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Understanding Intermarket Spreads: Platinum and Gold

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Spread trading is a widely-used trading strategy in futures markets and offers some key advantages over outright futures trading (i.e., going long or short a single futures contract), including capital efficiencies with lower margin outlay and potentially superior risk-adjusted returns. This is particularly true for precious metals markets, where the underlying commodities demonstrate strong correlations with each other due to close economic links, but also distinct fundamental drivers that can create profitable spreading opportunities using the associated futures contracts.

Creating a Futures Spread

A spread trade using futures is created by buying a futures contract and simultaneously selling another futures contract against it. The spread acts as a hedging transaction, altering your exposure from an outright price fluctuation to the price differential between the individual legs of the spread trade. The profitability of a futures spread trade depends on the price direction, or differences in price movement, for the legs of the strategy.

Spread trades may be executed across many markets, but traders often look at similar contracts, or related markets, for spread trading opportunities. A closer relationship between the spread markets means the individual legs are more likely to move in tandem, enabling relatively stable price changes governed primarily by the pace of price moves between the legs (i.e., the relative performance of the legs), thereby reducing the level of risk for the trader. These strategies are referred to as relative value strategies.

Types of Spreads

Spreads may be broadly classified as intra-market spreads and inter-market spreads.

Intra-market spreads, also known as calendar spreads, are where a trader opens a long or short position in one contract month and then opens an opposite position in another contract month for the same futures market. Given the popularity of these spread trades, as well as their contribution to futures rollover activity, dedicated calendar spread markets are available on the CME Direct platform, which allows spread execution with no legging risk.

Inter-market spreads involve two separate, but related, futures markets with legs of the same maturity time frames. Inter-market spread strategies may have legging risk, but can be mitigated by using dedicated inter-market spread contracts or by selecting liquid underlying contracts for each leg in conjunction with using the auto-spreading functionality offered by some software vendor trading screens.

Benefits of Spread Trading

The main advantages of spread trading are reduced volatility and lower margin requirements, as the legs are generally in related markets at the same exchange.

Compared to outright futures, which can exhibit significant price swings, spreads can demonstrate extended trending price moves, making it easier for you to visualize patterns and take a directional view or implement a technical trading strategy.

Spread Trading with Precious Metals

The precious metals complex includes gold, silver, platinum and palladium contracts and offers trading opportunities to a global market through a wide variety of instruments. These markets not only provide highly correlated commodities, but also with unique price drivers that can create many attractive spread trading opportunities.

While you can choose from the range of instruments available for trade execution once you have identified your preferred strategies, the Precious Metals futures markets at CME Group offers highly liquid and deep markets that enable the fast, efficient execution of spread strategies, with the additional benefits of considerable margin savings (as all trades are centrally cleared through CME Clearing) and much alleviated legging risk.

More importantly, these futures contracts are predominantly electronically traded (over 90%) on CME Globex, which allows easy access for participants across the world and high-quality trade executions virtually 24 hours a day.

Gold-Platinum Spread Trade

Platinum is both a precious and industrial metal, widely used in catalytic converters in the automotive industry but also in jewelry and as an investment asset.

The price relationship and the price spread between gold and platinum may be useful as an indicator of shifts in the macro environment. Historically, platinum has been more expensive than gold since the white metal is about 15 times rarer than gold and has many industrial uses compared to the yellow metal. However, gold can become pricier during times of economic distress and political uncertainty when the yellow metal sees increased demand as a safe-haven asset. Conversely, during a positive economic cycle with increasing automobile sales, platinum’s premium over gold prices can rise even further as the metal will see increased industrial use. Since 2015 Gold has been trading at a premium to Platinum and the spread has been widening.

Platinum-Gold Price Spread (in U.S. dollars per troy ounce) Chart based on NYMEX Platinum and COMEX Gold Futures Prices

CME Group offers one of the most liquid Platinum futures, making it a convenient instrument to manage risk and instantly capture trading opportunities, such as the platinum-gold price spread strategy.

Platinum-Gold Spread Profit and Loss Example

On March 2, a trader expects platinum demand to increase in the short term due to higher car sales and the platinum-gold spread to narrow. The trader buys two April Platinum futures contracts at $988.40/oz and simultaneously sells one April Gold futures contract at $1,231.90/oz (the Platinum contract is half the size, 50 oz, of the 100-oz Gold contract).

The resulting notional amounts for the legs are $98,840 and $123,190, respectively. The trader has thus entered the spread trade at -$243.50 and is long the spread.

The tables below show the trader’s realized profit and loss (P&L) as negative spread, narrowed as both Gold and Platinum increased, but at different rates.

Platinum-Gold (negative) spread narrows when position is closed by selling two Platinum April contracts and buying one Gold April contract simultaneously on March 30.

Platinum April Notional Amt Gold April Notional Amt Spread
Trade Enter Prices Buy $988.40 $98,840 Sell $1,231.90 $123,190 ($243.50)
Trade Exit Prices Sell $1,056.40 $105,640 Buy $1244.20 $124,420 ($187.80)
Strategy Leg P&L $6,800 -$1,230
Total P&L $5,570

Margin Offsets

One of the benefits of spread trading with futures is the reduced cost of margin, otherwise known as margin offset. Margin discounts can occur when CME Clearing scans the trader’s portfolio of futures positions looking for offsets.

In our example, we had a long Platinum position and a short Gold position. This spread position would have been identified as an offset and therefore would require less margin than the two outright positions.

Platinum-Palladium Spread Trade

Palladium, like platinum, is also a precious metal widely used in the automobile industry as an auto catalyst. The difference being palladium is predominantly used in petrol-engine vehicles, whilst platinum is used in diesel-engine vehicles. In the recent past, platinum has traded at a premium to palladium, but as the chart below illustrates, the premium has narrowed. The spread may cross, but the last time this happened was approximately 20 years ago. Traders can express a view on the platinum-palladium spread through trading individual outright futures contracts in a spread strategy like the ones demonstrated above.

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

Regards,
Peter Knight Advisor

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Fundamental Analysis vs Technical Analysis

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Fundamental Analysis vs Technical Analysis

There are many factors that traders look at and analyze when choosing a futures contract to trade. Some traders might look for trends on a chart while other traders might look to see if demand might be increasing for a commodity.

The evidence that traders use will typically be classified into two broad categories, fundamental analysis and technical analysis.

Both types of analysis allow a trader to collect evidence to form a decision about the trades they are considering placing in the market. The analysis will form the basis of where the trader thinks the market will move and thus, whether to buy or sell a given futures contract.

Some traders will use one type of analysis or a combination of fundamental and technical analysis to select trades and time their entries and exits. Evidence is collected by traders from all sources and rarely will it fall in to just one category. Having data from varied sources and of different types helps traders paint a more complete picture of the market they are trading.

Fundamental Analysis

Fundamental analysis refers to analyzing the factors that contribute to a futures contract’s supply and demand. For example, a trader might review Crude Oil Inventories to form an assumption about whether supply will increase or decrease in the future, causing the price of Crude Oil to move up or down in the future. This trader might choose to buy oil now with the assumption that prices will move higher based on his fundamental analysis from the inventories report.

There are many factors that will increase demand and supply for a market. These factors are complex, interrelated and their effect on price can change over time. A detailed model and analysis is required to create a complete fundamental picture of the market. Supply and demand is typically slow to react as supply and demand are with a strategy which protects them from shocks to the market either in the form of supply or demand. These shocks can come from events such as natural disasters, supply chain issues or product defects. For example, if there a natural disaster and a major port for unloading of crude oil is damaged so that ships cannot unload their cargo, creating a surprise and immediate reduction in supply, that was not forecast or predicted in a supply and demand model.

Technical Analysis

Technical analysis uses patterns on a chart created by price to determine where the market is moving. The movement of price is tracked on charts with various indicators or patterns to help determine where price is going to move next. Technical analysis uses the visual representation of price to help illustrate where price is and where it may move in the future. Common areas of interest to traders on charts are levels of supply and resistance. Supply and resistance can be indicated by many indications, such as moving averages, previous highs and lows and previous price levels that price could not move above or below. Traders will look at these levels and make buy and sell decisions when price is at a level that the technical analyst believes is a key buy or sell level.

While each form of analysis relies on different data and different assumptions, since they are both referencing the same market the information provided can be used together to build a more complete analysis of the market you want to trade.

E-mini S&P 500 Futures

A fundamental analysis for the ES contract can be created by looking at anticipated forward earnings for the 500 stocks that make up the S&P500 index. Stock prices are based on the earnings of a company. Stock prices should increase if the company is growing and earnings and profits are increasing. If earnings and profits are decreasing, the stock price will move down reflecting this decrease in earnings. Price is also dependent on future earnings, if future earnings are expected to grow due to prospects, the current stock price may increase to reflect this anticipated financial growth. The S&P500 index is created by looking at the price of 500 stocks. The price of each stock has an influence on the overall index. Each stock contributes to the index based on the size of its market capitalization. If overall stocks are in a growth cycle and earnings are increasing across the market then the price of the index should move up.

For example, an analyst might have an opinion that future earnings will actually be higher than what is currently being priced in by the index. If the trader is correct and earnings do increase more in the future than expected, then the ES contract should increase in price. The trader in this example would want to buy contracts in the S&P 500 futures contract to take advantage of this possible move up.

Crude Oil Futures

Another example is in the Crude Oil market. A technical analyst might believe that there is strong resistance at $100 per barrel of oil, because every time price has reached that level it is followed by a price decrease. Price has not been able to move through $100 because buyers cannot create enough demand to buy at that price and above to move the sellers out of the way.

Continuing with the same example but from the fundamental persepective. The fundamental trader may have researched production costs of different producers and realized that at around $100 per barrel that many oil producers will once again turn on wells with higher production costs that were not operating when the cost of Crude was lower, increasing supply and decreasing price. Crude oil has a range of extraction costs, some wells might be cost effective below $40 and others might not be cost effective until Crude reaches $60 or higher. The reason for this is because not all oil is extracted from the same geology, ranging from deep under sea wells to shale oil production, each with different exploration and extraction costs.

Using Fundamental and Technical Analysis Together

When looking at future demand and supply, technical analysis and fundamental analysis are many times combined to give the trader a bigger picture view of the market. There are many traders who will build pricing models and then look at charts to confirm their assumptions or fine tune entries and exits. There are also many traders who review charts then look at the fundamentals to see if future supply and demand is sufficient to potentially move price through support or resistance or create a supply or demand situation which makes price potentially trend for a long period of time. There are some shocks to the market that have supply and demand effects that can last months or years.

Interconnected Markets

Markets are interconnected, many times a trader will need to look at more than one market to build a complete picture of what they are trading. The fundamental analyst will model the relationship between two markets and attempt to understand how supply and demand in one market can affect supply and demand in another market.

An example is cost of livestock feed and the cost of livestock.  If feed costs increase so too will the cost per head of raising livestock. If the cost of feed is too high then farmers might liquidate herds in the short term, pushing down prices, and creating a situation where future supply is reduced and livestock prices increase in the future. These relationships can be complex and sometimes difficult to model easily, a trader will need to be aware that there are many factors that can move the market they are trading.

A technical analyst is interested in the correlation between two markets. The technical analyst will chart both commodities they are interested in analyzing on a single chart and look for correlations between the two products. They will look to see if the price of both markets move up and down at the same time or does the price in one market move up when the price in the related market moves down. The carts can also show that there is no relationship between the two markets.

Like any trading or analysis strategy, each trader will look at the data in a slightly different way and incorporate their own set of rules to make decisions.

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

Regards,
Peter Knight Advisor

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About Nikkei 225 Futures

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About Nikkei 225 Futures

The Nikkei 225 is the most widely-quoted index of Tokyo’s stock exchange. The index is composed of 225 Japanese companies from various industries, including Toyota, Mitsubishi and Panasonic.

Like the Dow Jones index, the Nikkei 225 is a price-weighted index where larger companies influence the value of the index more than smaller companies.

As many of these companies are export-based, the index offers you an opportunity to gain simultaneous exposure to both Japan’s economy and global markets.

The Contracts

For persons interested in gaining exposure to this index through a futures contract, CME Group has three options:

  • Nikkei 225 denominated in U.S. dollars (NKD)
  • E-Mini Nikkei 225 denominated in yen (ENY)
  • Nikkei 225 denominated in yen (NIY)

Of these three contracts, the Nikkei 225 denominated in yen (NIY) currently has the most active marketplace, followed by NKD and then ENY.

The minimum fluctuation on the both the USD and yen Nikkei 225 contracts is 5.00 index points. The minimum fluctuation on the E-Mini Nikkei 225 is 10 index points. All three contracts are traded electronically, six days a week, 23 hours per day, with a daily 60-minute break at 4 p.m. Central Time.

Market participants taking a stake in any of the futures contracts in the Nikkei 225 index should keep a close eye on all global economic developments in the U.S. and Japan.

The Nikkei is known for rising the day after a rally in the Dow, or falling on days subsequent to a slide in the DJIA.

Due to these known trends, market participants trading NKD, ENY or NIY often trade during the first hour of Tokyo’s trading day in order to profit from the prior day’s trends.

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

Regards,
Peter Knight Advisor

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What is the European Central Bank

Currency Education Home Page

The European Central Bank (ECB) is the central bank of the Eurozone, a collective of European countries that use the euro as their sole official currency. The ECB is responsible for administering monetary policy and safeguarding the value of the euro. Given the relative size of the Eurozone economy, actions undertaken by the ECB garner nearly as much attention from U.S. traders as the actions of the Federal Reserve.

The ECB is governed much like the Federal Reserve. Decisions are made by the Governing Council, which consists of six members of the executive board, plus the governors of the national central banks of the euro-area countries.

Developing Monetary Policy

This Governing Council is responsible for assessing economic and monetary developments and meets every six weeks to set monetary policy for the Eurozone. Monetary policy decisions are published in a press release on the day of the Governing Council policy meeting. Following this release, a press conference begins and the ECB president makes a statement and answers questions from journalists to further clarify policy decisions.

In order to foster transparency, the ECB also publishes an account of the Governing Council’s monetary policy discussions prior to the next meeting, allowing public review of the rationale behind ECB decisions.

ECB Monetary Policy and Trading

Members of the ECB try to be as proactive as possible in managing market expectations and preparing traders for a shift in monetary policy. The executive board of the ECB must often try to unify the differing motivations of the national central bankers into a centralized monetary policy. For this reason, a trader must carefully parse any statements made by the ECB president, who is responsible for sending a consolidated message about overall euro policy.

There are a number of factors to think about when trading ECB policy decision announcements, but with a little insight and thorough preparation, these announcements can provide numerous opportunities for traders.

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

Regards,
Peter Knight Advisor

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FX Spot Markets vs. Currency Futures

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There are many ways in which one may trade FX or currencies. Two of the most popular outlets include the spot FX markets and FX futures markets as offered by CME Group. This report provides a quick look at the similarities and distinctions between these two markets.

Spot FX Transactions

A spot or outright currency transaction is simply the exchange of one currency for another currency, at the current or spot rate. We often speak of “currency pairs” or the exchange rate between one currency and another, e.g., Euros (EUR) vs. U.S. dollars (USD) or Mexican pesos (MXN) vs. U.S. dollars or British pounds (GBP) vs. Swiss francs (CHF).

Spot FX transaction may be concluded immediately in a variety of retail focused markets, or on a commercial scale through so-called interbank markets. Sometimes these transactions are conducted via telephone, or increasingly via electronic trading systems.

Typically a spot FX transaction is concluded through a payment or settlement process two (2) business days after the transaction is concluded – although practices may vary from one trading venue to the next and in the context of particular currency pairs.

E.g., it is frequent practice to settle transactions between the Canadian dollar (CAD) and U.S. dollar (USD) one (1) business day after the transaction is concluded.

Quotes may be in either “American terms” or “European terms.”

E.g., consider the Swiss franc vs. U.S. dollar currency pairing. Conventionally, one quotes this pair in spot markets in European terms, or in terms of CHF per one (1) USD. The pair was priced at 0.8955 CHF per 1 USD as of May 30, 2014. The American terms quote is

1
American Terms Quote = —————————-
European Terms Quote

 

Thus, one may quote in American terms, or USD per CHF, as 1.1167 USD per 1 CHF.

1
1.1167 USD per 1 CHF = —————————-
0.8955 CHF per 1 USD

Standard spot market practice is to quote most currencies in European terms. There are some exceptions to this rule including the EUR, the GBP and British Commonwealth currencies, such as the AUD and NZD, which are generally quoted in American terms.

Select Spot Exchange Rates

(as of May 30, 2014)

Currency CODE In USD per USD
AMERICAS
Argentina Peso ARS 0.1238 8.0787
Brazil Real BRL 0.4462 2.2410
Canada Dollar CAD 0.9220 1.0846
Chile Peso CLP 0.001821 549.10
Colombia Peso COP 0.0005271 1897.00
US Dollar USD 1.000 1.0000
Mexico Peso MXN 0.0778 12.8576
ASIA-PACIFIC
Australian Dollar AUD 0.9311 1.0740
China Yuan CNY 0.1600 6.2486
Hong Kong Dollar HKD 0.1290 7.7529
India Rupee INR 0.01686 59.30895
Indonesia Rupiah IDR 0.0000857 11675
Japan Yen JPY 0.00982 101.78
Malaysia Ringit MYR 3.112 3.2135
New Zealand Dollar NZF 0.8498 1.1768
Singapore Dollar SGD 0.7973 1.2542
South Korean Won KRW 0.0009794 1021.0
Taiwan Dollar TWD 0.3328 30.047
Thailand Baht THB 0.03044 32.848
EUROPE
Denmark Krone DKK 0.1826 5.4750
Euro EUR 1.3632 0.7336
Norway Krone NOK 1.1674 5.9748
Russia Ruble RUB 0.02866 34.895
Sweden Krona SEK 0.1495 6.6886
Switzerland Franc CHF 1.1167 0.8955
Turkey Lira TRY 0.4768 2.0972
UK Pound GBP 1.6756 0.5968
MIDDLE EAST / AFRICA
Israel Shekel ILS 0.2878 3.4742
Saudi Arabia Riyal SAR 0.2666 3.7506
South Africa Rand ZAR 0.0946 10.5729

Source: Wall Street Journal, May 30, 2014

Most currencies are quoted to the 4th place past the decimal or 0.0001, also known as a “pip” or a “tick.” However, practices may vary with respect to currencies whose values are very small or very large in relative terms.

It is also possible to trade “cross-rates” or transactions which do not involve U.S. dollars. For example, one may trade the GBP/EUR exchange rate.

Select Spot Cross Rates

(as of May 30, 2014)

USD EUR GBP CHF MXN JPY
JPY 101.7843 138.7536 170.5547 113.6654 7.9163 –
MXN 12.8576 17.5276 21.5448 14.3585 – 0.1263
CHF 0.8955 1.2207 1.5005 – 0.0696 0.0088
GBP 0.5968 0.8135 – 0.6664 0.0464 0.0059
EUR 0.7336 – 1.2292 0.8192 0.0571 0.0072
USD – 1.3632 1.6756 1.1167 0.0778 0.0098

Source: Wall Stree Journal, May 30, 2014

FX Futures Fundamentals

Currency futures were developed in 1972 by Chicago Mercantile Exchange Chairman Leo Melamed. This development was a direct response to the breakdown of the Bretton Woods Accord, which pegged global currencies to the U.S. dollar, and represented the first financial futures market.

Over the years, many currency contracts have been added and the listings now include contracts on Euros vs. U.S. dollars (EUR/USD), Japanese yen vs. U.S. dollars (JPY/USD), British pounds vs. U.S. dollars (GBP/USD), Swiss francs vs. USD (CHF/USD), Canadian dollars vs. USD (CDN/USD), Australian dollars vs. USD (AUD/USD), Mexican pesos vs. USD (MXN/USD), New Zealand dollars vs. USD (NZD/USD), Russian ruble vs. USD (RUB/USD), South African rand vs. USD (ZAR/USD), Brazilian real vs. USD (BRL/USD), and many others.

More recent additions to the line-up include Chinese renminbi vs. USD (RMB/USD) and Korean won vs. USD (KRW/USD). Further, CME lists smaller sized or “E-mini” versions of several of our more popular FX futures contracts. The aforementioned contracts are generally quoted vs., and denominated in, the U.S. dollar.

Major cross-rate contracts included EUR/GBP, EUR/JPY, EUR/CHF, GBP/CHF, GBP/JPY and many others. CME Group further offers options on many of these currency futures contracts.

Mechanics of FX Futures

Futures are traded on a regulated futures exchange subject to standardized terms and conditions. They are distinguished from spot or other “over-the-counter” FX transactions by their standardization, which concentrates liquidity in a relatively small number of items.

FX futures are traded on the CME Globex® electronic trading platform and on the floor of the Exchange in an open outcry environment, although the predominant mode of trade is electronic.

These contracts generally call for delivery of a specified quantity of currency, or a cash settlement, during the months of March, June, September and December (the “March quarterly cycle”). 1 Thus, one may buy or sell 12,500,000 JPY for delivery on the 3rd Wednesday of June; or, 125,000 Euros for delivery on the 3rd Wednesday of September.

Traders who “go long” or buy JPY/USD futures are committed to take or accept delivery of 12,500,000 JPY while, traders who “go short” or sell EUR/USD futures are committed to make delivery of 125,000 Euros. The short making delivery is compensated by the buyer accepting delivery by an amount equal to the futures settlement price quoted in USD on the last day of trading.

American vs. European Terms Quotes

(as of May 30, 2014)

CME Quotes American Terms European Terms
USD vs. EUR 1.3632 0.7336
USD vs. JPY 101.78 0.00982
USD vs. GBP 1.6756 0.5968
USD vs. CHF 1.1167 0.8955
USD vs. MXN 0.0778 12.8576

Source: Wall Street Journal

CME Group FX futures are generally quoted in “American” terms, i.e., in terms of dollars per foreign unit. This is at variance from the typical interbank practice of quoting foreign exchange transactions in terms of foreign unit per USD. 2

1Our appendix includes contract specifications for several of the most popularly traded CME Group currency futures contracts.

2 Some CME Group currency futures are quoted in European terms. For example, we list a South African rand (“ZAR”) contract quoted in rand per USD. Further, many currencies listed on the CME Europe platform, launched in May 2014, are quoted in European terms as well. But most of our most popularly traded FX futures are quoted in American terms.

The information herein has been compiled by CME Group for general informational and educational purposes only and does not constitute trading advice or the solicitation of purchases or sale of any futures, options or swaps. All examples discussed are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. The opinions expressed herein are the opinions of the individual authors and may not reflect the opinion of CME Group or its affiliates. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT and NYMEX rules. Current rules should be consulted in all cases concerning contract specifications.

Although every attempt has been made to ensure the accuracy of the information herein, CME Group and its affiliates assume no responsibility for any errors or omissions. All data is sourced by CME Group unless otherwise stated.

CME Group is a trademark of CME Group Inc. The Globe Logo, CME, CME Direct and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX and ClearPort are trademarks of New York Mercantile Exchange, Inc. All other trademarks are the property of their respective owners.

Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade.

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

Regards,
Peter Knight Advisor

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Options Premium and the Greeks

Options Education Homepage

Futures contracts can be an effective and efficient risk management or trading tool. Their performance is basically two-dimensional, either you are up money or down depending on the entry price point and whether the market is up or down versus your position.

But with options on futures there are more dimensions, or forces, acting on the price, or premium, of the option.

There are metrics to measure each of these different forces impacts on the premium of an options. These metrics are often referred to by their Greek letter and collectively as the Greeks.

While we have addressed each Greek separately, it is important to understand they do not operate independently, but move and adjust dynamically with changes in market conditions.

Example

Assume futures are at 980. The 1000 call is priced at 12 with a:

Delta of 40

Gamma of 0.50

Theta equal to 0.20

Vega equal to 0.10 and

Volatility at 15%

If market goes to 1000 (up 20 points) in 2 weeks  and volatility drops to 14% (down one point) what is the resulting premium of the option?

Look at each one of our Greeks.

The effect on the option’s premium from delta alone would be .40  x 20 which equals 8 points.

To calculate the delta effect due to gamma, we multiply the gamma of .50 times the 20-point move, giving us 10 additional delta. This changes the options delta from 40 to 50.

The initial delta is 40, which would generate 8 points of change across the 20-point move. The new delta of 50 would generate a premium change of 10. Across the 20-point move, the delta changed from 40 to 50, therefore we take the average, 45. This will contribute 9 points to the options new premium.

To calculate theta, or time decay, multiply the theta value of 0.20 times 14 days which equals -2.8

The vega effect is calculated by multiplying the vega metric by the change in volatility.

Vega of -1 x 0.10 = -0.1

Now we can add those values to get our new option price.

Old option premium + delta + theta + volatility

The option premium is now 18.1

Conclusion

You should now have a greater understanding of how the options Greeks work together. Recognizing the pricing variables of options is a necessary component of option trading.

 

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

Regards,
Peter Knight Advisor

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Options Vega

Options Education Homepage

Futures contracts can be an effective and efficient risk management or trading tool. Their performance is basically two-dimensional, either you are up money or down depending on the entry price point and whether the market is up or down versus your position.

But with options on futures there are more dimension, or forces, acting on the price or premium of the option.

There are metrics to measure how each of these different forces impacts the premium of an option. These metrics are often referred to by their Greek letter and collectively known as the Greeks.

Options Vega

Vega is the Greek that measures an option’s sensitivity to implied volatility.

It is the change in the option’s price for a one-point change in implied volatility. Traders usually refer to the volatility without the decimal point.

For example, volatility at 14% would commonly be referred to as “vol at 14.”

Volatility should not be confused with Vega. Volatility is either the historical or expected bounciness of the underlying future. Historical volatility is volatility in the past and is therefore known. Expected volatility is unknown volatility in the futures contract that feeds into the option price as implied volatility.

Whereas, Vega is the sensitivity of a particular option to changes in implied volatility.

For example, if the value of an option is 7.50, implied volatility is at 20 and the option has a Vega of .12.

Assume that implied volatility moves from 20 to 21.5. This is a 1.5 volatility increase. The option price will increase by 1.5 x .12 = .18 to 7.68.

Conversely, if volatility dropped from 20 to 18. This two-point decrease times .12 equals .24, making the option premium 7.26.

Vega is the highest when the underlying price is near the option’s strike price. Vega declines as the option approaches expiration. The more time to expiration, the more Vega in the option.

If you are going to trade options, Vega is a measurement you will want to study.

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

Regards,
Peter Knight Advisor

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Options Theta

Options Education Homepage

Futures contracts can be an effective and efficient risk management or trading tool. Their performance is basically two-dimensional, either you are up money or down depending on the entry price point and whether the market is up or down versus your position.

But with options on futures there are more dimensions, or forces, acting on the price or premium of the option.

There are metrics to measure each of these different forces impacts on the premium of an option. These metrics are often referred to by their Greek letter, and collectively known as “the Greeks.”

Theta

Delta and gamma measure the effect of price movement of the underlying on the option premium. As we demonstrated in previous videos, both are dynamic as to the option being out-the-money (OTM), at-the-money (ATM), or in-the-money (ITM).

Now we will investigate the effects of time on an option. The Greek that measures an option’s sensitivity to time is theta. Theta is usually expressed as a negative number. Be careful to always make sure what time is referenced in the model you are using.

For example, if the value of an option is 7.50 and the option has a theta of .02. After one day, the option’s value will be 7.48, 2 days 7.46. etc.

Theta is highest for at-the-money (ATM) options and lower the further out-the-money or in-the-money the option is. The absolute value of theta of an option that is at- or near-the-money rises as the option approaches expiration. Theta for an option that is deep in- or out- the-money falls as the option approaches expiration.

In the prior example, theta was a constant value of .02 for all three days. In reality, the theta loss increases as the option approaches expiration.

Example

In March, a September option will have a daily time decay of .02. By August, the daily decay will increase to .06 and the option more quickly decays.

Time decay is not linear, and moreover, for ATM strikes decay continually accelerates into option expiration.

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

Regards,
Peter Knight Advisor

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Options Gamma

Options Education Homepage

Futures contracts can be an effective and efficient risk management or trading tool. Their performance is basically two-dimensional, either you are up money or down depending on the entry price point and whether the market is up or down versus your position.

But with options on futures there are more dimension, or forces, acting on the price or premium of the option.

There are metrics to measure each of these different forces impacts on the premium of an options. These metrics are often referred to by their Greek letter and collectively known as the Greeks.

Gamma

We discussed previously that delta is the change in the options price or premium due to the change in the underlying futures contract price.

We will now discuss how delta itself changes with a change in the underlying futures price. This is known as gamma. Think of gamma as the delta of the delta.

Look at it a different way; you are driving a car at 30 miles per hour (mph). If you increase your speed to 40 mph, you have accelerated by 10 miles per hour. If you think of speed as your delta, then the change in your speed is your gamma. In other words, gamma is your acceleration.

Understanding Gamma Movements

Gamma is usually expressed as a change in the delta per one point change in the price of the underlying.

For example, if the futures price is 200, a 220 call has a delta of 30 and a gamma of 2.

If the futures price increases to 201, the delta is now 32. Conversely, if the futures price decreased to 199, the delta is 28.

Just like delta, gamma is dynamic. It is the highest when the underlying price is near the option’s strike price.

As the underlying moves away from the strike price, the gamma decreases. As the underlying moves towards the strike price, the gamma increases.

At the money options have the highest gamma, because their deltas are the most sensitive to underlying price changes.

Calculating Gamma

Gamma is the difference in delta divided by the change in underlying price.

You have an underlying futures contract at 200 and the strike is 200. The options delta is 50 and the options gamma is 3. If the futures price moves to 201, the options delta is changes to 53. If the futures price moves down to 199, the options delta is 47.

Across the two-point underlying futures contract move, the delta changed by 6.

If you are going to trade options, Gamma is a measurement you will want to study.

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

Regards,
Peter Knight Advisor

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Options Delta

Options Education Homepage

Futures contracts can be an effective and efficient risk management or trading tool.  Their performance is basically two-dimensional, either you are up money or down depending on the entry price point and whether the market is up or down versus your position.

But with options on futures there are more dimensions, or forces, acting on the price or premium of the option.

There are metrics to measure each of these different impacts on the premium of an options.  These metrics are often referred to by their Greek letter symbols and collectively as “the greeks.”

Let’s look at one of the most commonly used Greeks – Delta.

Delta is the change in the option’s price or premium due to the change in the Underlying futures price.

It is some portion of the movement of the underlying. Delta is a percentage measure.

Assume, we have a call option priced at 1.00 and it has a .50 delta. This means whatever the change of the underlying future is, the option will move by 50% of that change. Our underlying futures product moved from 96 to 97.5.  This is a 1.5 point move.   So, our option’s premium will now change by 50% of 1.5 or .75.  Making the option’s new price 1.75

Calls always have positive delta between 0 and 1.00, while puts always have negative delta between 0 and -1.00.

The delta of a futures contract is 1.00.

Traders usually refer to the delta without the decimal point. So, a .40 delta is commonly referred to as a 40 delta.

Being Long a call will result in positive Delta; being short a call results in negative Delta. Conversely, being Long a put results in negative Delta; being short a put results in positive Delta. The absolute value of the Delta also tells the approximate probability that the option will finish in-the-money.

For example, if the option has a delta of 20 it suggests it has a 20% chance of finishing in-the-money.  A delta of 50 suggests it has a 50-50 chance of finishing in-the-money.

If an options delta is less than 50 it is said to be out of the-money.  If the delta is greater than 50 the option is said to be in-the-money.  If the delta is equal or close to 50 the option is said to be at-the-money.

The delta is used in calculating hedge ratios to establish a neutral or delta hedged position using the underlying futures. Let’s say we sold 8 call options that have a 25 delta, we have a delta position of -200. To be delta neutral, we need to buy 2 underlying Futures contract.

Delta is dynamic and changes with movement in the underlying.  That means delta neutral ratios and other hedge ratios using options are also dynamic and change too.

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

Regards,
Peter Knight Advisor

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Disclosure