FOT200911

November 2009 • Volume 3, No.
11
STOCHASTIC
breakout system
p. 8
THE NOB
FUTURES SPREAD
is back p. 12
COVERED CALLS
VS. COLLARS
p. 16
OPTION LAB
CREDIT SPREAD p. 22
basics p. 24
PENNY PILOT
gets new wings p. 28
CONTENTS
Options Trading System Lab

Credit spreads and the directional
movement index . . . . . . . . . . . . . . . . . . . . .22
This simple indicator-based system has
generated robust performance since 2001.
By Steve Lentz and Jim Graham
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Options Basics

Bull put spread . . . . . . . . . . . . . . . . . . . . . .24
Market Movers . . . . . . . . . . . . . . . . . . . . . . . .6 Looking under the hood of this vertical options
Futures market roundup. spread.
By FOT Staff
Trading Strategies
Stochastic breakout . . . . . . . . . . . . . . . . . . .8 Industry News
A system that fades stochastic signals produces A penny for your lots . . . . . . . . . . . . . . . . .28
profits over the long run in across a futures The SEC’s options Penny Pilot Program has just
portfolio. doubled in size. But not everyone is celebrating.
By Volker Knapp By FOT Staff
The return of the NOB spread . . . . . . . .12

An old favorite of futures spreaders is enjoying
renewed life.
By Keith Schap
To hedge or not to hedge? . . . . . . . . . . .16

A historical look at simple options-hedging
techniques sheds light on the debate between continued on p. 4
covered calls and collars.
By Mark D. Wolfinger
2 November 2009 • FUTURES & OPTIONS TRADER

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CONTENTS
Managed Money . . . . . . . . . . . . . . . . . . . . .28

Top 10 option strategy traders ranked by August
2009 return.
Futures & Options Watch:

COT extremes . . . . . . . . . . . . . . . . . . . . . . .29
A look at the relationship between
commercials and large speculators in all
45 futures markets.
Futures & Options Calendar . . . . . . . . . . . .32
Options Watch . . . . . . . . . . . . . . . . . . . . . .29
Technology sector ETF components Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .33
References and definitions.
Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .30
Momentum, volatility, and volume Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35
statistics for futures.
New Products and Services . . . . . . . . . . . . .36
Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .31
Notable volatility and volume Options Trade Journal . . . . . . . . . . . . . . .38
in the options market. This covered call wins with a bounce from RIMM.
Have a question about something you’ve seen

in Futures & Options Trader?
Submit your editorial queries or comments to webmaster@futuresandoptionstrader.com.
Looking for an advertiser?

Click on the company name below for a direct link to the ad
in this month’s issue of Futures & Options Trader.
eSignal
Las Vegas Traders Expo
MoneyShow.com
RS of Houston
Trade With Volume

CONTRIBUTORS
CONTRIBUTORS
Keith Schap is a freelance writer specializing in risk

management and trading strategies. He is the author of
A publication of Active Trader ®
numerous articles and several books on these subjects,
For all subscriber services: including The Complete Guide to Spread Trading (McGraw-Hill,
www.futuresandoptionstrader.com 2005). He was a senior editor at Futures magazine and senior
technical marketing writer at the CBOT.
Editor-in-chief: Mark Etzkorn
metzkorn@futuresandoptionstrader.com
Volker Knapp has been a trader, system developer, and
Managing editor: Molly Goad researcher for more than 20 years. His diverse background
mgoad@futuresandoptionstrader.com encompasses positions such as German National Hockey
Senior editor: David Bukey team player, coach of the Malaysian National Hockey team,
dbukey@futuresandoptionstrader.com and president of VTAD (the German branch of the
Contributing writers: Keith Schap, International Federation of Technical Analysts). In 2001, he became a part-
Chris Peters
ner in Wealth-Lab Inc. (www.wealth-lab.com), which he still runs.
cpeters@futuresandoptionstrader.com
Editorial assistant and

Mark Wolfinger (rookies@mdwoptions.com) has been trading options
webmaster: Kesha Green
kgreen@futuresandoptionstrader.com professionally since 1977. For the past nine years, he has educated individ-
ual investors, stressing the idea of using options to reduce the risk of invest-
Art director: Laura Coyle
lcoyle@futuresandoptionstrader.com ing. His latest book is The Rookie’s Guide to Options (W&A Publishing, 2008).
He writes a blog (http://blog.mdwoptions.com/Options_for_Rookies/)
President: Phil Dorman
pdorman@futuresandoptionstrader.com dedicated to options education.
Publisher,
Ad sales East Coast and Midwest: Jim Graham (advisor@optionvue.com) is the product
Bob Dorman manager for OptionVue Systems and a registered investment
bdorman@futuresandoptionstrader.com
advisor for OptionVue Research.
Ad sales
West Coast and Southwest only:
Allison Chee Steve Lentz (advisor@optionvue.com) is a well-estab-
achee@futuresandoptionstrader.com lished options educator and trader and has spoken all over
Classified ad sales: Mark Seger the U.S., Asia, and Australia on behalf of the CBOE’s Options
seger@futuresandoptionstrader.com Institute, the Options Industry Council, and the Australian
Stock Exchange. As a mentor for DiscoverOptions.com, he
Volume 3, Issue 11. Futures & Options Trader is pub- teaches select students how to use complex options strategies and develop
lished monthly by TechInfo, Inc., 161 N. Clark St.,
Suite 4915, Chicago, IL 60601. Copyright © 2009
TechInfo, Inc. All rights reserved. Information in this a consistent trading plan. Lentz is constantly developing new strategies on
publication may not be stored or reproduced in any
form without written permission from the publisher. the use of options as part of a comprehensive profitable trading approach.
The information in Futures & Options Trader magazine He regularly speaks at special events, trade shows, and trading group
is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply
the effectiveness of any trading system, strategy, or organizations.
approach. Traders are advised to do their own
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future
results.
FUTURES & OPTIONS TRADER • November 2009 5

MARKET MOVERS
Energies, grains — and meats — hold bullish ground

A mostly bullish October for commodity futures was led by an unlikely sector — meats, specifically lean hog futures, which
rallied despite renewed interest in the H1N1 (“don’t call me swine”) flu story that had battered the market for months.
After breaking out above the June and August highs, the Rogers
International Commodity Index TRAKRS (RCTY) turned lower in
late October, but in the first few days of November had not deeply
penetrated the roughly 18-22 congestion of the past six months.
Energies and grains — markets that had been notably weak in
September — helped lead the bullish charge in October, while pre-
cious metals reversed their previous upside momentum.
Stock-index futures, which surprised many by failing to com-
pletely unravel in October, nonetheless began to slide lower in the
latter of the month. U.S. interest-rate futures pulled back from a
nearly five-month high in early October before bouncing.
For momentum, volatility, and volume
data for the top U.S. futures contracts, see
the Futures Snapshot.
Source for all: TradeStation
Energy
Crude oil, gasoline, and heating oil all jumped higher in October, breaking out of
their nearly four-month consolidations. December crude oil (CLZ09) came up just
a penny short of $82/barrel on Oct. 21 before pulling back.
Meanwhile, December natural gas (NGZ09) perpetuated its con-
trarian ways, tumbling some 15 percent in the 20 trading days ending
Nov. 2 after having outperformed its energy compatriots the previous
month.
Metals
After hitting a new
Grains record high in
October, December
Most grains futures gold (GCZ09) trad-
pulled back in late ed as high as 1072
October, but they on Oct. 14 before
nonetheless remained consolidating and
near their highest lev- correcting late in
els since August. the month. The
December wheat (WZ09), which had been market jumped
decimated from June through September, higher on the first
reached 574.75 on Oct. 23 before retreating trading day in
below 500 by the end of the month. December November, push-
corn (CZ09) mirrored the move, pushing above ing back above
400, then retracing its steps back to around 360. $1050.
January soybeans (SF10) rallied above 1000 December silver
fairly early in October before (SIZ09) pulled off
consolidating between rough- much more sharply — falling
ly 9750 and 1010. from above 18 to around 16.
January rice (RRF10) was December copper (HGZ09)
by far the hottest grain in didn’t match gold and silver for
October, jumping more than excitement, but into early
12 percent over the 20 days November it had done a better job
ending Nov. 2. of hanging around its recent highs.

Wood and fiber
Softs January lumber (LBF10)
jumped more than 16 per-
December coffee (KCZ09), cent from Oct. 8 to Nov. 2.
which had zigzagged wildly December cotton
since June, thrust upward out (CTZ09) paused in late
of the top of its loose triangu- October after pushing out
lar pattern. of a trading range and trad-
Both January sugar (SBF10), ing above 68.50.
which had been the most con-
sistently bullish soft commod-
ity into late summer, extended
a mildly bearish trading range Treasuries
into early November.
December cocoa (CCZ09) Treasury futures slumped quietly
has picked up where sugar throughout most of October before
left off, extending its multi- bouncing late in the month. The
month rally and pushing December 10-year T-note contract
above 3,400 — its highest level (TYZ09),
since 2008. which trad-
ed to around 120 early in the
month, pulled back to 117
before making another
swing to the upside.
Meats
After a mid-September feint, Stock indices
December lean hogs (LHZ09)
continued to rebound in The December E-Mini S&P
October, trading to their high- 500 (ESZ09) declined in the
est level since July and rack- latter half of October. After
ing up a 22-percent gain over rallying to 1099, the market
the 20 days ending Nov. 2 — began to drift
the biggest gain of any U.S. lower, ulti-
commodity. February pork mately falling to 1026 by Nov. 2, putting it
bellies (PBG10) also remained within striking distance of the
in the bullish column, albeit Oct. 2 low of 1012.
with much more choppiness.
And although the market
bounced in early October,
December live cattle (LCZ09) Currencies
failed to embrace the rally,
pulling back after trading December U.S. dollar index
above 87.00 on Oct. 22. futures (DXZ09) regained their
footing — somewhat — after
falling to a multi-month low
around 75 in October.
For more coverage of the for-
eign exchange market, go to
Currency Trader magazine.

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Stochastic breakout
Inverting the standard oscillator overbought-oversold rules produces profits,
but not without some pain.
BY VOLKER KNAPP
Note: A version of this article originally appeared in the October 2004

issue of Active Trader magazine.
the new closing price. If the stop is
he typical oscillator-based trading system goes not hit, exit on the next open if %K
T long when the indicator is oversold and sells on

the opposite condition. This system does the
opposite: It goes short on very low stochastic
readings and long on very high readings, based on the
premise that extremely strong upward or downward
crosses below 2.
4. Short exit: Place a stop at the closing price of the day

before entry plus the 12-day ATR multiplied by four.
This stop should be recalculated every day based on
momentum is more likely to immediately continue than the new closing price. If the stop is not hit, exit on the
reverse. This application transforms the oscillator from a next open if %K crosses above 98.
countertrend to a trend-following tool.
Figure 1 shows some representative trades in corn
Indicator and rules
In this case, the indicator is the stochastic FIGURE 1 — SAMPLE TRADES
oscillator, which compares the current The stochastic breakout system caught a big up move in corn in 2004, but
price to the high-low range over a given failed to sell before the market had given back much of the profit — a com-
look-back period (see “Stochastic oscilla- mon problem with trend-following systems. The dots represent the stop level.
tor” for background information on this
tool). Trade signals are based on the basic
stochastic calculation, referred to as %K.
The entry rules are:
1. Long entry: Buy on the next open if

the 25-day %K crosses above 98.
2. Short entry: Sell short on the next

open if the 25-day %K reading
crosses below 2.
The profit-taking and stop-loss rules

exit trades when price either moves by a
certain volatility-adjusted amount, or
when a signal in the opposite direction
occurs:
3. Long exit: Place a stop at the closing

price of the day before entry minus
the 12-day average true range (ATR)
multiplied by four. This stop should
be recalculated every day based on Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com)

FIGURE 2 — EQUITY CURVE
futures (C). Notice the sell signal
The system returned 356 percent over nine years, but often stagnated for
toward the end of the chart occurs extended periods.
around the point a typical downside
breakout signal would have taken
place, upon the penetration of the April
2004 lows.
Other system parameters

In historical testing, we will risk a max-
imum of 2 percent of total equity based
on the ATR stop. For example, if on a
day a long trade is triggered the market
closes at 50, the stop is set at 40, and the
point value of the contract is $25, the
theoretical risk would be 10 points *
$25 = $250. If the account value on the
entry day is $150,000, you could risk a
total of $150,000 * .02 = $3,000). The
number of contracts you could pur-
chase is $3,000/$250 = 12.
The longer the position stays open,
the greater the likelihood the ATR will
expand and the stop will move away
Source: CBOE
from the original calculation. As a
result, most trades will be stopped out
FIGURE 3 — DRAWDOWN
by the %K-based rule.
Nonetheless, the ATR method will pre- Using the 2-percent money management rule, the system produced an
acceptable drawdown relative to profit.
vent any trade from chewing up more
than 2 percent of total equity. Futures
contracts have different values, and this
method allows us to adjust them to a spe-
cific risk level and treat them all the
same. The starting account equity will be
$200,000, $20 slippage/commission will
be deducted per contract (for every
round-turn trade).
The system will tested on the follow-
ing 19 futures contracts: DAX30 (AX),
corn (C), crude oil (CL), Euro bund (DT),
Eurodollar (ED), Euro (FX), gold (GC),
copper (HG), Japanese yen (JY), coffee
(KC), live cattle (LC), lean hogs (LH),
Nasdaq 100 (ND), natural gas (NG), soy-
Source: CBOE
continued on p. 10

TRADING STRATEGIES
10-DAY STOCHASTIC OSCILLATOR
Stochastic oscillator
The stochastic oscillator (or, simply “stochastics”) is
a technical tool designed to highlight shorter-term
momentum and so-called “overbought” and “over-
sold” levels — points at which a price move has, the-
oretically at least, temporarily exhausted itself and is
ripe for a correction or reversal.
The stochastic oscillator consists of two lines: %K
and a moving average of %K called %D. The basic
stochastic calculation compares the most recent
close to the price range (high of the range - low of the
range) over a particular period. For example, a 10-
day stochastic calculation (%K) would be the differ-
ence between today’s close and the lowest low of the
past 10 days divided by the difference between the
highest high and the lowest low of the past 10 days; Source: TradeStation
the result is multiplied by 100. The formula is:
Any of the parameters –– either the number of periods used
%K = 100*((Ct-Ln)/(Hn-Ln)) in the basic calculation or the length of the moving averages
used to smooth the %K and %D lines — can be adjusted to
where: make the indicator more or less sensitive to price action. The
shorter the number of days in the calculation, the more sensi-
Ct is today’s closing price tive the indicator will be.
Hn is the highest price of the most recent n days Horizontal lines are used to mark overbought and oversold
(the default value is five days) stochastic readings. These levels are discretionary; readings
Ln is the lowest price of the most recent n days of 80 and 20 or 70 and 30 are common, but different market
conditions and indicator lengths will result in different over-
For example, if today’s close was 58, the highest high of the bought and oversold levels. Because fixed indicator parame-
past 10 days was 60, and the lowest low of the past 10 days ters may be useful in certain conditions and not in others, ana-
was 45, the day’s %K reading would be 100*(58-45)/(60-45) = lysts sometimes create dynamic versions of indicators so they
100*(13-15) = 86.67. The second line, %D, is a three-period better adjust to changing market volatility.
simple moving average of %K. The resulting indicator fluctu- Typically, tools such as stochastics are interpreted as short-
ates between 0 and 100. er-term momentum indicators: relatively high readings are
Fast vs. slow: The preceding indicator formula is sometimes intended to alert traders to a market that is overextended to the
referred to as “fast” stochastics. Because it is very sensitive, upside, while relatively low readings suggest the opposite.
an additionally smoothed version of the indicator –– where the However, in a strongly trending market, such indicators tend to
original %D line becomes a new %K line and a three-period remain overbought or oversold for extended periods. Also, very
moving average of this line becomes the new %D line –– is high or low readings are signs of strong momentum in that
more commonly used, and is referred to as “slow” stochastics, direction — a concept that provides the counterintuitive appli-
or simply “stochastics.” cation for the system in this article.
STRATEGY SUMMARY (2% RISK)

LEGEND: Avg. return — The average percent-
Avg. Sharpe Best Worst Percentage Max. Max. age for the period • Sharpe ratio — Average
return ratio return return profitable consec. consec. return divided by standard deviation of returns
periods profitable unprofitable (annualized) • Best return — Best return for the
Weekly 0.35% 0.76 10.08% -15.76% 54.98% 8 7 period • Worst return — Worst return for the
Monthly 1.54% 0.71 24.97% -20.52% 57.85% 5 5 period • Percentage profitable periods — The
percentage of periods that were profitable • Max.
Quarterly 4.40% 0.76 36.34% -25.42% 60.98% 6 2 consec. profitable — The largest number of con-
Annually 15.48% 1.16 40.42% -2.50% 90.91% 7 1 secutive profitable periods • Max. consec.
unprofitable — The largest number of consecu-
tive unprofitable periods

FIGURE 4 — FLAT PERIOD
more than $912,000 in 10 years — a net profit of 356 percent.
The spike in the middle of the testing period represents a peri-
Out of the 446 trades, only 36 percent were winners.
od of more than 600 days without a new portfolio equity high.
However, they produced a per-trade profit of $1,598.
The system looks promising with the chosen portfolio of
markets, starting equity, and money management. The
results may also surprise some people, given the system
stands the typical rules of an oscillator system on their
head. Of course, further studies should include additional
markets, different time frames (weekly data showed very
good results too), and money management settings.
For information on the author see p. 5.
STRATEGY SUMMARY (2% RISK)
Profitability Trade statistics

Net profit: $712,744.71 No. trades: 446
Net profit: 356.37% Win/loss: 36.55%
Exposure: 32.47% Avg. trade: 0.77%
beans (S), sugar (SB), silver (SI), S&P 500 (SP) and 10-year T- Profit factor: 1.31 Avg. winner: 12.94%
notes (TY). Data source: Ratio-adjusted data from Pinnacle Payoff ratio: 2.07 Avg. loser: -6.25%
Data Corp. The test period was August 1994 to August 2004. Recovery factor: 1.75 Avg. hold time: 73.91
Drawdown Avg. hold time (winners): 138.18
System results Max. DD: 33.32% Avg. hold time (losers): 36.89
Overall, the equity curve (Figure 2) shows a steady increase Longest flat days: 605 Max. consec. win/loss: 7/11
that stays close to the linear regression line (magenta).

However, short trades (red line) were not very helpful in LEGEND: Net profit — Profit at end of test period, less commission •
the long run — after August 2003, they became net losers Exposure — The area of the equity curve exposed to long or short positions,
and by the end of the test period were in the red $200,000. as opposed to cash • Profit factor — Gross profit divided by gross loss •
Payoff ratio — Average profit of winning trades divided by average loss of
Short trades were very profitable, however, in 1998 and 1999 losing trades • Recovery factor — Net profit divided by max. drawdown •
when the long trades were going through an extended flat Max. DD (%) — Largest percentage decline in equity • Longest flat days
period. — Longest period, in days, the system is between two equity highs • No.
trades — Number of trades generated by the system • Win/Loss (%) — The
Figure 3 shows the drawdown, while Figure 4 shows the percentage of trades that were profitable • Avg. trade — The average prof-
flat period. The drawdown was stable during the test peri- it/loss for all trades • Avg. winner — The average profit for winning trades
od, but the biggest loss came in 2004. In a short period of • Avg. loser — The average loss for losing trades • Avg. hold time — The
average holding period for all trades • Avg. hold time (winners) — The
time, the system lost more than 33 percent from its equity
average holding time for winning trades • Avg. hold time (losers) — The
high. average holding time for losing trades • Max. consec. win/loss — The max-
System traders often overlook the flat period, but it is an imum number of consecutive winning and losing trades
important indicator since it tells us
how long it took the strategy to
recover from its lows and produce
new profits. Most of the time the sto-
chastic %K system recovered after
100 days, but on one occasion it took
the strategy 600 days to recover from
its losses.
Overall, the system had one down
year (1997) and turned $200,000 into

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
The return of the NOB spread

Technology has made spreading easier than ever for futures traders.
BY KEITH SCHAP
eunions with friends warm the 10-year T-note (TY) took over as they won’t necessarily change. (The
R our hearts. Especially sweet

is the return of a friend who
has been missing from our
lives for a long time. So it’s a joy to see
the CME Group offer the NOB spread
the long-term interest-rate benchmark,
and the NOB faded along with the
issue of new T-bonds.
Curiously, the resumption of T-bond
issuance in early 2006 didn’t immedi-
CTD Treasury issue for any maturity is
the issue the short will find most
advantageous to deliver into the
futures contract; as yields shift, differ-
ent issues can become CTD.) For
(“notes over bonds,” as in 10-year T- ately revive this trade. But now the example, for the June NOB the price
notes and 30-year T-bonds) as a single NOB is back. A big part of the resur- ratio was 1.8001 and the leg quantity
transaction, along with the FYT (“fives gence seems to result from how simple ratio was 9:5. But for the September
and tens”) spread and several others. the exchange has made it for the aver- NOB, the price ratio was 1.6668 while
A long-time favorite of interest-rate age trader. the leg quantity ratio shifted to 5:3.
traders, the NOB spread died a sudden Currently, the December ratios are the
death when the U.S. Treasury stopped Simplicity illustrated same as September’s ratios. The ratios
issuing 30-year Treasury bonds (US) in The simplicity starts with how you for the NOB and the other interest-rate
mid-February 2002. Granted, T-bond specify these new spread trades for spreads are available on the CME
futures continued to trade (a little), but order entry. Say you want to buy the Group Web site. (For different contract
NOB — going long 10-year T-note months, replace “December” in the
futures and short T-bond futures. Web address with the month of your
Rather than “legging” into the trade choice.)
Spread liquidity (placing two orders, one in each mar- Assume you bought the NOB on a
ket, to establish the spread), you now day when the December 10-year T-
New contracts often struggle to simply specify the spread in terms of note traded at 121-18, the December T-
build enough liquidity to make name, number of contracts in each leg, bond traded at 125-21+, and the prices
them feasible for traders, espe- contract month, and year. For exam- at unwinding were 122-17 for the T-
cially those who want to trade in ple, to buy the December 2009 NOB, note and 126-08+ for the T-bond —
size. One of the best features of you enter “NOB 05:03 Z9,” which that is, during the life of the trade the
the CME Group spread design means long five T-note contracts and T-note price rose 31/32 while the T-
addresses this issue. The answer short three T-bond contracts; “Z” des- bond price rose 19/32. (Note: “+”
to the liquidity question comes in ignates the December contract month refers to half-ticks — 21.5/32nds and
two parts. First, the liquidity pool and “9” represents 2009. Individual 8.5/32nds in the preceding example.)
behind each leg of the spread vendor codes may vary slightly, but The December price ratio is 1.6668.
consists of everyone who is trad- the idea is the same. To find the spread value for this trade,
ing the NOB and everyone who is Establishing a spread price requires divide the T-bond price change by the
trading the 10-year T-note and the three bits of information: the 10-year T- price ratio and subtract this result from
T-bond. Second, given a trade note and T-bond price changes (in the T-note price change:
specification, the CME will create 32nds) and the “price ratio” (the num-
an implied spread to take the ber of 30-year contracts divided by the Spread value =
other side of your trade. Your number of 10-year contracts, in this 31 – (19/1.6668) =
counterpart could be another case 5 / 3 = 1.6667). A word of caution: 31 – (11.3990) = 19.6009,
spread trader, but you could just Both the price ratio and the “leg quan- which rounds to 19.5/32, or 19+
as easily have two separate coun- tity ratio” (the number of contracts
terparties. It makes no difference. needed in each leg of the spread to ren- To determine the dollar gain or loss
There is a vast pool of liquidity der it approximately neutral to parallel for this trade, multiply the spread
underlying your trade. yield shifts) can change if the cheapest- value by the dollar value of 1/32
to-deliver (CTD) changes, although ($31.25) and by the number of front-

FIGURE 1 — THE NOB SPREAD
The easiest way to track the NOB spread is in terms of yield difference. The
NOB was an active spread between early 2008 and July 2009. wisdom is the notion spreads are safe.
Forget it — spreads are speculative
trades, although the focus of the spec-
ulation shifts to whether the spread
will widen or narrow rather than
whether the outright price will rise or
fall. You can predict spread direction
incorrectly, just as you can outright
market direction. In cases where one
leg gains and the other loses, and you
are on the wrong side of the spread,
the gaining leg may soften the blow,
but when both legs lose, being wrong
can be ugly.
A better reason for trading spreads
concerns how many ways a spread can
satisfy your trading goal. When you
simply buy the 10-year T-note futures
outright, for example, you have only
one way to be right: You need the price
leg contracts (for the NOB, the number you bought the NOB. Say the T-note to rise. But if you go long the NOB
of 10-year T-note contracts): traded at 121-21+ and the T-bond at spread in anticipation of a widening
123-26 at unwinding. On these price continued on p. 14
19.5 * $31.25 * 5 = $3,046.88 drops, the T-note price change is
-23.5/32 while the T-bond price
Leaving money on the table change is -59/32. Based on the 1.6668
You sometimes hear traders say price ratio and the 5:3 leg quantity
spreaders “leave money on the table.” ratio, this trade would have earned
Granted, a typical description of a $1,796.88. The spread value calculation
spread trade indicates spread traders is:
expect one leg of the trade to gain, the
other to lose. The hope is the gain will -23.5 – (-59/1.6668) = 11.8972,
be bigger than the loss. rounded to 11.5
This might be true, but it also miss-
es a crucial point. The gains don’t The gain or loss calculation is:
always come from the same leg of the
trade. Consider a pair of hypothetical 11.5 * 31.25 * 5 = $1,796.88
situations.
First, take the previous example, Admittedly, this is a modest gain,
where the spread earned $3,046.88. A but contrast it with the situation of a
trader who had bought five December spread skeptic who simply bought five
T-note contracts outright would have December T-note contracts. On the
earned $4,843.75 on the 31/32 price same T-note price move, he would
move: have lost $3,671.88 (-23.5 ticks * $31.25
* 5 = $3,671.88). The spread trader in
31 ticks * $31.25 * 5 contracts = this case ends up $5,468.76 better off
$4,843.75. than the spread skeptic. This demon-
strates an important motive for trad-
A spread skeptic would point out ing the NOB spread, or any other
that this leaves almost $1,800 on the spread.
table. No question — that’s a lot.
Second, assume the T-note traded at Realities of the NOB spread
122-13 and the T-bond at 125-21 when Among the worst bits of trading folk

TRADING STRATEGIES
TABLE 1 — NOB SPREAD WIDENING EVENTS

The numbers in the “nature of spread change” column
refer to the five ways a spread can widen.
spread, you have at least five ways to be right:
NOB 10-year 30-year Nature of
1. Both yields fall, but the 10-year yield falls more. spread yield yield spread
2. Both yields rise, but the 30-year yield rises more. (in bps) (%) (%) change
3. The 10-year yield falls, and the 30-year yield rises. 1/2/08 44 3.91 4.35
4. The 10-year yield remains stable, and the 30-year 1/23/08 72 3.51 4.23
Change 28 -0.40 -0.12 1
yield rises.
1/28/08 68 3.61 4.29
5. The 10-year yield falls, and the 30-year yield
2/6/08 76 3.61 4.37
remains stable. Change 8 0.00 0.08 4
1/29/08 65 3.69 3.34
Of course, the fourth and fifth possibilities are really just 2/15/08 82 3.76 4.58
special cases of the second and first possibilities. A parallel Change 17 0.07 0.24 2
set of situations applies to short NOB spreads. Whichever 2/20/08 72 3.93 4.65
view you take on the NOB relationship, trading the NOB 3/7/08 99 3.56 4.55
gives you more ways to be right than are available to a Change 27 -0.37 -0.10 1
trader long or short just the 10-year T-note or just the T- 5/2/08 68 3.89 4.57
bond. 5/9/08 76 3.77 4.53
Change 8 -0.12 -0.04 1
7/2/08 52 3.99 4.51
The various shapes
7/16/08 62 3.97 4.59
of NOB trading opportunity Change 10 -0.02 0.08 3
Although you evaluate NOB spread trades in futures price 10/14/08 19 4.08 4.27
terms, the easiest way to track this spread is in terms of the 10/21/08 44 3.76 4.20
yield difference. Figure 1 displays the NOB from the begin- Change 25 -0.32 -0.07 1
ning of 2008 through mid-July 2009. Even the quickest 10/30/08 30 4.00 4.30
glance shows this to have been an active spread during 11/18/08 61 3.53 4.14
these months. And active translates into opportunity to Change 31 -0.47 -0.16 1
trade. 12/10/08 40 2.69 3.09
Table 1 identifies 18 spread-buying opportunities (in 12/16/08 49 2.37 2.86
Change 9 -0.32 -0.23 1
expectation of a widening spread) that occurred in 2008
1/2/09 37 2.46 2.83
and the first half of 2009. The numbers in the “nature of
1/13/09 67 2.33 3.00
spread change” column refer to the five spread-widening Change 30 -0.13 0.17 3
possibilities. 1/16/09 53 2.36 2.89
1/28/09 73 2.71 3.44
Locating the opportunities Change 20 0.35 0.55 2
Figure 1 and Table 1 illustrate the abundance of opportu- 2/9/09 62 3.07 3.69
nities to buy the NOB, and Figure 1 shows at least an equal 2/19/09 83 2.85 3.68
number of places where you could have sold the NOB. Change 21 -0.22 -0.01 1
However, knowing how to identify these places in real 2/10/09 64 2.90 3.54
time confronts traders with an interesting challenge. 2/18/09 80 2.74 3.54
Change 16 -0.16 0.00 5
In principle, any tool you use to analyze an outright
3/6/09 67 2.83 3.50
price series should work with spreads. Many of the more
3/18/09 106 2.51 3.57
commonly used tools are easy to construct. Simple chart Change 39 -0.32 0.07 3
analysis works the same way as with an outright series. 4/21/09 80 2.94 3.74
Moving averages, Bollinger bands, and some of the 4/28/09 92 3.05 3.97
momentum indicators take only minutes to develop given Change 12 0.11 0.23 2
a spreadsheet. 5/5/09 86 3.20 4.06
How you determine when to trade when looking at out- 5/11/09 101 3.17 4.18
right futures should govern your trading decisions with Change 15 -0.03 0.12 3
these spreads. Will you always be right? Of course not. But 6/8/09 74 3.91 4.65
are you always right in your other trading? The trick, as 6/17/09 82 3.68 4.50
Change 8 -0.23 -0.15 1
always, is to control your losses and, more importantly, to
6/24/09 72 3.72 4.44
maximize your winners.
7/9/09 87 3.44 4.31
Change 15 -0.28 -.013 1
For information on the author see p. 5.

Currency_Trader_Ad-LVTE09_Layout 1 9/22/09 3:09 PM Page 1
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TRADING STRATEGY
OPTIONS STRATEGIES
LAB
To hedge or not to hedge?

Options offer plenty of alternatives to the traditional buy-and-hold approach.
But is hedging your bets with options worth the inevitable trade-offs?
BY MARK D. WOLFINGER
he 2008 market rout taught everyone that a tra-
T
Methodology
ditional buy-and-hold approach to investing has The study compares three methods of investing from June
flaws. However, finding a practical alternative 1988 to October 2009.
isn’t as simple as you might think. Buy and hold. The approach matches the S&P 500 Total
Options traders have three fairly straightforward choices Return index (SPTR), which reinvests all dividends.
— buying puts (too costly to be a reasonable choice), selling Writing covered calls. The technique owns the same index,
calls against an underlying position (covered calls), and a but sells front-month, at-the-money (ATM) call options. The
more conservative version that combines covered calls with Chicago Board Options Exchange’s (CBOE) BuyWrite Index
long puts for additional downside protection (collars). The (BXM) tracks this portfolio’s performance, with all divi-
latter two positions help hedge an underlying portfolio, but dends and option premium reinvested.
they aren’t free. In exchange for this protection, both strate- Options collars. A collar is essentially a covered call with a
gies limit potential upside profits. long put. The CBOE introduced a new collar index (CLL) in
Is hedging with covered calls or collars worthwhile, and September 2008 that tracks the performance of an S&P 500
if so, which position is preferable? A recent academic study portfolio for which the investor sells a front-month call 10
summarized in the December 2009 issue of Active Trader percent out-of-the-money (OTM) and buys a three-month
suggests collars beat a buy-and-hold approach, especially put 5 percent OTM. Note: This is referred to as the 95-110
when their strike prices are adjusted based on current mar- collar because the long puts have a strike price that is 95
ket conditions (see “Related reading”). But that study percent of the S&P 500’s value and the short calls have a
ignores covered calls. strike price that is 110 percent of its value.
This analysis weighs the benefits and drawbacks of these When the CBOE launched BXM on June 1, 1988, the
techniques by examining three indices that track the stock index’s value was set at 100.00. Later, index values were cal-
market, covered calls, and collars over the past 21 years. culated another 23 months back to allow comparisons with
the October 1987 crash.
For comparison purposes, SPTR
FIGURE 1 — STRATEGY SHOWDOWN and CLL values are normalized so
they were worth 100.00 on June 1,
The BuyWrite Index has been less volatile than buy-and-hold, and it performed
1988. Thus, the data shown here is
better than the Collar Index.
different than the actual daily val-
ues for the S&P 500 Total Return
and collar indices.
Figure 1 compares the normal-
ized daily values of each index
from June 1, 1988 to Oct. 15, 2009.
On the study’s final day, the nor-
malized index values were:
BXM: 677.58
SPTR: 588.16
CLL: 469.49
The BuyWrite Index seems to be

Source: CBOE
the clear winner, but before we

draw any hasty conclusions, let’s FIGURE 2 — TECH WRECK, 2000-2002
examine each strategy in depth.
The S&P 500 Total Return Index falls further than the BuyWrite Index after the
technology bubble burst in 2002. The Collar Index held more of its value, but was
Hold or hedge? slow to rebound.
The buy-and-hold approach has
one advantage — it provides the
best opportunity for earning sub-
stantial profits. All dividends are
reinvested for maximum growth,
and the possibility of a raging bull
market makes this method so pop-
ular. But hope is not a strategy and
downside risk is real and too often
ignored.
Many investors came to believe
they were entitled to double-digit
returns, especially as the technolo-
gy bubble was building during the
1990s, and they invested according- Source: CBOE
ly. They discovered there was no
need to manage their portfolios. FIGURE 3 — RECENT FINANCIAL MELTDOWN, 2008-2009
The bull market rewarded those
Losses in SPTR in the fall of 2008 were much more dramatic than in either hedged
who simply added to investments
strategy.
with no exit strategy. But when
those double-digit returns disap-
peared, many investors were hurt.
Although there have been some
decent rallies, the market has gone
nowhere over the past decade;
SPTR has increased by less than 5
percent since the end of 1998.
Given the pain involved in a pas-
sive buy-and-hold approach, is it a
good idea to hedge, or reduce the
risk of owning, an investment port-
folio and possibly accept lower
profits? The two hedging strategies
— covered calls and collars — are Source: CBOE
considered next.
When the market rallies strongly, BXM disappoints. But
Covered calls don’t misunderstand — the BuyWrite Index gained ground
What conclusions can we draw from the BuyWrite Index’s during bullish years. And it should because the portfolio
21 years of performance in Figure 1? As expected, BXM has a bullish bias. But the dream of (too) many investors is
lagged the market when it surged as the technology bubble to own stocks during one of those surges. Hoping to make
grew in the late 1990s, and more recently, in the middle half an immediate fortune (or quickly recover losses), these
of 2009. But the market also declined dramatically in 2000 investors refuse to hedge risk.
and 2008, years in which the BuyWrite Index more than We believe those very bullish markets occur too infre-
made up for lost ground (Figures 2 and 3). quently to base an investment portfolio on that hope. But
Because surging markets are unusual, a longer-term let’s also consider psychology. If you must achieve the best
strategy that includes covered calls could be suitable for possible result every time, then it may be tough to accept
most investors, especially those willing to trade part-time any investment that limits potential profits, as covered calls
underperformance for a higher expectancy of superior do.
long-term results. continued on p. 19

TRADING STRATEGIES
Covered calls and collars

FIGURE A — LONG UNDERLYING VS. COVERED CALL
Professional investors know a perfect hedge
doesn’t exist — you always give up some- A covered call is preferable if the underlying closes below the call’s
thing to protect a stock portfolio. Two ways to short strike, but if the market skyrockets, this position will limit your
gains. Also, covered calls reduce downside losses, but that won’t help
partially hedge a portfolio are with covered
much if the underlying plummets.
calls and options collars.
A covered call is arguably the most well-
known options position: Simply buy an under-
lying instrument and sell a higher-strike call to
generate income. In a bullish or neutral mar-
ket, this trade could produce consistent gains.
However, few traders focus on the strategy’s
downside risk: If the instrument tanks, you
could lose nearly all of your investment. In
short, a covered call is an imperfect hedge.
An option collar is a similar position that
solves this dilemma by buying puts to limit
losses. A collar is a conservative, flexible
strategy that profits if the underlying remains
above a certain price level when expiration
arrives. The strategy’s goal is to add low-cost
downside protection. It reduces the odds of
success, but that’s the cost of adding protec-
tion. Insurance is not free. Source: OptionVue
To demonstrate the potential gains and
losses of covered calls and collars, let’s start selling one November 110-strike call for $2.30 per share. This
by purchasing 100 shares of the S&P 500 tracking stock step lowers the position’s overall cost (and risk) by $2.30 to
(SPY) at 110 on Oct. 21. We can now create a covered call by 107.70. But it also limits potential upside profits to $2.30 if
SPY closes above the 110 strike at November
FIGURE B — COVERED CALL VS. COLLAR expiration.
Figure A compares the potential gains and
A collar gives up potential profits for downside protection. A covered losses (at expiration) of a long SPY position
call offers a slightly higher potential profit, but is more vulnerable to with a covered call (green and blue lines,
major down moves. respectively). The covered call earns more
profit from 107.70 to 112.30. Owning the
underlying is more profitable above 112.30,
but below 112.30, the covered call either
earns more or loses slightly less money.
To create an option collar, you could buy a
November put option with, say, a 105 strike for
$0.88. Figure B compares the collar to the
covered call at the November options expira-
tion (red and blue lines, respectively).
Purchasing a put lowers the position’s poten-
tial upside profit to $1.42 ($2.30 short call pre-
mium - $0.88 put cost). The collar’s
breakeven point rises by the same amount.
However, this collar can lose only $3.58 (5-
point difference in strikes - 1.42 credit) if the
market tanks. By contrast, the covered call is
vulnerable to large downside losses.
Source: OptionVue
— FOT Staff

Related reading:
Mark D. Wolfinger articles:
“Options for swing traders,” Options Trader, November 2005.
New options traders must understand how leverage and time decay could affect
The cash collected from selling
a trade’s performance. We compare buying stock, buying calls, and selling
calls, or premium, protects the overall
naked puts to illustrate how these two factors influence the outcome.
position modestly in case the market
falls. Covered call traders lose nothing
“Synthetic solutions,” Futures & Options Trader, March 2008.
unless the market drops further than
Any options strategy has at least one other synthetic alternative, which could be
that premium, which provides some
a better choice for a trade. Learn how to find an identical position with less risk
comfort.
and greater profit potential.
However, BXM is a bullish strategy
and its followers can get clobbered
during rapid market declines. That’s Other articles:
why more conservative investors
“Collaring your portfolio,” Active Trader, December 2009.
should consider the collar strategy.
Standard option collars can boost risk-adjusted returns, but the best-performing
collars take cues from market trends.
Protect investments
with a collar
“Covered calls vs. cash-secured short puts”
Collars provide complete, or almost
Futures & Options Trader, July 2007.
complete, protection against down-
A comparison of two strategies uncovers some guidelines about how to choose
side loss, but they cost more than cov-
between them.
ered calls. A collar strategy fares less
well when markets rally and much bet- BuyWrite Index methodology: www.cboe.com/micro/BuyWrite/introduction.aspx
ter when they fall.
Collar Index methodology: www.cboe.com/micro/cll/collarindexpaper.pdf
continued on p. 20
TRADING STRATEGIES
Collars are flexible and you can TABLE 1 — MAJOR MARKET TOPS AND BOTTOMS
choose among many different puts to
The S&P 500 Total Return Index (middle column) was cut in half from July 2007
buy and calls to sell. The specific collar
to November 2008, while the BuyWrite and Collar indices lost only 36 and 27
chosen by the CBOE for its CLL index
percent, respectively. However, the S&P also recovered more rapidly over the
is not ideal for this discussion. Again, next 11 months.
its collar index uses strikes that are 95
and 110 percent of the S&P’s price, but CBOE BuyWrite S&P 500 Total Return CBOE Collar
we prefer an index that uses the same Date Index (BXM) Index (SPTR) Index (CLL)
call strike as BXM (i.e., 95 and 100 per- 10/19/87 77.47 104.13
cent of the S&P 500).
6/1/88 100 100 100
When the market rallied, CLL sig-
6/19/00 627.87 758.74 482.8
nificantly underperformed buy-and-
hold and BXM, as Figure 1 shows. But 10/9/02 446.88 409.26 383.77
when the market declined, CLL pro- 7/13/07 850.34 891.77 628.57
tected its portfolio in an outstanding 11/20/08 544.39 445.11 457.18
fashion. Insuring a stock portfolio is 10/15/09 727.05 663.92 518.91
similar to insuring a home or other
valuables. It provides wonderful Source: CBOE
peace of mind, but there is a financial
cost. The real question is how much are you willing to pay
for this insurance policy? • When the S&P 500 Total Return Index bottomed in
Assuming the past 21 years can be accepted as normal, October 2002, it dipped more than 8 percent
then after the occasional downturn, SPTR and BXM will below the BuyWrite Index and was only 6.5 percent
catch up with CLL by declining to its level. Collar perform- higher than the collar index. SPTR had declined 46
ance might look far better — when compared with BXM percent and CLL declined 20 percent from their
and SPTR — if higher-priced call options were sold (i.e., 2000 peaks. At this point, BXM was the clear
selling ATM calls rather than 10-percent OTM calls). winner.
Digging into the details • At the 2007 market top, the S&P 500 Total Return
Table 1 lists normalized values for the three indices at mar- Index had regained the lead and collars lagged.
ket tops and bottoms since October 1987. The following
conclusions can be drawn from Figure 1 and Table 1: • SPTR again fell well below BXM at the November
2008 low. But this decline was enough to push it
• Black Monday, Oct. 19, 1987 highlights the collar below CLL too.
strategy’s power. Data for the S&P 500 Total Return
Index is not available, but with BXM worth only • During the strong 2009 rally, the S&P 500 Total
77 percent of its baseline value, CLL significantly Return index surpassed the collar index, but still
outperformed. lagged behind the BuyWrite Index.
• As the market recovered from the 1987 crash, the The covered-call compromise
BuyWrite Index caught up to the collar index by There are three obvious conclusions here: In rising markets,
June 1, 1988. SPTR outperforms and collars trail behind; in falling mar-
kets, collars easily outperform the other indices; and cov-
• At its 2000 market peak, SPTR was 21 percent ered calls are a compromise between maximum hedging
higher than BXM and 57 percent higher than CLL. and no hedging, and perform best over extended periods.
This is why bullish investors don’t like to limit Covered calls seem appropriate for most investors,
profits. As much as we recommend the collar because they offer a less volatile ride, and surging markets
strategy to conservative investors, this fact is hard are fairly rare. Collars are suitable for more conservative
to ignore. Indeed, the collar index was essentially investors, although selling ATM (as opposed to 10-percent
flat in 1998 and 1999, which is disturbing. In theory, OTM) call strikes makes more sense.
selling calls 10 percent OTM should have allowed
for growth. For information on the author see p. 5.

OPTIONS TRADING
TRADING SYSTEM
OPTIONS STRATEGY
OPTIONS SYSTEM
LAB LAB
LAB
Credit spreads
and the directional movement index
FIGURE 1 — BEAR CALL SPREAD ON S&P 500
We entered this bearish vertical credit spread on Sept. 2, 2009 when the S&P when strikes are 10 points apart, a five-
500 traded at 994.70. It had a maximum potential profit of $600. contract position requires gross margin of
$5,000. The spread is entered at a net cred-
it, which you keep if both options expire
worthless.
Figure 1 shows the potential gains and
losses of an October 1090/1100 bear call
spread entered on Sept. 2, 2009 when the
S&P 500 traded at 994.70. The trade will be
profitable if the S&P 500 closes below
1094.20 at Oct. 16 expiration. The spread
collected premium of $600, which repre-
sents its maximum gain and potential
yield of 13.6 percent (113 percent annual-
ized). However, the trade will lose $4,400
— the maximum amount — if the S&P 500
finishes at 1100 or above at expiration.
Trade rules:
Source: OptionVue Bullish signal

1. DM+ line crosses above DM- line.
2. Enter market after price exceeds that
Market: Options on the S&P 500 index (SPX). day’s high.
System concept: Previous Options Labs have tested Entering bull put spreads
credit spreads with different types of trend-following and 1. Sell five puts with a strike located one standard
countertrend signals. The most successful systems rely on deviation OTM.
the directional movement index (DMI), which Wells Wilder 2. Buy five puts at a strike 10 points below the
developed in 1978. short put.
The DMI indicator gauges the trend from the magnitude 3. Use the first expiration month with more than
of daily upward and downward price moves. This credit- 21 days left until expiration.
spread system focuses on the index’s core components: pos-
itive directional movement (DM+) and negative directional Bearish signal
movement (DM-). 1. DM+ crosses below DM- line.
A bullish signal begins when the DM+ line crosses above 2. Enter market after price falls below that day’s low.
the DM- line. The system triggers a bullish position after
price exceeds that day’s high. At that point, the system Entering bear call spreads
enters a bull put spread by selling a put option at the first 1. Sell five calls with a strike located one standard
strike that is one standard deviation lower and buying a put deviation OTM.
at a strike 10 points farther out-of-the-money (OTM). 2. Buy five calls at a strike price 10 points above
A bearish signal begins when the DM+ line crosses below the short call.
the DM- line. The system triggers a bearish position after 3. Use the first expiration month with more than
price falls below that day’s low. At that point, the strategy 21 days left until expiration.
enters a bear call spread by selling a call option at the first
strike that is one standard deviation higher and buying a Exit
call at a strike 10 points farther OTM. Close either spread if the underlying index touches the
These vertical credit spreads attempt to exploit the short short strike. Otherwise, allow the position to expire
options’ time decay and collect the most profit if the under- worthless.
lying doesn’t reverse beyond the short strike price by expi-
ration. Both options share the same expiration month, and Starting capital: $10,000.

FIGURE 2 — SYSTEM PERFORMANCE
Trading vertical credit spreads with the DMI gained 254 percent since January 2001.
Execution: When possible, option

trades were executed at the average
of the bid and ask prices at the daily
close; otherwise, theoretical prices
were used. Standard deviation was
calculated using the implied volatility
of the ATM call. Each spread held five
contracts per “leg.” Commissions
were $20 per trade.
Test data: The system was tested

using options on the S&P 500 index
(SPX).
Test period: Jan. 17, 2001 to Oct. 14,

2009. Source: OptionVue
Test results: Figure 2 tracks the Directional movement index

system’s performance, which gained
$25,365 (254 percent, 29 percent annu- Directional movement index (DMI): Measures trend strength, regardless of direction.
alized) since January 2001. The strate- The higher the value, the stronger the trend, whether the market is going up or down.
gy’s average winning trade ($501.00) Calculation:
is much lower than its average losing 1. Calculate the positive or negative directional movement (+DM and -DM) for
trade (-$1,337.73), reflecting the rela- each bar in the desired lookback period. Bars that make higher highs and
tively poor risk-reward ratio (about 7- higher lows than the previous bar have positive directional movement. Bars that
1) of these credit spreads. However, make lower highs and lower lows than the previous bar have negative
the high percentage of winning trades directional movement. If a bar has both a higher high and a lower low than the
(88 percent) shows this system has a previous bar, it has positive directional movement if its high is above the
definite trading edge. previous high more than its low is below the previous low. Reverse this criterion
for negative directional movement.
— Steve Lentz and Jim Graham
2. If a bar has positive (negative) directional movement, the absolute value of the
of OptionVue
distance between today’s high (low) and yesterday’s high (low) is added to the
running totals of +DM (-DM) calculated over a given lookback period (i.e., 20
Option System Analysis strategies are
tested using OptionVue’s BackTrader bars, 30 bars, etc.). The absolute value is used so both +DM and -DM are
module (unless otherwise noted). positive values.
If you have a trading idea or strategy that 3. Calculate the sum of the true ranges for all bars in the lookback period.
you’d like to see tested, please send the
trading and money-management rules to 4. Calculate the directional indicator (+DI and -DI) by dividing the running totals
Advisor@OptionVue.com. of +DM and -DM by the sum of the true ranges.
STRATEGY SUMMARY
LEGEND:
Net gain: $25,365.00 Net gain — Gain at end of test period.
Percentage return: 254.0% Percentage return — Gain or loss on a percentage basis.
Annualized return: 29.0% Annualized return — Gain or loss on a annualized percentage basis.
No. of trades: 91 No. of trades — Number of trades generated by the system.
Winning/losing trades: 80/11 Winning/losing trades — Number of winners and losers generated by the system.
Win/loss: 88% Win/loss — The percentage of trades that were profitable.
Avg. trade: $276.74 Avg. trade — The average profit for all trades.
Largest winning trade: $1,230.00 Largest winning trade — Biggest individual profit generated by the system.
Largest losing trade: -$2,015.00 Largest losing trade — Biggest individual loss generated by the system.
Avg. profit (winners): $501.00 Avg. profit (winners) — The average profit for winning trades.
Avg. loss (losers): -$1,337.73 Avg. loss (losers) — The average loss for losing trades.
Avg. hold time (winners): 36 Avg. hold time (winners) — The average holding period for winning trades (in days).
Avg. hold time (losers) — The average holding period for losing trades (in days).
Avg. hold time (losers): 24
Max consec. win/loss — The maximum number of consecutive winning and losing trades.
Max. consec. win/loss: 29/1

OPTIONS BASICS
Bull put spread

Selling out-of-the-money puts is like skydiving — fun, but dangerous. This spread is a less-risky alternative.
BY FOT STAFF
nstead of buying or selling options outright, traders If the underlying closes above the highest strike at
I often buy one option and sell another with the same
expiration month — a “vertical spread” that reduces
the risk of an outright position in exchange for limit-
ed profits. It’s a trade-off many traders might be willing to
make after watching the financial markets implode in 2008.
options expiration, you keep the credit received upon entry,
which represents the spread’s maximum profit. If the mar-
ket falls below that threshold, losses depend on the distance
between both strike prices; the further apart the short and
long strikes are, the bigger the maximum loss.
There are two types of vertical spreads: credit and debit. Figure 1 shows a daily chart of Northern Trust (NTRS), a
When the option you sell costs more than the option you Midwest bank that specializes in wealth management. After
purchase, you receive cash (“premium”) in your account, bouncing 22 percent off its June 17 low, Northern gave back
hence the name credit spread. On the other hand, when the much of that gain throughout August. However, the bank
option you buy costs more than the option you sell, you halted its slide around 56, a possible support level, in early
must pay cash to trade it — a debit spread. September. The support level held again in early October as
Each type of spread has bullish and bearish versions. NTRS continued to trade in a wide range from 56 to 61.
Despite some claims, one spread isn’t inherently better than Clearly, Northern hasn’t been nearly as strong as its bigger
the others. Whether you choose to trade a credit or debit competitors such as J.P. Morgan Chase (JPM). But NTRS
spread — and how you structure it — depends on your risk seems likely to continue trading above support over the
tolerance, expectations for profit, and market dynamics. next several weeks.
For simplicity, let’s focus on a bullish credit spread using Given this lukewarm forecast, a vertical spread is more
puts, one of the four types of vertical spreads (Table 1). The appropriate than simply buying the underlying stock or
position is a fairly conservative way to profit from uptrends purchasing calls outright. When Northern traded at $59.17,
by selling puts while keeping downside risk to a minimum. you could have sold a November 55-strike put and bought
Unlike outright positions, credit spreads can make money a 50-strike put to help protect it. Remember you receive
even when the underlying market doesn’t behave exactly as cash for entering this spread, which you will keep if
expected. Northern trades above the short 55 strike when options
expire on Nov. 21. The short strike’s location — 7 percent
Bull put spread below the market — acts as a cushion if Northern Trust
If you are extremely bullish on a stock, it makes sense to declines.
buy the underlying shares or purchase calls outright. But if
your bullish forecast is less enthusiastic, entering a bull put Picking the right price
spread may be preferable. These spreads often contain out- How much can you collect from selling this spread? Table 2
of-the-money (OTM) puts with strike prices below the lists the details of the spread’s components. The 55-strike
underlying market. After selling one or more puts, you then put had a bid price of $0.80 and an ask price of $0.95 per
buy an equal number of cheaper, lower-strike puts to pro- share, while the 50-strike put had a bid of $0.20 and an ask
tect them. of $0.25 per share. With a market order, you would sell the
TABLE 1 — GETTING VERTICAL

Traders use vertical options spreads because they limit risk and are often less expensive than buying options outright. But
profits are also capped, making them more conservative trades.
Name Type Components Risk Reward

Bull put spread Credit Sell one or more puts, buy an equal Strike price difference - Limited to credit
number of puts at a lower strike price credit received received
Bear call spread Credit Sell one or more calls, buy an equal Strike price difference - Limited to credit
number of calls at a higher strike price credit received received
Bear put spread Debit Buy one or more puts, sell an equal Amount paid Strike-price difference -
number of puts at a lower strike price amount paid
Bull call spread Debit Buy one or more calls, sell an equal Amount paid Strike-price difference -
number of calls at a higher strike price amount paid

FIGURE 1 — BULLISH ON BANKS
Given a moderately bullish forecast of Northern Trust, a 55-50 bull put spread could have been entered on Oct. 14. Ideally,
NTRS will trade above support until November options expire worthless in five weeks.
Source: eSignal
55 put at the bid and buy the 50 put at TABLE 2 — BULL PUT SPREAD EXAMPLE
the ask for a total credit of $0.55 ($0.80
This OTM bull put spread on Northern Trust was sold for $0.65 per share on Oct. 14.
- $0.25).
This might be acceptable if you need NTRS closed at $59.17 on Oct. 14.
to execute a trade immediately, but Long/ Bid Ask Trade price Dollar
buyers of this spread (i.e., long 55 put, Components short price price (credit/debit) cost
short 50 put) were willing to pay $0.75 1 November 55-strike put Short 0.80 0.95 0.90 $90.00
(Figure 2, right). A better idea is to 1 November 50-strike put Long 0.20 0.25 -0.25 -$25.00
place a limit order halfway between Total premium collected: 0.65 $65.00
the spread’s bid and ask prices, say, Total risk: 4.35 $435.00
$0.65 per share. There’s no guarantee
Breakeven point: 54.35
the order will be filled, but you can
Probability of profit: 79%
probably get a better price (as opposed
to selling the bid and paying the ask, a
tactic that really adds up when trading spreads with multi- bly won’t exercise it unless it trades close to its intrinsic
ple “legs”). value (strike price - current market price) near expiration.
Otherwise, they will lose money by exercising it too early.
Managing the trade The easiest way to avoid risk of assignment is to buy back
Figure 3 shows the November 55-50 bull put spread’s the spread at a loss. If assigned, you can exercise the long 50
potential gains and losses according to Northern’s price on put, buying Northern at 50, delivering it to the 55 put hold-
three dates: trade entry (Oct. 14, dotted line), halfway until er, and locking in a loss (55 short strike - underlying market
expiration (Nov. 3, dashed line), and expiration (Nov. 21, price - remaining extrinsic value of 50 put).
solid line).
The best-case scenario is both puts expire worthless and Location, location, location
you keep the premium. Collecting $0.65 in premium for the Figure 3 reveals this bull put spread risks $4.35 to gain just
spread lowers its breakeven point to $54.35 (short 55-strike $0.65, an unfavorable risk-reward ratio. However, the posi-
- 0.65 premium). Below that point, the position can lose up tion has a 79-percent chance of success because its short
to $4.35 (5 strike-price difference - 0.65) if NTRS drops strike is 7 percent below the market. When trading credit
below the long 50 strike by expiration. spreads, you balance profit with the odds of making money.
What happens if Northern drops below the spread’s Spreads with strikes closer to the market may offer higher
short strike? At that point, the 55-strike put’s holder might premiums, but they have lower odds of success.
exercise it, forcing you to buy NTRS at $55 and sell it at a For example, the November 60-55 bull put spread traded
lower price. In reality, anyone who holds the 55 put proba- continued on p. 26

OPTIONS BASICS continued
FIGURE 2 — DON’T SETTLE FOR LESS

The November 55-50 bull put spread on Northern Trust was selling for $0.55, but buyers were willing to pay $0.75. You probably
could have gotten a better fill using a limit order for, say, $0.65.
Source: Schwab.com
around $1.80 — almost three times as FIGURE 3 — POTENTIAL GAINS AND LOSSES – NTRS
much as the 55-50 spread (Figure 2).
This bull put spread risks $4.35 to earn $0.65 per share. Its risk-reward ratio isn’t
However, that spread had only a 56-
great, but it has a 79-percent chance of success because the short 55 strike is 7
percent chance of success, because its percent below the market.
60 short strike was actually in-the-
money by almost one point. In short,
credit spreads with close-to-the-
money strike prices leave less room
for error.
Choosing the width between short
and long strikes involves similar
trade-offs. For example, if we entered
the 55-45 spread on Northern, we may
have collected another $0.20 in premi-
um, but is that worth the additional $5
risk?
Most individual stocks have strike
prices at intervals of 2.5 or 5, while
index-based exchange-traded funds
(ETFs) such as the S&P 500 (SPY) and
Nasdaq 100 tracking stocks (QQQQ)
list options with strikes at one-point
intervals, which offer more spreading
Source: OptionVue
opportunities.
Related reading:
“Options 101” Options Trader, April 2005. “(Extra) credit spreads,”
Options can seem complex, but learning a few basic Active Trader, February 2002.
concepts will remove much of the mystery and intimidation. A look at trading credit spreads.
Here’s what you need to know to get started in the world of
puts and calls. “Stepping into options,” Active Trader, April 2001.
When trading options, you have to walk first and run later.
“Vertical spreads: Credit vs. debit” Taking things one step at a time will give you the
Futures & Options Trader, April 2008. confidence to use these tools more effectively.
Picking the right kind of spread requires considering
volatility and time decay in light of how much your position “Spreading your charting options”
is in or out of the money. Active Trader, July 2000.
To trade options efficiently, you need to know which strategy
“Putting time on your side with credit spreads” goes with which market condition.
Futures & Options Trader, May 2008.
If you pick appropriate strike prices, a credit spread will pay
you to wait for the underlying market to move.

ads1009 8/7/09 9:16 PM Page 77
INDUSTRY NEWS
A penny for your lots

Spreads tighten, but some decry dispersed liquidity.
BY FOT STAFF
O n Nov. 2, the option Penny Pilot Program, which

allows penny-increment trading in options on
certain stocks and exchange-traded funds
(ETFs), grew to include options on 75 more equities.
The expansion is the first in a series of four quarterly
pelled market makers to quote options priced below $3 in
pennies and those priced above $3 in nickels.
Although the program has been successful in tightening
spreads, not everyone is happy with the results. Bid-ask
spreads have narrowed and options volume has climbed in
additions that should increase the number of stocks and participating stocks and ETFs, according to July and August
ETFs with options trading in pennies by 300. Before the reports from the Chicago Board Options Exchange (CBOE)
Nov. 2 change, options on only 63 equities traded in pen- and the SEC. However, liquidity at the best bid-offer prices
nies. suffered, according to CBOE’s analysis from early 2009.
The Penny Pilot Program was launched by the Securities Several brokerage-firm executives voiced their concerns
and Exchange Commission (SEC) in January 2007 on 13 about the program’s liquidity impact at the October Futures
participating securities. Designed to tighten bid-ask Industry Association (FIA) conference in Chicago.
spreads and lower transaction costs, the program com- “The SEC needs to measure not just market width, but
liquidity,” OptionsHouse CEO
George Ruhana said.
Pricing in pennies doesn’t necessar-
MANAGED MONEY ily impact top-volume options, but
the program may reduce liquidity in
Top 10 option strategy traders ranked by September 2009 return. less-popular stocks and ETFs, accord-
(Managing at least $1 million as of September 30, 2009.) ing to Ruhana. At some point, “slight-
ly tighter markets with no liquidity
Sept 2009 YTD $ under are worse for retail customers” than
Rank Trading advisor return return mgmt.
those with wider spreads with more
1. CKP Finance Associates (Masters) 13.08% 210.51% 3.9 available contracts to trade, Ruhana
said. If the program causes an option
2. ACE Investment Strategists (DPC) 7.53% 76.80% 19.2
to change from a bid-ask spread of
3. LJM Partners (Aggr. Premium Writing) 4.05% 26.85% 25.0
0.10 with 25 contracts available to a
4. JPS Capital Mgmt (JPS Fund) 3.56% -17.38% 2.8 spread of 0.08 with just two contracts,
5. White River Group (Diversified) 3.21% 40.41% 1.0 it won’t be helping customers,
Ruhana said.
6. Censura Futures Mgmt. (TEOW) 3.20% 16.67% 21.9
Jon Schlossberg, product manager
7. Oak Investment Group (Ag Options) 2.89% 51.60% 4.3 at Lime Brokerage, shares those wor-
8. Kingdom Trading (Short Option) 2.58% 28.51% 2.4 ries.
9. Crescent Bay Capital (BVP) 2.39% -10.06% 1.6 “I like the idea of going to pennies,”
he said. “[But] I’m absolutely con-
10. LJM Partners (LJM Fund Ltd) 2.25% 21.89% 6.2
cerned about the implications for liq-
uidity.”
Source: Barclay Hedge (www.barclayhedge.com) Based on estimates of the composite of all
The SEC has extended the Penny
accounts or the fully funded subset method. Does not reflect the performance of any single account.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. Pilot Program until Dec. 31, 2010 and
plans to introduce a second set of 75
symbols on Jan. 25, 2010.

FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
Natural gas and heating oil The largest positive readings represent markets in which commercial
positions (longs-shorts) exceeded speculator holdings in October. And
near COT extremes the largest negative values represent the opposite relationship — specu-
lator positions exceeded 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-commercials,
and non-reportable.
Commercial traders, or hedgers, tend to operate in the
cash market (e.g., grain merchants and oil companies that
either produce or consume the underlying commodity).
Non-commercial traders are large speculators (“large specs”)
such as commodity trading advisors and hedge funds — pro-
fessional money managers who do not deal in the underlying
cash markets but speculate in futures on a large-scale basis.
Many of these traders are trend-followers. The non- For a list of contract names, see “Futures Snapshot.” Source: www.upperman.com
reportable category represents small traders, or the general
public. Legend: Figure 1 shows the difference between net commer-
Figure 1 shows the relationship between commercials and large speculators on cial and net large spec positions (longs - shorts) for all 45 futures
Oct. 27. Positive values mean net commercial positions (longs-shorts) are larger markets, in descending order. It is calculated by subtracting the
current net large spec position from the net commercial position
than net speculator holdings based on their five-year historical relationship. and then comparing this value to its five-year range.
Negative values mean large speculators have bigger positions than the commer- The formula is:
cials. a1 = (net commercial 5-year high - net commercial current)
In October, commercial positions were larger than speculator positions in nat- b1 = (net commercial 5-year high - net commercial 5-year low)
ural gas futures (NG). But this bullish dynamic has eased since September. c1 = ((b1 - a1)/ b1 ) * 100
Meanwhile, speculators dominated in heating oil (HO), platinum (PL), and pal- a2 = (net large spec 5-year high - net large spec current)
ladium (PA), a bearish sign. The bearish situation in platinum has existed for at b2 = (net large spec 5-year high - net large spec 5-year low)
least three months, while the relationship in heating oil has recently heated up. c2 = ((b2 - a2)/ b2 ) * 100
— Compiled by Floyd Upperman x = (c1 - c2)
Options Watch: Technology sector ETF components (as of Nov. 3) Compiled by Tristan Yates
The following table summarizes the expiration months available for the 20 top holdings of the S&P 500 technology sector ETF (XLK). It also
shows each stock’s average bid-ask spread for at-the-money (ATM) November options. The information does NOT constitute trade signals. It is
intended only to provide a brief synopsis of potential slippage in each option market.
Option contracts traded

2009 2010 2011 2012
Bid-ask
March
spread as %
June
April
Dec.
Nov.
Feb.
Jan.
Jan.
Jan.
May
Stock of underlying
Stock Ticker price Call Put price
International Business Machines IBM X X X X X X 120.30 0.05 0.04 0.04%
Google Inc. GOOG X X X X X X 535.49 0.25 0.23 0.04%
Microsoft Corp. MSFT X X X X X X 27.48 0.02 0.01 0.05%
Apple Inc. AAPL X X X X X X 187.95 0.08 0.10 0.05%
Intel Corp. INTC X X X X X X 18.43 0.01 0.01 0.05%
Qualcomm Inc. QCOM X X X X X X 41.99 0.02 0.02 0.05%
Verizon Communications Inc. VZ X X X X X X 29.03 0.01 0.02 0.05%
AT&T Inc. T X X X X X X 25.35 0.01 0.02 0.05%
Cisco Systems Inc. CSCO X X X X X X 22.80 0.01 0.02 0.06%
Texas Instruments Inc. TXN X X X X X X 23.41 0.02 0.02 0.07%
Hewlett Packard Co. HPQ X X X X X X X 47.65 0.05 0.03 0.08%
EMC Corp. EMC X X X X X X 16.35 0.02 0.01 0.08%
Ebay Inc. EBAY X X X X X X 22.38 0.02 0.02 0.09%
Yahoo Inc. YHOO X X X X X X 15.73 0.02 0.02 0.10%
Dell Corp. DELL X X X X X X X 14.42 0.02 0.02 0.10%
Oracle Corp. ORCL X X X X X X 20.77 0.03 0.03 0.13%
Motorola Inc. MOT X X X X X X 8.94 0.02 0.02 0.18%
ADP Inc. ADP X X X X X X X 40.34 0.09 0.06 0.19%
Adobe Systems Inc. ADBE X X X X X X 32.63 0.08 0.08 0.23%
Corning Inc. GLW X X X X X X X 14.51 0.05 0.05 0.34%
Legend:
Call: Three-day average difference between bid and ask prices for the front-month ATM call.
Put: Three-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.

FUTURES SNAPSHOT (as of Oct. 30)
The following table summarizes the most actively traded U.S. futures contracts. The information does NOT constitute trade signals. It is intended
only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the dif-
ferent fields. Volume figures are for the most active contract month in a particular market and may not reflect total volume for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity for CME futures is based on
pit-traded contracts.
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 2.01 M 2.36 M -4.53% / 100% 1.10% / 7% 3.82% / 4% .31 / 86%
10-yr. T-note TY CME 826.1 1.19 M 0.14% / 22% -0.73% / 58% 2.57% / 83% .36 / 85%
5-yr. T-note FV CME 401.1 773.8 0.72% / 45% -0.05% / 12% 1.72% / 80% .34 / 62%
Crude oil CL CME 315.5 272.7 -1.95% / 50% 10.08% / 63% 7.03% / 14% .29 / 35%
E-Mini Nasdaq 100 NQ CME 308.2 314.8 -3.81% / 86% 0.20% / 2% 4.01% / 1% .31 / 92%
Eurodollar* ED CME 286.8 838.3 0.23% / 83% 0.09% / 17% 0.91% / 93% .26 / 50%
Eurocurrency EC CME 238.6 166.3 -1.15% / 86% 0.95% / 24% 2.67% / 16% .33 / 78%
30-yr. T-bond US CME 218.7 737.8 0.73% / 17% -1.67% / 72% 4.30% / 78% .38 / 78%
2-yr. T-note TU CME 210.0 870.9 0.08% / 58% 0.05% / 26% 0.21% / 74% .37 / 65%
E-Mini Russell 2000 TF CME 151.2 375.7 -8.55% / 89% -2.90% / 80% -1.25% / 100% .45 / 100%
Mini Dow YM CME 147.9 65.3 -2.62% / 83% 2.43% / 45% 3.64% / 5% .21 / 68%
Gold 100 oz. GC CME 131.9 346.0 -1.06% / 40% 3.59% / 27% 8.05% / 74% .24 / 28%
British pound BP CME 130.0 99.1 0.56% / 8% 3.32% / 93% -1.98% / 57% .49 / 68%
Natural gas NG CME 128.8 115.0 5.52% / 36% 6.93% / 11% 37.32% / 83% .31 / 7%
Corn C CME 123.1 514.8 -1.61% / 33% 9.78% / 53% 10.11% / 35% .42 / 100%
Japanese yen JY CME 95.7 118.2 0.95% / 38% -0.45% / 19% 6.03% / 91% .29 / 30%
Soybeans S CME 91.2 188.1 -0.10% / 0% 10.33% / 97% -9.54% / 50% .16 / 23%
Australian dollar AD CME 82.6 111.1 -1.70% / 100% 4.27% / 59% 7.31% / 18% .24 / 65%
Canadian dollar CD CME 70.9 90.7 -3.87% / 83% 0.29% / 8% -0.11% / 0% .48 / 92%
Sugar SB ICE 53.1 364.6 -4.60% / 64% -4.08% / 36% 15.20% / 4% .22 / 20%
Swiss franc SF CME 48.1 51.0 -0.71% / 67% 0.90% / 23% 3.96% / 28% .31 / 67%
Wheat W CME 43.2 194.6 -0.88% / 20% 12.01% / 61% -1.20% / 9% .57 / 97%
E-Mini S&P MidCap 400 ME CME 40.0 106.8 -6.67% / 100% -0.62% / 0% 0.97% / 1% .37 / 93%
Soybean oil BO CME 33.2 91.4 -1.46% / 67% 6.84% / 44% -1.54% / 6% .39 / 50%
Heating oil HO CME 33.1 43.3 -1.21% / 0% 11.60% / 58% 3.54% / 7% .25 / 32%
RBOB gasoline RB CME 33.0 50.3 -1.00% / 50% 12.56% / 56% -4.91% / 23% .26 / 33%
Silver 5,000 oz. SI CME 31.3 94.3 -6.69% / 71% 0.15% / 0% 10.99% / 50% .38 / 53%
Soybean meal SM CME 25.1 60.9 0.78% / 0% 10.90% / 88% -12.52% / 50% .12 / 10%
Copper HG CME 22.7 88.2 3.87% / 31% 10.22% / 55% 7.39% / 5% .15 / 8%
Mexican peso MP CME 21.0 66.3 -0.69% / 43% 3.62% / 64% -1.44% / 62% .54 / 60%
S&P 500 index SP CME 20.2 376.2 -4.53% / 100% 1.11% / 9% 2.64% / 1% .31 / 88%
Crude oil e-miNY QM CME 12.5 5.3 -1.95% / 50% 10.08% / 63% 8.56% / 18% .29 / 30%
U.S. dollar index DX ICE 10.7 32.1 0.93% / 83% -0.96% / 25% -3.32% / 19% .29 / 88%
Nikkei 225 index NK CME 10.2 31.4 -4.65% / 50% 0.05% / 0% -6.84% / 100% .55 / 93%
Coffee KC ICE 9.9 66.3 -5.15% / 100% 4.47% / 33% 0.59% / 5% .47 / 48%
Lean hogs LH CME 9.6 45.1 4.81% / 31% 15.13% / 82% 11.01% / 78% .28 / 77%
Mini-sized gold YG CME 8.4 5.3 -0.79% / 40% 4.18% / 38% 8.37% / 74% .24 / 27%
Live cattle LC CME 8.3 34.0 1.87% / 10% 3.29% / 69% 2.97% / 55% .39 / 62%
Cocoa CC ICE 8.0 57.7 0.73% / 6% 9.86% / 89% 17.33% / 55% .12 / 0%
Fed Funds** FF CME 7.9 65.3 0.04% / 94% 0.05% / 49% 0.25% / 83% .13 / 63%
New Zealand dollar NE CME 5.5 24.2 -2.78% / 100% 0.42% / 2% 7.12% / 5% .34 / 100%
Natural gas e-miNY QG CME 4.4 4.9 5.52% / 36% 6.93% / 11% 37.32% / 82% .30 / 8%
E-Mini eurocurrency ZE CME 3.6 2.5 -1.15% / 86% 0.95% / 24% 3.91% / 24% .33 / 80%
Mini-sized silver YI CME 2.8 2.9 -6.64% / 88% 0.88% / 5% 12.16% / 50% .38 / 51%
Nasdaq 100 ND CME 2.0 18.9 -3.81% / 86% 0.20% / 2% 4.01% / 1% .31 / 92%
Feeder cattle FC CME 1.0 4.6 0.26% / 10% 1.34% / 100% -6.23% / 48% .18 / 15%
Dow Jones Ind. Avg. DJ CME 0.8 12.0 -2.62% / 83% 2.43% / 47% 4.71% / 6% .21 / 57%
*Average volume and open interest based on highest-volume contract (December 2010). **Average volume and open interest based on highest-volume contract (February 2010).
Legend
day moves, 20-day moves, etc.) show the per- larger than all the past readings, while a read-
Volume: 30-day average daily volume, in thou- centile rank of the most recent move to a certain ing of 0 percent means the current reading is
sands (unless otherwise indicated). number of the previous moves of the same size smaller than the previous readings. These fig-
OI: Open interest, in thousands (unless other- and in the same direction. For example, the ures provide perspective for determining how
wise indicated). rank for 10-day move shows how the most relatively large or small the most recent price
10-day move: The percentage price move from recent 10-day move compares to the past twen- move is compared to past price moves.
the close 10 days ago to today’s close. ty 10-day moves; for the 20-day move, the rank Volatility ratio/rank: The ratio is the short-term
20-day move: The percentage price move from field shows how the most recent 20-day move volatility (10-day standard deviation of prices)
the close 20 days ago to today’s close. compares to the past sixty 20-day moves; for divided by the long-term volatility (100-day stan-
the 60-day move, the rank field shows how the dard deviation of prices). The rank is the per-
60-day move: The percentage price move from most recent 60-day move compares to the past
the close 60 days ago to today’s close. centile rank of the volatility ratio over the past
one-hundred-twenty 60-day moves. A reading 60 days.
The “rank” fields for each time window (10- of 100 percent means the current reading is
This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & Options
Trader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buy
or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.
OPTIONS RADAR (as of Oct. 30)
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 189.9 1.63 M -4.73% / 100% 1.07% / 7% 26.4% / 16.5% 25.5% / 17.3%
S&P 500 volatility index VIX CBOE 110.1 2.09 M 43.21% / 100% 7.01% / 64% 79.4% / 82.8% 65.4% / 81.6%
Russell 2000 index RUT CBOE 49.5 436.4 -8.67% / 89% -3.00% / 70% 33.5% / 22.5% 31.3% / 24%
E-Mini S&P 500 futures ES CME 32.8 136.4 -4.53% / 100% 1.10% / 7% 26.4% / 19.6% 25% / 19.6%
Nasdaq 100 index NDX CBOE 15.5 169.2 -4.15% / 100% 0.28% / 2% 26.3% / 16.8% 26.6% / 18.3%
Stocks
Citigroup C 278.6 8.94 M -10.89% / 78% -9.51% / 85% 56.2% / 47.8% 67.9% / 73.1%
Bank of America BAC 197.2 3.48 M -15.53% / 91% -10.77% / 96% 59.6% / 42.6% 52.2% / 40.2%
Apple Inc. AAPL 117.0 799.3 0.24% / 0% 1.95% / 7% 34.1% / 22.3% 34.6% / 26%
Microsoft MSFT 94.6 2.04 M 4.64% / 29% 11.10% / 98% 29% / 23.5% 29% / 21.6%
Comp Vale do Rio Doce VALE 86.3 770.7 -4.10% / 50% 11.21% / 36% 55.1% / 46.6% 43.2% / 40%
Futures
Eurodollar ED CME 76.8 4.81 M 0.05% / 84% 0.05% / 14% 116.2% / 39.2% 116.7% / 139%
Corn C CME 55.7 696.5 -1.61% / 33% 9.78% / 53% 38.6% / 44.8% 31.5% / 47.3%
E-Mini S&P 500 futures ES CME 32.8 136.4 -4.53% / 100% 1.10% / 7% 26.4% / 19.6% 25% / 19.6%
10-year T-notes TY CME 31.6 473.9 0.14% / 22% -0.73% / 58% 6.8% / 5.1% 7.5% / 5.9%
Soybeans S CME 23.8 135.1 -0.10% / 0% 10.33% / 97% 29.3% / 31.5% 27.4% / 34.3%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
S&P 100 index OEX CBOE 76.8 4.81 M -4.09% / 100% 1.44% / 9% 116.2% / 39.2% 116.7% / 139%
S&P 500 index SPX CBOE 1.9 43.5 -4.73% / 100% 1.07% / 7% 2.1% / 1% 1.7% / 1%
S&P 100 index (European style) XEO CBOE 2.7 61.4 -4.09% / 100% 1.44% / 9% 5.3% / 2.8% 4.8% / 2.5%
Nasdaq 100 index NDX CBOE 4.2 21.3 -4.15% / 100% 0.28% / 2% 11.1% / 6.2% 9.7% / 7.5%
Dow Jones index DJX CBOE 11.8 113.8 -2.83% / 86% 2.37% / 36% 13.4% / 8.4% 12.3% / 24.3%
Indices - Low IV/SV ratio

S&P 500 futures SP CME 9.9 59.1 -4.53% / 100% 1.11% / 9% 16.1% / 16.9% 25.5% / 17.9%
S&P 500 volatility index VIX CBOE 110.1 2.09 M 43.21% / 100% 7.01% / 64% 79.4% / 82.8% 65.4% / 81.6%
Stocks - High IV/SV ratio

GTX Inc. GTXI 4.3 58.5 -12.48% / 60% -18.44% / 68% 154.7% / 47.5% 141.6% / 58.2%
Human Genome Sciences HGSI 19.4 232.5 -6.36% / 83% 2.69% / 13% 204.1% / 68% 136.8% / 62.4%
Sun Microsystems JAVA 16.8 367.0 -10.31% / 92% -8.71% / 95% 47.4% / 19.6% 17.1% / 8.9%
Arena Pharmaceuticals ARNA 3.2 114.0 -19.95% / 83% -13.05% / 68% 104.5% / 50% 94.6% / 106.2%
Chimera Invest. Corp. CIM 3.6 64.9 -10.51% / 92% -9.35% / 94% 79.9% / 39.1% 66.8% / 56.1%
Stocks - Low IV/SV ratio

Starent Networks STAR 3.2 52.5 -0.35% / 33% 34.64% / 87% 13.8% / 32.1% 50.9% / 56.1%
Harvest Energy Trust HTE 1.1 34.5 29.26% / 65% 51.67% / 96% 19.4% / 42.2% 62.2% / 55.6%
Fed Home Loan Bank FRE 3.9 333.9 -28.49% / 89% -25.90% / 70% 66.1% / 111.6% 106.7% / 99.9%
NCI Building Systems NCS 10.3 221.1 -37.18% / 78% -27.41% / 50% 108% / 149.9% 216.2% / 100.9%
Futures - High IV/SV ratio

Eurodollar ED CME 76.8 4.81 M 0.05% / 84% 0.05% / 14% 116.2% / 39.2% 116.7% / 139%
2-year T-notes TU CME 1.9 43.5 0.08% / 58% 0.05% / 26% 2.1% / 1% 1.7% / 1%
5-year T-notes FV CME 2.7 61.4 0.72% / 45% -0.05% / 12% 5.3% / 2.8% 4.8% / 2.5%
Eurocurrency EC CME 4.2 21.3 -1.15% / 86% 0.95% / 24% 11.1% / 6.2% 9.7% / 7.5%
30-yr T-bonds US CME 11.8 113.8 0.73% / 17% -1.67% / 67% 13.4% / 8.4% 12.3% / 24.3%
Futures - Low IV/SV ratio**

Wheat W CME 12.8 134.5 -0.88% / 20% 12.01% / 61% 35.6% / 52.5% 27.6% / 38.5%
Soybean meal SM CME 2.8 58.3 0.78% / 0% 10.90% / 88% 29.7% / 35.5% 26.6% / 39.8%
Corn C CME 55.7 696.5 -1.61% / 33% 9.78% / 53% 38.6% / 44.8% 31.5% / 47.3%
Sugar SB ICE 18.6 288.1 -4.60% / 64% -4.08% / 36% 49% / 54.8% 49.9% / 49.7%
Cotton CT ICE 9.5 75.0 -0.84% / 40% 11.51% / 87% 29.3% / 32% 29.6% / 29%
* 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 CALENDAR NOVEMBER/DECEMBER
MONTH
November
(NYMEX); November single stock
Legend 1 FDD: November crude oil and natural futures (OC); December T-bonds,
gas futures (NYMEX) corn, wheat, soybean products, and
CPI: Consumer price index oats options (CME); December orange
2 FND: November propane futures juice options (ICE); November index
ECI: Employment cost index (NYMEX); November orange juice and equity options
FDD (first delivery day): futures (ICE) U.S.: Cattle on feed
The first day on which deliv- FDD: November gold, silver, copper,
ery of a commodity in fulfill- aluminum, platinum, and palladium 21
ment of a futures contract futures (NYMEX); November soybeans
and rough rice futures (CME) 22
can take place.
FND (first notice day): Also
U.S.: Crop progress report 23 FND: December cotton futures (ICE)
3 FND: November heating oil and LTD: December natural gas options
known as first intent day, this
RBOB gasoline futures (NYMEX) (NYMEX); December gold and silver
is the first day a clearing-
U.S.: Weekly weather report options (NYMEX)
house can give notice to a U.S.: Crop progress report
buyer of a futures contract 4 U.S.: Petroleum status report
that it intends to deliver a 24 LTD: December natural gas futures
commodity in fulfillment of a 5 FDD: November propane futures (NYMEX); December heating oil, RBOB
futures contract. The clear- (NYMEX) gasoline options, copper, and aluminum
inghouse also informs the U.S.: Natural gas storage report options
U.S.: Weekly weather report
seller. 6 LTD: December cocoa and U.S. dollar
FOMC: Federal Open index options (ICE) 25 FND: December natural gas futures
Market Committee (NYMEX)
7 FDD: November heating oil and LTD: November gold, silver, copper,
GDP: Gross domestic RBOB gasoline futures (NYMEX) aluminum, and palladium futures
product
8 (NYMEX)
ISM: Institute for supply U.S.: Petroleum status report; natural
management 9 FDD: November orange juice futures gas storage report
(ICE)
LTD (last trading day): The LTD: November orange juice futures 26
first day a contract may (ICE)
trade or be closed out before U.S.: Crop progress report
27
the delivery of the underlying
10 U.S.: Crop production report; world
28
asset may occur.
agricultural production; weekly 29
PPI: Producer price index weather report
Quadruple witching Friday: 30 FND: December gold, silver, copper,
A day where equity options,
11 aluminum, platinum, and palladium
futures (NYMEX); December T-bond,
equity futures, index options, 12 LTD: December coffee options (ICE) corn, wheat, soybean products, and
and index futures all expire. U.S.: Petroleum status report oats futures (CME)
13 LTD: November soybeans, rough rice, LTD: December heating oil, RBOB
NOVEMBER 2009 and lumber futures (CME); December gasoline, and propane futures (NYMEX)
cotton options (ICE) U.S.: Crop progress report; agricultural
1 2 3 4 5 6 7
U.S.: Natural gas storage report prices
8 9 10 11 12 13 14
15 16 17 18 19 20 21
14 December
22 23 24 25 26 27 28 15 1 FDD: December crude oil, natural gas,
16 FND: December cocoa futures (ICE); gold, silver, copper, aluminum, platinum,
29 30 1 2 3 4 5
November lumber futures (CME) and palladium futures(NYMEX);
FDD: November lumber futures (CME) December T-bonds, corn, wheat,
LTD: December sugar options (ICE) soybean products, and oats futures
DECEMBER 2009 (CME); December coffee, Cocoa, and
U.S.: Crop progress report
29 30 1 2 3 4 5 cotton futures (ICE)
6 7 8 9 10 11 12
17 LTD: December crude oil options U.S.: Weekly weather report
(NYMEX
13 14 15 16 17 18 19 U.S.: Weekly weather report 2 FND: December heating oil, RBOB
gasoline, and propane futures (NYMEX)
20 21 22 23 24 25 26 18 LTD: December platinum options U.S.: Petroleum status report
27 28 29 30 31 1 2 (NYMEX)
U.S.: Petroleum status report 3 U.S.: Natural gas storage report
19 FND: December coffee futures (ICE) 4 FDD: December propane futures

The information on this page is (NYMEX)
subject to change. Futures & U.S.: Natural gas storage report
Options Trader is not responsible
LTD: December live cattle options
for the accuracy of calendar dates 20 FND: December crude oil futures (CME); January cocoa and U.S. dollar
beyond press time. (NYMEX) index options (ICE); December forex
LTD: December crude oil futures options

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-
tions that involve buying and selling options in different Theta: The rate at which an option loses value each day
proportions, usually in 1:2 or 2:3 ratios. Backspreads con- (the rate of time decay). Theta is relatively larger for
tain more long options than short ones, so the potential OTM than ITM options, and increases as the option gets
profits are unlimited and losses are capped. By contrast, closer to its expiration date.
ratio spreads have more short options than long ones and
have the opposite risk profile. Vega: How much an option’s price changes per a one-
Note: These labels are not set in stone. Some traders percent change in volatility.
describe either position as option trades with long and
short legs in different proportions.
kers are required to report daily the futures and options
Bear call spread: A vertical credit spread that consists positions of their customers that are above specific report-
of a short call and a higher-strike, further OTM long call in ing levels set by the CFTC.
the same expiration month. The spread’s largest potential For each futures contract, report data is divided into three
gain is the premium collected, and its maximum loss is lim- “reporting” categories: commercial, non-commercial, and
ited to the point difference between the strikes minus that non-reportable positions. The first two groups are those
premium. who hold positions above specific reporting levels.
The “commercials” are often referred to as the large
Bear put spread: A bear debit spread that contains puts hedgers. Commercial hedgers are typically those who actu-
with the same expiration date but different strike prices. ally deal in the cash market (e.g., grain merchants and oil
You buy the higher-strike put, which costs more, and sell companies, who either produce or consume the underlying
the cheaper, lower-strike put. commodity) and can have access to supply and demand
information other market players do not.
Bull call spread: A bull debit spread that contains calls Non-commercial large traders include large speculators
with the same expiration date but different strike prices. (“large specs”) such as commodity trading advisors (CTAs)
You buy the lower-strike call, which has more value, and and hedge funds. This group consists mostly of institution-
sell the less-expensive, higher-strike call. al and quasi-institutional money managers who do not deal
in the underlying cash markets, but speculate in futures on
Bull put spread (put credit spread): A bull credit a large-scale basis for their clients.
spread that contains puts with the same expiration date, but The final COT category is called the non-reportable posi-
different strike prices. You sell an OTM put and buy a less- tion category — otherwise known as small traders — i.e.,
expensive, lower-strike put. the general public.
Calendar spread: A position with one short-term short Covered call: Shorting an out-of-the-money call option
option and one long same-strike option with more time against a long position in the underlying market. An exam-
until expiration. If the spread uses ATM options, it is mar- ple would be purchasing a stock for $50 and selling a call
ket-neutral and tries to profit from time decay. However, option with a strike price of $55. The goal is for the market
OTM options can be used to profit from both a directional to move sideways or slightly higher and for the call option
move and time decay. to expire worthless, in which case you keep the premium.
Call option: An option that gives the owner the right, but Credit spread: A position that collects more premium
not the obligation, to buy a stock (or futures contract) at a from short options than you pay for long options. A credit
fixed price. spread using calls is bearish, while a credit spread using
puts is bullish.
The Commitments of Traders report: Published
weekly by the Commodity Futures Trading Commission Debit spread: An options spread that costs money to
(CFTC), the Commitments of Traders (COT) report breaks enter, because the long side is more expensive that the short
down the open interest in major futures markets. Clearing side. These spreads can be verticals, calendars, or diagonals.
members, futures commission merchants, and foreign bro- continued on p. 34

KEY CONCEPTS
Delivery period (delivery dates): The specific time Open interest: The number of options that have not
period during which a delivery can occur for a futures con- been exercised in a specific contract that has not yet expired.
tract. These dates vary from market to market and are deter-
mined by the exchange. They typically fall during the Out of the money (OTM): A call option with a strike
month designated by a specific contract — e.g. the delivery price above the price of the underlying instrument, or a put
period for March T-notes will be a specific period in March. option with a strike price below the underlying instru-
ment’s price.
Diagonal spread: A position consisting of options with
different expiration dates and different strike prices — e.g., Parity: An option trading at its intrinsic value.
a December 50 call and a January 60 call.
Physical delivery: The process of exchanging a physical
European style: An option that can only be exercised at commodity (and making and taking payment) as a result of
expiration, not before. the execution of a futures contract. Although 98 percent of
all futures contracts are not delivered, there are market par-
Exercise: To exchange an option for the underlying ticipants who do take delivery of physically settled con-
instrument. tracts such as wheat, crude oil, and T-notes. Commodities
generally are delivered to a designated warehouse; T-note
Expiration: The last day on which an option can be exer- delivery is taken by a book-entry transfer of ownership,
cised and exchanged for the underlying instrument (usual- although no certificates change hands.
ly the last trading day or one day after).
Premium: The price of an option.
Extrinsic value: The difference between an option's
intrinsic value and it's current price (premium). For exam- Put option: An option that gives the owner the right, but
ple, with the underlying instrument trading at 50, a 45- not the obligation, to sell a stock (or futures contract) at a
strike call option with a premium of 8.50 has 3.50 of extrin- fixed price.
sic value.
Put ratio backspread: A bearish ratio spread that con-
Front month (or “nearest month”): The contract tains more long puts than short ones. The short strikes are
month closest to expiration. closer to the money and the long strikes are further from the
money.
In the money (ITM): A call option with a strike price For example, if a stock trades at $50, you could sell one
below the price of the underlying instrument, or a put $45 put and buy two $40 puts in the same expiration month.
option with a strike price above the underlying instru- If the stock drops, the short $45 put might move into the
ment’s price. money, but the long lower-strike puts will hedge some (or
all) of those losses. If the stock drops well below $40, poten-
Intrinsic value: The difference between the strike price tial gains are unlimited until it reaches zero.
of an in-the-money option and the underlying asset price. A
call option with a strike price of 22 has 2 points of intrinsic Put spreads: Vertical spreads with puts sharing the same
value if the underlying market is trading at 24. expiration date but different strike prices. A bull put spread
contains short, higher-strike puts and long, lower-strike
Naked option: A position that involves selling an unpro- puts. A bear put spread is structured differently: Its long
tected call or put that has a large or unlimited amount of puts have higher strikes than the short puts.
risk. If you sell a call, for example, you are obligated to sell
the underlying instrument at the call’s strike price, which Simple moving average: A simple moving average
might be below the market’s value, triggering a loss. If you (SMA) is the average price of a stock, future, or other mar-
sell a put, for example, you are obligated to buy the under- ket over a certain time period. A five-day SMA is the sum of
lying instrument at the put’s strike price, which may be well the five most recent closing prices divided by five, which
above the market, also causing a loss. means each day’s price is equally weighted in the calcula-
Given its risk, selling naked options is only for advanced tion.
options traders, and newer traders aren’t usually allowed
by their brokers to trade such strategies. Straddle: A non-directional option spread that typically
consists of an at-the-money call and at-the-money put with
Naked (uncovered) puts: Selling put options to collect the same expiration. For example, with the underlying
premium that contains risk. If the market drops below the instrument trading at 25, a standard long straddle would
short put’s strike price, the holder may exercise it, requiring consist of buying a 25 call and a 25 put. Long straddles are
you to buy stock at the strike price (i.e., above the market). designed to profit from an increase in volatility; short strad-
dles are intended to capitalize on declining volatility. The
Near the money: An option whose strike price is close strangle is a related strategy.
to the underlying market’s price.
Strangle: A non-directional option spread that consists of

an out-of-the-money call and out-of-the-money put with the low of a price bar. The true range calculation was devel-
the same expiration. For example, with the underlying oped by Welles Wilder and discussed in his book New
instrument trading at 25, a long strangle could consist of Concepts in Technical Trading Systems (Trend Research,
buying a 27.5 call and a 22.5 put. Long strangles are 1978).
designed to profit from an increase in volatility; short stran- True range can be calculated on any time frame or price
gles are intended to capitalize on declining volatility. The bar — five-minute, hourly, daily, weekly, etc. The following
straddle is a related strategy. discussion uses daily price bars for simplicity. True range is
the greatest (absolute) distance of the following:
Strike (“exercise”) price: The price at which an under- 1. Today’s high and today’s low.
lying instrument is exchanged upon exercise of an option. 2. Today’s high and yesterday’s close.
3. Today’s low and yesterday’s close.
Time decay: The tendency of time value to decrease at an
accelerated rate as an option approaches expiration. Average true range (ATR) is simply a moving average of
the true range over a certain time period. For example, the
Time spread: Any type of spread that contains short five-day ATR would be the average of the true range calcu-
near-term options and long options that expire later. Both lations over the last five days.
options can share a strike price (calendar spread) or have
different strikes (diagonal spread). Vertical spread: A position consisting of options with
the same expiration date but different strike prices (e.g., a
Time value (premium): The amount of an option’s September 40 call option and a September 50 call option).
value that is a function of the time remaining until expira-
tion. As expiration approaches, time value decreases at an Volatility: The level of price movement in a market.
accelerated rate, a phenomenon known as “time decay.” Historical (“statistical”) volatility measures the price fluctu-
ations (usually calculated as the standard deviation of clos-
True range (TR): A measure of price movement that ing prices) over a certain time period — e.g., the past 20
accounts for the gaps that occur between price bars. This days. Implied volatility is the current market estimate of
calculation provides a more accurate reflection of the size of future volatility as reflected in the level of option premi-
a price move over a given period than the standard range ums. The higher the implied volatility, the higher the option
calculation, which is simply the high of a price bar minus premium.
EVENTS
Event: Lawrence G. McMillan’s For more information: Visit
Intensive Options Seminar www.tradestation.com/strategy
Date: Nov. 7
Location: New York City, Marriott Marquis Event: International Traders Expo
For more information: Go to Date: Feb. 13-16
www.optionstrategist.com and click on “Seminars” Location: Marriott Marquis Hotel, New York, N.Y.
For more information: www.tradersexpo.com
Event: The Fifth Middle East Forex Trading Expo and
Conference 2009 Event: 26th Annual Risk Management Conference
Date: Nov. 17-18 Date: March 7-9
Location: Jumeirah Emirates Towers Hotel, Dubai Location: The Ritz-Carlton Golf Resort, Naples, Fla.
For more information: www.meforexexpo.com For more information: Visit www.cboe.com/rmc
Event: International Traders Expo Event: The World MoneyShow Vancouver 2010
Date: Nov. 18-21 Date: April 6-8
Location: Mandalay Bay Resort & Casino, Las Vegas Location: Hyatt Regency Vancouver
For more information: www.tradersexpo.com For more information: Go to www.moneyshow.com
and click on “Events.”
Event: TradeStation Futures Symposium
Date: Dec. 10-12
Location: Naples, Fla.

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firm for active, professional, and certain buy-side institu- anonymous posting of all limit orders directly into the
tional traders, has launched its new TradeStation Prime quotes for anyone else to see and execute against; no limi-
Services division. TradeStation Prime Services seeks to fill tation on proximity of limit and stop orders; direct routing
the growing need of start-up to mid-sized hedge funds, reg- of market orders through proprietary algorithms to obtain
istered investment advisers, professional traders and asset best-price execution against banks, customers, and other
managers for prime brokerage services which are no longer dark pools of liquidity; and no restrictions against scalping.
being provided by the larger firms that traditionally served The company has also launched MetaTrader Webinars in
this market segment. The new division intends to provide a MBT University covering a range of topics from basic chart-
valuable combination of industry-leading execution plat- ing to custom indicator trading. Future courses will explain
forms, including the award-winning TradeStation, reliable the differences between deal desk and ECN MetaTrader
clearance and settlement of trades, and first-class service systems.
and support, including start-up assistance,
outsourced/direct access trading, real-time risk manage- Velocity Futures (www.tradewithvelocity.com), a
ment, portfolio reporting, securities lending, and capital global Futures Commission Merchant (FCM) that provides
introductions for its clients. TradeStation Prime Services active traders with connectivity to electronic futures mar-
plans to serve traders of equities, equity and index options, kets, now provides its customers and internal trading desks
futures, non-U.S. equities, and forex, making it a powerful access to CQG’s advanced trading platforms. CQG
36 November 2009 • OPTIONS TRADER

(www.cqg.com) is a trade execution, market data, and ana- that point. Rotate the device clockwise to see a trend com-
lytics provider for global electronically traded futures mar- parison of price, percent change, and volume for selected
kets. Customers clearing through Velocity Futures now stocks. Rotate counterclockwise and a single graph com-
have access to CQG’s advanced electronic trading via the pares price, percent change, or volume over time on the full
CQG Trader and CQG Integrated Client platforms. Velocity screen. Choose to display indices, funds, commodities, and
Futures traders are able to route orders to CME Globex, anything else on Yahoo finance. A full feature list is avail-
CBOT, NYMEX, COMEX, ICE Futures US, ICE Futures UK, able at www.allofzero.com/traxstocks.
and Eurex.
The new Web site TheThreeBlindMice.com
TradingScreen, a global leader in execution manage- (T3BM), created by investment professionals with more
ment systems, has released TradeSmart X, the next genera- than 70 years of cumulative trading experience, provides
tion version of its multi-broker, multi-asset class flagship daily market commentary on stocks and futures, price tar-
front-end. TradeSmart X has been designed to provide a gets, projected trends, model portfolios, sector rotation
more intuitive and richer user experience, integrating major updates, and more. The site is kept current with morning,
functionality enhancements for liquidity access, execution mid-day, and closing comments. T3BM generates actionable
management, cross-asset class trading, and reporting deliv- daily trading ideas as well as longer-term strategies cover-
ered with a new look and feel. TradeSmart is a customizable ing anything that trades on Wall Street. For more informa-
interface that enables buy-side clients to trade a broad port- tion, visit www.ttbmllc.com.
folio of financial instruments, around the clock, on any mar-
ket and with a wide range of counterparties. TradeSmart is Trade MONSTER (www.trademonster.com), an
unique in its ability to aggregate multiple-dealers and mul- online broker designed by professional traders for self-
tiple asset classes onto a single screen format for electronic directed investors, has introduced “Exit Plan,” a tool for set-
order routing. Its application service provider model ting profit and loss parameters upon making a trade. Exit
enables rapid deployment and activation and incorporates Plan uses plain English and easy-to-understand icons to
the most comprehensive and intuitive access to the propri- replace confusing trader jargon such as “trailing stops,”
etary algorithmic trading strategies offered by the leading “contingent orders,” “trigger orders,” and others previous-
global brokers. TradeSmart connects to all of the leading ly required to place such trades. In setting an Exit Plan,
portfolio and order management systems to ensure com- trade MONSTER shows the real-time probability of those
plete integration into the workflow of the buy-side institu- targets being hit, making it easy for investors to fine-tune
tion. each trade’s maximum profit and loss levels. This news fol-
lows the recent introduction of two additional tools that
All of Zero’s TraxStocks is free for iPhone and iPod give professional grade tools to retail investors:
touch users, available now in the iTunes App Store. “adjustTRADE,” which enables customers to adjust posi-
TraxStocks provides market data in an elegant, intuitive tions on current stock or options holdings with just a few
interface specifically designed to efficiently visualize trends clicks; and “Portfolio Analysis” which allows customers to
over time. TraxStocks displays only necessary data. Visual benchmark their portfolio against other indices and stress-
trends are depicted by “sparklines,” a graphing function test portfolios against various risk metrics.
designed specifically for ease of comprehension. A user can
Note: The New Products and Services section is a forum for industry
quickly see current values, highs, lows, and relative stock
businesses to announce new products and upgrades. Listings are adapted from
and index performance for all items over the selected time
press releases and are not endorsements or recommendations from
period. The iPhone makes interaction with market data the Active Trader Magazine Group. E-mail press releases to
incredibly simple. Touch any sparkline to get the value for editorial@futuresandoptionstrader.com. Publication is not guaranteed.

OPTIONS TRADE JOURNAL
FIGURE 1 — PROFITS HAMPERED BY SELLING CALLS
This hedged position is We timed the market well and collected a large portion of the covered call’s maximum
profit. However, we would have earned twice as much by owning the underlying outright.
ill suited for a strong rally
in Research in Motion.
TRADE
Date: Friday, Oct. 2., 2009
Market: Options and under-

lying stock of Research in
Motion (RIMM).
Entry: Buy 100 shares of

RIMM at $66.13.
Sell 1 October 65-
strike put for $2.81.
Reasons for trade/setup:

After missing second-quarter
earnings estimates, BlackBerry
manufacturer Research in Source: eSignal
Motion got punished on Sept.
25 as it fell 15 percent overnight. Such a large drop in a This cost represents the trade’s maximum loss, so we won’t
high-profile technology company with attractive funda- lose money unless RIMM drops more than 4 percent by
mentals is an opportunity to enter a conservatively bullish expiration on Oct. 15.
trade. Figure 2 shows the covered call’s potential gains and
RIMM has been an ideal candidate for covered calls (long losses on three dates: trade entry (Oct. 2, dotted line),
underlying stock, short calls) in 2009, according to an arti- halfway until expiration (Oct. 10, dashed line), and expira-
cle in the November 2009 issue of Active Trader. BlackBerry tion (Oct. 17, solid line). The position is somewhat protect-
controls 30 percent of the smartphone market and RIMM ed on the downside, but profits are limited to a mere $1.68
has a beta of 2.15, a sign of a volatile stock with high option per share if RIMM closes above the 65 strike at expiration.
premiums. By selling calls, our directional exposure is more than cut
A 15-percent drop implies investor sentiment in RIMM in half. The trade has a 67-percent chance of success with a
has clearly shifted. But Research in Motion’s competitive total delta of roughly 40 vs. 100 if we had simply bought the
position and the overall strength of technology stocks sug- underlying shares.
gest a short-term bounce is likely. But if the stock keeps
sinking, the premium we collect from selling a call option
will help protect us. TRADE SUMMARY
Getting the details right is the key to making money
with a covered call. Specifically, we need to pick the cor- Entry date: Oct. 2, 2009
rect strike price and expiration month. One rule of thumb
Underlying security: Research in Motion (RIMM)
is to select in- or at-the-money calls with 20 to 40 days left
until expiration. Moreover, the short call should have an Position: Long 100 shares
Short 1 October 65 call
extrinsic value of at least $2.50.
Figure 1 shows that we entered a covered call on Oct. 2 Initial capital required: $6,332
by purchasing 100 shares of RIMM for $66.13 and selling Initial stop: Exit if RIMM drops below $63.32
one October 65-strike call for $2.81 — a total cost of $63.32. Initial target: Sell if RIMM hits $70. Otherwise,
wait for expiration.
TRADE STATISTICS Initial daily time decay: $7.06
Date: Oct. 2 Oct. 9 Trade length: 7 days
Delta: 39.76 11.68 P/L: $150 (2.4%)
Gamma: -8.10 -4.08 LOP: $150
Theta: 7.06 5.91 LOL: -$20
Vega: -5.19 -2.21 LOP — largest open profit (maximum available profit during life of trade).
Probability of profit: 67% 96% LOL — largest open loss (maximum potential loss during life of trade).
Breakeven point: $63.32 $63.32

FIGURE 2 — RISK PROFILE — COVERED CALL
A covered call is a conservative position that limits upside profits for some
Initial stop: Exit if RIMM drops below downside protection.
breakeven price of 63.32 before expiration.
Initial target: Sell before expiration if

RIMM jumps to 70. Otherwise hold until
expiration and let shares get called away.
RESULT
Outcome: We entered the trade after a

pullback in the broader market, and Figure 1
shows it moved in the right direction almost
immediately. At first, RIMM stumbled, but
the position never lost more than $0.20 per
share. This hedge was reassuring, but as
RIMM began to climb, we realized how lim-
ited profits were.
We sold the covered call at a profit of
$1.50 per share (2.4 percent) when Research
in Motion hit $70 on Oct. 9. When we exited
the trade, it had already gained $1.50 of its Source: OptionVue
$1.68 maximum profit. Waiting a week to
collect another $0.18 per share wasn’t worth RIMM fell below its $60 support level. As RIMM tanked, the
the risk. covered call lost more than we thought because the short
Even though it made money, this trade lacked bite. By call’s value didn’t shrink as fast as we had hoped. In theo-
selling a call, we gave up the opportunity to earn twice as ry, short call’s value should shrink as the underlying falls,
much profit. but premiums often remain inflated, held higher by spiking
We reestablished this position later in October just before volatility.
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November 2009 • Volume 3, No.

Options Trading System Lab

Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 Options Basics

The return of the NOB spread . . . . . . . .12

To hedge or not to hedge? . . . . . . . . . . .16

2 November 2009 • FUTURES & OPTIONS TRADER

6 Reasons Why Options

1 Award-winning, reliable, real-time options,

3 Advanced charting with EFS, a unique

Managed Money . . . . . . . . . . . . . . . . . . . . .28

Futures & Options Watch:

Have a question about something you’ve seen

Looking for an advertiser?

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

Las Vegas Traders Expo

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4 November 2009 • FUTURES & OPTIONS TRADER

Keith Schap is a freelance writer specializing in risk

Editorial assistant and

FUTURES & OPTIONS TRADER • November 2009 5

Energies, grains — and meats — hold bullish ground

6 November 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • November 2009 7

Note: A version of this article originally appeared in the October 2004

T long when the indicator is oversold and sells on

4. Short exit: Place a stop at the closing price of the day

1. Long entry: Buy on the next open if

2. Short entry: Sell short on the next

The profit-taking and stop-loss rules

3. Long exit: Place a stop at the closing

8 November 2009 • FUTURES & OPTIONS TRADER

Other system parameters

FUTURES & OPTIONS TRADER • November 2009 9

10-DAY STOCHASTIC OSCILLATOR

STRATEGY SUMMARY (2% RISK)

10 November 2009 • FUTURES & OPTIONS TRADER

For information on the author see p. 5.

STRATEGY SUMMARY (2% RISK)

Profitability Trade statistics

that stays close to the linear regression line (magenta).

FUTURES & OPTIONS TRADER • November 2009 11

The return of the NOB spread

R our hearts. Especially sweet

12 November 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • November 2009 13

TABLE 1 — NOB SPREAD WIDENING EVENTS

14 November 2009 • FUTURES & OPTIONS TRADER

ATTEND AND LEARN PROFITABLE TRADING

Learn and Profit from 50+ Top

Robert Eric Alexander Linda

Lawrence Toni Carolyn Jon

and many more...

Take Home Expert Knowledge and

•Enhance your trade accuracy usingthelatesttools

a Production of Media Partner Platinum Sponsor Gold Sponsor

To hedge or not to hedge?

he 2008 market rout taught everyone that a tra-

The BuyWrite Index seems to be

16 November 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • November 2009 17

Covered calls and collars

18 November 2009 • FUTURES & OPTIONS TRADER

20 November 2009 • FUTURES & OPTIONS TRADER

•Enhance your trade accuracy usingthelatesttools