Futures and Options

Strategies, analysis, and news for futures and options traders.
August 2007 • Volume 1, Issue 5
GOLD TRADING HURRICANES AND

patterns and LUMBER FUTURES:
tendencies p. 8 Historical trading
patterns p. 14
HOW TO CHOOSE
between “identical”
option strategies p. 20
THE PRICE
MOVEMENT INDEX:
Trading system
analysis p. 32
THE LATEST
on penny options
trading p. 38
CONTENTS
Bull call ladders . . . . . . . . . . . . . . . . . . . . . .26

If you plan to trade a call ratio spread,
check out this strategy first. Ladders might
offer less premium, but they can boost
your odds of success.
By Philip Budwick
Futures Strategy Lab

The Price Movement Index (PMI) . . . . . .32
Another look at a mechanical method
for dynamically selecting the best markets
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6 for a trading system.
By Volker Knapp
Trading Strategies Options Strategy Lab

Beyond the glitter . . . . . . . . . . . . . . . . . . . . . .8 ADX credit spread system . . . . . . . . . . . .36
Breaking down the gold market’s day-to-day By Steve Lentz and Jim Graham
and intraday performance characteristics
highlights trading opportunities in this
always surprising market.
continued on p. 4
By FOT staff
Lumber:
The other weather market . . . . . . . . . . . . .14
Many commodity futures prices are
affected by the weather, but lumber futures
are especially prone to price swings
during hurricane season.
By Mike Zarembski
Putting put-call parity to work . . . . . . . . .20

Theories don’t pay the bills: This analysis
focuses on the practical side of the put-call
parity equation.
By Marc Allaire
2 August 2007 • FUTURES & OPTIONS TRADER

CONTENTS
Options News
Options exchanges give their
two cents on penny pricing . . . . . . . . . . .38
With a pilot program almost completed,
the six U.S. options exchanges have varying
views on pricing options in pennies.
Congress continues
Amaranth query . . . . . . . . . . . . . . . . . . . . . .38 Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .44
What role did the New York Mercantile Formulas, definitions, and references.
Exchange and the IntercontinentalExchange
play in the collapse of the Amaranth hedge Industry Events . . . . . . . . . . . . . . . . . . . . . . . .47
fund, and what can the Commodity Futures
Trading Commission do about it? Futures & Options Calendar . . . . . . . . . . . .48
New Products and Services . . . . . . . . . . . . .41 Futures Trade Journal . . . . . . . . . . . . . . .49

Pattern analysis sets up a buy in cocoa. Will
Futures Snapshot . . . . . . . . . . . . . . . . . . . .42 things turn out sweet?
Momentum, volatility, and volume statistics
for futures. Options Trade Journal . . . . . . . . . . . . . . .50
Trading the S&P effect.
Options Radar . . . . . . . . . . . . . . . . . . . . . . .43
Notable volatility and volume in the
options markets.
Have a question about something you’ve seen

in Futures & Options Trader?
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in this month’s issue of Futures & Options Trader.
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CONTRIBUTORS
CONTRIBUTORS
Marc Allaire is a consultant to the Chicago Board Options

Exchange, the Montreal Exchange, and other options industry
firms. He also teaches finance at the University of Indianapolis
A publication of Active Trader ® and investments and derivatives at the Ningbo Institute of
Technology in China. A former senior staff instructor at the
For all subscriber services: Chicago Board Options Exchange’s Options Institute, Allaire
www.futuresandoptionstrader.com was a featured contributor to the CBOE’s book Options: Fundamental Concepts
and Trading Strategies, co-authored Understanding LEAPS, and is a regular con-
tributor to professional publications on options, LEAPS, and trading strate-
Editor-in-chief: Mark Etzkorn
metzkorn@futuresandoptionstrader.com
gies. His latest publication is The Options Strategist. He can be reached at
optionstrategist@aol.com.
Managing editor: Molly Flynn
mflynn@futuresandoptionstrader.com Philip Budwick is co-author of The Option Trading
Handbook: Strategies and Trade Adjustments (Wiley, 2004) and the
Senior editor: David Bukey director of the capital markets trading room at George
dbukey@futuresandoptionstrader.com
Washington University. He actively trades options and futures,
consults as a trading coach, and runs online discussions on
Contributing editors:
Jeff Ponczak
option trading basics. He can be reached at pbudwick@gainllc.com.
jponczak@futuresandoptionstrader.com,
Keith Schap Mike Zarembski is a senior commodities analyst and bro-
ker for optionsXpress, Inc. He is the author of two daily newslet-
Editorial assistant and ters for optionsXpress, Daily Futures Spotlight and Futures Closing
Webmaster: Kesha Green
Bell. In addition, as product manager for optionsXpress, he is
kgreen@futuresandoptionstrader.com
responsible for helping develop and enhance tools and features
Art director: Laura Coyle for futures education, evaluation, and execution. Prior to joining
lcoyle@futuresandoptionstrader.com optionsXpress in 2002, he worked as an assistant manager for TD Waterhouse
on their inbound risk management team. His futures career began in 1990
President: Phil Dorman
working for Lind-Waldock at the CME. In 1991, after clerking for a floor bro-
pdorman@futuresandoptionstrader.com
ker at the CBOT, he began trading for himself as a floor trader at the Mid-
Publisher, America Commodities Exchange (MidAm) in the wheat and corn futures and
Ad sales East Coast and Midwest: options pits for nine years. He attended DePaul University and the University
Bob Dorman of Illinois-Chicago and holds a Series 3 license. He can be reached at
bdorman@futuresandoptionstrader.com mikez@xpresstrade.com.
Ad sales
Volker Knapp has been a trader, system developer, and
West Coast and Southwest only:
Allison Ellis researcher for more than 20 years. His diverse background
aellis@futuresandoptionstrader.com encompasses positions such as German National Hockey team
player, coach of the Malaysian National Hockey team, and
Classified ad sales: Mark Seger president of VTAD (the German branch of the International
mseger@futuresandoptionstrader.com Federation of Technical Analysts). In 2001 he became a partner
in Wealth-Lab Inc. (http://www.wealth-lab.com), which he is still running.
Volume 1, Issue 5 . Futures & Options Trader is pub-
lished monthly by TechInfo, Inc., 150 S. Wacker Drive,
Suite 880, Chicago, IL 60606. Copyright © 2007 Jim Graham (advisor@optionvue.com) is the product man-
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any ager for OptionVue Systems and a registered investment advisor
form without written permission from the publisher.
for OptionVue Research.
The information in Futures & Options Trader magazine
is intended for educational purposes only. It is not
meant to recommend, promote or in any way imply the Steve Lentz (advisor@optionvue.com) is executive vice
effectiveness of any trading system, strategy or
approach. Traders are advised to do their own president of OptionVue Research, a risk-management consulting company. He
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of also heads education and research programs for OptionVue Systems, includ-
risk. Past performance does not guarantee future
results.
ing one-on-one mentoring for intermediate and advanced traders.

TRADING STRATEGIES
FIGURE 1 — THIRTY YEARS OF GOLD

As part of a speculative bubble in hard assets, gold peaked in 1980 and has
Beyond
failed to match that price level since.
the glitter
Despite its reputation,
gold has a poor record as an
investment. That doesn’t mean
it’s not a good trading
vehicle, though.
BY FOT STAFF
Source: CQGNet (http://www.cqg.com)

G old is often referred to
as a safe-haven for in-
vestors during times of
economic uncertainty.
Unfortunately, while for many investors
and traders there have been plenty of
financial calamities that would justify
FIGURE 2 — REVIEW PERIOD
moving assets into gold, the yellow
Gold established the low for the review period when it dropped sharply in
June 2006. Price then turned up to make the review-period high in July. metal is not the safe haven it once was.
Since then, gold has remained between those two extremes. Gold traded above $850.00 an ounce in
1980 (Figure 1), a price investors and
traders have not seen since. Following
this peak, however, gold was essentially
in a bear market until 2002, when the
market successfully tested support
around $250. Then, in concert with glob-
al economic expansion, demand for gold
pushed the price temporarily over $700
an ounce in 2006. For the past year (June
2006 through May 2007), gold has been
in a broad trading range, from just below
$600 to just over $700 an ounce.
Despite its unfavorable performance
as a long-term investment, gold is
nonetheless a market that presents
opportunities for nimble traders. Here,
we explore the short-term trading char-
acteristics of this market to see how best
to trade it day to day.
Traders can buy and sell gold nearly
24 hours a day. Gold futures are traded

FIGURE 3 — DAILY RANGES
The average daily range was $12.01 and the median range was
$10.50. The largest daily range was $44.00 — more than four times
the median.
on two exchanges — the New York Mercantile

Exchange (NYMEX), which has pit- and electron-
ically-traded contracts, and the Chicago Board of
Trade (CBOT), which has an electronically-traded
mini gold contract.
The following analysis reviews daily data for
the CBOT mini gold futures (ticker symbol: YG)
from June 1, 2006 through May 31, 2007, a total of
251 trading days. The study determines key mar- FIGURE 4 — DAILY RANGE DISTRIBUTION
ket statistics for short-term traders, including
daily range, close-to-close changes, how low the Seventy-four percent of the daily ranges were between $5.01 and
$15.00.
market tends to trade down on days it closes
higher, and how high it tends to trade on days it
closes lower.
Intraday analysis of hourly price data from
April 2007 through May 31, 2007 is also included.
The electronic NYMEX gold price data is used to
identify times of the day when gold offers the
most price action.
Figure 2 is a daily continuous futures gold
chart from June 1, 2006 through May 31, 2007.
Gold hit its low during the review period during
the middle of June (after peaking the month
before) and then rallied to form its high for the
review period in July. Since that broad swing,
gold has been moving sideways, with the market
spending the final quarter of the review period in FIGURE 5 — CLOSE-TO-CLOSE DISTRIBUTION
the upper half of its year-long range.
Let’s see what this market tends to do from day The average closing change was -8 cents while the median closing
change was a gain of 30 cents.
to day.
Daily bar characteristics

Figure 3 shows the daily ranges for the review
period sorted from smallest to largest. The small-
est range ($2.80) occurred on Dec. 26, 2006 and
the largest ($44.00) occurred on June 13, 2006 —
one day ahead of the bottom.
The average daily range was $12.01 and the
median range was just $10.50. The difference
between the average and the median indicates
outliers — several large-range days evident on
the right side of the chart — pushed the average
range figure higher. In this case, the median
continued on p. 10
FUTURES & OPTIONS TRADER • August 2007 9

TRADING STRATEGIES continued
Gold trading tendencies
Insights from the June 1, 2006 through May 31,

FIGURE 6 — UP-CLOSING DAYS
2007 review of gold price:
There was a downward volatility shift during the review period. The
left side of the chart contains lows that were more than $10.00 below 1. The average range was $12.01 and the
the previous close, while the right side of the chart has none. median range was $10.50; 74 percent were
between $5.01 and $15.00. The daily range
exceeded $25.00 only 5 percent of the time
(12 days).
2. The average close-to-close change was

-$0.08, while the median close-to-close
change was +$0.30 — a reminder of this
market’s choppy nature. Eighty-four percent
of the close-to-close differences ranged from
a decline of $10.00 to a gain of $10.00. The
close-to-close changes exceeded $10.00 to
the upside seven percent of the time and
exceeded -$10.00 to the downside seven
percent of the time.
FIGURE 7 — DISTRIBUTION OF LOWS FOR UP-CLOSING DAYS 3. On up-closing days, the low was above the
previous day’s close 22 percent of the time.
The market closed up 129 of 251 days. The market traded down by $6 The market traded down by $6 or more and
or more and still closed up only 16 percent of the time. still closed up on the day only 16 percent of
the time.
4. On down-closing days, gold was up on the

day 85 percent of the time (i.e., it failed to
trade in positive territory only 15 percent of the
time). After being more than up $5.00 on the
day, gold closed down only 14 percent of the
time.
5. Intraday analysis from April 1, 2007 through

May 31, 2007 shows the 7:20 a.m. hour
(which corresponds to the opening of the pit
session for NYMEX gold) had the highest
average range of 60-minute bars.
range is more indicative of the “typical” behavior one up to and including $10.00 over 60 times (the value on the
would expect in this market. Y axis). We can see the one outlier where the $44.00 daily
Figure 4 is a frequency distribution chart of the daily range fell into the last category.
ranges. Frequency distribution analysis measures the num- Seventy-four percent of the daily ranges were greater
ber of times the daily ranges fell within a certain range. In than $5.00 and up to and including $15.00. The daily range
this case, the horizontal axis is the daily range in increments exceeded $25.00 only 5 percent of the time (12 sessions).
of $2.50 from left to right with each value displayed repre- Analyzing the close-to-close behavior shows that the
senting the upper limit of the range for the respective cate- largest one-day net loss on a closing basis was -$43.90 on
gory. For example, the daily range was greater than $7.50 June 13, 2006, and the largest one-day closing gain was

FIGURE 8 — DAILY BARS ADJUSTED TO THE PREVIOUS DAY’S
CLOSE
Gold climbed above the previous day’s close by more than $10.00
$26.90 on June 30, 2006. The market never closed only once. As was the case in Figure 6, the daily highs are lower on
without either a gain or a loss for the session. the right side of the chart.
Figure 5 shows the frequency distribution for
close-to-close differences. The peak number of
closing differences fell in the range of a loss of
more than -$2.50 up to unchanged. The average
close-to-close change was a loss of $0.08 and the
median was a gain of $0.30.
Eighty-four percent of the close-to-close differ-
ences were between a loss of $10.00 and a gain of
$10.00. The close-to-close changes exceeded
$10.00 to the upside 7 percent of the time and the
close-to-close changes were losses greater than -
$10.00 seven percent of the time. The market
closed up 51 percent of the time.
Figure 6 displays a chart of the daily bars when
the close was greater than the previous day’s
FIGURE 9 — DISTRIBUTION OF HIGHS FOR DOWN-CLOSING DAYS
close. The bars are adjusted so that the previous
day’s close is the zero line, and the individual On down-closing days the high was between unchanged and +0.0040
bar’s range is relative to the zero line. The market points 68 percent of the time.
closed in positive territory 129 days. We can see
the effect of volatility working its way lower over
the review period. The left-hand side of the chart
shows daily lows more than -$10.00 below the pre-
vious day’s close, while the right-hand side of the
chart shows the low was more than -$5.00 only
five times.
Figure 7 is a frequency distribution of the differ-
ence between the low and the previous day’s close
for those sessions the market closed in positive ter-
ritory. Twenty-nine or 22 percent of the time the
low was above the previous day’s close. The
largest positive difference between the low and
the previous day’s close (a gap up opening) was
$10.30 and the largest negative difference was -
$11.30.
Seventy-eight percent of the time for those days the ses- period. Eighteen sessions or 15 percent of the time the mar-
sion closed up the low was between unchanged and down ket did not trade in positive territory; therefore 85 percent
to a loss of $11.30. However, only 16 percent of the time did of the time the market was up on the day for down closes.
the low drop to $6.00 or more below the previous day’s The largest difference between the high and the close for a
close and the market recovered to close up for the session. gap down session was $4.30. Gold traded more than $5.00
Figure 8 is a chart of the sessions where the market closed above the previous day’s close and still closed down for the
down. Similar to Figure 5, the bars’ ranges and closing session only 14 percent of the time (17 sessions).
prices are adjusted relative to the previous day’s close. The
high was only $10.00 ($11.40) above the previous close once Intraday price action
for down closing sessions. The intraday analysis is based on 60-minute bars and a 24-
Figure 9 is a frequency distribution of the highs for those hour clock (Central Time). The NYMEX pit-trading session
sessions the market closed in negative territory. opens at 7:20 a.m. and closes at 12:30 p.m. To account for
The market closed down 122 times during the review continued on p. 12

FIGURE 10 — INTRADAY PRICE ACTION
During the intraday review period gold had a $45 range and displayed both
uptrending and a downtrending conditions.
both the electronic and pit-traded
gold sessions, some changes are made
to the data.
The electronically traded gold data
starts at 0:00 (midnight) and progress-
es in hourly increments. However, the
7 a.m. hour closes at 7:19:59 — just as
the pit-session begins. Then, the 60-
minute bars re-start at 7:20 to corre-
spond to the pit session. Accordingly,
the 7 a.m. “hour” is only 20 minutes
long. Also, because the pit session
closes at 12:30 p.m., the 12:20 “hour”
is only 10 minutes long, with 60-
minute increments beginning again at
12:30 p.m.
At 4:15 p.m., the electronic trading
session closes for 45 minutes, so the
3:30 p.m. hour is only 45 minutes long
and the intraday analysis starts with
the reopening of electronic trading at
5:00.
By analyzing the 60-minute bars,
we hope to identify the time of day
when the market is the most volatile.
The range for each 60-minute bar was
calculated and sorted by hour (0:00 to
23:00). Next, both the average and the
median were calculated for each peri-
od.
Figure 11 shows the average and
median ranges for the different hours
of the 24-hour trading day. Overall,
the first three hours following the
opening of the pit session at 7:20 a.m.
were the most volatile. The 7:20 hour
had the widest average range and the
second-highest median range. The
9:20 hour had the biggest median
range and the second-largest average
range. The 8:20 hour came in third on
both counts.
The average for the 7:20 hour was
$3.50 and the median was $3.00, a dif-
ference of $0.65. This relatively large
difference suggests several large-
range bars pushed up the average for
this hour. The average and median
values for the 9:20 hour were much
closer, indicating the ranges for this
hour were more consistent.
Figure 12, which shows the individ-

FIGURE 11 — HOURLY RANGES
ual ranges for the 7:20, 8:20, and 9:20 hours, high- The most volatile hour was the 7:20 a.m. hour, which coincides with
the opening of the NYMEX gold pit session.
lights some of these observations. The range was
$5.00 or more seven times in the 7:20 hour; the
9:20 hour had one range exceeding this threshold,
and the 8:20 hour had none.
Figure 13 shows the distribution of hourly
ranges during the three highly volatile hours.
Sixty-eight percent of the hourly ranges were
greater than $2.00 up to and including $4.00; the
hourly range was less than $2.00 only 15 percent
of the time. The largest hourly reading was
$10.60.
Keeping current
“Gold trading tendencies” (p. 10) summarizes
some of the highlights of this analysis. Traders
should remember that one of primary benefits of
FIGURE 12 — HIGH VOLATILITY PERIOD: 7:20 TO 10:20 A.M.
this type of research is staying abreast of chang-
ing market conditions that will affect the per- The 9:20 hour had the most consistently-sized ranges, while the 7:20
formance of trade strategies; as a result, such hour had the highest number of exceptionally large (outlier) ranges.
studies should be updated regularly — at least on
a quarterly basis.
Overall, gold has been a poor investment for
many years, and there’s no telling how long the
current bull market (which is already showing
signs of fatigue) will persist. However, traders
can take advantage of this market’s volatility by
understanding its day-to-day behavior and struc-
turing trade plans accordingly.
Related reading
“A better way to join a gold rush” FIGURE 13 — HOURLY RANGE DISTRIBUTION: 7:20 TO 10:20 A.M.
Active Trader, December 2006.
Even if gold’s bull run is over, there will still likely The majority (68 percent) of hourly ranges during the high-volatility
be trade opportunities in gold futures-gold stock period were between $2.01 and $4.00.
spreads.
“The platinum-gold sentiment spread”

Active Trader, February 2006.
The platinum-gold spread is a convenient way to
trade economic forecasts because it typically
changes as the U.S. economy expands or slows.
Note: This article is also part of the “Keith Schap:
Futures Strategy collection, Vol. 1.”
“Short-term crude oil tendencies”

Futures & Options Trader, June 2007.
A breakdown of oil’s daily and intraday trading
characteristics and patterns.

TRADING STRATEGIES
Lumber: The other weather market

Hurricane season means volatility in lumber futures.
BY MIKE ZAREMBSKI
W eather conditions during the upcoming

hurricane season could have traders
thinking twice about falling lumber
prices (Figure 1). Weather affecting the
markets is nothing new; commodity futures traders know
weather markets can produce exciting trade opportunities,
as increased market volatility and heightened investor
selves in lumber futures (LB), especially as the Atlantic hur-
ricane season begins.
According to the National Oceanic & Atmospheric
Administration (http://www.noaa.gov), the season offi-
cially begins June 1 and runs through the end of November.
More than 97 percent of tropical disturbances fall within
this window, with peak activity usually between August
interest spur major moves. and October.
Grains, orange juice, and heating oil are the best-known So how do traders react when weather forecasts predict
markets in which weather conditions can play a key role in tropical storms or hurricanes in the U.S.? Let’s take a look at
prices. However, such opportunities also present them- three tropical storms that reached the U.S. over the past
TABLE 1 — TRACKING THE STORMS

A look at all hurricanes to hit the U.S. in the past three years indicates that buying the rumor and selling the fact would have
made a profit.
Year Hurricane Category Date it was Lumber Date it Lumber

(at time it made upgraded to futures Contract hit U.S. futures Price
U.S. landfall) a hurricane closing price month shores closing price change
2004 Alex 1 Aug. 3 418.50 Sept. Aug. 3 418.50 Unch.
Charley 4 Aug. 11 409.60 Sept. Aug 13 407.00 -2.60
Frances 2 Aug. 26 435.30 Sept. Sept. 5 443.30 8.00
Gaston 1 Aug. 29 432.10 Sept. Aug. 30 432.10 Unch.
Ivan 3 Sept. 5 392.50 Nov. Sept. 16 363.10 -29.40
Jeanne 3 Sept. 16 363.10 Nov. Sept. 26 338.40 -24.70
2005 Cindy 1 July 6 326.90 Sept. July 6 326.90 Unch.
Dennis 4 July 7 327.50 Sept. July 10 324.60 -2.90
Katrina 3 Aug. 25 269.50 Sept. Aug. 29 287.50 18.00
Ophelia 1 Sept. 8 288.80 Nov. Sept. 14 299.90 11.10
Rita 3 Sept. 20 298.90 Nov. Sep. 23 326.00 27.10
Wilma 3 Oct. 18 283.50 Nov. Oct. 24 289.90 6.40
2006 Ernesto 1 Aug. 27 286.20 Sept. Aug. 30 289.50 3.30

FIGURE 1 — LUMBER LOWS
In late July, lumber had matched its 2007 low and was set to challenge
its 2003 low.
three years in August and early

September — the heart of hurricane
season — and what occurred in the
lumber futures market just before,
during, and after the storms went
ashore in the U.S.
The Atlantic hurricane

season officially begins
June 1 and runs
through the end of
November. More than Source: TradeStation
97 percent of tropical
disturbances fall within
this window.
2004
Hurricanes are ranked from 1 to 5,
with 5 being the strongest. In 2004,
Hurricane Charley was a category 4
hurricane — the strongest storm to
strike the U.S. in 12 years, causing
serious damage to parts of the Florida
peninsula.
The storm first caught the attention
of traders on Aug. 10, when a tropical
depression in the southeastern
Caribbean Sea strengthened to be-
come Tropical Storm Charley. How-
ever, the lumber market showed no
concerns, and prices fell sharply in the
front-month September contract, as
technical traders liquidated positions
fearing a potential double-top forma-
tion on the daily chart (Figure 2).
Charley continued to strengthen,
continued on p. 16

FIGURE 2 — POTENTIAL DOUBLE-TOP

Fearing a possible double-top formation, traders sold off September lumber becoming a hurricane on Aug. 11 as
futures the day Tropical Storm Charley formed. the storm’s eye hovered just outside
Jamaica. Lumber traders, however,
continued their selling spree for the
fourth consecutive session, causing
prices to move to a one-month low.
With the weekend approaching,
Charley strengthened to a category 2
storm as it approached the Cayman
Islands and Cuba, but the lumber
market closed lower for a fifth consec-
utive session, reaching lows of
$401.50 before a moderate short-cov-
ering rally cut the day’s decline.
On Friday, Aug. 13, another short-
covering rally ensued, as weather
forecasters were calling for Charley to
Source: XPRESSTRADE move toward the southwest coast of
Monthly lumber analysis

Cash lumber prices have historically
TABLE 2 — LUMBER BY THE MONTH
followed a seasonal trend, mostly
tied to the residential construction Range LUM LDM C2C %>0
season, with prices rising beginning
Avg. Med. Avg. Med. Avg. Med. Avg. Med.
in the spring, as builders start order-
ing lumber for the summer building Jan. 32.13 30.10 20.58 15.30 -15.31 -12.10 2.78 1.30 50.00%
season. In late summer, prices usu- Feb. 34.25 25.95 23.26 14.15 -13.75 -11.70 2.57 -5.65 40.00%
ally decline as construction jobs are March 29.12 28.20 15.14 11.70 -15.71 -9.90 -5.13 -1.80 43.33%
completed and new projects lessen
April 33.79 27.50 17.15 12.30 -20.71 -13.20 -2.93 -5.50 46.67%
going into the winter.
May 33.35 31.75 17.66 10.00 -16.23 -8.90 0.99 3.90 60.00%
Table 2 shows the average trading
range for lumber futures prices June 34.95 29.85 15.03 10.30 -21.95 -16.55 -5.56 -1.95 43.33%
(using the front-month contract) for July 33.20 33.00 17.88 12.90 -19.26 -17.30 -4.44 -7.95 33.33%
the past 30 years, along with the Aug. 33.87 32.60 22.23 20.70 -15.79 -11.40 5.24 3.45 56.67%
average largest up (LUM) and down
Sept. 34.70 24.70 10.34 7.60 -25.06 -16.60 -16.47 -12.90 33.00%
moves (LDM) for the month, average
close-to-close price, and the per- Oct. 32.12 28.85 17.28 11.65 -14.84 -8.90 2.53 3.10 53.33%
centage of times a month closed Nov. 28.32 24.35 21.08 14.25 -8.01 -4.90 10.55 8.70 76.67%
higher than the previous month. Dec. 29.74 25.25 15.02 9.20 -15.23 -13.75 3.03 1.05 56.67%
November, with an average close-
to-close move of 10.55, was the
Max. 34.95 33.00 23.26 20.70 -8.01 -4.90 10.55 8.70
most bullish month, while September
historically has seen lumber prices Min. 28.32 24.35 10.34 7.60 -25.06 -17.30 -16.47 -12.90
fall more than in any other month.

FIGURE 3 — THE AFTERMATH OF CHARLEY
After Hurricane Charley struck the southwest coast of Florida, lumber futures
opened limit up and rallied for three days.
Florida. Trading was choppy, but the
failure to make new lows at $401.50
allowed prices to end the day with a
modest gain of $3.50.
Over the weekend Charley became
a category 4 storm, with winds
approaching 125 knots. It made land-
fall on the southwest coast of Florida
and caused severe damage to the
cities of Punta Gorda and Port
Charlotte.
Charley continued to maintain hur-
ricane-strength winds as it moved
inland, passing close to the Orlando
area before moving back into the
Atlantic just outside Daytona Beach.
Source: XPRESSTRADE
When trading resumed on Monday,
Aug. 16, the news reports of the
destruction caused by Charley sent a
flurry of buy orders to the lumber pit,
causing a gap opening and eventually
sending prices up the $10 daily limit
(Figure 3).
On Tuesday, Aug. 17, only a small
number of sell orders kept prices
from opening limit bid. Once these
orders were absorbed, the market
once again closed limit-up.
Wednesday was a wild day of trad-
ing, with price limits expanding to
$15 and both bulls and bears fighting
for control of the market. The bulls
prevailed, and after posting a $13.50
daily range, September lumber closed
up the expanded $15 limit. The post-
storm rally continued for three more
sessions, finally topping out at
$458.70 on Aug. 23.
2005
On Aug. 24, 2005, the 11th tropical
storm of the 2005 season was official-
ly named Katrina as it gained
strength over the central Bahamas.
The following day, Katrina gained
continued on p. 18

Cash market traders were caught off guard in the summer of 2005,
with many buyers holding light inventories and in the process of
covering their needs for the fall when Katrina hit. This added to the
sharp price rise once early reports of the damaged surfaced.
hurricane status as its core moved as it reached land near Buras, La. This added to the sharp price rise once
over southeastern Florida. On this day, Lumber futures opened that morn- early reports of damage surfaced. The
September lumber closed below the ing up the $10 limit and traded briefly bulk of the post-storm rally peaked
lower end of a nearly two-week trad- off the limit before locking up the limit about three weeks after Katrina hit,
ing range, as traders continued to bid. Tuesday, prices opened sharply and once long liquidation selling
focus on overproduction and large higher but did not touch the $10 limit, began, prices fell to near the break-
imports rather than potential storm causing a selloff by weak longs that point back in August (Figure 4).
threats. allowed the September contract to
On Friday, Aug. 26, September lum- close the session with a small loss. 2006
ber made its contract lows of $267. That was the last chance for traders to Compared to 2005, the 2006 Atlantic
Traders finally started to take notice of enter the market on the long side or hurricane season turned out to be
the storm, and a short-covering rally cover short positions before prices mild, with only nine named storms
ensued, sending September lumber up moved sharply higher. and five that reached hurricane
$8 to end the week. Over the weekend, Cash market traders were caught off strength. Hurricane Ernesto occurred
Katrina strengthened to a category 5 guard in the summer of 2005, with at roughly the same time as Katrina
storm as it headed for the Gulf coast. many buyers holding light inventories the previous year, so let’s compare the
Early Monday morning, Katrina and in the process of covering their lumber market’s reaction to Ernesto
weakened to a strong category 3 storm needs for the fall when Katrina hit. and Katrina.
The storm that became Ernesto was
FIGURE 4 — KATRINA MAKES WAVES a tropical depression on Aug. 24, 2006,
as it moved just north of Grenada.
After Hurricane Katrina struck, a bear market in lumber quickly turned into a bull
September lumber was in a minor
market.
uptrend at the time, and choppy trade
allowed for a moderate price rally.
The following day, Aug. 25, Ernesto
was upgraded to tropical storm status
as it hovered south of Puerto Rico, and
lumber futures staged a sharp rally,
even briefly touching the $10 limit in
the day’s session. The market contin-
ued to drift moderately higher for the
next several sessions and made anoth-
er sharp move higher on Aug. 30,
when Ernesto made landfall near
Plantation Key, Fla. in the early morn-
ing.
Ernesto gained strength on Aug. 31
Source: XPRESSTRADE and lumber prices hit their peak of the
move that day, as the storm headed up

FIGURE 5 — ERNESTO HITS SHORE
Lumber traders witnessed a classic “buy the rumor, sell the fact” scenario once
the east coast towards North Carolina. Hurricane Ernesto struck the U.S. mainland in 2006.
On Sept. 1, Ernesto moved ashore at
Oak Island, N.C., and then moved
across the state, where it weakened
into a tropical depression.
Lumber prices also weakened that
day, closing near the lows of the day,
which sparked a wave of long liquida-
tion selling on Tuesday after the Labor
Day holiday. Prices gapped lower on
the opening and capped any further
rally attempts for the remainder of the
contract, which went off the board just
above the contract low (Figure 5).
The bottom line

From 2004 to 2006, 13 named hurri- Source: XPRESSTRADE
canes hit landfall in the U.S. To see if
the old adage “buy the rumor, sell the
fact” held true, we looked at the clos-
ing price for the nearby lumber
futures contract (if it fell within the
delivery month, the next contract was
used) on the day the storm first offi-
cially became a hurricane (rumor) and
compared that to the closing price on
the day the storm made landfall in the
U.S. (news).
Three of the storms acquired hurri-
cane strength on the same day they
came ashore in the U.S., so they didn’t
provide trading opportunities (Table
1). Of the remaining 10 storms, six
produced gains and four produced
losses. Overall, a trader who bought
the rumor (the date the storm became
a hurricane) and sold the fact (the
storm reached landfall in the U.S.)
produced a net gain of $14.30 per con-
tract.
However, in some extreme cases, as
with Hurricane Katrina, a major hurri-
cane can completely turn around the
trend and keep prices supportive for
months.
For information on the author see p. 6.

TRADING STRATEGIES
Putting put-call parity

to work
Selecting the appropriate option position is easier once you understand
the real-world limits of the put-call parity formula.
BY MARC ALLAIRE
TABLE 1 — PUT-CALL PARITY RULES: SAME STOCK,

STRIKE, AND EXPIRATION
In theory, put-call parity rules mean that each option strat-
egy has an equivalent position, assuming both options
share the same stock, strike, and expiration. In reality,
A
one trade often has an advantage.
ccording to the put-call parity concept, there
is a fixed link between the time premium of
puts and calls that is determined by the Long stock = long call, short put, long T-bill
options’ volatility and the risk-free interest Short stock = short call, long put, short T-bill
rate. The idea is intriguing, but retail traders rarely pay Long call = long stock, long put, short T-bill
much attention to it because its details can seem complex Short call = short stock, short put, long T-bill
and impractical — relevant only to theory geeks and floor Long put = short stock, long call, long T-bill
traders who pay miniscule transaction costs.
Short put = long stock, short call, short T-bill
But if you understand the simple equation behind put-
Note: Buy T-bill represents an investment of a cash balance. Sell
call parity, it may change the way you trade certain posi-
T-bill represents borrowing funds — i.e., using margin.
tions. This formula provides flexibility, because it shows
there are two ways to create any
options position. For example, if you
are bullish on a company, you can TABLE 2 — BUY-WRITE VS. SHORT PUT
either buy its stock or buy a call and
sell a put simultaneously (“synthetic This short put in Microsoft has a slight edge over the buy-write. However, selling
a put is cheaper because it requires just one commission instead of three (not
stock”), which theoretically offers the
shown).
same risks and rewards — often with a
lower capital requirement. MSFT traded at $29.63 on June 25.
The following four sets of equiva- Buy-write Cash-secured short put + T-bill
lent option positions illustrate how to
Position Per-share price Position Per-share price
use put-call parity to find the most
practical positions to trade. 100 shares of Microsoft
(MSFT) at $29.63 -$29.63 1 short August 30 put $1.02
The put-call parity equation 1 short August 30 call $0.79 T-bill interest $0.21
The put-call parity equation states that
the value (and therefore the time pre- Risk: $28.84 Risk: $28.77
mium) of puts and calls with the same Potential return: $1.16 Potential return: $1.23
expiration date and the same strike
price is linked. In its simplest form the
formula is: position will have the same potential risk and return of a
Treasury bill.
T-bill = Stock – call + put What’s the big deal? Anyone who wants a T-bill should
simply buy one instead of trying to clone it by executing
This means if you purchase a stock and sell a call and buy three trades and paying three commissions. However, the
a put with the same expiration date and strike price, your practical aspects of this formula appear when you rearrange

FIGURE 1 — RISK PROFILES: BUY-WRITE VS. SHORT PUT
This buy-write and short put have same potential risks and rewards
(within $7). But the short put is preferable because it requires fewer
its elements. Table 1 summarizes sev- commissions.
eral position equivalents using put-
call parity.
Buy-write vs.
cash-secured short put
Two familiar option strategies emerge
if you subtract the put from both sides
of the formula:
Stock – call = -Put + T-bill
The left side of the equation repre-

sents a buy-write, or covered call (long
stock and short call), and the right side
represents a “cash-secured” short put
— two positions that are often consid-
ered equivalent. gies offer the same potential rewards
Let’s test this theory with a recent and risks, give or take $0.07. Why
example. On June 25 Microsoft favor one strategy over the other?
(MSFT) traded at $29.63, the August The answer is real-life costs. Put-
30 call was at $0.79, and the August 30 call parity assumes no transaction
put was at $1.02. Which strategy is costs. However, trading a buy-write
better — a buy-write (long 100 shares, requires two commissions even in the
short call) or a short put? (The two best-case scenario. To enter the trade,
strategies must share the same expira- you must buy 100 shares of Microsoft
tion date and strike price or you’ll be and sell a call. If MSFT is above $30
comparing apples to oranges.) and the shares are called away by the
First we need to find the potential call’s owner, you must then pay a
return and risk of both strategies. third commission upon assignment.
Table 2 shows each trade’s compo- By contrast, you pay only one com-
nents and Figure 1 shows each posi- mission when you sell a cash-secured
tion’s profits and losses at expiration put. In the best-case scenario the short
on Aug. 18. put expires worthless. In reality, sell-
Both positions reach their maxi- ing a put seems preferable to a buy-
mum profits if MSFT trades above $30 write.
at expiration. The buy-write will gain
a total of $1.16 ($0.37 from the stock + Comparing vertical spreads
$0.79 call premium). The short 30 put You can use the original put-call pari-
will gain $1.23 overall. You keep its ty equation to find comparable
premium ($1.02), plus the interest options positions. To find the equiva-
earned on a T-bill ($0.21, assuming lent to a vertical debit spread, let’s
five-percent interest for 53 days). start with a long 85 call:
The risk of both strategies is stock
ownership. The buy-write represents a Call85 = + put85 + stock - T-bill
long stock position with a net cost of
$28.84 ($29.63 stock price - $0.79 pre- Then, find the alternative to a short
mium). If the short put is assigned, 95 call:
you will hold 100 shares of Microsoft
at a net cost of $28.77 ($30 strike - $1.02 -Call95 = - put95 - stock + T-bill
premium - $0.21 interest). Both strate- continued on p. 22

TABLE 3 — OPTIONS ON BLACK AND DECKER (BDK)
Assuming you were bullish on Black and Decker, you Next, combine a long 85 call with a short 95 call to create
could create a vertical spread (debit or credit) with these an 85-95 bull call debit spread:
August options when BDK traded at $87.76 on June 25.
Call85 – call95 = + put85 – put95 + stock
Calls (bid-ask) Puts (bid-ask) – stock + T-bill – T-bill
August 85 strike $5.50 – $5.70 $2.15 – $2.25
August 95 strike $1.05 – $1.15 $7.70 – $7.90
Finally, the answer appears after you simplify the right
side of the equation:
Call85 – call95 = + put85 – put95
TABLE 4 — BULLISH SPREADS — DEBIT VS. CREDIT This formula means an 85-95 bull call
spread should equal a 95-85 bull put
At first glance the credit and debit spreads are equivalent because their
potential risks and rewards are within $0.10. spread. Let’s check this with a trade
example.
BDK traded at $87.76 on June 25. Table 3 shows August option prices
Debit Credit for Black & Decker (BDK) when it
traded at $87.76 on June 25. To enter
August 85-95 bull call spread August 95-85 bull put spread
an 85-95 bull call spread, you would
Position Per-share price Position Per-share price buy an 85 call at $5.70 and sell a 95 call
1 long 85 call -$5.70 1 long 85 put -$2.25 at $1.05 — an initial net debit of $4.65.
1 short 95 call $1.05 1 short 95 put $7.70 To construct the equivalent 95-85 bull
put spread, sell a 95 put at $7.70 and
Risk: $4.65 Risk: $4.55 buy an 85 put at $2.25 for an initial
credit of $5.45. Table 4 shows both
Potential return: $5.35 Potential return: $5.45
strategies’ potential risk and profit.
Figure 2 compares their risk profiles at
expiration. Once again, the strategies
are equivalent (within $0.10).
FIGURE 2 — RISK-PROFILE COMPARISONS In this case it’s more difficult to argue one
position has higher transaction costs than the
The credit put spread (red line) seems to be slightly more profitable
other. However, the put-call parity equation
than the debit spread (blue line). However, this risk profile doesn’t
consider assignment risk, which gives the debit spread practical assumes options are European-style, which
advantages. means option holders can’t exercise them early.
This may be true for most index options, but
not for equity options.
Exercise and assignment

How does early exercise or assignment affect
the spreads? In the 85-95 bull call spread, the
short 95 call will only be assigned if BDK rises
above $95. If this happens, exercise the long 85
call. If you are assigned by the short call’s
owner, you will be forced to sell BDK at $95.
Exercising the 85 call will close the spread by
purchasing BDK at $85, effectively capturing its
$10 maximum value for a profit of $5.35 ($10 -
$4.65 debit).
In the 95-85 bull put spread, the short 95 put
could be assigned whenever BDK trades below

TABLE 5 — COMPARING TIME PREMIUMS
Whether you choose a credit or debit spread isn’t as important as the amount of
time premium you buy or sell. In this case, if both stocks trade flat, time decay
hurts this credit spread because you are actually buying $1.11 of time premium.
By contrast, time decay helps the debit spread, because you are selling $2.10
of time premium.
$95. If this happens, you will be forced
to buy shares from the put holder at AIG traded at $70.44 on July 3 FDX traded at $111 on July 3
$95. Unlike the debit spread there is no and trades flat until expiration. and trades flat until expiration.
clear next step. If BDK falls below $85 Credit Debit
you could exercise the long 85 put, sell AIG 75-70 bull put spread FDX 100-110 bull call spread
those shares, and exit the trade. Components Value Components Value
But BDK could be trading between
1 long August 70 put: 1 long August 100 call:
$95 and $85. In this case, it does not
Premium: -$1.15 Premium: -$12.10
make sense to exercise the long 85 put,
because you can sell BDK shares at a Intrinsic value: $0.00 Intrinsic value: $11.00
higher price. Also, if the short 95 put is Time premium: -$1.15 Time premium: -$1.10
assigned, the resulting position
includes BDK shares and a long 85 put 1 short August 75 put: 1 short August 110 call:
— something quite different from the
Premium: $4.60 Premium: $4.20
original spread (with a much higher
Intrinsic value: -$4.56 Intrinsic value: -$1.00
capital requirement).
Time premium: $0.04 Time premium: $3.20
The debit vs. credit debate Total time premium purchased: -$1.11 Total time premium collected: $2.10
So far debit spreads seem
preferable to credit spreads, at
least for stock and American- TABLE 6 — HEDGED SHORT SALE VS. LONG PUT
style index options. But aren’t The only real difference between both strategies is the long put costs slightly less and
credit spreads better because requires one trade instead of two.
they benefit from time decay
while debit spreads suffer from
AAPL traded at $123.87 on June 19.
it? Not necessarily.
Whether you choose a credit Short sale + long call +T-bill Long put
or debit spread isn’t as impor- Position Per-share price Position Per-share price
tant as the amount of time pre- 100 shares of Apple (AAPL) $123.87 1 long September 130 put -$11.10
mium you buy or sell. To 1 long September 130 call -$6.00
explain this, let’s compare two T-bill interest $1.00
more spreads. On July 3,
American International Group
(AIG) traded at $70.44. To con- Risk: $11.13 Risk: $11.10
struct a bull put spread, you Potential return: $118.87 Potential return: $118.90
could have sold an August 75
put for $4.60 and bought an
August 70 put at $1.15 — a credit of $3.45. only had $0.04 of time premium. When you buy more time
If AIG trades sideways in the 45 days until expiration, premium than you sell, time decay works against you.
this spread’s value will slowly increase from $3.45 to $4.56, In the FDX debit spread, the long 100 call had $1.10 of
bad news for a spread “seller” who is now feeling the neg- time premium, and the short 110 call had $3.20 of time
ative impact of time decay. value. When you buy the 100-110 call spread, you are actu-
And debit spreads can benefit from time decay. On July 3, ally selling $2.10 of time premium. Table 5 shows both
Federal Express (FDX) traded at $111.00. To create a bull call spread’s components and highlights each option’s time pre-
spread, you could have bought an August 100 call at $12.10 mium.
and sold an August 110 call for $4.20 — a debit of $7.90.
Assuming FDX remains at $111 until Aug. 18 expiration, Selling short vs. long put
this 100-110 call spread’s value will slowly increase from Let’s assume you decided to sell short 100 shares of Apple
$7.90 to $10 as it takes advantage of the calls’ time decay. Inc. (AAPL) when it traded at $123.87 on June 19. Because
What’s happening here? In the AIG credit spread, the selling short is a high-risk strategy, you also choose to buy
long 70 put had $1.15 in time premium, and the short 75 put continued on p. 24

FIGURE 3 — RISK PROFILES: HEDGED SHORT SALE VS. LONG PUT
Related reading Both positions share similar risks and rewards (within $3). However,
buying a put is easier (and cheaper) than selling short with a hedge.
Marc Allaire articles:
“Rolling profitable covered calls”
Futures and Options Trader, April 2007.
Taking profits on a winning covered call is
tempting, but extending the trade another month
could generate additional profits. This first
installment of a two-part series examines the
benefits and drawbacks of rolling a profitable
covered call position as expiration nears.
“Repairing a losing covered call”

Futures and Options Trader, May 2007.
This sequel to the first article on covered calls
shows how several repair strategies can help
minimize a covered call’s losses — and can
occasionally even turn a loser into a winner.
a September 130 call at $6.00 as a hedge. The bearish position limits
“Straddles vs. strangles, round two” upside risk and offers potential profit if AAPL heads south by Sept. 15
Options Trader, January 2007. expiration. Next, check the put-call parity equation to find the equiva-
Neither strategy always outperforms the other. lent strategy:
However, having a clear price forecast makes it
easier to select the best position. Put = -Stock + call + T-bill
“Selecting calls based on ROI” A long put also has limited risk and will be profitable if the under-
Options Trader, October 2006. lying stock declines by a sufficient amount. However, a long put has
Traders seem drawn to complex options two advantages over the first strategy: You don’t have to borrow
strategies, but sometimes simply buying calls shares, and transaction costs are lower (one trade instead of two).
is the best way to catch an up move. Learn On June 19, you could have bought a September 130 put for $11.10,
how to weigh the possibilities by comparing which also represents its total risk. By contrast, the risk of the short-
various calls’ return on investment. stock, long-call position is $12.13 ($130 strike - $123.87 entry price + $6
call premium).
Other articles: At first glance, the combined strategy’s risk appears higher. But the
“Covered calls vs. cash-covered short puts” T-bill’s interest from the equation hasn’t been included yet. Remember,
Futures and Options Trader, July 2007. if you sell a stock short, your broker might let you invest that capital
A comparison of two strategies uncovers some in a risk-free instrument such as T-bills. If you can invest the cash it
guidelines about how to choose between them. will generate $1.00 of interest, assuming the short sale’s proceeds
($123.87) are invested at 5 percent for 59 days. That interest reduces the
“Using put-call parity to locate stock-call-T-bill position’s risk to $11.13, virtually the same as the long
trade opportunities” put.
Active Trader, October 2006. Table 6 compares both trades’ risks and rewards and Figure 3 shows
Synthetic options can be useful tools when you their potential gains and losses at Sept. 15 expiration. Basically, both
have an opinion about the direction of the mar- strategies behave the same. The long put costs $0.03 less and requires
ket but little hope of a large price move. only one trade, which are the only practical differences.
“Trading synthetic spreads” Keeping it real

Options Trader, July 2006. In a world of European-style options without transaction costs,
Adding options to an underlying position can options traders would be completely indifferent to comparable posi-
transform your portfolio into virtually any type tions determined by the put-call parity equation.
of options spread. Lean how to create But reality gets in the way, and understanding put-call parity can
synthetic positions to fit your outlook. point you to toward the more advantageous of two seemingly equiv-
alent strategies.
You can purchase and download past articles at
http://www.activetradermag.com/purchase_articles.htm For information on the author see p. 6.

TRADING STRATEGIES
Bull call ladders

This position is more flexible and less risky than a ratio spread.
BY PHILIP BUDWICK
TABLE 1 — 1:2 CALL RATIO SPREAD — APPLE INC.

If you enter a call ratio spread with a credit, you can only lose if the market ral-
lies well beyond the short strike at expiration. However, that upside loss is
O ptions offer countless potentially unlimited.

ways to make money. Components Long/short Credit/debit
You can always find a 1 August 140 call Long -$8.35
new way to trade an old 2 August 145 calls Short $12.40
strategy by combining puts and calls at Net credit: $4.05
different strikes and expiration Scenario (at Aug. 18 expiration):
months. This flexibility also means that AAPL drops below $140. “Worst-case” gain: $4.05
most well-known positions are interre- AAPL trades at $145 short strike. Max. gain: $9.05
lated. AAPL trades above $153.50. Max. loss: Unlimited
For instance, if you are moderately
bullish on a market, you could enter a
bull call spread (long call, short higher-strike call), which expire in the same month.
profits if the stock rallies and limits losses to the spread’s Assume a stock trades at $50 on July 19. To enter a call
cost. However, if you sell two calls instead of just one, you ratio spread, you could purchase one $50 call and sell two
create a call ratio spread — a much cheaper way to trade a $55 calls in September options. Or you could enter a put
moderately bullish outlook. ratio spread by purchasing one $50 put and selling two $45
However, ratio spreads have two problems: Their largest puts. Because you sell more options than you buy, either
gains are possible only if the underlying instrument closes spread can usually be opened for a net credit or at no cost,
near the short option’s strike price at expiration, and they depending on where the stock trades in relation to both
face unlimited losses on one side of the market. One way to strike prices.
minimize these problems is to trade a
bull call ladder — the so-called
“Christmas tree” spread. Instead of Strategy snapshot
selling multiple calls at one strike, lad- Strategy: Bull call ladder.
ders sell the same number of calls at
two different strikes above the market. Components: ATM or ITM long call + OTM short call + second higher-strike
This discussion explains why some short call.
traders prefer bull call ladders to call Logic: Profit from a moderately bullish outlook and reduce call ratio
ratio spreads, describes how these spread’s upside risk. Collect less premium in exchange for
positions behave, and suggests ways more upside protection.
to reduce their risk. The examples use
calls but you can also create these posi- Criteria: Use front-month calls. Long call can be ATM or ITM. All
tions with puts. The main difference strikes can be equidistant. Increasing the distance between
involves directional risk: call ladders short strikes widens its range of maximum profit and leads to
and ratio spreads face losses above the a higher breakeven price. Ensure IV is not at historic lows.
market, while put spreads face losses Best-case Market climbs and closes between both short strikes
below it. scenario: at expiration.
Ratio spreads Worst-case Unlimited losses if market rallies far above the highest
If you sell more options than you buy, scenario: short strike.
you are creating a ratio spread. The Possible If market climbs to lowest short strike, buy a call one strike
long options are typically closer to the adjustments: above the highest short strike. Assuming long call costs less
money than the ones you sell, the ratio than initial premium collected, spread becomes a risk-free
is often fixed at 1:2 or 1:3 (long options condor.
to short options), and all options

FIGURE 1 — 1:2 CALL RATIO SPREAD — RISK PROFILE
This call ratio spread on Apple Inc. will gain $405 even if AAPL drops sharply.
If you enter a ratio spread for a net But the position faces unlimited upside losses if it jumps more than 9.6 percent
by the Aug. 18 expiration.
credit, you can be wrong about the
stock’s direction and still profit from the
trade. For example, if you entered a 50-55
call ratio spread for a credit and the stock
fell sharply by expiration, all calls would
expire worthless and you would keep
that credit. The premium removes any
downside risk.
On the other hand, a call ratio spread
has significant risks above the market,
because at least one short call isn’t cov-
ered. The above example includes an
uncovered 55 call, so if the stock rallies
far above that short strike, losses will
mount. You want the stock to climb, but
not too high.
Source: OptionVue
Call ratio spread example
On July 19 Apple Inc. (AAPL) hit $140 — TABLE 2 — BULL CALL LADDER COMPONENTS
an all-time high. Let’s assume you
believe AAPL could continue to rise in This bull call ladder will only lose ground if Apple rallies more than 12.5 percent
the next month, but not more than 10 per- within 30 days. Otherwise, you’ll gain up to $7.50.
cent. You could buy one at-the-money Components Long/short Credit/debit
(ATM) August call for $8.35 and sell two 1 August 140 call Long -$8.35
out-of-the-money (OTM) August 145 1 August 145 call Short $6.20
calls for $6.20 each, for a credit of $4.05. 1 August 150 call Short $4.65
Table 1 lists the components of this 1:2 Net credit: $2.50
call ratio spread and Figure 1 shows its Scenario (at Aug. 18 expiration):
potential gains and losses at the Aug. 18 AAPL drops below $140 “Worst-case” gain: $2.50
expiration. Figure 1 shows the spread AAPL trades between $145 and $150 short strikes Max. gain: $7.50
will still profit if AAPL drops sharply; its AAPL trades above $157.50 Max. loss: Unlimited
maximum gain ($9.05) occurs if Apple
rallies to the 145 short strike. Because the
position has more short calls than long FIGURE 2 — RATIO SPREAD VS. LADDER
ones, it loses ground quickly if AAPL If you enter a bull call ladder (blue line) instead of a call ratio spread (brown
rises above $153.50. line), you give up some downside gains in exchange for a higher upside
Therefore, call ratio spreads work best breakeven point.
when you expect the underlying to climb
to the short strike at expiration. If you are
wrong and the market tanks, you can still
make money. However, the spread’s
upside risk shouldn’t be overlooked. To
reduce this risk somewhat, you could
enter a bull call ladder instead — a slight
variation that shares the ratio spread’s
basic objectives.
Ladders add flexibility,

mitigate risk
A bull call ladder resembles a call ratio
spread, except the short calls are at two
different strikes — like successive steps
in a ladder. To enter a bull call ladder in
Source: OptionVue
continued on p. 28

TABLE 3 — BUILDING A WIDER-STRIKE LADDER receiving less premium) in exchange for

This wider-strike ladder offers less premium than the original position ($1.05 vs. more upside protection. Table 2 shows
$2.50, respectively). However, its maximum profit zone ($145-$155) is larger the bull call ladder’s components, and
and its upside breakeven point ($161.50) is higher. Figure 2 compares its potential gains
and losses to the original call ratio
Components Long/short Credit/debit
spread’s (blue vs. red lines, respective-
1 August 140 call Long -$8.35
ly).
1 August 145 call Short $6.20
If AAPL declines below the 140 long
1 August 155 call Short $3.20
strike by expiration, all calls expire
Net credit: $1.05
worthless, and you keep the premium
Scenario (at Aug. 18 expiration):
collected, regardless of which spread
AAPL drops below $140 “Worst-case” gain: $1.05
you choose. However, the ratio spread’s
AAPL trades between $145 and $155 short strikes Max. gain: $6.05
maximum profit ($9.05) occurs only if
AAPL trades above $161.50 Max. loss: Unlimited
Apple closes at the 145 short strike when
the options expire on Aug. 18.
FIGURE 3 — ORIGINAL LADDER VS. WIDE-STRIKE VERSION By contrast, the bull call ladder has a
wider maximum profit zone. Its biggest
The wider-strike call ladder (blue line) offers less profit than the original one
gain ($7.50) emerges when AAPL trades
(green line). But the wider-strike spread has a larger maximum profit zone and a
higher breakeven point. between the two short strikes ($145 and
$150). By using different short strikes,
you can create a wider profit range than
a ratio spread and provide more room to
profit if Apple continues to climb.
Finally, the ladder has a much higher
breakeven point, because its short 150
call is one strike above the ratio spread’s
short 145 calls. Selling a higher-strike
call lowers the possibility of losses if
AAPL rallies further than expected.
The bull call ladder’s wider profit
zone and higher breakeven point comes
at a cost, however. The position’s maxi-
mum profit is less than the call ratio
spread’s ($7.50 vs. $9.05), and its credit,
which you keep if Apple plummets, is
Source: OptionVue
also lower than the ratio spread’s ($2.50
vs. $4.05).
TABLE 4 — ITM LADDER DETAILS
If you buy a lower-strike 135 call, the ladder’s maximum profit is much higher Stretching the strikes
than either of the other two ladders ($9.75 vs. $7.50, respectively). The Apple position had equidistant strike
Components Long/short Credit/debit prices, but that isn’t the only way to build
1 August 135 call Long -$11.10 a call ladder. You can adjust its risk pro-
1 August 145 call Short $6.20 file by spreading the short strikes apart so
1 August 150 call Short $4.65 they are not equidistant. Or you can
Net debit: -$0.25 move the long call’s strike price higher or
Max. gain: $9.75 lower. With these modifications, you give
Downside breakeven: $135.25 up some initial credit in exchange for a
Max. downside loss: -$0.25 wider maximum profit zone, a higher
Upside breakeven: $159.75 breakeven point, or bigger potential
Max. upside loss: Unlimited gains.
Let’s start by increasing the distance
between the bull call ladder’s short 145
Apple, start by purchasing the same August call for $8.35. and 150 strikes. If you sell the August 155 call instead of the
Next, sell one same-month 145 call for $6.20 and sell one 150 150 call, this distance increases to $10. The 155 call costs less
call for $4.65 for a credit of $2.50. than the 150 call, so you collect less premium ($3.20 vs.
Basically, you are giving up some downside profit (i.e., $4.65, respectively).

FIGURE 4 — IN-THE-MONEY LADDER
Although this position could lose $25 if AAPL drops below $135.25, it could gain
$975 if Apple trades between the $145 and $150 short strikes at expiration.
Table 3 lists the modified ladder’s
components and Figure 3 compares
the wider-strike ladder to the original
spread (blue vs. green lines). The
wider spread includes a further OTM
short call, so its overall net credit
drops to $1.05 from $2.50. Therefore,
you will gain less if AAPL drops below
$140 by expiration. But the wider
spread has a larger maximum profit
zone and a higher breakeven point.
You can also move the ladder’s long
call into-the-money to create a slightly
different risk profile. This step increas-
es the distance between the long and
short calls and reduces the spread’s Source: OptionVue
overall credit. You may even have to
pay a small debit to enter this trade.
However, holding an ITM long call will increase the lad- Buying a lower-strike call increases the ladder’s potential
der’s potential gains, and the distance between the long and gains. Notice that the ITM ladder’s maximum profit ($9.75)
short strikes allows more room to profit on the upside. is higher than the other spreads’ largest gain ($7.50). Figure
For example, you could buy an ITM August 135 call for 4 shows there is not much profit to the downside, but the
$11.10 when Apple traded at $140 on July 19. Buying a call actual downside risk is only $0.25 per share. You still face
one strike lower costs an additional $2.75 per share, and a significant upside risk because of the uncovered 155 short
ladder with 135-145-150 strikes requires a net debit of $0.25. call. But the ITM ladder’s upside breakeven point is above
Table 4 shows this trade’s details, and Figure 4 shows its the original ladder’s ($159.75 vs. $157.50, respectively).
potential gains and losses at the Aug. 18 expiration. continued on p. 20
Related reading FIGURE 5 — LADDER VS. CONDOR ADJUSTMENT

Phil Budwick articles: The original bull call ladder (purple line) faces unlimited losses above $157.50.
“Squeezing extra profits from long calls” However, if AAPL rallies 3.6 percent within two weeks, you could then create a
Futures and Options Trader, May 2007. long call condor (green line) by buying an August 155 call. The adjustment low-
Before selling a winning long call, consider ers potential profits by $200, but it takes away all risk.
converting it into a spread to enhance its
potential profit.
“Calendar spreads surrounding

earnings news”
Options Trader, March 2007.
Trading options on stocks just before a com-
pany reports earnings isn’t always a great
idea, but this strategy takes advantage of the
market’s uncertainty in these situations.
“Avoiding options trading mistakes”

Options Trader, February 2007.
Some of the most popular option trades are
based on faulty assumptions about how
options behave. This discussion of common
mistakes and misconceptions might surprise Source: OptionVue
you.
“Directional butterfly spreads” bull call ladder (blue line), you will
Options Trader, December 2006. Adjusting the ladder realize that it corresponds to a con-
Butterflies aren’t just market-neutral strate- The original call ratio spread and dor’s risk profile with a missing
gies. They can be used to make directional bull call ladder (Figure 2) share higher-strike wing. To change the
bets with better risk-reward ratios than out- another important feature: Both original bull call ladder into a con-
right option purchases or simple vertical trades resemble market-neutral posi- dor, buy another call at a higher
spreads. tions with a missing “wing,” or pro- strike.
tective long call. A call ratio spread Let’s assume you entered the orig-
“Combining call calendar spreads resembles an unprotected long call inal bull call ladder on Apple for a
with stock” butterfly, and a bull call ladder credit of $2.50 per share on July 19
Options Trader, October 2006. resembles an unprotected long call (see Table 2). When you enter the
Adding a calendar spread to an underlying condor. Understanding these rela- trade, August options will expire in
position instead of simply creating a covered tionships is important, especially if 30 days, and the August 155 call costs
call offers some surprising benefits. The you want to adjust either trade to $3.30. If AAPL climbs to $145 from
combined strategy helps lock in profits with- take risk off the table. $140 within two weeks, the position
out sacrificing further upside gains. (With butterflies and condors, the should gain ground. However, you
“Selling premium with a twist,” two short strikes are closer to the are worried that Apple could climb
Options Trader, August 2006. money than the two long protective above $150, which would erode any
Ratio put spreads offer more potential profit options, which are placed above and gains and even lead to a large loss.
than other premium selling strategies such below the market. The butterfly’s You could simply close the spread,
as naked puts or simple credit spreads. And short options share the same strike, but that means giving up additional
these trades are more flexible than they ini- while a condor’s short options are at profits if AAPL does close within the
tially seem. different strikes.) ladder’s maximum profit range
If you study Figure 1’s call ratio ($145-$150) at expiration.
“Ratio call spreads,” spread, you will notice the left and At this point, the August 155 call
Options Trader, June 2006. middle sections match a butterfly’s will have lost value. Assuming it
Ratio call spreads can enhance an underly- risk profile — downside protection now trades at $2.00, down from
ing position’s potential gains at no extra cost, and maximum profit at the short $3.30, you could buy it and create a
or in many cases, for a net credit. strike. However, the right section long call condor for a net credit of
shows the significant risks of the $0.50. Buying the 155 call covers the
You can purchase and download past articles at
uncovered short call. short 150 call, removes all upside
http://www.activetradermag.com/purchase_articles.htm
Similarly, if you look at Figure 2’s risk, and eliminates the original bull

TABLE 5 — ADJUSTING THE BULL CALL LADDER
call ladder’s margin require-
ments. If the ladder posts a profit, you can take all risk off the table by buying a higher-strike
155 call and creating a call condor.
Table 5 shows how to adjust
the ladder, and Figure 5 com- Components Long/short Credit/debit
pares the risk profiles of the 1 August 140 call Long -$8.35
original ladder to the adjusted 1 August 145 call Short $6.20
condor (purple and green lines, 1 August 150 call Short $4.65
respectively). The adjustment Net credit: $2.50
creates a risk-free spread with a Scenario:
guaranteed profit of $0.50 and Apple climbs to $145 in two weeks (Aug. 2)
the chance to make more To create 140/145/150/155 call condor:
money if Apple trades between Buy 1 August 155 call: -$2.00
$140 and $155 at expiration. Net credit/"worst-case" gain: $0.50
Maximum profit: $5.50
The effects of implied
volatility and time
Because the bull call ladder has more short calls than long range of maximum profit and improving the odds of suc-
ones, the position is sensitive to changes in implied volatil- cess.
ity (IV). When IV rises, the short calls’ premiums will Ladders typically don’t collect as much premium as ratio
increase in a greater magnitude than the long calls. spreads, but they tend to be less risky. And you can cus-
Therefore, be careful not to enter these spreads when tomize a ladder by increasing the distance between short
implied volatilities are extremely low. strikes or moving the long strike into-the-money. Don’t for-
On the other hand, selling more calls than you buy helps get that ladders have extra short options, which increases
the spread benefit from time decay (i.e., positive theta), risks and margin requirements. But if the market moves in
especially if you use front-month options. the right direction, you can adjust a ladder to remove risk,
Some traders are wary of ratio spreads because they are or at least reduce it significantly.
exposed to significant losses on one side of the market.
Entering a ladder instead adds flexibility by widening the For information on the author see p. 6.
FUTURES TRADING SYSTEM LAB
The Price Movement Index (PMI)

TABLE 1.— THE PRICE MOVEMENT INDEX CALCULATION (JUNE 2007)
Market: Futures.
Price $ value $ value $
System concept: Last month’s
move of of price margin PMI Futures Trading System Lab tested the
Contract (ticks) tick move requirement (%) impact a market selection tool — the
Crude oil 404 10 4,040 4,050 99.75 Commodity Selection Index (CSI) — had
T-Bond 38 31.25 1,187.5 1,620 73.3 on a trend-following system. The logic
behind using the CSI is to dynamically
Corn 264 12.5 3,300 1,350 244.4
update the portfolio to concentrate
trades in markets exhibiting the most
relative trend potential.
The Price Movement Index
FIGURE 1 — SAMPLE TRADES
(PMI), featured in Nauzer
The CSI and the PMI have their differences, but they are definitely from the same family. Balsara’s book Money Management
Strategies For Futures Traders
(Wiley Finance, 1992), is a varia-
tion of the CSI that factors out its
directional movement and
volatility components.
“Price movement” is defined
simply as the difference between
high and low price extremes over
a given number of trading ses-
sions. The 10-day price move-
ment, for example, is the differ-
ence between the highest high
and lowest low over the past 10
trading days. The PMI measures
the amount of price movement in
dollar (rather than point or per-
centage) terms and expresses it
relative to a contract’s dollar mar-
gin requirement. The higher the
PMI — that is, the greater the dol-
lar value of a price move in a mar-
ket relative to its margin require-
Source: Wealth-Lab
ment — the more attractive the
STRATEGY SUMMARY
Profitability Basic w/PMI Trade statistics Basic w/PMI

Net profit ($): 210,179.27 491,617.37 No. trades: 1,512 549
Net profit (%): 21.02% 49.16% Win/loss (%): 32.80% 35.52%
Profit factor: 1.02 1.15 Avg. profit/loss (%): 0.15% 0.32%
Payoff ratio: 2.22 2.15 Avg. hold time (days): 20.37 20.94
Recovery factor: 0.25 1.36 Avg. profit (winners) %: 6.01% 5.84%
Exposure (%): 11.06% 4.13% Avg. hold time (winners): 39.71 40.03
Drawdown Avg. loss (losers) %: -2.71 -2.71
Max. DD (%): -48.42 -30.66 Avg. hold time (losers) : 10.93 10.43
Longest flat period: 1,629 days 903 days Max consec. win/loss: 7/22 7/12
Improvements highlighted in blue

PERIODIC RETURNS
Percentage Max Max

Avg. Sharpe Best Worst profitable consec. consec.
return ratio return return periods profitable unprofitable
Basic PMI Basic PMI Basic PMI Basic PMI Basic PMI Basic PMI Basic PMI
Monthly 0.46% 0.45% 0.06 0.09 28.77% 21.73% -18.27% -9.36% 46.67 52.50 6 6 5 4
Quarterly 1.13% 1.30% 0.09 0.16 34.43% 18.06% -14.27%-11.69% 42.50 50.00 3 3 3 4
Annually 3.29% 4.27% 0.18 0.37 37.97% 23.59% -24.61%-10.56% 54.55 63.64 4 6 2 2
FIGURE 2 — EQUITY CURVE (BASIC) LEGEND:

Low-probability trades destroyed the equity run-up. Avg. hold time — The average holding period
for all trades.
Avg. hold time (losers) — The average hold-
ing time for losing trades.
Avg. hold time (winners) — The average
holding time for winning trades.
Avg. loss (losers) — The average loss for
losing trades.
Avg. profit/loss — The average profit/loss for
all trades.
Avg. profit (winners) — The average profit for
winning trades.
Avg. return — The average percentage for
the period.
Best return — Best return for the period.
Exposure — The area of the equity curve
exposed to long or short positions, as
opposed to cash.
Longest flat period — Longest period (in
days) between two equity highs.
Max consec. profitable — The largest num-
Source: Wealth-Lab ber of consecutive profitable periods.
Max consec. unprofitable — The largest
number of consecutive unprofitable periods.
opportunity. The formula is: trend-following strategy used here Max consec. win/loss — The maximum num-
will take trade signals in the markets ber of consecutive winning and losing trades.
PMI = ((dollar value of price move with the five highest PMI readings at Max. DD (%) — Largest percentage decline
over x bars * 100) / margin require- the time of entry. The strategy identi- in equity.
ment) * 100 fies an uptrend after a certain number Net profit — Profit at end of test period, less
of consecutive closes above (below for commission.
Note: Initial testing indicated using downtrends and short trades) the trail-
No. trades — Number of trades generated by
the closing price difference rather than ing close from approximately a month the system.
intraday highs and lows did not sig- ago.
Payoff ratio — Average profit of winning
nificantly change the indicator’s end Two tests were conducted. The first
trades divided by average loss of losing
result. test executed all entry signals generat- trades.
Table 1 shows sample PMI calcula- ed by this system, while the second
Percentage profitable periods — The per-
tions in three markets. The numbers test limited the number of simultane-
centage of periods that were profitable.
indicate that in June 2007, the 14-day ous open positions to the five markets
Profit factor — Gross profit divided by gross
PMI clearly favored a trend trade in which have the highest PMI values for
loss.
corn. that day.
Recovery factor — Net profit divided by max.
Figure 1 shows the PMI along with
drawdown.
the CSI. In general, the PMI is more Strategy rules:
Sharpe ratio — Average return divided by
sensitive than the CSI, which general- 1. Calculate the 14-day PMI of
standard deviation of returns (annualized).
ly looks like a smoothed version of the today for each contract.
PMI. However, both indicators appear 2. Enter long tomorrow at the Win/loss (%) — The percentage of trades
that were profitable.
to be in sync. market when there have been
Similar to last month’s test, the continued on p. 34 Worst return — Worst return for the period.

FUTURES TRADING SYSTEM LAB continued
FIGURE 3 — EQUITY CURVE (PMI) most recent 20 days.

The equity curve improved notably after applying the PMI. 5. Exit short position on a stop at the
highest close of the most recent 20 days.
Money management: Risk 1 percent of

account equity per position.
Starting equity: $1,000,000 (nominal).

Deduct $8 commission and 0.1 percent slip-
page per trade.
Test data: Active Trader Standard Futures

Portfolio, which contains the following 20
futures contracts: British pound (BP), soybean
oil (BO), corn (C), crude oil (CL), cotton #2
(CT), E-Mini Nasdaq 100 (NQ), E-Mini S&P 500
(ES), 5-year T-note (FV), euro (EC), gold (GC),
Japanese yen (JY), coffee (KC), wheat (W), live
cattle (LC), lean hogs (LH), natural gas (NG),
sugar #11 (SB), silver (SI), Swiss franc (SF), and
T-Bonds (US). This test used ratio-adjusted
data from Pinnacle Data Corp.
(http://www.pinnacledata.com).
Source: Wealth-Lab
Test period: July 1997 to June 2007.
10 consecutive closes above the trailing close from
20 days ago. Test results: As was the case last month, this month’s
3. Enter short tomorrow at the market when there have basic system is merely representative and its performance is
been 10 consecutive closes below the trailing close second rate.
from 20 days ago. Nothing in its performance catches the eye. The 21-per-
4. Exit long position on a stop at the lowest close of the cent net profit is low, the average trade size is small enough
FIGURE 4 — DRAWDOWNS
The system’s drawdown was reduced in length as well as time.
Source: Wealth-Lab

FIGURE 5 — ANNUAL PERFORMANCE (PMI)
The PMI system was more profitable and profits were more
uniformly distributed.
to make it difficult for the system to overcome trading costs,

and the low winning percentage and high market exposure
complete the strategy’s unattractiveness. Nonetheless, the
equity curve (Figure 2) shows the system was able to exploit
the recent bullish run-up in commodities, doubling its cap-
ital at one point. It gave back its gains in an enormous
drawdown that nearly erased the system’s profits. This
makes the system a perfect guinea pig for the PMI.
The results after applying the PMI were positive. The net
profit jumped from 21 percent to 49 percent for a 4-percent
annualized gain. The average trade size doubled, reducing
worries about trading costs.
There was no visible improvement in the winning/losing
trade statistics, except the reduction of the number of con-
secutive losers (from 22 to 12) and an insignificant upturn in
the win/loss percentage. Also, there was no visible increase
in the Sharpe and payoff ratios.
However, the PMI filter was good at weeding out low-
probability trade signals. Almost 1,000 trades were dropped
(from the initial 1,500-plus), reducing market exposure 2.75
times. The maximum drawdown shrank from -48.4 percent
to -30.7 percent, improving the Recovery Factor to 1.36. The Source: Wealth-Lab
original equity curve, which resembled a
jagged mountain profile, stabilized (Figure 3). FIGURE 6 — PROFITS BY CONTRACT
Actual drawdown levels are much lower
compared to test 1, so the system is slowing The PMI brought more diversity, and thus, more stability, to per-market profits.
down its profitability rate right where it had
experienced a 1,200-day drawdown before
(Figure 4). The drawdown levels of the sys-
tem’s individual long/short components also
decreased.
Figure 5 shows the annual returns of the
PMI-ranked system where the profit distribu-
tion is more uniform and the profitable periods
experienced an increase from six to seven.
Notice how the second test didn’t have the best
periodic returns, but instead delivered smaller
losing periods than the first test.
The relative contribution of the portfolio’s
components in the first test is a concern — the
majority of profits (35 percent) were concen-
trated in the euro (EUR). The euro’s profit was Source: Reports-Lab
actually larger than the net profit, meaning this
single market became a locomotive for the whole portfolio. sound signal-filtering tools.
This is exactly the opposite of what you’d like to see in real — Volker Knapp of Wealth-Lab
trading.
Using the PMI benefited the portfolio in this sense, allo- For information on the author see p. 6.
cating good portions of profits between several markets
(Figure 6). Futures Lab strategies are tested on a portfolio basis (unless otherwise noted)
using Wealth-Lab Inc.’s testing platform. If you have a system you’d like to see
tested, please send the trading and money-management rules to
Bottom line: There was no substantial improvement in
editorial@activetradermag.com.
the key performance metrics, but the most visible effect of
ranking signals by the PMI is a reduction of poor-quality Disclaimer: The Futures Lab is intended for educational purposes only to
trades and noticeably smoother, more efficient perform- provide a perspective on different market concepts. It is not meant to rec-
ance. ommend or promote any trading system or approach. Traders are advised
Like its root (the CSI), the PMI was able to weed the to do their own research and testing to determine the validity of a trading
majority of fruitless trades. Despite the differences in their idea. Past performance does not guarantee future results; historical testing
calculations, testing indicates both these tools are useful may not reflect a system’s behavior in real-time trading.

OPTIONS TRADING SYSTEM LAB
ADX credit spread system

Market: Options on individual stocks.
FIGURE 1 — BEAR CALL SPREAD — RISK PROFILE
System could also be applied to indices
The system entered a bear call spread on Wal-Mart (WMT) on May 21. It has a 69-
and exchange-traded funds (ETFs) with percent probability of profit and will be profitable if WMT closes below $47.94 by June
liquid option contracts. 16 expiration.
System concept: This system uses

the Average Directional Movement
Index (ADX) to trade breakouts with
credit spreads. The idea is to spot a flat
market and enter a spread in the direc-
tion of a new trend.
A low ADX reading implies little
directional movement, or a flat market.
The longer the ADX remains low, the
more likely a strong move will appear.
The system identifies a neutral market if
the ADX stays below 20 for 30 trading
days. Then, it enters a bull put spread
(short put, long lower-strike put) if price
strengthens or a bear call spread (short
call, long higher-strike call) if price
weakens.
This concept was first tested prof-
itably in the futures markets (see, “ADX
Consolidation Breakout 1,” Futures and Source: OptionVue
Options Trader, May 2007). However, a
recent Options Lab captured gains with FIGURE 2 — CREDIT SPREAD PERFORMANCE
an opposite approach. Instead of search- The credit spread strategy lost 6.8 percent since February 2001.
ing for breakouts, it used the ADX to
pinpoint flat markets and entered iron
condors (bull put spread + bear call
spread) to exploit these directionless
periods (see “Trading iron condors with
the ADX,” Futures and Options Trader,
June 2007).
By contrast, this system applies the
original ADX rules to the options market
and attempts to exploit directional
moves in several widely held stocks.
When you enter a vertical credit
spread, you sell an option that is closer
to the money than one you buy to pro-
tect it. The spread tries to exploit the
short option’s time decay and collects
the most profit if a stock doesn’t reverse
beyond your entry price by expiration. Source: OptionVue
Both options share the same expiration
month, and when strikes are $5 apart, the position requires reward-risk ratio. Assuming the system trades 10 contracts,
total margin of $500 per contract. its maximum potential loss was $4,580, while its largest gain
Figure 1 shows a June bear call spread on Wal-Mart (WMT). was only $450 if held until expiration — a reward-risk ratio of
The system entered when Wal-Mart closed at $46.62 on May only 1:10.
21, and the trade would be profitable if WMT trades below Credit spreads only risk a defined amount, but you can lose
$47.94 by June 16 expiration. This credit spread had a poor money quickly if the underlying moves against you.

STRATEGY SUMMARY
Net gain/loss ($): -1,360.00

Percentage return (%): -6.8
Therefore, the system uses a trailing stop and exits after a
Annualized return (%): -1.1
stock hits the highest high (or lowest low) of the past five
No. of trades: 59
days.
Winning/losing trades: 26/33
Win/loss (%): 44
Trade rules:
Entry Avg. trade ($): -23.05
1. If the 14-day ADX remains below 20 for the past 30 Largest winning trade ($): 1,090.00
days, then either: Largest losing trade ($): -1,070.00
Avg. profit (winners): 399.62
a. Enter a bull put spread if the trend strengthens Avg. loss (losers): -356.06
(+DI moves above –DI), or Avg. hold time (winners): 17
b. Enter a bear call spread if the trend weakens (-DI Avg. hold time (losers): 7
moves above +DI). Max consec. win/loss : 8/10
2. To enter either spread, sell an at-the-money (ATM)

option in the first month with 21 days or more until One feature stands out: Losses were held only seven
expiration. Buy a same-month, same-type option with days, on average. This reduced the chance of a large loss,
a strike $5 further out-of-the-money (OTM). If the but it may have closed the positions too soon. Credit
short option’s premium is less than $0.50, then sell an spreads rely on time decay, and it takes time to capture their
option in the nearest month with $0.50 premium full profit potential. Next month’s Options Trading System
available. Lab tests another ADX-related idea: Buying options in the
direction of a breakout. This approach might work better for
3. If trade is stopped out and another signal appears such a short holding period.
when the ADX is below 20, enter another spread. Note: This test included minimal commissions, but larger
fees and bad fills will likely affect performance.
Exit
1. Close bull put spread if stock reaches the lowest low of — Steve Lentz and Jim Graham of OptionVue
the past five days, or
2. Close bear call spread if stock reaches the highest high
of the past five days, or LEGEND:
3. Let credit spread expire worthless. Net gain/loss – Gain or loss at end of test period, less commission.
Percentage return – Gain or loss on a percentage basis.
Test details: Annualized return – Gain or loss on an annualized percentage
• The test account began with $20,000 in capital. basis.
• Each position held 10 contracts per “leg.” No. of trades – Number of trades generated by the system.
• Daily closing prices were used. Winning/losing trades – Number of winners/losers generated by the
• Trades were executed at the bid and ask, when system.
available. Otherwise, theoretical prices were used. Win/loss (%) – The percentage of trades that were profitable.
• Commissions were $5 base fee plus $1 per option. Avg. trade – The average profit for all trades.
Largest winning trade – Biggest individual profit generated by the
Test data: The system was tested using options on Apple system.
Computer (AAPL), Citicorp (C), General Electric (GE), Intel Largest losing trade – Biggest individual loss generated by the
(INTC), Johnson and Johnson (JNJ), Microsoft (MSFT), and system.
Wal-Mart (WMT). Avg. profit (winners) – The average profit for winning trades.
Avg. loss (losers) – The average loss for losing trades.
Test period: Feb. 9, 2001 to May 29, 2007. Avg. hold time (winners) – The average holding time for winning
trades.
Avg. hold time (losers) – The average holding time for losing trades.
Test results: Figure 2 tracks the credit spread’s perform-
Max consec. win/loss – The maximum number of consecutive
ance, which lost $1,360 (6.8 percent) over the six-year test
winning and losing trades.
period. Each spread had a high probability of profit (typi-
cally 60 percent or higher), but more than half of all trades Option System Analysis strategies are tested using OptionVue’s
(66 percent) lost money. BackTrader module (unless otherwise noted).
The strategy’s average losing trade (-$356.06) was less If you have a trading idea or strategy that you’d like to see tested,
than its average winner ($399.62). However, posting losses please send the trading and money-management rules to
two-thirds of the time took its toll. Advisor@OptionVue.com.

INDUSTRY NEWS
…for your thoughts
Options exchanges give their two cents on penny pricing
U .S. options exchanges began penny trading in 13

select options in January, with an eye on increas-
ing the number of options classes available for
such pricing.
reduced by as much as 90 percent. However, the CBOE isn’t
convinced this proves penny pricing works.
“CBOE does not believe that quoting 13 option classes in
The pilot program, mandated by the Securities and

Exchange Commission (SEC), was designed to see how
“CBOE does not believe that quoting
options of different volumes, liquidity, and strike prices
fared with penny pricing. As option spreads are typically
13 option classes in penny increments
five or 10 cents, the pilot program lowered that to five cents
for options contracts costing more than $3, and a penny for over three months provides sufficient
contracts costing less than $3. (The exception was QQQQ
options, which always traded in pennies in the pilot.) data and information to make an
The six exchanges — the Chicago Board Options
Exchange (CBOE), the International Securities Exchange informed decision as to the program’s
(ISE), NYSE-Arca, the Philadelphia Stock Exchange (PHX),
the American Stock Exchange (AMEX), and the Boston
Options Exchange (BOX) — were required to study the
success or a basis to aggressively
option classes in the pilot program and report to the SEC.
The results were consistent across the six exchanges, as
expand the pilot program”
all reported a decrease — 30 percent, overall — in the aver-
age spread. In some individual classes, spreads were
—CBOE report to the SEC
The blame game
Congress continues Amaranth query
I n September 2006, the Amaranth hedge fund lost

almost $8 billion in value. The fund’s holdings were
primarily in natural gas.
Amaranth’s demise, though, presents a chicken-egg sce-
nario: Did the natural gas market collapse because
any customer who trades more than 12,000 contracts in a
month. Amaranth held as many as 100,000 contracts at time
— about 40 percent of the open interest at the NYMEX at
any time and as much as 75 percent of the contracts traded
in a month.
Amaranth controlled so much of it, or did the market col- Amaranth’s strategy was straightforward: It believed
lapse cause Amaranth to lose all its value? winter gas prices would be much more expensive than
A U.S. Senate subcommittee has continued to investigate summer and fall prices, because demand for natural gas
the circumstances surrounding the demise of Amaranth. In increased as colder temperatures demanded more homes to
late June and July, they held hearings that included a former use gas.
Amaranth trader and executives of the New York Typically, January gas futures cost $1 to $1.50 more than
Mercantile Exchange (NYMEX) and Intercontin- October futures. In 2006, though, January futures were $4
entalExchange (ICE), the two leading energy exchanges in more than October 2005 contracts, and Amaranth’s control
the U.S. Specifically, the government is interested in know- of the market was a big reason why.
ing why regulators didn’t — or couldn’t — intervene before Gas traders told the subcommittee that despite the inflat-
the situation reached a crisis level. ed prices, which were completely out of line with supply
The Senate also subpoenaed trading records and found and demand, they were hesitant to short contracts, knowing
Amaranth held an inordinate amount of natural gas con- Amaranth had the ability to keep prices high through large
tracts. The Commodity Futures Trading Commission trades.
(CFTC) considers anyone with more than 200 contracts a Utilities, in particular, had no choice but to pay the high-
“large trader,” and the NYMEX examines the holdings of continued on p. 40

MANAGED MONEY
penny increments over three months pro-
vides sufficient data and information to Top 10 option strategy traders ranked by June 2007 return
make an informed decision as to the pro- (Managing at least $1 million as of June 30, 2007.)
gram’s success or a basis to aggressively
2007
expand the pilot program,” the exchange June YTD $ under
wrote in its report to the SEC. Rank Trading advisor return return mgmt.
Reduced increments also tend to lead to 1. Ascendant Asset Adv. (Strategic2) 44.97 -5.19 23.2M
smaller quote sizes, because liquidity that 2. Argus Capital Mgmt (S&P Option) 16.59 -28.67 1.7M
was once concentrated in one five-cent
3. Aksel Capital Mgmt (Growth & Income) 11.52 3.62 6.9M
price point can now be spread out over five
penny price points. The results of the pilot 4. Parrot Trading Partners 10.71 -10.33 7.0M
program bore that out, as the average 5. Ascendant Asset Adv. (Strategic1) 10.56 30.91 3.5M
quote-size drop for the six exchanges was 6. Oxeye Capital Mgmt. (FTSE 100) 8.00 8.72 18.0M
32 percent.This is an area of concern for the
7. Oxeye Capital Mgmt. (Crude Oil) 6.54 17.15 3.5M
CBOE.
“Liquidity at the best bid or offer in the 8. Singleton Fund 6.49 40.37 11.0M
pilot classes has decreased substantially,” 9. Kawaller Fund 5.96 24.19 1.8M
the exchange wrote. “CBOE has also expe- 10. LJM Partners (Fund I) 5.67 -2.18 45.9M
rienced a reduction in the number of liq-
Source: Barclay Trading Group (http://www.barclaygrp.com)
uidity providers in the pilot classes, partic-
ularly the QQQQs, and believes that trend Based on estimates of the composite of all accounts or the fully funded subset method.
may continue if the pilot program is Does not reflect the performance of any single account.
expanded significantly. Although spreads PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
have narrowed in the pilot classes, some of
CBOE’s liquidity providers have expressed
that these narrowed spreads in the penny series are not sus- larger than the average retail order, ensuring adequate liq-
tainable and more time is needed to accurately assess the uidity.
impact on spreads of quoting in penny increments.” Other exchanges, though, were a bit more cautious.
Quote mitigation (the ability of the exchange’s trading The CBOE proposed to expand the pilot program by 37
systems to handle the additional quotes that come with stocks to 50. Each exchange would select five stocks, and
extra price points), which was a concern before the pilot the SEC would choose the remaining seven. While the orig-
began, was not an issue at any of the exchanges, although inal 13 stocks would keep their pricing, the new 37 would
all six had changed their platforms to handle the expected have penny quotes for contracts costing less than $1, and
increase in quotes. nickel quotes for other contracts.
The AMEX believes the exchanges’ ability to mitigate According to the CBOE, “Such an expansion would be
quotes should provide a change in the future. meaningful as approximately 45 percent of the volume in
“The Commission should work with the exchanges on most option classes is in series priced below $1. Thus,
implementing revised rules for the addition of new series CBOE’s proposal for expansion would allow for further
on all underlying securities, particularly expiration series analysis on a greater scale of quoting in these reduced incre-
replacements,” the exchange wrote in its report. “It is clear ments, and provide customers with penny pricing in those
to us that there is little or no value in listing strike prices series where it is most beneficial, i.e., below $1.”
from $2.50 to $50 on an $18 equity simply because those The ISE is also asking the SEC to be careful about expand-
strikes existed in the expiring month. Yet month after ing penny pricing. The exchange believes if an expansion
month we find ourselves adding these strikes for competi- occurs, penny quoting should be restricted to options where
tive reasons after another exchange adds them. By putting the underlying stock has high liquidity, low volatility, low
greater control on the listing of new series, the Commission value, and high retail appeal, and the option contract trades
could more seriously consider the expansion of one-point for less than $3.
strikes along with new Penny Pilot classes.” In a press release put out after the exchanges had provid-
Of all the exchanges, the BOX was the most optimistic ed their studies, the SEC said it had not concluded that
about penny trading. It told the SEC it believes the penny penny quoting in all options is appropriate. The
pilot has been a success and should be expanded to more Commission said it would evaluate which particular
option classes as soon as possible. Spreads and prices are options would most benefit from smaller increments.
definitely lower, and while quote size has dropped, it is still The pilot program concluded on July 25.

INDUSTRY NEWS continued
er price so they were adequately hedged against price jumps. after the fund imploded, disputed the notion Amaranth held
When the market collapsed, not only did Amaranth go “excessive” positions in natural gas contracts, telling the sub-
broke, but other traders were already locked in to their posi- committee “I understood that other market participants
tions and unable to take advantage of the lower prices. engaged in trading comparable in size to that of Amaranth.”
After their first round of interviews earlier in the year, the Lee also told the subcommittee he didn’t think Amaranth’s
committee concluded regulators were mostly powerless to act trading led to any price distortions.
because of the “Enron loophole,” a last-minute addition to a “The exchanges in question are high-volume, extremely liq-
bill passed in 2000 that states large traders in energy and uid markets, which are capable of absorbing transactions of
metal commodities on an electronic exchange are exempt the size of Amaranth’s trading,” he says.
from government oversight. Lee said that giving the ICE the same regulatory require-
ments as the NYMEX would add to the administrative bur-
dens of OTC traders and the ICE, but it would also increase
“The assertion that ICE is ‘unregulated,’ transparency, allow for the monitoring of open interest, and
help prevent improper conduct.
or is somehow comparable to Enron, In his testimony, NYMEX CEO James Newsome said that
because his exchange and the ICE are closely linked, the
integrity of the NYMEX markets was still at risk even when
however, is simply false and derisive.” Amaranth switched its positions to the ICE. Plus, the NYMEX
had no way to monitor Amaranth’s trading on the ICE.
—Jeffrey Sprecher, CEO of the ICE While Newsome said he did not favor increased regula-
tions of true OTC transactions, he believed “exempt commer-
That’s where Amaranth ran into trouble. In August 2006, cial markets” such as the ICE that function more like tradi-
the NYMEX, concerned with Amaranth’s large position, tional exchanges should have the same regulations as estab-
ordered the fund to reduce its positions. Amaranth did so, but lished exchanges.
they subsequently re-established the position at the ICE (the “Legislative change may be necessary to address the real
ICE contracts were swaps, not futures, but they functioned in public interest concerns created by the current structure of the
the same manner). natural gas market and the potential for systemic financial
The subcommittee’s implication was the NYMEX, which risk from a market crisis involving significant activity occur-
has a trading floor, is subject to government regulation ring on the unregulated trading venue,” Newsome said.
(although a large percentage of NYMEX energy trades occur Newsome recommended the CFTC be given additional
electronically). The all-electronic ICE is not, thanks to the legal authority to monitor aggregate positions on the NYMEX
Enron loophole. and the ICE, and the CFTC and all exchanges should improve
However, not everybody closely involved with the their monitoring and oversight to prevent excessive specula-
Amaranth situation agreed with the findings of the subcom- tion in all futures contracts, not just the months nearest to
mittee when it revisited the matter in the summer. expiration.
For starters, Jeffrey Sprecher, CEO of the ICE, told the sub- And despite his objections to certain findings by the
committee his exchange is not subject to the Enron loophole Subcommittee, Sprecher agrees that CFTC funding needs to
and is in favor of closing it. be increased, and the regulator should have greater access to
“It is accurate to state that ICE is not regulated in the same the ICE and the NYMEX.
manner as designated contract markets, but this is largely due “However, these markets are fundamentally different in
to the practicalities of the OTC market structure,” Sprecher significant respects, and any regulatory approach must take
said. “The assertion that ICE is ‘unregulated,’ or is somehow those differences into account,” Sprecher said. “While we sup-
comparable to Enron, however, is simply false and derisive.” port the maintenance of a ‘level playing field,’ we do not
Furthermore, Sprecher said that for all the talk of the believe that this can or should result in regulating cash-settled
NYMEX making Amaranth reduce its positions, the exchange OTC contracts in the same manner as physically settled
only did so during the final three days of the contract, and it futures contracts because they are fundamentally different
requires only an accountability report at other times. products.”
“NYMEX took no action as Amaranth consistently exceed- In July, the CFTC proposed legislation that would require
ed its accountability levels,” Sprecher said. “In fact, NYMEX traders on regulated exchanges to disclose their holdings on
increased the limits applicable to Amaranth, apparently based unregulated exchanges. The CFTC is also seeking greater
solely on Amaranth’s unsubstantiated requests and without monetary help from Congress, as its annual budget of just less
seeking information about Amaranth’s trading on ICE or than $100 million per year is about 11 percent of the SEC’s
other markets, despite its ability to request and obtain such budget.
information from market participants.” Among other things, the CFTC wants authorization to col-
Shane Lee, a trader with Amaranth who left the firm soon lect user fees from members, just as the SEC does.
40 August 2007 • OPTIONS TRADER

NEW PRODUCTS AND SERVICES
The Nasdaq plans to launch a new investor analytics present daily figures. USFE will initially list seven index
service through its Shareholder.com subsidiary — futures contracts based on two wind regions in New York
“Pinpoint Market Intelligence,” which is analysis of institu- and five wind regions in Texas as defined by the National
tional purchases and sales of a specific stock. This analysis Oceanic and Atmospheric Administration’s (NOAA)
is provided confidentially to the issuer and is used for National Center for Environmental Prediction division.
measuring and benchmarking investor relations program The futures contracts will be settled monthly. USFE and
effectiveness and prioritizing management and staff time Weather Bid also plan to develop a comprehensive suite of
spent with investors. Pinpoint Market Intelligence will be futures contracts for the benefit of renewable energy,
available to all public companies and delivered to Nasdaq- including hydro, solar, geothermal and biomass, and will
listed companies through the Market Intelligence Desk work closely with renewable energy advocacy groups to
(MID). Pinpoint Market Intelligence is expected to launch in promote the new contracts. For further information, visit
the fourth quarter of 2007 and will be available to compa- http://www.usfe.com.
nies listed on all U.S. exchanges. Pricing is based on trading
volume, market cap, and additional Shareholder.com serv- InstantBull Inc. has implemented a new ranking
ices purchased. For more information visit system that continuously monitors the top 100 stock market
http://www.nasdaq.com. bloggers on the Web. The system is based on impartial rank-
ings from services at Alexa and Technorati. The new soft-
Rosenthal Collins Group (RCG) has announced its ware release is free and also features “daily ticker trends”
new trading platform, RCG Onyx 2. The RCG Onyx 2 under InstantBull.com’s “Hot” tab. Investors can view
futures platform features Web-based access to comprehen- search trends for the most popular tickers over the course of
sive information, as well as enhanced speed, functionality, the last four days. For more information, visit
and performance. Through the launch of RCG Onyx 2, RCG http://www.InstantBull.com.
offers its own trading platform with an integrated interface
that allows clients to monitor positions and cash move- Note: The New Products and Services section is a forum for industry
ments for electronic and open outcry trading real time, businesses to announce new products and upgrades. Listings are
review statements and attributes of their account, and view adapted from press releases and are not endorsements or recommen-
prices as well as cleared transactions, among other features. dations from the Active Trader Magazine Group. E-mail press releas-
RCG Onyx 2 enables users to connect to all major futures es to editorial@futuresandoptionstrader.com. Publication is not guar-
exchanges globally and also includes trailing stops and anteed.
bracket orders, easy viewing of market
depth, multiple windows to facilitate
multi-market trading, Excel data
export capability, customizable screen
layouts, an easy online tutorial, and
around-the-clock client support. The
HIT YOUR MARK!
firm will immediately begin transi-
tioning its RCG Onyx clients to the
Advertise in Active Trader Magazine
platform. Further information about
Rosenthal Collins Group can be found
at http://www.rcgdirect.com.
U.S. Futures Exchange

(USFE) is now listing futures con-
tracts on NORDIX Financial Wind Contact Bob Dorman
Indexes, created by Weather Bid, LLC, Ad sales East Coast
that measure deviations from average and Midwest
wind speeds used in wind power gen- bdorman@activetradermag.com
eration. The contracts provide a finan- (312) 775-5421
cial hedging vehicle for wind resource
owners, developers, financiers, and Allison Ellis
consumers of wind energy. NORDIX Ad sales West Coast
Financial Wind Indexes are bench- and Southwest
marks for wind variability. USFE’s aellis@activetradermag.com
futures contracts are the first listed (626) 497-9195
exchange products designed to reflect
the needs of the greater renewable Mark Seger
energy community. The NORDIX Account Executive
Financial Wind Indexes are composed seger@activetradermag.com
of deviations from 20-year historical (312) 377-9435
wind speed averages compared with

FUTURES SNAPSHOT (as of July 26)
The following table summarizes the trading activity in the most actively traded futures contracts. The information does NOT constitute
trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility.
See the legend for explanations of the different fields. Volume figures are for the most active contract month in a particular market and
may not reflect total volume for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity for CME futures
is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).
Pit E- 10-day % 20-day % 60-day % Volatility
Market Sym Sym Exch Vol OI move Rank move Rank move Rank ratio/rank
S&P 500 E-Mini ES CME 1.50 M 1.64 M -4.35% 100% -2.04% 100% -0.32% 0% .50 / 100%
10-yr. T-note TY ZN CBOT 1.44 M 2.81 M 2.03% 100% 1.92% 100% -0.83% 20% .47 / 73%
5-yr. T-note FV ZF CBOT 541.9 1.55 M 1.87% 100% 1.12% 100% -0.06% 1% .52 / 92%
30-yr. T-bond US ZB CBOT 435.7 982.9 2.84% 100% 2.10% 100% -1.74% 43% .36 / 65%
Eurodollar* ED GE CME 406.8 1.68 M 0.09% 100% 0.07% 100% 0.08% 96% .66 /100%
Nasdaq 100 E-Mini NQ CME 343.5 388.8 -1.68% 100% 2.30% 32% 6.09% 50% .24 / 34%
Russell 2000 E-Mini ER CME 232.1 549.0 -7.71% 100% -6.32% 100% -3.41% 94% 1.03 / 100%
2-yr. T-note TU ZT CBOT 216.7 983.8 0.90% 100% 0.86% 100% 0.06% 8% .65 / 100%
Crude oil CL NYMEX 206.5 292.3 3.38% 25% 8.67% 70% 16.38% 82% .19 / 3%
Eurocurrency EC 6E CME 155.6 199.8 -0.36% 0% 2.08% 65% 0.86% 17% .22 / 55%
Mini Dow YM CBOT 150.6 83.5 -2.77% 100% 0.10% 0% 2.70% 18% .28 / 81%
Japanese yen JY 6J CME 120.7 288.0 3.04% 100% 2.81% 100% 1.01% 56% .48 / 100%
British pound BP 6B CME 83.3 151.1 0.95% 20% 2.61% 67% 2.43% 78% .30 / 30%
Gold 100 oz. GC NYMEX 70.9 167.7 -0.82% 57% 1.91% 71% -1.82% 41% .58 / 83%
Swiss franc SF 6S CME 66.4 105.8 -0.12% 0% 1.79% 65% 0.79% 41% .37 / 58%
Corn C ZC CBOT 62.3 208.9 -9.68% 50% -7.63% 26% -13.61% 93% .48 / 67%
Canadian dollar CD 6C CME 49.3 141.0 -0.84% 100% 1.42% 22% 5.18% 30% .13 / 32%
Natural gas NG NYMEX 48.7 82.1 -6.51% 29% -14.25% 70% -21.30% 96% .47 / 67%
Sugar SB NYBOT 47.0 319.5 5.36% 50% 5.91% 50% 11.82% 100% .31 / 42%
RBOB gasoline RB NYMEX 39.7 54.4 -9.40% 75% -7.03% 82% -8.03% 90% .45 / 88%
Australian dollar AD 6A CME 38.0 113.1 0.61% 0% 4.22% 94% 5.06% 60% 21 / 58%
S&P 500 index SP CME 37.5 583.4 -4.36% 100% -2.04% 100% -0.03% 0% .50 / 100%
Soybeans S ZS CBOT 34.4 59.1 -10.17% 100% 2.24% 14% 10.82% 44% .63 / 80%
Wheat W ZW CBOT 33.7 111.4 4.76% 64% 7.43% 34% 33.29% 94% .24 / 17%
Heating oil HO NYMEX 30.4 56.0 -2.06% 83% 1.28% 10% 10.80% 38% .25 / 53%
S&P MidCap 400 E-Mini ME CME 26.1 93.7 -5.96% 100% -3.60% 100% -1.84% 67% .69 / 100%
Soybean oil BO ZL CBOT 21.6 44.9 -3.51% 100% 4.66% 45% 9.58% 33% .21 / 45%
Gold 100 oz. ZG CBOT 20.3 17.6 -0.82% 17% 2.78% 82% -2.16% 45% .57 / 83%
Mexican peso MP 6M CME 19.5 76.2 -2.16% 100% -1.39% 90% -0.66% 40% .60 / 90%
Silver 5,000 oz. SI NYMEX 18.8 55.1 -1.75% 13% 6.06% 94% -2.23% 25% .42 / 43%
Soybean meal SM ZM CBOT 17.1 30.5 -14.19% 100% -0.09% 0% 9.89% 31% .86 / 95%
Live cattle LC LE CME 13.8 62.9 -0.11% 0% 3.11% 60% -1.97% 18% .15 / 17%
Crude oil e-miNY QM NYMEX 12.0 4.7 3.38% 25% 8.67% 73% 16.38% 82% .19 / 3%
Lean hogs LH HE CME 11.9 28.4 -1.25% 0% 1.14% 53% -3.81% 67% .11 / 35%
Coffee KC NYBOT 9.7 69.0 0% 0% 0.91% 13% 6.25% 84% .53 / 92%
Nikkei 225 index NK CME 9.4 50.8 -5.08% 100% -3.87% 100% -0.35% 10% .76 / 100%
Fed Funds** FF ZQ CBOT 7.4 45.4 0.03% 100% 0.03% 100% 0.03% 100% 2.37 / 100%
Cocoa CC NYBOT 6.7 68.1 -3.56% 100% -0.94% 38% 9.21% 33% .33 / 63%
Copper HG NYMEX 5.3 14.1 -2.21% 50% 4.93% 43% -2.57% 15% .28 / 85%
Nasdaq 100 index ND CME 4.8 59.1 -1.68% 100% 2.30% 32% 6.09% 50% .24 / 33%
Dow Jones Ind. Avg. DJ ZD CBOT 4.8 32.4 -2.77% 100% 0.10% 0% 2.70% 18% .28 / 80%
Cotton CT NYBOT 4.7 11.1 -6.90% 100% 1.59% 9% 25.99% 85% .38 / 44%
Silver 5,000 oz. ZI CBOT 4.5 5.4 -1.77% 13% 6.02% 94% -3.08% 34% .44 / 49%
Mini-sized gold YG CBOT 4.1 6.2 -0.82% 17% 2.78% 82% -2.16% 45% .57 / 83%
U.S. dollar index DX NYBOT 3.6 30.2 -0.19% 5% -2.19% 65% -1.58% 52% .17 / 38%
New Zealand dollar NE 6N CME 3.6 41.7 -0.04% 100% 3.38% 53% 5.41% 47% .28 / 73%
Natural gas e-miNY QG NYMEX 2.8 3.0 -6.51% 33% -8.73% 43% -21.42% 95% .45 / 65%
*Average volume and open interest based on highest-volume contract (March 2008).
**Average volume and open interest based on highest-volume contract (November 2007).
Legend (10-day moves, 20-day moves, etc.) show the of 100 percent means the current reading is
Vol: 30-day average daily volume, in thou- percentile rank of the most recent move to a larger than all the past readings, while a read-
sands (unless otherwise indicated). certain number of the previous moves of the ing of 0 percent means the current reading is
same size and in the same direction. For smaller than the previous readings. These fig-
OI: Open interest, in thousands (unless other-
example, the “% Rank” for 10-day move ures provide perspective for determining how
wise indicated).
shows how the most recent 10-day move relatively large or small the most recent price
10-day move: The percentage price move compares to the past twenty 10-day moves; move is compared to past price moves.
from the close 10 days ago to today’s close. for the 20-day move, the “% Rank” field shows Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move how the most recent 20-day move compares term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. to the past sixty 20-day moves; for the 60-day prices) divided by the long-term volatility (100-
60-day move: The percentage price move move, the “% Rank” field shows how the most day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. recent 60-day move compares to the past the percentile rank of the volatility ratio over
The “% Rank” fields for each time window one-hundred-twenty 60-day moves. A reading 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.
OPTIONS RADAR (as of July 26)
MOST-LIQUID OPTIONS*
Options Open 10-day % 20-day % IV/SV IV/SV ratio —
Indices Symbol Exchange volume interest move rank move rank ratio 20 days ago
Housing index HGX PHLX 1.21 M 23.9 -10.14% 100% -11.23% 97% 33.5% / 24.8% 25.2% / 20.9%
Banking index BKX PHLX 607.9 58.6 -7.49% 100% -6.69% 100% 28.7% / 18.4% 16.3% / 12.4%
S&P 500 index SPX CBOE 160.6 1.54 M -4.20% 100% -1.57% 75% 19.2% / 13.2% 14.4% / 12.5%
E-mini S&P 500 futures ES CME 28.4 152.8 -4.18% 100% -1.86% 100% 19.3% / 13.4% 13.7% / 14.3%
S&P 100 index OEX CBOE 18.6 131.7 -3.48% 100% -0.59% 30% 19.8% / 12.4% 13.5% / 12%
Stocks
Research in Motion RIMM 4.57 M 14.57 M 3.79% 0% 36.82% 96% 40% / 40.9% 42.2% / 48.7%
Apache APA 3.34 M 13.35 M -3.40% 44% 1.21% 18% 30.9% / 27.1% 30.9% / 27%
Cameco CCJ 2.73 M 12.73 M -18.60% 94% -18.86% 95% 46.9% / 38.5% NA
Deckers Outdoor DECK 910.0 10.9 1M -7.71% 100% -4.01% 100% 48.6% / 33.1% NA
Potash Saskatchewan POT 310.0 10.31 M -2.65% 100% 3.43% 5% 49.0% / 40.3% 46% / 42.7%
Futures
Eurodollar ED-GE CME 403.2 12.31 M 0.09% 100% 0.09% 100% 11.9% / 2.3% 9.6% / 1.1%
10-year T-notes TY-ZN CBOT 103.5 1.19 M 2.03% 100% 2.00% 100% 6.4% / 5.3% 4.6% / 5.4%
Corn C-ZC CBOT 51.7 805.8 -9.68% 50% -7.63% 26% 27.2% / 36.9% 37% / 37.6%
Crude oil CL NYMEX 49.8 623.4 3.21% 25% 7.56% 60% 28.6% / 20.2% 26.4% / 26.2%
VOLATILITY EXTREMES**
Indices — High IV/SV ratio
Russell 2000 index RUT CBOE 17.5 422.2 -7.45% 100% -5.60% 100% 26.4% / 16.1% 19.5% / 14.9%
S&P 100 index OEX CBOE 18.6 131.7 -3.48% 100% -0.59% 30% 19.8% / 12.4% 13.5% / 12%
Dow Jones index DJX CBOE 1.4 139.9 -2.80% 100% 0.34% 2% 19.1% / 12% 13.7% / 11.9%
Banking Index BKX PHLX 607.9 58.6 -7.49% 100% -6.69% 100% 28.7% / 18.4% 16.3% / 12.4%
Nasdaq 100 index NDX CBOE 16.2 157.0 -1.70% 100% 2.77% 47% 19.6% / 12.6% 16.4% / 13.7%
Indices — Low IV/SV ratio

S&P 500 volatility index VIX CBOE 13.6 596.6 33.46% 100% 33.55% 98% 78.2% / 118.9% 73.8% / 113.9%
Stocks — High IV/SV ratio

Rambus RMBS 1.8 241.1 -10.97% 100% -12.19% 100% 51.6% / 18.5% 43% / 27.7%
Alltel AT 1.21 M 104.2 -2.64% 100% -2.72% 100% 19.5% / 8% 13.6% / 5.1%
Radian Group RDN 3.03 M 22.2 -20.65% 100% -22.67% 100% 51.9% / 25.4% 37.7% / 24.2%
Rite Aid RAD 609.2 144.8 -8.51% 100% -9.11% 100% 49.7% / 24.9% 45.4% / 28.9%
iShares MSCI Emerg Mkt EEM 5.2 470.2 -5.87% 100% 1.24% 12% 38.5% / 19.4% 27.8% / 23.3%
Stocks — Low IV/SV ratio

Bausch & Lomb BOL 2.0 157.3 -4.92% 67% -4.82% 100% 9.6% / 20.8% 17.7% / 22.4%
Alcan AL 1.6 98.0 -2.29% 80% 18.91% 59% 16.8% / 24% 34.1% / 21.4%
Huntsman HUN 3.03 M 14.2 -4.59% 20% 3.79% 33% 17.8% / 22.4% 17.9% / 25.2%
Futures — High IV/SV ratio

Eurodollar ED-GE CME 403.2 12.31 M 0.09% 100% 0.09% 100% 11.9% / 2.3% 9.6% / 1.1%
Mini Dow YM CBOT 2.0 13.0 -2.77% 100% 0.10% 0% 19.1% / 12.3% 13.8% / 13.1%
Natural gas NG NYMEX 5.5 37.0 -6.42% 33% -8.64% 44% 73.6% / 49.5% 50.3% / 32.2%
Japanese yen JY-6J CME 4.8 74.8 3.04% 100% 2.81% 100% 9% / 6.1% 8.1% / 4.2%
Futures — Low IV/SV ratio

Sugar SB NYBOT 16.4 395.9 5.36% 50% 5.91% 50% 22.7% / 37.1% 27.9% / 38.6%
Corn C-ZC CBOT 51.7 805.8 -9.68% 50% -7.63% 26% 27.2% / 36.9% 37% / 37.6%
Orange juice OJ NYBOT 1.1 26.6 9.59% 100% 12.90% 90% 35% / 47% 43.5% / 43.9%
Soybean meal SM-ZM CBOT 5.4 45.3 -14.19% 100% -0.09% 0% 26.5% / 34.5% 28.9% / 23.4%
Cotton CT NYBOT 15.8 184.3 -6.90% 100% 1.59% 9% 23.1% / 27.6% 22.4% / 23.9%
*Ranked by volume **Ranked by high or low IV/SV values.
LEGEND:
Options vol: 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 asset.
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 exam-
ple, 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.

KEY CONCEPTS
The option “Greeks”
Delta: The ratio of the movement in the option price for
every point move in the underlying. An option with a
American style: An option that can be exercised at any delta of 0.5 would move a half-point for every 1-point
time until expiration. move in the underlying stock; an option with a delta of
1.00 would move 1 point for every 1-point move in the
Assign(ment): When an option seller (or “writer”) is underlying stock.
obligated to assume a long position (if he or she sold a put)
or short position (if he or she sold a call) in the underlying Gamma: The change in delta relative to a change in the
stock or futures contract because an option buyer exercised underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
the same option.
and lowest for deep ITM and OTM options.
At the money (ATM): An option whose strike price is Theta: The rate at which an option loses value each day
identical (or very close) to the current underlying stock (or (the rate of time decay). Theta is relatively larger for
futures) price. OTM than ITM options, and increases as the option gets
closer to its expiration date.
Average directional movement index (ADX):
Measures trend strength, regardless of direction. The high- Rho: The change in option price relative to the change
er the ADX value, the stronger the trend, whether the mar- in the interest rate.
ket is going up or down. The indicator can be applied to any
time frame, although it is typically used on daily charts. Vega: How much an option’s price changes per a one-
percent change in volatility.
Although the ADX concept is straightforward, its calcu-
lation is rather lengthy. The indicator was designed by
Welles Wilder and is described in detail in his book New 5. Calculate the directional index (DX) by taking the
Concepts in Technical Trading Systems (Trend Research 1978). absolute value of the difference between the +DI value
and the -DI value, dividing that by the sum of the +DI
Calculation: and -DI values, and multiplying by 100.
1. Calculate the positive or negative directional move-
ment (+DM and -DM) for each bar in the desired look- 6. To create the ADX, calculate a moving average of the
back period. Bars that make higher highs and higher DX over the same period as the lookback period used
lows than the previous bar have positive directional throughout the other calculations.
movement. Bars that make lower highs and lower lows
than the previous bar have negative directional move- Bear call spread: A vertical credit spread that consists
ment. of a short call and a higher-strike, further OTM long call in
If a bar has both a higher high and a lower low than the same expiration month. The spread’s largest potential
the previous bar, it has positive directional gain is the premium collected, and its maximum loss is lim-
movement if its high is above the previous high more ited to the point difference between the strikes minus that
than its low is below the previous low. Reverse this premium.
criterion for negative directional movement. An inside
bar (a bar that trades within the range of the Bear put spread: A bear debit spread that contains puts
previous bar) has no directional movement, and nei- with the same expiration date but different strike prices.
ther does a bar whose high is above the previous high You buy the higher-strike put, which costs more, and sell
by the same amount its low is below the previous low. the cheaper, lower-strike put.
2. If a bar has positive (negative) directional move- Beta: Measures the volatility of an investment compared
ment, the absolute value of the distance between to the overall market. Instruments with a beta of one move
today’s high (low) and yesterday’s high (low) is added in line with the market. A beta value below one means the
to the running totals of +DM (-DM) calculated over a instrument is less affected by market moves and a beta
given lookback period (i.e., 20 bars, 30 bars, etc.). The value greater than one means it is more volatile than the
absolute value is used so both +DM and -DM are pos- overall market. A beta of zero implies no market risk.
itive values.
Bull call spread: A bull debit spread that contains calls
3. Calculate the sum of the true ranges for all bars in with the same expiration date but different strike prices.
the lookback period. You buy the lower-strike call, which has more value, and
sell the less-expensive, higher-strike call.
4. Calculate the Directional Indicator (+DI and -DI) by
dividing the running totals of +DM and -DM by the Bull put spread (put credit spread): A bull credit
sum of the true ranges. spread that contains puts with the same expiration date, but

different strike prices. You sell an OTM put and buy a less-
expensive, lower-strike put. Credit spread: A position that collects more premium
from short options than you pay for long options. A credit
Butterfly: A non-directional trade consisting of options spread using calls is bearish, while a credit spread using
with three different strike prices at equidistant intervals: puts is bullish.
Long one each of the highest and lowest strike price options
and short two of the middle strike price options. Deep (e.g., deep in-the-money option or deep
out-of-the-money option): Call options with strike
Calendar spread: A position with one short-term short prices that are very far above the current price of the under-
option and one long same-strike option with more time lying asset and put options with strike prices that are very
until expiration. If the spread uses ATM options, it is mar- far below the current price of the underlying asset.
ket-neutral and tries to profit from time decay. However,
OTM options can be used to profit from both a directional Delta-neutral: An options position that has an overall
move and time decay. delta of zero, which means it’s unaffected by underlying
price movement. However, delta will change as the under-
Call option: An option that gives the owner the right, but lying moves up or down, so you must buy or sell
not the obligation, to buy a stock (or futures contract) at a shares/contracts to adjust delta back to zero.
fixed price.
Diagonal spread: A position consisting of options with
Carrying costs: The costs associated with holding an different expiration dates and different strike prices — e.g.,
investment that include interest, dividends, and the oppor- a December 50 call and a January 60 call.
tunity costs of entering the trade.
Double diagonal spread: A double diagonal resembles
Condor: A non-directional trade with options at four dif- an iron condor (call credit spread + put credit spread), but
ferent strike prices at equidistant intervals: Long one each the long side of each spread expires in a later month. This
of the highest and lowest strike price options and short two position combines two diagonal spreads on either side of
options with strikes in between these extremes. the market and tries to exploit the time decay of the short,
near-term options. It collects the most profit if the market
Continuous futures data (sometimes referred to trades sideways by expiration.
as “nearest futures”): Unlike stock (or spot currency) To construct a double diagonal, enter two spreads simul-
prices, which are unbroken price series, futures prices con- taneously: a call spread, which consists of a short out-of-
sists distinct contract months that begin and end at specific the-money call and a long, higher-strike call in a further
points in time. To perform longer-term analysis or system month; and a put spread, which consists of a short OTM put
testing you need a continuous, unbroken price series, simi- and a long, lower-strike put in a more-distant month. Both
lar to stock prices. However, because of the price differen- spread’s short options share the same expiration month,
tial between different contract months in the same futures and the long options expire together at least one month
market, moving from the prices in one month to the next later.
creates a fractured price series that doesn't accurately reflect
the market’s movement. European style: An option that can only be exercised at
Continuous futures data are prices that have been adjust- expiration, not before.
ed to compensate for the price gaps between successive
contract months. Typically, the data is “back adjusted” by Exercise: To exchange an option for the underlying
raising or lowering all previous prices in the series by the instrument.
difference between the last price in the continuous series
and the new data to be added to the series. The result is an Expiration: The last day on which an option can be exer-
unbroken price series that accurately reflects the day-to-day cised and exchanged for the underlying instrument (usual-
(or week-to-week) price changes in a market, but not the ly the last trading day or one day after).
actual price levels.
In the money (ITM): A call option with a strike price
Covered call: Shorting an out-of-the-money call option below the price of the underlying instrument, or a put
against a long position in the underlying market. An exam- option with a strike price above the underlying instru-
ple would be purchasing a stock for $50 and selling a call ment’s price.
option with a strike price of $55. The goal is for the market
to move sideways or slightly higher and for the call option Intrinsic value: The difference between the strike price
to expire worthless, in which case you keep the premium. continued on p. 46

KEY CONCEPTS continued
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 Put spreads: Vertical spreads with puts sharing the same
value if the underlying market is trading at 24. expiration date but different strike prices. A bull put spread
contains short, higher-strike puts and long, lower-strike
Iron condor: A market-neutral position that enters a bear puts. A bear put spread is structured differently: Its long
call spread (OTM call + higher-strike call) above the market puts have higher strikes than the short puts.
and a bull put spread (OTM put + lower-strike put) below
the market. Both spreads collect premium, and profit when Ratio spread: A ratio spread can contain calls or puts and
the market trades between the short strikes by expiration. includes a long option and multiple short options of the
All options share the same expiration month. same type that are further out-of-the-money, usually in a
ratio of 1:2 or 1:3 (long to short options). For example, if a
Lock-limit: The maximum amount that a futures contract stock trades at $60, you could buy one $60 call and sell two
is allowed to move (up or down) in one trading session. same-month $65 calls. Basically, the trade is a bull call
spread (long call, short higher-strike call) with the sale of
Long call condor: A market-neutral position structured additional calls at the short strike.
with calls only. It combines a bear call spread (short call, Overall, these positions are neutral, but they can have a
long higher-strike further OTM call) above the market and directional bias, depending on the strike prices you select.
a bull call spread (long call, short higher-strike call). Unlike Because you sell more options than you buy, the short
an iron condor, which contains two credit spreads, a call options usually cover the cost of the long one or provide a
condor includes two types of spreads: debit and credit. net credit. However, the spread contains uncovered, or
“naked” options, which add upside or downside risk.
Long-Term Equity AnticiPation Securities
(LEAPS): Options contracts with much more distant expi- Straddle: A non-directional option spread that typically
ration dates — in some cases as far as two years and eight consists of an at-the-money call and at-the-money put with
months away — than regular options. the same expiration. For example, with the underlying
instrument trading at 25, a standard long straddle would
Market makers: Provide liquidity by attempting to prof- consist of buying a 25 call and a 25 put. Long straddles are
it from trading their own accounts. They supply bids when designed to profit from an increase in volatility; short strad-
there may be no other buyers and supply offers when there dles are intended to capitalize on declining volatility. The
are no other sellers. In return, they have an edge in buying strangle is a related strategy.
and selling at more favorable prices.
Strangle: A non-directional option spread that consists of
Naked (uncovered) puts: Selling put options to collect an out-of-the-money call and out-of-the-money put with
premium that contains risk. If the market drops below the the same expiration. For example, with the underlying
short put’s strike price, the holder may exercise it, requiring instrument trading at 25, a long strangle could consist of
you to buy stock at the strike price (i.e., above the market). buying a 27.5 call and a 22.5 put. Long strangles are
designed to profit from an increase in volatility; short stran-
Open interest: The number of options that have not gles are intended to capitalize on declining volatility. The
been exercised in a specific contract that has not yet expired. straddle is a related strategy.
Outlier: An anomalous data point or reading that is not Strike (“exercise”) price: The price at which an under-
representative of the majority of a data set. lying instrument is exchanged upon exercise of an option.
Out of the money (OTM): A call option with a strike Time decay: The tendency of time value to decrease at an
price above the price of the underlying instrument, or a put accelerated rate as an option approaches expiration.
option with a strike price below the underlying instru-
ment’s price. Time spread: Any type of spread that contains short
near-term options and long options that expire later. Both
Parity: An option trading at its intrinsic value. options can share a strike price (calendar spread) or have
different strikes (diagonal spread).
Premium: The price of an option.
Time value (premium): The amount of an option’s
Put option: An option that gives the owner the right, but value that is a function of the time remaining until expira-
not the obligation, to sell a stock (or futures contract) at a tion. As expiration approaches, time value decreases at an
fixed price. accelerated rate, a phenomenon known as “time decay.”

Vertical spread: A position consisting of options with
True range (TR): A measure of price movement that the same expiration date but different strike prices (e.g., a
accounts for the gaps that occur between price bars. This September 40 call option and a September 50 call option).
calculation provides a more accurate reflection of the size of
a price move over a given period than the standard range Volatility: The level of price movement in a market.
calculation, which is simply the high of a price bar minus Historical (“statistical”) volatility measures the price fluctu-
the low of a price bar. The true range calculation was devel- ations (usually calculated as the standard deviation of clos-
oped by Welles Wilder and discussed in his book New ing prices) over a certain time period — e.g., the past 20
Concepts in Technical Trading Systems (Trend Research, 1978). days. Implied volatility is the current market estimate of
True range can be calculated on any time frame or price future volatility as reflected in the level of option premi-
bar — five-minute, hourly, daily, weekly, etc. The following ums. The higher the implied volatility, the higher the option
discussion uses daily price bars for simplicity. premium.
True range is the greatest (absolute) distance of the fol-
lowing: Volatility skew: The tendency of implied option volatil-
ity to vary by strike price. Although, it might seem logical
1. Today’s high and today’s low. that all options on the same underlying instrument with the
2. Today’s high and yesterday’s close. same expiration would have identical (or nearly identical)
3. Today’s low and yesterday’s close. implied volatilities. For example, deeper in-the-money and
out-of-the-money options often have higher volatilities than
Average true range (ATR) is simply a moving average of at-the-money options. This type of skew is often referred to
the true range over a certain time period. For example, the as the “volatility smile” because a chart of these implied
five-day ATR would be the average of the true range calcu- volatilities would resemble a line curving upward at both
lations over the last five days. ends. Volatility skews can take other forms than the volatil-
ity smile, though.
EVENTS
Event: Forex Trading Expo Dates: Sept. 29-Oct. 1, Seattle, Wash.

Date: Sept. 15-16 Nov. 30-Dec. 2, Schaumburg, Ill.
Location: Mandalay Bay Hotel and Casino, Las Vegas
For more information: Event: 20th Annual IFTA Conference
Visit http://www.forextradingexpo.com Date: Nov. 8-11
Location: Sharm el Sheikh, Egypt
Event: FIA and OIC New York Equity Options For more information: Visit
Conference http://www.ifta.org/events/next-conference/
Date: Sept. 19-20
Location: Grand Hyatt New York Event: The Traders Expo Las Vegas
For more information: Visit Date: Nov. 15-18
http://www.futuresindustry.org and click on “Conferences.” Location: Mandalay Bay Resort and Casino,
Las Vegas, Nev.
Event: Paris Trading Show For more information: Visit
Date: Sept. 21-22 http://www.tradersexpo.com
Location: Espace Champerret, Paris, France
For more information: Visit http://www.salonat.com
Event: 23rd Annual Futures & Options Expo
Event: Wealth Expo Date: Nov. 27-29
For more information: Dates and locations are listed Location: Hyatt Regency Chicago, Chicago, Ill.
here or visit http://www.thewealthexpo.com For more information: Visit
http://www.futuresindustry.org and click on “Conferences.”

FUTURES & OPTIONS CALENDAR AUGUST/SEPTEMBER
MONTH
August 23 FND: September crude oil futures
Legend (NYMEX); September coffee futures
1 FDD: August coal, natural gas, and
(NYBOT)
CPI: Consumer Price Index crude oil futures (NYMEX); August
aluminum, copper, palladium, platinum, 24 LTD: September T-bond options
ECI: Employment cost index
silver, and gold futures (NYMEX); (CBOT); September oats, rice, wheat,
First delivery day (FDD): August soybean products and soybean corn, soybean products, and soybean
The first day on which deliv- futures (CBOT) options (CBOT)
ery of a commodity in fulfill-
ment of a futures contract can
2 LTD: July milk options (CME) 25
FND: August propane, gasoline, and
take place. 26
heating oil futures (NYMEX)
First notice day (FND): Also 27
known as first intent day, this 3 July employment report
is the first day a clearing- LTD: August currencies options (CME); 28 LTD: September coal futures (NYMEX);
August U.S. dollar index options September natural gas, gasoline, and
house can give notice to a
buyer of a futures contract (NYBOT); September cocoa options heating oil options (NYMEX); September
that it intends to deliver a (NYBOT); August live cattle options aluminum, copper, silver, and gold
commodity in fulfillment of a (CME) options (NYMEX); August pork belly
futures contract. The clearing- futures (CME)
4
house also informs the seller. 29 LTD: September natural gas futures
FOMC: Federal Open Market
5 (NYMEX); August aluminum, copper,
Committee 6 FND: August pork belly and live cattle palladium, platinum, silver, and gold
GDP: Gross domestic futures (CME) futures (NYMEX)
product FDD: August propane futures (NYMEX) FND: September coal futures (NYMEX)
ISM: Institute for supply man- 7 FOMC meeting 30 Q2 GDP (prelim)

agement FDD: August pork belly futures (CME) LTD: August feeder cattle futures and
options (CME); August milk options
LTD: Last trading day; the 8 FDD: August gasoline and heating oil
first day a contract may trade (CME)
futures (NYMEX)
or be closed out before the FND: September natural gas futures
9 FDD: August live cattle futures (CME) (NYMEX)
delivery of the underlying
asset may occur. 10 LTD: September sugar and coffee 31 LTD: September propane, gasoline, and
PPI: Producer price index options (NYBOT) heating oil futures (NYMEX); September
Quadruple witching Friday: 11 lumber options (CME); August live cattle
futures (CME)
A day where equity options, 12 FND: September T-bond futures
equity futures, index options,
and index futures all expire.
13 July retail sales (CBOT); September aluminum, copper,
14 July PPI palladium, platinum, silver, and gold
LTD: August soybean futures (CBOT); futures (NYMEX)
August lean hogs futures and options
AUGUST 2007
(CME) September
29 30 31 1 2 3 4
15 July CPI 1 FDD: September coal, natural gas,
5 6 7 8 9 10 11
LTD: September platinum options and crude oil futures (NYMEX)
12 13 14 15 16 17 18 (NYMEX); August Goldman Sachs
2
19 20 21 22 23 24 25 commodity index options (CME)
3 Markets closed — Labor Day
26 27 28 29 30 31 1 16 LTD: September crude oil options
FND: September oats, rice, wheat, corn,
(NYMEX)
soybean products, and soybean futures
17 LTD: All August equity options; August (CBOT)
SEPTEMBER 2007 S&P options (CME); August Nasdaq
4 FND: September orange juice futures
26 27 28 29 30 31 1 options (CME); August Russell options
(NYBOT)
(CME); August Dow Jones options
2 3 4 5 6 7 8 FDD: September T-bond futures
(CBOT); August September cotton and
9 10 11 12 13 14 15 (CBOT); September aluminum, copper,
orange juice options (NYBOT)
platinum, palladium, silver, and gold
16 17 18 19 20 21 22
18 futures (NYMEX); September oats, rice,
23 24 25 26 27 28 29 wheat, corn, soybean products, and
19
30 1 2 3 4 5 6 soybean futures (CBOT); September
20 FND: September cocoa futures cocoa and coffee futures (NYBOT)
(NYBOT)
The information on this page is 5 FND: September propane, gasoline,
subject to change. Futures & 21 LTD: September crude oil futures and heating oil futures (NYMEX)
Options Trader is not responsible (NYMEX)
for the accuracy of calendar dates
beyond press time. 22
FUTURES TRADE JOURNAL
Like many trades, this cocoa

position was neither a home run
nor a strikeout. But prudent
management prevented giving back
profits on the back end of the trade.
TRADE
Date: Tuesday, July 3, 2007.
Entry: Long September 2007 cocoa

futures (CCU07) at 2,058.
Reasons for trade/setup: Cocoa

made a new 60-day high on June 29 and Source: TradeStation
rallied more than 125 points from the low
six days earlier. Testing this condition showed there was a Profit/loss: +47 (first half); +13 (second half).
positive expectancy of continued upside movement —
analysis that was buttressed by odds of a higher close on Trade executed according to plan? Yes.
the weekly time frame.
We actually wanted to wait for the market to pull back a Outcome: Cocoa followed through strongly almost
little after the big up day on June 29, but it basically moved immediately, and we raised the stop to 2,071 after the first
sideways for the next two days. We entered on July 3 half of the trade was filled on July 5. This locked in a profit
toward the end of the session, and near the middle of the on the total trade.
day’s range (and the closing price). The market made it as high as 2,141 — just 9 shy of the
secondary profit target — on both July 6 and July 7, but that
Initial stop: 2,021, which is 9 points above the June 29 was the end of the story. The contract gapped lower the next
low. day, tumbling below 2,120 before stabilizing somewhat and
moving back above 2,100.
Initial target: 2,105, which is approximately the median Perhaps the market’s failure to push above the July 6
gain of 1.8 percent above the previous high. Take partial high on July 7 should have been interpreted as a sign the
profits and raise stop. market’s momentum was ebbing, but at the time it seemed
this was simply a pause — rather than the beginning of a
Secondary target: 2,150. pullback — in a very strong bull move. However, given that
interpretation, we should have raised the stop even higher,
which would have resulted in leaving less money on the
RESULT table. But at least we didn’t pull the raised stop at the last
minute, or otherwise tinker with a serviceable trade
Exit: 2,105 (first half); 2,071 (second half). plan.
TRADE SUMMARY
Date Contract Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
7/3/07 CCU07 2,058 2,021 2,105 1.27 2,105 7/5/07 47 (2.3%) 83 147 1 day
2,071 7/10/07 13 (0.6%) 4 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).

OPTIONS
FOREX TRADE JOURNAL
DIARY
Riding the coattails of fund managers when they adjust to a change in the S&P 500 index.
FIGURE 1 — RIGHT DIRECTION, BAD FILL

After opening 5.22 percent higher, Akamai Technologies fell 1.56 percent by the
TRADE close, as expected. However, the long July 55 put broke even because of a bad fill
in an illiquid market.
Date: Tuesday, July 10.
Market: Options on Akamai

Technologies (AKAM).
Entry: First trade — buy 1

July 55 put for $5.60.
Second trade — buy 1
July 45 call for $4.50.
Reasons for trade/setup: On

July 9 Standard and Poor’s
announced it would add Akamai
Technologies (AKAM) to the S&P
500 index within two days.
Akamai would replace BioMet Inc.
(BMET), which was acquired by a
private equity firm.
Standard and Poor’s releases
statements about S&P 500 index Source: eSignal
changes after the close. Historical
testing shows that stocks jumped
TRADE SUMMARY
3.98 percent, on average,
overnight after it was announced
First trade Second trade
they were being added to the S&P
500 index (see “Testing the S&P Entry date: July 10 July 10
500 effect,” Active Trader, July Underlying security: Akamai Technologies same
2007). (AKAM)
However, traders have tended Position: 1 long 55 put at $5.60 1 long 45 call at $4.50
to overreact to these announce- Captial required: $560 $450
ments since 2000. After opening
Initial stop: Exit if AKAM rallies Exit if AKAM falls
higher, stocks dropped 1.18 per-
1 percent 1 percent
cent by the close. Then, stocks ral-
Initial target: Hold until close Hold until close
lied 0.76 percent on the day
Standard and Poor’s adds them — Initial daily time decay: -$2.33 -$2.56
the so-called “effective date.” We Trade length (in days): 1 1
plan to exploit two possible moves P/L: $0 $90 (20 percent)
in Akamai Technologies: an intra- LOP: $0 $90
day decline on July 10 and a rally
LOL: -$60 $0
the next day — AKAM’s effective
date. LOP — largest open profit (maximum available profit during lifetime of trade);
One simple way to profit from LOL — largest open loss (maximum potential loss during life of trade).
an underlying move is to buy in-
50 August 2007 • OPTIONS TRADER

FIGURE 2 — EFFECTIVE-DAY RALLY YIELDS RESULTS
Akamai climbed 1.75 percent on its effective date and the long July 45 call’s value
rose $0.90 — a 20-percent gain.
the-money (ITM) calls and puts.
ITM options often have deltas near
1, which means their prices move
in line with a stock’s price.
Figure 1 shows that Akamai
Technologies opened 5.22 percent
higher on the news. We bought 1
July 55 put for $5.60 when AKAM
traded at $49.83 just after the open-
ing bell on July 10. This long ITM
put has a delta of -0.92, so it should
gain ground if Akamai sells off.
We plan to exit at the close and
then purchase a high-delta July call
Source: eSignal
that will profit if AKAM rallies the
next day. An exit is triggered if
Akamai moves against either trade by 1 percent. is added to the S&P 500 index.
Figure 2 shows that AKAM climbed 1.19 percent by 12:30
Initial stop: Exit position if AKAM rallies 1 percent (put) p.m. on its effective date. The ITM call was sold for $5.40 for
or drops 1 percent (call) by the close. a profit of $0.90 (20 percent). The first trade wasn’t perfect,
but the second one captured solid gains.
Initial target: Hold until close.
TRADE STATISTICS
RESULT
First trade Entry Exit
Outcome: After opening higher,
Date July 10 — 9:20 a.m. CT July 10 — 2:30 p.m. CT
Akamai started to drop within five
Delta -92.11 -94.60
minutes (see Figure 1). We bought
Gamma 3.08 3.17
a July 55 put before AKAM fell 0.84
Theta -2.33 -1.25
percent by mid morning and trad-
ed lower throughout the day. Vega 1.57 1.12
In theory, we should have made Probability of profit 42 percent 49 percent
money on the first trade. In reality, Breakeven point $49.40 $49.40
options on Akamai were illiquid
and the wide bid-ask spread erod- Second trade Entry Exit
ed any potential profits. (Less than
Date July 10 — 2:30 p.m. CT July 11 — 12:30 p.m. CT
100 July 55 put contracts traded on
July 10.) The put was sold for $5.60 Delta 92.20 96.34
when AKAM traded at $49.48 and Gamma 4.66 2.71
we broke even. Theta -2.56 -1.69
Next, we bought a July 45 call Vega 1.19 0.63
for $4.50 when AKAM traded near Probability of profit 48 percent 60 percent
its daily lows that afternoon. It had
Breakeven point $49.50 $49.50
a delta of 0.96 — ideal for exploit-
ing a possible rally when Akamai

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Strategies, analysis, and news for futures and options traders.

August 2007 • Volume 1, Issue 5

GOLD TRADING HURRICANES AND

Bull call ladders . . . . . . . . . . . . . . . . . . . . . .26

Futures Strategy Lab

Trading Strategies Options Strategy Lab

Putting put-call parity to work . . . . . . . . .20

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New Products and Services . . . . . . . . . . . . .41 Futures Trade Journal . . . . . . . . . . . . . . .49

Have a question about something you’ve seen

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

eSignal Options Industry Council

4 August 2007 • FUTURES & OPTIONS TRADER

Marc Allaire is a consultant to the Chicago Board Options

6 August 2007 • FUTURES & OPTIONS TRADER

FIGURE 1 — THIRTY YEARS OF GOLD

Source: CQGNet (http://www.cqg.com)

8 August 2007 • FUTURES & OPTIONS TRADER

on two exchanges — the New York Mercantile

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2. The average close-to-close change was

4. On down-closing days, gold was up on the

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“The platinum-gold sentiment spread”

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14 August 2007 • FUTURES & OPTIONS TRADER

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18 August 2007 • FUTURES & OPTIONS TRADER

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For information on the author see p. 6.

FUTURES & OPTIONS TRADER • August 2007 19

Putting put-call parity

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20 August 2007 • FUTURES & OPTIONS TRADER

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FUTURES & OPTIONS TRADER • August 2007 21

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22 August 2007 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • August 2007 23

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“Repairing a losing covered call”

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24 August 2007 • FUTURES & OPTIONS TRADER