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February 2010 • Volume 4, No.

futures system p. 6 CHASING
the crude oil rebound
to option spreads p. 10 BULL CALL SPREAD
gets slaughtered p. 29
the butterfly effect p. 13 LATEST COT ANALYSIS
p. 16

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

Trading Strategies
Weekly Keltner channel system . . . . . . . . .6
A longer-term trend-following system based on Options Trading System Lab
a 50-year-old indicator produces surprisingly The butterfly effect . . . . . . . . . . . . . . . . . . .13
robust results. Butterfly spreads soar when applied to a simple
By Dion Kurczek and Volker Knapp market timing system.
By Steve Lentz and Jim Graham
Option spreads:
The reinsurance approach . . . . . . . . . . . .10 Futures & Options Watch:
An analysis of the credit spread provides a COT extremes . . . . . . . . . . . . . . . . . . . . . . .16
departure point for investigating the balance A look at the relationship between
between risk, reward, and probability of profit commercials and large speculators in
in options trading. 45 futures markets.
By Don Fishback
Options Watch . . . . . . . . . . . . . . . . . . . . . .16
Energy sector ETF components.

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .18

Momentum, volatility, and volume
statistics for futures.

continued on p. 4

2 February 2010 • FUTURES & OPTIONS TRADER

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Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .19

Notable volatility and volume
in the options market.

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .20

References and definitions.

Managed Money . . . . . . . . . . . . . . . . . . . . .24

Top 10 option strategy traders ranked by Futures & Options Calendar . . . . . . . . . . . .27
August 2009 return.
Futures Trade Journal . . . . . . . . . . . . . . .28
New Products and Services . . . . . . . . . . . . .26 Crude gets back to its high-flying ways.

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 Options Trade Journal . . . . . . . . . . . . . . .29

Buying the dip feels like falling off a cliff.

Have a question about something you’ve seen

in Futures & Options Trader?
Submit your editorial queries or comments to

Looking for an advertiser?

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

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



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4 February 2010 • FUTURES & OPTIONS TRADER


A publication of Active Trader ®

 Volker Knapp has been a trader, system developer, and

For all subscriber services: researcher for more than 20 years. His diverse background
encompasses positions such as German National Hockey team

Editor-in-chief: Mark Etzkorn player, coach of the Malaysian National Hockey team, and
president of VTAD (the German branch of the International Federation of
Managing editor: Molly Goad Technical Analysts). In 2001, he became a partner in Wealth-Lab Inc.
(, which he still runs.
Senior editor: David Bukey
 Don Fishback has been a pioneer in the financial profes-
Contributing writers: Keith Schap,
sion for more than 25 years. After first developing several mar-
Chris Peters ket sentiment models in the 1980s, Fishback then devoted his

Editorial assistant and research to options, culminating in the Fishback Option Pricing
webmaster: Kesha Green Formula. That model is the first of its kind that takes into account actual mar-
ket movement, as opposed to theoretical probabilities. Fishback’s option
Art director: Laura Coyle
analysis software is available at

President: Phil Dorman  Jim Graham ( is the product
manager for OptionVue Systems and a registered investment
Ad sales East Coast and Midwest: advisor for OptionVue Research.
Bob Dorman

Ad sales
West Coast and Southwest only:  Steve Lentz ( is a well-estab-
Allison Chee
lished options educator and trader and has spoken all over the
U.S., Asia, and Australia on behalf of the CBOE’s Options
Classified ad sales: Mark Seger Institute, the Options Industry Council, and the Australian
Stock Exchange. As a mentor for, he teaches select stu-

Volume 4, Issue 2. Futures & Options Trader is pub- dents how to use complex options strategies and develop a consistent trading
lished monthly by TechInfo, Inc., 161 N. Clark St.,
Suite 4915, Chicago, IL 60601. Copyright © 2010 plan. Lentz is constantly developing new strategies on the use of options as
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any
form without written permission from the publisher. part of a comprehensive profitable trading approach. He regularly speaks at
The information in Futures & Options Trader magazine special events, trade shows, and trading group organizations.
is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply
the effectiveness of any trading system, strategy, or
approach. Traders are advised to do their own
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future

FUTURES & OPTIONS TRADER • February 2010 5


Weekly Keltner channel system

Can a trading technique that was developed and published in 1960 still make money
in today’s markets? Simplicity — and a longer-term time frame — helps.


Note: A version of this article originally appeared in move without generating numerous whipsaw signals.
the February 2004 issue of Active Trader magazine.
The rules are:

hester W. Keltner published his “Keltner 1. Enter long and exit short when price crosses above

C Channel” technique in the book How to Make

Money in Commodities in 1960. Keltner Channels
are similar to Bollinger Bands, in that they con-
sist of a middle line and upper and
lower bands that encompass most
upper Keltner channel.
2. Enter short and exit long when price crosses below
lower Keltner channel.

price action. Price moves above or FIGURE 1 — EQUITY CURVE

below the bands indicate strong The system was profitable on both the long and short sides, with some
momentum in that direction. moderate volatility and drawdown periods.
The middle line is a 10-bar simple
moving average (SMA) of the bar’s
“typical price,” which is the sum of
the high, low, and close divided by
three: (close + high + low)/3. The
upper band is the middle line plus the
10-day moving average of the high
minus low; the lower band is the mid-
dle line minus the 10-day moving
average of the high minus low. (A
common variation of the indicator
uses an exponential moving average
instead of a simple moving average,
and true range instead of range.)
Keltner’s method for using his
bands was very simple: Buy when
price closes above the upper band,
and reverse and go short when price
closes below the lower band. This is a
trend-following approach that is
always in the market — a true stop-
and-reverse system. The area between
the upper and the lower bands
Source for all figures: Wealth-Lab Inc. (
provides some space for prices to

6 February 2010 • FUTURES & OPTIONS TRADER

In this test, approximately two per- The maximum drawdown of around 30 percent was significant, but the system
cent of account equity was risked per recovered from all drawdowns relatively quickly.
trade, based on exiting trades at the
opposite Keltner band value. For
example, if prices cross above the
upper band, the system goes long and
the initial exit price is the lower Keltner
band. The system buys the number of
contracts that would result in a 2-per-
cent loss of equity if the position is
closed out at that lower Keltner band
level. The starting equity was $500,000,
with $20 deducted for slippage and
commission per round-turn trade.
The system was tested on weekly
data from September 1993 to
December 2002 on a portfolio of 19
futures contracts: corn (C), crude oil FIGURE 3 — SAMPLE TRADES (WEEKLY)
(CL), Eurodollar (ED), Euro currency The system catches and rides a long trend in crude oil.
(FX), gold (GC), copper (HG), Japanese
yen (JY), coffee (KC), live cattle (LC),
lean hogs (LH), Nasdaq 100 (ND), nat-
ural gas (NG), soybeans (S), sugar (SB),
silver (SI), S&P 500 (SP), and 10 year T-
Note (TY), DAX 30 (AX), German bund
(DT). Later, we will compare the
results of the system using daily data.

Test results
The results reflect the Keltner system’s
trend-following nature. Trend-follow-
ing systems typically produce more
losing trades than winners, but a good
system will offset the smaller losses by
catching major trends. This implies a
good trend-following system should
hold winning trades longer than losing
trades. In this case, winning trades
were held for an average of 38.5 weeks
(more than nine months), while losing
trades lasted only 12.4 weeks (around
three months). As expected, the
Keltner channel system’s winning percentage was low cent and 8.11 percent. In comparison, the two best years had
(only 37.81 percent), but the average profit for winning returns of 59.21 and 40.10 percent.
trades (14.7 percent) is much higher than the average loss
for losing trades (6.92 percent). This is reflected in the favor- Daily vs. weekly
able 2.12 payoff ratio. A second test using the same system rules on the same time
By letting the profits run and cutting the losses short, the period, but using daily instead of weekly price data, result-
system delivered a very respectable annualized gain of ed in a net loss of 80.24 percent. Why such a dramatic dif-
18.78 percent during the 10-year test period. There were ference? To help answer this question, let’s examine one of
two losing years during the period, with losses of 3.4 per- continued on p. 8

FUTURES & OPTIONS TRADER • February 2010 7


FIGURE 4 — DAILY TIME FRAME the large winning trades on the weekly
Using daily price data on the same test period resulted in more frequent scale and compare it to system’s per-
whipsaw trades and negative returns. formance during the same period on
daily data.
Figure 3 shows the system held a long
trade in crude oil for 75 weeks. The con-
tract price during this period appreciat-
ed nearly 100 percent, and a one-contract
position returned nearly $12,500. On
daily data, however, the system traded a
total of 15 times (eight longs and seven
shorts) during the same period and only
five of the 15 trades were winners. One
contract would have netted $3,380 dur-
ing this period. By using a weekly time
frame, the system was able to catch a
long trend and avoid the noise and
whipsaws on the daily time frame.
Although it was published 50 years
ago, the Keltner system showed poten-
tial as a long-term trend-following sys-
tem on the weekly time frame. Consider
testing your systems on weekly data.
You will sometimes find this results in
less noise and better performance.

For information on the author see p. 5.


Profitability Trade statistics LEGEND: Net profit — Profit at end of test period, less commission •
Exposure — The area of the equity curve exposed to long or short positions,
Net profit: $1,866,139.00 No. trades: 439 as opposed to cash • Profit factor — Gross profit divided by gross loss •
Net profit: 373.23% Win/loss: 37.81% Payoff ratio — Average profit of winning trades divided by average loss of
losing trades • Recovery factor — Net profit divided by max. drawdown
Exposure: 62.72% Avg. gain/loss: 1.25% • Max. DD (%) — Largest percentage decline in equity • Longest flat
Profit factor: 1.36 Avg. hold time: 22.27 days — Longest period, in days, the system is between two equity highs •
No. trades — Number of trades generated by the system • Win/Loss (%)
Payoff ratio: 2.12 Avg. profit (winners): 14.70% — The percentage of trades that were profitable • Avg. trade — The aver-
Recovery factor: 3.01 Avg. hold time (winners): 38.50 age profit/loss for all trades • Avg. winner — The average profit for win-
ning trades • Avg. loser — The average loss for losing trades • Avg. hold
Drawdown Avg. loss (losers): -6.92% time — The average holding period for all trades • Avg. hold time (win-
ners) — The average holding time for winning trades • Avg. hold time
Max. DD: -33.39% Avg. hold time (losers): 12.40
(losers) — The average holding time for losing trades • Max. consec.
Longest flat days: 140 Max. consec. win/loss: 8/11 win/loss — The maximum number of consecutive winning and losing

LEGEND: Avg. return — The average percent-
age for the period • Sharpe ratio — Average
Avg. Sharpe Best Worst Percentage Max. Max.
return ratio return return profitable consec. consec. return divided by standard deviation of returns
periods profitable unprofitable (annualized) • Best return — Best return for the
period • Worst return — Worst return for the
Weekly 0.38% 0.86 10.72% -13.05% 56.14% 8 9 period • Percentage profitable periods — The
Monthly 1.63% 0.87 16.80% -13.23% 59.09% 5 4 percentage of periods that were profitable • Max.
consec. profitable — The largest number of con-
Quarterly 4.88% 0.86 27.38% -20.33% 56.76% 3 3
secutive profitable periods • Max. consec.
Annually 20.37% 0.94 59.21% -8.11% 77.78% 3 1 unprofitable — The largest number of consecu-
tive unprofitable periods

8 February 2010 • FUTURES & OPTIONS TRADER


Option spreads:
The reinsurance approach
The probabilities of options trading are not so different from those in
the insurance and gaming industries. To make money, it helps to play the odds
the way insurers and casinos do. Credit spreads are one way to do it.

The credit spread is an option strategy that involves sell-

Note: A version of this article originally appeared in the July 2004 issue
of Active Trader magazine. ing an option while simultaneously purchasing the same
type of option, with the short option being more expensive
than the long option. A “vertical” credit spread indicates the
options have the same expiration month.

ne of the biggest advantages of options is For instance, a credit spread on stock ABC, which is trad-
their flexibility. With sufficient study, you can ing at 16, would consist of selling the June 12.50 put (bid at
create a strategy that meets your personal cri- 0.90) and simultaneously buying the June 10 put (offered at
teria for risk, reward, and probability of suc- 0.40). The June 12.50 put is more expensive than the June 10
cess. Understanding and managing the relationship put, so the position provides a net credit of $0.50.
between these three factors is one of the most important The maximum profit potential for this trade is the net
skills option traders must master. The following discussion credit received, or $50 per spread. The maximum loss is $200
illustrates this by analyzing a well-known option spread. per spread, which means the risk is quadruple the potential
reward. Why would anyone want to
take on risk four times the maximum
FIGURE 1 — SHORT PUT OR CREDIT SPREADS? possible reward? The answer is proba-
With the stock trading around $100 in June 2003, a trader could sell July 80 bility — how frequently you get to
puts because of the low probability of a 20-point drop in the next month. make the $50 profit vs. how frequently
However, the risk on such a trade is unlimited. By also purchasing July 75 puts, you take the $200 loss. In this case, the
the risk on the trade is dramatically reduced. prior historical price action of the stock
indicated the probability of keeping the
eBay (EBAY), daily
$50 — i.e., the strategy’s winning per-
centage — was nearly 90 percent.
Implementing high-probability
130 trades such as this is the opposite of
what the majority of beginning traders
120 do in the options market. When most
people speculate with options (as
110 opposed to using them to hedge a
Profit zone position in the underlying instrument)
they tend to buy cheap options, hop-
ing to hit a home run and make a huge
profit with relatively small risk.
90 The credit spread strategy is a sub-
stantially different approach. It’s not
80 that buying options outright is a bad
idea. But realistically, if you are simply
Loss zone
70 buying them hoping to hit the jackpot,
you should know your odds of win-
ning are about equal to playing the
tables at a casino. And casinos don’t go
24 3 10 17 24 31 7 14 21 28 5 12 19 27 2 out of business too often because of
March April May June
gambling losses.
Source: Reuters Metastock
That’s because casinos (and even

10 February 2010 • FUTURES & OPTIONS TRADER

Selling a put outright has fixed profit and potentially disastrous risk.

Profit/loss of put sale

(at expiration)
state lottery commissions) know and

Profit/loss ($)
manage the risk, reward, and proba-
bility of profit for the games of chance -20,000
they run. It’s similar to the insurance -40,000
business, although the risk, reward,
and probability model in this area is
far more complex. However, individ- -80,000
ual investors can use the same princi- -100,000
ples in the options market. -120,000
Risk and reward:
Naked options -160,000
9 39 69 99 129 159 189
In the insurance business, you make
EBAY share price
money when something does not hap-
pen. Insurance companies collect pre- Source: chart — Excel; data —
miums, which they get to keep if you
don’t get sick, you don’t get into an FIGURE 3 — CREDIT SPREAD
automobile accident, your house does
not catch fire, etc. Adding long options to the short put position creates a credit spread, which has
Individual traders can replicate this a smaller potential profit than a naked put, but also limits downside risk.
concept with the credit spread, essen-
tially turning themselves into insur- Profit/loss of credit spread
ance companies, by selling an option, (at expiration)
collecting a premium and keeping it as 2,000
long as the stock does not move
adversely. 0
Let’s look at what happens when
Profit/loss ($)

you sell an option. Back in June 2003, -2,000

prior to eBay’s stock split when the
price was $100, let’s say you sold 20 of -4,000
the eBay July 80 puts at 0.85 (see
Figure 1). The net credit for the put -6,000
sales was $1,700, which was the posi-
tion’s maximum profit. You would get -8,000
to keep that credit as long as the stock
was above the 80 strike price at expira- -10,000
tion. 69.00 79.00 89.00 99.00 109.00 119.00 129.00
EBAY share price
Based on the one-year historical
volatility of the stock at the time (42 Source: chart — Excel; data —
percent), the odds of the stock being
below 80 at July expiration were less than 7 percent, which In effect, selling a naked option (particularly a call) is
means there was a 93-percent chance the stock would not be very similar to selling an insurance policy with no limit to
below 80. In other words, the odds were great a loss would the size of the claim. Lloyd’s of London used to sell this
not occur. kind of policy. Unfortunately, all it takes is one bad claim to
The problem is the maximum risk on this trade is $80 per bring catastrophe. In the case of Lloyd’s, it was asbestos.
share (the strike price of the put sold) multiplied by 100
(number of shares each option represents) multiplied by 20 The reinsurance option
(the number of puts sold): $160,000! So while this trade has If unlimited liability is the problem, then limiting the liabil-
a great probability of profit, and a decent possible reward, it ity is the solution. Insurance companies have two ways to
carries with it potentially catastrophic risk (see Figure 2). do that. First, they can set a limit on the amount the policy
Selling “naked,” or uncovered, options in this manner will pay. The second solution is to buy reinsurance.
has ruined more than one financial company in the past With reinsurance, the company that wrote the policy
several years. The centuries-old Barings Bank is one institu- takes a portion of the premium collected from the policy-
tion that suffered the consequences of a solitary trader who holder and buys coverage for part of the policy’s risk.
sold a huge number of options in the expectation a big However, this seemingly simple and effective solution has
move would not occur in the Japanese market over a short a downside: By capping the loss in this fashion, you also
period of time. But it did, and Barings collapsed as a result. continued on p. 12

FUTURES & OPTIONS TRADER • February 2010 11



Overlaying the profit/loss profiles of the naked put sale and the credit spread
highlights the credit spread’s risk control — a form of “resistance” for the short
put position.
Put sale vs. credit spread half — from $1,700 to $900. And
(at expiration) although the maximum risk is down to
10,000 $9,100 — much lower than before —
Credit spread
0 it’s still 10 times higher than the poten-
-10,000 tial reward. Figure 4 compares the
-20,000 naked put sale directly to the credit
Profit/loss ($)

Put sale The key to the success of this trade is
-40,000 probability. The probability of any loss
-50,000 is less than 7 percent, and the probabil-
-60,000 ity of reaching the maximum loss is
less than 3 percent. When you quanti-
tatively balance these probability num-
bers with risk and reward, you find the
-90,000 trade has a positive expected outcome.
39 59 79 99 119 139 159
EBAY share price (See “Gauging probability.”)

Source: chart — Excel; data — Games of chance:

The probability factor
The options industry doesn’t like the
Gauging probability comparison, but the analytics of
options trading are not too far removed
The probability figures are derived from standard volatility models and the prob- from the analytics of games of chance.
ability assumptions in the Black-Scholes option pricing formula. Basically, if a Casinos offer games that almost
distribution of values (such as prices or price changes over a period of time) is exclusively have expected outcomes
“normal,” it takes the shape of a bell curve, and one standard deviation will con- that are positive for the casino, nega-
tain approximately two-thirds of all the values in the data set. Two standard devi- tive for the player. Nevertheless, for the
ations will contain 95 percent of all the numbers in the set. By definition, volatil- casino operator, the risk in each incre-
ity is equal to one standard deviation of an asset's price returns. As a result, mental game is substantially larger
because of the implications of the bell curve, volatility produces a standard devi- than the rewards. With every pull of
ation, which in turn produces a probability. For a more in-depth discussion of the slot machine lever, someone has the
these issues, visit probability. opportunity to win a jackpot. That’s
what keeps people coming back. If
there was no jackpot, there would be
no players.
reduce the profit. That’s the trade-off. The question for the casino is, how many times does
Traders can do the same thing with options. Returning to someone put money in the slot machine and lose it before
the eBay example, taking $800 of the $1,700 premium and they hit a winning combination?
buying 20 July 75 puts at 0.40 would establish a credit spread Lottery commissions depend upon games where the
and effectively reinsure the original naked put position. The reward potential to the lottery board is just $1, and the
net credit (and maximum possible profit) is now $900, but potential risk could be a massive $80 million. The question
the maximum risk is now much lower, as well. The long put is, how many of those $1 lottery tickets are sold before a
option provides coverage for the risk that eBay would trade player collects the $80 million jackpot?
below $75. Insurance companies depend upon people making
The total risk on a vertical credit spread is the difference claims for losses. After all, if there were no losses, insurance
in strike prices minus the net credit. In this case, the differ- would be needless. For insurers, the questions are: How
ence in strike prices is 5. The net credit is 0.45 (0.85 - 0.40 = much money can we collect before we have to pay a claim?
0.45). Thus, the trade’s maximum risk is 4.55 (5.00 - 0.45 = How likely is it that a claim will be filed? How big will that
4.55), or $455 per spread. With this trade consisting of 20 claim be?
spreads, the total risk has dropped from $160,000 to just In the end, the analysis is the same with options. How
$9,100 (see Figure 3). much can the spread trader collect? How likely is it that the
To some traders these numbers still might not look very trader will lose? How big will the loss be? 
good. Comparing the put credit spread to the naked put
sale, the profit potential on the spread dropped by almost For information on the author see p. 5.

12 February 2010 • FUTURES & OPTIONS TRADER


The butterfly effect Butterfly spreads have attractive risk-reward ratios. This trade could earn
up to $15,205 if the S&P 500 climbs to 1110 by Nov. 20. If not, losses are
capped at only $4,820.
Market: Options on the S&P 500 index (SPX).

System concept: Options traders often use but-

terfly spreads as market-neutral strategies, but this
system uses three-legged butterflies to make direc-
tional bets.
Three years ago we tested this approach in S&P
500 options (“Directional butterflies on the S&P
500,” Options Trader, November 2006). Has this
strategy performed as well in recent years as it did
from 2001 to 2006?
Butterflies contain short options at one strike
price with half as many long options at equidistant
strike prices above and below that price. All options
share the same expiration and type (calls or puts).
Figure 1 shows the potential gains and losses of a
bullish call butterfly placed on Oct. 13, 2009 and
held through Oct. 28, 2009. The spread in Source: OptionVue
November options contained 10 short 1110 calls,
five long 1070 calls, and five long 1150 calls. FIGURE 2 — TRADE SIGNALS
The position would receive its maximum profit if
Not all of these signals were as well-timed as the bearish one in June
the S&P 500 closes at the short strike (1110) on the
2008. However, the signals generally preceded favorable price action.
Nov. 20 expiration date. At this point, both the long
1150 calls and short 1110 calls would expire worth-
less, while the long 1070 calls will have an intrinsic
value of $40. The position will be profitable at expi-
ration if the S&P 500 closes anywhere between the
two breakeven points of 1079.59 and 1140.38.
The appeal of a directional butterfly spread lies in
its reward-risk ratio. Figure 1 shows this spread
could potentially make $15,205 while risking no
more than $4,820, a reward-risk ratio of more than
3:1. This favorable ratio occurs within the bound-
aries of a one-standard-deviation move, so excep-
tionally large underlying moves aren’t required.
The system uses a 50-day simple moving average
(SMA) and a stochastic oscillator to find trade sig-
nals. First, it enters bullish spreads when the S&P
500 is above its 50-day SMA, while it places bearish
spreads when the S&P is below its 50-day SMA.
Also, the stochastic oscillator identifies when the
index’s momentum is accelerating. The system
enters bullish spreads when the S&P 500’s relative Source: MetaStock
price rises and enters bearish spreads when its rela-
tive price declines.
Figure 2 shows a daily chart of the S&P 500 from February to 2. Moving-average crossover: The S&P closes above its
June 2008 labeled with bullish and bearish stochastic and mov- 50-day SMA while %K is above %D but still below 70.
ing average crossovers.
A bearish butterfly spread is entered if the opposite scenario
Bullish and bearish conditions: Place a bullish butterfly occurs (i.e., %K must stay above %D but below 30).
spread when the following criteria are met:
Trade rules:
1. Stochastic crossover: The %K line crosses above the %D
line and the S&P 500 closes above its 50-day SMA. %K Bullish entry
must be below 70, however, to avoid overbought 1. Buy five calls of the lower strike that is at least three
situations. continued on p. 14

FUTURES & OPTIONS TRADER • February 2010 13



This profitable options strategy continued to make money after the original test
(3.00) points in-the-money (ITM).
was published in November 2006.
2. Buy five calls of the upper strike with
the first standard deviation
(determined by the ATM call’s middle
implied volatility [IV] — between bid
and ask IVs).

3. Sell 10 calls at the middle strike —

exactly in between the lower and
upper strikes. Adjust the strike price
to ensure all three strikes are
equidistant. Execute all trades at the

4. Use the first expiration month with 30

or more days remaining.
Source: OptionVue
Bearish entries use the exact same rules,
except the butterfly is constructed with puts. STRATEGY SUMMARY
Since 1/17/2001 Since 11/15/2006
Exit when any of the following conditions occur:
1. Both the stochastic and moving average signals an Initial capital: $10,000 $10,000
opposite trend. Net gain: $32,680 $12,110
2. The S&P 500 touches the short strike. Percentage return: 327% 121%
3. If the spread is still open on the Friday that is one week Annualized return: 37.2% 41%
before options expiration, exit at the close. No. of trades: 91 32
Winning/losing trades: 52/39 17/15
Starting capital: $10,000. Win/loss: 57% 53%
Avg. trade: $359.12 $378.44
Execution: Trades were executed at the average of the bid Largest winning trade: $7,755.00 $7,755.00
and ask prices at the daily close, if available; otherwise, theo- Largest losing trade: -$4,220.00 -$4,220.00
retical prices were used. The standard deviation was calculated Avg. profit (winners): $1,678.08 $2,371.18
with a probability calculator using the IV of the at-the-money Avg. loss (losers): -$1,399.49 -$1,880.00
call in the front month. Commissions were $5 per trade plus $1 Avg. hold time (winners): 16 15
per option. Avg. hold time (losers): 15 14
Max consec. win/loss: 7/3 4/3
Test data: The system was tested on cash-settled S&P 500
index (SPX) options at the CBOE.
average losing trade (-$1,399.49) was much less than its average
Test period: Jan. 18, 2001 to Oct. 28, 2009. winning trade ($1,678.00). In the original test, the average win-
ing trade was 20 percent higher than the average loser, and this
Test results: Figure 3 shows the strategy’s performance, dynamic has continued in recent years.
which gained $32,380 (327 percent) over the eight-year test peri-
od. Overall, the system entered 91 trades since January 2001 and — Steve Lentz and Jim Graham of OptionVue
57 percent were profitable.
Since its publication in November 2006,
the system, beginning with $10,000, LEGEND: Largest winning trade — Biggest individual profit
earned $12,110 (121.1 percent), an annual- Net gain — Gain at end of test period. generated by the system.
ized return of 41 percent. The strategy’s Percentage return — Gain or loss on a percentage Largest losing trade — Biggest individual loss
basis. generated by the system.
Annualized return — Gain or loss on a annualized Avg. profit (winners) — The average profit for win-
percentage basis. ning trades.
Option System Analysis strategies are tested No. of trades — Number of trades generated by Avg. loss (losers) — The average loss for losing
using OptionVue’s BackTrader module the system. trades.
(unless otherwise noted). Winning/losing trades — Number of winners and Avg. hold time (winners) — The average holding
losers generated by the system. period for winning trades (in days).
If you have a trading idea or strategy that Win/loss — The percentage of trades that were Avg. hold time (losers) — The average holding
you’d like to see tested, please send the profitable. period for losing trades (in days).
trading and money-management rules to Avg. trade — The average profit for all trades. Max consec. win/loss — The maximum number of consecutive winning and losing trades.

14 February 2010 • FUTURES & OPTIONS TRADER

In January, the commercial-speculator dynamic was bearish in live
Commercial traders sell cattle (LC) and copper futures (HG). Meanwhile, this relationship
live cattle, buy the euro was bullish in eurocurrency futures (FX) and wheat (W).

The Commitments of Traders (COT) report is published

weekly by the Commodity Futures Trading Commission
(CFTC). The report divides the open positions in futures mar-
kets into three categories: commercials, non-commercials,
and non-reportable.
Commercial traders, or hedgers, tend to operate in the cash
market (e.g., grain merchants and oil companies that either
produce or consume the underlying commodity).
Non-commercial traders are large speculators (“large specs”)
such as commodity trading advisors and hedge funds — pro-
fessional money managers who don’t deal in the underlying
cash markets but speculate in futures on a large-scale basis. For a list of contract names, see “Futures Snapshot.” Source:
Many of these traders are trend-followers. The non-
reportable category represents small traders, or the general public. Legend: Figure 1 shows the difference between net commer-
Figure 1 shows the relationship between commercials and large speculators on cial and net large spec positions (longs minus shorts) for all 45
futures markets, in descending order. It is calculated by subtract-
Jan. 26. Positive values mean net commercial positions (longs minus shorts) are larg- ing the current net large spec position from the net commercial
er than net speculator holdings, based on their five-year historical relationship. position and then comparing this value to its five-year range.
Negative values mean large speculators have bigger positions than the commercials. The formula is:
In January, commercial positions hit short extremes in live cattle (LC) and copper a1 = (net commercial 5-year high - net commercial current)
(HG) futures. On the other side, the commercials reached long extremes in eurocur- b1 = (net commercial 5-year high - net commercial 5-year low)
rency (EC) and wheat futures. c1 = ((b1 - a1)/ b1 ) * 100
Note: The CFTC recently improved this report, in part, by removing swaps deal- a2 = (net large spec 5-year high - net large spec current)
ers from the commercial category. The commission has also clarified the large spec- b2 = (net large spec 5-year high - net large spec 5-year low)
ulator category by highlighting the role of managed money vs. other participants. c2 = ((b2 - a2)/ b2 ) * 100
x = (c1 - c2)
— Compiled by Floyd Upperman

Options Watch: Energy sector components (as of Jan. 29) Compiled by Tristan Yates
The following table summarizes the expiration months available for the 20 top holdings of the S&P 500 energy sector exchange-traded-fund
(XLE). It also shows each stock’s average bid-ask spread for at-the-money (ATM) February options. The information does NOT constitute trade
signals. It is intended only to provide a brief synopsis of potential slippage in each option market.

Bid-ask spreads
2010 2011 2012

spread as %





Stock of underlying
Stock Ticker price Call Put price
Exxon Mobil Corp. XOM X X X X X X 64.43 0.04 0.04 0.06%
Chevron Corp. CVX X X X X X X 72.12 0.03 0.06 0.06%
Schlumberger Ltd. SLB X X X X X X 63.46 0.05 0.04 0.07%
Conoco Philips COP X X X X X X 48.00 0.03 0.05 0.08%
Halliburton Co. HAL X X X X X 29.21 0.03 0.03 0.10%
Chesapeake Energy Corp. CHK X X X X X X 24.78 0.03 0.03 0.13%
Apache Corp. APA X X X X X X 98.77 0.16 0.19 0.18%
EOG Resources Inc. EOG X X X X X X 90.42 0.18 0.16 0.19%
Noble Energy Inc. NBL X X X X X X 73.94 0.16 0.13 0.19%
Occidental Petroleum Corp. OXY X X X X X X 78.34 0.15 0.18 0.21%
Devon Energy Corp. DVN X X X X X X 66.91 0.14 0.15 0.21%
Anadarko Petroleum Corp. APC X X X X X 63.78 0.11 0.18 0.23%
Hess Corp. HES X X X X X X 57.79 0.11 0.15 0.23%
Southwestern Energy Co. SWN X X X X X X 42.88 0.10 0.13 0.26%
Baker Hughes Inc. BHI X X X X X X 45.28 0.14 0.13 0.29%
National Oilwell Varco Inc. NOV X X X X X X 40.90 0.13 0.11 0.29%
XTO Energy Inc. XTO X X X X X X 44.57 0.13 0.14 0.29%
Marathon Oil Corp. MRO X X X X X X 29.81 0.10 0.11 0.36%
Williams Cos. WMB X X X X X X 20.84 0.08 0.08 0.36%
Spectra Energy Corp. SE X X X X 21.25 0.14 0.15 0.68%

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.

16 February 2010 • FUTURES & OPTIONS TRADER

FUTURES SNAPSHOT (as of Jan. 29)
The following table summarizes the most actively traded U.S. futures contracts. The information does NOT constitute trade signals. It is intended
only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the dif-
ferent fields. Volume figures are for the most active contract month in a particular market and may not reflect total volume for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).

10-day move/ 20-day move/ 60-day move/ Volatility

Market Symbol Exchange Volume OI rank rank rank ratio/rank
E-Mini S&P 500 ES CME 1.67 M 2.43 M -6.53% / 100% -4.59% / 100% 3.03% / 2% .77 / 100%
10-yr. T-note TY CME 706.7 1.23 M 1.56% / 69% 2.41% / 96% -0.09% / 14% .25 / 7%
5-yr. T-note FV CME 333.5 793.4 0.88% / 62% 1.69% / 85% 0.02% / 2% .31 / 7%
E-Mini Nasdaq 100 NQ CME 278.0 308.5 -7.89% / 100% -7.33% / 100% 4.21% / 8% .68 / 100%
Crude oil CL CME 256.8 256.2 -8.19% / 44% -8.06% / 78% -8.43% / 100% .47 / 65%
Eurodollar* ED CME 238.3 536.3 0.16% / 20% 0.49% / 80% 0.58% / 50% .17 / 5%
Eurocurrency EC CME 234.4 153.2 -4.39% / 100% -3.27% / 75% -6.01% / 97% .47 / 68%
30-yr. T-bond US CME 198.3 661.1 1.73% / 42% 2.59% / 88% -0.84% / 25% .27 / 10%
2-yr. T-note TU CME 196.3 867.2 0.09% / 29% 0.22% / 63% 0.06% / 24% .30 / 3%
Gold 100 oz. GC CME 149.9 289.8 -5.18% / 100% -0.80% / 15% 2.83% / 5% .33 / 72%
Mini Dow YM CME 108.5 64.7 -5.17% / 86% -3.36% / 92% 3.09% / 1% .65 / 100%
Corn C CME 105.2 488.3 -6.46% / 17% -13.83% / 95% -6.75% / 24% .17 / 12%
Natural gas NG CME 103.7 95.2 -8.18% / 92% -10.12% / 79% 4.25% / 2% .33 / 72%
E-Mini Russell 2000 TF CME 102.0 340.5 -5.59% / 86% -3.67% / 55% 6.54% / 41% .69 / 100%
British pound BP CME 99.3 81.0 -2.07% / 100% -0.47% / 19% -2.42% / 82% .37 / 33%
Japanese yen JY CME 97.7 106.5 0.76% / 25% 2.40% / 66% 0.11% / 2% .36 / 42%
Soybeans S CME 75.3 176.0 -7.11% / 64% -11.79% / 100% -8.42% / 48% .34 / 50%
Australian dollar AD CME 73.5 108.1 -4.80% / 100% -0.64% / 21% -1.83% / 67% .48 / 97%
Canadian dollar CD CME 65.5 96.4 -4.37% / 100% -1.32% / 65% 0.87% / 14% .84 / 97%
Swiss franc SF CME 46.8 35.3 -4.02% / 100% -2.27% / 64% -3.53% / 97% .65 / 90%
Sugar SB ICE 44.2 312.7 8.25% / 89% 10.95% / 46% 24.74% / 46% .20 / 27%
Heating oil HO CME 36.8 56.9 -8.16% / 45% -9.31% / 100% -7.73% / 100% .39 / 58%
Wheat W CME 35.9 184.5 -10.16% / 58% -12.96% / 100% -8.25% / 23% .25 / 8%
Soybean oil BO CME 35.2 99.5 -6.18% / 38% -8.46% / 100% -1.74% / 14% .18 / 2%
RBOB gasoline RB CME 34.0 52.3 -7.73% / 78% -6.23% / 83% -4.35% / 51% .41 / 67%
Silver 5,000 oz. SI CME 30.0 77.5 -13.21% / 100% -3.64% / 53% -1.52% / 40% 1.10 / 98%
Soybean meal SM CME 26.5 60.8 -5.72% / 71% -13.41% / 100% -9.55% / 44% .41 / 88%
E-Mini S&P MidCap 400 ME CME 25.4 100.7 -6.70% / 100% -4.47% / 100% 6.32% / 35% .64 / 100%
Copper HG CME 23.1 106.4 -9.89% / 100% -8.74% / 100% 3.65% / 1% .58 / 100%
S&P 500 index SP CME 21.0 323.7 -6.53% / 100% -4.61% / 100% 3.01% / 1% .77 / 100%
Mexican peso MP CME 17.4 101.4 -2.72% / 75% 0.43% / 19% 1.77% / 31% .44 / 57%
U.S. dollar index DX ICE 16.6 52.8 2.80% / 88% 1.83% / 50% 5.04% / 100% .55 / 80%
Live cattle LC CME 13.7 68.8 -0.98% / 100% 0.88% / 10% -0.49% / 2% .41 / 35%
Lean hogs LH CME 12.6 55.5 -3.69% / 100% 1.33% / 0% 15.20% / 9% .27 / 73%
Coffee KC ICE 10.1 77.5 -8.76% / 100% -3.62% / 53% -7.48% / 41% .58 / 100%
Mini-sized gold YG CME 9.5 3.9 -5.31% / 100% -1.05% / 29% 2.08% / 3% .32 / 68%
Crude oil e-miNY QM CME 9.4 4.7 -8.19% / 44% -8.05% / 78% -8.43% / 100% .48 / 67%
Nikkei 225 index NK CME 7.2 33.1 -6.61% / 100% -4.08% / 52% 4.28% / 25% .56 / 72%
Cocoa CC ICE 7.2 68.2 -6.35% / 100% -3.19% / 75% -2.75% / 100% .84 / 100%
New Zealand dollar NE CME 7.1 22.2 -5.29% / 100% -2.31% / 54% -1.85% / 54% .78 / 95%
Fed Funds** FF CME 6.7 58.3 0.02% / 16% 0.11% / 51% 0.20% / 13% .05 / 3%
E-Mini eurocurrency ZE CME 3.0 2.6 -4.39% / 100% -3.27% / 75% -6.01% / 97% .47 / 68%
Mini-sized silver YI CME 2.7 2.9 -13.24% / 100% -3.61% / 47% -1.45% / 28% 1.08 / 98%
Natural gas e-miNY QG CME 2.7 2.9 -8.18% / 92% -10.14% / 79% 4.25% / 2% .34 / 76%
Nasdaq 100 ND CME 2.2 12.5 -7.89% / 100% -7.33% / 100% 4.21% / 8% .68 / 100%
Feeder cattle FC CME 1.4 7.5 1.38% / 25% 3.94% / 76% 3.94% / 92% .27 / 58%
Dow Jones Ind. Avg. DJ CME 0.8 10.6 -6.06% / 100% -4.51% / 100% 2.90% / 0% .63 / 98%
*Average volume and open interest based on highest-volume contract (March 2011). **Average volume and open interest based on highest-volume contract (May 2010).

day moves, 20-day moves, etc.) show the per- larger than all the past readings, while a read-
Volume: 30-day average daily volume, in thou- centile rank of the most recent move to a certain ing of 0 percent means the current reading is
sands (unless otherwise indicated). number of the previous moves of the same size smaller than the previous readings. These fig-
OI: Open interest, in thousands (unless other- and in the same direction. For example, the ures provide perspective for determining how
wise indicated). rank for 10-day move shows how the most relatively large or small the most recent price
10-day move: The percentage price move from recent 10-day move compares to the past twen- move is compared to past price moves.
the close 10 days ago to today’s close. ty 10-day moves; for the 20-day move, the rank Volatility ratio/rank: The ratio is the short-term
20-day move: The percentage price move from field shows how the most recent 20-day move volatility (10-day standard deviation of prices)
the close 20 days ago to today’s close. compares to the past sixty 20-day moves; for divided by the long-term volatility (100-day stan-
the 60-day move, the rank field shows how the dard deviation of prices). The rank is the per-
60-day move: The percentage price move from most recent 60-day move compares to the past
the close 60 days ago to today’s close. centile rank of the volatility ratio over the past
one-hundred-twenty 60-day moves. A reading 60 days.
The “rank” fields for each time window (10- of 100 percent means the current reading is
This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & Options
Trader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buy
or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.
18 February 2010 • FUTURES & OPTIONS TRADER
OPTIONS RADAR (as of Jan. 29)

Indices Symbol Exchange Options Open 10-day move / 20-day move / IV / IV / SV ratio —
volume interest rank rank SV ratio 20 days ago
S&P 500 index SPX CBOE 161.6 1.30 M -6.49% / 100% -4.67% / 100% 21.5% / 13.1% 16.8% / 12.3%
S&P 500 volatility index VIX CBOE 137.5 2.25 M 39.65% / 57% 23.35% / 86% 86% / 87.1% 158.6% / 92%
Russell 2000 index RUT CBOE 46.0 402.1 -6.87% / 100% -4.95% / 76% 25% / 17.1% 22.9% / 17.7%
E-Mini S&P 500 futures ES CME 24.1 120.1 -5.56% / 86% -3.74% / 87% 21.7% / 14.9% 16.5% / 15%
Nasdaq 100 index NDX CBOE 20.3 193.3 -7.71% / 100% -7.32% / 100% 23% / 15.2% 17.7% / 15%

Citigroup C 165.3 7.43 M -5.41% / 22% 0.00% / 0% 45.1% / 46.4% 49.3% / 46.4%
Bank of America BAC 164.4 3.71 M -9.75% / 63% 0.73% / 0% 38.9% / 41.4% 36.8% / 30.4%
AT&&T Inc T 135.2 495.4 -3.17% / 7% -10.45% / 100% 23.6% / 20.1% 19.2% / 18.1%
Apple Inc AAPL 121.3 922.3 -8.29% / 100% -9.25% / 100% 36.4% / 26.1% 33.3% / 27.2%
Verizon Comm VZ 102.4 336.2 -5.77% / 63% -11.97% / 95% 22.3% / 20% 18.2% / 19.3%

Eurodollar ED CME 274.9 4.96 M 0.00% / 0% 0.07% / 30% 103.7% / 32.8% 107.2% / 57.8%
10-year T-notes TY CME 77.7 707.2 1.56% / 69% 2.41% / 96% 6% / 4.8% 6.8% / 4.9%
Corn C CME 39.1 497.6 -6.46% / 17% -13.83% / 95% 27.1% / 32.1% 33.1% / 34.4%
30-year T-bonds US CME 27.2 156.4 1.73% / 42% 2.59% / 88% 10.2% / 7.7% 11% / 8.5%
E-Mini S&P 500 futures ES CME 24.1 120.1 -5.56% / 86% -3.74% / 87% 21.7% / 14.9% 16.5% / 15%

Indices - High IV/SV ratio
S&P 500 index SPX CBOE 161.6 1.30 M -6.49% / 100% -4.67% / 100% 21.5% / 13.1% 16.8% / 12.3%
S&P 100 index OEX CBOE 11.6 80.5 -6.52% / 100% -4.59% / 100% 20.9% / 12.9% 15.9% / 11.5%
S&P 100 index XEO CBOE 4.0 36.4 -6.52% / 100% -4.59% / 100% 20.2% / 13% 15.3% / 12.1%
Nasdaq 100 index NDX CBOE 20.3 193.3 -7.71% / 100% -7.32% / 100% 23% / 15.2% 17.7% / 15%
Dow Jones index DJX CBOE 6.5 128.6 -6.01% / 100% -4.57% / 100% 18.8% / 12.5% 15.1% / 12.3%

Indices - Low IV/SV ratio

S&P 500 volatility index VIX CBOE 137.5 2.25 M 39.65% / 57% 23.35% / 86% 86% / 87.1% 158.6% / 92%

Stocks - High IV/SV ratio

Burlington Northern SF BNI 1.2 106.8 0.52% / 80% 1.01% / 53% 12.5% / 2.2% 13.4% / 2.5%
Cell Therapeutics CTIC 15.2 215.0 -6.72% / 33% -3.48% / 10% 198.6% / 56.3% 155.2% / 70.6%
InterMune ITMN 1.8 56.9 8.55% / 41% 20.54% / 76% 144% / 51.8% 103.4% / 43.5%
Chimera Invest CIM 1.1 85.0 -5.31% / 100% 0.00% / 0% 61.1% / 25.6% 66.1% / 39.8%
YRC Worldwide YRCW 46.8 529.6 -8.82% / 0% -6.06% / 13% 373.8% / 166.3% 351.2% / 158.4%

Stocks - Low IV/SV ratio

Cadbury PLC CBY 7.4 48.9 2.55% / 25% 4.17% / 57% 11.4% / 19.1% 24.8% / 12.7%
Origin Agritech Ltd SEED 8.1 40.1 -18.15% / 57% -17.19% / 94% 77.8% / 113.4% 95% / 85.1%
McMoRan Exploration MMR 11.8 119.0 4.46% / 0% 82.16% / 65% 66.8% / 95.1% 78.7% / 50.5%
Taser Intl TASR 1.0 31.2 -11.74% / 100% 29.66% / 68% 62.6% / 84.7% 55.5% / 36.9%
Zions Bancorp ZION 9.4 111.5 13.52% / 22% 48.20% / 92% 56.1% / 75.6% 54% / 38.8%

Futures - High IV/SV ratio

Eurodollar ED CME 274.9 4.96 M 0.00% / 0% 0.07% / 30% 103.7% / 32.8% 107.2% / 57.8%
Cocoa CC ICE 1.3 10.4 -6.13% / 100% -1.94% / 52% 35.2% / 19.9% 37.6% / 25%
5-year T-notes FV CME 7.5 74.8 0.88% / 62% 1.69% / 85% 4.1% / 2.6% 4.9% / 3.2%
S&P 500 futures SP CME 12.7 63.1 -6.53% / 100% -4.61% / 100% 20.6% / 13.8% 16.8% / 12.2%
Live cattle LC CME 5.0 149.1 -0.98% / 100% 0.88% / 10% 15.2% / 10.4% 14.3% / 12.8%

Futures - Low IV/SV ratio

Orange juice OJ ICE 2.6 21.4 2.37% / 18% -0.58% / 14% 38.8% / 53.7% 48.6% / 37.4%
Soybean oil ZL CME 2.9 69.4 -6.18% / 38% -8.46% / 100% 22.6% / 28.1% 24.7% / 24.6%
Corn C CME 39.1 497.6 -6.46% / 17% -13.83% / 95% 27.1% / 32.1% 33.1% / 34.4%
Wheat ZW CME 6.6 134.6 -10.16% / 58% -12.96% / 100% 32% / 36.9% 38.2% / 31.7%
Silver SI CME 1.5 30.3 -13.21% / 100% -3.64% / 53% 31.9% / 35% 33.8% / 37.3%
* Ranked by volume ** Ranked based on high or low IV/SV values.
Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).
Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).
IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.
10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.
20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-day
moves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example, the “rank”
for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows how the most
recent 20-day move compares to the past sixty 20-day moves.

FUTURES & OPTIONS TRADER • February 2010 19


The option “Greeks”

American style: An option that can be exercised at any Delta: The ratio of the movement in the option price for
time until expiration. every point move in the underlying. An option with a
delta of 0.5 would move a half-point for every 1-point
Assign(ment): When an option seller (or “writer”) is move in the underlying stock; an option with a delta of
obligated to assume a long position (if he or she sold a put) 1.00 would move 1 point for every 1-point move in the
or short position (if he or she sold a call) in the underlying underlying stock.
stock or futures contract because an option buyer exercised
Gamma: The change in delta relative to a change in the
the same option.
underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
At the money (ATM): An option whose strike price is and lowest for deep ITM and OTM options.
identical (or very close) to the current underlying stock (or
futures) price. Rho: The change in option price relative to the change
in the interest rate.
Backspreads and ratio spreads are leveraged posi-
tions that involve buying and selling options in different Theta: The rate at which an option loses value each day
proportions, usually in 1:2 or 2:3 ratios. Backspreads con- (the rate of time decay). Theta is relatively larger for
tain more long options than short ones, so the potential OTM than ITM options, and increases as the option gets
profits are unlimited and losses are capped. By contrast, closer to its expiration date.
ratio spreads have more short options than long ones and
Vega: How much an option’s price changes per a one-
have the opposite risk profile.
percent change in volatility.
Note: These labels are not set in stone. Some traders
describe either position as option trades with long and
short legs in different proportions. Bands are placed two standard deviations above and below
a 20-period simple moving average.
Bear call spread: A vertical credit spread that consists
of a short call and a higher-strike, further OTM long call in Upper band = 20-period simple moving average +
the same expiration month. The spread’s largest potential 2 standard deviations
gain is the premium collected, and its maximum loss is lim- Middle line = 20-period simple moving average of closing
ited to the point difference between the strikes minus that prices
premium. Lower band = 20-period simple moving average - 2 stan-
dard deviations
Bear put spread: A bear debit spread that contains puts
with the same expiration date but different strike prices. Bollinger Bands highlight when price has become high or
You buy the higher-strike put, which costs more, and sell low on a relative basis, which is signaled through the touch
the cheaper, lower-strike put. (or minor penetration) of the upper or lower line. However,
Bollinger stresses that price touching the lower or upper
Bollinger Bands: Bollinger Bands are a type of trading band does not constitute an automatic buy or sell signal. For
“envelope” consisting of lines plotted above and below a example, a close (or multiple closes) above the upper band
moving average, which are designed to capture a market’s or below the lower band reflects stronger upside or down-
typical price fluctuations. side momentum that is more likely to be a breakout (or
The indicator is similar in concept to the moving average trend) signal, rather than a reversal signal. Accordingly,
envelope, with an important difference: While moving Bollinger suggests using the bands in conjunction with
average envelopes plot lines a fixed percentage above and other trading tools that can supply context and signal con-
below the average (typically three percent above and below firmation.
a 21-day simple moving average), Bollinger Bands use stan-
dard deviation to determine how far above and below the Bull call spread: A bull debit spread that contains calls
moving average the lines are placed. As a result, while the with the same expiration date but different strike prices.
upper and lower lines of a moving average envelope move You buy the lower-strike call, which has more value, and
in tandem, Bollinger Bands expand during periods of rising sell the less-expensive, higher-strike call.
market volatility and contract during periods of decreasing
market volatility. Bull put spread (put credit spread): A bull credit
Bollinger Bands were created by John Bollinger, CFA, spread that contains puts with the same expiration date, but
CMT, the president and founder of Bollinger Capital different strike prices. You sell an OTM put and buy a less-
Management. By default, the upper and lower Bollinger expensive, lower-strike put.

20 February 2010 • FUTURES & OPTIONS TRADER

Butterfly: A non-directional trade consisting of options
with three different strike prices at equidistant intervals: Covered call: Shorting an out-of-the-money call option
Long one each of the highest and lowest strike price options against a long position in the underlying market. An exam-
and short two of the middle strike price options. ple would be purchasing a stock for $50 and selling a call
option with a strike price of $55. The goal is for the market
Calendar spread: A position with one short-term short to move sideways or slightly higher and for the call option
option and one long same-strike option with more time to expire worthless, in which case you keep the premium.
until expiration. If the spread uses ATM options, it is mar-
ket-neutral and tries to profit from time decay. However, Credit spread: A position that collects more premium
OTM options can be used to profit from both a directional from short options than you pay for long options. A credit
move and time decay. spread using calls is bearish, while a credit spread using
puts is bullish.
Call option: An option that gives the owner the right, but
not the obligation, to buy a stock (or futures contract) at a Debit spread: An options spread that costs money to
fixed price. enter, because the long side is more expensive that the short
side. These spreads can be verticals, calendars, or diagonals.
The Commitments of Traders report: Published
weekly by the Commodity Futures Trading Commission Delivery period (delivery dates): The specific time
(CFTC), the Commitments of Traders (COT) report breaks period during which a delivery can occur for a futures con-
down the open interest in major futures markets. Clearing tract. These dates vary from market to market and are deter-
members, futures commission merchants, and foreign bro- mined by the exchange. They typically fall during the
kers are required to report daily the futures and options month designated by a specific contract — e.g. the delivery
positions of their customers that are above specific report- period for March T-notes will be a specific period in March.
ing levels set by the CFTC. continued on p. 22
For each futures contract, report
data is divided into three “reporting”
categories: commercial, non-commer-
cial, and non-reportable positions. The
first two groups are those who hold
positions above specific reporting lev-
The “commercials” are often
referred to as the large hedgers.
Commercial hedgers are typically
those who actually deal in the cash
market (e.g., grain merchants and oil
companies, who either produce or
consume the underlying commodity)
and can have access to supply and
demand information other market
players do not.
Non-commercial large traders
include large speculators (“large
specs”) such as commodity trading
advisors (CTAs) and hedge funds.
This group consists mostly of institu-
tional and quasi-institutional money
managers who do not deal in the
underlying cash markets, but specu-
late in futures on a large-scale basis for
their clients.
The final COT category is called the
non-reportable position category —
otherwise known as small traders —
i.e., the general public.

FUTURES & OPTIONS TRADER • February 2010 21


Diagonal spread: A position consisting of options with You can approximate a particular SMA length for an EMA
different expiration dates and different strike prices — e.g., by using this formula to calculate the equivalent smoothing
a December 50 call and a January 60 call. constant:

European style: An option that can only be exercised at SC = 2/(n + 1)

expiration, not before. where:
n = the number of days in a simple moving average of
Exercise: To exchange an option for the underlying approximately equivalent length.
For example, a smoothing constant of 0.095 creates an
Exponential moving average (EMA): The simple exponential moving average equivalent to a 20-day SMA
moving average (SMA) is the standard moving average cal- (2/(20 + 1) = 0.095). The larger n is, the smaller the constant,
culation that gives every price point in the average equal and the smaller the constant, the less impact the most recent
emphasis, or weight. For example, a five-day SMA is the price action will have on the EMA. In practice, most soft-
sum of the most recent five closing prices divided by five. ware programs allow you to simply choose how many days
Weighted moving averages give extra emphasis to more you want in your moving average and select either simple,
recent price action. Exponential moving average (EMA) weighted, or exponential calculations.
weights prices using the following formula:
Expiration: The last day on which an option can be exer-
EMA = SC * Price + (1 - SC) * EMA(yesterday) cised and exchanged for the underlying instrument (usual-
where: ly the last trading day or one day after).
SC is a “smoothing constant” between 0 and 1, and
EMA(yesterday) is the previous day’s EMA value. Extrinsic value: The difference between an option's
intrinsic value and it's current price
(premium). For example, with the
underlying instrument trading at 50, a
45-strike call option with a premium of
8.50 has 3.50 of extrinsic value.

Front month (or “nearest

month”): The contract month closest
to expiration.

In the money (ITM): A call option

with a strike price below the price of
the underlying instrument, or a put
option with a strike price above the
underlying instrument’s price.

Intrinsic value: The difference

between the strike price of an in-the-
money option and the underlying
asset price. A call option with a strike
price of 22 has 2 points of intrinsic
value if the underlying market is trad-
ing at 24.

Naked option: A position that

involves selling an unprotected call or
put that has a large or unlimited
amount of risk. If you sell a call, for
example, you are obligated to sell the
underlying instrument at the call’s
strike price, which might be below the

22 February 2010 • FUTURES & OPTIONS TRADER

market’s value, triggering a loss. If you sell a put, for exam- you could sell one $45 put and buy two $40 puts in the same
ple, you are obligated to buy the underlying instrument at expiration month. If the stock drops, the short $45 put
the put’s strike price, which may be well above the market, might move into the money, but the long lower-strike puts
also causing a loss. will hedge some (or all) of those losses. If the stock drops
Given its risk, selling naked options is only for advanced well below $40, potential gains are unlimited until it reach-
options traders, and newer traders aren’t usually allowed es zero.
by their brokers to trade such strategies.
Put spreads: Vertical spreads with puts sharing the same
Naked (uncovered) puts: Selling put options to collect expiration date but different strike prices. A bull put spread
premium that contains risk. If the market drops below the contains short, higher-strike puts and long, lower-strike
short put’s strike price, the holder may exercise it, requiring puts. A bear put spread is structured differently: Its long
you to buy stock at the strike price (i.e., above the market). puts have higher strikes than the short puts.

Near the money: An option whose strike price is close Simple moving average: A simple moving average
to the underlying market’s price. (SMA) is the average price of a stock, future, or other mar-
ket over a certain time period. A five-day SMA is the sum of
Open interest: The number of options that have not the five most recent closing prices divided by five, which
been exercised in a specific contract that has not yet expired. means each day’s price is equally weighted in the calcula-
Out of the money (OTM): A call option with a strike
price above the price of the underlying instrument, or a put Stochastic oscillator: A technical tool designed to
option with a strike price below the underlying instru- highlight shorter-term momentum and “overbought” and
ment’s price. “oversold” levels (points at which a price move has, theo-
continued on p. 24
Parity: An option trading at its
intrinsic value.

Physical delivery: The process of

exchanging a physical commodity
(and making and taking payment) as a
result of the execution of a futures con-
tract. Although 98 percent of all
futures contracts are not delivered,
there are market participants who do
take delivery of physically settled con-
tracts such as wheat, crude oil, and T-
notes. Commodities generally are
delivered to a designated warehouse;
T-note delivery is taken by a book-
entry transfer of ownership, although
no certificates change hands.

Premium: The price of an option.

Put option: An option that gives the

owner the right, but not the obliga-
tion, to sell a stock (or futures contract)
at a fixed price.

Put ratio backspread: A bearish

ratio spread that contains more long
puts than short ones. The short strikes
are closer to the money and the long
strikes are further from the money.
For example, if a stock trades at $50,

FUTURES & OPTIONS TRADER • February 2010 23


retically at least, temporarily exhausted itself and is ripe for “fast” stochastics. Because it is very volatile, an additional-
a correction or reversal). ly smoothed version of the indicator — where the original
Calculation: The stochastic oscillator consists of two lines: %D line becomes a new %K line and a three-period average
%K and a moving average of %K called %D. The basic sto- of this line becomes the new %D line –– is more commonly
chastic calculation compares the most recent close to the used (and referred to as “slow” stochastics, or simply “sto-
price range (high of the range - low of the range) over a par- chastics”).
ticular period. Any of the parameters — either the number of periods
For example, a 10-day stochastic calculation (%K) would be used in the basic calculation or the length of the moving
the difference between today’s close and the lowest low of averages used to smooth the %K and %D lines — can be
the last 10 days divided by the difference between the high- adjusted to make the indicator more or less sensitive to
est high and the lowest low of the last 10 days; the result is price action.
multiplied by 100. Horizontal lines are used to mark overbought and over-
The formula is: sold stochastic readings. These levels are discretionary;
readings of 80 and 20 or 70 and 30 are common, but differ-
%K = 100*{(Ct-Ln)/(Hn-Ln)} ent market conditions and indicator lengths will dictate dif-
where: ferent levels.
Ct is today’s closing price
Hn is the highest price of the most recent n days Straddle: A non-directional option spread that typically
(the default value is five days) consists of an at-the-money call and at-the-money put with
Ln is the lowest price of the most recent n days the same expiration. For example, with the underlying
instrument trading at 25, a standard long straddle would
The second line, %D, is a three-period simple moving consist of buying a 25 call and a 25 put. Long straddles are
average of %K. The resulting indicator fluctuates between 0 designed to profit from an increase in volatility; short strad-
and 100. dles are intended to capitalize on declining volatility. The
Fast vs. slow: This formula is sometimes referred to as strangle is a related strategy.

Strangle: A non-directional option

spread that consists of an out-of-the-
MANAGED MONEY money call and out-of-the-money put
with the same expiration. For example,
Top 10 option strategy traders ranked by December 2009 return. with the underlying instrument trad-
(Managing at least $1 million as of Dec. 31, 2009.) ing at 25, a long strangle could consist
of buying a 27.5 call and a 22.5 put.
Nov. 2009 YTD $ under Long strangles are designed to profit
Rank Trading advisor return return mgmt. from an increase in volatility; short
strangles are intended to capitalize on
1. Kingsview Mgmt (Retail) 11.31% 12.45% 2.5
declining volatility. The straddle is a
2. CKP Finance Associates (Masters) 10.63% 317.61% 8.5 related strategy.
3. LJM Partners (Aggr. Premium Writing) 7.35% 51.25% 28.7
Strike (“exercise”) price: The
4. ACE Investment Strategists (ASIPC) 7.01% 43.36% 3.3 price at which an underlying instru-
5. ACE Investment Strat. (SIPC INST) 6.28% 37.33% 9.6 ment is exchanged upon exercise of an
6. Kingsview Capital Ptnrs 5.26% 17.63% 1.6
7. Carter Road 5.00% 83.35% 1.3 Time decay: The tendency of time
value to decrease at an accelerated rate
8. Newport Private Capital (TEOW) 4.57% 25.88% 21.9
as an option approaches expiration.
9. Reynoso Asset Mgmt. (Options Arb.) 4.47% 2.92% 2.0

10. LJM Partners (LJM Fund LP) 4.33% 28.70% 63.7 Time spread: Any type of spread
that contains short near-term options
and long options that expire later. Both
Source: Barclay Hedge ( Based on estimates of the composite of all
options can share a strike price (calen-
accounts or the fully funded subset method. Does not reflect the performance of any single account.
dar spread) or have different strikes
(diagonal spread).

24 February 2010 • FUTURES & OPTIONS TRADER

Time value (premium): The amount of an option’s
value that is a function of the time remaining until expira- Average true range (ATR) is simply a moving average of
tion. As expiration approaches, time value decreases at an the true range over a certain time period. For example, the
accelerated rate, a phenomenon known as “time decay.” five-day ATR would be the average of the true range calcu-
lations over the last five days.
True range (TR): A measure of price movement that
accounts for the gaps that occur between price bars. This Vertical spread: A position consisting of options with
calculation provides a more accurate reflection of the size of the same expiration date but different strike prices (e.g., a
a price move over a given period than the standard range September 40 call option and a September 50 call option).
calculation, which is simply the high of a price bar minus
the low of a price bar. The true range calculation was devel- Volatility: The level of price movement in a market.
oped by Welles Wilder and discussed in his book New Historical (“statistical”) volatility measures the price fluctu-
Concepts in Technical Trading Systems (Trend Research, 1978). ations (usually calculated as the standard deviation of clos-
True range can be calculated on any time frame or price ing prices) over a certain time period — e.g., the past 20
bar — five-minute, hourly, daily, weekly, etc. The following days. Implied volatility is the current market estimate of
discussion uses daily price bars for simplicity. True range is future volatility as reflected in the level of option premi-
the greatest (absolute) distance of the following: ums. The higher the implied volatility, the higher the option
1. Today’s high and today’s low. premium.
2. Today’s high and yesterday’s close.
3. Today’s low and yesterday’s close.

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CNBC Plus, Power E*TRADE Pro now features a new look
and feel, new console header, improved windows manage- Note: The New Products and Services section is a forum for industry
ment, RSS feed capability, and redesigned stocks and businesses to announce new products and upgrades. Listings are adapted from
options order tickets. For more information about press releases and are not endorsements or recommendations from
E*TRADE Securities products, services and educational ini- the Active Trader Magazine Group. E-mail press releases to
tiatives, visit Publication is not guaranteed.

Event: International Traders Expo Event: The 11th Free Technical Analysis Expo
Date: Feb. 14-17 Date: March 26-27
Location: Marriott Marquis Hotel, New York, N.Y. Location: Paris, France
For more information: For more information: Go to

Event: 26th Annual Risk Management Conference Event: The World MoneyShow Vancouver 2010
Date: March 7-9 Date: April 6-8
Location: The Ritz-Carlton Golf Resort, Naples, Fla. Location: Hyatt Regency Vancouver
For more information: Visit For more information: Go to
Event: 35th Annual International
Futures Industry Conference Event: FIA/FOA International Derivatives Expo
Date: March 10-13 Date: June 8-9
Location: Boca Raton Resort & Club, Fla. Location: The Brewery, Chiswell Street, London
For more information: Go to For more information: Go to

Event: The 17th Forbes Cruise for Investors Event: Los Angeles Traders Expo
Date: March 18-30 Date: June 9-12
Location: Crystal Symphony, Sydney to Auckland Location: Pasadena Convention Center, Los Angeles
For more information: Go to For more information: Go to

26 February 2010 • FUTURES & OPTIONS TRADER

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

February 2010 • FUTURES & OPTIONS TRADER 27


Crude rebound follows chart levels.


Date: Thursday, Dec. 17, 2009.

Entry: Long February crude oil (CLG10) at

73.80. Source: TradeStation

Reason for trade/setup: This was a simple swing trade, RESULT

based on an uptrending market turning up after a pullback.
After rallying back above $70 in October, front-month crude Exit: 76.35 (first half); 81.89 (second half).
consolidated in November before swinging lower in early
December. Nonetheless, as the economic panic has continued to Profit/loss: +2.55 (first half); +8.09 (second half).
recede in traders’ memories, commodities benefited enormously
and there’s little in the way of resistance (other than a double-dip Outcome: After one more additional downswing (to 72.72) on
recession) for a longer-term up move in oil. Dec. 22, the market closed strongly and jumped up to the initial
The March contract bottomed a little below $71 on Dec. 14, profit target on Dec. 23. The next several days brought an almost
and after a couple of days of bullish price action, we entered a uninterrupted rally, and the stop was raised accordingly to protect
limit order to buy at 73.80 on Dec. 16 when the market was trad- the remainder of the position.
ing around 74.40. Note: This was a paper trade. Although oil traded even higher after hitting the second target
on Jan. 4 (trading as high as 83.95), the market turned lower on
Initial stop: 72.31. The recent swing low represents too-large Jan. 12. The target level did, in fact, act as resistance, although in
a risk, and if our outlook is correct, the market shouldn’t pull back this case the market traded a little above the previous contract
to that level before rallying. If it does, we don’t want to be in the high rather than a little below it. However, it could easily have
market anyway, so we will exit sooner rather than later. been the other way around; if we had set a target based on the
market exceeding that level by too much, we might have missed
Initial target: 76.35, just below the Dec. 8 high. Take partial the opportunity to exit.
profits and raise stop to protect remainder of position.
Note: Initial targets for trades are typically based on things such as the
Secondary target: 81.89, a little below the lower range of the historical performance of a price pattern or trading system signal.
October-November consolidation’s resistance level (which is However, individual trades are a function of immediate market behavior;
around the whole-number price of 82.00). initial price targets are flexible and are most often used as points at which
a portion of the trade is liquidated to reduce the position’s open risk. As a
result, the initial (pre-trade) reward-risk ratios are conjectural by nature.

Date Contract Entry price Initial stop Initial target IRR Exit Date Point % LOP LOL Length
12/17/09 CLG10 73.80 72.31 76.35 1.71 76.35 12/23/09 +2.55 3.5% -1.08 9.72 4 days
81.89 1/4/10 +8.09 11% 11 days

Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

28 February 2010 • FUTURES & OPTIONS TRADER

This February 110-115 bull call spread won’t profit unless SPY jumps
SPY fell 1.9 percent on Jan. 22, closing at least 1 percent to 112.50 by expiration. But the spread has limited
near its low. Is the market poised to rebound directional risk or exposure to changes in volatility.
or fall off a cliff?

Source: eSignal Source: OptionVue

A bad signal and a lack of discipline wounds this bull call spread on SPY.
TRADE series, which is why we are bullish, not bearish. Black
clouds may be forming over Wall Street, but the decline has
Date: Friday, Jan. 22. been fairly mild so far, suggesting that buying the dip could
be profitable.
Market: Options on S&P 500 tracking stock (SPY). Although we typically buy in-the-money (ITM) calls to
exploit a potential rally, options prices are too expensive;
Entry: Buy two February 110-strike calls for $3.25 each. the CBOE Volatility Index (VIX) has climbed 42 percent
Sell two February 115-strike calls for $0.75 each. within three days. To reduce costs and lower exposure to
swings in implied volatility, we will buy ITM calls and sell
Reasons for trade/setup: The S&P 500 index dropped higher-strike calls in the same expiration month — a bull
2 percent on Jan. 21 as President Obama revealed his plan to call spread.
reign in U.S. banks. The market then slid another 1 percent We bought February 110-115 bull call spreads for $2.50
the next morning as several U.S. senators announced their each when SPY traded at 111.36 at 12:40 p.m. ET. Figure 2
opposition to Federal Reserve Chairman Ben Bernanke’s continued on p. 30
Was this drop a brief interruption in a 10-month bull mar- TRADE SUMMARY
ket, or did it signal a major reversal (Figure 1)? Historical
testing suggests the stock market has tended to bounce Entry date: Friday, Jan. 22
back from such dips since the early 1990s, a pattern that has Underlying security: S&P 500 tracking stock (SPY)
been explored in Active Trader’s ongoing System Design Position: Bull call spread
series. 2 long February 110 calls
After a three-day decline of 3.3 percent, the market is 2 short February 115 calls
poised to trigger the long pullback pattern discussed in this Initial capital required: $500
Initial stop: Exit after five days
TRADE STATISTICS Initial target: SPY jumps to 114 or momentum
signal triggers
Date Jan. 22 Jan. 29 Initial daily time decay: $2.77
Delta: 72.49 64.39 Trade length: 5 days
Gamma: -1.59 10.48 P/L: -$264 (-53%)
Theta: -2.77 -6.18 LOP: $0
Vega: 4.35 13.78 LOL: -$264
Probability of profit: 39% 14% LOP — largest open profit (maximum available profit during life of trade).
Breakeven point: 112.50 112.50 LOL — largest open loss (maximum potential loss during life of trade).

FUTURES & OPTIONS TRADER • February 2010 29

The rebound we expected didn’t emerge, and SPY dropped 2.7 percent
within a week. Instead of exiting, we dig in and hope for a bounce.
shows the trade’s potential gains and losses on
three dates: trade entry (Jan. 22, dotted line),
halfway until expiration (Feb. 6, dashed line), and
expiration (Feb. 20, solid line).
This debit spread will remain underwater unless
SPY gains 1 percent and trades above 112.50 at
expiration. But with a total delta of only 72, the
trade’s directional risk is roughly two-thirds lower
than buying an equivalent amount of stock. And
our total risk is capped at $2.50 per spread.
We will exit at a profit if SPY jumps 2.4 percent
to 114 or if its momentum, which measures current
price relative to the high-low range over the past
32 days, hits a certain threshold (0.62). (Note: This
was a paper trade, although it tracks a real long
trade in the underlying ETF.)
Source: eSignal
Initial stop: Exit after five days.
trade too early and not waiting until the close to go long. If
Initial target: Exit if SPY climbs to 114 or if a momentum we simply followed the pullback system’s trade rules, we
signal is triggered. might have had a chance to exit with a small profit.
SPY plunged 2.7 percent the following week. Instead of
RESULT exiting on Jan. 29 as planned, we held on, hoping for a
rebound. But despite its bad timing, the trade could have
Outcome: Figure 3 shows the trade was a disaster as SPY been worse as the spread still held roughly one-half its
dropped like a stone. Our big mistake was entering the value.


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30 February 2010 • FUTURES & OPTIONS TRADER