specific reporting levels.

The “commercials” are often referred to as the large

hedgers. Commercial hedgers are typically those who actu-ally deal in the cash market (e.g., grain merchants and oilcompanies, who either produce or consume the underlyingcommodity) and can have access to supply and demandinformation 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 institution-al and quasi-institutional money managers who do not dealin the underlying cash markets, but speculate in futures ona large-scale basis for their clients.

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

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

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

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

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


KEY CONCEPTS The option “Greeks”

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

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

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

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

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


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

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

Exercise: To exchange an option for the underlyinginstrument.

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

In the money (ITM): A call option with a strike pricebelow the price of the underlying instrument, or a putoption with a strike price above the underlying instru-ment’s price.

Intrinsic value: The difference between the strike priceof an in-the-money option and the underlying asset price. Acall option with a strike price of 22 has 2 points of intrinsicvalue if the underlying market is trading at 24.

Naked option: A position that involves selling an unpro-tected call or put that has a large or unlimited amount ofrisk. If you sell a call, for example, you are obligated to sellthe underlying instrument at the call’s strike price, whichmight be below the market’s value, triggering a loss. If yousell a put, for example, you are obligated to buy the under-lying instrument at the put’s strike price, which may be wellabove the market, also causing a loss.

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

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

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

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

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

Parity: An option trading at its intrinsic value.

Physical delivery: The process of exchanging a physicalcommodity (and making and taking payment) as a result ofthe execution of a futures contract. Although 98 percent ofall futures contracts are not delivered, there are market par-ticipants who do take delivery of physically settled con-

tracts such as wheat, crude oil, and T-notes. Commoditiesgenerally are delivered to a designated warehouse; T-notedelivery 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, butnot the obligation, to sell a stock (or futures contract) at afixed price.

Put ratio backspread: A bearish ratio spread that con-tains more long puts than short ones. The short strikes arecloser to the money and the long strikes are further from themoney.

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 themoney, but the long lower-strike puts will hedge some (orall) of those losses. If the stock drops well below $40, poten-tial gains are unlimited until it reaches zero.

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

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

Stochastic oscillator: A technical tool designed tohighlight shorter-term momentum and “overbought” and“oversold” levels (points at which a price move has, theo-retically at least, temporarily exhausted itself and is ripe fora correction or reversal).

Calculation: The stochastic oscillator consists of twolines: %K and a moving average of %K called %D. The basicstochastic calculation compares the most recent close to theprice range (high of the range - low of the range) over a par-ticular period.

For example, a 10-day stochastic calculation (%K) wouldbe the difference between today’s close and the lowest lowof the last 10 days divided by the difference between thehighest high and the lowest low of the last 10 days; theresult is multiplied by 100. The formula is:

%K = 100*{(Ct-Ln)/(Hn-Ln)} whereCt is today’s closing price Hn is the highest price of the most recent n days (thedefault value is five days) Ln is the lowest price of the most recent n days

The second line, %D, is a three-period simple moving continued on p. 42


average of %K. The resulting indicator fluctuates between 0and 100.

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

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

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

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

Strangle: A non-directional option spread that consists ofan out-of-the-money call and out-of-the-money put withthe same expiration. For example, with the underlyinginstrument trading at 25, a long strangle could consist ofbuying a 27.5 call and a 22.5 put. Long strangles aredesigned to profit from an increase in volatility; short stran-gles are intended to capitalize on declining volatility. Thestraddle is a related strategy.

Strike (“exercise”) price: The price at which an under-lying instrument is exchanged upon exercise of an option.

Support and resistance: Support is a price level thatacts as a “floor,” preventing prices from dropping belowthat level. Resistance is the opposite: a price level that actsas a “ceiling;” a barrier that prevents prices from risinghigher.

Support and resistance levels are a natural outgrowth ofthe interaction of supply and demand in any market. Forexample, increased demand for a stock will cause its priceto rise, creating an uptrend. But when price has risen to acertain level, traders and investors will take profits andshort sellers will come into the market, creating “resistance”to further price increases. Price may retreat from andadvance to this resistance level many times, sometimeseventually breaking through it and continuing the previoustrend, other times reversing completely.

Support and resistance should be thought of more as gen-

eral price levels rather than precise prices. For example, if astock makes a low of 52.15, rallies slightly, then declinesagain to 52.15, then rallies again, a subsequent move downto 52 does not violate the “support level” of 52.15. In thiscase, the fact that the stock retraced once to the exact pricelevel it had established before is more of a coincidence thananything else.

Time decay: The tendency of time value to decrease at anaccelerated rate as an option approaches expiration.

Time spread: Any type of spread that contains shortnear-term options and long options that expire later. Bothoptions can share a strike price (calendar spread) or havedifferent strikes (diagonal spread).

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

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

VIX: The Volatility Index (VIX) measures the impliedvolatility of S&P 500 index options traded on the ChicagoBoard Option Exchange (CBOE). The VIX is designed toreflect the market expectation of near-term (in this case, 30-day) volatility and is a commonly referenced gauge of thestock market’s “fear level.”

The original VIX, launched in 1990, was derived fromeight near-term at-the-money S&P 100 (OEX) options (callsand 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 andout-of-the-money S&P 500 (SPX) calls and puts to make theindex better represent the full range of volatility. At thesame time the CBOE applied the new calculation method tothe CBOE NDX Volatility Index (VXN), which reflects thevolatility of the Nasdaq 100 index.

The exchange still publishes the original VIX calculation,which can be found under the ticker symbol VXO. Figure 1shows 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 fluctu-ations (usually calculated as the standard deviation of clos-ing prices) over a certain time period — e.g., the past 20days. Implied volatility is the current market estimate offuture volatility as reflected in the level of option premi-ums. The higher the implied volatility, the higher the optionpremium.

KEY CONCEPTS continued

http://www.cboe.com/vix


TRADE

Date: Friday, Feb. 13.

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

Entry: Sell 1 February 79 put for $0.57.Buy 1 February 74 put for $0.16

Reasons for trade/setup: Inthe first six weeks of 2009, SPYtraded in a range between 95 and80, and it seemed poised to retestsupport at 80 during options expi-ration week in February (Figure 2).Whether support was likely to hold was an open questionwhen SPY traded around $83.10 on Friday, Feb. 13.

Historically, serial, or non-quarterly, options’ expirationweeks (January, February, April, and so on) have been rela-tively bullish for the S&P 500 index, which climbed an aver-age 0.36 percent from 1980 to 2007. In addition, SPY suc-cessfully bounced off 80 in mid-January, suggesting thissupport level would likely remain intact.

Given this mildly bullish outlook, we sold a February79/74 bull put spread for $0.41 at the close on Feb. 13.Selling puts below support made sense, especially whenthey expire in one week, and the market was closed onMonday for President’s day.

Figure 1 shows the credit spread’s potential gains andlosses on three dates: trade entry (Feb. 13, dotted line),halfway until expiration (Feb. 17, dashed line), and expira-tion (Feb. 21, solid line). The trade’s $0.41 collected premi-um is also its maximum profit, which we will keep if SPYcloses above $78.59 at expiration. But the spread will loseup to $4.59 if SPY drops below 74.

The spread’s risk-reward ratio is more than 10:1, whichseems foolhardy. However, the trade has an 82-percentchance of success, because SPY must drop 5.4 percentbefore it faces losses at expiration. The goal is to hold theposition for a week unless SPY falls this far.

Initial stop: Buy back spread if SPY drops belowbreakeven price of $78.59 before options expire.

TRADE STATISTICS

Date: Feb. 13, 2009 Feb. 18, 2009

Delta: 13.28 41.57

Gamma: -3.37 -8.81

Theta: 5.92 13.32

Vega: -1.96 -1.42

Probability of profit: 82% 53%

Breakeven point: 78.59 78.59

TRADE SUMMARY

Entry date: Feb. 13, 2009

Underlying security: S&P 500 tracking stock (SPY)

Position:1 short Feb. 79-strike put1 long Feb. 74-strike put

Initial capital required: $500

Initial stop: Exit if SPY drops below breakeven (78.59)

Initial target: Hold one week until expiration

Initial daily time decay: $5.92

Trade length: 5 days

P/L: -$99 (-20 percent)

LOP: $0

LOL: -$109

LOP — largest open profit (maximum available profit during life of trade).

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

The breakeven point of this 79/74 bull put spread is 5.4 percent below the currentprice, and the position had an 82-percent chance of success.

FIGURE 1 — RISK PROFILE — BULL PUT SPREAD

Source: OptionVue

When support broke, this

bullish credit spread collapsed.

continued on p. 44

OPTIONS TRADE JOURNAL

Initial target: Hold 4 trading daysuntil expiration.

RESULT

Outcome: Our timing couldn’t havebeen worse. Figure 2 shows SPYgapped down 3.5 percent, opening at$80.16 on Feb. 17. Within hours, SPYpenetrated support at 80 and kept slid-ing; the market fell 4.2 percent that day— its worst performance in nearly amonth.

Clearly, the trade was a disaster, butwe stuck to the plan and held onbecause SPY never hit the bull putspread’s 79 short strike. And trading a vertical spreadinstead of simply selling 79 puts was a wise choice, becausethe long 74 put helped absorb some of the short 79 put’sloss.

However, SPY dropped below our initial stop the nextmorning, and we bought back the 79/74 spread for $1.40when the market traded at $78.80 at 10 a.m. ET on Feb. 18.

The position lost $0.99 — nearly 20 percent of its initial capital.

In hindsight, this trade was a big mistake, but followingthe exit plan was the right decision. SPY fell much furtherbefore February options expired, and we would have lostmore money if we had dug in and waited for SPY to bouncebefore the end of the week.�

After entering a bullish credit spread, SPY gapped down 3.5 percent overnightand fell below support within hours. We exited with a 20-percent loss when themarket fell below the position’s breakeven point.

FIGURE 2 — LOOK OUT BELOW

Source: eSignal

OPTIONS TRADE JOURNAL continued

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