FOT200908

August 2009 • Volume 3, No.
FUTURES STRATEGY:
The MAX moving
average p. 10
CROSSING THE OPTIONS
finish line p. 14
OPTION
MARTINGALE
system p. 18
NEW POSITION
LIMITS
for futures
traders? p. 22
TWISTS AND
TURNS
in the crude oil
market p. 33
RATING
UPGRADE
option play p. 34
CONTENTS
Options Trading System Lab

Naked-call Martingale
strategy on the Russell 2000 . . . . . . . . . .18
A risky system that doubles down after losses
generates surprisingly consistent performance.
By Steve Lentz and Jim Graham
News
CFTC flexes muscles on
position limits . . . . . . . . . . . . . . . . . . . . . . .22
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6 The ICE’s natural gas market becomes the
CFTC’s first target as it looks to reign in
Market Movers . . . . . . . . . . . . . . . . . . . . . . . .8 speculative positions in U.S. commodity markets.
Futures market roundup.
Futures Snapshot . . . . . . . . . . . . . . . . . . . .24
Trading Strategies Momentum, volatility, and volume
The Power of X: The MAX statistics for futures.
moving average . . . . . . . . . . . . . . . . . . . . .10
A novel approach to weighting prices
results in a new moving average that
compares favorably to its mainstream
counterparts.
By Stephan Bisse
Crossing the options finish line . . . . . . .14

A simple technique for setting profit
targets makes it easier to identify
potentially profitable option trades.
By George Hoekstra continued on p. 4
2 August 2009 • FUTURES & OPTIONS TRADER

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090706_273x206_FOT.indd 1 29/06/2009 13:28:54

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

References and definitions.
Futures & Options Calendar . . . . . . . . . . . .31
New Products and Services . . . . . . . . . . . . .32

Options Radar . . . . . . . . . . . . . . . . . . . . . . .25
Notable volatility and volume Futures Trade Journal . . . . . . . . . . . . . . .33
in the options market. Old-fashioned resistance level generates a trade
in the volatile crude oil market. But support and
Futures & Options Watch resistance are vague levels upon which to hang
COT extremes . . . . . . . . . . . . . . . . . . . . . . .26 precise stops.
A look at the relationship between commercials
and large speculators in U.S. futures markets. Options Trade Journal . . . . . . . . . . . . . . .34
Hooking up with Dow newcomer Cisco Systems.
Options Watch:
S&P 500 Health care sector . . . . . . . . . .26 Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
Have a question about something you’ve seen

in Futures & Options Trader?
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CONTRIBUTORS
CONTRIBUTORS
A publication of Active Trader ®
For all subscriber services:

www.futuresandoptionstrader.com
Editor-in-chief: Mark Etzkorn

metzkorn@futuresandoptionstrader.com
Managing editor: Molly Goad

mgoad@futuresandoptionstrader.com
Stephan Bisse is a principal of Tannhauser Gate GmbH and

Senior editor: David Bukey
dbukey@futuresandoptionstrader.com Tradernomics.com, a Web site dedicated to trading education. He has an MBA
from the University of Oxford. For seven years he was an executive director
Contributing editor:
Keith Schap of Goldman, Sachs & Co. in London in the financial futures and options divi-
sion where, among other things, he was responsible for the daily technical
Associate editor: Chris Peters
cpeters@futuresandoptionstrader.com analysis of the European fixed-income futures markets. His e-mail address is
stephan.bisse@tannhausergate.ch.
Editorial assistant and
webmaster: Kesha Green
kgreen@futuresandoptionstrader.com
George Hoekstra is a research engineer in the petroleum
Art director: Laura Coyle refining business. He started trading options 30 years ago while
lcoyle@futuresandoptionstrader.com studying under Myron Scholes who was his professor at the
University of Chicago. Hoekstra holds degrees in chemical engi-
President: Phil Dorman
pdorman@futuresandoptionstrader.com neering from Purdue University and an MBA from the
University of Chicago. Hoekstra can be contacted via his Web site,
Publisher,
Ad sales East Coast and Midwest: http://hoekstratrading.com/default.aspx.
Bob Dorman
bdorman@futuresandoptionstrader.com
Steve Lentz (advisor@optionvue.com) is a well-established
Ad sales options educator and trader and has spoken all over the U.S.,
West Coast and Southwest only:
Allison Chee Asia, and Australia on behalf of the CBOE’s Options Institute,
achee@futuresandoptionstrader.com the Options Industry Council, and the Australian Stock
Classified ad sales: Mark Seger

Exchange. As a mentor for DiscoverOptions.com, he teaches
seger@futuresandoptionstrader.com select students how to use complex options strategies and develop a consis-
Volume 3, Issue 8. Futures & Options Trader is pub-

tent trading plan. Lentz is constantly developing new strategies on the use of
lished monthly by TechInfo, Inc., 161 N. Clark St.,
Suite 4915, Chicago, IL 60601. Copyright © 2009 options as part of a comprehensive profitable trading approach. He regular-
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any ly speaks at special events, trade shows, and trading group organizations.
form without written permission from the publisher.
The information in Futures & Options Trader magazine

is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply Jim Graham (advisor@optionvue.com) is the product man-
the effectiveness of any trading system, strategy, or
approach. Traders are advised to do their own ager for OptionVue Systems and a registered investment advisor
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future
for OptionVue Research.
results.

ads0909 7/9/09 6:20 PM Page 33
MARKET MOVERS
Commodities stabilize in July

After sliding lower for about a month, commodity
futures stabilized in the middle of last month. By the
end of July, the Rogers International Commodity
Index TRAKRS (RCTY) had rallied more than 12 per-
cent of their mid-month low to close at 20.82.
Energy
September crude Source for all: TradeStation
(CLU09) see-
sawed wildly in
July, tumbling Grains
from above $70/barrel
early in the month to September rice (RRU09) was the big win-
around $60 by July 13 — ner last month in a mostly moribund grain
only to shoot back up to market, rallying more than 14 percent from
$69 and pull back to its late-June low close to
below $63, finally ending its late-July high close.
the month knocking again September soybeans
on the door of $70. (SU09) bounced back a bit
Gasoline’s action was from the June sell-off,
much more a one-way while wheat (W) and corn
street — the September (C) merely stabilized.
contract (RBU09) rocketed
24 percent from mid-
month to close above
2.000 on July 31.
September natural gas
(NGU09) consolidated,
closing July roughly
halfway between the
month’s high and low
closes.
Metals
September gold (GCU09) was another
roller coaster market in July, opening the
month with a $30/ounce drop, jumping nearly $50,
then zigzagging twice more to close above $950 on
July 31.
September silver (SIU09) was more low key,
bouncing back a little from the June sell-off to end
the month around $14.00
Copper (HGU09) was the hot metal last month,
though, rallying more than 20 percent from the July
8 close to end the month above 2.600.

Softs
Meats
Sugar (SB) contin-
ued the rally noted last Lean hogs plummeted
month as it continued to to a new contract low
diverge from a choppy soft in late July, continuing
sector. The October contract to suffer at the hands
(SBV09) nearly reached 19.00 of a swine flu story
in late July after trading as that won’t fade away
low as 15.50 in mid-June — a (a vaccine is being pre-
roughly 22-percent rally. pared for distribution).
September coffee (KCU09) The October contract
climbed back above 125.00 in (LHV09), which had
late July — still well off its pushed back above
early June level — while 60.000 by mid-month,
September cocoa (CCU09) broke sharply to the
managed to shimmy above downside, falling
its June high, closing the below 52.000 and clos-
month just shy of 2900. ing the month only
Having pushed above 100 slightly higher. Like
in mid-July, September hogs, August pork bel-
orange juice (OJU09) pulled lies (PBQ09) bounced
back more than 10 percent to early in the month, but
close the month around 91.30. pulled back much less
dramatically.
October live cattle futures (LCV09), which had been
ticking higher since mid-June, peaked in mid-July
above 92.000 and closed the month around 90.000.
Treasuries
Treasury futures were mostly quiet in
July as equities blossomed. After ral-
lying as high as 119
early in the month, Currencies
the September 10-
year T-note contract September Canadian dollar
(TYU09) pulled (CDU09) futures jumped
back to around 116 nearly 9 percent from their
before closing the July 8 low to their July 31
month around 117. high of .9292. Overall, the Canadian dollar weakened in
July, making a final push lower the last day of the month.
For more coverage of the forex market, check out the
August issue of Currency Trader magazine.
Stock indices
Stock index futures made a startling comeback in July. After closing at
873.75 on July 8, the September E-Mini S&P 500 futures (ESU09) closed at 982.25 on July
30 — a gain of more than 12 percent.
A positive beginning to the Q2 earnings season and mostly benign economic numbers
buoyed the market.
FUTURES & OPTIONS TRADER • August 2009 9

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
The power of X:
The MAX moving average
This indicator modifies the standard weighted moving average calculation
to attempt to create a more responsive and customizable indicator.
BY STEPHAN BISSE
Note: A version of this article originally appeared
in the June 2005 issue of Active Trader magazine.
add a series of data points and divide the sum by the num-
M oving averages are useful for filtering the noise

from a time series to show its underlying trend.
They are popular tools and serve as the basis
for many trading strategies and systems.
However, because moving averages are “backward look-
ber of data points in the series. The next value of the SMA
is calculated by adding the new data point into the calcula-
tion and dropping the oldest to keep the number of data
points in the calculation constant. The lag of an SMA is one
half the look-back period over which the SMA was calcu-
ing” — that is, they are calculated using past price values lated (e.g., five days for a 10-day SMA).
from the look-back period — they suffer from lag. This There are numerous variations on the SMA that give dif-
means trading signals based on moving averages are ferent weight, or emphasis, to the data points, not only with
always following the price action, never leading it. As a the goal of reducing lag, but also because newer data has
result, controlling lag is crucial to successfully applying more relevance to future price action. Therefore, the most
moving averages in trading. recent data points are typically weighted more heavily than
the older ones.
Modifying moving averages: WMAs and EMAs Two common variations of this type are the weighted
The most widely used moving average is the simple mov- moving average (WMA) and the exponential moving aver-
ing average (SMA). To calculate a simple moving average, age (EMA). A WMA weights data points in a linear manner
according to the order in which they occur. For
example, to calculate a 10-period WMA of closing
FIGURE 1 — THE LAG FACTOR prices, the most recent price is given 10 times the
A sine wave representing price is shown with a 10-period SMA and a weight of the oldest data point, the second most
10-period WMA. The SMA lags the sine wave by five periods (half recent price is given nine times the weight of the
the look-back period) and the WMA lags only three periods. oldest data point, and so on.
The EMA on the other hand uses an exponent to
determine the rate at which the weight of previous
data points diminishes. To calculate a “10-percent”
EMA, which is the same as a 19-period EMA (see
“Converting EMA percentages to SMA look-back
periods”), start by calculating a 19-period SMA.
Then take the next price and multiply it by 0.1 while
multiplying the 19-period SMA value by 0.9 before
adding the two values together. From then on each
new value of the EMA is a weighted average of 90
percent of the value of the previous bar’s EMA value
and 10 percent of the new data-point.
Tuning to market conditions: The MAX

Although both the WMA and EMA can significantly
reduce lag relative to an SMA, neither of them can
be tuned to different markets and market condi-
tions. The idea behind MAX is to enhance the WMA
calculation by raising the weighting factors to a
user-defined power. This power can be greater than
1, in which case the MAX becomes more responsive

FIGURE 2 — THE MAX FACTOR
The same sine wave from Figure 1 is accompanied here by a WMA
(a “MAX1”), a MAX0.5, and a MAX2. The lag decreases as the power
than a WMA, or smaller than 1, in which case
of MAX increases — in this case, from roughly three periods for the
the MAX is less responsive than a WMA. WMA to approximately two periods for the M AX2. The MAX0.5
For example, in a 10-period MAX with a user- increases the lag to about four periods.
specified power of 3 (“MAX3”), the most recent
price is weighted by 103 (1000), the second most
recent price is weighted by 93 (729), etc., all the
way to the oldest data-point, which is weighted
by 13, or 1. To calculate a MAX0.5, the most
recent data-point would be weighted by 100.5 or
3.16, the second data-point is weighted by 90.5 or
3, down to the tenth and oldest data-point,
which is weighted by 10.5 or 1. By raising each of
the weighting factors to a power, the MAX
increases or decreases the difference between
the relative weighting given to each of the
prices.
For instance, whereas in a standard 10-period
WMA, the relative weighting between the first
and second prices is 10:9, in the equivalent
MAX3, the relative weighting is 10:7.29 and the
difference between the oldest data-point is even
more pronounced — 10:1 vs. 1000:1.
When the power of MAX is smaller than 1 —
for example, MAX0.5 — the relative weighting
between the first and second prices is 3.16:3 and the differ-
ence between the first and oldest prices is only 3.16:1 vs. Converting EMA percentages
10:1 for the WMA. (Another way to think of a WMA is that to SMA look-back periods
it represents a special case of the MAX using a power of 1,
or MAX1.) Most traders are more comfortable thinking in terms of look-
The following examples illustrate the superior lag-tuning back period rather than percentages. The formula to convert
capability of a MAX over a WMA. Figure 1 shows a 10-peri- EMA percentages to their simple moving average look-back
equivalent is:
od SMA and a 10-period WMA applied to a sine wave (rep-
resenting price) with a frequency of 20 periods and an EMA percent = 2/(periods + 1)
amplitude of 10. Note how the SMA lags the sine wave by
five periods (half its look-back period) while the WMA has For example, a 19-period EMA is therefore the same as a
a lag of only three periods. 10-percent EMA, or a 39-period EMA is the same as a 5-
Figure 2 shows the same 20-period sine wave, this time percent EMA.
with a WMA (which is equal to MAX1), a MAX0.5, and a However, the easiest way to think about EMAs is as a
MAX2. The lag is reduced as the power of MAX goes up — percentage of how much of the latest data-point is averaged
in this example, from a lag of roughly three periods for the with the previous EMA value, and inversely, how much of
WMA to a lag of about two periods for the MAX2, while the the previous data is “remembered” in the latest value of the
MAX0.5 increases the lag to about four periods. EMA.
Note that the lag reduction diminishes as the power of
MAX goes up, with the biggest reduction in lag occurring out-of-sample period. This increases the likelihood the per-
by raising the original weightings in a WMA, or MAX1, to formance will continue going forward.
the power of 2, or MAX2. The power does not have to be an
integer, but can take any value, and it is highly advisable to Testing the theory
optimize MAX for different markets, or at least for different So much for the theory. The real question is of course
market groups. For example, for the currency futures or whether MAX can outperform a WMA over a series of dif-
spot FX, a more responsive MAX might be advantageous, ferent markets. To find out, both a WMA and a MAX were
whereas for short-term interest-rate futures, a lower MAX optimized for seven different markets over a 15-year in-
value will probably be more appropriate. sample period and the optimum setting applied to a subse-
When optimizing it is important to keep a sufficiently quent five-year out-of-sample period.
large amount of your data, preferably the most recent part, One market was chosen from each of the following asset
as out-of-sample data to ensure the optimum settings classes: currencies (British pound), bonds (U.S. 10-year T-
obtained in the in-sample data optimization hold up in the continued on p. 12

TRADING STRATEGIES
MAX, and all trades were

Calculating MAX executed the following day
on the open.
Although the weighted moving average (WMA) tries to address the problem of lag in the simple To keep things manage-
moving average, because it uses a linear weighting of the prices based on their order of occur- able, the simulation was
rence, it does not allow the user to fine tune its responsiveness to different markets and conditions. done by optimizing for the
The idea behind MAX is to raise the weighting factor to a user-specified power that can be opti-
best WMA using values
mized. The formula for a four-period MAX3 is:
between 5 and 100 in incre-
=((E8*43)+(E7*33)+(E6*23)+(E5*13))/((433)+(33)+(23)+(13)) ments of 5. This optimum
look-back period was then
The spreadsheet can be made interactive by simply changing the power in the formula to a cell used for the MAX with the
reference, in this case cell H3, where the desired power can then be entered: additional step of optimiz-
ing the power for values
=((E8*4H$3)+(E7*3H$3)+…(E5*1H$3))/((4H$3)+(3H$3)+…(1H$3)) between 0.5 and 2.5 in
increments of 0.25 to ascer-
An interactive spreadsheet with the formulas for a 10-period and 20-period MAX can be down- tain whether this could
loaded for free from www.keyreversal.com. improve on the perform-
ance of the WMA. No stop-
FIGURE A — MAX WORKSHEET loss orders were used to
simplify the slippage
The selected cell shows the formula for calculating a “MAX2” moving average, which raises
assumptions (set at $50 per
the weightings of a WMA to a power of 2.
contract, per side), which
means the system was
always in the market. The
in-sample period was from
Jan. 1, 1985 to Jan. 1, 2000,
with the best setting for
each market subsequently
applied to the period from
Jan. 1, 2000 to Jan. 1, 2005.
The results were very
interesting. The in-sample
performance of the MAX
was always going to at
least match the in-sample
performance of the WMA
as the latter is a subset of
note), stock indices (S&P 500), short-term interest rates the former. The key question, therefore, was whether this
(eurodollars), energy (crude oil), grains (soybeans), and out-performance would carry on through to the out-of-sam-
precious metals (gold). To compensate for different contract ple period. Furthermore, it would be interesting to see in
sizes and price levels, the number of contracts used in each how many cases the best MAX power would be below 1,
market was determined by allocating $10,000 of capital to how often it would be equal to 1 (and therefore the same as
each market and then using the dollar value of a one-stan- a WMA), and how often it would be greater than 1.
dard deviation move calculated over the last 100 trading As shown in Table 1, the original MAX power of 1 was
days as the “margin” required to trade one contract in that the optimum weighting only in the S&P 500 futures. In all
market. This methodology produces a risk-adjusted return other markets the additional flexibility offered by MAX
for each market that can be directly compared with the improved the in-sample performance. The overall profit
return generated in the other markets. achieved by the WMA in the seven markets over the 15-year
Although there are numerous ways to trade using mov- period was $3,194,820.00, while the MAX achieved
ing averages and WMAs, one of the most effective ways is $3,476,811.25, an improvement of 9 percent. More impor-
to use a moving average as a smoothed proxy for price and tantly, the WMA out-of-sample profit of $420,222.50 was
a one-period lagged value of the same as a signal line: eclipsed by the MAX profit of $493,201.25 — an even
When the moving average crosses over its value of 1 period greater 17 percent. What is perhaps most surprising is that
ago to the upside, a buy signal is produced, while a cross- the most profitable MAX power for most of the markets
ing to the downside produces a sell signal. In the simulation was smaller than 1, the only exception being the U.S. 10-
the closing price was used to calculate the WMA and the year T-note futures, with a MAX power of 2.

TABLE 1 — MAX VS WMA
The MAX out-of-sample profit was 17 percent greater than the WMA out-of-sample profit. Interestingly, the most profitable
MAX power for most of the markets was less than 1. The only exception was the U.S. 10-year T-note futures, which used a
MAX power of 2.
Best Power In-sample Profitable Out-of-sample Profitable

Market WMA P&L years/15 P&L years/5
British pound 5 1 261,512.50 10 -84,506.25 1
U.S. 10-year note 40 1 681,200.00 13 242,031.25 5
S&P 500 85 1 32,950.00 9 -36,750.00 3
Eurodollar 30 1 969,175.00 14 218,975.00 4
Crude oil 100 1 947,550.00 11 111,070.00 3
Soybeans 25 1 13,012.50 7 27,212.50 4
Gold 15 1 289,420.00 11 -57,810.00 2
Portfolio: 3,194,820.00 Portfolio: 420,222.50
Best Best In-sample Profitable Out-of-sample Profitable

Market MAX power P&L years/15 P&L years/5
British pound 5 0.75 299,800.00 12 -8,043.75 2
U.S. 10-year note 40 2.00 693,256.25 15 171,662.50 4
S&P 500 85 1.00 32,950.00 9 -36,750.00 3
Eurodollar 30 0.75 996,425.00 14 259,525.00 4
Crude oil 100 0.75 963,500.00 12 110,490.00 3
Soybeans 25 0.50 74,150.00 8 48,287.50 2
Gold 15 0.50 416,730.00 12 -51,970.00 3
Portfolio: 3,476,811.25 Portfolio: 493,201.25
Another interesting fact of a more general Related reading

nature is the deterioration of average annual
“Indicator Insight: Simple moving average,” Active Trader, June 2000.
performance between the in-sample and out-
of-sample periods for both the WMA and the
“Indicator Insight: Weighted and exponential moving averages”
MAX. The average annual WMA in-sample
Active Trader, July 2002.
performance of $212,988 ($3,194,820.00 divid-
The basic principles and uses of weighted and exponential moving averages.
ed by 15 years) dropped to $84,044.50 for the
out-of-sample period, while the MAX per-
“Indicator Basics: Weighted and exponential moving averages”
formance dropped from $231,787.42 to
Currency Trader, December 2004.
$98,640.25. This is a good reminder to ade-
This adaptation of the article from Active Trader includes comparison tests
quately discount expectations generated by
of simple, weighted, and exponential moving averages.
in-sample optimized performance numbers.
“The adaptive moving average,” Currency Trader, August 2006.
Tuning in to specific markets
Making a moving average responsive to volatility changes results in a
Moving averages are great tools for filtering
dynamic, more accurate indicator.
out noise from time series and for showing
where a time series has been. However, moving
“KAMA range trader” Futures & Options Trader, June 2007.
averages suffer from lag, which typically in an
Kaufman’s Adaptive Moving Average (KAMA) is a dynamic indicator devel-
SMA is one-half of the look-back period.
oped by Perry Kaufman and described in his book New Trading Systems and
Various methods have been developed to
Methods (Wiley, 2005). This system focuses on trading range-bound by exe-
improve the responsiveness of moving aver-
cuting short-term trades with a price pattern after a combination of indicators
ages, including the weighted moving average
has identified suitable range-bound price action.
(WMA), the exponential moving average
(EMA), and the volatility-index dynamic mov-
You can purchase and download past articles at
ing average (VIDYA).
http://store.activetradermag.com.
However, none of these is easily tunable to
different markets. The idea behind MAX is to
introduce the concept of raising the weighting factors in a fering markets and market conditions.
WMA to a user-specifiable power. This allows for fine-tun-
ing the lag reduction or responsiveness of the MAX to dif- For information on the author see p. 6.

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Crossing the
options finish line
Analyzing options in terms of their intrinsic values and using a 50-percent profit target
provides a simple framework for determining whether to hold or fold a trade.
BY GEORGE HOEKSTRA
Note: A version of this article originally appeared in the TABLE 1 — CSCO CALL OPTIONS (UNDERLYING PRICE OF $18.75)
April 2005 issue of Active Trader magazine. Three of Cisco’s April 2005 calls are listed with their intrinsic values and
bid/ask prices when the stock traded at $18.75 on Sept. 3, 2004.
O
Option Amount in-the-money Bid Ask
ption prices reflect their underlying (Intrinsic value)
stock’s implied volatility, which is
April 15 call $3.75 $4.50 $4.70
the market’s estimate of its future
April 17.5 call $1.25 $2.80 $2.90
volatility. If you can gain insight into a stock’s
volatility characteristics, it is easier to buy April 20 call -$1.25 $1.50 $1.60
underpriced call options and construct a poten-
tially profitable trading strategy that requires FIGURE 1 — CSCO CALL OPTION CURVE
little maintenance.
By plotting option prices in terms of how much they are in-the-money
“Bargain hunting for options” (Active Trader,
(i.e., their intrinsic value), you can estimate an at-the-money option’s
January 2005) shows that a good way to ana-
price and implied volatility.
lyze option prices is to chart them by the
amount they are in-the-money (ITM).
Following up on some of the same stocks and
options from that article, Table 1 and Figure 1
show the prices of three Cisco Systems (CSCO)
April 2005 call options on Sept. 3, 2004. Table 1
lists the amount each option is in the money
(the intrinsic value), and the bid and ask prices.
Figure 1 shows the option’s ask prices in terms
of their intrinsic values. The x-axis represents
the amount each call is in-the-money and the
point where its curve crosses zero — $2.10 — is
the estimated ask price of an at-the-money
(ATM) April call option.
If you make similar charts for options on dif-
ferent stocks, you can compare how volatile the
market expects them to be. For a given expira- Source: MSN Money
tion date, the higher the estimated price of an
at-the-money call, the higher the implied stock their options’ prices imply, and 2) Hold these calls until
volatility. When searching for underpriced calls to buy, look they can be sold for a 50-percent profit or until they expire.
for stocks you expect to be more volatile than what is
implied by the price of their options. (See “Related read- The finish line
ing,” for other articles that discuss this technique.) The finish line represents the price the stock must hit for a
While there are many ways to attempt to capture the specific call option to post a 50-percent gain. Figure 2 shows
potential profit in these situations, the “finish-line” strategy the finish line for a Cisco April 17.5 call, which was priced
is fairly straightforward: 1) Buy call options that expire in at $2.90 on Sept. 3, 2004 when the underlying stock was
seven months on stocks you expect to be more volatile than trading at $18.75.

FIGURE 2 — CISCO FINISH-LINE CHART
This daily Cisco bar chart also shows the April 17.5 call’s finish line, or
50-percent profit target, based on the Sept. 3 purchase as the stock
Cisco’s call option curve (Figure 1) contains traded at $18.75. Cisco moved higher in mid-September and
all the information needed to draw the April approached the finish line before selling off toward the end of the
17.5 call’s finish line. You need two points: The month.
underlying price required for the call to be
worth 50 percent more ($2.90 + 1.45 = $4.35) on
both Sept. 3, 2004 (point A) and April 15, 2005
(expiration day — point B).
Figure 1 shows the option must be $3.20 in-
the-money for it to be worth $4.35 on Sept. 3.
Cisco must trade at $20.70 (point A on Figure 2),
or the call’s strike ($17.50) plus its intrinsic
value ($3.20), for the call to be worth $4.35 that
day.
On expiration day, the call has no time value,
so its price will be the same as its intrinsic
value. On April 15, 2005, Cisco must trade at
$21.85 (point B), or the call’s strike price ($17.50)
plus its target market value ($4.35), for the
option to post a 50-percent profit.
The finish line is simply a straight line con-
necting point A and point B. When Cisco cross-
es above this line, you would sell the April 17.5
Source: MSN Money
call since it will be worth at least $4.35, which
represents a 50-percent gain. If the stock lan-
guishes, you can let the option expire. FIGURE 3 — MAYTAG FINISH-LINE CHART
Figure 2 shows Cisco quickly rose from Maytag was quite volatile after we bought an April 2005 call on Aug. 27
$18.75 to $20.75 in the first two weeks after Sept. when the stock traded at $20. Over the past several months, the stock
3, but fell short of the finish line. The stock then hasn’t approached the call’s 50-percent profit level.
traded between $18 and $20 over the next cou-
ple of months. If you’d bought the April 17.5
call on Sept. 3 with this strategy, you’d continue
to hold it.
Figure 3 shows a finish-line chart for a
Maytag (MYG) April 20 call purchased at $2.20
on Aug. 27, 2004 when the stock was trading at
$20.20. The call’s 50-percent profit target is
$3.30.
On that day, the April 20 call must be $1.80
ITM (with $1.50 in time value) to trade at this
level, which corresponds to a stock price of
$21.80 (point A = $20 strike price + $1.80 intrin-
sic value). To calculate the April 15, 2005 expi-
ration-day stock price ($23.30), simply add the
call price target to its strike price (point B =
$3.30 + $20).
Figure 3 shows Maytag has been volatile
since Aug. 27, and sold off sharply in mid-
September before regaining ground a month Source: MSN Money
later — a $6 range in 13 weeks. Here, as in the
previous example, you’d still be waiting for finish-line strat- volatility suggested that Maytag was likely to show higher
egy to pay off. near-term volatility, so its calls were better priced than
On Sept. 3, 2004, the Maytag and Cisco options had the Cisco’s. A simple way to estimate average historical volatili-
same price for an ATM April call ($2.10). Analysis of weekly continued on p. 16

TRADING STRATEGIES
FIGURE 4 — CROSSING THE FINISH LINE

This figure shows a successful options trade: After we bought an ATM ty on a weekly basis is to calculate a six-week
ESLT April 20 call on Sept. 7, we sold it two months later when it hit the moving average of the weekly ranges. If the cur-
50-percent target. rent weekly range is below this average, volatil-
ity will likely increase in the near-term; the
opposite is true if the current weekly range is
above the average.
If you compare Figures 2 and 3, it’s obvious
Maytag was more volatile in the subsequent
three months, and covered a $6 range vs.
Cisco’s $3 range. As of Dec. 3, however, the fin-
ish-line strategy had not yet paid off for either
example.
Elbit Systems (ESLT) call options also looked
attractive on Sept. 3, according to the weekly
volatility analysis. Figure 4 shows a finish-line
chart for an ESLT April 20 call purchased for
$1.40 on Sept. 7 when the underlying stock trad-
ed at $20.
We sold the call at its 50-percent profit level
($2.10) on Nov. 4 with the stock at $21.70. After
waiting two months, a move of just $1.70 in the
stock was enough to chalk up a 50-percent prof-
Source: MSN Money it.
Balancing volatility and probability

Finish-line charts highlight the challenge of finding cheap
options. Overall, longer-term profits will depend on the
Related reading percentage of options that cross their finish lines. The lower
Variance and standard deviation the finish line — that is, the closer it is to the current stock
price — and/or the higher the volatility, the greater the
“Bargain hunting for options,”
chance the stock will reach the profit target.
by George Hoekstra. Active Trader, January 2005.
Cheaper options offer lower finish lines. Higher stock
Using statistical and implied volatility to find cheap call
volatility means more fuel to drive a stock toward the fin-
options.
ish line. Because this approach is structured so most of your
“Getting started in options,” Active Trader, April 2001. winners will be 50-percent profits and most of your losers
A beginner’s guide to trading options. will be complete losses, it is advisable to keep a 75-percent
winning percentage in mind.
“Choosing the best option,” Active Trader, July 2001.
In general, if you buy a seven-month ATM call and the
One trader’s guidelines for finding the option that best
underlying stock moves up by the same amount as the
suits the needs of a particular trade.
option’s original price within one month, you should be
“Long straddles: The importance of buying time” able to sell the option for a 50-percent profit.
Active Trader, November 2004. For example, Cisco’s and Maytag’s ATM April calls were
How to construct higher-probability long straddles by find- selling for $2.10 on Sept. 3, and their finish lines were
ing options with the best volatility characteristics and tap- approximately $2.10 above their respective stock prices
ping into LEAPS. during September. Similarly, the Elbit Systems ATM April
call cost $1.40, and its finish line was roughly $1.40 above
“Putting volatility to work,” Active Trader, April 2001.
the stock price during September.
A guide to different types of volatility, and how to improve
your trading with practical volatility-based analysis and
Cheap options and market direction
trading techniques.
Buying calls is just one variation of the finish-line strategy.
You can purchase and download past articles at You can easily change the strategy’s market bias (i.e., bull-
http://store.activetradermag.com. ish, bearish, or neutral). If you’re bearish, buy puts instead
of calls. In sideways markets, you can take advantage of
potential volatility increases with long straddles, which

consist of the simultaneous purchase of call and put or zero. It is not necessary to continually monitor the
options. option’s price. If it was underpriced when you bought it,
Whichever direction you chose, underpriced options will you can expect to benefit from that edge as expiration
give an advantage in a long-option position, which means approaches.
more potential profit if the stock moves in your direction, A fixed target also imposes discipline and focus. You
and less risk if it doesn’t. Overall, “bargain” options offer a don’t run the risk of overreacting to the latest news or hic-
better chance of gains than fairly priced ones. cup in the stock. Instead, once you buy a bargain-priced
However, if you buy options with seven months to expi- option, your work is done and you can start searching for
ration and use a strategy with a directional bias (i.e., more other cheap options.
long calls than puts or vice versa), you must protect against Why set a 50 percent target? Why not 100 percent or 150
unfavorable market moves. A sudden drop in the overall percent? It makes sense to set a target that is easily reached
market can wipe out an entire portfolio of call options, even within a stock’s normal variation. For bargain-priced
if you bought them at underpriced levels. Holding cash, options, 50 percent is such a target. A well-chosen, under-
using neutral strategies or other forms of hedging are nec- priced, seven month option will move up 50 percent if the
essary to avoid ruin. stock moves favorably by about 1.5 times its typical weekly
range within 3 months. It is reasonable to aim for this to
Profit target advantages happen on 75 percent of your trades.
Why set a fixed profit target at all? Wouldn’t it make more Finally, when selecting options, always consider the
sense to monitor each option position and hold it until it is effect of dividends and check for possible mergers or
no longer underpriced? While this ultimately is a matter of rumors that might explain odd option pricing before trad-
preference, an underpriced option (unlike a stock) can’t stay ing.
underpriced for long.
On expiration day, it will be worth the amount it is ITM, For information on the author see p. 6.
OPTIONS TRADING
TRADING SYSTEM
OPTIONS STRATEGY
OPTIONS SYSTEM
LAB LAB
LAB
Naked-call Martingale strategy

on the Russell 2000
Market: Call options on the Russell 2000 index (RUT). How can the system avoid this risk of very large losses —
i.e., the cliff on the right side of Figure 2? The solution is to
System concept: The June 2009 Options Lab examined buy back the slightly OTM calls quickly (even at a loss) if
a trading strategy that bought at-the-money (ATM) calls on the underlying index rises to touch the short strike price. If
2-percent dips, or pullbacks, in S&P 500 futures (SP). The enough time has elapsed, the system might make money
original pattern’s title — nerves of steel —
inspired us to search for other approaches that FIGURE 1 — BEARISH RSI DIVERGENCE SIGNAL
take guts to trade, but earn money most of the
time (see “Nerves of steel pullback pattern,” A bearish divergence signal occurs when price makes a new high and
Futures & Options Trader, October 2008). the RSI fails to make a similar new high.
One trading idea is to sell uncovered calls on
an index to collect premium and then “roll” the
position into higher-strike calls when the mar-
ket nears the call’s strike price, an approach
described in the fifth chapter of Larry
McMillan’s Options as a Strategic Investment
(New York Institute of Finance, fourth edition,
2002). The technique resembles the Martingale
betting system, which doubles down after every
loss. In theory, you will eventually win and thus
recoup all losses plus the initial bet.
The system sells naked calls on the Russell
2000 when a bearish divergence signal between
price and the 14-day relative strength index
(RSI) is triggered. The signal appears when price
makes a new high and the RSI fails to make a
similar new high (Figure 1). This is a sign the
Source: MetaStock
bullish trend is slowing down and a rever-
sal to the downside may be imminent — a
good time to sell out-of-the-money (OTM) FIGURE 2 — RISK PROFILE — SHORT NAKED CALL
calls. The system sells an out-of-the-money call, which on average has a
The technique sells calls with the first 66-percent probability of profit.
OTM strike when the divergence signal
appears and the market closes down. This
“bearish-only” approach is a direct way of
collecting premium; gains can mount
quickly if the underlying index really
drops. On the other hand, potential losses
are theoretically unlimited because the
underlying has no upside “ceiling.”
Figure 2 shows the potential gains and
losses of a trade entered on Aug. 15, 2008.
The Russell 2000 index was trading at
753.20, and the system sold a September
760 call with 35 days left until expiration.
The probability of profit by expiration was
66 percent and the yield on initial margin
was 12 percent. Remember if the Russell
rallies, losses can be substantially greater
Source: OptionVue
than the maximum potential gain.

STRATEGY SUMMARY LEGEND:
Initial capital — Starting account value
Initial capital: $75,000 Net gain — Gain at end of test period.
Net gain: $19,850 Percentage return — Gain or loss on a percentage basis.
Percentage return: 26.5% Annualized return — Gain or loss on a annualized percentage basis.
Annualized return: 3.5%
No. of trades — Number of trades generated by the system.
No. of trades: 26
Winning/losing trades — Number of winners and losers generated by the system.
Winning/losing trades: 25/1
Win/loss (%) — The percentage of trades that were profitable.
Win/loss: 96%
Avg. trade — The average profit for all trades.
Avg. trade: $763.46
Largest winning trade: $2,305.00 Largest winning trade — Biggest individual profit generated by the system.
Largest losing trade: -$5,569.00 Largest losing trade — Biggest individual loss generated by the system.
Avg. profit (winners): 1,016.76 Avg. profit (winners) — The average profit for winning trades.
Avg. profit (losers): -5,569.00 Avg. loss (losers) — The average loss for losing trades.
Avg. hold time (winners): 15 Avg. hold time (winners) — The average holding period for winning trades (in days).
Avg. hold time (losers): 1 Avg. hold time (losers) — The average holding period for losing trades (in days).
Max. consec. win/loss: 19/1 Max consec. win/loss — The maximum number of consecutive winning and losing trades.
repurchasing them, although not if the month as it waits for the underlying to down. The divergence and con-
market jumps immediately after entry. bounce around and (hopefully) drop firmation signals may (or may
After buying back the short call, the enough so the short calls expire worth- not) occur on the same day.
system then sells enough calls at the less. Meanwhile, this can take quite a continued on p. 20
next OTM strike price so that the pre- bit of capital.
mium collected will cover any previ-
ous loss plus one-half of the original Trade rules:
credit received.
If the market continues to rise and Entry
hits the second strike price, the system 1. Bearish RSI divergence signal.
repeats this process. Although this tac- Price makes higher highs, while
tic doesn’t necessarily double the the 14-day RSI fails to make
number of contracts each time, the higher highs.
position’s size increases fairly rapidly.
Eventually, if the market continues 2. Confirmation. Once the divergence
to climb, the strategy needs to roll the signal appears, the system waits
short calls to the next expiration for the underlying index to close
FIGURE 3 — SYSTEM PERFORMANCE

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

OPTIONS TRADING SYSTEM LAB
3. Position. Sell a naked call at the first OTM strike and cash-settled options at the CBOE.
in the first month with at least 22 calendar days until
options expiration. Test period: Jan. 18, 2001 to Sept. 19, 2008.
Exit Test results: Figure 3 tracks the system’s performance,

1. Allow the sold call(s) to expire worthless, or: which gained $19,850 (26.5 percent) during the test period.
Notably, the system posted gains 96 percent of the time —
2. If the market rises and touches the short strike, buy 25 winning trades with an average size of $1,017 and only
back the call(s) and then sell enough calls at the next one losing trade ($5,569).
OTM strike price to cover the accrued loss plus at The system remained profitable for most of the test peri-
least one-half of the original credit. od, with the main exception occurring in April and May of
2003 as stocks entered a new bull market. Statistically, the
3. If the number of contracts required is more than system should make money only 66 percent of the time, but
double the previous position, roll to the next month. it posted gains surprisingly often (96 percent). Thus, the
system has a definite trading edge.
4. If losses reach or exceed five times the original
credit on any day’s close, exit the entire position. — Steve Lentz and Jim Graham of OptionVue
Test details: Daily closing prices were used. Trades were

executed at the bid and ask, when possible. Otherwise, the- Option System Analysis strategies are tested using OptionVue’s
oretical prices were used. BackTrader module (unless otherwise noted).
Commissions were $5 plus $1 per option trade. If you have a trading idea or strategy that you’d like to see tested,
please send the trading and money-management rules to
Test data: System was tested on the Russell 2000 index’s Advisor@OptionVue.com.
Three good tools for targeting customers . . .
— CONTACT —
Bob Dorman Allison Chee Mark Seger
Ad sales East Coast and Midwest Ad sales West Coast and Southwest Account Executive
bdorman@activetradermag.com achee@activetradermag.com seger@activetradermag.com
(312) 775-5421 (415) 272-0999 (312) 377-9435

INDUSTRY NEWS
CFTC flexes muscles on position limits

The CFTC moves to limit positions on the ICE while discussing the role
of speculators in commodity markets.
I t has been a busy summer for Commodity Futures

Trading Commission Chairman Gary Gensler. Since
his confirmation in May, the CFTC has ramped up its
efforts to curb volatility in commodity markets, much of
which has been blamed on speculators, including the run-
“Gasoline prices, for example, can
determine whether a family takes a
summer vacation. Natural gas futures
up of gas prices last summer. contracts can affect utility bills, and
Among other things, the CFTC’s investigation has
focused on the position-limit exemptions offered to certain lack of convergence in the wheat
market participants. Except for commercial traders (those
with direct business activity to the underlying commodity), market can shorten a grocery list.”
the number of contracts a market participant can hold is
— Gary Gensler, Commodity Futures
typically capped. However, certain non-commercial partic-
Trading Commission Chairman
ipants have been granted exemptions from these limits.
Classified as “bona fide” hedgers, these participants were
allowed to exceed the typical limits imposed upon non- trading days. “The exchanges, however, are not required by
commercial traders. statute to set and enforce position limits to address the bur-
Critics note that many exemptions have been granted to dens of excessive speculation,” Gensler said.
swaps dealers — traders who participate in over-the-count-
er (OTC) agreements with third parties and then use their London loophole
exemptions to purchase futures contracts to hedge their In one of the most forceful steps it has taken during
OTC exposure. The large number of these contracts pur- Gensler’s tenure, the CFTC exercised authority granted to it
chased has been blamed for artificially driving up com- through the 1936 Commodity Exchange Act (CEA) to
modity prices. impose requirements on exempt commercial markets — in
The CFTC scheduled three meetings, open to the public, this case the IntercontinentalExchange (ICE). The CEA
to discuss the issue and how to regulate speculative posi- allows the commission to take such action if a contract is
tions. The first two meetings were held on July 27 and 28, determined as serving a significant price discovery func-
while the final meeting is on Aug. 5. During his July 27 tion.
opening statement, Gensler remarked that futures contracts On July 24, the CFTC announced the Henry Financial
not only serve as important risk-management tools for LD1 Fixed Prices contract, a natural gas contract traded on
farmers, producers, and other commercial interests, but the ICE, served as a significant price discovery contract,
they have a direct affect on American families. and would be required to fall in line with position limits
“Gasoline prices, for example, can determine whether a similar to those imposed on the New York Mercantile
family takes a summer vacation,” Gensler said. “Natural Exchange (NYMEX).
gas futures contracts can affect utility bills, and lack of con- An investigation into the contract began on June 9, and
vergence in the wheat market can shorten a grocery list.” because of its high average daily trading volume, reliance
Although the CFTC enforces positions on agricultural on the settlement price for NYMEX’s physically delivered
products, it has been up to the exchanges to set limits for natural gas futures contract, and its use by traders, new reg-
energy markets, which typically apply in a contract’s final ulatory criteria was deemed necessary.

“Bringing this natural gas contract under the CFTC’s reg- play the positions of swaps dealers separately from those of
ulatory authority is a critical step toward ensuring a fair commercial dealers, while the non-commercial category
and orderly marketplace,” Gensler said in a statement. will be disaggregated as well, categorizing the positions of
The move is an attempt to close what has been referred to professional market managers, such as hedge funds. The
as the “London loophole.” The ICE is regulated by the UK’s CFTC will also incorporate data it receives for all foreign
Financial Services Authority (FSA), and had received a contracts linked to domestic contracts, and will display data
CFTC exemption to offer contracts based on U.S. products. on contracts, such as the ICE’s natural gas contract, which
Some speculated that traders sidestep U.S. position lim- have been determined as serving a significant price discov-
its by trading through the ICE, gaining exposure to the ery function.
same contracts without having to adhere to the stricter In its first move to improve the transparency of the week-
regulations imposed on exchanges under the CFTC’s ly COT report, the CFTC included data for positions in ICE
authority. Futures Europe West Texas crude oil contracts in the report
In response, the ICE stated that its U.S.-linked energy published on July 31. The CFTC has said further additions
contracts have been subject to increased reporting require- will be forthcoming.
ments since its “no-action” letter
issued by the CFTC allowing it to
operate in the U.S. while remaining
MANAGED MONEY
under FSA authority was amended in
fall 2008. The ICE argues it’s being Top 10 option strategy traders ranked by June 2009 return.
asked to adopt position and accounta- (Managing at least $1 million as of June 30, 2009.)
bility limits established by its com-
June 2009 YTD $ under
petitor, NYMEX, without “access to
Rank Trading advisor return return mgmt.
the information needed to judge the
suitability or size of these limits,” and 1. ACE Investment Strategists (DPC) 12.66% 49.14% 12.8
without “access to the methodology 2. Kingsview Mgmt (Retail) 9.59% 31.75% 2.2
or determining factors that NYMEX 3. Carter Road LLC 9.10% 57.51% 2.0
used in deciding to grant over 115 4. Financial Comm Inv (CPP) 8.19% 23.33% 4.5
hedge exemptions since 2006.” 5. CKP Finance Associates (Masters) 7.82% 111.67% 1.0
6. ACE Investment Strategists (ASIPC) 6.43% 29.48% 3.7
Increased transparency
7. Kingsview Capital Ptnrs 6.36% 17.27% 3.1
While the future of speculative posi-
tion limits remains to be seen, the 8. Financial Comm Inv (Option Selling) 6.10% 17.97% 12.6
CFTC has made an effort to increase 9. NEOS Advisors (Special Opportunities) 5.84% 12.67% 54.5
transparency in commodity markets 10. ACE Investment Strategists (SIPC) 5.61% 17.60% 29.7
by altering its weekly Commitments
of Traders (COT) report, which aggre- Source: Barclay Hedge (http://www.barclayhedge.com) Based on estimates of the composite of all
accounts or the fully funded subset method. Does not reflect the performance of any single account.
gates data to highlight the positions of
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
different types of market participants.
The revamped COT report will dis-

FUTURES SNAPSHOT (as of July 29)
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 leg-
end 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).
10-day move/ 20-day move/ 60-day move/ Volatility

Market Symbol Exchange Volume OI rank rank rank ratio/rank
E-Mini S&P 500 ES CME 1.88 M 2.36 M 5.15% / 42% 6.06% / 64% 7.91% / 33% .28 / 68%
10-yr. T-note TY CME 737.4 1.04 M -0.19% / 17% -0.07% / 7% -3.58% / 65% .18 / 8%
5-yr. T-note FV CME 341.3 762.7 -0.74% / 29% -0.08% / 3% -2.38% / 80% .26 / 17%
Eurodollar* ED CME 281.0 535.0 -0.10% / 14% -0.02% / 0% -0.05% / 5% .38 / 15%
E-Mini Nasdaq 100 NQ CME 280.9 256.1 6.91% / 50% 8.25% / 88% 12.16% / 37% .29 / 68%
Crude oil CL NYMEX 268.1 226.7 2.94% / 0% -8.60% / 53% 17.66% / 15% .25 / 50%
30-yr. T-bond US CME 215.8 696.1 -0.10% / 0% -1.63% / 5% -4.94% / 31% .17 / 8%
Eurocurrency EC CME 207.0 122.2 -0.86% / 67% -0.98% / 60% 5.24% / 43% .15 / 7%
2-yr. T-note TU CME 137.2 594.4 -0.06% / 33% -0.02% / 0% -0.16% / 53% .27 / 33%
E-Mini Russell 2000 TF CME 132.8 357.1 6.97% / 45% 6.47% / 64% 8.50% / 33% .32 / 73%
Mini Dow YM CME 128.4 54.9 5.90% / 36% 7.09% / 81% 7.93% / 39% .30 / 75%
British pound BP CME 96.4 88.7 -0.41% / 30% -0.72% / 54% 8.54% / 40% .06 / 2%
Natural gas NG NYMEX 91.2 97.3 8.07% / 67% -6.51% / 27% -1.85% / 5% .28 / 7%
Japanese yen JY CME 86.3 87.9 -0.69% / 0% 1.57% / 33% 4.20% / 59% .31 / 60%
Gold 100 oz. GC NYMEX 82.1 203.2 -1.03% / 33% 0.25% / 3% 3.05% / 20% .35 / 48%
Corn C CME 80.4 247.5 -2.67% / 5% -9.54% / 27% -20.92% / 96% .15 / 0%
Australian dollar AD CME 68.5 88.7 1.06% / 9% 0.62% / 4% 9.56% / 36% .14 / 15%
Canadian dollar CD CME 58.8 79.5 1.87% / 8% 5.20% / 47% 7.72% / 47% .27 / 38%
Sugar SB ICE 47.5 317.2 4.45% / 29% 3.98% / 17% 23.57% / 75% .24 / 58%
Swiss franc SF CME 40.3 35.2 -1.53% / 83% -1.43% / 93% 4.08% / 40% .20 / 17%
Wheat W CME 39.0 126.9 -4.34% / 53% -5.40% / 35% -7.19% / 54% .28 / 27%
Soybeans S CME 35.1 62.1 -5.53% / 35% -13.87% / 64% -12.63% / 100% .24 / 55%
Heating oil HO NYMEX 33.6 40.7 5.64% / 14% -5.35% / 42% 17.19% / 32% .33 / 50%
RBOB gasoline RB NYMEX 33.3 44.1 8.60% / 38% -0.22% / 5% 17.99% / 14% .32 / 70%
E-Mini S&P MidCap 400 ME CME 27.2 102.0 6.85% / 45% 6.27% / 58% 7.06% / 24% .31 / 67%
Soybean oil BO CME 24.0 42.9 -2.52% / 8% -5.57% / 44% -13.02% / 100% .24 / 33%
S&P 500 index SP CME 23.7 380.9 5.14% / 42% 6.06% / 67% 7.91% / 32% .28 / 68%
Silver 5,000 oz. SI NYMEX 21.1 49.3 0.38% / 0% -2.51% / 29% 1.11% / 6% .26 / 20%
Soybean meal SM CME 17.9 31.7 -6.10% / 30% -18.11% / 73% -11.11% / 100% .18 / 7%
Copper HG NYMEX 17.2 63.7 3.57% / 38% 6.31% / 41% 18.97% / 22% .22 / 48%
Live cattle LC CME 13.0 58.8 -1.15% / 100% -1.52% / 14% 2.53% / 46% .37 / 57%
Mexican peso MP CME 12.5 47.3 2.01% / 45% -0.89% / 42% 0.17% / 1% .25 / 65%
Crude oil e-miNY QM NYMEX 11.8 3.5 2.94% / 14% -8.60% / 53% 17.66% / 15% .25 / 45%
Nikkei 225 index NK CME 9.3 26.9 6.37% / 50% 1.29% / 11% 8.93% / 23% .38 / 93%
Coffee KC ICE 8.9 62.6 4.15% / 33% 2.46% / 22% 1.65% / 20% .33 / 35%
Lean hogs LH CME 8.5 19.6 -11.36% / 100% -3.28% / 18% 1.38% / 16% .72 / 73%
Cocoa CC ICE 7.4 47.4 3.17% / 7% 11.67% / 53% 20.82% / 78% .44 / 47%
U.S. dollar index DX ICE 6.1 20.5 0.41% / 75% -0.80% / 10% -5.35% / 45% .11 / 5%
Fed Funds** FF CME 5.1 59.2 0.03% / 50% 0.07% / 53% 0.09% / 13% .14 / 38%
New Zealand dollar NE CME 4.7 22.3 0.49% / 8% 1.89% / 21% 13.02% / 44% .12 / 8%
Mini-sized gold YG CME 4.4 3.1 -1.03% / 33% 0.30% / 0% 2.96% / 21% .31 / 37%
Natural gas e-miNY QG NYMEX 3.1 5.9 8.07% / 67% -6.51% / 28% -1.85% / 5% .25 / 5%
E-Mini eurocurrency ZE CME 2.4 1.8 -0.86% / 67% -0.98% / 60% 5.24% / 43% .15 / 7%
Nasdaq 100 ND CME 2.3 15.7 6.91% / 50% 8.25% / 88% 12.16% / 37% .29 / 67%
Mini-sized silver YI CME 1.9 2.0 0.25% / 13% -2.13% / 29% 2.07% / 8% .24 / 15%
Dow Jones Ind. Avg. DJ CME 1.2 9.7 5.90% / 36% 7.09% / 81% 7.93% / 39% .30 / 75%
Russian ruble RU CME 0.5 5.9 6.79% / 100% 1.11% / 11% 6.40% / 22% .38 / 93%
*Average volume and open interest based on highest-volume contract (September 2010). **Average volume and open interest based on highest-volume contract (November 2009)
Legend day moves, 20-day moves, etc.) show the percent means the current reading is larger than
Volume: 30-day average daily volume, in centile rank of the most recent move to a cer- all the past readings, while a reading of 0 per-
thousands (unless otherwise indicated). tain number of the previous moves of the cent means the current reading is smaller than
same size and in the same direction. For the previous readings. These figures provide
OI: Open interest, in thousands (unless other-
example, the rank for 10-day move shows perspective for determining how relatively
wise indicated).
how the most recent 10-day move compares large or small the most recent price move is
10-day move: The percentage price move to the past twenty 10-day moves; for the 20- compared to past price moves.
from the close 10 days ago to today’s close. day move, the rank field shows how the most Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move recent 20-day move compares to the past term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. sixty 20-day moves; for the 60-day move, the prices) divided by the long-term volatility (100-
60-day move: The percentage price move rank field shows how the most recent 60-day day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. move compares to the past one-hundred- the percentile rank of the volatility ratio over
The “rank” fields for each time window (10- twenty 60-day moves. A reading of 100 per- 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 28)
MOST-LIQUID OPTIONS*
Indices Symbol Exchange Options Open 10-day move / 20-day move / IV / IV / SV ratio —
volume interest rank rank SV ratio 20 days ago
S&P 500 index SPX CBOE 174.0 1.61 M -1.04% / 40% -0.10% / 2% 22.6% / 20.9% 22.5% / 22.6%
S&P 500 volatility index VIX CBOE 106.9 1.70 M -0.04% / 0% -1.34% / 2% 135.3% / 76.8% 126.7% / 93.5%
Russell 2000 index RUT CBOE 55.8 479.5 11.16% / 73% 8.10% / 76% 28.2% / 28.2% 28.8% / 28.7%
E-Mini S&P 500 futures ES CME 34.2 131.9 8.26% / 58% 6.61% / 71% 22.7% / 24.1% 22.6% / 25.4%
Nasdaq 100 index NDX CBOE 17.7 152.8 10.51% / 67% 8.20% / 80% 23.5% / 23% 24% / 23.1%
Stocks
Citigroup C 759.3 14.67 M 1.71% / 14% -1.66% / 3% 70% / 72.2% 92.7% / 56.4%
Bank of America BAC 245.9 4.33 M 3.33% / 69% 1.14% / 6% 51.1% / 58% 58.9% / 62.8%
General Electric GE 119.4 2.42 M 7.56% / 67% 6.46% / 41% 40.5% / 45.9% 42.7% / 41.6%
Microsoft MSFT 108.5 2.44 M 1.56% / 27% -1.63% / 80% 29.9% / 31.7% 32.8% / 30.6%
Wells Fargo WFC 92.5 1.50 M 0.49% / 15% -0.04% / 0% 43.8% / 48.9% 49.2% / 72%
Futures**
Eurodollar ED CME 92.7 5.46 M 0.07% / 40% 0.16% / 31% 83% / 38% 78.6% / 71.4%
Corn C CME 53.8 446.6 -5.32% / 35% -9.59% / 27% 34.2% / 46.2% 40.5% / 33.6%
10-year T-notes TY CME 26.6 393.7 -1.04% / 40% -0.10% / 2% 9.5% / 8.8% 9.4% / 8.7%
Sugar SB ICE 19.2 344.6 4.64% / 36% 3.35% / 13% 38.1% / 29.3% 40.9% / 33.9%
VOLATILITY EXTREMES***
Indices - High IV/SV ratio
S&P 500 volatility index VIX CBOE 106.9 1.70 M -0.04% / 0% -1.34% / 2% 135.3% / 76.8% 126.7% / 93.5%
S&P 100 index OEX CBOE 14.5 87.0 7.49% / 58% 5.33% / 64% 21.7% / 19.7% 21.1% / 20.8%
S&P 500 index SPX CBOE 174.0 1.61 M -1.04% / 40% -0.10% / 2% 22.6% / 20.9% 22.5% / 22.6%
S&P 500 futures SP CME 12.9 67.7 8.26% / 58% 6.60% / 71% 22.6% / 21.3% 22.6% / 21.9%
S&P 100 index (European style) XEO CBOE 4.1 47.6 7.49% / 58% 5.33% / 64% 21.1% / 19.9% 20.4% / 21%
Indices - Low IV/SV ratio

Mini Nasdaq 100 index MNX CBOE 7.7 248.2 10.51% / 67% 8.20% / 80% 23.1% / 31.9% 23.9% / 23.1%
Semiconductor index SOX PHLX 1.7 13.8 12.48% / 54% 15.34% / 87% 32.9% / 36.2% 36% / 37.1%
E-Mini Nas-100 futures NQ CME 1.8 8.2 10.70% / 75% 8.48% / 90% 23.8% / 25.2% 24.3% / 26.6%
Stocks - High IV/SV ratio**

Savient Pharma SVNT 11.0 201.5 15.48% / 71% 5.11% / 5% 115.1% / 56.8% 92% / 100.5%
Acadia Pharma ACAD 1.6 8.7 112.62% / 91% 117.91% / 96% 172.8% / 87.5% 176.5% / 105.8%
Mylan Inc. MYL 5.3 158.5 1.70% / 38% -5.21% / 42% 59.9% / 33.1% 45.5% / 38.1%
Arena Pharma ARNA 2.3 118.7 24.25% / 75% 2.26% / 2% 119.4% / 66.2% 131.3% / 95.3%
Sun Microsystems JAVA 3.6 497.7 0.33% / 25% 0.22% / 12% 12.9% / 7.3% 13.7% / 7.8%
Stocks - Low IV/SV ratio

Medarex MEDX 6.9 113.3 86.40% / 81% 93.20% / 97% 13.3% / 43.5% 62.7% / 50.9%
Human Genome Sciences HGSI 29.9 249.8 485.20% / 92% 402.75% / 92% 70% / 165.4% 197.8% / 136.9%
NRG Energy NRG 14.6 193.8 5.84% / 42% 5.41% / 18% 41.8% / 70.5% 60.4% / 69.1%
AIG AIG 35.1 143.3 -6.77% / 6% -49.81% / 57% 105.6% / 163.1% % / 58.7%
CIT Group CIT 48.7 469.2 -50.31% / 70% -65.22% / 88% 284.4% / 437.1% 130.5% / 91.2%
Futures - High IV/SV ratio**

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

Corn C CME 53.8 446.6 -5.32% / 35% -9.59% / 27% 34.2% / 46.2% 40.5% / 33.6%
Soybean meal SM CME 3.5 52.6 -0.63% / 0% -11.33% / 32% 37.9% / 44.3% 43.8% / 34.8%
Wheat W CBOT 6.9 109.3 -2.60% / 29% -4.51% / 32% 33% / 38% 40.4% / 35.6%
Orange juice JO ICE 3.4 32.2 -3.32% / 100% 23.84% / 74% 46.1% / 51.9% 40.1% / 36.5%
Cotton CT ICE 5.8 62.5 -7.50% / 100% 3.58% / 12% 32.2% / 36.2% 36.3% / 38.6%
* Ranked by volume ** Ranked based on high or low IV/SV values.
LEGEND:
Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).
Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).
IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.
10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.
20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-day
moves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example, the “rank”
for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows how the most
recent 20-day move compares to the past sixty 20-day moves.

FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
The largest positive readings represent markets in which commercial posi-
tions (longs-shorts) exceeded speculator holdings in July. And the largest
COT extremes negative values represent the opposite relationship — speculator positions
exceeding commercial positions.
The Commitments of Traders (COT) report is published each
week by the Commodity Futures Trading Commission
(CFTC). The report divides the open positions in futures mar-
kets into three categories: commercials, non-commericals,
and non-reportable.
Commercial traders, or hedgers, tend to operate in the
cash market (e.g., grain merchants and oil companies that
either produce or consume the underlying commodity).
Non-commercial traders are large speculators (“large
specs”) such as commodity trading advisors and hedge
funds — professional money managers who do not deal in
the underlying cash markets but speculate in futures on a
large-scale basis. Many of these traders are trend-followers. For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
The non-reportable category represents small traders, or the
general public. Legend: Figure 1 shows the difference between net commer-
Figure 1 shows the relationship between commercials and large speculators cial and net large spec positions (longs - shorts) for all 45 futures
markets, in descending order. It is calculated by subtracting the
on July 21. Positive values mean that net commercial positions (longs-shorts) are current net large spec position from the net commercial position
larger than net speculator holdings, based on their five-year historical relation- and then comparing this value to its five-year range.
ship. Negative values mean that large speculators have bigger positions than the The formula is:
commercials. a1 = (net commercial 5-year high - net commercial current)
In July, commercial positions exceeded speculator positions in natural gas b1 = (net commercial 5-year high - net commercial 5-year low)
(NG) and Dow Jones Industrial Average futures (DJ), a bullish sign. Meanwhile, c1 = ((b1 - a1)/ b1 ) * 100
speculators held more positions than commercials in Japanese yen (JY) and a2 = (net large spec 5-year high - net large spec current)
Nikkei 225 futures (NK), a bearish sign. However, these relationships failed to b2 = (net large spec 5-year high - net large spec 5-year low)
hit five-year extremes — positive or negative — in any market. c2 = ((b2 - a2)/ b2 ) * 100
— Compiled by Floyd Upperman x = (c1 - c2)
Options Watch: S&P 500 — Health care sector (as of July 23) Compiled by Tristan Yates
The following table summarizes the expiration months available for the top 20 stocks in the S&P 500 health care sector exchange-traded fund
(XLV). It also shows each stock’s average bid-ask spread for at-the-money (ATM) July options. The information does NOT constitute trade sig-
nals. It is intended only to provide a brief synopsis of potential slippage in each option market.
Option contracts traded

2009 2010 2011
Bid-ask
March
spread as %
Sept.
Aug.
Dec.
Nov.
Feb.
Jan.
Jan.
Oct.
Closing of underlying
Stock Ticker price Call Put price
Amgen Inc. AMGN X X X X X 59.84 0.04 0.03 0.06%
Bristol-Myers Squibb Co. BMY X X X X X X 20.86 0.02 0.03 0.10%
Pfizer Inc. PFE X X X X X X 16.15 0.02 0.02 0.12%
Celgene Corp. CELG X X X X X 55.97 0.08 0.09 0.15%
Express Scripts Inc. ESRX X X X X X X 69.66 0.09 0.13 0.15%
Baxter International Inc. BAX X X X X X X 54.00 0.09 0.09 0.16%
Johnson & Johnson JNJ X X X X X 60.22 0.09 0.11 0.17%
Gilead Sciences Inc. GILD X X X X X X 48.34 0.10 0.08 0.18%
Abbot Laboratories ABT X X X X X X 43.84 0.06 0.10 0.19%
Medco Health Solutions Inc. MHS X X X X X 49.42 0.09 0.13 0.21%
WellPoint Inc. WLP X X X X X X 52.00 0.13 0.10 0.22%
Wyeth WYE X X X X X 47.10 0.13 0.10 0.24%
Merck & Co. Inc. MRK X X X X X 30.25 0.06 0.09 0.25%
Medtronic Inc. MDT X X X X X X 34.38 0.09 0.11 0.29%
Eli Lilly & Co. LLY X X X X X 34.28 0.10 0.11 0.31%
UnitedHealth Group Inc. UNH X X X X X X 27.05 0.11 0.09 0.37%
Thermo Fisher Scientific Inc. TMO X X X X 43.93 0.19 0.18 0.41%
Schering-Plough Corp. SGP X X X X X X 26.81 0.11 0.14 0.47%
Boston Scientific Corp. BSX X X X X X X 10.43 0.06 0.06 0.60%
Becton Dickinson & Co. BDX X X X X 71.42 0.49 0.45 0.66%
Legend:
Call: Four-day average difference between bid and ask prices for the front-month ATM call.
Put: Four-day average difference between bid and ask prices for the front-month ATM put.
Bid-ask spread as % of underlying price: Average difference between bid and ask prices for front-month, ATM call, and put divided by the underlying's closing price.

KEY CONCEPTS The option “Greeks”
Delta: The ratio of the movement in the option price for
American style: An option that can be exercised at any
every point move in the underlying. An option with a
time until expiration. delta of 0.5 would move a half-point for every 1-point
move in the underlying stock; an option with a delta of
Assign(ment): When an option seller (or “writer”) is 1.00 would move 1 point for every 1-point move in the
obligated to assume a long position (if he or she sold a put) underlying stock.
or short position (if he or she sold a call) in the underlying
stock or futures contract because an option buyer exercised Gamma: The change in delta relative to a change in the
the same option. underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
At the money (ATM): An option whose strike price is and lowest for deep ITM and OTM options.
identical (or very close) to the current underlying stock (or
futures) price. Rho: The change in option price relative to the change
in the interest rate.
Backspreads and ratio spreads are leveraged posi-
Theta: The rate at which an option loses value each day
tions that involve buying and selling options in different
(the rate of time decay). Theta is relatively larger for
proportions, usually in 1:2 or 2:3 ratios. Backspreads con-
OTM than ITM options, and increases as the option gets
tain more long options than short ones, so the potential closer to its expiration date.
profits are unlimited and losses are capped. By contrast,
ratio spreads have more short options than long ones and Vega: How much an option’s price changes per a one-
have the opposite risk profile. percent change in volatility.
Note: These labels are not set in stone. Some traders
describe either position as option trades with long and
short legs in different proportions. weekly by the Commodity Futures Trading Commission
(CFTC), the Commitments of Traders (COT) report breaks
Bear call spread: A vertical credit spread that consists down the open interest in major futures markets. Clearing
of a short call and a higher-strike, further OTM long call in members, futures commission merchants, and foreign bro-
the same expiration month. The spread’s largest potential kers are required to report daily the futures and options
gain is the premium collected, and its maximum loss is lim- positions of their customers that are above specific report-
ited to the point difference between the strikes minus that ing levels set by the CFTC.
premium. For each futures contract, report data is divided into three
“reporting” categories: commercial, non-commercial, and
Bear put spread: A bear debit spread that contains puts non-reportable positions. The first two groups are those
with the same expiration date but different strike prices. who hold positions above specific reporting levels.
You buy the higher-strike put, which costs more, and sell The “commercials” are often referred to as the large
the cheaper, lower-strike put. hedgers. Commercial hedgers are typically those who actu-
ally deal in the cash market (e.g., grain merchants and oil
Bull call spread: A bull debit spread that contains calls companies, who either produce or consume the underlying
with the same expiration date but different strike prices. commodity) and can have access to supply and demand
You buy the lower-strike call, which has more value, and information other market players do not.
sell the less-expensive, higher-strike call. Non-commercial large traders include large speculators
(“large specs”) such as commodity trading advisors (CTAs)
Bull put spread (put credit spread): A bull credit and hedge funds. This group consists mostly of institution-
spread that contains puts with the same expiration date, but al and quasi-institutional money managers who do not deal
different strike prices. You sell an OTM put and buy a less- in the underlying cash markets, but speculate in futures on
expensive, lower-strike put. a large-scale basis for their clients.
The final COT category is called the non-reportable posi-
Calendar spread: A position with one short-term short tion category — otherwise known as small traders — i.e.,
option and one long same-strike option with more time the general public.
until expiration. If the spread uses ATM options, it is mar-
ket-neutral and tries to profit from time decay. However, Correlation coefficient, sometimes referred to simply
OTM options can be used to profit from both a directional as correlation, refers to the degree of similarity between two
move and time decay. variables. In the markets, correlation is typically used to
measure how close the relationship is between two price
Call option: An option that gives the owner the right, but series (e.g., two distinct stocks or markets), between an indi-
not the obligation, to buy a stock (or futures contract) at a vidual stock (or trading fund) and an index, and so on.
fixed price. Correlation coefficients range between -1.00 and +1.00,
with +1.00 representing perfect positive correlation (i.e.,
The Commitments of Traders report: Published two variables moving precisely in tandem); -1.00 represents

perfect negative correlation (i.e., two variables moving might be below the market’s value, triggering a loss. If you
exactly opposite to one another). A correlation coefficient of sell a put, for example, you are obligated to buy the under-
zero means the two variables have no discernible relation. lying instrument at the put’s strike price, which may be well
The site http://davidmlane.com/hyperstat/index.html above the market, also causing a loss.
offers relatively easy-to-digest definitions of this and other Given its risk, selling naked options is only for advanced
statistical terms. options traders, and newer traders aren’t usually allowed
by their brokers to trade such strategies.
Covered call: Shorting an out-of-the-money call option
against a long position in the underlying market. An exam- Naked (uncovered) puts: Selling put options to collect
ple would be purchasing a stock for $50 and selling a call premium that contains risk. If the market drops below the
option with a strike price of $55. The goal is for the market short put’s strike price, the holder may exercise it, requiring
to move sideways or slightly higher and for the call option you to buy stock at the strike price (i.e., above the market).
to expire worthless, in which case you keep the premium.
Near the money: An option whose strike price is close
Credit spread: A position that collects more premium to the underlying market’s price.
from short options than you pay for long options. A credit
spread using calls is bearish, while a credit spread using Open interest: The number of options that have not
puts is bullish. been exercised in a specific contract that has not yet expired.
Debit spread: An options spread that costs money to Out of the money (OTM): A call option with a strike
enter, because the long side is more expensive that the short price above the price of the underlying instrument, or a put
side. These spreads can be verticals, calendars, or diagonals. option with a strike price below the underlying instru-
ment’s price.
Delivery period (delivery dates): The specific time
period during which a delivery can occur for a futures con- Parity: An option trading at its intrinsic value.
tract. These dates vary from market to market and are deter-
mined by the exchange. They typically fall during the Physical delivery: The process of exchanging a physical
month designated by a specific contract — e.g. the delivery commodity (and making and taking payment) as a result of
period for March T-notes will be a specific period in March. the execution of a futures contract. Although 98 percent of
all futures contracts are not delivered, there are market par-
Diagonal spread: A position consisting of options with ticipants who do take delivery of physically settled con-
different expiration dates and different strike prices — e.g., tracts such as wheat, crude oil, and T-notes. Commodities
a December 50 call and a January 60 call. generally are delivered to a designated warehouse; T-note
delivery is taken by a book-entry transfer of ownership,
European style: An option that can only be exercised at although no certificates change hands.
expiration, not before.
Premium: The price of an option.
Exercise: To exchange an option for the underlying
instrument. Put option: An option that gives the owner the right, but
not the obligation, to sell a stock (or futures contract) at a
Expiration: The last day on which an option can be exer- fixed price.
cised and exchanged for the underlying instrument (usual-
ly the last trading day or one day after). Put ratio backspread: A bearish ratio spread that con-
tains more long puts than short ones. The short strikes are
In the money (ITM): A call option with a strike price closer to the money and the long strikes are further from the
below the price of the underlying instrument, or a put money.
option with a strike price above the underlying instru- For example, if a stock trades at $50, you could sell one
ment’s price. $45 put and buy two $40 puts in the same expiration month.
If the stock drops, the short $45 put might move into the
Intrinsic value: The difference between the strike price money, but the long lower-strike puts will hedge some (or
of an in-the-money option and the underlying asset price. A all) of those losses. If the stock drops well below $40, poten-
call option with a strike price of 22 has 2 points of intrinsic tial gains are unlimited until it reaches zero.
value if the underlying market is trading at 24.
Put spreads: Vertical spreads with puts sharing the same
Naked option: A position that involves selling an unpro- expiration date but different strike prices. A bull put spread
tected call or put that has a large or unlimited amount of contains short, higher-strike puts and long, lower-strike
risk. If you sell a call, for example, you are obligated to sell puts. A bear put spread is structured differently: Its long
the underlying instrument at the call’s strike price, which continued on p. 30

KEY CONCEPTS
puts have higher strikes than the short puts.

Strike (“exercise”) price: The price at which an under-
Relative strength index (RSI): Developed by Welles lying instrument is exchanged upon exercise of an option.
Wilder, the relative strength index is an indicator in the
“oscillator” family designed to reflect shorter-term momen- Time decay: The tendency of time value to decrease at an
tum. It ranges from zero to 100, with higher readings sup- accelerated rate as an option approaches expiration.
posedly corresponding to overbought levels and low read-
ings reflecting the opposite. The formula is: Time spread: Any type of spread that contains short
near-term options and long options that expire later. Both
RSI = 100 – (100/[1+RS]) options can share a strike price (calendar spread) or have
where different strikes (diagonal spread).
RS = relative strength = the average of the up closes over
the calculation period (e.g., 10 bars, 14 bars) divided by the Time value (premium): The amount of an option’s
average of the down closes over the calculation period. value that is a function of the time remaining until expira-
tion. As expiration approaches, time value decreases at an
For example, when calculating a 10-day RSI, if six of the accelerated rate, a phenomenon known as “time decay.”
days closed higher than the previous day’s close, subtract
the previous close from the current close for these days, add Variance and standard deviation: Variance meas-
up the differences, and divide the result by 10 to get the up- ures how spread out a group of values are — in other
close average. (Note that the sum is divided by the total words, how much they vary. Mathematically, variance is the
number of days in the look-back period and not the number average squared “deviation” (or difference) of each number
of up-closing days.) in the group from the group’s mean value, divided by the
For the four days that closed lower than the previous number of elements in the group. For example, for the num-
day’s close, subtract the current close from the previous bers 8, 9, and 10, the mean is 9 and the variance is:
low, add these differences, and divide by 10 to get the
down-close average. If the up-close average is 0.8 and the {(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667
down close average is 0.4, the relative strength over this
period would be 2. The resulting RSI would be 100 - Now look at the variance of a more widely distributed set
(100/[1+2]) = 100 - 33.3 = 66.67. of numbers: 2, 9, and 16:
Simple moving average: A simple moving average {(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67
(SMA) is the average price of a stock, future, or other mar-
ket over a certain time period. A five-day SMA is the sum of The more varied the prices, the higher their variance —
the five most recent closing prices divided by five, which the more widely distributed they will be. The more varied a
means each day’s price is equally weighted in the calcula- market’s price changes from day to day (or week to week,
tion. etc.), the more volatile that market is.
A common application of variance in trading is standard
Straddle: A non-directional option spread that typically deviation, which is the square root of variance. The stan-
consists of an at-the-money call and at-the-money put with dard deviation of 8, 9, and 10 is: .667 = .82; the standard
the same expiration. For example, with the underlying deviation of 2, 9, and 16 is: 32.67 = 5.72.
instrument trading at 25, a standard long straddle would
consist of buying a 25 call and a 25 put. Long straddles are Vertical spread: A position consisting of options with
designed to profit from an increase in volatility; short strad- the same expiration date but different strike prices (e.g., a
dles are intended to capitalize on declining volatility. The September 40 call option and a September 50 call option).
strangle is a related strategy.
Volatility: The level of price movement in a market.
Strangle: A non-directional option spread that consists of Historical (“statistical”) volatility measures the price fluctu-
an out-of-the-money call and out-of-the-money put with ations (usually calculated as the standard deviation of clos-
the same expiration. For example, with the underlying ing prices) over a certain time period — e.g., the past 20
instrument trading at 25, a long strangle could consist of days. Implied volatility is the current market estimate of
buying a 27.5 call and a 22.5 put. Long strangles are future volatility as reflected in the level of option premi-
designed to profit from an increase in volatility; short stran- ums. The higher the implied volatility, the higher the option
gles are intended to capitalize on declining volatility. The premium.
straddle is a related strategy.

FUTURES & OPTIONS CALENDAR AUGUST/SEPTEMBER
MONTH
August 21 FND: September coffee futures (ICE)

Legend LTD: August single stock futures
1 FDD: August crude oil and natural (OC); September T-bond, corn, wheat,
CPI: Consumer price index gas futures (NYMEX)
soybeans, soybean products, oats,
ECI: Employment cost index 2 and rough rice options (CME);
FDD (first delivery day): September orange juice and cotton
The first day on which deliv-
3 FND: August propane futures (NYMEX) options (ICE); August index and
ery of a commodity in fulfill-
FDD: August gold, silver, copper, equity options
aluminum, platinum, and palladium U.S.: Cattle on feed
ment of a futures contract
futures (NYMEX); August soybean
can take place.
and soybean products futures (CME) 22
FND (first notice day): Also U.S.: Crop progress report
known as first intent day, this 23
is the first day a clearing- 4 FND: August heating oil and RBOB
24 U.S.: Crop progress report
house can give notice to a gasoline futures (NYMEX)
buyer of a futures contract U.S.: Weekly weather report 25 U.S.: Weekly weather report
that it intends to deliver a
5 U.S.: Petroleum status report and 26 LTD: August pork bellies futures (CME);
commodity in fulfillment of a
agricultural prices September natural gas, heating oil,
futures contract. The clear-
RBOB gasoline, gold, silver, copper, and
inghouse also informs the 6 FDD: August propane futures
aluminum options (NYMEX)
seller. (NYMEX)
U.S.: Petroleum status report
FOMC: Federal Open Market U.S.: Natural gas storage report
Committee 7 LTD: August live cattle and pork
27 LTD: September natural gas futures;
August gold, silver, copper, aluminum,
GDP: Gross domestic bellies options (NYMEX); September
platinum, and palladium futures
product cocoa options (ICE)
(NYMEX)
ISM: Institute for supply 8 FDD: August heating oil and RBOB U.S.: Natural gas storage report
management gasoline futures (NYMEX)
LTD (last trading day): The
28 FND: September natural gas futures
first day a contract may trade
9 (NYMEX)
or be closed out before the 10 FND: August live cattle futures (CME) 29
delivery of the underlying U.S.: Crop progress report
asset may occur.
30
11 FDD: August pork bellies futures (CME)
31 FND: September gold, silver, copper,
PPI: Producer price index
U.S.: Weekly weather report
Quadruple witching Friday: aluminum, platinum, and palladium
A day where equity options, 12 U.S.: Petroleum status report, crop futures (NYMEX); September T-bonds,
equity futures, index options, production, and world agricultural corn, wheat, soybeans, soybean
and index futures all expire. supply and demand products, oats, and rough rice futures
(CME)
13 FDD: August live cattle futures (CME) LTD: September heating oil, RBOB
U.S.: Natural gas storage report gasoline, and propane futures
AUGUST 2009
26 27 28 29 30 31 1 14 LTD: August soybeans and soybean (NYMEX); August live cattle futures
products futures (CME); September (CME); September lumber options
2 3 4 5 6 7 8 (CME)
coffee options (ICE)
9 10 11 12 13 14 15 U.S.: Crop progress report
16 17 18 19 20 21 22
15
23 24 25 26 27 28 29 16 September
30 31 1 2 3 4 5 17 LTD: September crude oil futures 1 FND: September orange juice futures
(NYMEX); September sugar options (ICE)
(ICE) FDD: September crude oil, natural gas
SEPTEMBER 2009 U.S.: Crop progress report futures, gold, silver, copper, aluminum,
30 31 1 2 3 4 5 platinum, and palladium futures
18 FND: September cocoa futures (ICE)
6 7 8 9 10 11 12 U.S.: Weekly weather report (NYMEX); September T-bond, corn,
13 14 15 16 17 18 19 wheat, soybeans, soybean products,
19 U.S.: Petroleum status report oats, and rough rice futures (CME);
20 21 22 23 24 25 26
20 FND: September crude oil futures September coffee and cocoa futures
27 28 29 30 1 2 3 (ICE)
(NYMEX)
LTD: September crude oil futures U.S.: Weekly weather report
The information on this page is
subject to change. Futures & (NYMEX); September platinum
Options Trader is not responsible
2 FND: September heating oil, RBOB
for the accuracy of calendar dates options (NYMEX) gasoline, and propane futures (NYMEX)
beyond press time. U.S.: Natural gas storage report U.S.: Petroleum status report

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color-coded Web portal provides access to audio squawks, platforms SaxoTrader, SaxoWebTrader, and SaxoMobileTrader.
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the morning report product. “Flip,” launched from the pass- launch of the FX Options Board, which allows investors to see
word-protected browser, lets users maintain the functionality of standardized dates and strike increments.
the Web portal’s scrolling headlines using limited screen space.
Additionally, Flip offers access to “Ask the Desk,” an interactive Note: The New Products and Services section is a forum for industry
analyst service made available to TradeTheNews.com audio businesses to announce new products and upgrades. Listings are adapted
users. “NewsFlashes,” enabled when Flip is minimized, are from press releases and are not endorsements or recommendations from
desktop headline alerts that slide up from the icon tray when the Active Trader Magazine Group. E-mail press releases to
fresh headlines are published. editorial@futuresandoptionstrader.com. Publication is not guaranteed.

FUTURES TRADE JOURNAL
Market follows script, but a few

ad-libs render trade plan moot.
TRADE
Date: Thursday, July 23, 2009.
Entry: Short September crude oil futures

(CLU09) at 67.45.
Reason for trade/setup: After running

into the $70s, crude oil fell sharply at the
beginning of July, with the September con-
tract retreating to $59.30 by July 13. The
market then rebounded over the next week
or so, pulling to within $.25-30 of the
implied chart resistance established by the
breakdown through the June-July lows.
Source: TradeStation
Crude oil is likely to climb higher in the
long-term, but there will be obvious pres-
sure on the market as it challenges this threshold. We’ll expected path.
attempt to go short on a move we expect to push slightly Nonetheless, entry was activated one day later, July 23,
above the July 2 low of 67.29. Note: This trade was a paper when price rallied to 67.49. Initially, things looked promis-
trade. ing: Price dropped almost a full point the next day (which
We chose a multiple of $.05 for the entry price because 38 might have been a good reason to lower the stop to
percent of the highs over the previous 200 days occurred at breakeven). It was just a pullback, however, and price
nickel increments. If the prices were entirely random, the climbed steadily higher before thrusting through the stop
odds should be no more than 20 percent. level on July 26.
One other observation: We should have anticipated the
Initial stop: 68.23. strength of the move through the resistance level. Even after
being stopped out, the basic trade premise appeared to
Initial target: $63.55, a little above the July 16 high. have some merit. But having missed an opportunity once, it
was difficult to give the market more leeway and risk
RESULT another missed trade. This, however, is precisely the wrong
attitude. By July 29, the market had fallen below the initial
Exit: 68.23. profit target.
Profit/loss: -.78 (-1.16%). Note: Initial targets for trades are typically based on things such as the
historical performance of a price pattern or trading system signal.
Outcome: The trade was initially conceived on July 20, However, individual trades are a function of immediate market behavior;
and price came up a little short of the desired entry point on initial price targets are flexible and are most often used as points at which
July 21 before pulling back to just above the proposed prof- a portion of the trade is liquidated to reduce the position’s open risk. As
it target on July 22. Perhaps the trade idea should have been a result, the initial (pre-trade) reward-risk ratios are conjectural by
abandoned at that point, given the market had followed the nature.
TRADE SUMMARY
P/L
Date Contract Entry Initial stop Initial target IRR Exit Date Point % LOP LOL Length
7/23/09 CLU09 67.45 68.23 63.55 5 68.23 7/26/09 -.78 -1.16% +.99 -.78 2 days
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 TRADE JOURNAL
FIGURE 1 — RISK PROFILE — LONG CALLS

Buying ITM calls on Cisco Systems (CSCO) is an easy way to exploit an up
move without investing much capital.
Long calls on Cisco Systems

gain ground after a high-profile
ratings upgrade.
TRADE
Date: Monday, July 20.
Market: Options on Cisco Systems

(CSCO).
Entry: Buy two August 19 calls for

$2.12 each.
Source: OptionVue
Reasons for trade/setup: On July
20, CSCO was upgraded from “neu-
tral” to “outperform” by investment bank Credit Suisse. of spread, but ITM calls have high deltas, meaning the posi-
The upgrade was the first time any firm had changed its rat- tion should move in line with the underlying stock.
ing on Cisco since it replaced ailing General Motors (GM) August 19.00-strike calls were purchased for $2.12 each
on June 8 in the Dow Jones Industrial Average (DJIA). when Cisco was trading at $20.95 at 9:40 a.m. Although
Historical research shows Dow stocks that are upgraded CSCO had already gained 0.7 percent in the first 10 minutes
by analysts tend to open higher and continue climbing of trading, we still took the trade because the broader mar-
throughout the day. In fact, this pattern remained bullish ket pointed higher.
even during the financial crisis of 2008: Stocks climbed an Figure 1 shows the trade’s potential gains and losses on
average 0.5 percent from the open to the close between June July 20. The position has a total delta of 169, so it initially
2007 and June 2009. resembles 169 Cisco shares.
Moreover, the stock market resumed its upswing, with
the S&P 500 index (SPX) bouncing 8.2 percent off its July 8
TRADE SUMMARY
low. Also, technology stocks led the pack — the Nasdaq 100
index (NDX) gained 9.5 percent during the same period.
After the upgrade, Cisco jumped 1.5 percent overnight. Entry date: July 20, 2009
The goal is to capture additional gains by the end of the Underlying security: Cisco Systems (CSCO)
day. The easiest way to exploit a possible up move is to buy Position: 2 long August 19 calls
in-the-money (ITM) calls. The approach isn’t as exciting as Initial capital required: $424
selling naked, or uncovered, options or creating some type
Initial stop: Exit if CSCO drops below yesterday’s close.
Initial target: Hold until today’s close
TRADE STATISTICS
Initial daily time decay: $1.59
July 20 9:40 a.m. 10 a.m. Trade length: 1 day
Delta: 169 177.6 P/L: $44 (10.4 percent)
Gamma: 22.03 18.28
LOP: $44
Theta: -1.59 -1.21
LOL: $0
Vega: 3.13 2.46
LOP — largest open profit (maximum available profit during life of trade).
Probability of profit: 44% 53%
LOL — largest open loss (maximum potential loss during life of trade).
Breakeven point: $21.12 $21.12

FIGURE 2 — LATE ENTRY, EARLY EXIT
Although we entered the trade after Cisco had already rallied 0.7 percent from the
open, CSCO rose another 1.2 percent within 20 minutes. We sold the calls near
Cisco’s intraday high and earned 0.22 per contract (10.4 percent).
Initial stop: Exit if Cisco drops
below yesterday’s close (2.1 percent).
Initial target: Hold until today’s

close.
RESULT
Outcome: Figure 2 shows we

entered the trade late, but Cisco gained
1.2 percent within 20 minutes. We sold
the calls for $2.34 each — a profit of
10.4 percent — when CSCO traded at
$21.20 at 10 a.m. Luckily, we managed
to sell near the intraday high and
avoided the late-morning slump,
which would have erased any unreal- Source: eSignal
ized gains.
EVENTS
Event: International Investors’ Trade Fair Event: Lawrence G. McMillan’s
Date: Sept. 4-6 Intensive Options Seminar
Location: Düsseldorf, Germany Date: Nov. 7
For more information: http://www.mdna.com Location: New York City, Marriott Marquis
For more information: Go to
Event: 4th Annual Paris Trading Show http://www.optionstrategist.com and click on “Seminars”
Date: Sept. 18-19
Location: Paris, France Event: The Fifth Middle East Forex Trading Expo and
For more information: http://www.salonat.com Conference 2009
Date: Nov. 17-18
Event: Melbourne Trading & Investing Expo Location: Jumeirah Emirates Towers Hotel, Dubai
Date: Oct. 2-3 For more information: http://www.meforexexpo.com
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Event: Sydney Trading & Investing Expo Event: International Traders Expo
Date: Oct. 30-31 Date: Nov. 18-21
Location: Sydney Convention & Exhibition Centre Location: Mandalay Bay Resort & Casino, Las Vegas
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Event: FXstreet’s International Traders Conference

Date: Oct. 14-16
Location: Barcelona, Spain
For more information: http://www.fxstreet.com

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August 2009 • Volume 3, No.

Options Trading System Lab

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

2 August 2009 • FUTURES & OPTIONS TRADER

What’s a Binary Option?

At Nadex we’ve made it easy to trade what you want. Nadex

090706_273x206_FOT.indd 1 29/06/2009 13:28:54

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

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

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

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

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4 August 2009 • FUTURES & OPTIONS TRADER

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For all subscriber services:

Editor-in-chief: Mark Etzkorn

Managing editor: Molly Goad

Stephan Bisse is a principal of Tannhauser Gate GmbH and

Classified ad sales: Mark Seger

Volume 3, Issue 8. Futures & Options Trader is pub-

The information in Futures & Options Trader magazine

6 August 2009 • FUTURES & OPTIONS TRADER

Commodities stabilize in July

8 August 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • August 2009 9

M oving averages are useful for filtering the noise

Tuning to market conditions: The MAX

10 August 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • August 2009 11

MAX, and all trades were

12 August 2009 • FUTURES & OPTIONS TRADER

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

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

Another interesting fact of a more general Related reading

FUTURES & OPTIONS TRADER • August 2009 13

14 August 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • August 2009 15

FIGURE 4 — CROSSING THE FINISH LINE

Balancing volatility and probability

16 August 2009 • FUTURES & OPTIONS TRADER

Naked-call Martingale strategy

18 August 2009 • FUTURES & OPTIONS TRADER

FIGURE 3 — SYSTEM PERFORMANCE

FUTURES & OPTIONS TRADER • August 2009 19

Exit Test results: Figure 3 tracks the system’s performance,

Test details: Daily closing prices were used. Trades were

Three good tools for targeting customers . . .

20 August 2009 • FUTURES & OPTIONS TRADER

CFTC flexes muscles on position limits

I t has been a busy summer for Commodity Futures

22 August 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • August 2009 23

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

Indices - Low IV/SV ratio

Stocks - High IV/SV ratio**

Stocks - Low IV/SV ratio

Futures - High IV/SV ratio**

Futures - Low IV/SV ratio**