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Have you ever heard the saying “straddle the fence?” It means that you support both sides of an issue. Similarly, a common options strategy is referred to as a straddle because a straddle is used when you think the underlying futures market is going to make a move, but you are not sure which way.

Buying a Straddle

If you are buying a straddle, it is referred to as being long the straddle. A trader buys the call and the put of the same strike, same expiration and same underlying product.

For example, if you want to straddle E-mini Sep 2425, you would buy the E-mini 2425 Sep call and buy the 2425 Sep put. The cost of the straddle in this example would be 103.75.

Traders will buy the straddle if they expect the market to start moving but are not sure which way. In our example, the E-mini futures contract would be at 2420 and we expect the future to move up or down but we are not quite sure which way.

The profit potential is much larger than the cost of the straddle in either direction. At expiration, the break-even points are 2525 and 2315. These are the strike plus the straddle cost and the strike minus the straddle cost.

Loss is limited to the cost of spread. Maximum loss occurs if the market is at the strike at expiration. Because the straddle is composed of only long options, it loses option premium due to time decay. Time decay is most costly if the market is near the strike.

Selling a Straddle

Traders will sell a straddle, or short the straddle, when they expect the market is going to stagnate. Because the traders are short the straddle, they profit as the options decay, provided the market does not move far from the strike.

Like the long straddle the straddle’s break-even points are at the strike plus the cost of straddle on the call side and the strike minus the cost of the straddle on the put side at expiration. These break-even points are the same regardless if you are long or short the straddle.

For a short straddle, profit is maximized if the market is at the strike price at expiration.

Loss potential is open-ended in either direction. Dramatic movements above the strike will make the call much more valuable. Conversely, movements below the strike will make the put more valuable. Because you are short both the call and the put, either case is potentially costly.

Because being short the straddle is essentially short options, you pick up time-value decay at an increasing rate as expiration approaches. You profit from the time decay that the long straddle holder loses.  Again, time decay is most profitable if the market is near the strike.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Before we look at the covered call strategy, remember that the writer, or seller, of an option is obligated to deliver the underlying futures contract to the buyer of the option when it is exercised. To cover the risk of a short call position, at any time prior to the options expiration, a trader can buy a futures contract to deliver to the call owner if the short call is exercised.

Owning the futures contract to deliver into the call means that the assignment risk is covered; hence the phrase covered call.

Selling a naked call, which means selling the call without owning the underlying instrument, exposes the option writer to unlimited losses if the market moves up. The maximum profit potential is the premium received for the call.

For example, if a trader sold the 100 call for $5, the breakeven point for the call would be the strike plus the premium. In this case 105.

Between 105 (the breakeven point) and 100 (the strike), the profit increases from zero to $5. At or below 100, the profit is the full amount of the premium, namely $5.

Covered Call Strategy

The covered call strategy consists of a long futures contract and a short call on that futures contract. The call can be in-, at- or out-of-the-money. Generally, traders choose a call that is at-the-money to maximize the premium that is received from the sale of the call.

Covered calls are executed as an income-generating strategy when the futures contract holder expects the market to remain stable.

The trader foregoes some of the up-side potential of the futures position in return for the premium received from the sale of the call.

Example

It is the end of June and our trader is long a September futures contract. He believes that the market will be quiet and stable through July, after which he believes that the market will rally tremendously.

He could hold his September futures position until expiration. But instead, he attempts to generate income by selling a call option that expires before August. He sells the July 100 call for $5.

Since he already owns the underlying futures contract, his positions will be aggregated. This is the payoff profile for the long September futures contract.

He received $5 from the sale of the 100 call. So, the futures contract breakeven point is lowered by $5 dollars, to 95.

But because he sold the call, his up-side potential is capped. He forgoes profit if the underlying market is above 105.

The long September futures contract and short July call combined have a payoff profile as shown. His profit is capped at $5, from the sale of the call, through July expiration. This is because he needs to deliver the futures contract into the short call.

Scenarios

At July option expiration, if the September futures contract is at 93, his loss on this strategy would be two. The $7 of futures contract loss was mitigated by the $5 of premium from the call.

At July option expiration, with the September futures at 100, his profit will be $5 due to the futures PNL being zero and the call expiring worthless. This allows him to keep the full $5 of premium.

If the September futures contract was at 103, his profit would again be $5, $3 from the futures contract gain and $2 from the 100 call.

If the market had a tremendous rally earlier than he had anticipated, and the September futures rose to 120, his profit will remain $5, $20 from the futures contract minus $15 from the short call.

Conclusion

Covered calls are a commonly used and valuable options strategy providing income while lessening the sting of a downward market movement.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Currency Education Home Page

Market participants can trade futures contracts that represent the relationship between two currencies, also known as the foreign exchange (Forex, FX) market. FX futures contracts are regulated and traded on the open market, just like all futures contracts, which is a major difference compared to the cash Forex market, where each dealer sets their own prices with no common exchange. This transparency in currency futures benefits foreign exchange traders.

FX contracts are priced based on how much of one country’s currency it takes to buy one unit of another country’s currency. Contracts, like Euro/U.S. dollar futures, allow you to trade based on the exchange rate between the euro and U.S. dollar. Most futures contracts are based on a foreign currency in terms of U.S. dollars; the Euro/U.S. dollar futures contract is priced based on how many U.S. dollars it takes to buy one euro.

You can also trade cross rate futures, which allow you to trade the relationship between two foreign currencies, such as Euro/British Pound futures, where both the base and foreign currency are not in U.S. dollars. The fundamental analyst will look at certain factors to determine where the price of the currencies they are trading might move next.

Exchange Rates

Since exchange rates are a direct comparison of two currencies, the fundamental analyst will evaluate the relative differences between economic factors rather than their absolute values. The analyst will look at factors that make the economies of the two countries different and will attempt to determine how each economy will perform in the future, allowing them to make an assumption about the movement of the exchange rates between the two countries. While the analyst will spend the most time comparing the two countries in terms of relative values, the absolute value each country’s economy will also impact the exchange rate.

For example, if you compare two currencies where there is 20% or higher inflation, the economic conditions will be much different than if you compare two currencies where the countries have less than 5% inflation. The difference in inflation rates between two countries will tend to have a larger effect than the absolute level of inflation.

Price Influencers

Since futures are priced as a ratio, there are a combination of changes that can influence price:

• The base currency can strengthen, thus decreasing the price of the currency futures contract
• The base currency can weaken,  increasing the price of the currency futures contract. For example, if the U.S. dollar strengthens against the euro, the price of the EUR/USD futures contract will decrease
• The quote, or terms, currency can strengthen, increasing the price of the currency futures contract
• The quote, or terms, currency can weaken, decreasing the price of the currency futures contract. For example, if the euro strengthens against the U.S. dollar, the price of the EUR/USD futures contract will increase

Economic Factors

There are also a number of economic factors that affect the price of currency futures including inteste rates, inflation and trade with foreign countries.

Fundamental analysts will look at interest rates, and variables that affect interest rates, for the two currencies they are trading.

Interest rates impact the demand for currencies. If interest rates are high in a particular country, the demand for their bonds will be high as investors look to make investments that offer a higher relative rate of return compared to the alternatives. As investors buy bonds, the demand for the currency increases because the foreign buyer needs to exchange their currency for the foreign currency to purchase the bonds. This demand leads to an increase in the relative value of that country’s currency.

Fundamental analysts will look at the relative levels of inflation in each country to evaluate the strength of each currency.

Inflation decreases the buying power of a country’s currency. This causes a country with higher inflation to have a weaker currency, meaning the price of the foreign exchange futures will increase.

For example, if the rate of inflation in the United States is higher than the rate of inflation in the United Kingdom, the U.S. dollar will decrease in price relative to the British pound. A trader interested in the GBP/USD futures contract will see the price increase, meaning it will take more U.S. dollars to buy a British pound.

Trade between countries will influence the relative value of a country’s currency. Countries that export more will have a currency more in demand, increasing the relative value of their currency.

If the United States exports more good than it imports, demand for its currency will be high and the value of the dollar will increase. If the U.S. exports relatively more goods than the European Union, then the U.S. dollar might increase in value and the EUR/USD futures contract could decrease in price.

The interactions can be complex and fundamental traders will create models to show the relationships between the economy and foreign exchange futures.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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CME Euro FX futures and options allow you to take positions on the value of the euro currency versus the U.S. dollar. These deep and liquid currency contracts grant traders wide exposure to the economy of the Eurozone,  a monetary union of 19 of the 28 European Union member states which have adopted the euro as their common currency. The Eurozone ranks as the fourth largest trading partner of U.S.

Euro FX futures and options are valuable tools for gaining or hedging exposure to the euro as well as managing exposures to the U.S. dollar. Given the importance of these two currencies in the world economy, you can see increased activity in times of global market volatility driven by interest rate changes, inflation announcements and other monetary policy changes as well as payroll, unemployment and geopolitical events.

The Contract

Euro FX futures trade on CME Globex Sunday through Friday from 5 p.m. to 4 p.m. Central Time (CT), with daily trading breaks from 4 p.m. to 5 p.m. (CT), and is priced in U.S. dollars per euro. The Euro FX futures contract is available in standard [6E], e-mini [E7] and e-micro [M6E] contract sizes, allowing market participants to carefully calibrate levels of market exposure. Euro futures currently expire on a quarterly basis, and the contract’s minimum tick value is $6.25 for both standard size and E-mini Euro contracts, and $1.25 for the E-Micro contract.

Trading Euro FX Futures and Options

Euro FX can also be traded as options in weekly, monthly and quarterly formats which expire on Fridays, and in both European- and American-style. Euro options markets are extremely liquid and allow tremendous flexibility in managing existing option positions across multiple expiration dates targeted trading based on market movement and the ability to trade high impact economic events.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Japanese Yen futures (6J) allow market participants to take a position in the value of the yen against the U.S. dollar.

A majority, 80%, of the global foreign exchange (forex) market is concentrated on seven currencies. The yen is the third-most commonly traded. Because the Japanese economy is one of the largest in the world, and Tokyo is an important financial center, the relative dominance of the Japanese currency is appropriate.

However, for the last 30 years, Japan has experienced subpar economic growth, which lead its central bank to take a uniquely interventionist role in the currency and bond markets. This combination of a vibrant trade-based economy paired with Bank of Japan-depressed interest rates gives the yen unique properties sought by traders.

The Contract

Each Japanese Yen futures contract represents 12,500,000 Japanese yen with a minimum price fluctuation of .0000005 per yen increment. The contract trades Sunday-Friday from 5 p.m. to 5 p.m. Central Time (CT), with a daily 60-minute break at 4 p.m. CT.

Watching the Markets

Like all participants in the forex market, those taking a position on the yen should monitor the release of economic data such as GDP, retail sales and inflation.

As typical of all major currencies, the valuation of the yen is largely influenced by the activities of Japan’s central bank. For the past few decades, the BOJ strove to keep interest rates low, which allowed traders to profit by selling the yen and using the proceeds to buy higher yielding currencies.

This transaction, known as the carry trade, is popular in low-interest rates and low-volatility environments, which often characterizes the yen trade.

Nonetheless, investors should remain vigilant as the Bank of Japan has a reputation of intervening in the currency markets when the yen moves in a direction that could hurt its export-based economy.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Canadian Dollar futures (6C) at CME Group allow you to trade the value of the Canadian dollar against the U.S. dollar in a liquid and transparent market.

As the sixth-most widely held reserve currency, the Canadian dollar, popularly called the loonie, is one of the most widely traded currencies in the foreign exchange (forex) market.

Though Canada’s GDP ranks 10th in the world, it ranks ninth in the world in terms of dollar-value exports and is an important commodity producer.

The Bank of Canada is known for its lack of intervention in the currency markets which, when coupled with Canada’s fiscal discipline and high interest rates, give the loonie a relative stability that is rare.

The Contract

Each Canadian Dollar futures contract represents 100,000 Canadian dollars with a minimum price fluctuation of $.00005 per Canadian dollar increment. The contract trades Sunday-Friday from 6 p.m. to 5 p.m. Eastern Time (ET) with a daily 60-minute break at 5 p.m.  ET.

Trading the Markets

Market participants trading the CAD/USD with the futures contract should watch for all the traditional factors that impact exchange rates, such as purchasing power and interest rate parity, along with releases of economic data such as GDP, retail sales, inflation data and general daily news.

Predictably, by virtue of geography and tightly intertwined trade, the value of the Canadian dollar can be closely connected to the economic health of the U.S. As the U.S. accounts for more than 50% of Canada’s exports, and vice versa, the currencies can sometimes move in lockstep.

Another important note, 60% of Canada’s exports are commodities, and commodity prices can influence investor sentiment regarding the loonie. Oil’s influence is particularly large; traders tend to buy the loonie when oil is on the rise.

Overall, the Canadian dollar is becoming an increasingly viable alternative to the U.S. dollar and is poised to gain importance in the forex market in years ahead.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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British Pound futures (6B) at CME Group allow you to take positions on the value of the British pound sterling currency versus the U.S. dollar.

Once the world’s leading currency, the pound lost its preeminence with the dissolution of the British Empire in the 1940s. Because the U.K. remains the sixth largest economy and London is a financial hub, the pound remains the third-most widely held reserve currency and the fourth-most widely traded currency.

The Contract

Each British Pound futures contract represents 62,500 British pounds with a minimum price fluctuation of .0001 per British pound increments. The contract trades Sunday-Friday from 5 p.m. to 6 p.m. Central Time (CT) with a daily 60-minute break at 4 p.m. CT.

Trading the Market

This GBP/USD pair represented by 6B is frequently traded, very liquid and characterized by tight bid-ask spreads and nearly nonexistent arbitrage opportunities.

Therefore, investors that wish take a position on the pound are well advised to understand the relative strength between the British and U.S. economies and their interest rates. Stronger British economic performance often translates to a higher pound against the dollar.

Conversely, the dollar typically strengthens against the pound when the U.S. economy outperforms Britain’s. As such, market participants should follow releases on broad economic data such GDP, retail sales and inflation as well as any statement issued by either the Bank of England or the Federal Reserve.

Finally, with New York and London both serving as global financial hubs, industry-specific news concerning U.S. or British banks could also impact the contract’s value.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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Australian Dollar futures (6A) allow you to trade the value of the Australian dollar against the U.S. dollar in a liquid and transparent market.

The AUD/USD is typically the fifth-most traded currency pair in the foreign exchange (forex) market. Though Australia only ranks 13th in the world in terms of GDP, its status as an important commodity producer and key trading partner with developing Asian economies gives its currency an outsized importance.

Australia has a stable government, fiscal discipline and an approach to business and law that is attractive to investors and not always typical of the APAC countries. When these qualities are paired with its central bank, The Reserve Bank of Australia, with a sparse history of intervention and success at controlling inflation, it is little wonder that Australia’s currency attracts interest from a global marketplace eager to invest in the region.

The Contract

Each AUD/USD futures contract represents 100,000 Australian dollars with a minimum price fluctuation of $.0001 per Australian dollar. The contract trades Sunday-Friday from 6 p.m. to 5 p.m. Eastern Time (ET) with a daily 60-minute break at 5 p.m. ET.

Trading the Market

Market participants trading the AUD/USD futures contract should watch for the traditional factors that impact exchange rates, such as purchasing power and interest rate parity, along with releases of economic data such as GDP, retail sales, inflation data and general daily news.

Additionally, Australia’s economy is largely driven by metal and agricultural commodities and the value of the Australian dollar generally rises and falls in partner with the commodity indexes.

People taking a stake in 6A monitor reports from Australia’s Bureau of Agricultural and Resource Economics and Sciences for supply developments in mining, weather and harvests.

Due to Australia’s close trading ties with China and other developing countries in the APAC region, stories that reflect growing demand in those countries ultimately cascade into changing valuations in 6A.

These factors make the Australian dollar attractive for investors wishing to go long on commodities and profit from the seemingly insatiable resource demand of Asia’s emerging economies.

If you have questions send us a message or schedule an online review .

Regards,
Peter Knight Advisor

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