FOT200810

October 2008 • Volume 2, No.
10
FUTURES: T-BOND
System trading with seasonals p. 9
the %C filter p. 10
SHORT-TERM
calendar
spreads p. 15
FUTURES
SYSTEM LAB:
Bottom-catcher p. 26
THE MARKET’S
stress test p. 36
FUTURES BASICS:
Commodity
sectors p. 32
RATIO SPREADS
vs. BACK SPREADS
p. 20
CONTENTS
Backspreads and ratio spreads . . . . . . .20

These spreads aren’t for every trader, but
their unique structure can capture large profits
from big, sudden moves in the underlying market.
By Frederic Ruffy
Futures Trading System Lab

“Nerves of steel” pullback system . . . . . .26
Examining a stock-index futures pullback system
reveals the potential pitfalls behind some of the
attractive performance statistics.
By FOT Staff
Options Trading System Lab

Trading credit spreads with the CCI . . . . .30
Historical analysis of an option system
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 triggered by the Commodity Channel Index.
By Steve Lentz and Jim Graham
Market Movers . . . . . . . . . . . . . . . . . . . . . . . .6
A roundup of price action in the different Trading Basics
futures sectors. Futures sectors . . . . . . . . . . . . . . . . . . . . . . .32
A look at the sub-groups that make up the
Trading Strategies futures market.
Seasonal T-bond patterns . . . . . . . . . . . . .9 By FOT Staff
Analysis reveals long-term and short-term
tendencies in T-bond futures that show
Trader Interview
surprising consistency over time.
Bill Greenwalt . . . . . . . . . . . . . . . . . . . . . . . .34
By Jay Kaeppel
A professional option trader explains how to
manage risk in today’s difficult markets.
System filtering with %C . . . . . . . . . . . . .10
By David Bukey
The %C indicator is designed to show continued on p. 4
when the market shifts from a trading
range to a trending environment. See what
happens when it’s combined with a volatility
breakout system.
By Jack F. Cahn, CMT
Short-term calendar spreads . . . . . . . . .15

Exploring the nuances of calendar spreads
leads to short-term trading opportunities.
By Jonathan Maher
2 October 2008 • FUTURES & OPTIONS TRADER

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CONTENTS
News
Financial panic tanks markets . . . . . . . .36
Financial turmoil in late September and early
October rocks markets around the world and
promises to usher in a new financial era, for
better or worse.
Other stories: Options Watch:

ICE Futures takes over Russell Financial Sector ETF components . . . . . . . . .42
stock index futures trading . . . . . . . . . . . . . . .38
Futures & Options Calendar . . . . . . . . . . . .43
New markets: Merc launches steel and
Euro-denominated S&P futures . . . . . . . . . . .39 Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .44
References and definitions.
Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .40
Momentum, volatility, and volume Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50
statistics for futures.
Options Trade Journal . . . . . . . . . . . . . . .52
Option Radar . . . . . . . . . . . . . . . . . . . . . . . . . .41 Buying puts on Bank of America before the
Notable volatility and volume financial storm hits.
in the options market.
New Products and Services . . . . . . . . . . . . .53
Futures & Options Watch
COT extremes . . . . . . . . . . . . . . . . . . . . . . .42
A look at the relationship between commercials
and large speculators in 45 futures markets.
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.
CBOE PFGBEST.com
eSignal RS of Houston
GCFF The Wizard
OptionsMentoring TradeStation

CONTRIBUTORS
CONTRIBUTORS
Jonathan F. Maher has a Ph.D. in engineering and an MBA

from the top-ranked program for technology management. He
worked in the high-tech industry for more than 20 years, holding
many high-level managerial positions in development and market-
ing. Maher first started trading options in 1984 while working on
his Ph.D. In 2004, he founded DocMaher Trading LLC, an invest-
A publication of Active Trader ® ment education company that works with traders one-on-one. He
has taught hundreds of people about options strategies. Maher’s specialty is con-
For all subscriber services: servative income strategies that capitalize on time and volatility. These include
www.futuresandoptionstrader.com iron condors, calendars, and hybrid strategies such as the “W” trade. Income
strategies are intended to be higher probability trades that can profit over a wide
range of stock movement. You can also find his writings as an “All
Editor-in-chief: Mark Etzkorn
Star Commentator” on the TradeKing’s blog.
metzkorn@futuresandoptionstrader.com
Jay Kaeppel is a trading strategist with Optionetics, Inc.

Managing editor: Molly Flynn Goad
and writes a weekly column, “Kaeppel’s Corner” for
mgoad@futuresandoptionstrader.com
http://www.optionetics.com. An independent trader, Kaeppel has
been active in the financial markets for more than two decades. He
Senior editor: David Bukey
was the head trader at a CTA for 8 years and a trading system and trading soft-
dbukey@futuresandoptionstrader.com
ware developer for 15 years. As an author, Kaeppel has published three books on
trading, The Four Biggest Mistakes in Option Trading, The Four Biggest Mistakes in
Contributing editor:
Futures Trading, and The Option Trader’s Guide to Probability, Volatility and Timing.
Keith Schap
His latest book, Seasonal Stock Market Trends: The Definitive Guide to Seasonal Stock
Associate editor: Chris Peters
Market Trading, will be released by Wiley in January 2009. Kaeppel has also been
cpeters@futuresandoptionstrader.com
a noted speaker at a variety of live and online investment seminars.
Editorial assistant and Jack F. Cahn, CMT has been involved in the financial mar-
Webmaster: Kesha Green kets since 1974. Over the years, he has worked as a technical market
kgreen@futuresandoptionstrader.com analyst for Stix & Co, Merrill Lynch, Sherson Loeb Rhodes, and R.
Rowland and Co. He was director of the Markets Technicians
Art director: Laura Coyle Association from 1990 to 1995 and is a member of the Australian
lcoyle@futuresandoptionstrader.com Technical Analysts Association and the International Federation of Technical
Analysts. Cahn has developed trading systems as president of Creative
President: Phil Dorman Breakthrough, Inc. (http://www.traderassist.com) since 1989.
pdorman@futuresandoptionstrader.com
Frederic Ruffy is the senior options strategist at
Publisher, http://whatstrading.com, a site dedicated to helping traders make
Ad sales East Coast and Midwest: sense of the complex and fragmented nature of listed options trad-
Bob Dorman ing. In addition to writing market commentary and trading-related
bdorman@futuresandoptionstrader.com books and articles, Ruffy has also worked as an instructor, educat-
ing investors on advanced topics such as volatility, the benefits of
Ad sales sector rotation, and trading around earnings. Ruffy is an active trader with more
West Coast and Southwest only: than 15 years experience in the industry. His market observations and analysis of
Allison Chee the options market are featured regularly in the financial press including Barron’s,
achee@futuresandoptionstrader.com
Reuters, The Wall Street Journal, Bloomberg, and Futures Magazine.
Classified ad sales: Mark Seger Steve Lentz (advisor@optionvue.com) is a well-established

seger@futuresandoptionstrader.com
options educator and trader and has spoken all over the U.S., Asia,
and Australia on behalf of the CBOE’s Options Institute, the
Volume 2, Issue 10. Futures & Options Trader is pub-
lished monthly by TechInfo, Inc., 161 N. Clark Street,
Options Industry Council, and the Australian Stock Exchange. As a
Suite 4915, Chicago, IL 60601. Copyright © 2008 mentor for DsicoverOptions.com, he teaches select students how to
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any use complex options strategies and develop a consistent trading plan. Lentz is
form without written permission from the publisher. constantly developing new strategies on the use of options as part of a compre-
The information in Futures & Options Trader magazine hensive profitable trading approach. He regularly speaks at special
is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply
events, trade shows, and trading group organizations.
the effectiveness of any trading system, strategy, or
approach. Traders are advised to do their own
research and testing to determine the validity of a trad- Jim Graham (advisor@optionvue.com) is the product manag-
ing idea. Trading and investing carry a high level of er for OptionVue Systems and a registered investment advisor for
risk. Past performance does not guarantee future
results. OptionVue Research.
FUTURES & OPTIONS TRADER • October 2008 5

MARKET MOVERS
Financial panic pressures

already-weak commodities
Late summer and early fall have been the pack, stabilizing a bit after their big agers and investors closed out posi-
mostly red ink for commodity futures, July-September shakeout. tions across asset classes.
with some food and fiber markets Until Sept. 29, that is. The financial For detailed performance statistics
bearing the brunt of the most recent market calamity that unfolded when of top-volume futures contracts, see
decline, along with some grain the U.S. congress bailed on the $700 the Futures Snapshot on p. 40.
futures. Meats and metals were among billion bailout plan sent many com-
the stronger sectors. For the most part, modity futures — especially crude
energy contracts were in the middle of oil — into a tailspin as money man-
Energy
Crude oil consolidated between
$105 and $110 after bouncing
back from its mid-September
dive below the $100 mark —
only to plunge more than 10 per-
cent on Sept. 29. As of Oct. 3,
November futures (CLX09) had
turned down again and were
trading around $94.00.
Source for all: TradeStation
Metals
As might be expected, gold and
silver benefited from the financial
market’s jitters in September.
After falling below $740 on Sept. Grains
11, December gold (GCZ08) After a brief consolidation, grain
exploded nearly $200 to $926.40 futures renewed their sell-off in late
by Sept. 18. The market was trad- September and early October, push-
ing around $842.00 on Oct. 3. ing to new lows for the year.
Industrial metals did not enjoy November rough rice (RRX09)
the same bounce. December cop- futures, however, rallied more than
per futures (HGZ08) made a new 20 percent from their August low to
low for the year when they fell to 3.000 on Sept. 18, and have subsequently the Sept. 24 high before pulling back
fallen as low as 2.6030. with the rest of the complex.

Softs and fibers
While coffee, cocoa, and sugar all
moved sideways to moderately
lower in choppy trading, cotton
(CT) and orange juice (OJ) took big
hits in late summer, extending their
runs of new yearly lows. December
cotton (CTZ08) fell some 30 percent
from its spring high to lows below
60.00 in September.
Currencies
Meats For in-depth analysis of the FX mar-
Livestock futures have been relatively ket, go to http://www.currencytra-
robust, if characteristically volatile. dermag.com for a free subscription to
After trading as low as 83.600 in early Currency Trader magazine.
September, February 2009 pork belly
futures (PBG09) traded above 100.000
by Sept. 26 before dropping again to
below 95 as of Oct. 3.
Treasuries
Treasuries were definitely not the ben-
eficiary of the stock market’s woes —
at least initially. The December 10-year
T-note futures (TYZ08) fell from 119-
00 to around 114-00 between Sept. 17
and 25. They shot back up on Sept. 29
on a flight-to-quality move, however,
climbing as high as 118-00.
Stock indices
E-Mini Nasdaq 100 index futures
(NQZ08) took the biggest hit on Sept.
29, plunging as much as 10 percent (to
1,494) before rallying slightly into the
close. The Nasdaq 100 index (NDX)
fell to its lowest level since August
2006. The market challenged this low
with another sharp drop on Oct. 2.

MARKET MOVERS continued
Putting the Sept. 29 drop in context

Any way you slice it, Sept. 29 was a pretty big day, although day ranges, regardless if the day was up or down. (The
perhaps not quite the earth-shattering event the news day’s range is expressed as a percentage of the day’s mid-
media made it out to be. point, for consistency.)
But we must cut the commentators some slack, as the Sept. 29 trailed only Oct. 19 and Oct. 26, 1987 in terms of
U.S. market’s decline that day was bigger than any other in the close-to-close and close-to-low declines, but it was only
more than 20 years — since the immediate aftermath of the the fifth largest day in terms of range.
Oct. 19, 1987 crash, in fact. Table 2 extends the analysis by looking at the Dow
Table 1 shows the biggest one-day drops in the S&P 500 Industrial Average’s (DJIA) biggest one-day declines from
index (SPX) from September 1978 through September 2008. October 1928 through September 1978. Sept. 29, 2008 would
The first two sections of the table show the 10 largest have been the ninth-biggest close-to-close decline if it had
declines measured from the previous close to the current occurred during this period, and it wouldn’t have even
close and the previous close to the current low, respectively. cracked the top-10 largest close-to-low moves or intraday
The bottom section shows the days with the biggest intra- ranges.
TABLE 1 — BIGGEST S&P 500 ONE-DAY DECLINES, TABLE 2 — BIGGEST DOW ONE-DAY DECLINES,
1978-2008 1928-1978
As % Close Close As % Close Close
of to to of to to
Date Close Range midpoint low close Date Close Range midpoint low close
Close to close Close to close
10/19/1987 224.83 57.86 22.80% -20.47% -20.47% 10/28/1929 260.6 38.4 13.91% -14.74% -13.48%
10/26/1987 227.66 20.47 8.62% -8.45% -8.28% 10/29/1929 230.1 40.1 17.26% -18.53% -11.70%
9/29/2008 1117.85 96.53 8.32% -8.32% -7.88% 10/5/1931 86.5 6.6 7.43% -11.76% -10.73%
10/27/1997 876.97 64.91 7.14% -6.87% -6.84% 11/6/1929 232.1 23.8 9.90% -11.37% -9.93%
8/31/1998 957.55 76.05 7.64% -6.80% -6.79% 12/4/1933 89.9 9.5 10.04% -9.10% -9.10%
1/8/1988 243.39 18.13 7.19% -6.94% -6.77% 8/12/1932 63.1 6.6 10.03% -9.29% -8.42%
10/13/1989 333.64 22.72 6.60% -6.35% -6.12% 1/4/1932 71.6 3.2 4.41% -8.99% -8.09%
4/14/2000 1356.02 101.11 7.27% -7.02% -5.87% 7/21/1933 88.7 14.2 15.50% -12.25% -7.89%
10/16/1987 282.69 17.39 5.99% -5.56% -5.16% 9/29/2008 1117.85 96.53 8.32% -8.32% -7.88%
9/17/2001 1038.77 55.08 5.17% -5.04% -4.92% 6/16/1930 230.1 13.3 5.65% -8.33% -7.85%
Close to low Close to low
10/19/1987 224.83 57.86 22.80% -20.47% -20.47% 10/29/1929 230.1 40.1 17.26% -18.53% -11.70%
10/26/1987 227.66 20.47 8.62% -8.45% -8.28% 10/28/1929 260.6 38.4 13.91% -14.74% -13.48%
9/29/2008 1117.85 96.53 8.32% -8.32% -7.88% 7/21/1933 88.7 14.2 15.50% -12.25% -7.89%
4/14/2000 1356.02 101.11 7.27% -7.02% -5.87% 10/5/1931 86.5 6.6 7.43% -11.76% -10.73%
1/8/1988 243.39 18.13 7.19% -6.94% -6.77% 11/6/1929 232.1 23.8 9.90% -11.37% -9.93%
10/27/1997 876.97 64.91 7.14% -6.87% -6.84% 10/24/1929 299.5 40.5 13.84% -10.98% -2.09%
8/31/1998 957.55 76.05 7.64% -6.80% -6.79% 5/21/1940 114.1 9.9 8.57% -9.64% -6.78%
10/13/1989 333.64 22.72 6.60% -6.35% -6.12% 8/12/1932 63.1 6.6 10.03% -9.29% -8.42%
11/30/1987 230.3 14.56 6.25% -6.06% -4.17% 12/4/1933 89.9 9.5 10.04% -9.10% -9.10%
10/22/1987 248.25 15.38 6.14% -5.95% -3.92% 1/4/1932 71.6 3.2 4.41% -8.99% -8.09%
Daily range as % of the day’s midpoint Daily range as % of day’s midpoint
10/19/1987 224.83 57.86 22.80% -20.47% -20.47% 10/29/1929 230.1 40.1 17.26% -18.53% -11.70%
10/20/1987 236.83 29.15 12.62% -3.72% +5.34% 7/21/1933 88.7 14.2 15.50% -12.25% -7.89%
10/26/1987 227.66 20.47 8.62% -8.45% -8.28% 10/28/1929 260.6 38.4 13.91% -14.74% -13.48%
7/24/2002 843.43 68.64 8.47% -2.76% +5.73% 10/24/1929 299.5 40.5 13.84% -10.98% -2.09%
9/29/2008 1117.85 96.53 8.32% -8.32% -7.88% 10/6/1931 99.3 13 13.83% +1.16% +14.80%
10/21/1987 258.37 20.46 8.22% +0.83% +9.10% 10/30/1929 258.5 30 12.20% +0.35% +12.34%
8/31/1998 957.55 76.05 7.64% -6.80% -6.79% 12/18/1931 80.7 8.5 11.06% -1.63% +9.35%
10/28/1997 921.86 67.82 7.63% -2.47% +5.12% 7/20/1933 96.3 10.9 10.87% -8.49% -7.05%
4/4/2000 1494.72 110.04 7.48% -5.95% -0.75% 11/7/1929 238.2 24.3 10.57% -6.16% +2.63%
4/14/2000 1356.02 101.11 7.27% -7.02% -5.87% 8/3/1932 58.2 5.8 10.39% -0.56% +9.40%

TRADING STRATEGIES
Seasonal T-bond patterns

Certain months appear to be more bullish or bearish than others.
BY JAY KAEPPEL
FIGURE 1 — THE BEST VS. THE REST, 1977-2008
Being long during May, June, August, November, and December was
“S easonals” are trends that tend to

repeat at regular intervals or at
certain times of the month or
year. The following analysis
looks at seasonal trends that appear to influence
profitable (blue line), while going long the other seven months of the
year produced a net loss (red line).
T-bond futures, focusing on two areas:
1. The most bullish months of the year.

2. The most bearish months of the year.
Additional research, noted at the end of this

article, indicates there are also certain bullish and
bearish trading days each month.
The analysis suggests each of these categories
holds unique opportunities for alert traders and
investors.
Most bullish months of the year

Research conducted on more than 30 years of T-
bond prices indicates the market has a tendency
to perform better during certain months of the The results are compelling. Between November 1977 and
year. At first this seems to make little intuitive sense. The July 2008, a one-contract long position held only during the
idea of seasonal trends in markets such as grains (soybeans, five seasonally bullish months each year gained almost
corn, wheat) or softs (cocoa, sugar, coffee) is logical because $112,000 (each one-point move in the T-bond futures is
these “hard” commodities have fixed growing and produc- worth $1,000), and was profitable in 22 of the past 31 years.
tion cycles: they must be planted, grown, and harvested, By contrast, a one-contract long position in T-bond futures
and as a result they are subject to the vagaries of weather. held during the remaining seven months of the year would
A T-bond, by comparison, is simply a piece of paper con- have registered a loss in excess of -$75,000.
ferring certain rights to its owner, so it would seem unlike-
ly that T-bonds would be influenced by any seasonal fac- Most bearish months of the year
tors. Nevertheless, the data strongly suggest that not all Figure 1 shows the seven months other than May, June,
months are created equal when it comes to T-bond price August, November, and December produced a net loss in T-
trends. bond prices over the past 30 years. Closer examination
The most bullish months for T-bond futures are May, reveals the damage was done primarily during one seg-
June, August, November, and December. First, this infor- ment of the calendar year — January through April.
mation does not mean T-bond prices will always rise during One way to take advantage of this information would be
these favorable months or that these months will show to hold a short T-bond futures position during this period.
gains during any given calendar year. The implication is There are no guarantees a short position held during this
simply that bonds have demonstrated a tendency to per- period will generate a profit during any given year. In fact,
form better during these months than during the rest of the the batting average is about 65 percent, as holding a short
year. position in T-bonds during these unfavorable months
Figure 1 illustrates this by showing the equity growth of would have resulted in an annual profit during 20 of the
being long one T-bond futures contract during May, June, past 31 years. Nonetheless, the long-term trend is what we
August, November, and December, buying at the close of are focusing on here, and that trend clearly runs to the plus
the previous month and selling at the close on the last day side.
of the favorable month every year since November 1977
For more in-depth analysis of seasonal tendencies in the T-bonds,
(blue line). It also displays what would have happened if including a comprehensive seasonal trading model that combines long-
you had skipped these favorable months and instead held a term and short-term patterns, see the December issue of Active Trader
long T-bond futures position only during the remaining magazine (http://www.activetradermag.com). For information on the
seven months of the year (red line). author, see p. 5.

TRADING STRATEGIES
System filtering with %C

Applying a trend-strength indicator to a volatility breakout system
helps pinpoint the most promising trades.
BY JACK F. CAHN, CMT
T raders often try to forecast the market’s direc-

tion while ignoring how the market is behav-
ing. The key question isn’t where the market is
headed, but how it gets there. Anyone can
make a directional forecast that becomes accurate, but that
doesn’t mean they will make money. Identifying a market’s
condition — flat, trending, or volatile — is what increases
to eight years. They hunt for the ultimate oscillator that
gives great overbought or oversold readings, but they find
those signals only work in non-volatile conditions. Or they
follow the trend and then suffer losses when the market
returns to a trading range.
Instead, you need to know how to identify the current
market’s condition and anticipate when it will change. The
your trading edge. percent contraction (%C) indicator helps determine the
Identifying a market’s condition can tell you which trad- market’s condition and can be used to boost trading system
ing systems will likely be the most profitable, independent performance.
of market direction. A good example of this distinction is
the difference between the bear markets of 1973 and 1987. Different market conditions
Stocks fell 20 percent in both cases, but market conditions The key to finding better trade opportunities is to identify a
were very different in both years. In 1973, the S&P 500 market as being in one of four main conditions:
bounced around, staged several strong, fast counter rallies,
and took 10 months to drop 20 percent. In 1987, the S&P fell 1. A strong trend that travels in one direction, either up
that far on Oct. 19 alone. or down, with little or no retracement along the way.
Traders who fail to realize why market conditions are rel- 2. A ranging trend that moves up or down over the
evant search in vain for the one robust strategy that trades same time period as the first condition, but with
well across all markets in any time frame over the past five increased volatility and deep retracements. These
countertrend moves take the
market into overbought or
FIGURE 1 — AN IDEAL TRADE oversold territory as the
On Aug. 8, the %C indicator was above its moving average and closed at 59.57, sug- market remains within a
gesting the E-Mini Russell 2000 could break out of its trading range. As expected, the trading channel.
market rallied the next morning. 3. A broad trading range that
includes the volatility and
retracements of the second
condition, but lacks direction
or trend.
4. A dull trading range that is
the opposite of a strong trend.
The market lacks volatility
and is also directionless.
The percent
contraction indicator
The %C indicator is designed to
identify a market’s condition and
when it might shift from one con-
dition to another. Like the Average
Directional Movement Index
(ADX), the indicator measures
trend strength, but it has less lag
and contains more information
Source: TradeStation
about the market’s condition. Also,

FIGURE 2 — TRADING RANGE
Indicator code The trade system went short on May 28 but the trade was unprofitable because the
%C indicator:
market lacked direction as %C moved higher from an extreme low.
Inputs:lng(numericsimple);
Value1=TrueHigh;
Value2=TrueLow;
Value3=Value1-value2;
Value4=Summation(value3,lng);
Value5=Highest(Value1,lng);
Value6=Lowest(value2,lng);
If value5-value6>0 then Value7=value5-value6;
Value8=(value4/value7);
if Value8 <> 0 then Value9 = Log (value8);
Value10=value9/log(lng);
Value11=Value10*100;
@PercentC=Value11;
the %C indicator shows when the

market’s condition has reached an
extreme and is ready to change. Source: TradeStation
The %C indicator uses true range
to measure trend strength, as fol-
lows: Therefore, the %C indicator’s value
is 85.14. Logarithms are used in this
1. Add each bar’s true range in calculation to make sure the extreme
the 14-bar look-back period. levels range from one to 99.
2. Divide this running total by The indicator’s extremes can vary
the largest one-day true range from market to market but normally
value of that look-back cycle in a 40-point range — e.g., 20 to
period. 60, 25 to 65, or 30 to 70. “Indicator
3. Calculate the logarithm of the code” shows the TradeStation code for
raw value from step 2. the %C indicator.
4. Divide the result by the In general, the %C indicator meas-
logarithm of the look-back ures stress levels in a market. A dull
period (14, in this case). trading range develops when market
5. Multiply by 100. tensions are high, as the lack of direc-
tion frustrates both bullish and bearish
The following example uses 15- traders. In this scenario, the %C indi-
minute bars on the E-Mini Russell 2000 cator trends higher from its low
futures. On Sept. 12 at noon, the run- extreme to its high extreme.
ning total of the E-Mini Russell 2000 As the indicator’s value rises, the
futures’ 14-bar true range was 47.3, market is increasingly less likely to
and the largest one-bar true-range of trend until an extreme is reached. As
the past 14 bars was 5. The %C reading the indicator’s value declines, the mar-
would be: ket is less likely to be range-bound
until an extreme is reached. Extreme
1. 47.3/5 = 9.46. readings represent turning points.
2. log(9.46) = 0.9758. When the indicator climbs above 55,
3. log(14) = 1.1461 the market will likely shift from trad-
4. 0.9758/1.1461 = .8514 ing sideways (conditions 3 or 4) to
5. 0.8514*100 = 85.14 breaking out in one direction (condi-
continued on p. 12

TRADING STRATEGIES continued
Filtered strategy #1: If EntriesLongToday(date)<2

[LegacyColorValue = true];
and ( PercentC(CDLF)<TrendExup and
PercentC(CDLF)>15 )
Inputs: fac(.9),facs(.9);
Inputs: LChopEx(65),CDLF(14);
or (PercentC(CDLF)>LChopEx )
Inputs: SChopEx(65),CDSF(14);
Then Begin
Buy ( "TON%CPlus-LE" ) next bar at
If EntriesshortToday(Date)<1
OpenD(0) + ((HighD(1) - LowD(1)) * facs) stop ;
End;
and PercentC(CDSF)>SChopEx
Then Begin
Sell Short ( "DayTrader-SE" ) next bar at Filtered strategy #3:
OpenD(0) - ((HighD(1) - LowD(1)) * fac) stop ;
end; Inputs: fac(0.9),facs(.9);
Inputs: TrendExup(36),LChopEx(65),CDLF(16);
If EntriesLongToday(date)<1 Inputs: TrendExdw(36),SChopEx(65),CDSF(14);
and PercentC(CDLF)>LChopEx If EntriesshortToday(Date)<2

Then Begin
Buy ( "DayTrader-LE" ) next bar at and (PercentC(CDSF)<TrendExdw and PercentC(CDSF)>15 and
OpenD(0) + ((HighD(1) - LowD(1)) * facs) stop ; PercentC(CDSF)<XAverage(PercentC(CDSF), 6))
End; or (PercentC(CDSF)>SChopEx )
Then Begin
Filtered strategy #2: If (time>0930 and time <1000 or time>1200 and time <1530) then
Sell Short ( "TON%CPlusA-SE" ) next bar at
Inputs: fac(0.9),facs(.9);
end;
Inputs: TrendExup(36),LChopEx(65),CDLF(14);
Inputs: TrendExdw(36),SChopEx(65),CDSF(14);
If EntriesLongToday(date)<2
If EntriesshortToday(Date)<2
and ( PercentC(CDLF)<TrendExup and
PercentC(CDLF)>15 )
and (PercentC(CDSF)<TrendExdw and PercentC(CDSF)>15 )
or (PercentC(CDLF)>LChopEx )
or (PercentC(CDSF)>SChopEx )
Then Begin
If (time>0930 and time <1000 or time>1200 and time <1530)
Then Begin
then Buy ( "TON%CPlusA-LE" ) next bar at
Sell Short ( "TON%CPlus-SE" ) next bar at
OpenD(0) + ((HighD(1) - LowD(1)) * facs) stop ;
End;
end;
tions 1 or 2). The strongest trends follow the most extreme the market remains in a range until the indicator hits an
indicator readings. However, the longer it stays above this extreme. When it climbs above 55, the trading range is con-
upper threshold, the more likely a weaker trend will devel- sidered overdone and ripe for change. On Aug. 8, the indi-
op. cator was above its moving average and closed at 59.57,
As the market starts to trend, the %C indicator’s value which suggests the E-Mini Russell 2000 could break out.
will drop as the tension between bullish and bearish traders Again, the longer the indicator remains above 55, the
dissipates. A trend is confirmed when the indicator falls more likely the ensuing trend will be weaker. The opposite
from a high extreme (such as 55) to below its seven-bar is also true; the less time %C remains above its upper
moving average. Finally, when the %C indicator drops threshold, the faster and stronger the subsequent price
below 25, the trend is potentially overextended. move will be. This is exactly what happened on Aug. 11 as
You can use the %C indicator either as a filter in an exist- the indicator dropped below 55 and below its moving aver-
ing trading strategy or as a portfolio management tool. As a age. These moves confirm that the breakout is underway.
filter, it can help identify trending markets, avoid losing Notice the indicator declined as the market rallied, and the
trades, and boost system performance. At the portfolio up trend lost steam after the %C indicator fell below 30 and
level, it can tell you which trading system to favor and bottomed out around 1 p.m.
when to increase a trade’s size. The market is in a trading range when %C is ascending
and between 15 and 65 while also above its moving aver-
Trade examples age. Figure 2 shows the E-Mini Russell 2000 futures on May
Figure 1 shows a 15-minute chart of the E-Mini Russell 2000 28, which is a good example of a trading range when it pays
futures (ER2) from Aug. 8 to 11. The %C indicator and its to buy low and sell high (condition 3). In this example, the
seven-bar moving average are plotted below it (red and breakout short trade failed because the market lacked direc-
dashed lines, respectively). Notice Aug. 8 was a dull trad- tion as %C moved higher from an extreme low.
ing-range day (condition 4). As the indicator’s value rises,

TABLE 1 — PERFORMANCE RESULTS — NO FILTER TABLE 2 — FILTERED RESULTS
The unfiltered volatility breakout system basically broke The breakout system was improved by adding the %C fil-
even with a profit factor of 1.00. ter. By only taking trades when %C was above 65, the
profit factor climbed to 1.19 from 1, net profit jumped to
Total net profit $322.00 $5,170.00 from just $322, and the number of trades was
Gross profit $99,737.00 reduced by nearly 400.
Gross loss $99,415.00 Total net profit $5,170.00
Profit factor 1.00 Gross profit $31,789.50
Total number of trades 564 Gross loss $26,619.50
Percent profitable 37.94% Profit factor 1.19
Avg. profit 0.57 Total number of trades 160
Avg. winner $466.06 Percent profitable 43.13%
Avg. loser $284.04 Avg. profit $32.31
Ratio avg. win / avg. loss 1.64 Avg. winner $460.72
Largest winning trade 2295.5 Avg. loser $292.52
Largest losing trade -1074.5 Ratio avg. win / avg. loss 1.57
Max. consec. winning trades 5 Largest winning trade $1,015.50
Max. consecutive losing trades 8 Largest losing trade $1,074.50
Avg. bars in total trades 7.79 Max. consec. winning trades 6
Avg. bars in winning trades 9.62 Max. consecutive losing trades 9
Avg. bars in losing trades 6.68 Avg. bars in total trades 7.54
Return on initial capital 0.32% Avg. bars in winning trades 8.62
Account size required $10,561.50 Avg. bars in losing trades 6.73
Percent of time in market 10.49% Return on initial capital 5.17%
Annual rate of return 0.06% Account size required $3,190.50
Max. drawdown (intraday peak to valley) -$10,744.25 Percent of time in market 4.71%
Net profit as percentage of drawdown 3% Annual rate of return 1.01%
Max. drawdown (intraday peak to valley) -$3,386.00
Net profit as percentage of drawdown 152.69%
Filtering a volatility breakout system Source: TradeStation
To demonstrate how the %C indicator can increase a trading
system’s edge, let’s apply it to a volatility breakout system take trades when %C is above 65, you increase the likeli-
that measures yesterday’s high-low range, adds and sub- hood that the market’s tension has come to a boil and a sus-
tracts a percentage of it from today’s open, and then buys or tained move is imminent.
sells the market when it reaches either threshold. The origi- Table 2 shows the filtered system’s results. The number of
nal system exited at tomorrow’s open. (Figures 1 and 2 trades was reduced by nearly 400, and the net profit rose to
show trades generated by a less-strict version of the system $5,170.00 from just $322.00. Also, the profit factor climbed to
tested here.) 1.19 from 1, the percentage of winners increased to 43 per-
cent from 38 percent, and the average trade jumped to
1. Go long on a stop if the market climbs to today’s $32.31.
open + 90 percent of yesterday’s high-low range.
2. Sell short on a stop if the market drops to today’s Waiting for the end of a trend
open - 90 percent of yesterday’s high-low range. Despite these improvements, the system could still perform
3. Exit at a $250 stop-loss for short and long trades, or better. Another idea is to use the %C indicator to also take
exit with a trailing stop that uses a 1-percent trades near the end of an existing trend when price moves
retracement after a profit target of $450 is reached. are often strongest. The late technician Joe Granville com-
pared this phenomenon to water draining out of a bathtub.
The system was tested on one E-Mini Russell 2000 con- At first, the water level seems to barely move, but as the
tract using 15-minute bars from Sept. 9, 2003 to Sept. 9, 2008, water rushes out, it becomes a rapid whirlpool.
with $15 commission deducted per trade. Only one trade in To capture the end of strong trends, the system will be
each direction was allowed each day. modified to only enter trades when the %C indicator drops
below 36 while remaining above 15. At this point, liquidity
Test results is added to the market as new traders try to profit from an
Table 1 shows the system basically broke even with a profit existing trend (condition 1).
factor (gross profit/gross loss) of 1.00 in 564 trades. Table 3 shows the system’s net profit climbed to
However, the system’s performance can be improved if you $19,631.50 from $5,170, the profit factor rose to 1.37, and the
add the %C indicator as a filter. For example, if you only continued on p. 14

TABLE 3 — FURTHER IMPROVEMENTS
To capture the end of strong trends, the system was modi-
fied to also enter trades when the %C indicator drops below
average profit increased to $55.61. Short trades generated 36 while remaining above 15. The modified system’s net
$13,713 in profits, while long trades contributed just profit climbed to $19,631.50 from $5,170, the profit factor
$5,918.50 (not shown), despite the sustained bull market rose to 1.37, and the average profit increased to $55.61.
from March 2003 to October 2007. Total net profit $19,631.50
The stock market tends to rally slower than it falls, which Gross profit $73,189.00
is one reason to use a slightly longer look-back period on Gross loss $53,557.50
%C for long trades than for short ones. The test results in Profit factor 1.37
Tables 1 to 3 use the same 14-bar look-back period for all Total number of trades 353
trades, but the final test uses a 16-bar look-back period for Percent profitable 44.76%
long trades and a 14-bar look-back period for short trades. Avg. profit $55.61
In addition, the profit target is increased to $1,000, the Avg. winner $463.22
stop-loss is raised to $550, and trades are only taken during Avg. loser $274.65
two time periods — after the 9:30 a.m. open but before 10 Ratio avg. win / avg. loss 1.69
a.m., and from 12 p.m. to 3:30 p.m. Largest winning trade $1,075.50
Table 4 shows the revised system’s net profit jumped to Largest losing trade $514.50
$47,601, the profit factor edged up to 1.48, and the average Max. consec. winning trades 6
profit increased to $147.83. Max. consecutive losing trades 9
The statistics in Tables 1 to 4 show there are several ways Avg. bars in total trades 10.11
to filter an existing strategy’s trade signals to improve its Avg. bars in winning trades 11.64
overall edge. Other ideas include taking trend-following Avg. bars in losing trades 8.87
signals only when the %C indicator is falling, enter count- Return on initial capital 19.63%
er-trend signals only when %C is rising, or tracking the Account size required $6,265.50
indicator on daily or weekly intervals to identify the under- Percent of time in market 9.39%
lying market condition for an intraday strategy. Annual rate of return 2.99%
Max. drawdown (intraday peak to valley) -$6,645.50
For information on the author see p. 5. Net profit as percentage of drawdown 295.41%
Related reading TABLE 4 — MORE TWEAKS BOOST PERFORMANCE

“Trading volatility breakouts” The system’s net profit rose to $47,601 and its average
Futures & Options Trader, May 2008. profit jumped to $147.83 after a slightly longer look-back
This breakout approach enters calm markets in hopes that period was used for long trades (among other changes).
volatility will pick up.
Total net profit $47,601.00
“Trading System Lab: Gross profit $145,857.50
Bollinger Band breakout-anticipation system” Gross loss $98,246.50
Active Trader, March 2008. Profit factor 1.48
A low BandWidth reading reflects a temporary balance of Total number of trades 322
buyers and sellers. When the bands tighten significantly, sharp
Percent profitable 45.03%
volatility expansions — and trends — are possible. The follow-
Avg. profit $147.83
ing system attempts to capitalize on this idea.
Avg. winner $1,005.84
“Filtering Bollinger Band breakouts” Avg. loser $555.05
Active Trader, December 2007. Ratio avg. win / avg. loss 1.81
Does volatility make or break your strategy? Avoiding choppy Largest winning trade $1,695.50
market conditions strengthens this system.
Largest losing trade $1,314.50
“Opening shots,” Active Trader, April 2003. Max. consec. winning trades 6
Narrow-range bars and inside bars represent short-term Max. consecutive losing trades 11
volatility lows out of which price can move sharply. This Avg. bars in total trades 35.19
strategy uses a simple volatility measurement to determine Avg. bars in winning trades 39.84
where to enter trades to capitalize on this behavior.
Avg. bars in losing trades 31.93
“Futures Trading System Lab: Volatility breakout system” Return on initial capital 238.01
Active Trader, October 2002. Account size required 20,000.00
This trading strategy is based on identifying situations when a Percent of time in market 29.31%
market is about to burst out of a congestion area and potential- Annual rate of return -31.50%
ly establish a long-term trend. Max. drawdown (intraday peak to valley) -7,955.50
You can purchase and download past articles at Net profit as percentage of drawdown 595.01%
http://store.activetradermag.com/. Source: TradeStation

TRADING STRATEGIES
Short-term calendar spreads

Calendar spreads are versatile positions that can make money quickly if market conditions
are right. Implied volatility and the market’s direction play a pivotal role.
BY JONATHAN MAHER
C alendar spreads are best known as strategies

that exploit the time decay of options, but like
all options positions, they are also affected by
moves in the underlying market and implied
volatility (IV) changes.
Making money with calendar spreads requires an under-
standing of how each of these three factors influences the
However, the position can also profit from an IV increase
or even compensate for a move in the underlying, assuming
you adjust it correctly. It’s possible to earn modest profits
with calendar spreads in a short period of time; the trick is
to be sure IV won’t drop and to add a second position if the
underlying makes a definitive move.
position’s value. Calendar spreads are flexible, which Calendar spread example
means you can make money even in a very short time peri- Figure 1 shows a daily chart of Google Inc. (GOOG) from
od, assuming you can profit from either changes in the Jan. 16, 2007 to July 31, 2007.
underlying’s price or implied volatility. Google dropped 7.1 percent on July 20 after its second-
Calendar spreads are created by selling an option in one quarter earnings were announced. After falling so sharply,
month and buying an option with the same strike price that GOOG was likely to trade sideways for a few days before
expires later. The spread typically profits from the differ- picking a direction — a good time to enter a short-term cal-
ence in the rate of time decay of the two options. The short- endar spread.
er-term option you sell will lose value faster than the Figure 2 shows Google’s 30-day historical volatility and
longer-term option you buy. its IV over the past 12 months (blue and yellow lines,
respectively). In early July, IV
jumped to 35 percent from 25
Strategy snapshot
percent before dropping to
Strategy: Short-term calendar spread. roughly 24 percent after Google’s
earnings announcement. At this
Market bias: Neutral.
point IV was near the low end of
Components: One short front-month option and one long same-strike option its 12-month range, so it was
with more time until expiration. Use at-the-money (ATM) options unlikely to drop further and had
for a neutral outlook (calls or puts). the potential to bounce back
slightly.
Logic: To benefit from short option’s time decay as it approaches
With GOOG trading at $518 on
expiration. Underlying will trade sideways, implied volatility may
July 31, a calendar spread was
increase, and time value will decrease.
entered by selling 10 August 520-
Looking for a 5-percent gain in less than a week.
strike calls and buying 10
Criteria: Use front-month options. You must believe that IV will hold or September 520 calls for a net cost
increase. of 8.80 ($8,800). Table 1 shows the
calendar spread’s details. The IV
Max. gain: The underlying closes at the strike price when the short option expires
of the September calls is slightly
and you keep its premium.
lower than August calls’ IV (23.9
Max. risk: The price paid for the spread. percent vs. 24.84 percent, respec-
tively).
Adjustments: If the underlying starts to move in one direction, exit half of original
Figure 3 shows the calendar
spread and add a second calendar spread with the proceeds.
spread’s potential gains and loss-
If market drops, use lower-strike puts. If market rallies, use
es on three dates: trade entry
higher-strike calls. continued on p. 16

FIGURE 1 — GOOGLE INC.

(July 31, blue line), halfway to
After dropping sharply on earnings news, Google was likely to trade sideways — a August expiration (Aug. 8, green
good time to enter a calendar spread. line), and August expiration (Aug.
18, red line). The position is prof-
itable only in a narrow range
between $502 and $539, with a
maximum profit of roughly $7,000
at the 520 strike price.
You have to be careful with
such a narrow profit range, espe-
cially because Google is such a
volatile stock. This spread is delta
neutral, which means the position
will lose ground if GOOG moves
either up or down.
Implied volatility
is important…
Figure 3 shows how the calendar
spread is affected by underlying
price moves and time decay, but it
doesn’t show the effect of IV
changes. Also, it only shows
potential gains and losses up to
Source: eSignal the August expiration. At that
point, you still own the September
FIGURE 2 — VOLATILITY VIEW 520 call that hasn’t expired yet.
You can’t afford to ignore IV when
Google’s implied volatility (yellow line) neared a 12-month low after dropping to
trading calendar spreads, because it
24 percent.
can dramatically impact their value.
The value of the September 520 calls
will fluctuate along with changes in
implied volatility.
Short-term calendar spreads are as
influenced by IV as by time. You
shouldn’t enter a calendar spread if
you think implied volatility will drop.
On the other hand, the position will be
helped immensely if IV increases.
…but time decay still matters

Calendar spreads take time to make
money, but you can often find short-
term calendar spreads that offer an
attractive balance between reward and
risk and last only a few days.
Calendars work especially well if you
anticipate a rise in implied volatility.
Source: IVolatility.com Let’s take another look at the
August-September Google calendar

TABLE 1 — CALENDAR SPREAD DETAILS
Buying this August-September 520 call calendar spread on Google cost $8.80,
which represents its maximum risk. The spread could earn 5 percent within a
few days if GOOG traded sideways and IV didn’t drop.
Google traded at $518 on July 31, 2007.

spread. Because the spread sells
August calls, there are only 14 trading Aug./Sept. 520 calendar spread
days left before these options expire. Dollar amount
Therefore, these calls’ time value (price * no.
should decay rapidly. Position Long/ Implied of contracts *
Figure 4 is similar to Figure 3, but it short volatility Price 100 multiplier)
shows the spread’s percentage yield, 10 August 520 calls Short 24.84% $11.30 $11,300
which peaks at roughly 80 percent. 10 Sept. 520 calls Long 23.91% -$20.10 -$20,100
Given the trade’s narrow upper and
lower breakeven points, it wouldn’t
Total debit (max. loss): -$8.80 -$8,800
take much of an underlying move for
the trade to become a loser. But
there are a couple of ways to FIGURE 3 — RISK PROFILE: CALENDAR SPREAD
adjust the trade to help neutral-
ize that risk. This calendar spread was profitable only in a narrow range between $502 and $539
The trade can last up to 14 with its maximum profit of roughly $7,000 at the 520 strike price.
trading days, but you don’t have
to hold it that long. Instead, you
can exit after it posts a small
profit. Although an 80-percent
gain is possible, this strategy
waits for a 5-percent profit with-
in a few days and get out before
something happens.
Double your fun

Google fell to $510 after we
entered the August-September
calendar at $518 at 10:15 a.m. on
July 31. Luckily, however,
implied volatility jumped as
GOOG dropped, and we man-
aged to sell half the position (5
contracts) at $8.80 per contract
— their original cost.
The next adjustment was to
add a lower-strike calendar Source: MarketGear Inc.
spread to help reduce the overall
position’s delta. Table 2 shows that five August-September Figure 5 compares the risk profiles of the original and
500-strike put calendar spreads were bought for $6.20 each. adjusted calendar spreads. The adjustment neutralized the
You can use calls or puts when entering calendar spreads. position’s delta and stretched its range of profitability. The
In general, it makes sense to use puts when adjusting the upper and lower breakeven points widened to $491 and
spread downward and to use calls when adjusting the $531.
spread upward, because these options are out of the money The tradeoff is the potential profit drops to about 50 per-
(OTM) and could expire worthless. cent of the spread’s cost. But remember you only need a
The position was now a double calendar spread that con- gain of 5 percent, so this isn’t a problem.
tains four different options with a cost of $15 ($8.80 + $6.20).
The overall position includes only five contracts for a total Waiting to adjust the spread
value of $7,500 ($15 cost * 5 contracts * 100 options multi- Why not just enter a double calendar spread in the first
plier). continued on p. 18

FIGURE 4 — PROFITS AND LOSSES BY YIELD
Although an 80-percent gain is possible, it’s easier to wait for a 5-percent profit and
exit the trade before the underlying moves sharply or IV drops. place? One reason is to see which
direction Google may move before
you decide which way to adjust.
You may have to adjust multiple
times if the underlying keeps mov-
ing.
Figure 6 shows a daily chart of
Google through Aug. 2, 2007.
Fortunately, the stock cooperated
by trading sideways within the
spread’s profitable range. The dou-
ble calendar’s bid price was $15.50
and its ask price was $16.50, which
means you could have sold the
spread for $16.00 the next morning
— a $1 profit per contract ($500
overall). This represents a yield of
6.7 percent ($500/$7,500) in less
than four days. The key to small
and consistent gains is not to get
greedy.
Source: MarketGear Inc. If you waited another day, you
could have earned an additional 10
TABLE 2 — ADJUSTMENTS percent. By Aug. 6, the adjusted
spread’s value climbed to $17.50 as
After Google fell to $510, we made two adjustments. First, half the original trade
was sold at the same price. Then, a second calendar was bought using 500-strike the bid-ask spread rose to $17.40-
puts. The adjusted position became a double calendar spread that contained four $18.40. However, these gains can be
options with a cost of $15. fleeting, which is one reason to
limit your risk by limiting the time
Google fell to $510 on July 31, 2007. you hold a trade. For instance, the
Double calendar spread trade’s bid-ask spread fell to $14.80-
Dollar amount (price * $15.80 by Aug. 8 as Google climbed
Position Long/ no. of contracts * 1.8 percent to $519 and IV crashed.
short Price 100 multiplier)
Original spread:
Picking the right market
10 August 520 calls Short $11.30 $11,300 Short-term calendar spreads can be
10 Sept. 520 calls Long -$20.10 -$20,100 profitable if conditions are right.
Ideally, the underlying should be
Debit (max. loss): -$8.80 -$8,800 stable and implied volatility should
be likely to rise. These trades are an
Adjustment: attempt to capture changes in
1. Sell half the original position implied volatility as much as cap-
at same price. $8.80 $4,400 turing time value. If IV drops, the
strategy probably won’t work.
Finally, be ready to add addition-
2. Add a second spread al calendar spreads if the underly-
with a 500 strike. ing starts to move in one direction.
5 August 500 puts Short $6.43 $6,430 This adjustment lowers the
5 Sept. 500 puts Long -$12.63 -$12,630 spread’s maximum profit and
increases the profit zone.
Adjusted debit: -$6.20 -$3,100 Remember you’re just trying to
earn small gains in a few days.
Final cost: -$15.00 -$7,500
For information on the author see p. 5.

FIGURE 5 — SINGLE VS. DOUBLE CALENDAR SPREADS
Related reading The adjusted double calendar spread has a lower potential profit, but the position
becomes delta-neutral and its breakeven points are widened to $491 and $531.
“Calendar spreads surrounding
earnings news”
Options Trader, March 2007.
More versatile than you might think,
these calendar spreads profit from
changes in volatility rather than the
time decay.
“Directional calendars
on the S&P 500”
Futures & Options Trader, May 2007.
This lab compares two strategies
with similar profiles: a horizontal cal-
endar spread and a butterfly spread.
Both positions try to collect premium
from short options and protect them
with long options, but they protect
against large losses differently.
“Calendar spreads:
Taking time out of the market”
Options Trader, February 2005.
Trading time spreads offers a way to
take advantage of time decay and Source: MarketGear Inc.
volatility changes while limiting risk.
“Combining calendar spreads
with stock” FIGURE 6 — GOOGLE IN A TRADING RANGE
Options Trader, October 2006. After the calendar spread was adjusted, Google traded in a range over the next
Adding a calendar spread to an couple of days, allowing us to sell the spread on Aug. 3, 2007 for $16.00 — a
underlying position instead of simply 6.7 percent profit.
creating a covered call offers some
surprising benefits. The combined
strategy helps you lock in profits with-
out sacrificing further upside gains.
“Calendar spreads
after earnings releases”
Options Trader, September 2006.
The system placed an at-the-money
(ATM) horizontal debit (calendar)
spread on stocks one day after quar-
terly earnings were announced.
“Calendar spreads
on the S&P 500”
Options Trader, August 2006.
This system tested an at-the-money
(ATM) horizontal (calendar) debit
spread strategy on the cash-settled
options of the S&P 500. The goal of
the calendar spread is to profit from
the near-term short options time
decay while partially protecting it with
a longer-term long option.
You can purchase past articles at

http://store.activetradermag.com/
Source: eSignal

TRADING STRATEGIES
Backspreads and ratio spreads

Which options spread is preferable when you’re expecting an explosive underlying move?
BY FREDERIC RUFFY
A ratio backspread is an options strategy that

can produce profits in uncertain markets.
The goal is to benefit from an explosive
move in one direction while limiting risk.
A backspread can be created with either puts or calls. In
either case, you short options while buying a larger number
of options (in a ratio such as 1:2 or 2:3) with strikes that are
FIGURE 1 — AFTER THE GOLD RUSH
The SPDR Gold Trust (GLD) has been quite volatile lately,
dropping 14 percent from July 14 to Aug. 8. If you expect gold
to rally substantially in the next few months, entering a call
backspread might make sense.
further from the market’s current value.

If you enter the spread at a credit (which means the pre-
mium you receive from the short options is larger than the
cost of the long options), you keep the premium if the
underlying trades in a range. However, a backspread can
earn much larger profits if the underlying moves substan-
tially in the right direction, especially if you expect implied
volatility to climb.
One disadvantage of backspreads is they tend to show
losses before becoming profitable, which is why profession-
al traders often prefer the opposite trade — the ratio spread.
To create a ratio spread, you buy options and sell a larger
number of options with more distant strikes — again, typi-
cally in a 1:2 or 2:3 ratio. Instead of profiting the most when
an explosive move occurs, a ratio spread earns the largest Source: eSignal
profit if the underlying doesn’t
move too far.
TABLE 1 — BACKSPREAD COMPONENTS
Which strategy is better?
The answer depends on your This trade can be entered at no cost because the premium received from selling 85-strike
calls equals the cost of buying 89-strike calls.
directional forecast, risk toler-
ance, and margin limits. The SPDR Gold Trust (GLD) traded at $84.43 on Aug. 8.
following examples focus on January 2009 85-89 backspread
strategies that use calls, but Dollar amount (price *
you can create similar posi- No. of Long/ no. of contracts *
tions with puts. For more contracts Month Type Strike short Price 100 multiplier)
details, see “Backspreads vs.
20 January 2009 Calls 85 Short $6.00 $12,000
ratio spreads.”
30 January 2009 Calls 89 Long -$4.00 -$12,000
Backspread ratios
and strikes Total cost: $0
To enter a call backspread,

short one or more calls and buy two or more calls with a higher strike prices in five-point increments; GLD has more choices. On
strike price but the same expiration month. Common ratios are Aug. 8, the SPDR Gold Trust traded at $84.43, so let’s build a call
one short call and two long calls (1:2) or two short calls and three backspread with January 2009 calls, which expire roughly five
long calls (2:3). Ratio values are normally continued on p. 22
0.667 or less (2:3 = 0.667); you can use
any combination of long and short calls
(e.g., 3:5) that yield a ratio less than
0.667.
Backspreads typically consist of short
calls with near- or at-the-money (ATM)
strikes and long calls with out-of-the-
money (OTM) strikes. Selling ATM calls
generates premium that covers the cost of
part, or all, of the long OTM calls.
Favorable market conditions

The call backspread doesn’t work well in
every type of market environment. It
yields the best results in an explosive
market with high implied volatility. For
example, a backspread might make sense
on a biotechnology stock when you have
a bullish outlook ahead of an important
event, such as the upcoming FDA
approval of a key product.
If your forecast is correct and the stock
rallies dramatically, the backspread will
gain ground quickly because it includes
more long calls than short ones. In
options parlance, this means it quickly
becomes delta positive.
Let’s look at gold, which has been a
volatile market. Price hit a high of
1,033.90 an ounce on March 17 before
dropping more than 25 percent; the
October futures contract (GCV08) traded
as low as 736.40 on Sept. 11 before
shooting $920 a week later. The SPDR
Gold Trust (GLD) is an exchange-traded
fund that holds gold; the ETF also has an
active option series. If you expect gold to
rally substantially in the fourth quarter of
2008 and into 2009, a call backspread
might make sense.
Options on GLD are listed in one-
point strike-price intervals (84, 85, 86,
etc.), which is great for option-spread
traders. Most options contracts have

FIGURE 2 — RISK PROFILE: BACKSPREAD
The sooner GLD climbs, the more profitable this spread will be. Time decay will kill
this trade if GLD’s rally is gradual rather than dramatic. However, the trade has no
downside risk.
months later.
You could enter a 2:3 ratio
backspread by shorting 20
January 2009 calls with an 85
strike for 6.00 per contract and
buying 30 calls with an 89 strike
in the same month for 4.00 per
contract. As Table 1 shows, the
backspread didn’t cost money to
enter, because the premium from
the sale of 20 calls at 6.00 each
($12,000) completely offset the
cost of buying 30 contracts at
4.00 each ($12,000).
The position has no downside
risk. If GLD fails to climb above
$85 by expiration Friday on Jan.
16, 2009, the spread’s calls will
Source: OptionVue simply expire worthless. If you
had entered this spread with a
credit and gold went nowhere,
FIGURE 3 — RISK PROFILE: RATIO SPREAD
you would simply keep the pre-
A ratio spread’s potential gains and losses are the opposite of a backspread’s risk pro- mium.
file. The January 85-89 ratio spread’s maximum gain occurs at the long strike and losses However, the trade will per-
mount above $97.
form better if the underlying
jumps higher. Figure 1 shows a
daily chart of GLD from June 1 to
Aug. 8. Price fell 12.5 percent
from July 15 to Aug. 8. A
rebound is possible over the next
five months, but remember if
gold keeps falling, the spread
won’t lose money.
Figure 2 shows the back-
spread’s potential gains and loss-
es on three dates: trade entry
(Aug. 8, dotted line), halfway
until expiration (Oct. 28, dashed
line), and expiration (Jan. 17,
solid line). The sooner GLD
climbs, the more profitable the
spread will be. For example, if
gold rose suddenly in the next
few weeks, the trade will quickly
Source: OptionVue become profitable. On the other

hand, if the ETF rallies briefly and then stalls, the
backspread will start to lose money. Time decay
will kill this trade if GLD’s rally is gradual rather
than dramatic.
In the worst-case scenario, the SPDR Gold
Trust settles at $89.00 at expiration Friday on
Jan. 16 expiration and the 89-strike long calls
expire worthless. The 85-strike short calls will be
worth their intrinsic value, 4.00. Although the
short side of the trade earned 2.00 per contract,
that gain isn’t large enough to cover the long
calls’ losses of 4.00 per contract.
Therefore, if GLD closes at $89 at expiration,
the backspread’s maximum loss is $8,000
($12,000 long call loss - $4,000 short call gain).
The backspread’s maximum loss won’t occur
until expiration. If the underlying doesn’t jump
as high as expected, it makes sense to exit the
trade well before expiration rather than waiting
for the underlying to drop toward the long calls’
strike price.
The ratio-spread alternative

Entering a ratio spread can reverse the back-
spread’s components by purchasing 20 January
85-strike calls for 6.00 each and selling 30
January 89-strike calls for 4.00 each. Table 2
shows this ratio spread’s details. Again, the
spread is entered at no cost and has no downside
risk.
The risk profile of a ratio spread is the exact
opposite of a backspread. Figure 3 shows the
ratio spread’s profit zone at expiration is between
$85 and $97, with a maximum gain of $8,000 if
GLD climbs to $89 at Jan. 17 expiration. The
trade begins to turn sour above $97.
Ratio spreads are not suitable for many indi-
vidual traders because they have more risk and
higher margin requirements. With call back-
spreads, you are buying more calls than you are
selling. Therefore, the position is covered
because the long calls protect the short calls.
In the ratio spread, however, more options are
sold than bought. These uncovered or “naked”
continued on p. 24

Backspreads and ratio spreads
Backspreads and ratio spreads are leveraged positions Ratio spreads

that involve buying and selling options in different propor- Ratio spreads may be appropriate when such a large
tions, usually in 1:2 or 2:3 ratios. Backspreads contain underlying price move is unlikely. A ratio call spread con-
more long options than short ones, so the potential profits tains a long call and two (or more) short calls at a higher
are unlimited and losses are capped. By contrast, ratio strike. The position is a vertical bull call spread with addi-
spreads have more short options than long ones and have tional calls at the higher strike. The trade’s maximum profit
the opposite risk profile. Table A lists the basic differences occurs at the short strike, while unlimited losses are possi-
among these spreads using call and put options. ble if the underlying rallies significantly above this level.
However, the trade typically protects against sharp sell-offs.
Backspreads Ratio put spreads have the opposite outlook — neutral
Traders typically enter backspreads when they believe a to slightly bearish. These positions combine one long put
large underlying move is possible (in either direction), but with two (or more) short lower-strike OTM puts, which is a
they want to limit risk if they’re wrong. For example, if you’re bull put spread with an additional short put. While the ratio
extremely bullish, sell one near-the-money or ITM call and put spread’s largest possible gain occurs at the short
buy two higher-strike calls. Here, you’ll be protected if price strike, it will post massive losses if the underlying sells off
drops drastically, and you’ll gain if it jumps well above the dramatically. However, potential losses are capped if price
long strike. The strategy loses a limited amount around the unexpectedly surges above the long strike.
long strike.
If you’re extremely TABLE A
bearish, enter a put
backspread by selling Backspreads Components Market outlook Profit/loss
one near-the-money Using calls Short call + long multiple Extremely bullish Unlimited upside gains;
put and buying two higher-strike calls maximum loss at long strike.
lower-strike OTM puts. Using puts Short put + long multiple Extremely bearish Unlimited downside gains;
You’ll profit if price sells lower-strike puts maximum loss at long strike.
off sharply, and an
unexpected rally won’t Ratio spreads
hurt the position. Again, Using calls Long call + short multiple Neutral to bearish Maximum profit at short strike;
put backspreads post higher-strike calls unlimited upside losses.
capped losses if the Using puts Long put + short multiple Neutral to bullish Maximum profit at short strike;
underlying is near the lower-strike puts unlimited downside losses.
long strike.
calls dramatically increase

TABLE 2 — RATIO SPREAD COMPONENTS
the trade’s risk profile, and
A ratio spread simply reverses the components of a backspread. Here, you buy close-to- most brokers require more
the-money calls and sell higher-strike calls. margin to trade them. Figure
SPDR Gold Trust (GLD) traded at $84.43 on Aug. 8. 3’s January 85-89 ratio
January 2009 85-89 ratio spread spread faces unlimited losses
above $97.
Dollar amount (price *
No. of Long/ of contracts *
Backspreads do not have
contracts Month Type Strike short Price no. 100 multiplier) the margin requirements
associated with selling naked
20 January 2009 Calls 85 Long -$6.00 -$12,000
options. The margin is the
30 January 2009 Calls 89 Short $4.00 $12,000 same as for vertical spreads
such as bull-call or bear-put
Total cost: $0 spreads, plus the cost of buy-
ing additional options. In the

GLD example, the backspread’s margin would be the same as buying doesn’t move sufficiently within a reasonable amount of time,
ing 20 January 85-89 bull call spreads plus 10 long January 89 it is better to close the trade rather than risk the maximum loss,
calls. which happens if the spread’s long side expires worthless.
Weighing the options For information on the author see p. 5.

The backspread is not for everyone and
certainly is not the right strategy for every
market. In fact, the ratio spread, which is
essentially the opposite position, is often
preferable when you have a directional
forecast for the underlying market.
However, the backspread can deliver
profits when you expect a big move but
are uncertain about direction.
As with most options strategies, risk
management is important. If the underly-
Related reading
“Managing profitable trades”
Options Trader, August 2006.
Handling a profitable options trade
may seem easy, but it can be difficult
to decide whether to cash out or hold
on for further gains.
“A closer look at put backspreads”
Options Trader, July 2006.
Perfect on paper but still a trade you
may want to avoid.
“Ratio call spreads:
Leverage profits and reduce risk”
Options Trader, June 2006.
Ratio call spreads can enhance an
underlying position’s potential gains at
no extra cost, or in many cases, for a
net credit.
“Put ratio spreads:
Selling volatility to buy an option”
Options Trader, June 2006.
Put ratio spreads profit from slightly
bearish moves, but the trick is to
understand how implied volatility
affects these positions. We explore
several trade scenarios and discover
the best time to place these spreads.
You can purchase past articles at
http://store.activetradermag.com/

OPTIONS STRATEGY
FUTURES TRADING SYSTEM
LAB LAB
“Nerves of steel” pullback system

A basic trade idea looks good on paper, but putting it to work will require a lot more effort.
Market: Stock index futures. The system’s entry rule has two components: a series of
lower highs, lower lows, and lower closes, plus a 2-percent
Time frame: Daily. decline from the low two days ago to today’s low. Together,
the rules are designed to get into trades when the market
System concept: This system uses a pattern-based entry has strung together consecutive downtrending days, punc-
setup to buy pullbacks on the daily time frame. The goal is tuated by a large decline (the 2-percent drop) intended to
to find a signal that trades with moderate frequency and identify points at which the market is potentially oversold
has a high winning percentage. and likely to rebound.
The system uses a simple
momentum calculation as one of
PERFORMANCE SUMMARY
its exit rules. Signals are triggered
Test period when the current close is above the
1997-1999 1999-2001 2001-2003 close seven days ago and is in the
Total net profit $17,752.50 $18,425.00 $14,632.50 upper 25 percent of the high-low
Gross profit $24,437.50 $36,527.50 $24,245.00 range of the past seven days. This
Gross loss ($6,685.00) ($18,102.50) ($9,612.50) momentum calculation can be
fixed as:
Profit factor 3.66 2.02 2.52
Total number of trades 18 25 19
Seven-day momentum =
Percent profitable 83.33% 72.00% 73.68%
(close today-lowest(low,7))/
Winning trades 15 18 14
(highest(high,7)-lowest(low,7))
Losing trades 3 7 5
Avg. trade net profit $986.25 $737.00 $770.13 Essentially, if you think of this
Avg. winning trade $1,629.17 $2,029.31 $1,731.79 indicator as an overbought-over-
Avg. losing trade ($2,228.33) ($2,586.07) ($1,922.50) sold tool, a reading of 0.75 or high-
Avg. win/avg. loss 0.73 0.78 0.9 er represents a short-term over-
Largest winning trade $4,130.00 $7,130.00 $3,505.00 bought condition.
Largest losing trade ($3,370.00) ($6,982.50) ($4,220.00) Some of the system's
Largest winner as % of gross profit 16.90% 19.52% 14.46% parameters were selected through
Largest loser as % of gross loss 50.41% 38.57% 43.90% observation; others were the result
Max. consecutive winning trades 7 13 5 of optimization. The series of two
Max. consecutive losing trades 2 3 2 consecutive lower lows and lower
Total slippage $900.00 $1,250.00 $950.00 highs and three lower closes was
Total commission $360.00 $500.00 $380.00 selected by comparing different
Return on initial capital 35.50% 36.85% 29.27%
continued on p. 28
Annual rate of return 15.81% 16.28% 13.34%
Buy & hold return 19.41% -27.45% -5.47%
Avg. monthly return $1,183.50 $1,304.26 $1,045.18 LEGEND
Percent of time in the market 18.80% 24.29% 19.91% Profit factor: Gross profit/gross loss.
Time in the market 4 months, 5 months, 4 months, Avg. trade net profit: Dollar return for the
10 days 18 days 18 days average trade.
Longest flat period 118 days 65 days 105 days Longest flat period: Longest time between
new equity highs.
Max. equity run-up $24,817.50 $37,922.50 $20,060.00
Max. intraday drawdown: Largest equity
Max. intraday drawdown ($14,495.00) ($18,812.50) ($12,107.50) decline measured on a intraday basis.
Max. trade drawdown ($7,587.50) ($8,612.50) ($7,437.50) Max. trade drawdown: Largest equity
Source: TradeStation decline based on closed trades.

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▲ ACCEPT NO SUBSTITUTE.
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics
and Risks of Standardized Options (ODD). Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options
Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. CBOE ®, Chicago Board Options Exchange ®, CBOE Volatility
Index ®‚ and VIX®‚ are registered trademarks of Chicago Board Options Exchange, Incorporated. All other trademarks and servicemarks are the
property of their respective owners. Copyright 2008, Chicago Board Options Exchange, Incorporated. All rights reserved.
OPTIONS
FUTURES STRATEGY
TRADING LAB
SYSTEM LAB continued
FIGURE 1 — SAMPLE TRADES

The system enters after a three-day pullback pattern. One notable flaw is
the system’s lack of protection against continued down moves after entry.
pullbacks in different stock-index contracts.

The 2-percent decline and the momentum
calculation’s look-back period and trigger
threshold were the result of optimization on
two years of randomly selected E-Mini S&P
500 (ES) data. The performance using look-
back periods between five and 15 days were
relatively consistent, as were the results using
1.5 to 4 percent declines. (The biggest differ-
ence was the number of signals.) The specific
parameters selected for the subsequent testing
were not the most profitable in the optimiza-
tion period; instead, the median values of the
10 most profitable settings were used for each
parameter. Source: TradeStation
The system will be tested on three separate
two-year periods to see how consistent performance is from 4. Today’s low is at least 2 percent below the low two
one period to the next. day’s ago.
5. Take up to five consecutive signals.
Trade rules: 6. Exit when the seven-day momentum calculation is
Go long on the next day’s open when: 0.75 or higher.
7. Exit any remaining open positions after 10 days on
1. Today’s low is below yesterday’s low and yesterday’s the close.
low is below the previous day’s low.
2. Today’s high is below yesterday’s high and Figure 1 shows a few signals from 2001, during a period
yesterday’s high is below the previous day’s high. when the market was trending both lower and higher.
3. Today’s close is below yesterday’s close, yesterday’s
close is below the previous day’s close, and the Initial account size: $50,000.
previous day’s close is below the close the day before
that. Test data: Continuous daily prices for the E-Mini S&P 500
futures (ES).
FIGURE 2 — EQUITY CURVE
The system’s upward march was disrupted only once. Trade size: One contract per signal. Deduct $10
commission and $25 slippage per trade.
Test period: Sept. 23, 1997 to Sept. 24, 1999;

Sept. 25, 1999 to Sept. 26, 2001; and Sept. 27, 2001
to Sept. 28, 2003.
Test results: The “Performance summary”

table breaks down the system’s performance into
the three test periods. Figure 2 shows the equity
curve for all six years. Other than the one jagged
interruption two-thirds of the way through, the
equity growth looks really good.
Ahh, but there is more than meets the eye in a
simple equity curve. Although there are plenty
of things to admire in the test results — high
profit factors, really high winning percentages,

FIGURE 3 — DRAWDOWN
The maximum intraday drawdown was relatively moderate at around
14 percent, but it should probably be much smaller.
relatively low drawdowns, and outperforming
buy-and-hold in two of three periods — the sys-
tem has obvious flaws.
First, although it may be comforting to have
low market exposure (overall, the system was
in the market around 20 percent of the time),
the system made only 62 trades in six years, and
many of the signals occurred on consecutive
days — meaning, a single pullback was often
responsible for more than one signal. (The sys-
tem allowed up to five long positions before
exiting, but the maximum number never
exceeded three in any of the tests.)
And the relative size of the average winning
and losing trades shows you had to take some
heat to reap the eventual rewards; the high win- Source: TradeStation
ning percentage was, in fact, a necessi-
ty because losers were almost always FIGURE 4 — MONTHLY RETURNS
larger than winners. Of course, this is a
direct result of the system having no Positive months outnumbered negative months more than two to one.
stop-loss mechanism.
Referring again to Figure 1 will make
the system’s Achilles' heels evident: It
often enters too early (that is, the mar-
ket continues to fall after an initial sig-
nal, putting the system in the red as
second or third signals are triggered),
gets out of winners too quickly, and
doesn’t get out of losers quickly
enough. (Notice in the performance
how big the largest losing trades were
as percentages of the gross losses in
each period.) Again on the plus side,
though, the maximum number of los-
ing trades never exceeded three.
The drawdown curve (Figure 3) isn’t
too bad — the maximum intraday Source: TradeStation
drawdown was a little more than 14
percent. Figure 4 shows the system posted 33 total prof- cept and market selection to testing, refinement and, final-
itable months and 14 unprofitable months in six years. ly, trading with real money. The starting point will be the
Another bit of good news is the relative consistency from ideas in this Trading System Lab.
period to period.
Overall, though, this trade idea is a work in progress.
Which is exactly the point: In its January 2009 issue, Active Disclaimer: The Futures Trading System Lab is intended for educational
Trader magazine (http://www.activetradermag.com) will purposes only to provide a perspective on different market concepts. It is
not meant to recommend or promote any trading system or approach.
launch a series of articles detailing the development, test-
Traders are advised to do their own research and testing to determine the
ing, and ultimate application of a trading system. The series validity of a trading idea. Past performance does not guarantee future
will highlight the entire process — good, bad, and ugly — results; historical testing may not reflect a system’s behavior in real-time
of designing and trading a mechanical system, from con- trading.

OPTIONS STRATEGY
OPTIONS TRADING SYSTEM
LAB LAB
Trading credit spreads with the CCI

Market: Options on the Russell 2000 index (RUT). This to a lower low, and the CCI must be -100 or less.
strategy could also be applied to other instruments with liq- If the first rule is true, enter the trade at the close on the
uid options contracts. first day the underlying posts a gain.
System concept: This Options Lab uses vertical credit Entering bull put spreads
spreads to trade signals generated by the commodity chan- 1. Sell puts with a strike located one standard
nel index (CCI) — a momentum indicator developed by deviation out-of-the-money (OTM).
Donald Lambert in 1980. The CCI incorporates a volatility 2. Buy puts at a strike 10 points below the short put.
component not found in many other momentum indicators. 3. Use the first expiration month with more than
The CCI generates buy and sell signals. When a buy sig- 21 days left until expiration.
nal appears, the system enters a bull put spread (short put, 4. The spread’s minimum yield must be at least five
long lower-strike put). When a sell signal emerges, the percent (premium received/net margin required).
strategy enters a bear call spread (short call, long higher-
strike call). It holds each trade until the spread either Bearish signal
expires worthless or an opposite signal appears. The system 1. CCI divergence: The underlying index climbs to a
isn’t always in the market, so there may be periods of inac- higher high than yesterday while the CCI doesn’t
tivity. rise to a higher high, and the CCI must be +100 or
When you enter a vertical credit spread, you short an more.
option with a strike that is closer to the money than the one 2. If the first rule is true, enter the trade at the close
you buy. The spread tries to exploit the short option’s time on the first day the underlying posts a loss.
decay and collects the most profit if the underlying doesn’t
reverse beyond the short strike’s price by expiration. Both
options share the same expiration month, and when the Entering bear call spreads
strikes are 10 points apart, the position requires a gross 1. Sell calls with a strike located
margin of $1,000 per contract.
The spread is entered at a net FIGURE 1 — RISK PROFILE: BULL PUT SPREAD
credit, which you keep if both
options expire worthless. This 620-630 bull put spread has a 78-percent probability of profit and will make money
Figure 1 shows the potential if the Russell 2000 index closes above 628.49 at Aug. 15 expiration.
gains and losses of an August
620/630 bull put spread entered
on June 27 when the Russell
2000 traded at 698.20. The trade
will be profitable if the Russell
2000 closes above 628.49 at Aug.
15 expiration. The spread col-
lected premium of $765, which
represents its maximum gain
and potential yield of 18 per-
cent (135 percent annualized).
The position can lose up to
$4,255 if the Russell 2000 drops
to 620 or below at expiration.
Trade rules:
Bullish signal
CCI divergence: The
underlying index drops to
a lower low than yesterday
Source: OptionVue
while the CCI doesn’t drop

FIGURE 2 — CCI SYSTEM PERFORMANCE
Trading vertical credit spreads with the CCI gained 96.9 percent since February 2005.
one standard deviation OTM.

2. Buy calls at a strike price 10
points above the short call.
3. Use the first expiration month
with more than 21 days left
until expiration.
4. The spread’s minimum
yield must be at least five
percent (premium
received/net margin
required).
Exit
Close either spread if the under-
lying index touches the short
Source: OptionVue
strike. Otherwise, allow the
position to expire worthless.
STRATEGY SUMMARY
Starting capital: $10,000
Net gain: $9,695.00
Execution: When possible, option trades were execut- Percentage return: 96.9%
ed at the average of the bid and ask prices at the daily
Annualized return: 26.8%
close; otherwise, theoretical prices were used. Standard
No. of trades: 27
deviation was calculated using the implied volatility of
the at-the-money (ATM) call. Each spread held 5 con- Winning/losing trades: 25/2
tracts per “leg.” Commissions were $10 per contract. Win/loss: 93%
Avg. trade: $359.07
Test data: The system was tested using options on the Largest winning trade: $870.00
Russell 2000 index (RUT). Largest losing trade: -$1,315.00
Avg. profit (winners): $464.60
Test period: Feb. 6, 2005 to Sept. 19, 2008.
Avg. loss (losers): -$960.00
Test results: Figure 2 tracks the system’s perform- Avg. hold time (winners): 40
ance, which gained $9,695 (96.9 percent) since February Avg. hold time (losers): 24
2005. The strategy’s average winning trade ($464.60) is Max consec. win/loss: 16/1
lower than its average losing trade (-$960.00). However,
given the high percentage of winning
trades, the statistics suggest this sys-
LEGEND:
tem has a definite trading edge.
Net gain – Gain at end of test period.
Percentage return – Gain or loss on a percentage basis.
—Steve Lentz and Jim Graham Annualized return – Gain or loss on a annualized percentage basis.
of OptionVue No. of trades – Number of trades generated by the system.
Winning/losing trades – Number of winners and losers generated by the system.
Win/loss – The percentage of trades that were profitable.
Avg. trade – The average profit for all trades.
Option System Analysis strategies are
Largest winning trade – Biggest individual profit generated by the system.
tested using OptionVue’s BackTrader
Largest losing trade – Biggest individual loss generated by the system.
module (unless otherwise noted).
Avg. profit (winners) – The average profit for winning trades.
Avg. loss (losers) – The average loss for losing trades.
If you have a trading idea or strategy that Avg. hold time (winners) – The average holding period for winning trades (in days).
you’d like to see tested, please send the Avg. hold time (losers) – The average holding period for losing trades (in days).
trading and money-management rules to Max consec. win/loss – The maximum number of consecutive winning and losing trades.
Advisor@OptionVue.com.

TRADING BASICS
TABLE 1 — U.S. FUTURES SECTORS AND GROUPS
“Commodity futures” encompass all physical assets, from agricultural
products to metals and energy. Financial futures are represented by stock
indices, single-stock futures, interest rates, and currencies.
Financial Representative
futures markets Symbol
Stock indices E-Mini S&P 500
E-Mini Nasdaq 100
Russell 2000
ES
NQ
Futures
Mini Dow YM
Single-stock futures
Interest rates 10-year T-note
5-year T-note
TY
FV
sectors
2-year T-note TU
30-year T-bond US
Although there are such things as
Eurodollar ED
Fed Funds FF
commodity “sectors,” don’t think of
Currencies Eurocurrency EC them the same way you think of their
Japanese yen JY
British pound BP stock-market counterparts.
Swiss franc SF
Canadian dollar CD
Mexican peso MP1
U.S. dollar index DX
BY FOT STAFF
Commodity futures
Energy Crude oil CL
T
Heating oil HO he nice thing about the futures
Gasoline RB market is there are only a few
Natural gas NG dozen instruments to keep tabs
Metals
on, as opposed to thousands of
Precious metals Gold GC
individual stocks. Like equities, though,
Silver SI
futures (and specifically, commodity futures)
Platinum PL
are commonly divided into specific groups, or
Base/Industrial
sectors.
metals Copper HG
Aluminum AL First, let’s clear up some confusion about
the words “commodities” and “futures,”
Agricultural Grains Corn C which are often used interchangeably even
Wheat W though they don’t mean the same thing.
Rice RR Commodities are physical items — crude
Oats O oil, corn, gold — that are often traded on the
Soybeans S open market via “futures contracts,” which
Soybean meal SM allow people to buy or sell something at an
Soybean oil BO agreed-upon price at a future date.
In short, some commodities are futures, but
Softs Coffee KC not all futures are commodities. Stock indices
Sugar SB and T-notes aren’t commodities, but they have
Cocoa CC futures contracts. The reason the term “com-
Orange juice OJ modities” or “commodity futures” is some-
times applied to instruments such as the E-
Meats (Livestock) Live cattle LC Mini S&P 500 futures or 10-year T-note futures
Lean hogs LH is because, originally, all futures contracts
were based on physical commodities.
Wood and Fiber Cotton CT Financial futures are a relatively new develop-
Lumber LB ment (around 30 years old in an approximate-

ly 140-year-old business in the U.S.), although within the
space of a generation they have come to dwarf the trading
Related reading
volume in commodity futures.
“Commodity indices,” Active Trader, May 2006.
Categorizing futures An overview of the various indices that track the
Table 1 shows the major U.S. futures market groups, or sec- commodity market.
tors, divided first into financial and commodity futures.
Representative markets are shown for each category. (The “The futures advantage,” Active Trader, October 2002.
list of markets is not exhaustive; more detailed analysis of Part one of a two- part guide showing the unique short-
the most-actively traded U.S. futures contracts is available term trading benefits of futures. The article also explains
each month on the Futures & Options Trader “Futures basic principles, highlights key trading concepts, and pro-
Snapshot” page.) vides ideas for minimizing the risks of trading in this arena.
Financial futures include stock index futures, single-stock “Market mechanics,” Active Trader, November 2002.
futures, interest-rate futures, and currency (forex) futures. This article highlights the unique properties of futures con-
Stock index and interest-rate futures are by far the biggest- tracts and the mechanics of futures trading that will allow
volume contracts in the world. you to focus on strategy instead of things like “rollover” and
Commodity futures are a little more difficult to group price limits.
than financial futures. Traditional categorization was casu-
Note: The preceding articles are also contained in the
al and determined not just by the nature of a commodity
“Futures Basics Collection,” a set of nine past Active
itself but sometimes by the exchange on which it was trad-
Trader articles that provide a solid foundation for under-
ed. For example, cotton has often been lumped together
standing how the futures market works, the unique charac-
with the traditional “soft” commodities — coffee, sugar,
teristics of futures contracts, and an introduction to some
and cocoa — because it was the only commodity of its type basic futures data and analysis tools.
(in the U.S.) and it traded on the same exchange. Ditto for
orange juice, which, while admittedly soft (at least when it’s You can purchase and download past articles at
not frozen solid), doesn’t have much in common with cof- http://store.activetradermag.com/
fee, sugar, or cocoa.
The fact that coffee, sugar, and cocoa themselves don’t
have much in common, other than being edible, emphasizes
that in some cases, commodity sectors are often categoriza- their various sectors, there are also several commodity
tions of convenience rather than logical divisions represent- indices that reflect the performance of physical commodi-
ing strong correlations between their components. While ties (financial futures are not included).
two companies in the equity semiconductor sector group Among the more widely watched are the
might be competing head-to-head for the same customers, Reuters/Jefferies CRB Index (CRY), Goldman Sachs
cocoa, for example, does not have a “competitor” in the soft Commodity Index (GSCI), Dow Jones-AIG Commodity
commodity category. Index (DJAIG), and the Rogers International Commodity
There are no universally accepted sector definitions for Index (RICI). The last index was developed by hedge fund
commodities, beyond the major breakdown of energy, manager Jim Rogers to address the flaws he found in other
metal, and agricultural. The divisions in Table 1 reflect com- commodity indices — namely, that they didn’t include
monly accepted groupings, as well an innovation to address many important commodities (such as rice), and that the
one of the aforementioned inconsistencies: Lumber and cot- weighting schemes assigned to component markets were
ton are placed in their own category (rather than “other,” as out of sync with modern economic reality.
is often the case), which could include such international However, because of the disparities between the com-
futures contracts as rubber and wool. Not a perfect solution, modities included in any broad-based commodity index
admittedly, but at least an effort to find a sector “home” for (i.e., why should copper and orange juice belong to the
these wayward markets. same index?), there are those who argue that such indices
are not particularly useful financial tools, and that it is bet-
Commodity indices ter to analyze and trade commodity markets
Just as there are indices that track broad stock markets or individually.

TRADER INTERVIEW
Bill Greenwalt
After a rocky start, a fund manager learns the key to trading options
is keeping risk low. He explains his conservative strategy in this excerpt
from the December 2008 issue of Active Trader.
BY DAVID BUKEY
S eptember was a tough month for most traders,

especially option sellers. The S&P 500 moved in a
132-point range on Sept. 18 and 19, its largest two-
day swing since the technology bubble began to collapse in
spring 2000. This type of volatility can wipe out option sell-
Entering the position is only five
percent of the game; managing risk
ers who bet the market will remain relatively stable. is 95 percent of it.
However, fund manager Bill Greenwalt, 59, has endured
the current financial crisis better than most options traders.S&P 500, and has one of the lowest drawdowns (26 of 417)
Unlike some traders who swing for the fences, Greenwalt of any managed program during this period, according to
uses a conservative approach that has earned modest but the Institutional Advisory Services Group (Figure 1).
consistent profits. Greenwalt has been trading options for more than a
His Aspen Private Capital fund has lost money in only decade, but he began his career in real estate. After study-
four of 68 months since January 2003, outperformed the ing economics at UCLA, he started selling real estate in
1972 and eventually started an invest-
ment company that bought and man-
FIGURE 1 — FIGURE 1: ASPEN PRIVATE CAPITAL VS. S&P 500
aged multi-unit apartment buildings.
Greenwalt’s fund has outperformed the S&P 500 index with minimal drawdowns In 1992, Greenwalt co-founded
over the last five years. Mortgage Technology Inc., a mortgage
brokerage business he ran until 2006.
In the mid-1990s, Greenwalt began
trading covered calls — an income
strategy that buys stock and shorts call
options on those shares. He focused on
beat-up stocks that seemed poised to
rebound, earning up to 90 percent per
year using the strategy.
Eventually, Greenwalt began man-
aging other people’s money and
helped run Rainmaker Partners, an
option program launched in August
2001 that sold options strangles in the
S&P 500 options. The strategy works
well when the market is calm but loss-
es can mount if the market moves
strongly in one direction. The fund
quickly ran into trouble, losing 13.99
percent after the Sept. 11 terrorist
attacks. Although Greenwalt and his
partners bounced back, they lost

another 19.9 percent in July 2002 when their head trader
made a bullish bet that didn’t pan out. FOT: Your strategy is market-neutral and also includes pro-
Greenwalt learned a great deal from those large losses. tective options — an iron condor that includes a credit
“We lived through Sept. 11 and a disastrous directional spread on either side of the market.
trade that helped me appreciate the importance of risk man- BG: Yes. We occasionally have strangles or one-sided
agement,” he says. “I had to call investors and tell them we naked (uncovered) positions. But only 4 percent of our port-
lost 20 percent, which wasn’t fun. When I lose my own folio contains naked short puts and calls.
money, I just kick myself, but when I lose someone else’s We have learned two lessons: limit risk and don’t take
money, that’s much more stressful and disappointing.” directional bets. I have an opinion about what the market is
After shutting down the fund, Greenwalt revised his going to do, but in reality, that opinion is worthless.
strategy and began trading again in December 2002. That’s why we rely on probabilities. I may have a slight
Greenwalt stopped making directional bets and lowered his directional bias on one side. Right now (on Sept. 15), I’m
risk substantially. biased toward the downside. For example, the S&P 500 is
In 2006, he reduced risk even further by purchasing down 55.22 points, but I didn’t have to exit any short puts
options on either side of the market to protect the ones he today even though I’m holding 25,000 short puts overall.
sold. Like an options strangle, this iron condor strategy The point is that we take risk seriously. The market has been
makes money from the time decay of its short options. unstable, so we just sold strikes further below the market.
Losses are limited to a predefined amount, which I use charts and the various technical indicators that
Greenwalt prefers. everyone knows — volume, stochastics, moving average
convergence-divergence, Bollinger Bands, and so on. I
believe the indicators are similar to my opinion of the mar-
We are prepared to take small losses ket’s direction. It’s interesting, but I can’t use it to run my
strategy. I’m not good enough to make directional bets.
in order to avoid the potential of a Let’s say the S&P 500 is at 1,200 and I think it’ll climb to
1,300. I have only one chance of being right and three
large loss. We don’t often have to buy chances of being wrong. If the market goes down, obvious-
ly I’m wrong. If the market stays the same, I’m wrong too.
back sold options, but we err on the And if the market goes up, but not far enough and soon
enough, I’ll lose money. I’ll be right only if the market
moves in the right direction, by the right amount, and with-
side of caution rather than hoping it in the time I’ve predicted.
Those are terrible odds — one in three. Instead, our strat-
works out. Hope is not a strategy. egy is based on what the market won’t do. Therefore, we
have three chances of being right and one of being wrong.
FOT: How does your current strategy work? FOT: What are the advantages of iron condors or credit
BG: The basic strategy is to sell option premium, a very spreads compared to the short strangle, or selling naked
widely known strategy. We sell OTM puts and calls on the options?
S&P 500 index. The strike prices are far enough out-of-the- BG: There’s nothing wrong with [selling uncovered
money that they are expected to expire worthless. It’s a sim- options] if the strikes are far enough out of the money and
ple strategy, but a lot of people blow up because they don’t you’re willing to take a loss or adjust your position. But if
manage risk closely. you don’t adjust a position and start losing ground, it’s hard
Entering the position is only five percent of the game; to recover. With an options spread, you have a long side
managing risk is the other 95 percent. We watch the posi- that can help you recover.
tions every minute of every day and we are ready to take In my experience, it’s easier to get out of spreads when
action if needed. When we enter a position, it has an 80 to the market is going against you than when you hold naked
90 percent probability of expiring worthless. But those short options. Years ago, however, we only sold naked
probabilities change right after you execute a trade. options and strangles.
We are prepared to take small losses in order to avoid the
potential of a large loss. We don’t often have to buy back An extended version of this interview appears in the December
sold options, but we err on the side of caution rather than 2008 issue of Active Trader magazine, on newsstands in
hoping it works out. Hope is not a strategy. November.

INDUSTRY NEWS
Financial panic tanks markets

Good-bye banks, hello bailouts. Traders watch their screens and ponder the future.
W hat a difference 12 months makes.

Approximately a year after the S&P 500 set an all-time
ing of the market.”
Approximately 40,000 contracts were sold off in the soy-
high and the credit crisis began to spread its dark wings, the bean, soybean oil, corn, wheat, live cattle, and lean hog
U.S. stock market has suffered its worse sell-off in a gener- futures. (A complete liquidation of their positions would
ation, the U.S. investment banking system is essentially no have flooded the markets, sending commodity prices plum-
more, and the federal government is taking unprecedented meting even more than they did. See “Market Movers” for
steps to, essentially, nationalize failing institutions. an overview of commodity and stock index futures action
On the bright side, crude oil is around 30 percent cheap- in recent weeks.)
er than it was three months ago — although this is small Stock markets dropped again in the morning of Sept. 16,
comfort, since some of this decline is part of the recent glob- while 10-year T-note yields fell to a five-month low.
al asset liquidation across all asset classes. However, following the FOMC’s decision to hold rates at 2
Political maneuvering in election season added fuel to percent, markets rallied and the S&P 500 gained 1.8 percent.
the fire, as the U.S. congress debated a $700 billion financial But equities dropped again the following day, with the
bailout package that initially failed to pass in the House, S&P falling to a three-and-a-half-year low. As the market
won approval (after some tweaking) in the Senate, and, as tumbled, the SEC instated a ban on short sales which would
of Oct. 3, faced another showdown in the House. eventually extend to more than 900 firms. October Gold
futures climbed as much as $90 above the previous day’s
The banking landscape
First, Bear Stearns disappeared in a Fed-orchestrated sale to
JP Morgan in March. With barely a chance to catch its col- Crude’s interesting surge
lective breath, the market witnessed the harrowing govern-
ment rescue of mortgage giants Fannie Mae and Freddie The October crude oil
Mac on Sept. 7 and the bankruptcy of Lehman Brothers. contract (CLV08) jumped
Following failed attempts to find a purchaser, the 158- more than $25 on Sept.
year-old bank announced its intention to file for bankrupt- 22, the contract’s last day
cy in the early morning hours of Sept. 14. This, coupled of trading, prompting reg-
with news Bank of America would buy Merrill Lynch, fur- ulators to investigate the
ther unsettled markets as investors tried to again gauge the move.
fallout. “CFTC enforcement
Stock markets plummeted in the biggest drop since the staff will scour today’s
Sept. 11 terrorist attacks, while government bond futures trading activity to deter-
jumped. However, the following weeks would lead to many mine whether anyone
more dramatic moves as the government, after allowing engaged in illegal manip-
Lehman to fail, once again decided to step in to help a ulative activity,” said
floundering institution. Stephen J. Obie, Director
of the CFTC’s Division of
The AIG effect Enforcement, in a CFTC release on the day of the move. “No
The government announced on Sept. 16 they would pro- one should be trying to game our nation’s commodity futures
vide an $85 billion loan to bail out AIG, the nation’s largest markets.”
insurer, while taking an 80-percent stake in the company. The $25-dollar move was the largest single-day move in
Although widely seen as simply the latest collapse in the crude oil’s history, most of which occurred in the final hours
financial sector, AIG had important, direct ties to the com- of trading before the contract expired. Even though the con-
modity markets. tract hit $130, a two-month high, it fell back to close at
The firm had acted as counterparty for a significant por- $120.92, a 16-percent gain from the previous day. The figure
tion of the $30 billion invested in the Dow Jones AIG above displays the October contract’s daily price move-
Commodity Index (DJAIG). After the announcement of the ments since July. Price had actually fallen 39 percent from
rescue package, the CME Group announced an emergency its all-time high in July to $90.51 per barrel on Sept. 16, a
block sale of AIG’s livestock and agricultural holdings to seven-month low.
reduce their positions and “to protect the orderly function-

FIGURE 1 — DOW JONES AIG
COMMODITY INDEX
close and closed the day at $847.1, a 9-per- AIG woes were compounded
(Figure 2), and down more than 3.7 per-
cent gain. by its association with the cent from the previous day’s high.
Also on Sept. 17, the London Stock commodity markets. October crude oil futures (CLV08)
Exchange halted trading in 113 of ETF surged. Crude had already risen 15 per-
Securities’ Exchange Traded cent over the three trading days before
Commodities (ETC), which were backed this record jump.
by AIG as a counterparty. Liquidity issues Over the next several days, Treasury
arose for the ETCs when, despite the gov- Secretary Paulson and Federal Reserve
ernment bailout, market makers remained Chairman Ben Bernanke faced tough
reluctant to facilitate markets for the AIG- scrutiny as they defended the $700 billion
backed securities. By Sept. 22, however, bailout plan before the Senate Banking
trading in all impacted ETCs had Committee and the House Financial
resumed. Since then, ETF securities have Services Committee. Meanwhile, market
been in discussions with AIG to provide turmoil seemed to moderate as partici-
100 percent of the capital required to back pants came to grips with the situation
the commodity funds. Source: eSignal and hope began to arise that perhaps the
The CFTC announced on Sept. 19 it government had a handle, if just barely,
would offer “temporary and conditioned on the situation. On Wednesday, Sept. 24,
hedge exemption relief for firms taking on swap positions President Bush made a televised speech to the American
from distressed companies. This will allow for continued public to drum up support for the proposed rescue pack-
risk management and orderly functioning of the markets.” age.
Commodity prices in general slumped as conditions in “Our entire economy is in danger,” he bluntly told the
the U.S. financial market took a turn for the (even) worse in nation.
September. Figure 1 shows from the end of August through Government representatives reassured the public as the
Sept. 16 DJAIG fell 12 percent as Lehman Brothers collapsed week went on that an agreement on the bail out plan was
and Bank of America bought Merrill Lynch. This drop near. The Presidential candidates met with the President
marked a 12-month low for the index. and other high-profile figures to discuss the situation.
From the beginning of September 2007 through its all- However, talks soon began to disintegrate and House
time high on July 3, 2008, DJAIG gained 44 percent as com- Republicans revealed their own counter proposal to use
modity prices across the globe rose because of skyrocketing continued on p. 38
oil prices, a weakening dollar, and numerous
environmental dilemmas. By the end of July,
however, the index had dropped 14 percent, a MANAGED MONEY
trend which continued through subsequent
Top 10 option strategy traders ranked by August 2008 return.
months.
(Managing at least $1 million as of Aug. 31, 2008.)
The $700 billion plan August YTD $ under
In a month of twists and turns, the weekends Rank Trading advisor return return mgmt.
have held some of the biggest surprises. On 1. PTP Managment Co. 15.23% 70.42% 24.8M
Saturday, Sept. 20, the Bush administration 2. Ascendant Asset Adv. (Strategic2) 12.00% -37.97% 18.8M
announced its $700 billion dollar plan to buy the 3. Parrot Trading Partners 8.23% 49.78% 24.8M
soured mortgage securities that were at the 4. Aksel Capital Mgmt (Growth & Income) 7.87% 125.49% 13.0M
source of the liquidity issues plaguing financial
5. Ascendant Asset Adv. (Strategic1) 7.00% -63.39% 2.0M
firms and effectively bail out Wall Street.
6. Eickelberg & Associates (Option) 6.63% 7.73% 2.0M
And then, late Sunday Sept. 21 it was
7. ACE Investment Strategists (DPC) 6.01% 38.50% 8.4M
announced that Goldman Sachs and Morgan
8. H T Funds CTA 5.16% 33.65% 1.3M
Stanley would hang up their investment bank-
9. GrowthPoint Invest. (Index Condor) 4.56% 35.38% 1.0M
ing hats and be converted into holding compa-
10. Unimarket Corp
nies, subjecting themselves to increased govern-
(Solaris Mkt Neutral Bourtov Options) 0.05% 0.18% 3.0M
ment regulation in return for access to govern-
ment funding, effectively shutting the door on Source: Barclay Hedge (http://www.barclayhedge.com)
the U.S. investment banking structure that had Based on estimates of the composite of all accounts or the fully funded subset method.
thrived for decades. Does not reflect the performance of any single account.
On Monday, Sept. 22, December U.S. dollar PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
index futures (DXZ08) closed 2 percent lower

INDUSTRY NEWS continued
FIGURE 2 — DOLLAR INDEX

The dollar index futures dropped sharply on Sept. 22
before rebounding. market into a tailspin. The day’s 7.88-percent drop in the
S&P 500 marked its biggest in more than 20 years and it’s
largest single-day point drop ever (Figure 3).
On the same day, in an FDIC-arranged deal, Citibank
bought Wachovia’s assets for $2.2 billion.
Markets rebounded significantly the following day. And
on Wednesday, Oct. 1, the Senate approved a re-tooled ver-
sion of the House-rejected bill.
ICE Futures takes over Russell

stock index futures trading
T
he IntercontinentalExchange (ICE) set new daily
volume records for Russell 2000 contracts traded
on the exchange on six different occasions in
September leading up to Sept. 19, when ICE’s exclusive
Source: TradeStation rights to list Russell-based contracts kicked in. Previously,
Russell contracts had
Wall Street’s assets to fund the recovery, and not taxpayer also traded on the TABLE 1 — CHANGING
dollars. The outcome was anything but certain. CME, which con- OF THE GUARD
On Sept. 25 Washington Mutual collapsed, marking the trolled most of the Sept. Dec.
biggest bank failure in history, and was seized by the FDIC. volume. Date E-Mini Russ mini Russ
JP Morgan then purchased their assets for $1.9 billion. This streak of 2000 (CME) 2000 (ICE)
Congressional leaders worked through the weekend to records included four
Sept. 2 216592 243
hash out a deal that would be acceptable to both parties, consecutive days of Sept. 3 230884 256
reassuring the public that an agreement was imminent. new records for the Sept. 4 232557 1442
mini Russell contract Sept. 5 248601 2127
Biggest drop since 1987 (TF) from Sept. 8 Sept. 8 288856 5898
However, on Monday, Sept. 29, the house failed to pass the through Sept. 11. Sept. 9 253664 12538
proposed legislation by just 12 votes, sending the stock On Sept. 8, ICE Sept. 10 250903 46317
traded a record of Sept. 11 174182 148744
FIGURE 3 — S&P 500 INDEX 22,553 mini Russell Sept. 12 120852 129782
The S&P 500 closed down more than 7 percent on Sept. 29. 2000 contracts. By Sept. 15 103173 247474
Sept. 11 the record Sept. 16 123807 331563
had increased to Sept. 17 77146 331824
272,756 contracts. On Sept. 18 79902 368896
Sept. 17, the record Sept. 19 1679 224457
increased to 500,394. Sept. 22 149371
Total open interest in Sept. 23 146549
the ICE mini and full- Sept. 24 131520
Sept. 25 155635
size Russell 2000 (TO)
Sept. 26 158333
contracts traded on
Sept. 29 231877
the exchange reached
Sept. 30 164392
828,426, an astound-
Oct. 1 124037
ing increase from the Oct. 2 165590
Jan. 1 combined open
interest of 1,377.
Table 1 compares the volume in the last E-Mini Russell
2000 contract to trade at the CME (September 2008) to the
volume in the December 2008 mini Russell contract (TFZ08)
traded on the ICE — the first contract month to which the
ICE had exclusive rights.

New markets: Merc launches steel and Euro-denominated S&P futures
T he Chicago Mercantile Exchange (CME) is adding

two new futures markets to its lineup.
On Oct. 20 the exchange will list contracts for U.S.
Midwest Domestic Hot-Rolled Coil Steel (HR), which are
12.5 Euros. The contract’s ticker symbol will be EME and it
will trade exclusively on CME’s electronic Globex platform.
The contracts will list the five nearest months in the
March quarterly cycle (March, June, September, and
designed to offer steel industry participants a vehicle to December). Final settlement will occur on the third Friday
hedge against volatility. Units will trade 20 short tons with of the contract month. The cash settlement will be deter-
minimum price movements of $5 per short ton. Contracts mined by a special opening quotation (SOQ) based on the
will be listed for 18 consecutive months, with the last day of opening price of each component stock in the index on
trading taking place on the last business day prior to the expiration Friday.
fourth Wednesday of the contract month. Aside from the hedging and speculating possibilities, the
The contract’s settlement will reflect an assessment of the new contract will also create spreading opportunities
prevailing market prices for U.S. Midwest Domestic HRC between the Euro contract and its U.S. dollar-denominated
steel as determined through an index developed by CRU counterpart.
International. A similar opportunity arose in 2004 when the CME
Steel has been hard to price globally because many fac- launched the yen-denominated Nikkei 225 futures contract
tors affect the finished product. Unlike other exchange- (NIY). Prior to that launch, the dollar-denominated Nikkei
traded metals such as gold and copper, steel is an alloy, not 225 futures contracts (NKD) traded roughly 4,000 contracts
an element, made through the combination of iron and car- per day, according to the CME Group’s guide explaining
bon. the spread. After launching the yen-denominated contract,
In April, the London Metals Exchange launched two volume for both contracts hit 15,000 per day by Q1 2008.
regional Steel Billet contracts for the Mediterranean and the On Oct.1 the U.S. Futures Exchange (USFE) began offer-
Middle East. ing dollar-denominated mini futures contracts for the DAX
index, a German stock market index consisting of 30 major
New E-Mini S&P futures companies trading on the Frankfurt Stock Exchange. The
The exchange will launch Euro-denominated E-Mini S&P contract trades at $10 times the index, with ticks sized at 1
500 futures contracts on Oct. 27, offering traders simultane- index point. The USFE launched a similar contract in April
ous exposure to U.S. large cap stocks and the Eurocurrency. that tracks the Bombay Stock Exchange’s SENSEX index at
The value of the contracts will be 50 Euros times the S&P $100 per index point.
500 index. The tick size will be 0.25 index points, equal to
Three good tools for targeting customers . . .
— CONTACT —
Bob Dorman Allison Chee Mark Seger
Ad sales East Coast and Midwest Ad sales West Coast and Southwest Account Executive
bdorman@activetradermag.com achee@activetradermag.com seger@activetradermag.com
(312) 775-5421 (626) 497-9195 (312) 377-9435
FUTURES SNAPSHOT (as of Sept. 29)
The following table summarizes the trading activity in the most actively traded futures contracts. The information does NOT constitute
trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility.
See the legend for explanations of the different fields. Volume figures are for the most active contract month in a particular market and
may not reflect total volume for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).
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 2.53 M 2.12 M -6.46% / 89% -12.77% / 100% -11.56% / 96% .51 / 98%
10-yr. T-note TY CME 997.2 1.57 M -1.54% / 82% 0.89% / 31% 1.81% / 49% .95 / 97%
5-yr. T-note FV CME 739.3 1.32 M -0.74% / 50% 0.91% / 38% 2.61% / 69% .82 / 97%
E-Mini Nasdaq 100 NQ CME 423.0 281.8 -12.16% / 100% -19.36% / 100% -17.01% / 100% .57 / 81%
2-yr. T-note TU CME 361.3 719.1 0.01% / 21% 0.90% / 79% 1.76% / 80% .69 / 87%
Eurodollar* ED CME 354.6 1.43 M -0.28% / 50% 0.34% / 65% 0.63% / 67% .79 / 95%
30-yr. T-bond US CME 337.3 797.5 -1.51% / 50% 1.85% / 30% 3.46% / 54% .92 / 97%
Crude oil CL NYMEX 278.4 239.8 0.69% / 0% -16.53% / 92% -33.16% / 98% .45 / 83%
Eurocurrency EC CME 253.8 143.0 2.52% / 29% -0.98% / 20% -7.36% / 79% .35 / 30%
Mini Dow CME 231.1 93.6 -4.34% / 88% -9.25% / 92% -7.21% / 38% .39 / 86%
Japanese yen JY CME 137.8 157.2 1.74% / 35% 4.99% / 89% 2.68% / 55% .46 / 85%
E-Mini Russell 2000 TF CME 90.3 183.9 -5.92% / 89% -12.14% / 100% -2.09% / 43% 1.04 / 100%
British pound BP CME 85.5 101.6 1.95% / 0% -0.13% / 0% -8.02% / 87% .30 / 12%
Corn C CME 83.5 315.3 -8.72% / 83% -9.71% / 44% -32.29% / 100% .22 / 28%
Natural gas NG NYMEX 82.9 95.0 -2.07% / 9% -9.09% / 26% -46.79% / 100% .10 / 15%
Swiss franc SF CME 66.8 51.8 3.30% / 38% 1.99% / 67% -5.16% / 66% .35 / 45%
S&P 500 index SP CME 63.5 473.6 -6.46% / 89% -12.77% / 100% -10.62% / 86% .51 / 100%
Sugar SB ICE 53.3 299.0 0.07% / 0% 8.86% / 54% -0.14% / 0% .27 / 32%
Australian dollar AD CME 52.9 66.6 0.41% / 0% -6.62% / 39% -15.93% / 95% .34 / 40%
Soybeans S CME 51.5 116.1 -7.21% / 33% -17.87% / 83% -33.66% / 100% .24 / 20%
Canadian dollar CD CME 48.0 96.4 3.08% / 50% 2.49% / 100% -1.55% / 41% .57 / 70%
RBOB gasoline RB NYMEX 36.2 47.2 -6.42% / 55% -16.02% / 96% -32.46% / 100% .35 / 55%
Silver 5,000 oz. SI NYMEX 33.9 59.7 16.97% / 63% -4.98% / 23% -28.43% / 89% .39 / 35%
Heating oil HO NYMEX 31.7 34.5 -1.10% / 7% -13.52% / 71% -32.09% / 100% .30 / 72%
Wheat W CME 30.7 103.1 -8.12% / 38% -14.27% / 86% -24.72% / 81% .43 / 68%
E-Mini S&P MidCap 400 ME CME 30.5 90.5 -7.77% / 95% -14.42% / 100% -11.35% / 95% .64 / 100%
Fed Funds FF CME 25.0 143.1 0.20% / 80% 0.47% / 100% 0.71% / 91% .54 / 92%
Crude oil e-miNY QM NYMEX 20.7 7.8 0.69% / 0% -16.53% / 92% -33.15% / 97% .44 / 83%
Mexican peso MP CME 20.2 65.3 -2.56% / 45% -7.68% / 100% -6.18% / 100% .48 / 63%
Nikkei 225 index NK CME 17.5 67.5 -4.39% / 58% -13.13% / 100% -16.09% / 98% .47 / 85%
Live cattle LC CME 14.7 75.1 -5.49% / 100% -5.77% / 89% -5.54% / 100% .38 / 87%
Lean hogs LH CME 13.1 56.0 1.78% / 25% 0.18% / 0% -5.15% / 41% .14 / 8%
Coffee KC ICE 12.3 93.5 -6.33% / 69% -10.63% / 93% -14.25% / 84% .43 / 52%
Soybean meal SM CME 12.2 25.6 -12.12% / 93% -19.52% / 89% -33.65% / 100% .24 / 23%
Copper HG NYMEX 10.5 31.6 -7.33% / 50% -15.25% / 100% -25.13% / 100% .35 / 33%
Soybean oil BO CME 10.5 20.6 -2.99% / 29% -16.29% / 81% -33.81% / 100% .28 / 17%
U.S. dollar index DX ICE 8.1 44.4 -1.60% / 38% -0.24% / 6% 6.25% / 78% .37 / 37%
Cocoa CC ICE 6.8 70.4 -1.92% / 10% -11.34% / 82% -18.46% / 94% .41 / 63%
Gold 100 oz. GC NYMEX 6.0 28.4 13.32% / 70% 6.86% / 52% -5.08% / 39% .65 / 73%
Nasdaq 100 ND CME 5.4 24.1 -12.16% / 100% -19.36% / 100% -17.01% / 100% .57 / 82%
Dow Jones Ind. Avg. DJ CME 5.0 27.7 -1.67% / 29% -5.67% / 71% -3.07% / 14% .39 / 87%
E-Mini eurocurrency ZE CME 3.9 1.9 2.52% / 29% -0.98% / 20% -7.36% / 80% .34 / 28%
New Zealand dollar NE CME 3.9 24.0 3.21% / 83% -4.13% / 49% -10.47% / 91% .26 / 27%
Natural gas e-miNY QG NYMEX 3.6 3.4 -2.07% / 9% -9.09% / 30% -47.16% / 100% .11 / 18%
Silver 5,000 oz. ZI CME 1.4 2.1 16.98% / 63% -4.90% / 23% -29.08% / 91% .39 / 39%
Feeder cattle FC CME 0.8 5.0 -4.50% / 95% -6.96% / 97% -6.33% / 97% .63 / 100%
Mini-sized gold YG CME 0.8 0.8 13.32% / 70% 6.88% / 58% -4.90% / 47% .66 / 75%
*Average volume and open interest based on highest-volume contract (March 2009).
Legend day moves, 20-day moves, etc.) show the percent means the current reading is larger than
Volume: 30-day average daily volume, in centile rank of the most recent move to a cer- all the past readings, while a reading of 0 per-
thousands (unless otherwise indicated). tain number of the previous moves of the cent means the current reading is smaller than
same size and in the same direction. For the previous readings. These figures provide
OI: Open interest, in thousands (unless other-
example, the rank for 10-day move shows perspective for determining how relatively
wise indicated).
how the most recent 10-day move compares large or small the most recent price move is
10-day move: The percentage price move to the past twenty 10-day moves; for the 20- compared to past price moves.
from the close 10 days ago to today’s close. day move, the rank field shows how the most Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move recent 20-day move compares to the past term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. sixty 20-day moves; for the 60-day move, the prices) divided by the long-term volatility (100-
60-day move: The percentage price move rank field shows how the most recent 60-day day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. move compares to the past one-hundred- the percentile rank of the volatility ratio over
The “rank” fields for each time window (10- twenty 60-day moves. A reading of 100 per- the past 60 days.
This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & Options
Trader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buy
or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.

OPTIONS RADAR (as of Sept. 29)
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 280.6 2.15 M -7.23% / 94% -13.75% / 100% 33.7% / 36.2% 20.8% / 17.9%
S&P 500 volatility index VIX CBOE 136.5 1.07 M 47.38% / 85% 126.25% / 100% 192.2% / 136.6% 80.2% / 86.4%
Russell 2000 Index RUT CBOE 107.6 787.2 -4.65% / 88% -11.06% / 93% 43.7% / 37.3% 25.3% / 22.9%
Nasdaq 100 Index NDX CBOE 48.0 225.8 -12.27% / 100% -20.10% / 100% 36.9% / 38.1% 25.2% / 21.7%
E-Mini S&P 500 futures ES CME 38.3 141.4 -4.01% / 72% -8.54% / 90% 39.5% / 40.6% 20.8% / 19.8%
Stocks
Citigroup C 299.9 3.80 M 16.47% / 100% -6.53% / 33% 95.6% / 117.8% 59.7% / 55.7%
Apple Inc. AAPL 270.8 1.05 M -25.01% / 100% -37.91% / 100% 88.7% / 73.5% 40.4% / 30.5%
Bank of America BAC 249.2 2.83 M 13.94% / 80% -2.86% / 13% 87.6% / 110.6% 57.6% / 62.7%
General Electric GE 202.1 2.02 M -6.10% / 55% -17.79% / 97% 61.1% / 83.6% 29% / 30%
Wachovia WB 156.3 1.12 M -99.91% / 100% -99.94% / 100% 292% / 273.1% 84% / 89.7%
Futures
Eurodollar ED-GE CME 579.5 7.49 M -0.61% / 83% -0.42% / 71% 58.3% / 47.1% 25.9% / 7.9%
Crude oil CL NYMEX 49.0 444.1 10.41% / 100% -8.27% / 37% 60.8% / 60.3% 45.4% / 46.8%
10-year T-notes TY-ZN CME 35.9 231.9 -1.55% / 82% 0.89% / 31% 12.6% / 10.6% 6.5% / 4.4%
5-year T-notes FV-ZF CME 25.9 113.0 -0.75% / 33% 0.90% / 32% 9.3% / 6.1% 5.6% / 3.2%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
Mini Dow YM CME 1.7 5.5 -4.01% / 72% -8.54% / 90% 38.7% / 24.6% 21% / 15.3%
S&P 500 volatility index VIX CBOE 136.5 1.07 M 47.38% / 85% 126.25% / 100% 192.2% / 136.6% 80.2% / 86.4%
Banking Index BKX PHLX 3.8 68.9 -10.07% / 100% -11.43% / 61% 103.4% / 81.6% 53.8% / 53.8%
Russell 2000 Index RUT CBOE 107.6 787.2 -4.65% / 88% -11.06% / 93% 43.7% / 37.3% 25.3% / 22.9%
Eurodollar index XDE PHLX 2.2 39.3 1.34% / 14% -1.61% / 27% 16.1% / 14% 11.5% / 8.6%
Indices - Low IV/SV ratio

Oil Service Index OSX PHLX 1.8 14.3 -8.44% / 29% -23.74% / 100% 42.6% / 65.6% 38.9% / 37.8%
Gold/Silver Index XAU PHLX 4.2 33.1 11.44% / 50% -10.86% / 37% 58.6% / 79.1% 44.6% / 51.8%
Housing Index HGX PHLX 3.4 50.9 -2.47% / 33% -2.61% / 14% 54.4% / 67.3% 45.2% / 53.8%
Yen Index YUK ISE 1.2 33.5 -0.46% / 5% -4.25% / 93% 13.4% / 16.1% 11.4% / 9.2%
Australian Dollar Index XDA PHLX 1.2 7.2 -0.50% / 0% -6.57% / 39% 19.2% / 21.8% 16.3% / 12.7%
Stocks - High IV/SV ratio

Fifth Third Bancorp FITB 10.4 192.8 -35.44% / 100% -42.27% / 100% 208.1% / 115.9% 67.1% / 72.4%
Ericsson ERIC 5.2 231.4 -8.03% / 71% -16.81% / 98% 82.2% / 46.8% 38.4% / 34.5%
Genentech DNA 30.5 677.2 -9.09% / 100% -13.62% / 100% 48.8% / 32.1% 26.3% / 11.8%
Sovereign Bancorp SOV 4.6 120.4 -74.11% / 100% -75.88% / 100% 196.8% / 150.7% 73.5% / 86.1%
Google GOOG 65.2 190.3 -12.18% / 80% -17.76% / 100% 66% / 52.6% 39% / 30%
Stocks - Low IV/SV ratio

Freddie Mac FRE 7.6 111.1 3.38% / 75% 3.65% / 20% 252.7% / 647.8% 186.6% / 245.7%
Fannie Mae FNM 48.2 492.7 155.74% / 100% -77.19% / 81% 266.4% / 532.3% 204.6% / 186.9%
American Intl. Group AIG 134.6 808.0 -47.48% / 33% -88.37% / 98% 243.4% / 472.7% 74.4% / 89.2%
Huntington Bancshares HBAN 1.4 52.4 -9.15% / 100% 1.78% / 2% 102.2% / 159.2% 76.4% / 75.4%
Goldman Sachs Group GS 116.6 456.2 -10.92% / 18% -26.39% / 95% 81.1% / 125.3% 44.9% / 38.5%
Futures - High IV/SV ratio

Eurocurrency EC-6E CME 7.4 44.5 2.52% / 29% -0.98% / 20% 21.8% / 13.5% 11.8% / 8.7%
Mini Dow YM CME 1.7 5.5 -4.01% / 72% -8.54% / 90% 38.7% / 24.6% 21% / 15.3%
Japanese yen JY-6J CME 2.9 56.1 1.74% / 35% 4.99% / 89% 17.6% / 12% 13.2% / 5.8%
Eurodollar ED-GE CME 579.5 7.49 M -0.61% / 83% -0.42% / 71% 58.3% / 47.1% 25.9% / 7.9%
Crude oil CL NYMEX 49.0 444.1 10.41% / 100% -8.27% / 37% 60.8% / 60.3% 45.4% / 46.8%
Futures - Low IV/SV ratio

Natural gas NG NYMEX 7.3 50.8 -2.07% / 9% -9.09% / 26% 49.2% / 64% 49.4% / 69%
Gold 100 oz. GC NYMEX 7.0 68.0 13.32% / 70% 6.86% / 52% 39.4% / 51% 26.2% / 31.5%
Heating oil HO NYMEX 1.1 3.8 6.43% / 100% -5.82% / 21% 50.2% / 57.5% 45.2% / 44.5%
30-year T-bonds US-ZB CBOT 25.8 147.5 -1.51% / 50% 1.85% / 30% 14.2% / 14.4% 9.7% / 6.7%
* Ranked by volume ** Ranked by high or low IV/SV values.
LEGEND:
Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).
Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).
IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.
10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.
20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-
day moves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example,
the “rank” for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows
how the most recent 20-day move compares to the past sixty 20-day moves.

FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
COT extremes The largest positive readings represent markets in which net commercial
The Commitment of Traders (COT) report is published each positions (longs - shorts) exceed net fund holdings in September. By
contrast, the largest negative values represent markets in which net fund
week by the Commodity Futures Trading Commission
holdings surpass net commercial positions.
(CFTC). The report divides the open positions in futures
markets into three categories: commercials, non-commeri-
cals, and non-reportable.
Commercial traders, or hedgers, tend to operate in the
cash market (e.g., grain merchants and oil companies, that
either produce or consume the underlying commodity).
Non-commercial traders are large speculators (“large
specs”) such as commodity trading advisors and hedge
funds — professional money managers who do not deal in
the underlying cash markets but speculate in futures on a
large-scale basis. Many of these traders are trend-followers.
The non-reportable category represents small traders, or the For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
general public.
Figure 1 shows the relationship between commercials Legend: Figure 1 shows the difference between net commer-
cial and net large spec positions (longs - shorts) for all 45 futures
and large speculators on Sept. 23. Positive values mean net commercial positions markets, in descending order. It is calculated by subtracting the
(longs - shorts) are larger than net speculator holdings, based on their five-year current net large spec position from the net commercial position
historical relationship. Negative values mean large speculators have bigger posi- and then comparing this value to its five-year range. The formu-
la is:
tions than the commercials.
a1 = (net commercial 5-year high - net commercial current)
In U.S. dollar index futures (DX), the difference between commercials and large b1 = (net commercial 5-year high - net commercial 5-year low)
speculators is ranked lowest among all futures markets, which is a bearish sign. c1 = ((b1 - a1)/ b1 ) * 100
But in natural gas futures (NG), this relationship is near a five-year high, a bullish a2 = (net large spec 5-year high - net large spec current)
indication. These extremes shouldn’t be mistaken for trade signals, but they some- b2 = (net large spec 5-year high - net large spec 5-year low)
times appear before price reversals. c2 = ((b2 - a2)/ b2 ) * 100
– Compiled by Floyd Upperman x = (c1 - c2)
Options Watch: Financial Sector ETF components (as of Sept. 29) Compiled by Tristan Yates
The following table summarizes the expiration months available for the top components of the Financial Sector exchange-traded fund (XLF). It also
shows each index's average bid-ask spread for at-the-money (ATM) September 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
2008 2009 2010 2011 Bid-ask spreads
Bid-ask
spread as %
Dec.
Nov.
Feb.
Jan.
Mar.
Jan.
Jan.
Oct.
Apr.
May
Closing of underlying
Stock Symbol price Call Put price
Bank of America Corp. BAC X X X X X X 35.00 0.14 0.14 0.39%
Citigroup Inc. C X X X X X X 20.51 0.13 0.04 0.40%
CME Group Inc. CME X X X X X X 371.51 2.45 1.73 0.56%
Goldman Sachs Group Inc. GS X X X X X X 128.00 0.65 0.83 0.58%
JPMorgan Chase & Co. JPM X X X X X X 46.70 0.32 0.27 0.62%
Finance Select SPDR XLF X X X X X X 19.89 0.16 0.13 0.74%
U.S. Bancorp USB X X X X X X 36.02 0.40 0.16 0.78%
Wells Fargo & Co. WFC X X X X X X 37.53 0.38 0.28 0.87%
Chubb Corp. CB X X X X X X 54.90 0.74 0.51 1.14%
American Express Co. AXP X X X X X X 35.43 0.49 0.33 1.15%
PNC Financial Services Group Inc. PNC X X X X X X 74.70 1.40 0.53 1.29%
Travelers Cos. Inc. TRV X X X X X X 45.20 0.75 0.50 1.38%
Morgan Stanley MS X X X X X X 23.00 0.45 0.30 1.63%
Bank of New York Mellon Corp. BK X X X X X X 32.58 0.58 0.53 1.69%
BB&T Corp. BBT X X X X X X 37.80 0.81 0.66 1.95%
Allstate Corp. ALL X X X X X X 46.12 0.96 0.86 1.98%
Prudential Financial Inc. PRU X X X X X X 72.00 1.43 1.53 2.05%
MetLife Inc. MET X X X X X X 56.00 1.45 0.91 2.11%
AFLAC Inc. AFL X X X X X X 58.75 1.84 1.18 2.56%
State Street Corp. STT X X X X X X 56.88 2.39 2.55 4.34%
Legend:
Call: Four-day average difference between bid and ask prices for the front-month ATM call.
Put: Four-day average difference between bid and ask prices for the front-month ATM put.
Bid-ask spread as % of underlying price: Average difference between bid and ask prices for front-month, ATM call, and put divided by the underlying's closing price.

FUTURES
GLOBAL & OPTIONS
ECONOMIC CALENDAR
CALENDAR OCTOBER/NOVEMBER
MONTH
Legend October 22 LTD: October VIX options (CBOE)

Petroleum status report
FDD (first delivery day): 1 FDD: October copper, gold, silver,
The first day on which deliv- platinum, palladium, aluminum, crude 23 LTD: November crude oil (NYMEX)
ery of a commodity in fulfill- oil, and natural gas futures (NYMEX);
ment of a futures contract October gold, silver, and soybean 24 LTD: November oats, rice, soybeans,
can take place. products futures (CME); October cotton T-bonds, and wheat options (CME);
and sugar futures (ICE); October cotton November wheat options (MGX)
FND (first notice day): Also
known as first intent day, this and sugar options (ICE) 25 LTD: November wheat options
is the first day a clearing- FND: October sugar (ICE) (KCBOT)
house can give notice to a
Petroleum status report
September ISM 26
buyer of a futures contract
that it intends to deliver a 2 FND: October gasoline and heating oil 27 Crop progress report
commodity in fulfillment of a futures (NYMEX) 28 LTD: November copper, gold, silver,
futures contract. The clear- aluminum, gasoline, heating oil, and
inghouse also informs the
3 LTD: October live cattle options (CME);
November cocoa options (ICE) natural gas options (NYMEX)
seller. Weather and crop bulletin
LTD (last trading day): The 4
first day a contract may 29 LTD: October copper, gold, silver,
5 platinum, palladium, aluminum, and
trade or be closed out before
6 FND: October live cattle futures (CME) November natural gas futures
the delivery of the underlying
Crop progress report (NYMEX); October gold and silver
asset may occur.
futures (CME)
7 Petroleum status report
CPI: Consumer price index
8 FDD: October gasoline and heating oil 30 FND: November natural gas futures
ECI: Employment cost index futures (NYMEX) (NYMEX)
FOMC: Federal Open Petroleum status report LTD: October feeder cattle futures
Market Committee (CME); October feeder cattle options
9 LTD: October cotton futures (ICE) (CME)
GDP: Gross domestic
product
10 LTD: November coffee options (ICE) 31 FND: November gold, silver, copper,
U.S. crop production platinum, aluminum, and palladium
ISM: Institute for supply World agricultural supply and demand
management (NYMEX); November rice, gold, silver,
World agricultural production and soybeans futures (CME)
PPI: Producer price index
11 LTD: November gasoline and heating
Quadruple witching Friday: oil futures (NYMEX); October live cattle
A day where equity options, 12 futures (CME); November lumber
equity futures, index options, 13 options (CME)
and index futures all expire. U.S. agricultural prices
14 FDD: October live cattle futures (CME) Q3 ECI
LTD: October lean hogs and soybean
OCTOBER 2008 products futures (CME); October lean November
28 29 30 1 2 3 4 hogs options (CME) 1 FDD: November crude oil and natural
Crop progress report gas futures (NYMEX); November sugar
5 6 7 8 9 10 11
15 LTD: November platinum options futures (ICE)
12 13 14 15 16 17 18
(NYMEX); November sugar options 2
19 20 21 22 23 24 25
(ICE)
26 27 28 29 30 31 1 Weather and crop bulletin 3 FDD: November copper, gold, silver,
September PPI palladium, and platinum futures
(NYMEX); November, gold, silver, and
NOVEMBER 2008 16 LTD: November crude oil options soybeans futures (CME)
Petroleum status report FND: November orange juice (ICE)
26 27 28 29 30 31 1 September CPI Crop progress report
2 3 4 5 6 7 8
17 LTD: October single stock futures; 4 FND: November gasoline and heating
9 10 11 12 13 14 15 October equity options; November oil (NYMEX)
16 17 18 19 20 21 22 cotton and orange juice options (ICE) Weather and crop bulletin
Cattle on feed report
23 24 25 26 27 28 29 5 Petroleum status report
30 1 2 3 4 5 6 18
6 LTD: November orange juice futures
The information on this page is
19 (ICE)
subject to change. Futures &
Options Trader is not responsible
20 Crop progress report 7 LTD: December cocoa and cotton
for the accuracy of calendar dates options (ICE)
beyond press time. 21 Weather and crop bulletin
October 2008 • FUTURES & OPTIONS TRADER 43

KEY CONCEPTS
American style: An option that can be exercised at any

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

below the average (typically three percent above and below expiration. If the spread uses ATM options, it is market-neu-
a 21-day simple moving average), Bollinger Bands use stan- tral and tries to profit from time decay. However, OTM
dard deviation to determine how far above and below the options can be used to profit from both a directional move
moving average the lines are placed. As a result, while the and time decay.
upper and lower lines of a moving average envelope move
in tandem, Bollinger Bands expand during periods of rising Call option: An option that gives the owner the right, but
market volatility and contract during periods of decreasing not the obligation, to buy a stock (or futures contract) at a
market volatility. fixed price.
Bollinger Bands were created by John Bollinger, CFA,
CMT, the president and founder of Bollinger Capital The Commitments of Traders report: Published
Management (see Active Trader, April 2003, p. 60). By weekly by the Commodity Futures Trading Commission
default, the upper and lower Bollinger Bands are placed (CFTC), the Commitments of Traders (COT) report breaks
two standard deviations above and below a 20-period sim- down the open interest in major futures markets. Clearing
ple moving average. members, futures commission merchants, and foreign bro-
kers are required to report daily the futures and options
Upper band = 20-period simple moving average + 2 stan- positions of their customers that are above specific report-
dard deviations ing levels set by the CFTC.
Middle line = 20-period simple moving average of closing For each futures contract, report data is divided into three
prices “reporting” categories: commercial, non-commercial, and
Lower band = 20-period simple moving average - 2 stan- non-reportable positions. The first two groups are those
dard deviations who hold positions above specific reporting levels.
The “commercials” are often referred to as the large
Bollinger Bands highlight when price has become high or hedgers. Commercial hedgers are typically those who actu-
low on a relative basis, which is signaled through the touch ally deal in the cash market (e.g., grain merchants and oil
(or minor penetration) of the upper or lower line. continued on p. 46
However, Bollinger stresses that price
touching the lower or upper band does not
constitute an automatic buy or sell signal.
For example, a close (or multiple closes)
above the upper band or below the lower
band reflects stronger upside or downside
momentum that is more likely to be a
breakout (or trend) signal, rather than a
reversal signal. Accordingly, Bollinger sug-
gests using the bands in conjunction with
other trading tools that can supply context
and signal confirmation.
Bull call spread: A bull debit spread

that contains calls with the same expiration
date but different strike prices. You buy the
lower-strike call, which has more value,
and sell the less-expensive, higher-strike
call.
Bull put spread (put credit spread):

A bull credit spread that contains puts with
the same expiration date, but different
strike prices. You sell an OTM put and buy
a less-expensive, lower-strike put.
Calendar spread: A position with one

short-term short option and one long
same-strike option with more time until

KEY CONCEPTS continued
companies, who either produce or consume the underlying Trader, December 2001), “The CCI stochastic” (Active Trader,
commodity) and can have access to supply and demand September 2004), and “The CCI Ghost” (Active Trader, May
information other market players do not. 2004).
Non-commercial large traders include large speculators
(“large specs”) such as commodity trading advisors (CTAs) Covered call: Shorting an out-of-the-money call option
and hedge funds. This group consists mostly of institution- against a long position in the underlying market. An exam-
al and quasi-institutional money managers who do not deal ple would be purchasing a stock for $50 and selling a call
in the underlying cash markets, but speculate in futures on option with a strike price of $55. The goal is for the market
a large-scale basis for their clients. to move sideways or slightly higher and for the call option
The final COT category is called the non-reportable posi- to expire worthless, in which case you keep the premium.
tion category — otherwise known as small traders — i.e.,
the general public. Credit spread: A position that collects more premium
from short options than you pay for long options. A credit
The Commodity Channel Index (CCI): The CCI spread using calls is bearish, while a credit spread using
measures how much price (most often, the typical price of a puts is bullish.
bar) deviates from the average price over a specific look-
back period (e.g., five bars, 10 bars, etc.). Despite its name, Debit: A cost you must pay to enter any position if the
the commodity channel index has nothing to do with chan- components you buy are more expensive than the ones you
nels, nor is it limited to commodities. sell. For instance, you must pay a debit to buy any option,
The indicator fluctuates around a “zero line,” with a and a spread (long one option, short another) requires a
majority of its readings between -100 and +100. High read- debit if the premium you collect from the short option does-
ings mean the current price is unusually high relative to the n’t offset the long option’s cost.
average price over the look-back period.
1. Calculate the typical price for each bar, which is the Debit spread: An options spread that costs money to
sum of the high, low, and closing prices divided by enter, because the long side is more expensive that the short
three. side. These spreads can be verticals, calendars, or diagonals.
2. Calculate a moving average of the typical prices over a
desired look-back period (e.g., 10 bars). Deep (e.g., deep in-the-money option or deep
3. Calculate the difference between each typical price out-of-the-money option): Call options with strike
over the look-back period and the moving average of prices that are very far above the current price of the under-
the typical price for the respective bar. lying asset and put options with strike prices that are very
4. Sum the absolute value of all the differences from far below the current price of the underlying asset.
step 3 and divide by the look-back period.
5. Subtract the value calculated in step 2 from the last Delivery period (delivery dates): The specific time
bar’s value as calculated in step 1, and divide it by the period during which a delivery can occur for a futures con-
value calculated in step 4 times 0.015. (The factor 0.015 tract. These dates vary from market to market and are deter-
will force most readings to fall within +/- 100.) mined by the exchange. They typically fall during the
month designated by a specific contract - e.g. the delivery
Theoretically, there are no limits to how high or low CCI period for March T-notes will be a specific period in March.
values can go. Because of its construction, however, most
markets should have a large majority of their CCI values Delta-neutral: An options position that has an overall
between the +/- 100 levels, and very seldom should you see delta of zero, which means it’s unaffected by underlying
readings above or below 300. price movement. However, delta will change as the under-
The most basic way to interpret CCI is to look for a read- lying moves up or down, so you must buy or sell
ing above or below a significant level, as determined by shares/contracts to adjust delta back to zero.
past study of the indicator. Typically these levels are +/-100,
but other levels could be used, including “asymmetrical” Diagonal spread: A position consisting of options with
values (e.g., -150 and +200), depending on whether you use different expiration dates and different strike prices — e.g.,
the indicator to confirm breakouts or to look for tops and a December 50 call and a January 60 call.
bottoms, its two main uses.
For more information, see the following articles: Double calendar spread: A calendar spread involves
“Indicator Insight: The Commodity Channel Index” (Active purchasing an option and selling a shorter-term, same-

strike option of the same type (call or put) against it. Double power equals 10,000.
calendars have two strikes: one put calendar spread below
the current underlying price and one call calendar spread Moving average convergence-divergence
above it. The goal is to collect premium and capture theta (MACD): Although it is often grouped with oscillators, the
from the shorter-term sold options as expiration approach- MACD is more of an intermediate-term trend indicator
es. Single calendars only profit in a fairly narrow range of (although it can reflect overbought and oversold condi-
underlying prices, so the double calendar widens this range tions).
and increases its chances of success. The default MACD line (which can also be plotted as a
histogram) is created by subtracting a 26-period exponen-
European style: An option that can only be exercised at tial moving average (EMA) of closing prices from a 12-peri-
expiration, not before. od EMA of closing prices; a nine-period EMA is then
applied to the MACD line to create a “signal line.”
Exercise: To exchange an option for the underlying MACD = EMA(C,12)-EMA(C,26)
instrument. Signal line = EMA(MACD,9)
Expiration: The last day on which an option can be exer- Naked option: A position that involves selling an unpro-
cised and exchanged for the underlying instrument (usual- tected call or put that has a large or unlimited amount of
ly the last trading day or one day after). risk. If you sell a call, for example, you are obligated to sell
the underlying instrument at the call’s strike price, which
Intermonth (futures) spread: A trade consisting of might be below the market’s value, triggering a loss. If you
long and short positions in different contract months in the sell a put, for example, you are obligated to buy the under-
same market — e.g., July and November soybeans or continued on p. 48
September and December crude oil. Also
referred to as a futures “calendar spread.”
In the money (ITM): A call option with

a strike price below the price of the under-
lying instrument, or a put option with a
strike price above the underlying instru-
ment’s price.
Intrinsic value: The difference between

the strike price of an in-the-money option
and the underlying asset price. A call
option with a strike price of 22 has 2 points
of intrinsic value if the underlying market
is trading at 24.
Iron condor: A market-neutral position

that enters a bear call spread (OTM call +
higher-strike call) above the market and a
bull put spread (OTM put + lower-strike
put) below the market. Both spreads collect
premium, and profit when the market
trades between the short strikes by expira-
tion. All options share the same expiration
month.
Logarithm: The exponent by which a cer-

tain base, such as 10, is raised to produce
another number. For example, the loga-
rithm of 10,000 is 4 because 10 to the 4th

lying instrument at the put’s strike price, which may be well expiration date but different strike prices. A bull put spread
above the market, also causing a loss. contains short, higher-strike puts and long, lower-strike
Given its risk, selling naked options is only for advanced puts. A bear put spread is structured differently: Its long
options traders, and newer traders aren’t usually allowed puts have higher strikes than the short puts.
by their brokers to trade such strategies.
Ratio spread: A ratio spread can contain calls or puts and
Naked (uncovered) puts: Selling put options to collect includes a long option and multiple short options of the
premium that contains risk. If the market drops below the same type that are further out-of-the-money, usually in a
short put’s strike price, the holder may exercise it, requiring ratio of 1:2 or 1:3 (long to short options). For example, if a
you to buy stock at the strike price (i.e., above the market). stock trades at $60, you could buy one $60 call and sell two
same-month $65 calls. Basically, the trade is a bull call
Near the money: An option whose strike price is close spread (long call, short higher-strike call) with the sale of
to the underlying market’s price. additional calls at the short strike.
Overall, these positions are neutral, but they can have a
Open interest: The number of options that have not directional bias, depending on the strike prices you select.
been exercised in a specific contract that has not yet expired. Because you sell more options than you buy, the short
options usually cover the cost of the long one or provide a
Out of the money (OTM): A call option with a strike net credit. However, the spread contains uncovered, or
price above the price of the underlying instrument, or a put “naked” options, which add upside or downside risk.
option with a strike price below the underlying instru-
ment’s price. Simple moving average: A simple moving average
(SMA) is the average price of a stock, future, or other mar-
Parity: An option trading at its intrinsic value. ket over a certain time period. A five-day SMA is the sum of
the five most recent closing prices divided by five, which
Physical delivery: The process of exchanging a physical means each day’s price is equally weighted in the calcula-
commodity (and making and taking payment) as a result of tion.
the execution of a futures contract. Although 98 percent of
all futures contracts are not delivered, there are market par- Stochastic oscillator: A technical tool designed to
ticipants who do take delivery of physically settled con- highlight shorter-term momentum and “overbought” and
tracts such as wheat, crude oil, and T-notes. Commodities “oversold” levels (points at which a price move has, theo-
generally are delivered to a designated warehouse; T-note retically at least, temporarily exhausted itself and is ripe for
delivery is taken by a book-entry transfer of ownership, a correction or reversal).
although no certificates change hands. Calculation: The stochastic oscillator consists of two
lines: %K and a moving average of %K called %D. The basic
Premium: The price of an option. stochastic calculation compares the most recent close to the
price range (high of the range - low of the range) over a par-
Put option: An option that gives the owner the right, but ticular period.
not the obligation, to sell a stock (or futures contract) at a For example, a 10-day stochastic calculation (%K) would
fixed price. be the difference between today’s close and the lowest low
of the last 10 days divided by the difference between the
Put ratio backspread: A bearish ratio spread that con- highest high and the lowest low of the last 10 days; the
tains more long puts than short ones. The short strikes are result is multiplied by 100. The formula is:
closer to the money and the long strikes are further from the %K = 100*{(Ct-Ln)/(Hn-Ln)}
money. where
For example, if a stock trades at $50, you could sell one Ct is today’s closing price
$45 put and buy two $40 puts in the same expiration month. Hn is the highest price of the most recent n days (the
If the stock drops, the short $45 put might move into the default value is five days)
money, but the long lower-strike puts will hedge some (or Ln is the lowest price of the most recent n days
all) of those losses. If the stock drops well below $40, poten-
tial gains are unlimited until it reaches zero. The second line, %D, is a three-period simple moving
average of %K. The resulting indicator fluctuates between 0
Put spreads: Vertical spreads with puts sharing the same and 100.

Fast vs. slow: This formula is sometimes referred to as provides a more accurate reflection of the size of a price
“fast” stochastics. Because it is very volatile, an additional- move over a given period than the standard range calcula-
ly smoothed version of the indicator –– where the original tion, which is simply the high of a price bar minus the low
%D line becomes a new %K line and a three-period average of a price bar. The true range calculation was developed by
of this line becomes the new %D line –– is more commonly Welles Wilder and discussed in his book New Concepts in
used (and referred to as “slow” stochastics, or simply “sto- Technical Trading Systems (Trend Research, 1978).
chastics”). True range can be calculated on any time frame or price
Any of the parameters –– either the number of periods bar — five-minute, hourly, daily, weekly, etc. The following
used in the basic calculation or the length of the moving discussion uses daily price bars for simplicity.
averages used to smooth the %K and %D lines –– can be True range is the greatest (absolute) distance of the fol-
adjusted to make the indicator more or less sensitive to lowing:
price action.
Horizontal lines are used to mark overbought and over- 1. Today’s high and today’s low.
sold stochastic readings. These levels are discretionary; 2. Today’s high and yesterday’s close.
readings of 80 and 20 or 70 and 30 are common, but differ- 3. Today’s low and yesterday’s close.
ent market conditions and indicator lengths will dictate dif-
ferent levels. Average true range (ATR) is simply a moving average of
the true range over a certain time period. For example, the
Strangle: A non-directional option spread that consists of five-day ATR would be the average of the true range calcu-
an out-of-the-money call and out-of-the-money put with lations over the last five days.
the same expiration. For example, with the underlying
continued on p. 50
instrument trading at 25, a long strangle could consist of
buying a 27.5 call and a 22.5 put. Long
strangles are designed to profit from an
increase in volatility; short strangles are
intended to capitalize on declining volatil-
ity. The straddle is a related strategy.
Strike (“exercise”) price: The price

at which an underlying instrument is
exchanged upon exercise of an option.
Time decay: The tendency of time

value to decrease at an accelerated rate as
an option approaches expiration.
Time spread: Any type of spread that

contains short near-term options and long
options that expire later. Both options can
share a strike price (calendar spread) or
have different strikes (diagonal spread).
Time value (premium): The amount

of an option’s value that is a function of
the time remaining until expiration. As
expiration approaches, time value
decreases at an accelerated rate, a phe-
nomenon known as “time decay.”
True range (TR): A measure of price

movement that accounts for the gaps that
occur between price bars. This calculation

Variance and standard deviation: Variance meas- etc.), the more volatile that market is.
ures how spread out a group of values are — in other A common application of variance in trading is standard
words, how much they vary. Mathematically, variance is the deviation, which is the square root of variance. The stan-
average squared “deviation” (or difference) of each number dard deviation of 8, 9, and 10 is: .667 = .82; the standard
in the group from the group’s mean value, divided by the deviation of 2, 9, and 16 is: 32.67 = 5.72.
number of elements in the group. For example, for the num-
bers 8, 9, and 10, the mean is 9 and the variance is: Vertical spread: A position consisting of options with
the same expiration date but different strike prices (e.g., a
{(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667 September 40 call option and a September 50 call option).
Now look at the variance of a more widely distributed set Volatility: The level of price movement in a market.
of numbers: 2, 9, and 16: Historical (“statistical”) volatility measures the price fluctu-
ations (usually calculated as the standard deviation of clos-
{(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67 ing prices) over a certain time period — e.g., the past 20
days. Implied volatility is the current market estimate of
The more varied the prices, the higher their variance — future volatility as reflected in the level of option premi-
the more widely distributed they will be. The more varied a ums. The higher the implied volatility, the higher the option
market’s price changes from day to day (or week to week, premium.
EVENTS
Event: The Options Intensive Two-day Seminars Event: Traders Expo Las Vegas
Dates: Oct. 23, Dec. 4 Date: Nov. 19-22
Location: CBOE Options Institute, Chicago Location: Mandalay Bay Resort & Casino, Las Vegas
For more information: http://www.cboe.com For more information: http://www.tradersexpo.com
Event: Regulation: Challenge or Business Event: The Options Initiative Two-day Seminars
Opportunity? Date: Nov. 20
Date: Oct. 24, 9 a.m. to 1 p.m. Location: CBOE Options Institute, Chicago
Location: Harvard Club, NYC For more information: http://www.cboe.com
For more information: Go to
http://www.thompsonhine.com and click on “Events” Event: TradeStation ETF Symposium
Date: Dec. 4-6
Event: SIFMA’s Annual Meeting Location: Delray Beach Marriott, Delray, Fla.
Date: Oct. 28 For more information:
Location: Marriott Marquis, NYC http://www.TradeStation.com/Strategy
For more information: http://www.sifma.org/events
Event: Dynamic Hedging of Long Volatility Strategies
Event: SIFMA’s OFAC Compliance Symposium Date: Dec. 4-5
Date: Nov. 6 Location: Sheraton Suites on the Hudson, New York
Location: AXA Equitable Conference Center, NYC For more information: http://www.marcusevans.com
For more information: http://www.sifma.org/events
Event: TradeTech Foreign Exchange 2009
Event: 23rd Annual Futures & Options Expo Date: Feb. 9-11
Date: Nov. 10-12 Location: Bridgewaters, NYC
Location: Hyatt Regency Chicago For more information:
For more information: Go to http://www.TradeTechForeignExchange.com
http://www.futuresindustry.org and click on “Conferences”

ads0908 7/15/08 1:28 PM Page 39
FOREX DIARY
OPTIONS TRADE JOURNAL
Betting against Bank of America after an analyst downgrade.

FIGURE 1 — RISK PROFILE – LONG PUT
TRADE
This deep in-the-money long put will make money fast if BAC tanks, but it will lose
Date: Wednesday, Sept. 10. up to 6.00 if the stock rallies above the 37.5 strike price by Oct. 18 expiration.
Market: Options on Bank of

America (BAC).
Entry: Buy one October 37.5 put

for $6.00.
Reasons for trade/setup:

BAC was downgraded by invest-
ment bank Keefe, Bruyette, and
Woods before the market opened
on Sept. 10. Meanwhile, Lehman
Brothers announced a third-quar-
ter loss of $3.9 billion, the bank’s
largest quarterly loss.
When analysts downgrade a
company, the stock typically
drops sharply overnight, making
it difficult for traders to initially
participate in these events. But
historical testing shows down-
graded stocks in the Dow Jones Source: OptionVue
Industrial Average continue to fall
after the market opens.
To profit from further weakness in bank stocks, we Initial target: Hold until close.
bought October Bank of America 37.5 puts for $6.00 when
BAC traded at $32.15 at 10 a.m. on Sept. 10. Buying puts is RESULT
a simple directional trade; the idea is to hold the position
until today’s close. The puts were in-the-money (ITM) by Outcome: Figure 2 shows BAC climbed 1.8 percent with-
5.35 points and had a delta of -77.33, meaning they were in 15 minutes of entering the trade, but it then reversed
well suited to profit from a short-term market sell-off. direction and fell 3.3 percent by 11 a.m. We closed the trade
Figure 1 shows the position’s potential gains and lows on by selling the puts for 6.40 as Bank of America traded at
three dates: trade entry (Sept. 10, dotted line), halfway to $31.65. A 0.40 profit within an hour isn’t bad, and we man-
expiration (Sept. 29, dashed line), and expiration (Oct.
18, solid line). Again, if BAC drops sharply the trade will TRADE SUMMARY
gain ground quickly, but it will lose up to 6.00 ($600) if
Bank of America rallies above $37.50 by Oct. 18 expira- Entry date: Sept. 10, 2008
tion.
Underlying security: Bank of America (BAC)
Initial stop: Exit if position loses one-third of its Position: 1 long Oct. 37.5 put
value. Initial capital required: $600
Initial stop: Exit if put loses one-third of its value.
TRADE STATISTICS
Initial target: Hold until close.
Sept. 10 10 a.m. 11 a.m. Initial daily time decay: $2.29
Delta: -77.33 -80.46 Trade length (in days): 1
Gamma: 5.26 4.96 P/L: $40 (6.7%)
Theta: -2.29 -2.02 LOP: $40
Vega: 3.22 2.93 LOL: -$20
Probability of profit: 44% 48%
LOP — largest open profit (maximum available profit during life of trade).
Breakeven point: 31.50 31.50
LOL — largest open loss (maximum potential loss during life of trade).

FIGURE 2 — CATCHING A SHORT DROP
This trade earned 0.40 (6.7 percent) within an hour as BAC dropped 1.6 percent.
aged to capture a large portion of

the intraday down move.
The trade wasn’t ideal, though.
We chose October puts to mini-
mize the effect of time decay, but
this wasn’t a factor in such a
short-term trade. September 37.5
puts cost $0.75 less and had a
slightly higher delta, so we could
have earned more money with
less capital.
More importantly, we failed to
recognize the significance of
Lehman Brother’s growing prob-
lems. Had we waited a couple of
days, we could have doubled our
capital as BAC sank to $25 after
Lehman Brothers filed for bank- Source: eSignal
ruptcy on Sept. 15.
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the launch of EBS, the new data feed CEF ultra+ of BATS Trading. The BATS data feed is free to everyone visit-
Deutsche Börse Market Data & Analytics was started. CEF ing the Quote.com and RagingBull.com sites, and the infor-
ultra+ contains the same market depth as EBS but distrib- mation provided by BATS includes not only last sale, but
utes Eurex trading data to non-Eurex members. also full depth of book data.
Note: The New Products and Services section is a forum for
CQG has created an elementized news data feed detail-
industry businesses to announce new products and upgrades.
ing U.S. economic releases available on the CQG data line. Listings are adapted from press releases and are not endorsements
Need to Know News Economic Release Bullets are viewable or recommendations from the Active Trader Magazine Group. E-
in real-time through any of CQG’s quote displays. CQG mail press releases to editorial@futuresandoptionstrader.com.
includes historical economic report data for chart analysis Publication is not guaranteed.

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October 2008 • Volume 2, No.

Backspreads and ratio spreads . . . . . . .20

Futures Trading System Lab

Options Trading System Lab

Short-term calendar spreads . . . . . . . . .15

2 October 2008 • FUTURES & OPTIONS TRADER

They’re called “mavericks,” “individualists,”

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Stocks Options Futures Forex Member NYSE FINRA NFA SIPC

Other stories: Options Watch:

Have a question about something you’ve seen

Looking for an advertiser?

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

GCFF The Wizard

4 October 2008 • FUTURES & OPTIONS TRADER

Jonathan F. Maher has a Ph.D. in engineering and an MBA

Jay Kaeppel is a trading strategist with Optionetics, Inc.

Classified ad sales: Mark Seger Steve Lentz (advisor@optionvue.com) is a well-established

FUTURES & OPTIONS TRADER • October 2008 5

Financial panic pressures

6 October 2008 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • October 2008 7

Putting the Sept. 29 drop in context

8 October 2008 • FUTURES & OPTIONS TRADER

Seasonal T-bond patterns

“S easonals” are trends that tend to

T-bond futures, focusing on two areas:

1. The most bullish months of the year.

Additional research, noted at the end of this

Most bullish months of the year

FUTURES & OPTIONS TRADER • October 2008 9

System filtering with %C

T raders often try to forecast the market’s direc-

10 October 2008 • FUTURES & OPTIONS TRADER

if Value8 <> 0 then Value9 = Log (value8);

the %C indicator shows when the

FUTURES & OPTIONS TRADER • October 2008 11

Filtered strategy #1: If EntriesLongToday(date)<2

and PercentC(CDLF)>LChopEx If EntriesshortToday(Date)<2

12 October 2008 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • October 2008 13

Related reading TABLE 4 — MORE TWEAKS BOOST PERFORMANCE

14 October 2008 • FUTURES & OPTIONS TRADER

Short-term calendar spreads

C alendar spreads are best known as strategies

FUTURES & OPTIONS TRADER • October 2008 15

FIGURE 1 — GOOGLE INC.

…but time decay still matters

16 October 2008 • FUTURES & OPTIONS TRADER

Google traded at $518 on July 31, 2007.

Double your fun

FUTURES & OPTIONS TRADER • October 2008 17

FIGURE 4 — PROFITS AND LOSSES BY YIELD

18 October 2008 • FUTURES & OPTIONS TRADER

You can purchase past articles at

FUTURES & OPTIONS TRADER • October 2008 19

Backspreads and ratio spreads

A ratio backspread is an options strategy that

further from the market’s current value.

20 October 2008 • FUTURES & OPTIONS TRADER

Favorable market conditions

FUTURES & OPTIONS TRADER • October 2008 21