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August 2009 • Volume 3, No. 8

FUTURES STRATEGY:The MAX movingaverage p. 10

CROSSING THE OPTIONSfinish line p. 14

OPTIONMARTINGALEsystem p. 18

NEW POSITIONLIMITSfor futures

traders? p. 22

TWISTS ANDTURNSin the crude oilmarket p. 33

RATING

UPGRADEoption play p. 34

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Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Market Movers . . . . . . . . . . . . . . . . . . . . . . . .8

Futures market roundup.

Trading Strategies

The Power of X: The MAX

moving average . . . . . . . . . . . . . . . . . . . . .10

A novel approach to weighting prices

results in a new moving average that

compares favorably to its mainstream

counterparts.

By Stephan Bisse

Crossing the options finish line . . . . . . .14

A simple technique for setting profit

targets makes it easier to identify

potentially profitable option trades.

By George Hoekstra

Options Trading System Lab

Naked-call Martingale

strategy on the Russell 2000 . . . . . . . . . .18

A risky system that doubles down after losses

generates surprisingly consistent performance.

By Steve Lentz and Jim Graham

News

CFTC flexes muscles on

position limits . . . . . . . . . . . . . . . . . . . . . . .22

The ICE’s natural gas market becomes the

CFTC’s first target as it looks to reign in

speculative positions in U.S. commodity markets.

Futures Snapshot . . . . . . . . . . . . . . . . . . . .24Momentum, volatility, and volume

statistics for futures.

CONTENTS

continued on p. 4

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Options Radar . . . . . . . . . . . . . . . . . . . . . . .25

Notable volatility and volume

in the options market.

Futures & Options Watch

COT extremes . . . . . . . . . . . . . . . . . . . . . . .26

A look at the relationship between commercials

and large speculators in U.S. futures markets.

Options Watch:

S&P 500 Health care sector . . . . . . . . . .26

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . 28

References and definitions.

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

New Products and Services . . . . . . . . . . . . .32

Futures Trade Journal . . . . . . . . . . . . . . .33

Old-fashioned resistance level generates a trade

in the volatile crude oil market. But support and

resistance are vague levels upon which to hang

precise stops.

Options Trade Journal . . . . . . . . . . . . . . .34

Hooking up with Dow newcomer Cisco Systems.

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

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4 August 2009 • FUTURES & OPTIONS TRADER

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CONTRIBUTORS

Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Senior editor: David Bukey

[email protected]

Contributing editor:Keith Schap

Associate editor: Chris Peters

[email protected]

Editorial assistant and

webmaster: Kesha Green

[email protected]

Art director: Laura Coyle

[email protected]

President: Phil Dorman [email protected]

Publisher,

Ad sales East Coast and Midwest:

Bob Dorman

[email protected]

Ad sales

West Coast and Southwest only:

Allison Chee

[email protected]

Classified ad sales: Mark Seger [email protected]

Volume 3, Issue 8. 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, or approach. 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 of risk. Past performance does not guarantee futureresults.

For all subscriber services:www.futuresandoptionstrader.com

A publication of Active Trader ®

CONTRIBUTORS

Stephan Bisse is a principal of Tannhauser Gate GmbH and

Tradernomics.com, a Web site dedicated to trading education. He has an MBA

from the University of Oxford. For seven years he was an executive director

of Goldman, Sachs & Co. in London in the financial futures and options divi-

sion where, among other things, he was responsible for the daily technical

analysis of the European fixed-income futures markets. His e-mail address is

[email protected].

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.

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

options educator and trader and has spoken all over the U.S.,

Asia, and Australia on behalf of the CBOE’s Options Institute,

the Options Industry Council, and the Australian Stock

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

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

tent trading plan. Lentz is constantly developing new strategies on the use of

options as part of a comprehensive profitable trading approach. He regular-

ly speaks at special events, trade shows, and trading group organizations.

Jim Graham ([email protected]) is the product man-

ager for OptionVue Systems and a registered investment advisor

for OptionVue Research.











http://www.futuresandoptionstrader.com/



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After sliding lower for about a month, commodityfutures stabilized in the middle of last month. By theend of July, the Rogers International CommodityIndex TRAKRS (RCTY) had rallied more than 12 per-

cent of their mid-month low to close at 20.82.

Commodities stabilize in July

Energy

September crude(CLU09) see-sawed wildly in July, tumblingfrom above $70/barrelearly in the month toaround $60 by July 13 —

only to shoot back up to$69 and pull back to below $63, finally endingthe month knocking againon the door of $70.

Gasoline’s action wasmuch more a one-waystreet — the Septembercontract (RBU09) rocketed24 percent from mid-month to close above2.000 on July 31.

September natural gas(NGU09) consolidated,closing July roughlyhalfway between themonth’s high and lowcloses.

Grains

September rice (RRU09) was the big win-ner last month in a mostly moribund grain

market, rallying more than 14 percent fromits late-June low close toits late-July high close.September soybeans(SU09) bounced back a bitfrom the June sell-off,while wheat (W) and corn(C) merely stabilized.

Metals

September gold (GCU09) was another

roller coaster market in July, opening themonth with a $30/ounce drop, jumping nearly $50,then zigzagging twice more to close above $950 on July 31.

September silver (SIU09) was more low key, bouncing back a little from the June sell-off to endthe month around $14.00

Copper (HGU09) was the hot metal last month,though, rallying more than 20 percent from the July8 close to end the month above 2.600.

MARKET MOVERS

Source for all: TradeStation

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Softs

Sugar (SB) contin-ued the rally noted lastmonth as it continued todiverge from a choppy soft

sector. The October contract(SBV09) nearly reached 19.00in late July after trading aslow as 15.50 in mid-June — aroughly 22-percent rally.

September coffee (KCU09)climbed back above 125.00 inlate July — still well off itsearly June level — whileSeptember cocoa (CCU09)managed to shimmy aboveits June high, closing the

month just shy of 2900.Having pushed above 100in mid-July, Septemberorange juice (OJU09) pulled back more than 10 percent toclose the month around 91.30.

Meats

Lean hogs plummetedto a new contract lowin late July, continuing

to suffer at the handsof a swine flu storythat won’t fade away(a vaccine is being pre-pared for distribution).The October contract(LHV09), which hadpushed back above60.000 by mid-month, broke sharply to thedownside, falling below 52.000 and clos-

ing the month onlyslightly higher. Likehogs, August pork bel-lies (PBQ09) bouncedearly in the month, butpulled back much lessdramatically.

October live cattle futures (LCV09), which had beenticking higher since mid-June, peaked in mid-Julyabove 92.000 and closed the month around 90.000.

Treasuries

Treasury futures were mostly quiet in July as equities blossomed. After ral-

lying as high as 119early in the month,the September 10-year T-note contract(TYU09) pulled back to around 116 before closing themonth around 117.

Stock indices

Stock index futures made a startling comeback in July. After closing at873.75 on July 8, the September E-Mini S&P 500 futures (ESU09) closed at 982.25 on July30 — a gain of more than 12 percent.

A positive beginning to the Q2 earnings season and mostly benign economic numbers

buoyed the market.

Currencies

September Canadian dollar(CDU09) futures jumpednearly 9 percent from their July 8 low to their July 31high of .9292. Overall, the Canadian dollar weakened in

July, making a final push lower the last day of the month.For more coverage of the forex market, check out the

August issue of Currency Trader magazine.

FUTURES & OPTIONS TRADER • August 2009 9

http://www.currencytradermag.com/


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OPTIONS STRATEGY LABTRADING STRATEGIES


The power of X:The MAX moving average

Note: A version of this article originally appeared

in the June 2005 issue of Active Trader magazine.

Moving averages are useful for filtering the noisefrom a time series to show its underlying trend.They are popular tools and serve as the basis

for many trading strategies and systems.However, because moving averages are “backward look-

ing” — that is, they are calculated using past price valuesfrom the look-back period — they suffer from lag. Thismeans trading signals based on moving averages arealways following the price action, never leading it. As aresult, controlling lag is crucial to successfully applyingmoving averages in trading.

Modifying moving averages: WMAs and EMAs

The most widely used moving average is the simple mov-ing average (SMA). To calculate a simple moving average,

add a series of data points and divide the sum by the number of data points in the series. The next value of the SMAis calculated by adding the new data point into the calcula-tion and dropping the oldest to keep the number of datapoints in the calculation constant. The lag of an SMA is onehalf the look-back period over which the SMA was calcu-

lated (e.g., five days for a 10-day SMA).There are numerous variations on the SMA that give dif-

ferent weight, or emphasis, to the data points, not only withthe goal of reducing lag, but also because newer data hasmore relevance to future price action. Therefore, the mostrecent data points are typically weighted more heavily thanthe older ones.

Two common variations of this type are the weightedmoving average (WMA) and the exponential moving aver-age (EMA). A WMA weights data points in a linear manner

according to the order in which they occur. Forexample, to calculate a 10-period WMA of closing

prices, the most recent price is given 10 times theweight of the oldest data point, the second mostrecent price is given nine times the weight of theoldest data point, and so on.

The EMA on the other hand uses an exponent todetermine the rate at which the weight of previousdata points diminishes. To calculate a “10-percent”EMA, which is the same as a 19-period EMA (see“Converting EMA percentages to SMA look-back periods”), start by calculating a 19-period SMA.Then take the next price and multiply it by 0.1 whilemultiplying the 19-period SMA value by 0.9 before

adding the two values together. From then on eachnew value of the EMA is a weighted average of 90percent of the value of the previous bar’s EMA valueand 10 percent of the new data-point.

Tuning to market conditions: The MAX

Although both the WMA and EMAcan significantlyreduce lag relative to an SMA, neither of them can be tuned to different markets and market condi-tions. The idea behind MAX is to enhance the WMAcalculation by raising the weighting factors to auser-defined power. This power can be greater than1, in which case the MAX becomes more responsive

This indicator modifies the standard weighted moving average calculation

to attempt to create a more responsive and customizable indicator.

A sine wave representing price is shown with a 10-period SMA and a

10-period WMA. The SMA lags the sine wave by five periods (half

the look-back period) and the WMA lags only three periods.

FIGURE 1 — THE LAG FACTOR

BY STEPHAN BISSE

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than a WMA, or smaller than 1, in which casethe MAX is less responsive than a WMA.

For example, in a 10-period MAX with a user-specified power of 3 (“MAX3”), the most recentprice is weighted by 103 (1000), the second mostrecent price is weighted by 93 (729), etc., all theway to the oldest data-point, which is weighted

by 13 , or 1. To calculate a MAX0.5, the mostrecent data-point would be weighted by 100.5 or3.16, the second data-point is weighted by 90.5 or3, down to the tenth and oldest data-point,which is weighted by 10.5 or 1. By raising each of the weighting factors to a power, the MAXincreases or decreases the difference betweenthe relative weighting given to each of theprices.

For instance, whereas in a standard 10-periodWMA, the relative weighting between the firstand second prices is 10:9, in the equivalent

MAX3, the relative weighting is 10:7.29 and thedifference between the oldest data-point is evenmore pronounced — 10:1 vs. 1000:1.

When the power of MAX is smaller than 1 —for example, MAX0.5 — the relative weighting between the first and second prices is 3.16:3 and the differ-ence between the first and oldest prices is only 3.16:1 vs.10:1 for the WMA. (Another way to think of a WMA is thatit represents a special case of the MAX using a power of 1,or MAX1.)

The following examples illustrate the superior lag-tuningcapability of a MAX over a WMA. Figure 1 shows a 10-peri-

od SMA and a 10-period WMA applied to a sine wave (rep-resenting price) with a frequency of 20 periods and anamplitude of 10. Note how the SMA lags the sine wave byfive periods (half its look-back period) while the WMA hasa lag of only three periods.

Figure 2 shows the same 20-period sine wave, this timewith a WMA (which is equal to MAX1), a MAX0.5, and aMAX2. The lag is reduced as the power of MAX goes up —in this example, from a lag of roughly three periods for theWMA to a lag of about two periods for the MAX2, while theMAX0.5 increases the lag to about four periods.

Note that the lag reduction diminishes as the power of

MAX goes up, with the biggest reduction in lag occurring by raising the original weightings in a WMA, or MAX1, tothe power of 2, or MAX2. The power does not have to be aninteger, but can take any value, and it is highly advisable tooptimize MAX for different markets, or at least for differentmarket groups. For example, for the currency futures orspot FX, a more responsive MAX might be advantageous,whereas for short-term interest-rate futures, a lower MAXvalue will probably be more appropriate.

When optimizing it is important to keep a sufficientlylarge amount of your data, preferably the most recent part,as out-of-sample data to ensure the optimum settingsobtained in the in-sample data optimization hold up in the

out-of-sample period. This increases the likelihood the per-formance will continue going forward.

Testing the theory

So much for the theory. The real question is of coursewhether MAX can outperform a WMA over a series of dif-ferent markets. To find out, both a WMA and a MAX wereoptimized for seven different markets over a 15-year in-sample period and the optimum setting applied to a subse-quent five-year out-of-sample period.

One market was chosen from each of the following assetclasses: currencies (British pound), bonds (U.S. 10-year T-

continued on p. 12

The same sine wave from Figure 1 is accompanied here by a WMA

(a “MAX1”), a MAX0.5, and a MAX2. The lag decreases as the power

of MAX increases — in this case, from roughly three periods for the

WMA to approximately two periods for the M AX2. The MAX0.5

increases the lag to about four periods.

FIGURE 2 — THE MAX FACTOR

Converting EMA percentages

to SMA look-back periods

Most traders are more comfortable thinking in terms of look-back period rather than percentages. The formula to convertEMA percentages to their simple moving average look-backequivalent is:

EMA percent = 2/(periods + 1)

For example, a 19-period EMA is therefore the same as a10-percent EMA, or a 39-period EMA is the same as a 5-percent EMA.

However, the easiest way to think about EMAs is as apercentage of how much of the latest data-point is averagedwith the previous EMA value, and inversely, how much of the previous data is “remembered” in the latest value of theEMA.

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TRADING STRATEGIES

note), stock indices (S&P 500), short-term interest rates(eurodollars), energy (crude oil), grains (soybeans), andprecious metals (gold). To compensate for different contractsizes and price levels, the number of contracts used in eachmarket was determined by allocating $10,000 of capital toeach market and then using the dollar value of a one-stan-

dard deviation move calculated over the last 100 tradingdays as the “margin” required to trade one contract in thatmarket. This methodology produces a risk-adjusted returnfor each market that can be directly compared with thereturn generated in the other markets.

Although there are numerous ways to trade using mov-ing averages and WMAs, one of the most effective ways isto use a moving average as a smoothed proxy for price anda one-period lagged value of the same as a signal line:When the moving average crosses over its value of 1 periodago to the upside, a buy signal is produced, while a cross-ing to the downside produces a sell signal. In the simulationthe closing price was used to calculate the WMA and the

MAX, and all trades wereexecuted the following dayon the open.

To keep things manage-able, the simulation wasdone by optimizing for the best WMA using values

between 5 and 100 in incre-ments of 5. This optimumlook-back period was thenused for the MAX with theadditional step of optimiz-ing the power for values between 0.5 and 2.5 inincrements of 0.25 to ascer-tain whether this couldimprove on the perform-ance of the WMA. No stop-loss orders were used to

simplify the slippageassumptions (set at $50 percontract, per side), whichmeans the system wasalways in the market. Thein-sample period was from Jan. 1, 1985 to Jan. 1, 2000,with the best setting foreach market subsequentlyapplied to the period from Jan. 1, 2000 to Jan. 1, 2005.

The results were very

interesting. The in-sampleperformance of the MAXwas always going to atleast match the in-sampleperformance of the WMAas the latter is a subset of

the former. The key question, therefore, was whether thisout-performance would carry on through to the out-of-sam-ple period. Furthermore, it would be interesting to see inhow many cases the best MAX power would be below 1,how often it would be equal to 1 (and therefore the same asa WMA), and how often it would be greater than 1.

As shown in Table 1 , the original MAX power of 1 wasthe optimum weighting only in the S&P 500 futures. In allother markets the additional flexibility offered by MAXimproved the in-sample performance. The overall profitachieved by the WMAin the seven markets over the 15-yearperiod was $3,194,820.00, while the MAX achieved$3,476,811.25, an improvement of 9 percent. More impor-tantly, the WMA out-of-sample profit of $420,222.50 waseclipsed by the MAX profit of $493,201.25 — an evengreater 17 percent. What is perhaps most surprising is thatthe most profitable MAX power for most of the marketswas smaller than 1, the only exception being the U.S. 10-year T-note futures, with a MAX power of 2.


Calculating MAX

Although the weighted moving average (WMA) tries to address the problem of lag in the simplemoving average, because it uses a linear weighting of the prices based on their order of occur-rence, it does not allow the user to fine tune its responsiveness to different markets and conditions.

The idea behind MAX is to raise the weighting factor to a user-specified power that can be opti-

mized. The formula for a four-period MAX3 is:

=((E8*43)+(E7*33)+(E6*23)+(E5*13))/((433)+(33)+(23)+(13))

The spreadsheet can be made interactive by simply changing the power in the formula to a cellreference, in this case cell H3, where the desired power can then be entered:

=((E8*4H$3)+(E7*3H$3)+…(E5*1H$3))/((4H$3)+(3H$3)+…(1H$3))

An interactive spreadsheet with the formulas for a 10-period and 20-period MAX can be down-loaded for free from www.keyreversal.com.

The selected cell shows the formula for calculating a “MAX2” moving average, which raises

the weightings of a WMA to a power of 2.

FIGURE A — MAX WORKSHEET

http://www.keyreversal.com/

http://www.keyreversal.com/

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Another interesting fact of a more generalnature is the deterioration of average annualperformance between the in-sample and out-of-sample periods for both the WMA and theMAX. The average annual WMA in-sample

performance of $212,988 ($3,194,820.00 divid-ed by 15 years) dropped to $84,044.50 for theout-of-sample period, while the MAX per-formance dropped from $231,787.42 to$98,640.25. This is a good reminder to ade-quately discount expectations generated byin-sample optimized performance numbers.

Tuning in to specific marketsMoving averages are great tools for filteringout noise from time series and for showingwhere a time series has been. However, moving

averages suffer from lag, which typically in anSMA is one-half of the look-back period.Various methods have been developed toimprove the responsiveness of moving aver-ages, including the weighted moving average(WMA), the exponential moving average(EMA), and the volatility-index dynamic mov-ing average (VIDYA).

However, none of these is easily tunable todifferent markets. The idea behind MAX is tointroduce the concept of raising the weighting factors in aWMA to a user-specifiable power. This allows for fine-tun-ing the lag reduction or responsiveness of the MAX to dif-

fering markets and market conditions.

For information on the author see p. 6.

Related reading“Indicator Insight: Simple moving average,” Active Trader, June 2000.

“Indicator Insight: Weighted and exponential moving averages”

Active Trader, July 2002.

The basic principles and uses of weighted and exponential moving averages.

“Indicator Basics: Weighted and exponential moving averages”

Currency Trader , December 2004.

This adaptation of the article from Active Trader includes comparison tests

of simple, weighted, and exponential moving averages.

“The adaptive moving average,” Currency Trader , August 2006.

Making a moving average responsive to volatility changes results in a

dynamic, more accurate indicator.

“KAMA range trader” Futures & Options Trader , June 2007.

Kaufman’s Adaptive Moving Average (KAMA) is a dynamic indicator devel-oped by Perry Kaufman and described in his book New Trading Systems and

Methods (Wiley, 2005). This system focuses on trading range-bound by exe-

cuting short-term trades with a price pattern after a combination of indicators

has identified suitable range-bound price action.

You can purchase and download past articles at

http://store.activetradermag.com.

The MAX out-of-sample profit was 17 percent greater than the WMA out-of-sample profit. Interestingly, the most profitable

MAX power for most of the markets was less than 1. The only exception was the U.S. 10-year T-note futures, which used a

MAX power of 2.

TABLE 1 — MAX VS WMA

Best Power In-sample Profitable Out-of-sample Profitable

Market WMA P&L years/15 P&L years/5

British pound 5 1 261,512.50 10 -84,506.25 1

U.S. 10-year note 40 1 681,200.00 13 242,031.25 5S&P 500 85 1 32,950.00 9 -36,750.00 3

Eurodollar 30 1 969,175.00 14 218,975.00 4

Crude oil 100 1 947,550.00 11 111,070.00 3

Soybeans 25 1 13,012.50 7 27,212.50 4

Gold 15 1 289,420.00 11 -57,810.00 2

Portfolio: 3,194,820.00 Portfolio: 420,222.50

Best Best In-sample Profitable Out-of-sample ProfitableMarket MAX power P&L years/15 P&L years/5

British pound 5 0.75 299,800.00 12 -8,043.75 2

U.S. 10-year note 40 2.00 693,256.25 15 171,662.50 4

S&P 500 85 1.00 32,950.00 9 -36,750.00 3

Eurodollar 30 0.75 996,425.00 14 259,525.00 4Crude oil 100 0.75 963,500.00 12 110,490.00 3

Soybeans 25 0.50 74,150.00 8 48,287.50 2

Gold 15 0.50 416,730.00 12 -51,970.00 3

Portfolio: 3,476,811.25 Portfolio: 493,201.25

http://store.activetradermag.com/


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Cisco’s call option curve (Figure 1) containsall the information needed to draw the April17.5 call’s finish line. You need two points: Theunderlying price required for the call to be

worth 50 percent more ($2.90 + 1.45 = $4.35) on both Sept. 3, 2004 (point A) and April 15, 2005(expiration day — point B).

Figure 1 shows the option must be $3.20 in-the-money for it to be worth $4.35 on Sept. 3.Cisco must trade at $20.70 (point Aon Figure 2),or the call’s strike ($17.50) plus its intrinsicvalue ($3.20), for the call to be worth $4.35 thatday.

On expiration day, the call has no time value,so its price will be the same as its intrinsicvalue. On April 15, 2005, Cisco must trade at

$21.85 (point B), or the call’s strike price ($17.50)plus its target market value ($4.35), for theoption to post a 50-percent profit.

The finish line is simply a straight line con-necting point A and point B. When Cisco cross-es above this line, you would sell the April 17.5call since it will be worth at least $4.35, whichrepresents a 50-percent gain. If the stock lan-guishes, you can let the option expire.

Figure 2 shows Cisco quickly rose from$18.75 to $20.75 in the first two weeks after Sept.3, but fell short of the finish line. The stock then

traded between $18 and $20 over the next cou-ple of months. If you’d bought the April 17.5call on Sept. 3 with this strategy, you’d continueto hold it.

Figure 3 shows a finish-line chart for aMaytag (MYG) April 20 call purchased at $2.20on Aug. 27, 2004 when the stock was trading at$20.20. The call’s 50-percent profit target is$3.30.

On that day, the April 20 call must be $1.80ITM (with $1.50 in time value) to trade at thislevel, which corresponds to a stock price of

$21.80 (point A = $20 strike price + $1.80 intrin-sic value). To calculate the April 15, 2005 expi-ration-day stock price ($23.30), simply add thecall price target to its strike price (point B =$3.30 + $20).

Figure 3 shows Maytag has been volatilesince Aug. 27, and sold off sharply in mid-September before regaining ground a monthlater — a $6 range in 13 weeks. Here, as in theprevious example, you’d still be waiting for finish-line strat-egy to pay off.

On Sept. 3, 2004, the Maytag and Cisco options had thesame price for an ATM April call ($2.10). Analysis of weekly

volatility suggested that Maytag was likely to show highernear-term volatility, so its calls were better priced thanCisco’s. A simple way to estimate average historical volatili-

continued on p. 16

This daily Cisco bar chart also shows the April 17.5 call’s finish line, or

50-percent profit target, based on the Sept. 3 purchase as the stock traded at $18.75. Cisco moved higher in mid-September and

approached the finish line before selling off toward the end of the

month.

FIGURE 2 — CISCO FINISH-LINE CHART

Source: MSN Money

Maytag was quite volatile after we bought an April 2005 call on Aug. 27

when the stock traded at $20. Over the past several months, the stock

hasn’t approached the call’s 50-percent profit level.

FIGURE 3 — MAYTAG FINISH-LINE CHART

Source: MSN Money

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ty on a weekly basis is to calculate a six-week moving average of the weekly ranges. If the cur-rent weekly range is below this average, volatil-ity will likely increase in the near-term; theopposite is true if the current weekly range is

above the average.If you compare Figures 2 and 3, it’s obvious

Maytag was more volatile in the subsequentthree months, and covered a $6 range vs.Cisco’s $3 range. As of Dec. 3, however, the fin-ish-line strategy had not yet paid off for eitherexample.

Elbit Systems (ESLT) call options also lookedattractive on Sept. 3, according to the weeklyvolatility analysis. Figure 4 shows a finish-linechart for an ESLT April 20 call purchased for$1.40 on Sept. 7 when the underlying stock trad-

ed at $20.We sold the call at its 50-percent profit level

($2.10) on Nov. 4 with the stock at $21.70. Afterwaiting two months, a move of just $1.70 in thestock was enough to chalk up a 50-percent prof-it.

Balancing volatility and probabilityFinish-line charts highlight the challenge of finding cheapoptions. Overall, longer-term profits will depend on thepercentage of options that cross their finish lines. The lowerthe finish line — that is, the closer it is to the current stock

price — and/or the higher the volatility, the greater thechance the stock will reach the profit target.

Cheaper options offer lower finish lines. Higher stock volatility means more fuel to drive a stock toward the fin-ish line. Because this approach is structured so most of yourwinners will be 50-percent profits and most of your loserswill be complete losses, it is advisable to keep a 75-percentwinning percentage in mind.

In general, if you buy a seven-month ATM call and theunderlying stock moves up by the same amount as theoption’s original price within one month, you should beable to sell the option for a 50-percent profit.

For example, Cisco’s and Maytag’s ATM April calls wereselling for $2.10 on Sept. 3, and their finish lines wereapproximately $2.10 above their respective stock pricesduring September. Similarly, the Elbit Systems ATM Aprilcall cost $1.40, and its finish line was roughly $1.40 abovethe stock price during September.

Cheap options and market direction

Buying calls is just one variation of the finish-line strategy.You can easily change the strategy’s market bias (i.e., bull-ish, bearish, or neutral). If you’re bearish, buy puts insteadof calls. In sideways markets, you can take advantage of potential volatility increases with long straddles, which


TRADING STRATEGIES

Related readingVariance and standard deviation

“Bargain hunting for options,”by George Hoekstra. Active Trader , January 2005.

Using statistical and implied volatility to find cheap call

options.

“Getting started in options,” Active Trader , April 2001.

A beginner’s guide to trading options.

“Choosing the best option,” Active Trader , July 2001.

One trader’s guidelines for finding the option that best

suits the needs of a particular trade.

“Long straddles: The importance of buying time”

Active Trader , November 2004.

How to construct higher-probability long straddles by find-

ing options with the best volatility characteristics and tap-

ping into LEAPS.

“Putting volatility to work,” Active Trader , April 2001.

A guide to different types of volatility, and how to improve

your trading with practical volatility-based analysis and

trading techniques.

You can purchase and download past articles at

http://store.activetradermag.com.

This figure shows a successful options trade: After we bought an ATM

ESLT April 20 call on Sept. 7, we sold it two months later when it hit the50-percent target.

FIGURE 4 — CROSSING THE FINISH LINE

Source: MSN Money



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consist of the simultaneous purchase of call and putoptions.

Whichever direction you chose, underpriced options willgive an advantage in a long-option position, which meansmore potential profit if the stock moves in your direction,

and less risk if it doesn’t. Overall, “bargain” options offer a better chance of gains than fairly priced ones.

However, if you buy options with seven months to expi-ration and use a strategy with a directional bias (i.e., morelong calls than puts or vice versa), you must protect againstunfavorable market moves. A sudden drop in the overallmarket can wipe out an entire portfolio of call options, evenif you bought them at underpriced levels. Holding cash,using neutral strategies or other forms of hedging are nec-essary to avoid ruin.

Profit target advantages

Why set a fixed profit target at all? Wouldn’t it make moresense to monitor each option position and hold it until it isno longer underpriced? While this ultimately is a matter of preference, an underpriced option (unlike a stock) can’t stayunderpriced for long.

On expiration day, it will be worth the amount it is ITM,

or zero. It is not necessary to continually monitor theoption’s price. If it was underpriced when you bought it,you can expect to benefit from that edge as expirationapproaches.

A fixed target also imposes discipline and focus. You

don’t run the risk of overreacting to the latest news or hic-cup in the stock. Instead, once you buy a bargain-pricedoption, your work is done and you can start searching forother cheap options.

Why set a 50 percent target? Why not 100 percent or 150percent? It makes sense to set a target that is easily reachedwithin a stock’s normal variation. For bargain-pricedoptions, 50 percent is such a target. A well-chosen, under-priced, seven month option will move up 50 percent if thestock moves favorably by about 1.5 times its typical weeklyrange within 3 months. It is reasonable to aim for this tohappen on 75 percent of your trades.

Finally, when selecting options, always consider theeffect of dividends and check for possible mergers orrumors that might explain odd option pricing before trad-ing.

For information on the author see p. 6.

http://www.discoveroptions.com/public/pages/mentoring/domentoring/inquire.html?ovs.tr=FuturesAndOptionsTraderMagazine

8/8/2019 FOT200908


OPTIONS STRATEGY LABOPTIONS TRADING SYSTEM LAB

Market: Call options on the Russell 2000 index (RUT).

System concept: The June 2009 Options Lab examineda trading strategy that bought at-the-money (ATM) calls on2-percent dips, or pullbacks, in S&P 500 futures (SP). Theoriginal pattern’s title — nerves of steel —inspired us to search for other approaches thattake guts to trade, but earn money most of thetime (see “Nerves of steel pullback pattern ,”Futures & Options Trader , October 2008).

One trading idea is to sell uncovered calls onan index to collect premium and then “roll” theposition into higher-strike calls when the mar-

ket nears the call’s strike price, an approachdescribed in the fifth chapter of LarryMcMillan’s Options as a Strategic Investment(New York Institute of Finance, fourth edition,2002). The technique resembles the Martingale betting system, which doubles down after everyloss. In theory, you will eventually win and thusrecoup all losses plus the initial bet.

The system sells naked calls on the Russell2000 when a bearish divergence signal betweenprice and the 14-day relative strength index(RSI) is triggered. The signal appears when price

makes a new high and the RSI fails to make asimilar new high (Figure 1). This is a sign the bullish trend is slowing down and a rever-sal to the downside may be imminent — agood time to sell out-of-the-money (OTM)calls.

The technique sells calls with the firstOTM strike when the divergence signalappears and the market closes down. This“bearish-only” approach is a direct way of collecting premium; gains can mountquickly if the underlying index really

drops. On the other hand, potential lossesare theoretically unlimited because theunderlying has no upside “ceiling.”

Figure 2 shows the potential gains andlosses of a trade entered on Aug. 15, 2008.The Russell 2000 index was trading at753.20, and the system sold a September760 call with 35 days left until expiration.The probability of profit by expiration was66 percent and the yield on initial marginwas 12 percent. Remember if the Russellrallies, losses can be substantially greaterthan the maximum potential gain.

How can the system avoid this risk of very large losses —

i.e., the cliff on the right side of Figure 2? The solution is to buy back the slightly OTM calls quickly (even at a loss) if the underlying index rises to touch the short strike price. If enough time has elapsed, the system might make money


FIGURE 1 — BEARISH RSI DIVERGENCE SIGNAL

The system sells an out-of-the-money call, which on average has a

66-percent probability of profit.

Source: OptionVue

FIGURE 2 — RISK PROFILE — SHORT NAKED CALL

A bearish divergence signal occurs when price makes a new high and

the RSI fails to make a similar new high.

OPTIONS TRADING SYSTEM LAB

Naked-call Martingale strategyon the Russell 2000

Source: MetaStock

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STRATEGY SUMMARY

Initial capital: $75,000

Net gain: $19,850

Percentage return: 26.5%

Annualized return: 3.5%

No. of trades: 26

Winning/losing trades: 25/1

Win/loss: 96%

Avg. trade: $763.46

Largest winning trade: $2,305.00

Largest losing trade: -$5,569.00

Avg. profit (winners): 1,016.76

Avg. profit (losers): -5,569.00

Avg. hold time (winners): 15

Avg. hold time (losers): 1

Max. consec. win/loss: 19/1


LEGEND:

Initial capital — Starting account value

Net gain — Gain at end of test period.

Percentage return — Gain or loss on a percentage basis.

Annualized return — Gain or loss on a annualized percentage basis.

No. of trades — Number of trades generated by the system.

Winning/losing trades — Number of winners and losers generated by the system.

Win/loss (%) — The percentage of trades that were profitable.

Avg. trade — The average profit for all trades.

Largest winning trade — Biggest individual profit generated by the system.

Largest losing trade — Biggest individual loss generated by the system.

Avg. profit (winners) — The average profit for winning trades.

Avg. loss (losers) — The average loss for losing trades.

Avg. hold time (winners) — The average holding period for winning trades (in days).

Avg. hold time (losers) — The average holding period for losing trades (in days).

Max consec. win/loss — The maximum number of consecutive winning and losing trades.

The Martingale-style system gained 26.5 percent over the past seven years.

Source: OptionVue

FIGURE 3 — SYSTEM PERFORMANCE

repurchasing them, although not if themarket jumps immediately after entry.

After buying back the short call, thesystem then sells enough calls at thenext OTM strike price so that the pre-mium collected will cover any previ-ous loss plus one-half of the originalcredit received.

If the market continues to rise andhits the second strike price, the systemrepeats this process. Although this tac-

tic doesn’t necessarily double thenumber of contracts each time, theposition’s size increases fairly rapidly.

Eventually, if the market continuesto climb, the strategy needs to roll theshort calls to the next expiration

month as it waits for the underlying to bounce around and (hopefully) dropenough so the short calls expire worth-less. Meanwhile, this can take quite a bit of capital.

Trade rules:

Entry

1. Bearish RSI divergence signal.Price makes higher highs, while

the 14-day RSI fails to makehigher highs.

2. Confirmation. Once the divergencesignal appears, the system waitsfor the underlying index to close

down. The divergence and con-firmation signals may (or maynot) occur on the same day.

continued on p. 20

http://www.rsofhouston.com/

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3. Position. Sell a naked call at the first OTM strike andin the first month with at least 22 calendar days untiloptions expiration.

Exit1. Allow the sold call(s) to expire worthless, or:

2. If the market rises and touches the short strike, buy back the call(s) and then sell enough calls at the nextOTM strike price to cover the accrued loss plus atleast one-half of the original credit.

3. If the number of contracts required is more thandouble the previous position, roll to the next month.

4. If losses reach or exceed five times the original

credit on any day’s close, exit the entire position.

Test details: Daily closing prices were used. Trades wereexecuted at the bid and ask, when possible. Otherwise, the-oretical prices were used.

Commissions were $5 plus $1 per option trade.

Test data: System was tested on the Russell 2000 index’s

cash-settled options at the CBOE.

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

Test results: Figure 3 tracks the system’s performance,which gained $19,850 (26.5 percent) during the test period.Notably, the system posted gains 96 percent of the time —25 winning trades with an average size of $1,017 and onlyone losing trade ($5,569).

The system remained profitable for most of the test peri-od, with the main exception occurring in April and May of 2003 as stocks entered a new bull market. Statistically, thesystem should make money only 66 percent of the time, butit posted gains surprisingly often (96 percent). Thus, thesystem has a definite trading edge.

— Steve Lentz and Jim Graham of OptionVue

OPTIONS TRADING SYSTEM LAB

Option System Analysis strategies are tested using OptionVue’sBackTrader 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].

Bob Dorman

Ad sales East Coast and Midwest

[email protected]

(312) 775-5421

Allison Chee

Ad sales West Coast and Southwest

[email protected]

(415) 272-0999

Mark Seger

Account Executive

[email protected]

(312) 377-9435

Three good tools for targeting customers . . .

— CONTACT —










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It has been a busy summer for Commodity Futures

Trading Commission Chairman Gary Gensler. Since

his confirmation in May, the CFTC has ramped up its

efforts to curb volatility in commodity markets, much of

which has been blamed on speculators, including the run-

up of gas prices last summer.

Among other things, the CFTC’s investigation has

focused on the position-limit exemptions offered to certain

market participants. Except for commercial traders (thosewith direct business activity to the underlying commodity),

the number of contracts a market participant can hold is

typically capped. However, certain non-commercial partic-

ipants have been granted exemptions from these limits.

Classified as “bona fide” hedgers, these participants were

allowed to exceed the typical limits imposed upon non-

commercial traders.

Critics note that many exemptions have been granted to

swaps dealers — traders who participate in over-the-count-

er (OTC) agreements with third parties and then use theirexemptions to purchase futures contracts to hedge their

OTC exposure. The large number of these contracts pur-

chased has been blamed for artificially driving up com-

modity prices.

The CFTC scheduled three meetings, open to the public,

to discuss the issue and how to regulate speculative posi-

tions. The first two meetings were held on July 27 and 28,

while the final meeting is on Aug. 5. During his July 27

opening statement, Gensler remarked that futures contracts

not only serve as important risk-management tools for

farmers, producers, and other commercial interests, but

they have a direct affect on American families.

“Gasoline prices, for example, can determine whether a

family takes a summer vacation,” Gensler said. “Natural

gas futures contracts can affect utility bills, and lack of con-

vergence in the wheat market can shorten a grocery list.”

Although the CFTC enforces positions on agricultural

products, it has been up to the exchanges to set limits for

energy markets, which typically apply in a contract’s final

trading days. “The exchanges, however, are not required by

statute to set and enforce position limits to address the bur-

dens of excessive speculation,” Gensler said.

London loopholeIn one of the most forceful steps it has taken during

Gensler’s tenure, the CFTC exercised authority granted to it

through the 1936 Commodity Exchange Act (CEA) to

impose requirements on exempt commercial markets — in

this case the IntercontinentalExchange (ICE). The CEA

allows the commission to take such action if a contract is

determined as serving a significant price discovery func-

tion.

On July 24, the CFTC announced the Henry Financial

LD1 Fixed Prices contract, a natural gas contract traded on

the ICE, served as a significant price discovery contract,

and would be required to fall in line with position limits

similar to those imposed on the New York Mercantile

Exchange (NYMEX).

An investigation into the contract began on June 9, and

because of its high average daily trading volume, reliance

on the settlement price for NYMEX’s physically delivered

natural gas futures contract, and its use by traders, new reg-

ulatory criteria was deemed necessary.

INDUSTRY NEWS

“Gasoline prices, for example, can

determine whether a family takes a

summer vacation. Natural gas futures

contracts can affect utility bills, and

lack of convergence in the wheat

market can shorten a grocery list.”

— Gary Gensler, Commodity Futures

Trading Commission Chairman

CFTC flexes muscles on position limitsThe CFTC moves to limit positions on the ICE while discussing the role

of speculators in commodity markets.

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“Bringing this natural gas contract under the CFTC’s reg-

ulatory authority is a critical step toward ensuring a fair

and orderly marketplace,” Gensler said in a statement.

The move is an attempt to close what has been referred to

as the “London loophole.” The ICE is regulated by the UK’s

Financial Services Authority (FSA), and had received a

CFTC exemption to offer contracts based on U.S. products.

Some speculated that traders sidestep U.S. position lim-

its by trading through the ICE, gaining exposure to the

same contracts without having to adhere to the stricterregulations imposed on exchanges under the CFTC’s

authority.

In response, the ICE stated that its U.S.-linked energy

contracts have been subject to increased reporting require-

ments since its “no-action” letter

issued by the CFTC allowing it to

operate in the U.S. while remaining

under FSA authority was amended in

fall 2008. The ICE argues it’s being

asked to adopt position and accounta- bility limits established by its com-

petitor, NYMEX, without “access to

the information needed to judge the

suitability or size of these limits,” and

without “access to the methodology

or determining factors that NYMEX

used in deciding to grant over 115

hedge exemptions since 2006.”

Increased transparency

While the future of speculative posi-

tion limits remains to be seen, the

CFTC has made an effort to increase

transparency in commodity markets

by altering its weekly Commitments

of Traders (COT) report, which aggre-

gates data to highlight the positions of

different types of market participants.

The revamped COT report will dis-

play the positions of swaps dealers separately from those of

commercial dealers, while the non-commercial category

will be disaggregated as well, categorizing the positions of

professional market managers, such as hedge funds. The

CFTC will also incorporate data it receives for all foreign

contracts linked to domestic contracts, and will display data

on contracts, such as the ICE’s natural gas contract, which

have been determined as serving a significant price discov-

ery function.

In its first move to improve the transparency of the week-ly COT report, the CFTC included data for positions in ICE

Futures Europe West Texas crude oil contracts in the report

published on July 31. The CFTC has said further additions

will be forthcoming.

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 June 2009 return.

(Managing at least $1 million as of June 30, 2009.)

June 2009 YTD $ under Rank Trading advisor return return mgmt.

1. ACE Investment Strategists (DPC) 12.66% 49.14% 12.8

2. Kingsview Mgmt (Retail) 9.59% 31.75% 2.2

3. Carter Road LLC 9.10% 57.51% 2.0

4. Financial Comm Inv (CPP) 8.19% 23.33% 4.5

5. CKP Finance Associates (Masters) 7.82% 111.67% 1.0

6. ACE Investment Strategists (ASIPC) 6.43% 29.48% 3.77. Kingsview Capital Ptnrs 6.36% 17.27% 3.1

8. Financial Comm Inv (Option Selling) 6.10% 17.97% 12.6

9. NEOS Advisors (Special Opportunities) 5.84% 12.67% 54.5

10. ACE Investment Strategists (SIPC) 5.61% 17.60% 29.7

MANAGED MONEY

http://www.barclayhedge.com/



8/8/2019 FOT200908


The following table summarizes the trading activity in the most actively traded futures contracts. The information does NOT constitute tradesignals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the leg-end for explanations of the different fields. Volume figures are for the most active contract month in a particular market and may not reflecttotal volume for all contract months.

Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).

Legend

Volume: 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.



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. For example, 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 of prices) divided by the long-term volatility (100-day standard deviation of prices). The rank isthe percentile rank of the volatility ratio over the past 60 days.

This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & Options

Trader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buy or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.

FUTURES SNAPSHOT (as of July 29)

10-day move/ 20-day move/ 60-day move/ VolatilityMarket Symbol Exchange Volume OI rank rank rank ratio/rank

E-Mini S&P 500 ES CME 1.88 M 2.36 M 5.15% / 42% 6.06% / 64% 7.91% / 33% .28 / 68%

10-yr. T-note TY CME 737.4 1.04 M -0.19% / 17% -0.07% / 7% -3.58% / 65% .18 / 8%

5-yr. T-note FV CME 341.3 762.7 -0.74% / 29% -0.08% / 3% -2.38% / 80% .26 / 17%Eurodollar* ED CME 281.0 535.0 -0.10% / 14% -0.02% / 0% -0.05% / 5% .38 / 15%

E-Mini Nasdaq 100 NQ CME 280.9 256.1 6.91% / 50% 8.25% / 88% 12.16% / 37% .29 / 68%

Crude oil CL NYMEX 268.1 226.7 2.94% / 0% -8.60% / 53% 17.66% / 15% .25 / 50%

30-yr. T-bond US CME 215.8 696.1 -0.10% / 0% -1.63% / 5% -4.94% / 31% .17 / 8%

Eurocurrency EC CME 207.0 122.2 -0.86% / 67% -0.98% / 60% 5.24% / 43% .15 / 7%

2-yr. T-note TU CME 137.2 594.4 -0.06% / 33% -0.02% / 0% -0.16% / 53% .27 / 33%

E-Mini Russell 2000 TF CME 132.8 357.1 6.97% / 45% 6.47% / 64% 8.50% / 33% .32 / 73%

Mini Dow YM CME 128.4 54.9 5.90% / 36% 7.09% / 81% 7.93% / 39% .30 / 75%

British pound BP CME 96.4 88.7 -0.41% / 30% -0.72% / 54% 8.54% / 40% .06 / 2%

Natural gas NG NYMEX 91.2 97.3 8.07% / 67% -6.51% / 27% -1.85% / 5% .28 / 7%

Japanese yen JY CME 86.3 87.9 -0.69% / 0% 1.57% / 33% 4.20% / 59% .31 / 60%

Gold 100 oz. GC NYMEX 82.1 203.2 -1.03% / 33% 0.25% / 3% 3.05% / 20% .35 / 48%

Corn C CME 80.4 247.5 -2.67% / 5% -9.54% / 27% -20.92% / 96% .15 / 0%

Australian dollar AD CME 68.5 88.7 1.06% / 9% 0.62% / 4% 9.56% / 36% .14 / 15%

Canadian dollar CD CME 58.8 79.5 1.87% / 8% 5.20% / 47% 7.72% / 47% .27 / 38%Sugar SB ICE 47.5 317.2 4.45% / 29% 3.98% / 17% 23.57% / 75% .24 / 58%

Swiss franc SF CME 40.3 35.2 -1.53% / 83% -1.43% / 93% 4.08% / 40% .20 / 17%

Wheat W CME 39.0 126.9 -4.34% / 53% -5.40% / 35% -7.19% / 54% .28 / 27%

Soybeans S CME 35.1 62.1 -5.53% / 35% -13.87% / 64% -12.63% / 100% .24 / 55%

Heating oil HO NYMEX 33.6 40.7 5.64% / 14% -5.35% / 42% 17.19% / 32% .33 / 50%

RBOB gasoline RB NYMEX 33.3 44.1 8.60% / 38% -0.22% / 5% 17.99% / 14% .32 / 70%

E-Mini S&P MidCap 400 ME CME 27.2 102.0 6.85% / 45% 6.27% / 58% 7.06% / 24% .31 / 67%

Soybean oil BO CME 24.0 42.9 -2.52% / 8% -5.57% / 44% -13.02% / 100% .24 / 33%

S&P 500 index SP CME 23.7 380.9 5.14% / 42% 6.06% / 67% 7.91% / 32% .28 / 68%

Silver 5,000 oz. SI NYMEX 21.1 49.3 0.38% / 0% -2.51% / 29% 1.11% / 6% .26 / 20%

Soybean meal SM CME 17.9 31.7 -6.10% / 30% -18.11% / 73% -11.11% / 100% .18 / 7%

Copper HG NYMEX 17.2 63.7 3.57% / 38% 6.31% / 41% 18.97% / 22% .22 / 48%

Live cattle LC CME 13.0 58.8 -1.15% / 100% -1.52% / 14% 2.53% / 46% .37 / 57%

Mexican peso MP CME 12.5 47.3 2.01% / 45% -0.89% / 42% 0.17% / 1% .25 / 65%

Crude oil e-miNY QM NYMEX 11.8 3.5 2.94% / 14% -8.60% / 53% 17.66% / 15% .25 / 45%Nikkei 225 index NK CME 9.3 26.9 6.37% / 50% 1.29% / 11% 8.93% / 23% .38 / 93%

Coffee KC ICE 8.9 62.6 4.15% / 33% 2.46% / 22% 1.65% / 20% .33 / 35%

Lean hogs LH CME 8.5 19.6 -11.36% / 100% -3.28% / 18% 1.38% / 16% .72 / 73%

Cocoa CC ICE 7.4 47.4 3.17% / 7% 11.67% / 53% 20.82% / 78% .44 / 47%

U.S. dollar index DX ICE 6.1 20.5 0.41% / 75% -0.80% / 10% -5.35% / 45% .11 / 5%

Fed Funds** FF CME 5.1 59.2 0.03% / 50% 0.07% / 53% 0.09% / 13% .14 / 38%

New Zealand dollar NE CME 4.7 22.3 0.49% / 8% 1.89% / 21% 13.02% / 44% .12 / 8%

Mini-sized gold YG CME 4.4 3.1 -1.03% / 33% 0.30% / 0% 2.96% / 21% .31 / 37%

Natural gas e-miNY QG NYMEX 3.1 5.9 8.07% / 67% -6.51% / 28% -1.85% / 5% .25 / 5%

E-Mini eurocurrency ZE CME 2.4 1.8 -0.86% / 67% -0.98% / 60% 5.24% / 43% .15 / 7%

Nasdaq 100 ND CME 2.3 15.7 6.91% / 50% 8.25% / 88% 12.16% / 37% .29 / 67%

Mini-sized silver YI CME 1.9 2.0 0.25% / 13% -2.13% / 29% 2.07% / 8% .24 / 15%

Dow Jones Ind. Avg. DJ CME 1.2 9.7 5.90% / 36% 7.09% / 81% 7.93% / 39% .30 / 75%

Russian ruble RU CME 0.5 5.9 6.79% / 100% 1.11% / 11% 6.40% / 22% .38 / 93%

*Average volume and open interest based on highest-volume contract (September 2010). **Average volume and open interest based on highest-volume contract (November 2009)

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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 July 28)

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 174.0 1.61 M -1.04% / 40% -0.10% / 2% 22.6% / 20.9% 22.5% / 22.6%S&P 500 volatility index VIX CBOE 106.9 1.70 M -0.04% / 0% -1.34% / 2% 135.3% / 76.8% 126.7% / 93.5%Russell 2000 index RUT CBOE 55.8 479.5 11.16% / 73% 8.10% / 76% 28.2% / 28.2% 28.8% / 28.7%E-Mini S&P 500 futures ES CME 34.2 131.9 8.26% / 58% 6.61% / 71% 22.7% / 24.1% 22.6% / 25.4%Nasdaq 100 index NDX CBOE 17.7 152.8 10.51% / 67% 8.20% / 80% 23.5% / 23% 24% / 23.1%

Stocks

Citigroup C 759.3 14.67 M 1.71% / 14% -1.66% / 3% 70% / 72.2% 92.7% / 56.4%Bank of America BAC 245.9 4.33 M 3.33% / 69% 1.14% / 6% 51.1% / 58% 58.9% / 62.8%General Electric GE 119.4 2.42 M 7.56% / 67% 6.46% / 41% 40.5% / 45.9% 42.7% / 41.6%Microsoft MSFT 108.5 2.44 M 1.56% / 27% -1.63% / 80% 29.9% / 31.7% 32.8% / 30.6%Wells Fargo WFC 92.5 1.50 M 0.49% / 15% -0.04% / 0% 43.8% / 48.9% 49.2% / 72%

Futures**Eurodollar ED CME 92.7 5.46 M 0.07% / 40% 0.16% / 31% 83% / 38% 78.6% / 71.4%Corn C CME 53.8 446.6 -5.32% / 35% -9.59% / 27% 34.2% / 46.2% 40.5% / 33.6%E-Mini S&P 500 futures ES CME 34.2 131.9 8.26% / 58% 6.61% / 71% 22.7% / 24.1% 22.6% / 25.4%10-year T-notes TY CME 26.6 393.7 -1.04% / 40% -0.10% / 2% 9.5% / 8.8% 9.4% / 8.7%Sugar SB ICE 19.2 344.6 4.64% / 36% 3.35% / 13% 38.1% / 29.3% 40.9% / 33.9%

VOLATILITY EXTREMES***Indices - High IV/SV ratio

S&P 500 volatility index VIX CBOE 106.9 1.70 M -0.04% / 0% -1.34% / 2% 135.3% / 76.8% 126.7% / 93.5%S&P 100 index OEX CBOE 14.5 87.0 7.49% / 58% 5.33% / 64% 21.7% / 19.7% 21.1% / 20.8%S&P 500 index SPX CBOE 174.0 1.61 M -1.04% / 40% -0.10% / 2% 22.6% / 20.9% 22.5% / 22.6%S&P 500 futures SP CME 12.9 67.7 8.26% / 58% 6.60% / 71% 22.6% / 21.3% 22.6% / 21.9%S&P 100 index (European style) XEO CBOE 4.1 47.6 7.49% / 58% 5.33% / 64% 21.1% / 19.9% 20.4% / 21%

Indices - Low IV/SV ratioMini Nasdaq 100 index MNX CBOE 7.7 248.2 10.51% / 67% 8.20% / 80% 23.1% / 31.9% 23.9% / 23.1%Semiconductor index SOX PHLX 1.7 13.8 12.48% / 54% 15.34% / 87% 32.9% / 36.2% 36% / 37.1%E-Mini S&P 500 futures ES CME 34.2 131.9 8.26% / 58% 6.61% / 71% 22.7% / 24.1% 22.6% / 25.4%E-Mini Nas-100 futures NQ CME 1.8 8.2 10.70% / 75% 8.48% / 90% 23.8% / 25.2% 24.3% / 26.6%

Stocks - High IV/SV ratio**Savient Pharma SVNT 11.0 201.5 15.48% / 71% 5.11% / 5% 115.1% / 56.8% 92% / 100.5%

Acadia Pharma ACAD 1.6 8.7 112.62% / 91% 117.91% / 96% 172.8% / 87.5% 176.5% / 105.8%Mylan Inc. MYL 5.3 158.5 1.70% / 38% -5.21% / 42% 59.9% / 33.1% 45.5% / 38.1%

Arena Pharma ARNA 2.3 118.7 24.25% / 75% 2.26% / 2% 119.4% / 66.2% 131.3% / 95.3%Sun Microsystems JAVA 3.6 497.7 0.33% / 25% 0.22% / 12% 12.9% / 7.3% 13.7% / 7.8%

Stocks - Low IV/SV ratioMedarex MEDX 6.9 113.3 86.40% / 81% 93.20% / 97% 13.3% / 43.5% 62.7% / 50.9%Human Genome Sciences HGSI 29.9 249.8 485.20% / 92% 402.75% / 92% 70% / 165.4% 197.8% / 136.9%NRG Energy NRG 14.6 193.8 5.84% / 42% 5.41% / 18% 41.8% / 70.5% 60.4% / 69.1%

AIG AIG 35.1 143.3 -6.77% / 6% -49.81% / 57% 105.6% / 163.1% % / 58.7%CIT Group CIT 48.7 469.2 -50.31% / 70% -65.22% / 88% 284.4% / 437.1% 130.5% / 91.2%

Futures - High IV/SV ratio**Eurodollar ED CME 92.7 5.46 M 0.07% / 40% 0.16% / 31% 83% / 38% 78.6% / 71.4%Eurocurrency EC CME 2.1 31.4 1.74% / 64% 0.98% / 22% 15.2% / 7.1% 13.6% / 11.8%2-year T-notes TU CME 2.1 76.4 -0.07% / 100% 0.04% / 26% 2% / 1.2% 2.1% / 2.1%5-year T-notes FV CME 6.8 97.8 -1.48% / 83% 0.05% / 11% 6.3% / 4.5% 5.9% / 3.9%Sugar SB ICE 19.2 344.6 4.64% / 36% 3.35% / 13% 38.1% / 29.3% 40.9% / 33.9%

Futures - Low IV/SV ratio**Corn C CME 53.8 446.6 -5.32% / 35% -9.59% / 27% 34.2% / 46.2% 40.5% / 33.6%Soybean meal SM CME 3.5 52.6 -0.63% / 0% -11.33% / 32% 37.9% / 44.3% 43.8% / 34.8%Wheat W CBOT 6.9 109.3 -2.60% / 29% -4.51% / 32% 33% / 38% 40.4% / 35.6%Orange juice JO ICE 3.4 32.2 -3.32% / 100% 23.84% / 74% 46.1% / 51.9% 40.1% / 36.5%Cotton CT ICE 5.8 62.5 -7.50% / 100% 3.58% / 12% 32.2% / 36.2% 36.3% / 38.6%

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

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Options Watch: S&P 500 — Health care sector (as of July 23) Compiled by Tristan Yates

The following table summarizes the expiration months available for the top 20 stocks in the S&P 500 health care sector exchange-traded fund(XLV). It also shows each stock’s average bid-ask spread for at-the-money (ATM) July options. The information does NOT constitute trade sig-nals. It is intended only to provide a brief synopsis of potential slippage in each option market.

spread as %

Closing of underlyingStock Ticker price Call Put price

Amgen Inc. AMGN X X X X X 59.84 0.04 0.03 0

Bristol-Myers Squibb Co. BMY X X X X X X 20.86 0.02 0.03 0.10%

Pfizer Inc. PFE X X X X X X 16.15 0.02 0.02 0.12%

Celgene Corp. CELG X X X X X 55.97 0.08 0.09 0.15%

Express Scripts Inc. ESRX X X X X X X 69.66 0.09 0.13 0.15%

Baxter International Inc. BAX X X X X X X 54.00 0.09 0.09 0.16%

Johnson & Johnson JNJ X X X X X 60.22 0.09 0.11 0.17%

Gilead Sciences Inc. GILD X X X X X X 48.34 0.10 0.08 0.18%

Abbot Laboratories ABT X X X X X X 43.84 0.06 0.10 0.19%

Medco Health Solutions Inc. MHS X X X X X 49.42 0.09 0.13 0.21%WellPoint Inc. WLP X X X X X X 52.00 0.13 0.10 0.22%

Wyeth WYE X X X X X 47.10 0.13 0.10 0.24%

Merck & Co. Inc. MRK X X X X X 30.25 0.06 0.09 0.25%

Medtronic Inc. MDT X X X X X X 34.38 0.09 0.11 0.29%

Eli Lilly & Co. LLY X X X X X 34.28 0.10 0.11 0.31%

UnitedHealth Group Inc. UNH X X X X X X 27.05 0.11 0.09 0.37%

Thermo Fisher Scientific Inc. TMO X X X X 43.93 0.19 0.18 0.41%

Schering-Plough Corp. SGP X X X X X X 26.81 0.11 0.14 0.47%

Boston Scientific Corp. BSX X X X X X X 10.43 0.06 0.06 0.60%

Becton Dickinson & Co. BDX X X X X 71.42 0.49 0.45 0.66%

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.

A u g .

S e p t .

O c t .

N o v .

D e c .

J a n .

F e b .

M a r c h

J a n .

2009 2010 2011

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

Commercial traders, or hedgers, tend to operate in thecash market (e.g., grain merchants and oil companies thateither produce or consume the underlying commodity).

Non-commercial traders are large speculators (“largespecs”) such as commodity trading advisors and hedgefunds — professional money managers who do not deal inthe underlying cash markets but speculate in futures on alarge-scale basis. Many of these traders are trend-followers.The non-reportable category represents small traders, or thegeneral public.

Figure 1 shows the relationship between commercials and large speculatorson July 21. Positive values mean that net commercial positions (longs-shorts) arelarger than net speculator holdings, based on their five-year historical relation-ship. Negative values mean that large speculators have bigger positions than the

commercials.In July, commercial positions exceeded speculator positions in natural gas(NG) and Dow Jones Industrial Average futures (DJ), a bullish sign. Meanwhile,speculators held more positions than commercials in Japanese yen (JY) andNikkei 225 futures (NK), a bearish sign. However, these relationships failed tohit five-year extremes — positive or negative — in any market.

— Compiled by Floyd Upperman

The largest positive readings represent markets in which commercial posi-

tions (longs-shorts) exceeded speculator holdings in July. And the largest

negative values represent the opposite relationship — speculator positions

exceeding 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 formula 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)

Option contracts traded

FUTURES & OPTIONS WATCH

Bid-ask

http://www.upperman.com/

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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.

Backspreads and ratio spreads are leveraged posi-tions that involve buying and selling options in differentproportions, usually in 1:2 or 2:3 ratios. Backspreads con-tain more long options than short ones, so the potentialprofits are unlimited and losses are capped. By contrast,ratio spreads have more short options than long ones andhave the opposite risk profile.

Note: These labels are not set in stone. Some tradersdescribe either position as option trades with long andshort legs in different proportions.

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:Published

weekly 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 largehedgers. 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.

Correlation coefficient, sometimes referred to simplyas correlation, refers to the degree of similarity between twovariables. In the markets, correlation is typically used tomeasure how close the relationship is between two priceseries (e.g., two distinct stocks or markets), between an indi-vidual stock (or trading fund) and an index, and so on.

Correlation coefficients range between -1.00 and +1.00,with +1.00 representing perfect positive correlation (i.e.,

two variables moving precisely in tandem); -1.00 represents


KEY CONCEPTSThe 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 of 1.00 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 for

deep 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.

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perfect negative correlation (i.e., two variables movingexactly opposite to one another). A correlation coefficient of zero means the two variables have no discernible relation.

The site http://davidmlane.com/hyperstat/index.htmloffers relatively easy-to-digest definitions of this and otherstatistical terms.

Covered call: Shorting an out-of-the-money call option

against 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 to

enter, 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.

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 price

below 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 of risk. If you sell a call, for example, you are obligated to sellthe underlying instrument at the call’s strike price, which

might 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 allowed by 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 not been exercised in a specific contract that has not yet expired.

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

price above the price of the underlying instrument, or a 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 of the execution of a futures contract. Although 98 percent of all 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 the

money.For example, if a stock trades at $50, you could sell one

$45 put and buy two $40 puts in the same expiration month.If the stock drops, the short $45 put might move into 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 long

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puts have higher strikes than the short puts.

Relative strength index (RSI): Developed by WellesWilder, the relative strength index is an indicator in the

“oscillator” family designed to reflect shorter-term momen-tum. It ranges from zero to 100, with higher readings sup-posedly corresponding to overbought levels and low read-ings reflecting the opposite. The formula is:

RSI = 100 – (100/[1+RS])

where

RS = relative strength = the average of the up closes over

the calculation period (e.g., 10 bars, 14 bars) divided by the

average of the down closes over the calculation period.

For example, when calculating a 10-day RSI, if six of the

days closed higher than the previous day’s close, subtractthe previous close from the current close for these days, addup the differences, and divide the result by 10 to get the up-close average. (Note that the sum is divided by the totalnumber of days in the look-back period and not the numberof up-closing days.)

For the four days that closed lower than the previousday’s close, subtract the current close from the previouslow, add these differences, and divide by 10 to get thedown-close average. If the up-close average is 0.8 and thedown close average is 0.4, the relative strength over thisperiod would be 2. The resulting RSI would be 100 -(100/[1+2]) = 100 - 33.3 = 66.67.

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

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 would

consist 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 of an 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 of buying 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.

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.”

Variance and standard deviation: Variance meas-ures how spread out a group of values are — in otherwords, how much they vary. Mathematically, variance is theaverage squared “deviation” (or difference) of each numberin the group from the group’s mean value, divided by thenumber of elements in the group. For example, for the numbers 8, 9, and 10, the mean is 9 and the variance is:

{(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667

Now look at the variance of a more widely distributed setof numbers: 2, 9, and 16:

{(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67

The more varied the prices, the higher their variance —the more widely distributed they will be. The more varied amarket’s price changes from day to day (or week to week,etc.), the more volatile that market is.

A common application of variance in trading is standarddeviation, which is the square root of variance. The stan-dard deviation of 8, 9, and 10 is: .667 = .82; the standarddeviation of 2, 9, and 16 is: 32.67 = 5.72.

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).

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 of future volatility as reflected in the level of option premi-ums. The higher the implied volatility, the higher the optionpremium.

KEY CONCEPTS

8/8/2019 FOT200908


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): Also

known as first intent day, this

is the first day a clearing-

house can give notice to a

buyer of a futures contract

that it intends to deliver a

commodity in fulfillment of a

futures contract. The clear-

inghouse also informs the

seller.

FOMC: Federal Open Market

Committee

GDP: Gross domestic

product

ISM: Institute for supply

management

LTD (last trading day): The

first day a contract may trade

or be closed out before the

delivery of the underlying

asset may occur.

PPI: Producer price index

Quadruple witching Friday:

A day where equity options,equity futures, index options,

and index futures all expire.

August

1 FDD: August crude oil and natural

gas futures (NYMEX)

2

3 FND: August propane futures (NYMEX)

FDD: August gold, silver, copper,

aluminum, platinum, and palladium

futures (NYMEX); August soybean

and soybean products futures (CME)

U.S.: Crop progress report

4 FND: August heating oil and RBOB

gasoline futures (NYMEX)

U.S.: Weekly weather report

5 U.S.: Petroleum status report and

agricultural prices

6 FDD: August propane futures

(NYMEX)

U.S.: Natural gas storage report

7 LTD: August live cattle and porkbellies options (NYMEX); September

cocoa options (ICE)

8 FDD: August heating oil and RBOB

gasoline futures (NYMEX)

9

10 FND: August live cattle futures (CME)


11 FDD: August pork bellies futures (CME)


12 U.S.: Petroleum status report, cropproduction, and world agricultural

supply and demand

13 FDD: August live cattle futures (CME)


14 LTD: August soybeans and soybean

products futures (CME); September

coffee options (ICE)

15

16

17 LTD: September crude oil futures

(NYMEX); September sugar options(ICE)


18 FND: September cocoa futures (ICE)


19 U.S.: Petroleum status report

20 FND: September crude oil futures

(NYMEX)

LTD: September crude oil futures

(NYMEX); September platinum

options (NYMEX)


21 FND: September coffee futures (ICE)

LTD: August single stock futures

(OC); September T-bond, corn, wheat,

soybeans, soybean products, oats,

and rough rice options (CME);

September orange juice and cotton

options (ICE); August index and

equity options

U.S.: Cattle on feed22

23

24 U.S.: Crop progress report

25 U.S.: Weekly weather report

26 LTD: August pork bellies futures (CME

September natural gas, heating oil,

RBOB gasoline, gold, silver, copper, a

aluminum options (NYMEX)

U.S.: Petroleum status report

27 LTD: September natural gas futures; August gold, silver, copper, aluminum,

platinum, and palladium futures

(NYMEX)


28 FND: September natural gas futures

(NYMEX)

29

30

31 FND: September gold, silver, copper,

aluminum, platinum, and palladium

futures (NYMEX); September T-bondscorn, wheat, soybeans, soybean

products, oats, and rough rice futures

(CME)

LTD: September heating oil, RBOB

gasoline, and propane futures

(NYMEX); August live cattle futures

(CME); September lumber options

(CME)


September

1 FND: September orange juice futures

(ICE)

FDD: September crude oil, natural gas

futures, gold, silver, copper, aluminum

platinum, and palladium futures

(NYMEX); September T-bond, corn,

wheat, soybeans, soybean products,

oats, and rough rice futures (CME);

September coffee and cocoa futures

(ICE)


2 FND: September heating oil, RBOB

gasoline, and propane futures (NYMEX

U.S.: Petroleum status report

AUGUST/SEPTEMBERFUTURES & OPTIONS CALENDAR

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

AUGUST 2009

26 27 28 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 31 1 2 3 4 5

SEPTEMBER 2009

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 3

8/8/2019 FOT200908


eSignal released three new products: eSignal OnDemand— Forex; eSignal OnDemand — Mini Futures; and eSignalOnDemand — Advanced GET Edition. OnDemand has beendesigned to accommodate forex and mini futures tradersthrough trade support tools, along with a combination of his-torical, end-of-day, and real-time data. In addition to decision-support tools, the new products allow traders to send trade

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Global Forex Trading (GFT) and Autochartist offertraders new Fibonacci-based market patterns, including twopatterns exclusive to GFT. GFT customers now have access toAutochartist’s market-pattern-recognition capabilities. In addi-tion to chart patterns such as flags, pennants, double-tops, dou-

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with an active account. Customers with a practice or miniaccount can receive the product for $29.99 per month.

CME Group announced the launch of 11 new financiallysettled natural-gas basis options contracts and three new finan-cially settled petroleum crack spread average price options con-tracts available on the New York trading floor; clearing serviceswill be available through CME ClearPort. The CME Group alsoannounced new sulfur dioxide (SO2) emission 25-allowancefutures and options contracts, six new physically delivered nat-ural gas liquids futures contracts, and clearing services for over-the-counter (OTC) London gold forwards available throughCME ClearPort. The CME Group also launched S&P 500 Weekly

Options contracts. Weekly options on standard and E-Mini S&P500 futures contracts will expire European-style on the first andsecond Friday of each month. This new product completes thesuite of S&P 500 options products that include end-of-month,serial, and quarterly expiration cycles. The exchange alsoannounced that the multiplier for the S&P Financial SPCTRIndex and the S&P Technology SPCTR Index futures contractshave each doubled to $250 times the index price. The new min-imum tick size also doubled to $25 per contract. Finally, theexchange’s new In-Delivery Month European Union Allowance(EUA) and Certified Emission Reduction (CER) futures con-tracts are available for trading on CME Globex. These contractsare listed for trading by NYMEX and are subject to NYMEX

rules and regulations.

TradeTheNews.com has redesigned its Web portal.Replacing TradeTheNews.com’s desktop application, the newcolor-coded Web portal provides access to audio squawks,streaming headlines, portfolios, calendars, market updates, andthe morning report product. “Flip,” launched from the pass-word-protected browser, lets users maintain the functionality of the Web portal’s scrolling headlines using limited screen space.Additionally, Flip offers access to “Ask the Desk,” an interactiveanalyst service made available to TradeTheNews.com audiousers. “NewsFlashes,” enabled when Flip is minimized, aredesktop headline alerts that slide up from the icon tray whenfresh headlines are published.

TradeGuider Systems International (http://www.-TradeGuider.com) launched the VSA Club (http://www.VSA-Club.com). TradeGuider Systems International owns the rightsto the Volume Spread Analysis (VSA) methodology and pro-vides ongoing VSA education and support. The VSAClub offersa range of features and facilities for members including biweek-ly live online educational sessions with the VSA expert panel,

weekly chart presentations, online discussion forums, bloggingapplications, advance access to new products and services, andinput into product and service development.

Interactive Data Corporation has released Market-Q3.0, the latest update to its browser-based, real-time streamingmarket data desktop terminal for financial professionals. Thenew version includes templates for setting up new pages, allow-ing users to share symbol lists between pages and share work-spaces with other users. New capabilities have also been addedto Market-Q’s Watch List tool, and a new portfolio managerhelps monitor gains and losses. Additionally, Market-Q 3.0 nowallows users to export data into a spreadsheet using DynamicData Exchange (DDE) or Real-time Data (RTD). For more infor-

mation, including pricing and a complete list of Market-Q fea-tures, visit http://www.Market-Q.com.

Scottrade Advisor Services, a division of Scottradesupporting independent registered investment advisors (RIAs),has introduced a new advisor services Web platform with trad-ing and account-management resources. The platform offersadvisors new tools to help manage and organize accounts, track gains and losses, and produce client reports. The platform fea-tures back-end technology that allows Scottrade to add new fea-tures and functionality; Scottrade plans to make quarterlyenhancements to the platform.

7ticks offers access to European-based derivatives prod-ucts, starting with NYSE Liffe. As a Managed Services Provider(MSP) connecting via NYSE Technologies’ Secure FinancialTransaction Infrastructure (SFTI) network, 7ticks offers clientsdirect connectivity to NYSE Liffe, as well as other London-basedexchanges. 7ticks has microsecond-level insight into network architecture and latency, with a suite of monitoring tools forinstitutions, latency sensitive hedge funds, and proprietarytrading firms.

Saxo Bank launched its new FX Choice account. FX Choiceallows fee-based FX spot trading to traders with deposits of $25,000. Trading fees start from as little as $50 for every

1,000,000 currency units traded and decrease as the volume of trades increases. FX Choice allows clients to trade on a marginwith leverage of up to 200 times the value of their accounts. Theaccount is fully compatible with Saxo Bank’s online tradingplatforms SaxoTrader, SaxoWebTrader, and SaxoMobileTrader.Saxo Bank also expanded its Saxo Trader platform with thelaunch of the FX Options Board, which allows investors to seestandardized dates and strike increments.

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

NEW PRODUCTS AND SERVICES



http://www.tradeguider.com/




http://www.vsaclub.com/




http://www.market-q.com/











8/8/2019 FOT200908


Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit

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

TRADE

Date: Thursday, July 23, 2009.

Entry: Short September crude oil futures(CLU09) at 67.45.

Reason for trade/setup: After runninginto the $70s, crude oil fell sharply at the beginning of July, with the September con-tract retreating to $59.30 by July 13. Themarket then rebounded over the next week or so, pulling to within $.25-30 of theimplied chart resistance established by the

breakdown through the June-July lows.Crude oil is likely to climb higher in thelong-term, but there will be obvious pres-sure on the market as it challenges this threshold. We’llattempt to go short on a move we expect to push slightlyabove the July 2 low of 67.29. Note: This trade was a papertrade.

We chose a multiple of $.05 for the entry price because 38percent of the highs over the previous 200 days occurred atnickel increments. If the prices were entirely random, theodds should be no more than 20 percent.

Initial stop: 68.23.

Initial target: $63.55, a little above the July 16 high.

RESULT

Exit: 68.23.

Profit/loss: -.78 (-1.16%).

Outcome: The trade was initially conceived on July 20,

and price came up a little short of the desired entry point on July 21 before pulling back to just above the proposed prof-it target on July 22. Perhaps the trade idea should have beenabandoned at that point, given the market had followed the

expected path.Nonetheless, entry was activated one day later, July 23,

when price rallied to 67.49. Initially, things looked promis-ing: Price dropped almost a full point the next day (whichmight have been a good reason to lower the stop to breakeven). It was just a pullback, however, and priceclimbed steadily higher before thrusting through the stoplevel on July 26.

One other observation: We should have anticipated the

strength of the move through the resistance level. Even after being stopped out, the basic trade premise appeared tohave some merit. But having missed an opportunity once, itwas difficult to give the market more leeway and risk another missed trade. This, however, is precisely the wrongattitude. By July 29, the market had fallen below the initialprofit target.

Note: Initial targets for trades are typically based on things such as the

historical performance of a price pattern or trading system signal.

However, individual trades are a function of immediate market behavior;

initial price targets are flexible and are most often used as points at whicha portion of the trade is liquidated to reduce the position’s open risk. As

a result, the initial (pre-trade) reward-risk ratios are conjectural by

nature.

Market follows script, but a few

ad-libs render trade plan moot.

P/L

Date Contract Entry Initial stop Initial target IRR Exit Date Point % LOP LOL Length

7/23/09 CLU09 67.45 68.23 63.55 5 68.23 7/26/09 -.78 -1.16% +.99 -.78 2 days

TRADE SUMMARY

FUTURES TRADE JOURNAL

Source: TradeStation

8/8/2019 FOT200908


TRADE

Date: Monday, July 20.

Market: Options on Cisco Systems

(CSCO).

Entry: Buy two August 19 calls for

$2.12 each.

Reasons for trade/setup: On July

20, CSCO was upgraded from “neu-

tral” to “outperform” by investment bank Credit Suisse.

The upgrade was the first time any firm had changed its rat-

ing on Cisco since it replaced ailing General Motors (GM)

on June 8 in the Dow Jones Industrial Average (DJIA).Historical research shows Dow stocks that are upgraded

by analysts tend to open higher and continue climbing

throughout the day. In fact, this pattern remained bullisheven during the financial crisis of 2008: Stocks climbed anaverage 0.5 percent from the open to the close between June2007 and June 2009.

Moreover, the stock market resumed its upswing, withthe S&P 500 index (SPX) bouncing 8.2 percent off its July 8low. Also, technology stocks led the pack — the Nasdaq 100index (NDX) gained 9.5 percent during the same period.

After the upgrade, Cisco jumped 1.5 percent overnight.The goal is to capture additional gains by the end of theday. The easiest way to exploit a possible up move is to buyin-the-money (ITM) calls. The approach isn’t as exciting as

selling naked, or uncovered, options or creating some type

of spread, but ITM calls have high deltas , meaning the posi-tion should move in line with the underlying stock.

August 19.00-strike calls were purchased for $2.12 eachwhen Cisco was trading at $20.95 at 9:40 a.m. AlthoughCSCO had already gained 0.7 percent in the first 10 minutesof trading, we still took the trade because the broader mar-

ket pointed higher.Figure 1 shows the trade’s potential gains and losses on

July 20. The position has a total delta of 169, so it initiallyresembles 169 Cisco shares.


TRADE STATISTICS

July 20 9:40 a.m. 10 a.m.

Delta: 169 177.6

Gamma: 22.03 18.28

Theta: -1.59 -1.21

Vega: 3.13 2.46

Probability of profit: 44% 53%

Breakeven point: $21.12 $21.12

TRADE SUMMARY

Entry date: July 20, 2009

Underlying security: Cisco Systems (CSCO)

Position: 2 long August 19 calls

Initial capital required: $424

Initial stop: Exit if CSCO drops below yesterday’s close.

Initial target: Hold until today’s close

Initial daily time decay: $1.59

Trade length: 1 day

P/L: $44 (10.4 percent)

LOP: $44

LOL: $0

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

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

Buying ITM calls on Cisco Systems (CSCO) is an easy way to exploit an up

move without investing much capital.

FIGURE 1 — RISK PROFILE — LONG CALLS

Source: OptionVue

Long calls on Cisco Systems

gain ground after a high-profileratings upgrade.

OPTIONS TRADE JOURNAL

8/8/2019 FOT200908


Initial stop: Exit if Cisco drops below yesterday’s close (2.1 percent).

Initial target: Hold until today’s

close.

RESULT

Outcome: Figure 2 shows we

entered the trade late, but Cisco gained

1.2 percent within 20 minutes. We sold

the calls for $2.34 each — a profit of 10.4 percent — when CSCO traded at

$21.20 at 10 a.m. Luckily, we managed

to sell near the intraday high and

avoided the late-morning slump,

which would have erased any unreal-

ized gains.

Although we entered the trade after Cisco had already rallied 0.7 percent from the

open, CSCO rose another 1.2 percent within 20 minutes. We sold the calls near

Cisco’s intraday high and earned 0.22 per contract (10.4 percent).

FIGURE 2 — LATE ENTRY, EARLY EXIT

Source: eSignal


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Event: International Investors’ Trade Fair Date: Sept. 4-6

Location: Düsseldorf, Germany

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Event: FXstreet’s International Traders Conference

Date: Oct. 14-16

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Event: Lawrence G. McMillan’sIntensive Options Seminar

Date: Nov. 7

Location: New York City, Marriott Marquis

For more information: Go to

http://www.optionstrategist.com and click on “Seminars”

Event: The Fifth Middle East Forex Trading Expo and

Conference 2009

Date: Nov. 17-18

Location: Jumeirah Emirates Towers Hotel, Dubai

For more information: http://www.meforexexpo.com

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Date: Nov. 18-21

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8/8/2019 FOT200908


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FOT200908

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