Vous êtes sur la page 1sur 45

March 2009 • Volume 3, No.

Can you identify your
strategy’s best signals?
p. 6

system p. 12

golden butterflies p. 16

Trading options with
a new volatility
measure p. 22

for stock splits
and dividends p. 30


p. 32

Applying a simpler
volatility measure . . . . . . . . . . . . . . . . . . . .22
This new calculation demystifies volatility and
provides an easy way to compare the details of
two (or more) stocks. It also helps you uncover
opportunities that other options traders ignore.
By George Hoekstra

Options Trading System Lab

The return of the short butterfly . . . . . .28
These positions hit their stride in tough times.
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .5 By Steve Lentz and Jim Graham

Trading Strategies Trading Basics

Using probability as a guide . . . . . . . . . . . .6 Option adjustments . . . . . . . . . . . . . . . . . . .30
Digging into a strategy’s historical statistics may It’s not just about buying and selling: Traders
reveal how to enhance its performance. This test need to understand how dividends, stock splits,
explores variations of the Martingale rule, which and mergers change the terms of their options.
doubles position sizes after a loss based on the By FOT Staff
notion that a winning trade is imminent.
By Lee Leibfarth News
CFTC’s new monthly report dresses
Intermarket soybean strategy . . . . . . . . .12 up the weekly COT . . . . . . . . . . . . . . . . . . . .32
Deciphering the relationships between Charged with the task of improving transparency
different markets offers a different way to
in the futures markets, the CFTC begins a six-
trade commodity futures.
month trial for a new Commitments of Traders
By Markos Katsanos

Land softly with

butterflies and condors . . . . . . . . . . . . . . .16 continued on p. 4
These low-risk options spreads can reap
profits even if your market forecast isn’t
perfect. An example in gold compares but-
terflies to condors, which boost your odds
of success in certain situations.
By Frederic Ruffy


ads0409 2/10/09 5:13 PM Page 37

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34

Futures & Options Calendar . . . . . . . . . . . .35

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .36

Momentum, volatility, and volume
statistics for futures.

Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .37 New Products and Services . . . . . . . . . . . . .39

Notable volatility and volume
in the options market. Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .40
References and definitions.
Futures & Options Watch
COT extremes . . . . . . . . . . . . . . . . . . . . . . .38 Options Trade Journal . . . . . . . . . . . . . . .43
A look at the relationship between commercials A “bull”-headed put spread sees red during
and large speculators in all 45 futures markets. options expiration week.

Options Watch:
Large-cap stocks . . . . . . . . . . . . . . . . . . . . . . .38

Have a question about something you’ve seen

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

Looking for an advertiser?

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

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

eSignal RS of Houston

Global Futures The Wizard

Paris Expo Xview




 Markos Katsanos is the author of Intermarket Trading

Strategies published in February by John Wiley & Sons and has
been an active trader since 1995. He can be reached at
A publication of Active Trader ®

 Frederic Ruffy is the senior options strategist at

For all subscriber services:
www.futuresandoptionstrader.com http://whatstrading.com, a site dedicated to helping traders
make sense of the complex and fragmented nature of listed
Editor-in-chief: Mark Etzkorn options trading. In addition to writing market commentary and
metzkorn@futuresandoptionstrader.com trading-related books and articles, Ruffy has also worked as an
instructor, educating investors on advanced topics such as volatility, the ben-
Managing editor: Molly Goad
mgoad@futuresandoptionstrader.com efits of sector rotation, and trading around earnings. Ruffy is an active trader
with more than 15 years experience in the industry. His market observations
Senior editor: David Bukey and analysis of the options market are featured regularly in the financial press
including Barron’s, Reuters, The Wall Street Journal, Bloomberg, and Futures
Contributing editor: Magazine.
Keith Schap
 George Hoekstra is a research engineer in the petroleum
Associate editor: Chris Peters
cpeters@futuresandoptionstrader.com refining business. He started trading options 30 years ago while
studying under Myron Scholes who was his professor at the
Editorial assistant and
University of Chicago. Hoekstra holds degrees in chemical engi-
webmaster: Kesha Green
kgreen@futuresandoptionstrader.com neering from Purdue University and an MBA from the
University of Chicago. Hoekstra can be contacted via his Web site,
Art director: Laura Coyle http://hoekstratrading.com/default.aspx.

President: Phil Dorman  Lee Leibfarth (lee@powerzonetrading.com) is an inde-

pdorman@futuresandoptionstrader.com pendent futures trader and trading system researcher. He is an
affiliate of the Market Technicians Association and president of
Ad sales East Coast and Midwest: PowerZone Trading, a company that provides a range of servic-
Bob Dorman es for traders. His articles on technical analysis and market tech-
nology have been featured in a variety of publications.
Ad sales
West Coast and Southwest only:  Steve Lentz (advisor@optionvue.com) is a well-estab-
Allison Chee
lished options educator and trader and has spoken all over the
U.S., Asia, and Australia on behalf of the CBOE’s Options
Classified ad sales: Mark Seger Institute, the Options Industry Council, and the Australian Stock
seger@futuresandoptionstrader.com Exchange. As a mentor for DiscoverOptions.com, he teaches
select students how to use complex options strategies and develop a consis-
Volume 3, Issue 3. Futures & Options Trader is pub-
lished monthly by TechInfo, Inc., 161 N. Clark St., tent trading plan. Lentz is constantly developing new strategies on the use of
Suite 4915, Chicago, IL 60601. Copyright © 2009
TechInfo, Inc. All rights reserved. Information in this options as part of a comprehensive profitable trading approach. He regularly
publication may not be stored or reproduced in any
form without written permission from the publisher. speaks at special events, trade shows, and trading group organizations.
The information in Futures & Options Trader magazine
is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply  Jim Graham (advisor@optionvue.com) is the product
the effectiveness of any trading system, strategy, or
approach. Traders are advised to do their own manager for OptionVue Systems and a registered investment
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of advisor for OptionVue Research.
risk. Past performance does not guarantee future



Using probability as a guide

This approach uses the Martingale rule in a conservative way to trade larger positions
after a string of losses without getting wiped out.


W hen evaluating the merits of a trading

strategy, many arm-chair system develop-
ers focus almost exclusively on its per-
centage of profitable trades. If a trading
system has a high percentage of winning trades, it seems
logical it will withstand the rigors of real-world trading bet-
ter than a system with a lower percentage of winners.
lowing discussion explores the concept of probability and
uses it to strengthen an intraday trend-following strategy.
Intuitively, many traders feel after one (or more) losing
trade(s), their probability of winning has increased. At that
point, traders often increase their trade size to benefit from
the next trade’s (perceived) higher odds of success. Or they
may also take a signal only after a series of paper losses. Is
However, the percentage of winning trades doesn’t con- this logic valid and can these tactics improve a trading strat-
tain enough information to make a valid comparison egy’s performance?
between two trading systems. You also need to know the
typical size of its winning and losing trades (among other Probability as a trading tool
metrics). For example, most trend-following systems have In trading, the probability of winning is calculated by divid-
winning percentages of less than 50 percent, but the win- ing the number of winning trades by the total number of
ners tend to be much bigger than the losers, which helps trades for a given period; a probability of zero means all
give these systems an edge. traders were losers, and a probability of 100 percent means
The winning percentage can be an important clue of a all traders were winners.
strategy’s potential success, but it shouldn’t be measured in To use probability to improve trading performance, you
isolation from other performance statistics. Instead of sim- first need to establish a consistent set of strategy rules,
ply trying to boost a system’s winning percentage, the fol- grouped into three categories:


many shares/contracts to
This system uses the fast stochastic to identify short-term trends instead of reversals.
Three of the five short trades made money on Jan. 22.
• Entry rules — when to
enter the market (and
which direction)?
• Exit rules — when to exit
winners and losers?

This sounds obvious, but iso-

lating just one of these factors
lets you build a system that can
truly test the effects of probabili-
ty. The following examples use a
standard set of exit rules to test
the effects of different-sized
Short-term trading strategies
are ideal for this experiment,
because they trade more often
and endure more price swings
than longer-term ones, generat-
ing more statistically significant
results. An intraday trend-fol-
lowing strategy was tested on
Source: TradeStation
the Mini Russell 2000 futures


The Martingale rule doubles the next trade’s size after the previous trade loses
money with the expectation that the odds of success increase. Applying this rule to
a trading system may help it rebound from losses, but it can also wipe you out
(TF) in the 60-day period from Nov. 19,
2008 to Feb. 11, 2009. Instead of using
standard time-based intervals, the
approach uses 610-tick bars — a more
detailed method that highlights price
action and trade activity simultane-
ously. Finally, the strategy trades
futures, because it is easier to change
the size of futures contracts than
shares of stock.

Trade rules
The strategy uses a 14-period fast sto-
chastic oscillator to generate entry sig-
nals. Instead of buying the market
when the fast %K line crosses below 25
— a classic oversold signal — the sys-
tem sells the market to exploit further
weakness. And instead of selling short
when the fast %K line crosses above 75 Source: TradeStation
— a traditional overbought signal —
the approach goes long to benefit from the market’s poten- Trade rules
tial strength. These signals are sometimes referred to as a 1. Go long if the 14-period fast %K line crosses
stochastic “pop” and trade in the direction of the intraday above 75.
trend. 2. Sell short if the 14-period fast %K line crosses
The system trades from 8:30 a.m. to 3:00 p.m. ET and below 25.
holds each trade until one of the exit conditions are met, 3. Exit the trade if it earns $800 (profit target),
even if a signal triggers in the opposite direction (i.e., trades loses $800 (stop loss), or at the stock market’s close
are not reversed). at 4 p.m. ET.
continued on p. 8


The intraday stochastics system was mildly profitable, but nothing special. It had a winning percentage of 54 percent, a profit
factor of 1.19, and a maximum drawdown of 6.3 percent.
Total net profit $8,920.00 Profit factor 1.19
Gross profit $55,880.00 Gross loss -$46,960
Total number of trades 146 Percent profitable 54.11%
Winning trades 79 Losing trades 67
Avg. profit $61.10 Ratio avg. win / avg. loss 1.01
Avg. winner $707.34 Avg. loser -$700.90
Largest winning trade $800.00 Largest losing trade -$800
Largest winning trade as percentage of gross profit 1.43% Largest losing trade as percentage of gross loss 1.70%
Max. consec. winning trades 5 Max. consecutive losing trades 4
Avg. bars in winning trades 44.15 Avg. bars in losing trades 37.21
Avg. bars in total trades 40.97 Account size required $5,960
Max. contracts held 1 Percent of time in market 15.53%
Return on initial capital 8.92% Annual rate of return 37.46%
Buy-and-hold return 13.25% Return on account 149.66%
Avg. monthly return $2,230.00 Standard deviation of monthly return $5,188.85
Max. drawdown (intraday peak to valley) -$6,310.00 Longest flat period 2 days, 20 hours
Max. drawdown as % of initial capital 6.31%
Source: TradeStation




Doubling a trade’s size up to four times boosted performance, but it also magnified risk. The profit factor increased to 1.74 from
1.19, total net profit climbed substantially, but the maximum drawdown nearly tripled.

Total net profit $55,620.00 Profit factor 1.74

Gross profit $130,580.00 Gross loss $74,960
Total number of trades 146 Percent profitable 54.11%
Winning trades 79 Losing trades 67
Avg. profit $380.96 Ratio avg. win / avg. loss 1.48
Avg. winner $1,652.91 Avg. loser $1,118.81
Largest winning trade $7,840.00 Largest losing trade $6,400
Largest winning trade as percentage of gross profit 6.00% Largest losing trade as percentage of gross loss 8.54%
Max. consec. winning trades 5 Max. consecutive losing trades 4
Avg. bars in winning trades 44.15 Avg. bars in losing trades 37.21
Avg. bars in total trades 40.97 Account size required $10,300
Max. contracts held 16 Percent of time in market 15.53%
Return on initial capital 55.62% Annual rate of return 193.87%
Buy-and-hold return 13.25% Return on account 540%
Avg. monthly return $13,905.00 Standard deviation of monthly return $12,423.06
Max. drawdown (intraday peak to valley) -$18,840.00 Longest flat period 2 days, 20 hours
Max. drawdown as % of initial capital 18.84%
Source: TradeStation

Figure 1 shows five short trades on Jan. 22, three of which drawdowns. The system’s winning percentage doesn’t
were profitable. The approach earned $1,600 as the Mini change, but it could earn significantly more money than if
Russell 2000 futures dropped roughly 4 percent in the you simply traded one contract.
morning. It gave back profits in the early afternoon before However, the Martingale rule magnifies risk. By trading
moving back into the black as it sold short when the market increasingly larger positions, you could easily go broke
fell apart again in the final two hours of trading. before you have the chance to bounce back. Figure 2’s equi-
Because the strategy’s profit target and stop loss amounts ty curve shows how the Martingale rule can ruin a strategy:
are identical, performance depends entirely on the percent- Drawdowns are steep as just one or two trades can wipe
age of winning trades. In other words, the system earns you out. When the Martingale rule was applied to this sys-
money if more than half of all trades are winners, and it tem, equity fell from a $22,000-profit to a loss of more than
loses money if more than half of all trades are losers. Thus, $46,000 within 90 trades. You must have very deep pockets
the strategy is basically a coin toss with the entry rules pro- to succeed with a Martingale system.
viding the only hope of positive expectancy and potential Clearly, this approach is too risky to trade, but you can
profit. add elements of the Martingale rule to a system and still
Table 1 lists the system’s back-tested results, which were trade responsibly. One idea is to double the trade’s size a
modestly profitable when trading one contract (commis- certain number of times before the system stops trading or
sions are excluded). The strategy traded 146 times in the 60- resets, even if it hasn’t recovered. The goal, of course, is to
day test period and gained ground 54 percent of the time recoup any losses before this limit is reached. This method
with a 1.19-profit factor (gross profit/gross loss). Its maxi- relies on a system’s favorable winning percentage to keep it
mum drawdown was $6,310, and it posted losses up to four from shutting down.
times in a row (more in a moment). Remember that the intraday stochastic system posted up
So far the strategy isn’t very impressive, as a good chunk to four consecutive losses. Instead of trading just one con-
of its average profit ($61.10) will likely be eroded by com- tract, let’s apply the Martingale rule and double the next
missions and slippage. Let’s try to improve performance by trade’s size after a loss up to four times in a row. After four
adjusting each trade’s size based on whether previous consecutive losses, the fifth trade should pull the system
trades gained or lost money. out of its hole. If the strategy starts with one contract and
posts a loss, the next trade will be two contracts; and if loss-
Sizing positions the Martingale way es continue, the system will then trade four, eight, and final-
In theory, you can sharpen a system’s performance by trad- ly 16 contracts. Ideally, a single 16-contract winning trade
ing larger positions after each losing trade, a tactic known will overcome the losses of the previous four trades — a
as Martingale betting. The idea is to successively double the total of 15 contracts (1 + 2 + 4 + 8 = 15).
size of a previous losing trade until a single winner recoups Table 2 shows the back-test results of applying the
your losses. The upside is you could quickly overcome any Martingale rule up to four times on the intraday stochastic


TradeStation EasyLanguage Code:
// =================================
// Stoch Probability Strategy
strategy. Although the system’s win- // Coded by: Lee Leibfarth 2009
ning percentage remained 54 percent, // =================================
its profit factor increased to 1.74, and inputs:
the total net profit climbed substan- StopLoss(800),
tially. However, this adjustment mul- ProfitTarget(800),
tiplied risk as the maximum draw- Line1(25),
down almost tripled to $18,840 from Line2(75),
$6,310 — a harsh reality of this type of StochLength(14),
position-sizing technique. DoubleDSwitch(false),
Natural selection variables:
Conservative traders who can’t stom- oFastK(0),
ach additional risk can still benefit oFastD(0),
from the Martingale rule’s logic that oSlowK(0),
winning trades tend to follow a string oSlowD(0),
of losing ones. Instead of increasing count(0),
trade size, you can monitor signals PrevLosTrades(0),
and trade only the ones with a higher PrevWinTrades(0),
probability of success. This method NumContracts(1);
aims to boost a strategy’s winning value1 = Stochastic( h, l, c, StochLength, 3, 3, 1, oFastK, oFastD, oSlowK, oSlowD);
percentage and profits (without // ==== MONEY MANAGEMENT ====
increasing risk) by taking significant- if DoubleDSwitch then begin
ly fewer trades. if PrevLosTrades <> numlostrades then begin
To trade this approach, you need to if count <= DoubleDLimit or DoubleDLimit = 0 then NumContracts
run two strategies at the same time: = NumContracts * 2;
the original system and one with a fil- if count > DoubleDLimit and DoubleDLimit <> 0 then
ter that trades only after the original NumContracts = 1;
plan loses a fixed number of times in count = count + 1;
a row. You just need to decide how end;
many consecutive paper losses will if PrevWinTrades <> numwintrades then begin
trigger a real trade, keeping in mind NumContracts = 1;
that skipping additional losses may count = 1;
boost the system’s winning percent- end;
age, but the number of trades will PrevLosTrades = numlostrades;
drop. PrevWinTrades = numwintrades;
Let’s track the original strategy, but end;
take trades only following two con- //==== TRADE RULES ====
secutive losses per day, a limit select- if marketposition = 0 and time > 830 and time < 1500 then begin
ed after reviewing Mini Russell 2000 if oFastK crosses under Line1 then sellshort (“ST_Sell”) NumContracts con-
futures chart during the test period. tracts next bar at market ;
The revised strategy treats each day if oFastK crosses over Line2 then buy (“ST_Buy”) NumContracts contracts
separately as the number of consecu- next bar at market ;
tive losses resets each morning. end;
Table 3 lists the performance statis- if time > 1600 then begin
tics for this filtered strategy. Its win- sell (“EOD_LX”) next bar at market;
ning percentage climbed to 64 percent buytocover (“EOD_SX”) next bar at market;
from 54 percent, while the profit fac- end;
tor rose to 2.12 from 1.19. Also, the setstopcontract;
maximum drawdown was only setexitonclose;
$1,590 (1.59 percent), meaning you setstoploss(StopLoss);
could trade more than one contract to setprofittarget(ProfitTarget);
boost performance (if you are com-
fortable with additional risk). You can copy this code at
However, the system’s $2,720 (2.7 http://www.futuresandoptionstrader.com/index.php/c/Strategy_Code
continued on p. 10




Trading the original stochastic strategy only after it posted two consecutive losses improved performance. But it traded only 11
times in 60 days — far less often than the basic system.

Total net profit $2,720.00 Profit factor 2.12

Gross profit $5,140.00 Gross loss -$2,420
Total number of trades 11 Percent profitable 63.64%
Winning trades 7 Losing trades 4
Avg. profit $247.27 Ratio avg. win / avg. loss 1.21
Avg. winner $734.29 Avg. loser -$605.00
Largest winning trade $800.00 Largest losing trade $800
Largest winning trade as percentage of gross profit 15.56% Largest losing trade as percentage of gross loss 33.06%
Max. consec. winning trades 6 Max. consecutive losing trades 2
Avg. bars in winning trades 32.00 Avg. bars in losing trades 60.5
Avg. bars in total trades 42.36 Account size required $1,280
Max. contracts held 1 Percent of time in market 0.95%
Return on initial capital 2.72% Annual rate of return 11.76%
Buy-and-hold return 19.50% Return on account 212.50%
Avg. monthly return $680 Standard deviation of monthly return $1,555.46
Max. drawdown (intraday peak to valley) -$1,590.00 Longest flat period 40 days, 23 hours
Max. drawdown as % of initial capital 1.59%
Source: TradeStation

percent) profit is relatively low because it traded only 11 exploring the role of probability is an important step in
times during the 60-day test period. designing a trading system and can be beneficial if done
Adding risk to a trading strategy shouldn’t be taken properly. 
lightly. These adjustments were proposed to inspire creativ-
ity — not to be traded without further research. That said, For information on the author see p. 5.

Related reading: Lee Leibfarth articles Other articles

“Improving the three-bar pullback pattern” “Trading System Lab: Martingale rule (futures)”
Futures & Options Trader, August 2008. Active Trader, December 2005.
Getting in is only part of the story. This pullback strategy The Martingale rule is based on an old and simple rule often
illustrates the crucial role exit rules play in profitability. used by inexperienced gamblers: Start with one bet and
each time you lose, double the amount of your prior losing
“Fibonacci pivot points” bet. If you win, bet again with the minimum amount. The
Futures & Options Trader, April 2008. goal is to recover all lost bets as well as gain additional
Countertrend and breakout rules complement a Fibonacci profit. Although infallible in theory, the technique turns out to
pivot-point technique. be extremely dangerous in practice. It is a position-sizing
“Sharpening a countertrend strategy” method that tries to take advantage of the improbable nature
Active Trader, October 2007. of a very long losing streak.
Designing a trading system involves more than just creating “The ‘high probability’ myth”
profitable signals. You also need to consider how to size Active Trader, January-February 2001.
your trades. “High probability.” It’s one of the biggest buzz terms in trad-
“Intraday hybrid strategy” ing. We all hear about it. We all want it — or think we do.
Active Trader, July 2007. But high probability and successful trading don’t necessarily
Because simple trend-following methods can fall flat during go hand in hand. Find out why.
choppy markets, this breakout system adjusts its exits to fit “Probability vs. profitability”
different market environments. Active Trader, June 2000.
“Forecasting techniques” It’s not the winning percentage of a trading system that
Active Trader, October 2006. counts, it’s how you manage positions and control losses.
Predicting probable market action is a challenging task, but You can purchase and download past articles at
a handful of calculations make it possible to measure the http://store.activetradermag.com.
reliability — and improve the accuracy — of price forecasts.


ads0908 7/15/08 1:28 PM Page 39

Intermarket soybean strategy

An intermarket system for soybean futures incorporates data
from markets inside and outside the grain sector.


I ntermarket analysis, which studies the relationship

between different markets, is a neglected area of
research, but it offers the opportunity to develop a
system based on the divergences between two or
more highly correlated commodities, as well as avoid
trades against the prevailing direction of correlated mar-
by the same fundamentals. However, their correlation can
be used to exploit short-term inefficiencies because the fun-
damentals might not be fully reflected in the price of all the
markets at the same time.
Other grains, however, are not the only markets that
should be considered when designing an intermarket trad-
ing system. Soybeans are denominated in U.S. dollars, so
Soybeans (S), corn (C), and wheat (W) have always tend- the price of the dollar relative to other currencies can be an
ed to move in the same direction. The price of one market, important component. Also, the price of crude oil can have
however, does not move in a particular direction because an effect, since more than 80 percent of estimated biodiesel
the other is moving the same way; both markets are driven production in the U.S. comes from soybean oil.


Soybeans correlated well with the other commodities during the entire 10-year period.


Soybeans (S) 1 0.95 0.92 0.83 0.87 0.80 0.79 -0.83 0.75
Soybean oil (BO) 0.95 1 0.82 0.83 0.92 0.86 0.80 -0.88 0.78
Soymeal (SM) 0.92 0.82 1 0.76 0.78 0.71 0.70 -0.63 0.68
Corn (C) 0.83 0.83 0.76 1 0.84 0.65 0.57 -0.64 0.54
Wheat (W) 0.87 0.92 0.78 0.84 1 0.86 0.79 -0.79 0.77
Potash Corp. (POT) 0.80 0.86 0.71 0.65 0.86 1 0.87 -0.86 0.87
CRB index (CRB) 0.79 0.80 0.70 0.57 0.79 0.87 1 -0.84 0.97
Dollar index (DXY) -0.83 -0.88 -0.63 -0.64 -0.79 -0.86 -0.84 1 -0.82
Crude oil (CL) 0.75 0.78 0.68 0.54 0.77 0.87 0.97 -0.82 1


The correlations were volatile over time: Soybeans’ correlations with the CRB, crude The correlations
oil, dollar index, and Potash stock dropped significantly in the 2004-2008 period. To select the best markets for an
intermarket system, we’ll start by
Price 10-day yield
calculating the correlations of raw
No. of years: 10 5 Fit line 10 5 prices (Table 1) and percentage
Soybean oil 0.95 0.93 Linear 0.73 0.77
changes (the last two columns of
Soymeal 0.92 0.98 Linear 0.84 0.87
Table 2) between soybeans and
Corn 0.83 0.86 Linear 0.56 0.59
Wheat 0.87 0.80 Approx. L 0.33 0.36
related markets — other commodi-
Potash Corp. 0.80 0.59 Linear 0.27 0.31 ties, stocks, and the U.S. dollar
CRB index 0.79 0.30 Approx. L 0.48 0.50 index.
Dollar index -0.83 -0.56 Parabolic -0.20 -0.18 The correlation coefficient varies
Crude oil 0.75 0.41 Non-linear 0.11 0.23 between +1 and -1. A +1 value indi-
cates a perfect positive relationship


between the two variables — that is, two markets that are ahead of time. In other words, you want the predictor mar-
moving precisely in tandem; a -1 value indicates a perfect ket to sometimes diverge from the predicted market. This
negative relationship between the two variables; a value of can only be revealed by a leading and lagging correlation
zero means there is no linear relationship between the vari- analysis, which is simply a list of related intermarket corre-
ables. Values in between indicate the degree of positive and lations displaced at specified time intervals (lags).
negative correlation. To determine which market was leading, the weekly soy-
During the entire 10-year period, soybeans correlated continued on p. 14
well with all the other commodities
in Table 1. However, Table 2 shows
the correlations with the CRB, crude
oil, dollar index, and Potash
dropped significantly during the
more recent five-year period (2004-
2008). This indicates there is consid-
erable correlation volatility over
time, which makes these instru-
ments undesirable for a predictive
trading system. Also, the correla-
tions with wheat, the dollar index,
and crude oil broke down in terms
of their 10-day percentage yields (in
blue, Table 2).
Although the correlation with the
dollar index is not as strong as it is
with some of the other commodities,
it can increase dramatically during
periods of rising volatility and
sharp dollar declines (Figure 1).
During the preceding seven years,
there were three such periods, all
resulting in strong, inverse correla-
tions between soybeans and the dol-
lar index. These coincided with
sharp dollar declines: The dollar
became the dominant price-moving
factor for soybeans.

Market selection
To design an intermarket system
based on this analysis, we need to
decide which market has the best
predictive correlation for soybeans.
However, the main purpose of a
predictive model is not to select a
commodity with the highest correla-
tion value from a contemporaneous
correlation analysis but to find a
predictive market that produces dis-
parities between forecasted and
observed values that warn you of
dangers and opportunities well




The correlation with the dollar index increased dramatically during periods of rising
volatility and sharp dollar declines. other market (top half of the
table), while higher correla-
tions with the positive lag
numbers indicate soybeans
are leading the other market.
The table shows there was
no significant lead or lag rela-
tive to soybean oil and soy-
bean meal, but soybeans
lagged corn considerably and
led the dollar and wheat. The
lead on the dollar seemed
counterintuitive; a closer look
at Figure 1, however, confirms
the correlation analysis, as it
was evident soybeans bot-
tomed at least a week before
the dollar peaked and topped
before the dollar bottomed.
The correlation analysis
Data source: Reuters revealed that except for soy-
bean oil and soybean meal,
bean price percent changes were shifted both forward and corn had the most consistent correlation during both time
backward in time, and the lagging or leading correlation to periods. Also, it was the only commodity that led soybeans.
related commodities was calculated. The second-best selection was soybean oil because of its
In Table 3 the first column shows the number of days soy- higher correlation with energy futures (Table 1), which had
bean data was shifted forward or backward in time: “+1” the potential to add new information influencing price
indicates yesterday’s soybean weekly price change was cor- dynamics.
related with today’s weekly price change in the other mar- Having determined the most appropriate commodities,
ket, while “-1” indicates tomorrow’s soybean weekly price the next task is to develop a mechanical trading system to
change was correlated with today’s weekly price change in exploit divergences in their relationship. There are several
the corresponding commodity. Higher correlations with methods for calculating the divergence between two corre-
negative lag numbers indicate soybeans are lagging the lated markets. This test used the regression equation to pre-
dict the likely values of the predict-
TABLE 3 — LEADING OR LAGGING? ed market (soybeans) based on the
Soybeans showed no significant lead or lag relative to soybean oil and soybean values of a correlated market
meal, but they lagged corn considerably and led both the dollar and wheat. (corn). The divergence between the
predicted value and the actual
Lag (days) BO SM C W DXY
value is then calculated; a buy sig-
-3 0.302 0.339 0.249 0.117 -0.089
nal is triggered when the diver-

-2 0.442 0.510 0.354 0.176 -0.138

gence reaches a certain extreme
-1 0.578 0.668 0.450 0.233 -0.183
0 0.728 0.843 0.561 0.329 -0.201
Because divergence values vary
+1 0.571 0.667 0.434 0.256 -0.186
according to the market, the

+2 0.437 0.497 0.315 0.193 -0.145

Intermarket Momentum oscillator
+3 0.292 0.333 0.190 0.132 -0.109
(IM) was used to normalize them
on a scale of zero to 100. The calcu-


Related reading
lation of this indicator is similar to the stochastic Book:
oscillator, but it is designed to be applied to an Intermarket Trading Strategies by Markos Katsanos
indicator instead of price because it ignores intra- (2009, Wiley Trading).
Note: The proprietary indicators in this article are covered in greater
day extreme values. Buy signals are generated
detail in this book.
when the indicator reaches a peak above a cer-
tain level (usually 80-85) and subsequently Articles:
declines. Similarly, sell signals are triggered “Stock index spreads: S&P vs. Naz”
when the indicator reaches a bottom below a cer- Active Trader, May 2006.
tain level (usually 10 to 15) and rises. They aren’t often the subjects of spread trading, but the obvious con-
We tested a simple regression-divergence sys- nections and subtle differences of various stock index futures offer
tem, first using corn and then soybean oil. The opportunities to play one market off the other. (Note: This article is
soybean-corn combination produced slightly also part of two discounted article collections: “Keith Schap: Futures
better results on a total profit basis but the soy- Strategy collection, Vol. 1” and “Stock index futures trading collec-
bean-soybean oil combination produced a higher tion.”)
profit factor, so both commodities were used in a
“Getting technical with John Murphy”
combined system.
Active Trader, September 2001.
Noted analyst, author and money manager John Murphy discusses
For information on the author see p. 5.
what he has learned about the technical approach to trading during
his 30-plus-year career, including intermarket analysis.
Note: The May issue of Active Trader magazine
(http://www.activetradermag.com) has an expanded
You can purchase and download past articles at
version of this article that includes test results of a
trading system based on this analysis.

Three good tools for targeting customers

Bob Dorman Allison Chee Mark Seger
Ad sales East Coast and Midwest Ad sales West Coast and Southwest Account Executive
bdorman@activetradermag.com achee@activetradermag.com seger@activetradermag.com
(312) 775-5421 (415) 272-0999 (312) 377-9435



Land softly with

butterflies and condors
Both positions are well-suited for volatile markets
Strategy Snapshot
Strategy: Call butterfly spread. because they have fairly wide profit ranges.
Components: Buy one call, sell two calls at a higher
strike, and buy another call at an even
higher strike. BY FREDERIC RUFFY
Logic: Time decay erodes the short calls’ time
value to a greater degree than the ITM

long call’s value.
n times of economic uncertainty and market volatil-
Criteria: Calls are spaced at equidistant strike ity, investors have fewer places to turn. The Dow
prices. Short strike is placed at the Jones Industrial Average was down roughly 44 per-
underlying’s target price. Use options
cent year-to-date at its Nov. 21 nadir with daily
that expire in fewer than 45 days.
ranges around 5 to 6 percent. Mutual funds are getting
Best-case Underlying closes at the short strike hammered and, in October, stock funds lost more than $1
scenario: at expiration. All short calls expire trillion, or 20 percent of their assets, according to the
Investment Company Institute.
Worst-case Underlying moves beyond one of the Crude oil and other commodities have been in freefall.
scenario: long protective wings. The maximum Bonds are performing well, but with the yield on 10-year
loss is the spread’s cost. Treasuries at 2.4 percent on Dec. 16 and corporate bonds’
Possible Create a condor instead by selling two default risk still high, the bond market also looks dicey.
modifications: strike prices instead of just one. Fortunately, investors can turn to the options market to
Chances of earning maximum profit create a variety of pre-defined risk-reward opportunities.
are increased. Directional butterflies and condors are two option spreads


The trades executed on Nov. 19 have all the characteristics of a butterfly spread: They occurred at the same time, and the
trader sold the 78 strike and bought the 81 and 75 strikes in a ratio of 2:1.

Quantity Symbol Expiration month Strike Type Price Bid/ask side Exchange Time
278 GLD December 78 Calls $2.41 Bid side ISE 9:45:26
139 GLD December 81 Calls $1.64 Ask side ISE 9:45:26
139 GLD December 75 Calls $3.58 Ask side ISE 9:45:26
Source: Trade Alert


that risk a little for a
By purchasing a December GLD 75/78/81 butterfly, you are risking $0.40 to make $2.60 if GLD
chance to earn a great
climbs from $74 to $78.
deal if the underlying
GLD traded at $74 on Nov. 19. moves in the desired
Position Long/short Strike price Expiration month Credit/debit direction.
Wing 1 call Long 81 December -$1.64
Body 2 calls Short 78 December $4.82 Flying with
Wing 1 call Long 75 December -$3.58 a butterfly
Butterfly spreads are
Total debit: -$0.40 best known as range-
Max. gain: $2.60
bound strategies, but
Upside breakeven point: $75.40
they also work well if
Downside breakeven point: $80.60
you have an underly-


ing directional forecast. One drawback FIGURE 1 — GOLDEN OPPORTUNITY?
is they require multiple trades, which If you were bullish on the SPDR Gold Trust on Nov. 19, you could enter a
increases commission costs. However, 75/78/81 butterfly in December options, which could earn $2.60 per share if
commissions have dropped in recent GLD rallies to the $78 short strike within a month.
years, meaning butterflies have
become practical even for retail
Because a butterfly is an advanced
strategy, investors should practice on
paper before trading it with real
money. The trade can be created with
only puts or calls or both (i.e., an
“iron” butterfly).
A long call butterfly has three main
components: one long in-the-money
(ITM) call, two at-the-money (ATM)
short calls at a higher strike price, and
an out-of-the-money (OTM) call at an
even higher strike. The two short calls
create the butterfly’s “body,” and the
other two strikes form the “wings.”
Ideally, after entering a call butterfly
spread, the underlying’s price will
Source: eSignal
continued on p. 18

FIGURE 2 — RISK PROFILE — BUTTERFLY traders prefer to focus on options with

fewer than 45 days left until expira-
This bullish December 75/78/81 butterfly gains up to $2.60 per share if GLD tion.
climbs from $74 to the $78 strike by Dec. 20 expiration (solid line). But it will still
make money if the SPDR Gold Trust trades between $75.40 and $80.60.
A golden butterfly
Let’s look at a specific example in the
SPDR Gold Trust (GLD). Unlike most
exchange-traded funds (ETFs), GLD
doesn’t hold shares of individual com-
panies. Instead, it holds the precious
metal and allows you to bet directly on
gold’s direction. Let’s assume you are
bullish on the yellow metal and antici-
pate price will gradually move higher
from its Nov. 19 price of $735 an ounce
to $775 in one month.
At that point, GLD traded at $74 —
about one-tenth of gold futures (GC).
Options on GLD are spaced at one-
point strikes prices (84, 85, 86, etc.),
which offers many choices for butter-
flies. With a target price of $78 in the
SPDR Gold Trust ($775 in gold
Source: OptionVue futures), the December 78 call will be
this butterfly’s short
(center) strike.
Table 1 shows an
A condor is similar to a butterfly, but it has four strike prices instead of three. This condor risks options chain for select
$0.46 to earn a maximum profit of $2.54, and it is more likely to earn that amount than the December GLD calls
butterfly from Table 2.
on Nov. 19. The day’s
GLD traded at $74 on Nov. 19. order flow shows
Position Long/short Strike price Expiration month Credit/debit another trader has
Wing 1 call Long 82 December -$1.52 entered a butterfly. At
Body 1 call Short 79 December $2.23 9:45 a.m. ET, 278 GLD
Body 1 call Short 78 December $2.41 December 78 calls
Wing 1 call Long 75 December -$3.58 traded at the bid price
of $2.41 per contract.
Total debit: $0.46 Meanwhile, half as
Max. gain: $2.54 many (139) December
Upside breakeven point: $81.54 81 and 75 calls traded
Downside breakeven point: $75.46 at the ask prices of
$1.64 and $3.58,
move toward the short strike, and the short calls will expire The collective action has all the characteristics of a but-
worthless. However, the lower-strike long call will retain terfly spread: The trades occurred at the same time, and the
most of its value. The trade generates profits, because time trader sold the 78 strike and bought the 81 and 75 strikes in
decay erodes the short calls’ value to a greater degree than a 2:1 ratio.
the long ITM call’s. The highest-strike call is merely a To calculate a butterfly spread’s cost (excluding commis-
hedge, which expires worthless if the trade works as sions), add the long calls and subtract the short ones. For
planned. example, Table 2 shows the GLD December 75/78/81 but-
Because butterflies exploit time decay, it makes sense to terfly costs $0.40 (long strikes [$3.58 + $1.64] minus short
use shorter-term options. Options that expire sooner lose strike [$2.41*2]). The butterfly’s maximum loss is $0.40 per
time value at a faster rate than options that expire later, spread, excluding any risk from dividends, which reduce a
because time decay is non-linear in nature. Many butterfly call’s value. Its maximum gain is $2.60 ($3 strike-price dif-


The condor’s largest profit is between its two short strikes of $78 and $79.
ference minus $0.40 cost), so you are
risking $0.40 to make $2.60.
Figure 1 shows a daily chart of GLD
with the butterfly’s highlighted strike
prices, and Figure 2 shows the
spread’s potential gains and losses on
three dates: trade entry (Nov. 19, dot-
ted line), halfway to expiration (Dec.
5, dashed line), and expiration (Dec.
20, solid line).
The GLD December 75/78/81 but-
terfly has a very bullish bias. It will
only make money if the gold ETF ral-
lies, and its largest profit occurs at $78
— 5.4 percent above its entry price.
The spread’s downside breakeven
point is $75.40, so the trade will lose
money if GLD fails to climb that far.
However, the upshot is its wide Source: OptionVue
profit range, which makes the position
attractive in uncertain times. As long Remember, the butterfly risked stop, if the underlying doesn’t move
as GLD settles between $75.40 and $0.40 to make it up to $2.60. Also, the within the profit range after a certain
$80.60 (its upside breakeven point) at condor’s profit range is smaller than time period (e.g., one week, two
expiration, the butterfly will gain the butterfly’s ($75.46 to $81.54 vs. continued on p. 20
ground. $75.40 to $81.60, respectively).
Figure 3 shows the condor’s poten-
Cruising with a condor tial gains and losses, and Figure 4
Instead of trading a butterfly, you can compares the condor’s risk profile
trade a condor, which offers a greater with the butterfly’s (red and blue lines,
chance of earning maximum profits. A respectively). Admittedly, the butter-
condor is similar to a butterfly, but it fly can earn slightly more and its prof-
has four strike prices instead of three. it range is wider.
The difference is a condor’s body has But Figure 4 clearly shows the con-
two strike prices compared to only one dor offers a better chance of extracting
for a butterfly. However, the goal the maximum possible profit of $2.54.
remains the same — wait for the short The condor’s largest profit is between
options to expire worthless. its two short strikes of $78 and $79.
Let’s create a condor on GLD and With a butterfly, however, you will
compare it to the butterfly example. earn significantly less if the SPDR
Table 3 lists the condor’s four Gold Trust closes at $79.
December calls: short 78 and 79 strikes
and long 75 and 82 strikes. The short Stops, assignment,
78 and 79 calls form the condor’s body, and commissions
and the long 75 and 82 strikes form the Managing risk is the key to success-
protective wings. fully trading butterflies and condors
To calculate a condor’s cost, subtract over the long haul. If the underlying
the long calls’ cost from the short calls’ fails to move within the profit range,
collected premium. Table 3 shows the all calls will likely expire worthless,
condor costs $0.46 per spread ($1.52 + and you will lose the spread’s cost.
$3.58 - $2.41 - $2.23). It costs slightly Even if that loss is small compared to
more to trade a condor, and the extra the potential profit, 100-percent losses
cost also increases its risk. The condor can mount over time.
risks $0.46 to earn a maximum profit Stop losses can lessen the risk of los-
of $2.54. ing a spread’s entire cost. With a timed




The butterfly can earn slightly more than the condor (blue and red lines, respec- weeks, three weeks, etc.), you exit the
tively) and its profit range is wider, but the condor has a better chance of earn- trade. Trailing stops can be set below
ing its largest gain of $2.54 per share. the underlying, so the trade is closed
if it falls, say, 5 percent from a previ-
ous high. A third type of stop tracks a
spread’s value. If, for example, you
pay $1 for a spread and its value falls
to $0.50 (50 percent), then exit the
Understand the risks of assignment
at expiration as well. If the ITM calls
(or puts) are held until expiration,
they may be assigned, forcing you to
buy or sell the underlying and pay
commissions. How will this affect
your account balance, and how will
your broker handle the assignment?
If the butterfly or condor is prof-
itable, it might make sense to exit on
expiration Friday even if you leave
some money on the table. By side-
Source: OptionVue stepping assignment, you also avoid
any unexpected market moves
between expiration Friday’s close
Related reading: Frederic Ruffy article when positions are exercised.
Sometimes it might be optimal to
“Backspreads and ratio spreads,” Futures & Options Trader, October 2007. exercise the deep in-the-money call to
Which options spread is preferable when you’re expecting an explosive get the maximum profit from the
underlying move? trade. If you aren’t sure, discuss it
Other articles: with your broker and they can guide
“Directional butterfly spreads,” Options Trader, December 2006. Finally, consider the commission
Placing a butterfly spread near a price target establishes a wide, low-risk costs of butterflies and condors. Some
profit zone. brokers charge more for four-legged
“Options Strategy Lab: Directional butterflies on the S&P 500” strategies (condors) than three-legged
Options Trader, November 2006. strategies (butterflies). Find out how
This system uses butterfly spreads to make directional bets by placing the short much your broker charges per con-
strike near a price target. tract, and if you are serious about
becoming a spread trader, find a firm
“Option butterflies: A safer way to sell volatility”
Options Trader, July 2005. that specializes in these types of
Long butterfly spreads allow you to profit from time decay of short options — but trades.
with the added benefit of providing a “safety net” around your position.
Trade with confidence
“Options Strategy Lab: Employment report iron butterfly” In times of uncertainty, it’s important
Futures & Options Trader, April 2007.
to trade with confidence. Developing
Playing the monthly jobs report with an options spread.
a trading plan with exit rules is a
“The butterfly in the iron mask,” Options Trader, November 2005. good start. Using options helps
Does the iron butterfly have any advantage over its generic counterpart? because many strategies have clearly
We unmask this strategy to find out how it really works. defined risk-reward profiles that you
You can purchase and download past articles at http://store.activetradermag.com. can study before entering a trade.

For information on the author see p. 5.



Applying a simpler volatility measure

A close look at the gain-loss spread demonstrates how it can pinpoint volatility patterns
that standard deviation might miss.


I n the wake of last year’s stock market collapse, every-

one seems to be talking about volatility. However, few
investors really understand what volatility is and how
to calculate it. Volatility is typically measured by standard
deviation, a somewhat abstract concept for most investors.
subtle differences between the volatilities of two underly-
ing markets that options traders focusing on standard devi-
ation may overlook. In short, the gain-loss spread can help
you uncover trading opportunities that the options-trading
crowd neglect. (Estrada’s study can be downloaded from
Luckily, there are more tangible ways to measure volatility http://papers.ssrn.com/sol3/papers.cfm?abstract_id=130
including a new calculation introduced by Professor Javier 8103.)
Estrada from the IESE Business School in Spain.
Professor Estrada’s volatility measure is called the gain- Gain-loss spread basics
loss spread (GLS), which is easier to understand and is To calculate the gain-loss spread for a stock, first select a
explained in a recent issue of Active Trader (see “A simpler historical time period — one year, for example. Next, break
volatility measure,” April 2009). This discussion reviews the time period into intervals of 52 weeks. Finally, ask four
how the GLS is constructed and shows how it can uncover simple questions:

FIGURE 1 — FLOWERS FOODS 1. In how many of the 52 weeks did

the stock go up?
Flowers Foods ranged from roughly $23 to $33 over the past year, but more
2. In how many of the 52 weeks did
definitive conclusions about its volatility are hard to draw from this weekly price
chart. the stock go down?
3. For the up weeks, what was the
average percentage gain?
4. For the down weeks, what was
the average percentage loss?

The weekly gain-loss spread is cal-

culated directly from these four num-

• The probability of gain is

estimated as the number of up
weeks divided by 52.
• The probability of loss is
estimated as the number of
down weeks divided by 52.
• The gain loss spread is the size
of the average percentage gain
times the probability of gain,
minus the size of the average
percentage loss times the
probability of loss.


Is the gain-loss spread useful? FIGURE 2 — WEEKLY MOVES (FLO)
Figure 1 shows a weekly chart of
The gain-loss spread for Flowers Foods indicates it is expected to vary by 4.1
Flowers Foods, Inc. (FLO) for the 52- percent (up or down) in any given week.
week period ending Jan. 30. Figure 2
shows FLO’s weekly percentage price
changes over the same period as well
as its average weekly percentage gain
(green line) and loss (red line).
Flowers Foods increased in 23 of the
52 weeks, and it dropped in 29 of those
weeks. The average gain for the 23 up
weeks was 4.0 percent, and the average
loss for the 29 down weeks was 4.2 per-
cent. In calculating the GLS, the aver-
age upside gain is weighted by the
fraction 23/52, which is an estimate of
the probability of gain; the average
downside loss is weighted by the frac-
tion 29/52, which is an estimate of the
probability of loss. The GLS is calculat-
ed as follows:

Weekly GLS = 23/52 * (4.0%) -

29/52 * (-4.2%) = 4.1%

Estrada’s article provides convincing

evidence that the gain-loss spread is at
least as good — and in some ways bet-
ter — than standard deviation as a
measure of stock-price volatility. One of
its big benefits is simplicity.
Using the GLS, Flowers Foods’
volatility can be expressed as follows:
In a typical week, Flowers Foods is
expected to vary by 4.1 percent (up or
down) from the prior week’s close. That
is a simple, tangible statement about
Using standard deviation, Flowers
Foods’ volatility is harder to grasp: The
square root of the average quadratic
deviation from Flowers Foods’ arith-
metic mean return is expected to be 36

Painting a volatility picture

Unlike Figure 1, Figure 2 reveals a fin-
gerprint of Flowers Foods’ volatility.
What can be learned from studying this
chart? First, the distance between green
continued on p. 24



FIGURE 3 — WEEKLY MOVES (RTN) and red lines is a simple indicator of

average volatility — the farther apart
Raytheon has a much different volatility pattern than Flowers Foods (Figure 2).
In early 2008, RTN’s volatility was low, but it increased steadily during the year, these lines are, the higher the volatili-
climaxing with a 17-percent weekly loss in October and a 16-percent gain three ty.
weeks later. Figure 2’s individual bars represent
weekly percentage moves that lead to
a certain level of volatility; they are
the spread’s sole components. Bars
that exceed the green line indicate
unusually strong weeks. Flowers
Foods had only two really strong
weeks, one in July and one in October
(8- and 13-percent gains, respective-
Bars extending below the red line
show losses exceeding the average
weekly loss of 4.2 percent. There were
8 such weeks, all of them in the sec-
ond half of 2008 (three exceeding 10
A pattern of FLO’s volatility
emerges over time. Flowers Foods
was relatively stable in the first half of
2008 as up and down weeks were
evenly distributed and mostly con-
tained within the two average lines.
By contrast, the second half of 2008
Raytheon had a bad year in 2008 as it plunged 34 percent from mid-September was much more volatile, especially on
to mid-October. the downside.
Weekly GLS charts show price
action through a new and different
lens. Instead of simply using a stan-
dard deviation value for volatility,
you are studying underlying informa-
tion that drives option prices — a
deeper level of detail.

Comparing volatilities
of different stocks
Let’s use weekly gain-loss charts to
compare the volatility of Flowers
Foods with Raytheon (RTN), which
has a one-year standard deviation of
30 percent (similar to FLO). Figure 3
shows RTN’s weekly gain-loss chart,
and Figure 4 shows its weekly bar
If you compare Figures 2 and 4, you
will notice Raytheon has a much dif-


The difference in GLS percentage values for FLO and THI is relatively large (4.1
vs. 4.6 percent, respectively), a discrepancy that doesn’t appear in their stan-
dard deviations.

ferent volatility pattern than Flowers

Foods. In early 2008, RTN’s volatility
was low, but it increased steadily dur-
ing the year, climaxing with a 17-per-
cent weekly loss in October and a 16-
percent gain three weeks later.
Meanwhile, FLO’s volatility was more
Figure 4’s weekly bar chart shows
both price trends and volatility — the
two kinds of information are inter-
mixed. Clues about volatility are often
ignored because your attention is
drawn to the stock’s directional move-
ment. For example, the first thing you down) in half of those weeks during cent on a weekly basis. By contrast,
probably notice about Figure 4 is that that period and moved more than 15 Flowers Foods (Figure 2) showed a
Raytheon had a very bad year. But percent at least once. This differs much more consistent volatility pat-
Figure 3’s GLS chart helps you focus sharply with the first half of the year, tern.
solely on volatility. when THI often swung less than 3 per- continued on p. 26
Comparing Tim Hortons (THI) to
Flowers Foods makes more sense,
because its stock moves and volatility
were similar in 2008. Table 1 lists three
measures of volatility for both stocks:
100-day standard deviation, one-year
standard deviation, and weekly gain-
loss spread.
The 100-day standard deviations are
essentially the same — 54 percent
(FLO) and 52 percent (THI). These val-
ues are based on 100 trading days and
are sometimes used in theoretical
option-pricing models. The one-year
standard deviation values are smaller
than their 100-day counterparts, mean-
ing the most recent 100 days have been
more volatile than the entire previous
year. Both calculations show similar
Figure 5 shows a weekly gain-loss
chart for THI. The difference in GLS
spread values for FLO and THI is rela-
tively large (4.1 vs. 4.6 percent, respec-
tively), a discrepancy that doesn’t
appear in their standard deviations.
THI volatility was dominated by
several explosive weeks in the fourth
quarter of 2008, according to Figure 5.
THI lurched at least 10 percent (up and




The standard deviations for Flowers Foods and Tim Hortons are about the same,
The next step is to show how but their weekly GLS percentages are wider apart.
options traders can use this dis-
100-day 1-year Weekly
crepancy to find potential trade Stock standard standard gain-loss
opportunities. Stock price deviation deviation spread
Flowers Foods, Inc. (FLO) $21.50 54% 36% 4.1%
Parsing options prices
Tim Hortons Inc. (THI) $24.50 52% 41% 4.9%
Because the standard deviations
and stock prices of Flowers Foods
and THI are similar, you would expect their options to be values (price minus amount in the money) roughly match.
priced about the same. Table 2 lists the details of several Figure 6 plots both stocks’ July call prices (y-axis) against
July 2009 calls on FLO and THI and shows their extrinsic the amount they are in the money (x-axis). The data fall


The July calls for Flowers Foods and Tim Hortons have similar prices (if you examine their extrinsic values).

Flowers Foods Inc. Tim Hortons Inc.

Stock price $21.50 $24.60
Amount in Option Extrinsic Amount in Option Extrinsic
Option Strike price the money price value the money price value
July 20 call $20.00 $1.50 $3.40 $1.90 $4.60 $5.70 $1.10
July 22.5 call $22.50 -$1.00 $2.10 $3.10 $2.10 $3.90 $1.80
July 25 call $25.00 -$3.50 $1.30 $0.00 -$0.40 $2.55 $0.00
July 30 call $30.00 -$8.50 $0.40 $0.00 -$5.40 $0.85 $0.00

Related reading: George Hoekstra articles

“A simpler volatility measure,” Active Trader, April 2009. ture a search that focuses on a certain stock price, exercise
Measuring volatility with standard deviation can be confus- price, and expiration date, and then use a simple analysis
ing for some traders. The gain-loss spread is a new volatility approach to identify options that are the most underpriced.
formula that is easier to grasp.
“The option pricing edge” Options Trader, October 2005.
“Who buys options?” Buying options at a 10- to 20-percent discount can be the
Futures & Options Trader, November 2008. difference between making and losing money over time. A
An academic paper analyzing who trades different types of popular trading approach is to buy options on a stock you
options strategies offers clues for successful trading. expect to have more volatility than the level implied by the
price of its options. Higher volatility translates into higher
“The quest for cheap options” option prices, so if your assessment of future volatility is
Futures & Options Trader, August 2008. correct, such options give you an advantage in that higher
This option-buying strategy builds on a recent academic actual volatility increases the chance of a profitable trade.
study that found a compelling edge in the options market
from 1996 to 2005. “Bargain hunting options”
Active Trader, January 2005.
“Getting a handle on volatility” If you get the willies every time read “standard deviation,”
Options Trader, September 2006. take heart: This volatility analysis approach and option trad-
Want to understand volatility? Before you dive into option- ing strategy takes the mathematical sting out of finding inex-
pricing models and complex math, do some basic price pensive options.
comparison. You’ll be surprised how much you can learn.
You can purchase and download past articles at
“Focusing on volatility,” Options Trader, August 2005. http://store.activetradermag.com/
To hone in on options with the most favorable odds, struc-


along a single trend line, showing FIGURE 6 — OPTIONS PRICING — FLO VS. THI
option prices are equivalent for these The options prices of both stocks fall along a single trend line, showing they
two stocks. This trend line crosses the are equivalent.
x-axis at $2.50, which represents the
cost of an at-the-money (ATM) July
call for both stocks.
In short, the options market doesn’t
care about the difference in volatility
patterns of FLO and THI. Option
prices reflect both stocks’ average
volatility as measured by the stan-
dard deviation. They are indifferent
to the manner in which volatility has
changed over time.
Again, the weekly gain-loss charts
in Figures 2 and 5 highlight signifi-
cantly different volatility patterns in
FLO and THI, but their options are
priced identically. How can you
exploit this situation? To answer this
question, dig deeper to diagnose their
volatility patterns. Flowers Foods was
relatively stable, but THI has been
more sensitive to something going on
in the market or in its business.
Whatever the cause, is it likely to con-
tinue in the next few months? If you
believe it will, then you would want
to buy options on THI instead of FLO.
By examining recent news on a
stock, you can uncover reasons why
particular large moves occurred when
they did. First, find out what type of
news broke when FLO and THI made
unusual weekly moves last year. Were
these moves driven by market or
company-specific events? Also, deter-
mine if other noteworthy events
occurred in the same week; if so, do
they tend to recur? Volume trends can
also pinpoint patterns of when large
price moves occur.
The goal is to figure out what is
driving the volatility of these stocks.
By answering these questions, you
may discover clues that reveal how
volatility may unfold in the future. If
so, you can then enter an options
position to take advantage of this

For information on the author see p. 5.



The return of the short butterfly

Market: Options on the S&P 500 index (SPX). This strategy trade doesn’t need a one-standard-deviation move to become
could also be applied to other equity indices, ETFs, and profitable, but time decay works against it. Thus, a number of
stocks with liquid options contracts. stop-loss rules were added to ensure the trade is closed if the
S&P 500 index had not moved substantially (at least 10 points
System concept: Short butterflies are options spreads that beyond either short strikes) before options expiration.
tend to perform well in volatile mar-
kets. These positions were first test- FIGURE 1 — SHORT BUTTERFLY SPREAD
ed on the S&P 500 index back in
2006, and they lost money in part This short butterfly risks $9,500 to make $500 — a poor risk-reward ratio. However, this
because market volatility had dried trade will be profitable if the S&P 500 moves only 20 points (up or down) by expiration.
up over the previous five years.
Now that volatility has returned
with a vengeance, let’s examine
whether short butterflies are effec-
tive ways to exploit current volatile
conditions. The following study
compares the original test’s results
(2001 to 2006) to the overall per-
formance from 2001 to 2008.
Short butterfly spreads contain
long options at one strike price and
half as many short options at equi-
distant strike prices both above and
below that strike. The spread results
in a credit to your account, because
the long options cost less than the
short ones. And the position is prof-
itable only if the underlying moves
substantially (up or down) by
options expiration.
A short butterfly resembles a long Source: OptionVue
straddle (long call + long same-
strike put) because it profits from an FIGURE 2 — SHORT BUTTERFLY PERFORMANCE
underlying move in either direction.
This strategy’s win/loss ratio was significantly better over the past two years, and it
However, short butterflies aren’t as
gained 20 percent since January 2001.
expensive as long straddles, so they
can profit from smaller underlying
Figure 1 shows the potential gains
and losses of a short butterfly placed
on the S&P 500 on Nov. 21, 2008 and
held until Dec. 19, 2008. The spread
contained 10 long 800 December
calls, 5 short 780 December calls, and
5 short 820 calls. It will make money
if the S&P 500 finishes above the
higher short strike (820) or below the
lower short strike (780) at expiration
(Dec. 19).
The short butterfly has an unat-
tractive risk-reward ratio. Figure 1
shows the spread could lose up to
Source: OptionVue
$9,500, and it can earn only $500. The


Trade rules: Overall, the strategy’s average loss ($1,258.37) was more
than its average gain ($1,117.60) since 2001. This approach
Entry performed poorly when volatility (both IV and the actual
1. Buy 10 at-the-money (ATM) calls. volatility of the asset) was low on a historical basis and con-
siderably better when it was high. Incorporating this into
2. Sell 5 calls 20 points above the ATM strike the trade rules might lead to a better success rate.
and sell 5 calls 20 points below this level.
—Steve Lentz and Jim Graham of OptionVue
3. All options are in the second expiration month
available in the S&P 500 index.
Option System Analysis strategies are tested using OptionVue’s
BackTrader module (unless otherwise noted).
Exit on Friday before expiration if any of the
following conditions occur: If you have a trading idea or strategy that you’d like to see tested,
please send the trading and money-management rules to
1. The S&P 500 trades between the short strikes. Advisor@OptionVue.com.

2. The S&P 500 is trading within 10 points of either

short strike (i.e., not more than 10 points below
the lower strike or 10 points above the upper Orig. test Updated test
strike). 1/18/01 to 1/18/01 to
5/12/06 12/19/08
3. If the SPX is outside this range on Friday before Net return: -$2,755.00 $4,005
expiration, monitor the spread and close it if the Percentage return: -13.8% 20%
S&P 500 hits either short strike. Otherwise, let
Annualized return: -2.4% 2.5%
the options expire.
No. of trades: 68 95
Winning/losing trades: 34/34 52/43
4. Always open a new position on the same day as
exiting the old trade. Win/loss: 50% 55%
Avg. trade: -$40.51 $42.16
Largest winning trade: $2,280.00 $2,280.00
Test details: Largest losing trade: -$2,870.00 -$2,870.00
• The test account began with $20,000. Avg. profit (winners): $1,218.38 $1,117.60
• Commissions were $5 base fee plus $1 per Avg. loss (losers): -$1,299.41 -$1,258.37
option. Avg. hold time (winners): 33 33
• Prices executed between the bid and ask, when Avg. hold time (losers): 27 27
available. Otherwise, theoretical prices are used. Max consec. win/loss: 4/4 8/4
• Daily closing prices were used.

Test data: The system was tested on LEGEND:

cash-settled S&P 500 index (SPX) options Net return – Gain or loss at end of test period.
at the CBOE. Percentage return – Gain or loss on a percentage basis.
Annualized return – Gain or loss on a annualized percentage basis.
Test period: Jan. 18, 2001 to Dec 19, 2008. No. of trades – Number of trades generated by the system.
Winning/losing trades – Number of winners and losers generated by the system.
Test results: Figure 2 tracks the short Win/loss – The percentage of trades that were profitable.
butterfly strategy’s performance, which Avg. trade – The average profit for all trades.
gained $4,005 (20 percent) over the eight- Largest winning trade – Biggest individual profit generated by the system.
year test period. Overall, there were 95 Largest losing trade – Biggest individual loss generated by the system.
butterfly trades since January 2001 and 55 Avg. profit (winners) – The average profit for winning trades.
percent were profitable. By contrast, the Avg. loss (losers) – The average loss for losing trades.
same approach lost $2,755 (13.8 percent) in Avg. hold time (winners) – The average holding period for winning trades (in days).
the original test from January 2001 to May Avg. hold time (losers) – The average holding period for losing trades (in days).
2006, a period in which the CBOE Volatility Max consec. win/loss – The maximum number of consecutive winning and losing trades.
index fell below 10, an all-time low.



Option adjustments
The option you traded last week might be a different creature altogether
after a special dividend, stock split, or merger occurs.

D ividend payments, stock splits, and mergers

all affect stock prices. When dividends are
paid, the stock price drops by the same
amount, a split lowers a stock’s price because
more shares are issued, and mergers often result in a new,
higher-priced stock.
Stock options are also affected by dividends, stock splits,
For example, if the dividend was $3.60, a $30 strike would
need to be reduced to $26.40, which can’t be expressed in a
one-eighth increment. In this case, the cash difference ($3.60
per share) would likely be added to the option’s premium.
The contract’s symbol would be adjusted to reflect this
change, but the strike price codes (the symbol representing
the contract’s strike price) and the number of shares remain
and mergers, but the changes they the same.
undergo aren’t as straightforward as
the ones in the underlying stock
Before trading options, Sometimes companies will pay div-
idends by issuing additional shares of
because option contract details are stock, in which case the OCC will
sometimes changed by the Options
it’s a good idea to check increase the number of shares an
Clearing Corporation (OCC) in option contract represents. For exam-
response to these events. if dividends, splits, or ple, if a company issues a 5-percent
Before trading options, it’s a good stock dividend, the options will now
idea to check if dividends, splits, or mergers are scheduled represent 105 shares instead of the
mergers are scheduled for the underly- usual 100 shares. Again, the option
ing stock. If so, you need to know how for the underlying stock. symbols will change to reflect the new
an option’s price will change, whether contract terms.
the contract’s terms may change, and when these changes Contract adjustments can be more complicated, such as
will occur. For dividends and splits, stock prices adjust on when a firm distributes both stock and cash. In such situa-
what is called the ex-dividend (“ex”) date; details are avail- tions the OCC may increase a contract’s share size and add
able at http://www.theocc.com a cash payout upon exercise.

Dividends Stock splits

When a company pays a dividend, its stock price drops by A company will typically announce a stock split after its
that amount on the ex date. Both the dividend amount and stock has rallied. The idea is to lower the stock’s price so
the ex date are usually announced well enough in advance more investors will be tempted to buy it. Let’s assume you
for the option premium to adjust accordingly. Call prices own 100 shares of a stock trading at $100 — a $10,000 posi-
drop and put prices increase in response. tion. If the company splits its stock two for one (2:1), the
Companies sometimes issue special dividends — those stock will drop to $50 on the ex date and you will receive
that are larger than usual or occur at irregular times. In another 100 shares and still own the same dollar position
these cases the OCC may adjust an options contract’s terms. ($10,000).
Recently the OCC decided to consider adjusting a contract For 2:1 or 4:1 splits, the OCC’s adjustment rules are quite
only if a special dividend is at least $12.50 per contract simple: The strike price drops and the number of option
(0.125 per share). Previously, the OCC used a threshold of contracts rises. For example, a 4:1 split on a $100 stock
10 percent of the contract’s price to make this decision. means a $100-strike option becomes four $25-strike options.
If a special cash dividend reduces the stock price in a one- In these cases, option ticker symbols are usually
eighth increment, the corresponding option strike prices unchanged.
will be changed. For example, if the dividend is $1.375 (1 Stock splits in irregular ratios of 3:2 or 4:3 result in the
3/8) per share, then strike prices will drop by that amount OCC adjusting an option contract’s share count, similar to
— i.e., an option originally with a $30 strike price would the way stock dividends are sometimes handled. After a 3:2
have its strike lowered to $28.625 ($28 5/8). The option’s split, strike prices remain unchanged, but each contract will
ticker symbol will change and a new code for the abnormal control 150 shares of stock. More complicated stock splits
strike price will be added. may prompt the OCC to add cash to a contract’s exercise
Alternately, the OCC may add the dividend in cash upon value delivery to compensate for fractional shares.
exercise, leaving the rest of the contract’s terms untouched. If a stock’s price has been beaten down, the company


may announce a reverse stock split that
increases its price and lowers the number of
shares outstanding. If a stock traded at $1 and
you owned 100 shares, a reverse 1:10 split
would drive the stock to $10, but you would
now own just 10 shares. At this point, all affect-
ed options contracts would control just 10
shares of stock.

Mergers and acquisitions

Two companies can join in myriad ways,
including transfers of stock, cash, or a mix of
both. Each combination affects the stocks of the
merging companies in different ways, which in
turn impacts any options that are scheduled to
expire after the official merger date.
All-cash transactions convert the relevant in-
the-money (ITM) options into cash when the
deals close; all-stock transactions change the
number of shares (and the stock type) each
option represents based on the merger’s
details. For example, if concert promoters
Ticketmaster (TKTM) and Live Nation (LYV)
merge in the first half of 2009, Ticketmaster
investors might get 1.384 shares of Live Nation
stock for each Ticketmaster share, and July
2009 options on Ticketmaster would be con-
verted to Live Nation options that control 138.4
If merger transactions include both stock
and cash, it could result in a combination of the
two upon delivery. In any case, the contract’s
symbol will most likely be altered to reflect the

In the money or not?

Many of these adjustments can alter how you
calculate whether a contract is in the money
and by how far. Let’s assume a stock trades at
$29, and a $30-strike call includes a $3.60 spe-
cial dividend payment. In effect, this adjust-
ment lowers the strike price to $26.40, so even
though the $30 call is technically out of the
money (OTM), it has an intrinsic value of $2.60.
Finally, if a special dividend or stock split
prompts the OCC to issue a new contract, it
may not be available to trade immediately after
the open on the ex date, and these new con-
tracts may initially have large bid-ask spreads
that make them difficult to trade.
The Options Industry Council’s Web site
(http://www.888options.com) has plenty of
examples of different options adjustments.
Because each adjustment is unique, however,
consult your broker or call the OIC if your con-
tract has been altered or if you believe a change
is pending.



CFTC’s new monthly report dresses up the weekly COT

The CFTC has released a new monthly report based on COT data.

O n Feb. 4, the Commodity Futures Trading Com-

mission (CFTC) began a six-month trial of a new
monthly report meant to enhance transparency
in the futures markets. “This Month in Futures Markets”
aggregates the previous month’s weekly Commitment of
tion, and/or other aspects of the markets themselves and
use the futures and options markets as a means to offset
their risk. These traders are often referred to as the “smart
money” because they are directly involved in the market
and should therefore have the best insight into where the
Traders (COT) data into an easy-to-digest format, complete market is headed.
with graphs and commentary on commercial and non-com- Non-commercials represent commodity trading advi-
mercial open interest for 22 different futures markets. sors, hedge funds, and other large institutional investors
looking for investment opportunities. Non-reportables are
Commitments of traders traders who are too small to need to report their positions
The COT report is released each Friday and displays the to the CFTC — generally, individual traders.
previous Tuesday’s levels of futures and options open inter- While the weekly report is fairly timely and contains
est in major markets. Broken down by exchange, the report a great deal of useful information, its presentation can be a
shows the number of open positions of commercial traders little off-putting. Consisting of basic tables in a text-only
(hedgers), non-commercial traders (large speculators), and format, digesting the information is easier said than done.
non-reportables (small speculators). It also highlights long, “It’s a little past due for a facelift,” says Jeff Harris, chief
short, and spread positions, as well as the number of economist for the CFTC. “One of the things we noticed
traders in each category, weekly changes, and the percent- last year was we were getting a lot of press calls and
age of open interest held by the largest four and eight [they] would say ‘You’re doing this research and you’re
traders in the market. doing these analyses, where are you finding this?’ So
Commercial traders represent companies and institu- we pointed them to the [COT] reports, but that requires
tions directly involved in the production, storage, distribu- a lot of user intervention to download, graph, compile,

House derivatives bill faces opposition

he House Committee on Agriculture, which over- “divert trading in highly regulated commodity and energy
sees the Commodity Futures Trading Commission futures markets to less-regulated OTC and foreign markets
(CFTC), approved the “Derivatives Markets accessible to U.S. investors but beyond the reach or
Transparency and Accountability Act of 2009” on Feb. 12, jurisdiction of the U.S. government,” while forcing OTC
after holding two days of congressional hearings that derivatives onto regulated exchanges would drive trade
brought more than 20 witnesses before the committee. It overseas.
will soon be heading for a vote in the House. The Chicago Board Options Exhange (CBOE) also issued
The bill, sponsored by Minnesota Democrat and chair- a statement saying that while they support the need for
man of the House Committee on Agriculture Collin revamped regulation, it should be through “a collaborative
Peterson, would broaden the authority of the Commodity process that includes the Obama administration, all
Futures Trading Commission to include oversight of OTC Congressional Committees with relevant jurisdiction, the
derivatives, set stringent trading limits on deliverable com- members of the President’s Working Group on Financial
modities, and would require OTC derivatives to be cleared Markets, and the private sector.”
on a CFTC- or (for financial derivatives) a Securities Democratic Representative Barney Frank, chairman of
Exchange Commission (SEC)-regulated exchange. Among the House Financial Services Committee, has also voiced
further provisions, the bill would also require greater infor- opposition to the bill. His committee oversees the SEC and
mation sharing between international regulatory bodies, the Federal Reserve, organizations that have also vied for
increased data reporting requirements, and would grant regulatory authority in this area. Frank had proposed a
the CFTC the ability to criminally prosecute violators of the Systemic Risk Regulator charged with assessing risk across
act’s provisions. all financial markets, along with a strengthening of the
Exchanges raised some opposition following the bill’s CFTC and SEC’s regulatory power. The proposed Systemic
approval for a House vote. The CME Group issued a Risk Regulator would most likely be part of the Federal
statement which claimed that increased trade limits would Reserve.


The CFTC’s new monthly report summarizes the previ- covers six categories: energy, agriculture, softs, financials,
ous month’s COT report into an easily digestible format. metals, and livestock. The summary page graphs several
This chart from the agriculture summary displays an years of open interest data for each category and breaks
open interest chart for corn as well as weekly and down monthly and yearly changes for each tracked com-
monthly changes for several other markets.
modity within each category for both futures open interest,
and combined futures and options open interest. Figure 1
displays the summary graph and figures from the January
report (released on Feb. 4), showing the open interest graph
for corn along with data for wheat, soybeans, and soybean
Each of the six categories is then broken down on indi-
vidual pages into their most heavily traded contracts. For
example, energy is broken down into crude oil, natural gas,
heating oil, and RBOB gasoline. Each page contains two
tables compiling the major data from each of the previous
month’s COT reports and eight sets of graphs displaying
several years of data.

Further enhancements in the wings?

While the report might seem to be just a shiny new package
for already-available information, its reception could play a
role in determining the nature of other reporting enhance-
Open interest Change from last ments from the CFTC. Using commentary gained during
1/27/09 Month Year the six-month trial, the new report could serve as a template
Corn Futures 798.4  -4.3  -626.6 for further attempts to increase transparency in the futures
Futures and options 1,227.5  -11.5  -777.3 markets.
Wheat Futures 278.9  31.5  -176.0 Harris says that depending on how well it is received, the
Futures and options 366.6  44.8  -225.3 new format could be expanded to cover all markets and
Soybeans Futures 322.5  43.7  -247.7 could possibly be released on a weekly basis. Reports such
Futures and options 458.8  79.7  -334.4 as the CFTC’s quarterly staff report on commodity swaps
Soybean Futures 207.7  -4.9  -75.8 dealers and index traders, first released in September 2008,
oil Futures and options 249.6  4.5  -82.5 could also be overhauled.
Source: http://www.CFTC.gov The CFTC also compiles information on specific hedge-
fund participation for internal use, which could also begin
and do the analysis.” to make its way to the public’s eye in some form. Harris
This Month in Futures Markets is the CFTC’s attempt to says there has been talk of providing price charts on the
provide a more accessible version of this information. It CFTC’s Web site as well. 

CFTC approves limit on grain delivery instruments

n Feb. 13, The Commodity Futures Trading ber of instruments that can be held by a non-commercial
Commission (CFTC) approved limits proposed firm in line with the spot month speculative limits already
by the Chicago Board of Trade (CBOT) on the in place.
number of delivery instruments, such as warehouse “We will monitor the effectiveness of this and other grain
receipts and shipping certificates, that can be held by a non- contract changes to see if convergence remains an issue
commercial entity in the grain markets. The move is the lat- requiring further action,” said acting CFTC chairman
est effort to improve the convergence of grain futures and Michael Dunn in the committee’s statement announcing the
spot cash prices, a problem which first arose in early 2008 as approval. The commission believes this new rule will also
commodity prices skyrocketed. reduce the grain market’s susceptibility to manipulation.
The limit applies to corn, mini-sized corn, wheat, mini- Non-commercial entities will have until May 31 to com-
sized wheat, oats, rough rice, soybean, mini-sized soybean, ply with the new rules, while soybean oil certificate holders
soybean oil, and soybean meal contracts. It brings the num- will have until Sept. 25.




CFE launches mini-VIX futures The VIX jumped as high as 89.53 in
October 2008, but in February dropped

he Chicago Futures Exchange tracks the implied volatility of S&P 500 to a range between 40 and 50.
(CFE), which is owned by the index options. The contract will be
Chicago Board Options Ex- priced off the VIX using a $100 multi-
change (CBOE), announced mini-sized plier, as opposed to the $1,000 multi-
versions of their VIX futures contracts plier used for the larger VIX futures
to begin trading in March. contracts (VX).
The new contracts, which will trade This cash-settled contract will ini-
under the symbol “VM,” will track the tially be available for March, April,
CBOE’s volatility index (VIX), which and May serial months, with a mini-

Top 10 option strategy traders ranked by January 2009 return.
(Managing at least $1 million as of Jan. 31, 2009.)

January 2009 YTD $ under

Rank Trading advisor return return mgmt.
1. JPS Capital Mgmt (JPS Fund) 19.39% 19.39% 4.2 Source: eSignal
2. Oxeye Capital Mgmt. (FTSE 100) 10.62% 10.62% 9.7
3. Financial Comm Inv (Option Selling) 9.23% 9.23% 13.1 mum tick size of $5 and reduced mar-
4. ACE Investment Strategists (DPC) 8.15% 8.15% 6.8 gin requirements compared to its larg-
5. Financial Comm Inv (CPP) 7.10% 7.10% 1.6 er counterpart.
6. HB Capital Mgmt (Diversified) 4.11% 4.11% 10.0 The launch comes on the heels of a
7. LJM Partners (Aggr. Premium Writing) 3.60% 3.60% 19.5 period of unprecedented volatility.
8. Harbor Assets 3.40% 3.40% 3.4 Shown in Figure 1, the VIX, often
referred to as the “fear gauge,” had
9. Crescent Bay Capital (BVP) 3.35% 3.35% 2.9
jumped to record levels after
10. LJM Fund Ltd 3.00% 3.00% 4.4
September 2008. It has since settled
Source: Barclay Hedge (http://www.barclayhedge.com) somewhat above 40, a level breached
Based on estimates of the composite of all accounts or the fully funded subset method. only a handful of times prior to the
Does not reflect the performance of any single account. jump in September.

Event: The World Money Show Event: Securities Operations World 2009
Date: March 17-19 Location: Hong Kong Date: May 27
Date: May 11-14 Location: Las Vegas Location: New York City
For more information: Go to For more information: http://www.fmwonline.com
http://www.moneyshow.com and click on “Events”
Event: The 15th Forbes Cruise for Investors
Event: 10th Free Annual Technical Analysis Expo Date: June 2-14
Date: March 20-21 Location: Lisbon to Venice
Location: Paris, France For more information: Go to
For more information: http://www.salonAT.com http://www.moneyshow.com and click on “Events”

Event: Capital Markets Boot Camp Event: International Trader’s Expo

Date: March 25-26 Date: June 3-6
Location: New York City Location: Los Angeles
For more information: http://www.fmwonline.com For more information: http://www.tradersexpo.com


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


FUTURES SNAPSHOT (as of Feb. 27)
The following table summarizes the trading activity in the most actively traded futures contracts. The information does NOT constitute
trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility.
See the legend for explanations of the different fields. Volume figures are for the most active contract month in a particular market and
may not reflect total volume for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity for CME futures
is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).
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 2.59 M 2.68 M -12.12% / 93% -12.87% / 93% -9.99% / 32% .36 / 90%
10-yr. T-note TY CME 605.8 964.6 -3.26% / 92% -1.84% / 55% -1.77% / 91% .25 / 55%
E-Mini Nasdaq 100 NQ CME 337.8 267.2 -10.30% / 90% -7.38% / 85% 2.06% / 27% .42 / 95%
5-yr. T-note FV CME 316.9 861.0 -0.91% / 38% -0.76% / 39% -0.03% / 0% .20 / 58%
Crude oil CL NYMEX 277.8 280.9 31.72% / 100% 8.01% / 46% -9.17% / 0% .24 / 100%
30-yr. T-bond US CME 227.7 669.3 -4.63% / 71% -3.10% / 32% -5.45% / 100% .20 / 37%
Eurodollar ED CME 225.8 1.26 M -0.09% / 29% -0.21% / 62% 0.57% / 9% .06 / 0%
Mini Dow YM CME 214.9 72.2 -11.15% / 94% -13.07% / 98% -13.36% / 45% .36 / 90%
Eurocurrency EC CME 199.6 142.8 -0.58% / 6% -1.98% / 23% 0.22% / 7% .21 / 45%
2-yr. T-note TU CME 136.4 458.0 -0.67% / 38% 0.01% / 6% -0.77% / 50% .14 / 47%
E-Mini Russell 2000 TF CME 129.2 407.7 -12.44% / 80% -12.22% / 95% -14.26% / 39% .42 / 93%
Corn C CME 111.3 258.0 -1.97% / 12% -5.92% / 39% 7.94% / 100% .27 / 80%
Gold 100 oz. GC NYMEX 100.3 207.0 -0.71% / 50% 3.97% / 22% 21.33% / 64% .27 / 17%
Japanese yen JY CME 91.5 106.4 -7.60% / 88% -8.28% / 95% -4.67% / 100% .58 / 98%
Soybeans S CME 85.0 120.5 -9.95% / 74% -10.14% / 62% 3.07% / 12% .44 / 88%
British pound BP CME 78.1 80.6 0.94% / 0% 0.10% / 0% -3.93% / 4% .10 / 7%
Natural gas NG NYMEX 63.7 91.0 -6.40% / 33% -8.26% / 20% -36.43% / 72% .13 / 18%
Sugar SB ICE 46.2 213.5 4.57% / 65% 9.05% / 63% 17.85% / 89% .39 / 73%
Soybean oil BO CME 39.0 87.9 -5.24% / 60% -3.89% / 31% 0.00% / 0% .36 / 90%
Wheat W CME 36.5 100.1 -3.19% / 17% -9.79% / 76% 2.32% / 26% .20 / 55%
S&P 500 index SP CME 35.6 544.4 -12.11% / 93% -12.89% / 93% -10.00% / 32% .36 / 90%
Canadian dollar CD CME 33.9 62.7 -1.23% / 25% -3.72% / 71% -2.46% / 20% .21 / 75%
Swiss franc SF CME 33.6 29.8 -0.15% / 6% -1.44% / 14% 2.87% / 67% .16 / 18%
E-Mini S&P MidCap 400 ME CME 33.3 112.3 -12.53% / 92% -12.53% / 89% -6.54% / 16% .39 / 92%
Australian dollar AD CME 32.3 45.1 -0.14% / 0% -1.35% / 21% -0.31% / 0% .25 / 73%
RBOB gasoline RB NYMEX 29.7 37.4 9.08% / 82% 11.50% / 34% 23.52% / 100% .37 / 100%
Soybean meal SM CME 29.4 46.8 -11.45% / 76% -12.60% / 84% 6.94% / 16% .40 / 88%
Heating oil HO NYMEX 28.2 37.7 -4.11% / 21% -11.26% / 25% -21.52% / 2% .14 / 68%
Silver 5,000 oz. SI NYMEX 19.8 47.3 -2.96% / 0% 7.95% / 20% 40.14% / 81% .34 / 78%
Crude oil e-miNY QM NYMEX 14.2 7.3 31.72% / 100% 8.01% / 43% -4.68% / 0% .24 / 100%
Copper HG NYMEX 14.0 46.2 0.26% / 0% 5.56% / 48% -5.67% / 3% .19 / 98%
Nikkei 225 index NK CME 13.2 37.0 -5.51% / 63% -8.66% / 63% -4.90% / 9% .24 / 80%
Live cattle LC CME 10.2 35.3 1.87% / 58% 5.95% / 95% 0.56% / 0% .61 / 100%
Coffee KC ICE 9.6 46.3 -0.22% / 13% -7.90% / 81% -1.45% / 5% .35 / 85%
Mexican peso MP CME 9.1 37.9 -3.17% / 74% -5.93% / 93% -10.27% / 39% .22 / 100%
Lean hogs LH CME 8.7 35.8 -4.55% / 60% 6.84% / 53% 3.70% / 41% .60 / 83%
Mini-sized gold YG CME 7.3 3.0 -0.73% / 50% 4.05% / 24% 21.34% / 64% .27 / 17%
Cocoa CC ICE 6.9 33.7 -8.74% / 67% -13.85% / 89% 11.51% / 27% .51 / 95%
Fed Funds FF CME 6.2 40.7 0.03% / 25% -0.01% / 16% 0.20% / 0% .04 / 57%
U.S. dollar index DX ICE 4.7 18.2 2.11% / 73% 1.95% / 31% 1.13% / 9% .26 / 58%
Nasdaq 100 ND CME 3.3 27.5 -10.30% / 90% -7.38% / 85% 2.06% / 27% .42 / 95%
E-Mini eurocurrency ZE CME 2.6 2.4 -0.58% / 6% -1.98% / 23% 0.22% / 7% .21 / 45%
Natural gas e-miNY QG NYMEX 2.2 3.0 -6.40% / 33% -8.26% / 20% -36.43% / 72% .13 / 17%
Dow Jones Ind. Avg. DJ CME 1.8 19.7 -11.15% / 94% -13.07% / 98% -13.36% / 45% .36 / 90%
Mini-sized silver YI CME 1.7 2.3 -2.74% / 0% 8.15% / 22% 40.16% / 81% .34 / 78%
New Zealand dollar NE CME 1.5 12.1 -2.10% / 50% -1.76% / 10% -5.72% / 12% .15 / 35%
Mini-sized soybeans YK CME 1.4 5.9 -9.95% / 74% -10.14% / 55% 3.07% / 15% .44 / 88%

Legend day moves, 20-day moves, etc.) show the per- cent 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 Feb. 27)

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 217.1 1.63 M -11.99% / 93% -13.02% / 93% 40.9% / 39.3% 37.2% / 36.2%
Russell 2000 Index RUT CBOE 71.0 514.1 -13.63% / 93% -14.17% / 88% 47.3% / 41.3% 47.1% / 45.1%
S&P 500 volatility index VIX CBOE 55.4 748.4 12.36% / 67% 8.73% / 58% 84.4% / 124.7% 105.5% / 118.9%
E-Mini S&P 500 futures ES CME 24.6 107.1 -12.12% / 93% -12.87% / 93% 41.8% / 25.7% 37.7% / 26.6%
S&P 100 Index OEX CBOE 19.1 68.4 -11.52% / 94% -12.84% / 96% 37.1% / 37.7% 36.5% / 33.9%

Bank of America BAC 398.7 1.72 M -32.71% / 89% -41.74% / 62% 194.4% / 205.1% 136.4% / 157%
General Electric GE 296.0 2.19 M -27.14% / 95% -33.10% / 98% 104.1% / 82.7% 64.7% / 73.4%
Citigroup C 244.0 2.59 M -58.45% / 100% -61.54% / 98% 153.6% / 165.4% 131.7% / 172.4%
Wells Fargo WFC 190.9 1.03 M -27.98% / 54% -35.57% / 76% 140.7% / 148% 106.6% / 119.9%
Apple Inc. AAPL 165.1 844.0 -10.03% / 67% -3.97% / 19% 50.6% / 45.3% 43.5% / 49.4%

Eurodollar ED CME 397.5 6.48 M -0.09% / 29% -0.21% / 67% 77.5% / 72.6% 90.5% / 99.4%
10-year T-notes TY CME 58.0 247.8 -3.26% / 92% -1.85% / 55% 11.1% / 10.6% 10.7% / 11%
Corn C CME 44.0 512.4 -1.97% / 12% -5.92% / 39% 41.1% / 33.7% 41.6% / 46.4%
Crude oil CL NYMEX 31.8 264.4 31.72% / 100% 8.01% / 46% 69.6% / 74.1% 81% / 92.5%
30-yr T-bonds US CME 28.7 138.8 -4.63% / 71% -3.10% / 32% 21.2% / 16.9% 19.4% / 17.8%

Indices - High IV/SV ratio
E-Mini S&P 500 futures ES CME 24.6 107.1 -12.12% / 93% -12.87% / 93% 41.8% / 25.7% 37.7% / 26.6%
Japanese Yen index YUK ISE 1.2 17.0 7.36% / 88% 8.45% / 85% 17.8% / 13.6% 20.4% / 15.4%
S&P 500 futures SP CBOE 12.6 78.9 -12.11% / 93% -12.89% / 93% 36.6% / 31.9% 34.1% / 31.4%
Russell 2000 Index RUT CBOE 71.0 514.1 -13.63% / 93% -14.17% / 88% 47.3% / 41.3% 47.1% / 45.1%
Gold/Silver Index XAU PHLX 1.0 14.4 -10.39% / 100% -5.08% / 80% 61.1% / 53.6% 59.7% / 70%

Indices - Low IV/SV ratio

S&P 500 Volatility index VIX CBOE 55.4 748.4 12.36% / 67% 8.73% / 58% 84.4% / 124.7% 105.5% / 118.9%
Banking index BKX PHLX 2.6 45.8 -12.37% / 47% -19.14% / 46% 91.3% / 114.4% 90.4% / 91.4%
Oil Service index OSX PHLX 2.2 20.0 -7.80% / 56% -7.80% / 42% 61.8% / 75.7% 62.2% / 71.9%
Housing index HGX PHLX 1.1 15.4 -12.91% / 67% -12.16% / 67% 66.1% / 77.7% 63% / 65.8%
S&P 100 index OEX CBOE 19.1 68.4 -11.52% / 94% -12.84% / 96% 37.1% / 37.7% 36.5% / 33.9%

Stocks - High IV/SV ratio

Dendreon DNDN 4.8 128.9 -19.74% / 67% -8.68% / 53% 316% / 80.3% 225.8% / 67.6%
Barclays BCS 2.0 33.9 -17.76% / 73% -8.87% / 17% 227.5% / 118.5% 178.1% / 152.4%
Synta Pharm SNTA 4.4 66.4 -83.17% / 100% -83.57% / 100% 150.9% / 84.7% 142.7% / 81.4%
Genentech DNA 43.4 532.1 1.85% / 33% 1.74% / 9% 36% / 20.8% 35.5% / 29.3%
Omnicare OCR 1.5 11.5 -10.86% / 88% -9.43% / 47% 63% / 38.2% 54.9% / 50.6%

Stocks - Low IV/SV ratio

Dev Diversified Realty DDR 1.9 20.4 -20.49% / 33% -38.67% / 54% 82% / 156.7% 161.2% / 200.4%
Marshall & Ilsley MI 2.6 36.7 0.88% / 0% -28.10% / 50% 124% / 216.9% 97.6% / 134.9%
Time Warner Cable TWC 2.2 37.1 -1.51% / 31% -5.64% / 38% 42.5% / 67% 48.2% / 57.6%
Fifth Third Bancorp FITB 10.4 90.9 -4.09% / 0% -30.82% / 47% 206.2% / 324.7% 156.7% / 175.4%
Huntington Bancshares HBAN 2.1 18.9 -19.34% / 11% -57.43% / 69% 208% / 311.3% 116.8% / 165.7%

Futures - High IV/SV ratio

Soybean oil BO CME 8.3 74.9 -5.24% / 60% -3.89% / 31% 366.8% / 36.8% 372.8% / 45.1%
E-Mini S&P 500 futures ES CME 24.6 107.1 -12.12% / 93% -12.87% / 93% 41.8% / 25.7% 37.7% / 26.6%
Japanese yen JY CME 2.8 10.1 -7.60% / 88% -8.28% / 95% 18.8% / 12.8% 20.5% / 20.7%
Wheat W CME 12.9 97.6 -3.19% / 17% -9.79% / 76% 46.2% / 31.7% 44.3% / 40.4%
Swiss franc SF CME 1.2 5.7 -0.15% / 6% -1.44% / 14% 15.2% / 11.5% 17.4% / 15.5%

Futures - Low IV/SV ratio

Australian dollar AD CME 2.2 7.9 -0.14% / 0% -1.35% / 21% 21.1% / 23.6% 28.3% / 23.6%
Crude oil CL NYMEX 31.8 264.4 31.72% / 100% 8.01% / 46% 69.6% / 74.1% 81% / 92.5%
Natural gas NG NYMEX 2.0 12.2 -6.40% / 33% -8.26% / 20% 56.9% / 59.1% 59.6% / 66.7%
* Ranked by volume ** Ranked by high or low IV/SV values.
Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).
Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).
IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.
10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.
20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-day
moves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example, the “rank”
for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows how the most
recent 20-day move compares to the past sixty 20-day moves.


COT extremes The largest positive readings represent markets in which net commercial
positions (longs - shorts) exceed net fund holdings in February. By con-
The Commitment of Traders (COT) report is published each trast, the largest negative values represent markets in which net fund
week by the Commodity Futures Trading Commission (CFTC). holdings surpass net commercial positions.
The report divides the open positions in futures markets into
three categories: commercials, non-commericals, and non-
Commercial traders, or hedgers, tend to operate in the cash
market (e.g., grain merchants and oil companies that either pro-
duce or consume the underlying commodity).
Non-commercial traders are large speculators (“large specs”)
such as commodity trading advisors and hedge funds — pro-
fessional money managers who do not deal in the underlying
cash markets but speculate in futures on a large-scale basis.
Many of these traders are trend-followers. The non-reportable
category represents small traders, or the general public. For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
Figure 1 shows the relationship between commercials and
large speculators on Feb. 24. Positive values mean net commer- Legend: Figure 1 shows the difference between net commer-
cial and net large spec positions (longs - shorts) for all 45 futures
cial positions (longs - shorts) are larger than net speculator holdings, based on their markets, in descending order. It is calculated by subtracting the
five-year historical relationship. Negative values mean large speculators have bigger current net large spec position from the net commercial position
positions than the commercials. and then comparing this value to its five-year range. The formu-
la is:
In copper (HG), orange juice (OJ), and oats (O) futures, the difference between com-
a1 = (net commercial 5-year high - net commercial current)
mercials and large speculators is ranked highest among all futures markets, which is b1 = (net commercial 5-year high - net commercial 5-year low)
a bullish sign. By contrast, this relationship is near a five-year low in the E-Mini S&P
c1 = ((b1 - a1)/ b1 ) * 100
500 (ES), Japanese yen (JY), and platinum (PL) futures, a bearish indication.
a2 = (net large spec 5-year high - net large spec current)
These extremes aren’t trade signals, but they sometimes appear before price rever- b2 = (net large spec 5-year high - net large spec 5-year low)
sals. c2 = ((b2 - a2)/ b2 ) * 100
– Compiled by Floyd Upperman x = (c1 - c2)

Options Watch: Large-cap stocks (as of Feb. 26) Compiled by Tristan Yates
The following table summarizes the expiration months available for the 20 largest U.S. stocks, the large-cap S&P 100 index (OEX), and the S&P
100 tracking stock (OEF). It also shows each ETF’s average bid-ask spread for at-the-money (ATM) March options. The information does NOT
constitute trade signals. It is intended only to provide a brief synopsis of potential slippage in each option market.
Option contracts traded
2009 2010 2011 Bid-ask spreads
spread as %









Closing of underlying
Stock Ticker price Call Put price
Wal Mart Stores WMT X X X X X X 48.25 0.03 0.02 0.05%
AT&T Inc T X X X X X X 24.09 0.02 0.02 0.08%
Exxon Mobil Corp XOM X X X X X X 70.95 0.07 0.04 0.08%
Microsoft Corp MSFT X X X X X X 16.42 0.01 0.02 0.08%
Verizon Communications VZ X X X X X X 28.48 0.03 0.02 0.09%
Google Inc GOOG X X X X X X 337.18 0.30 0.30 0.09%
Cisco Sys Inc CSCO X X X X X X 14.49 0.01 0.02 0.10%
Pfizer Inc PFE X X X X X X 12.7 0.02 0.01 0.12%
JP Morgan Chase & Co JPM X X X X X X 23.05 0.04 0.03 0.14%
S&P 100 index OEX X X X X X X X X 357.22 0.58 0.50 0.15%
Apple Inc AAPL X X X X X X 89.18 0.19 0.09 0.15%
IBM IBM X X X X X X 88.97 0.13 0.15 0.15%
Hewlett Packard HPQ X X X X X X 30.24 0.05 0.05 0.17%
Proctor & Gamble PG X X X X X X 48.97 0.09 0.10 0.19%
Abbot Labs ABT X X X X X X 50.58 0.10 0.10 0.20%
Pepsico Inc PEP X X X X X X 49.42 0.10 0.10 0.20%
Chevron Corp CVX X X X X X X 63.17 0.10 0.18 0.22%
Philip Morris PM X X X X X X 34.21 0.08 0.08 0.22%
General Electric Co GE X X X X X X 9.1 0.02 0.02 0.22%
Coca Cola Co KO X X X X X X 41.07 0.10 0.09 0.23%
Johnson & Johnson JNJ X X X X X X 52.44 0.11 0.31 0.41%
S&P 100 tracking stock OEF X X X X X X X X 35.95 0.84 0.94 2.47%
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.

 The New York Institute of Finance (NYIF) has dedicated to beginning traders; a series of intelligence reports; a
formed a strategic partnership with the Chicago Board Options weekly and monthly online Webinar series; a strategies func-
Exchange (CBOE) that allows registered CBOE.com users tion, which allows traders to sort choices by skill level and mar-
access to NYIF’s entire curriculum of instructor-led virtual ket outlook; and 35 hours of educational video content on stock,
classes. Users can access more than 175 hours of online learning, options, and fixed-income investing.
covering more than 25 financial-area topics, including back
office operations, derivatives, equities, credit, risk management,  Lightspeed Financial launched Lightspeed Spotlight,
and corporate finance. In addition, the entire instructor-led an online social networking community enabling its customers
public courses curriculum is available both in New York and in to interact with other Lightspeed customers and participate in
Chicago. All courses earn professional continuing education online educational courses and seminars. Members can partici-
credits. Registered users receive a discount on NYIF courses, pate in group discussions; create groups and personal blogs;
and can register directly through the CBOE site gain access to educational information and resources including
(http://www.theoptionsinstitute.com) or through NYIF’s Web discussions and online Webinars from Lightspeed Trading,
site for virtual, “e-learning,” and public instructor-led courses Options Industry Council, and the Chicago Mercantile
(http://www.nyif.com/cboe). Exchange; view and post videos, articles and events on
Spotlight’s message boards, blogs, and calendar; and access
 optionsXpress announced three additions to its broker- research and analyst Webinars from StreetBrains.com and chart-
age platform. The new myOX portal allows users to customize pattern recognition techniques provided by Recognia, Inc.
the http://www.optionsXpress site to their specific interests
and preferences. myOX users design their own “control cen-  Wolters Kluwer Financial Services’s GainsKeeper
ters” on the site by using the adaptable modular interface to (http://www.gainskeeper.com) tax-lot accounting technology
select the information they want to see, its location on the has been integrated with Firstrade Securities’
screen, and even how it is displayed. Users can select from 16 (http://www.firstrade.com) online trading platform, offering
different preset myOX modules including account balances, Firstrade customers new functionality and helping Firstrade
watch lists, charts, positions, futures and options chains, and prepare for requirements of the recently enacted cost-basis
even RSS feeds from financial news sites or blogs. Similarly, the reporting law (http://www.costbasisreporting.com).
new Research Center provides a single access point for research GainsKeeper assists Firstrade customers with portfolio track-
reports, breaking news, market commentary, quotes, and other ing, adjusting cost basis, and gain/loss reports for wash sales
information. The Research Center allows users to read any full and corporate actions, while its tax-trading tools help investors
report or news item without ever leaving the page. The new manage their portfolios in a tax-efficient manner and identify
Education Center offers investors access to progressive invest- the tax impact on their investment returns. Firstrade customers
ment education courses, hundreds of free online learning are also able to easily generate a Schedule D for tax filing using
events, as well as a library of general investing information. GainsKeeper.

 CME Group announced 10 new natural gas basis swap  Patsystems announced it is now a Certified ISV for
futures contracts, trading on the CME ClearPort electronic BM&F, the derivatives segment of BM&FBOVESPA. Patsystems
clearing and trading system. The new contracts and their com- will provide direct market access to the exchange for both local
modity codes are: Columbia Gulf Mainline (5Z); Florida Zone 2 and international participants. As well as direct access,
(8A); OneOk, Oklahoma (8X); Southern Star, Texas, Oklahoma, Patsystems also offers access to BM&F products via CME
Kansas (8Z); Tennessee 800 (6Z); Texas Eastern West LA (8B); Globex, which allows existing CME customers to trade the main
Texas Gas Zone 1 (9F); Transco Zone 1 (8E); Transco Zone 2 (8F); BM&F derivatives contracts listed on the Globex platform. All
and SoCal Citygate (9A). The contracts are 2,500 MMBtus in BM&F segment products will be available through Patsystems’
size with a minimum price fluctuation of $0.0025 per MMBtu. front-ends, J-Trader and Pro-Mark, and risked by Patsystems’
Trading began with the April 2009 contract and is listed for the pre-trade System and Risk Administration (SARA) module.
current year plus the next five years. The CME Group also
announced the dual listing of Henry Hub natural gas financial  RTS Realtime Systems Group is offering connectivity
last day options, trading on CME ClearPort and the New York to Nasdaq Dubai. Users are able to trade all of Nasdaq Dubai’s
trading floor. The new contract (commodity code: E7) is a listed products, including equities, derivatives, and structured
European-style option that is 10,000 MMBtus in size with a min- products. RTS will offer direct market access through its entire
imum price fluctuation of $0.0001 per MMBtu. It began trading trading solutions portfolio, including its RTD-API, the front-
with the March 2009 contract and is listed for the balance of the end trading systems RTD and eRTD, as well as RTD Tango, its
current year, plus consecutive months for the next five years automated algorithmic trading solution. With the connectivity
through 2014. These contracts are listed with, and subject to, the to Nasdaq Dubai, RTS now offers access to all three Dubai-
rules and regulations of the New York Mercantile Exchange. based exchanges.
Note: The New Products and Services section is a forum for industry
 TradeKing (http://www.tradeking.com) has launched an businesses to announce new products and upgrades. Listings are adapted
education offering that is free to any TradeKing client and from press releases and are not endorsements or recommendations from
accessible through its new Online Learning Center. TradeKing’s the Active Trader Magazine Group. E-mail press releases to
new learning center features the “Rookies Corner” with content editorial@futuresandoptionstrader.com. Publication is not guaranteed.


KEY CONCEPTS The option “Greeks”
Delta: The ratio of the movement in the option price for
American style: An option that can be exercised at any
every point move in the underlying. An option with a
time until expiration. delta of 0.5 would move a half-point for every 1-point
move in the underlying stock; an option with a delta of
Assign(ment): When an option seller (or “writer”) is 1.00 would move 1 point for every 1-point move in the
obligated to assume a long position (if he or she sold a put) underlying stock.
or short position (if he or she sold a call) in the underlying
stock or futures contract because an option buyer exercised Gamma: The change in delta relative to a change in the
the same option. underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
At the money (ATM): An option whose strike price is and lowest for deep ITM and OTM options.
identical (or very close) to the current underlying stock (or
futures) price. Rho: The change in option price relative to the change
in the interest rate.
Bear call spread: A vertical credit spread that consists
of a short call and a higher-strike, further OTM long call in Theta: The rate at which an option loses value each day
the same expiration month. The spread’s largest potential (the rate of time decay). Theta is relatively larger for
OTM than ITM options, and increases as the option gets
gain is the premium collected, and its maximum loss is lim-
closer to its expiration date.
ited to the point difference between the strikes minus that
premium. Vega: How much an option’s price changes per a one-
percent change in volatility.
Bear put spread: A bear debit spread that contains puts
with the same expiration date but different strike prices.
You buy the higher-strike put, which costs more, and sell hedgers. Commercial hedgers are typically those who actu-
the cheaper, lower-strike put. ally deal in the cash market (e.g., grain merchants and oil
companies, who either produce or consume the underlying
Bull call spread: A bull debit spread that contains calls commodity) and can have access to supply and demand
with the same expiration date but different strike prices. information other market players do not.
You buy the lower-strike call, which has more value, and Non-commercial large traders include large speculators
sell the less-expensive, higher-strike call. (“large specs”) such as commodity trading advisors (CTAs)
and hedge funds. This group consists mostly of institution-
Bull put spread (put credit spread): A bull credit al and quasi-institutional money managers who do not deal
spread that contains puts with the same expiration date, but in the underlying cash markets, but speculate in futures on
different strike prices. You sell an OTM put and buy a less- a large-scale basis for their clients.
expensive, lower-strike put. The final COT category is called the non-reportable posi-
tion category — otherwise known as small traders — i.e.,
Calendar spread: A position with one short-term short the general public.
option and one long same-strike option with more time
until expiration. If the spread uses ATM options, it is mar- Covered call: Shorting an out-of-the-money call option
ket-neutral and tries to profit from time decay. However, against a long position in the underlying market. An exam-
OTM options can be used to profit from both a directional ple would be purchasing a stock for $50 and selling a call
move and time decay. option with a strike price of $55. The goal is for the market
to move sideways or slightly higher and for the call option
Call option: An option that gives the owner the right, but to expire worthless, in which case you keep the premium.
not the obligation, to buy a stock (or futures contract) at a
fixed price. Credit spread: A position that collects more premium
from short options than you pay for long options. A credit
The Commitments of Traders report: Published spread using calls is bearish, while a credit spread using
weekly by the Commodity Futures Trading Commission puts is bullish.
(CFTC), the Commitments of Traders (COT) report breaks
down the open interest in major futures markets. Clearing Debit spread: An options spread that costs money to
members, futures commission merchants, and foreign bro- enter, because the long side is more expensive that the short
kers are required to report daily the futures and options side. These spreads can be verticals, calendars, or diagonals.
positions of their customers that are above specific report-
ing levels set by the CFTC. Delivery period (delivery dates): The specific time
For each futures contract, report data is divided into three period during which a delivery can occur for a futures con-
“reporting” categories: commercial, non-commercial, and tract. These dates vary from market to market and are deter-
non-reportable positions. The first two groups are those mined by the exchange. They typically fall during the
who hold positions above specific reporting levels. month designated by a specific contract — e.g. the delivery
The “commercials” are often referred to as the large period for March T-notes will be a specific period in March.


Diagonal spread: A position consisting of options with tracts such as wheat, crude oil, and T-notes. Commodities
different expiration dates and different strike prices — e.g., generally are delivered to a designated warehouse; T-note
a December 50 call and a January 60 call. delivery is taken by a book-entry transfer of ownership,
although no certificates change hands.
European style: An option that can only be exercised at
expiration, not before. Premium: The price of an option.

Exercise: To exchange an option for the underlying Put option: An option that gives the owner the right, but
instrument. not the obligation, to sell a stock (or futures contract) at a
fixed price.
Expiration: The last day on which an option can be exer-
cised and exchanged for the underlying instrument (usual- Put ratio backspread: A bearish ratio spread that con-
ly the last trading day or one day after). tains more long puts than short ones. The short strikes are
closer to the money and the long strikes are further from the
In the money (ITM): A call option with a strike price money.
below the price of the underlying instrument, or a put For example, if a stock trades at $50, you could sell one
option with a strike price above the underlying instru- $45 put and buy two $40 puts in the same expiration month.
ment’s price. If the stock drops, the short $45 put might move into the
money, but the long lower-strike puts will hedge some (or
Intrinsic value: The difference between the strike price all) of those losses. If the stock drops well below $40, poten-
of an in-the-money option and the underlying asset price. A tial gains are unlimited until it reaches zero.
call option with a strike price of 22 has 2 points of intrinsic
value if the underlying market is trading at 24. Put spreads: Vertical spreads with puts sharing the same
expiration date but different strike prices. A bull put spread
Naked option: A position that involves selling an unpro- contains short, higher-strike puts and long, lower-strike
tected call or put that has a large or unlimited amount of puts. A bear put spread is structured differently: Its long
risk. If you sell a call, for example, you are obligated to sell puts have higher strikes than the short puts.
the underlying instrument at the call’s strike price, which
might be below the market’s value, triggering a loss. If you Simple moving average: A simple moving average
sell a put, for example, you are obligated to buy the under- (SMA) is the average price of a stock, future, or other mar-
lying instrument at the put’s strike price, which may be well ket over a certain time period. A five-day SMA is the sum of
above the market, also causing a loss. the five most recent closing prices divided by five, which
Given its risk, selling naked options is only for advanced means each day’s price is equally weighted in the calcula-
options traders, and newer traders aren’t usually allowed tion.
by their brokers to trade such strategies.
Stochastic oscillator: A technical tool designed to
Naked (uncovered) puts: Selling put options to collect highlight shorter-term momentum and “overbought” and
premium that contains risk. If the market drops below the “oversold” levels (points at which a price move has, theo-
short put’s strike price, the holder may exercise it, requiring retically at least, temporarily exhausted itself and is ripe for
you to buy stock at the strike price (i.e., above the market). a correction or reversal).
Calculation: The stochastic oscillator consists of two
Near the money: An option whose strike price is close lines: %K and a moving average of %K called %D. The basic
to the underlying market’s price. stochastic calculation compares the most recent close to the
price range (high of the range - low of the range) over a par-
Open interest: The number of options that have not ticular period.
been exercised in a specific contract that has not yet expired. For example, a 10-day stochastic calculation (%K) would
be the difference between today’s close and the lowest low
Out of the money (OTM): A call option with a strike of the last 10 days divided by the difference between the
price above the price of the underlying instrument, or a put highest high and the lowest low of the last 10 days; the
option with a strike price below the underlying instru- result is multiplied by 100. The formula is:
ment’s price. %K = 100*{(Ct-Ln)/(Hn-Ln)}
Parity: An option trading at its intrinsic value. Ct is today’s closing price
Hn is the highest price of the most recent n days (the
Physical delivery: The process of exchanging a physical default value is five days)
commodity (and making and taking payment) as a result of Ln is the lowest price of the most recent n days
the execution of a futures contract. Although 98 percent of
all futures contracts are not delivered, there are market par- The second line, %D, is a three-period simple moving
ticipants who do take delivery of physically settled con- continued on p. 42


KEY CONCEPTS continued

average of %K. The resulting indicator fluctuates between 0 eral price levels rather than precise prices. For example, if a
and 100. stock makes a low of 52.15, rallies slightly, then declines
Fast vs. slow: This formula is sometimes referred to as again to 52.15, then rallies again, a subsequent move down
“fast” stochastics. Because it is very volatile, an additional- to 52 does not violate the “support level” of 52.15. In this
ly smoothed version of the indicator –– where the original case, the fact that the stock retraced once to the exact price
%D line becomes a new %K line and a three-period average level it had established before is more of a coincidence than
of this line becomes the new %D line –– is more commonly anything else.
used (and referred to as “slow” stochastics, or simply “sto-
chastics”). Time decay: The tendency of time value to decrease at an
Any of the parameters –– either the number of periods accelerated rate as an option approaches expiration.
used in the basic calculation or the length of the moving
averages used to smooth the %K and %D lines –– can be Time spread: Any type of spread that contains short
adjusted to make the indicator more or less sensitive to near-term options and long options that expire later. Both
price action. options can share a strike price (calendar spread) or have
Horizontal lines are used to mark overbought and over- different strikes (diagonal spread).
sold stochastic readings. These levels are discretionary;
readings of 80 and 20 or 70 and 30 are common, but differ- Time value (premium): The amount of an option’s
ent market conditions and indicator lengths will dictate dif- value that is a function of the time remaining until expira-
ferent levels. tion. As expiration approaches, time value decreases at an
accelerated rate, a phenomenon known as “time decay.”
Straddle: A non-directional option spread that typically
consists of an at-the-money call and at-the-money put with Vertical spread: A position consisting of options with
the same expiration. For example, with the underlying the same expiration date but different strike prices (e.g., a
instrument trading at 25, a standard long straddle would September 40 call option and a September 50 call option).
consist of buying a 25 call and a 25 put. Long straddles are
designed to profit from an increase in volatility; short strad- VIX: The Volatility Index (VIX) measures the implied
dles are intended to capitalize on declining volatility. The volatility of S&P 500 index options traded on the Chicago
strangle is a related strategy. Board Option Exchange (CBOE). The VIX is designed to
reflect the market expectation of near-term (in this case, 30-
Strangle: A non-directional option spread that consists of day) volatility and is a commonly referenced gauge of the
an out-of-the-money call and out-of-the-money put with stock market’s “fear level.”
the same expiration. For example, with the underlying The original VIX, launched in 1990, was derived from
instrument trading at 25, a long strangle could consist of eight near-term at-the-money S&P 100 (OEX) options (calls
buying a 27.5 call and a 22.5 put. Long strangles are and puts) using the Black-Scholes options pricing model.
designed to profit from an increase in volatility; short stran- The VIX underwent a major transformation in late 2003.
gles are intended to capitalize on declining volatility. The The current index is derived from both at-the-money and
straddle is a related strategy. out-of-the-money S&P 500 (SPX) calls and puts to make the
index better represent the full range of volatility. At the
Strike (“exercise”) price: The price at which an under- same time the CBOE applied the new calculation method to
lying instrument is exchanged upon exercise of an option. the CBOE NDX Volatility Index (VXN), which reflects the
volatility of the Nasdaq 100 index.
Support and resistance: Support is a price level that The exchange still publishes the original VIX calculation,
acts as a “floor,” preventing prices from dropping below which can be found under the ticker symbol VXO. Figure 1
that level. Resistance is the opposite: a price level that acts shows both indices: the VXO from May 19, 1993 to Sept 19,
as a “ceiling;” a barrier that prevents prices from rising 2003 and the new VIX over the next four years.
higher. For more information about the VIX and its calculation,
Support and resistance levels are a natural outgrowth of visit http://www.cboe.com/vix.
the interaction of supply and demand in any market. For
example, increased demand for a stock will cause its price Volatility: The level of price movement in a market.
to rise, creating an uptrend. But when price has risen to a Historical (“statistical”) volatility measures the price fluctu-
certain level, traders and investors will take profits and ations (usually calculated as the standard deviation of clos-
short sellers will come into the market, creating “resistance” ing prices) over a certain time period — e.g., the past 20
to further price increases. Price may retreat from and days. Implied volatility is the current market estimate of
advance to this resistance level many times, sometimes future volatility as reflected in the level of option premi-
eventually breaking through it and continuing the previous ums. The higher the implied volatility, the higher the option
trend, other times reversing completely. premium.
Support and resistance should be thought of more as gen-




The breakeven point of this 79/74 bull put spread is 5.4 percent below the current
When support broke, this price, and the position had an 82-percent chance of success.
bullish credit spread collapsed.


Date: Friday, Feb. 13.

Market: Options on the S&P 500

tracking stock (SPY).

Entry: Sell 1 February 79 put

for $0.57.
Buy 1 February 74 put
for $0.16

Reasons for trade/setup: In

the first six weeks of 2009, SPY
traded in a range between 95 and
80, and it seemed poised to retest
support at 80 during options expi- Source: OptionVue
ration week in February (Figure 2).
Whether support was likely to hold was an open question The spread’s risk-reward ratio is more than 10:1, which
when SPY traded around $83.10 on Friday, Feb. 13. seems foolhardy. However, the trade has an 82-percent
Historically, serial, or non-quarterly, options’ expiration chance of success, because SPY must drop 5.4 percent
weeks (January, February, April, and so on) have been rela- before it faces losses at expiration. The goal is to hold the
tively bullish for the S&P 500 index, which climbed an aver- position for a week unless SPY falls this far.
age 0.36 percent from 1980 to 2007. In addition, SPY suc-
cessfully bounced off 80 in mid-January, suggesting this Initial stop: Buy back spread if SPY drops below
support level would likely remain intact. breakeven price of $78.59 before options expire.
Given this mildly bullish outlook, we sold a February
79/74 bull put spread for $0.41 at the close on Feb. 13. continued on p. 44
Selling puts below support made sense, especially when
they expire in one week, and the market was closed on TRADE SUMMARY
Monday for President’s day.
Figure 1 shows the credit spread’s potential gains and Entry date: Feb. 13, 2009
losses on three dates: trade entry (Feb. 13, dotted line), Underlying security: S&P 500 tracking stock (SPY)
halfway until expiration (Feb. 17, dashed line), and expira- Position:
tion (Feb. 21, solid line). The trade’s $0.41 collected premi- 1 short Feb. 79-strike put
um is also its maximum profit, which we will keep if SPY 1 long Feb. 74-strike put
closes above $78.59 at expiration. But the spread will lose Initial capital required: $500
up to $4.59 if SPY drops below 74.
Initial stop: Exit if SPY drops below breakeven (78.59)

TRADE STATISTICS Initial target: Hold one week until expiration

Initial daily time decay: $5.92
Date: Feb. 13, 2009 Feb. 18, 2009
Trade length: 5 days
Delta: 13.28 41.57
Gamma: -3.37 -8.81 P/L: -$99 (-20 percent)
Theta: 5.92 13.32 LOP: $0
Vega: -1.96 -1.42 LOL: -$109
Probability of profit: 82% 53% LOP — largest open profit (maximum available profit during life of trade).
Breakeven point: 78.59 78.59 LOL — largest open loss (maximum potential loss during life of trade).




After entering a bullish credit spread, SPY gapped down 3.5 percent overnight
and fell below support within hours. We exited with a 20-percent loss when the
market fell below the position’s breakeven point.
Initial target: Hold 4 trading days
until expiration.


Outcome: Our timing couldn’t have

been worse. Figure 2 shows SPY
gapped down 3.5 percent, opening at
$80.16 on Feb. 17. Within hours, SPY
penetrated support at 80 and kept slid-
ing; the market fell 4.2 percent that day
— its worst performance in nearly a
Clearly, the trade was a disaster, but
we stuck to the plan and held on Source: eSignal
because SPY never hit the bull put
spread’s 79 short strike. And trading a vertical spread The position lost $0.99 — nearly 20 percent of its initial
instead of simply selling 79 puts was a wise choice, because capital.
the long 74 put helped absorb some of the short 79 put’s In hindsight, this trade was a big mistake, but following
loss. the exit plan was the right decision. SPY fell much further
However, SPY dropped below our initial stop the next before February options expired, and we would have lost
morning, and we bought back the 79/74 spread for $1.40 more money if we had dug in and waited for SPY to bounce
when the market traded at $78.80 at 10 a.m. ET on Feb. 18. before the end of the week.
Click on these boxes to link directly to these advertisers’ web sites