Tag: Futures Trading Advisors

Option Bull Spread

A bull spread consists of a buy leg and a sell leg of different strikes for the same expiration and same underlying contract.

This strategy will pay off in a rising market, also known as a bull market, that is why it is referred to as a bull spread.

Bull spreads can be constructed from either going long a call spread or going short a put spread.

Call Bull Spreads

A trader believes that the market will have a moderate rise before the options expire.

If the underlying market was trading at 100, he would buy a 105 call for $3 and sell the 110 call for $2. By selling the 110 call, he receives a premium, which offsets the cost of the 105 leg. The total cost of the spread is $1. The breakeven point for the spread is 106. This is the cost of the spread plus the 105 strike.

The best-case scenario is if the market finishes at or above 110 because the 105-110 call spread will pay off $5. This is the maximum payoff for the spread, regardless of where the underlying finishes. If we subtract the $1 cost of the spread, the total profit for the trade will be $4.

Assume the underlying finished at 113. The 105 call will pay the trader $8, but he will need to payout $3 on the 110 call. Another example, if the market finishes at 130, the 105 call will pay the trader $25, but he will need to payout $20 on the 110 call.

The worst-case scenario is if the market finishes at or below 105. Because both the 105 and 110 call expire out-of-the-money and are therefore worthless. The trader loses the full cost of the spread, $1.

If the trader had purchased only the 105 call at $3, his loss would be $3 versus $1.

If the underlying finishes at 107.5, the long 105 call will be worth $2.50 and the short 110 call expires worthless. The trader’s payout of $2.50 minus the $1 cost of the spread gives him $1.50 profit.

If the trader had bought only the 105 call, his payout would still be $2.50, but that is less than the $3 he would have paid for the 105 call alone.

Put Bull Spreads

Bull spreads can also be constructed from selling a put spread.

Selling a put allows you to collect a premium that you can keep if the underlying futures contract finishes at or above the strike price.

Instead of buying the 105-110 call spread, we can sell the 110-105 put spread. This would entail selling the 110 puts and buying the 105 puts which would result in a $4 credit with the underlying future trading at 100

The breakeven point for the spread is 106, the 110 strike minus the spread credit of $4. This is the same breakeven point as the call bull spread.

If the market finishes above 110, the puts expire worthless. Therefore, the trader keeps the $4 he received by selling the put.

If the market finishes at 103, the 110 put is worth $7 and the 105 put is worth $2. Therefore, the put spread is worth $5 dollars. The trader received $4, and must now payout $5, resulting in a $1 loss.

If the market finishes at 107.5, the 110 put is worth $2.50 and the 105 put expires worthless. The trader must pay out $2.50 from his $4 credit. Resulting in a $1.50 profit.

We can see in this chart, that these three scenarios have the same outcome whether we buy a call spread or sell a put spread to create a bullish position. Traders still want the market to finish above the high strike of the spread.

Bull spreads are a commonly used and valuable options strategy.

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

Regards,
Peter Knight Advisor

—————————————————————-

Options Education Homepage

Trading Option Calendar Spreads

Trading Option Calendar Spreads

Being long a calendar spread consists of a selling an option in a near-term expiration month and buying an option in a longer-term expiration month. The options are both calls or puts, have the same strike price and the same contract. There are always exceptions to this.

One reason to buy a calendar spread — also referred to as a horizontal spread and a time spread — is because of its low-risk and profit potential from the passage of time. This may be due to known events, such as an economic report or an election, that you feel will not move the market as much as anticipated.

Let’s look at an example.

How an option calendar spread works – an example

A trader believes that the market will be very quiet and stable until after September expiration, when she believes that the market will rally tremendously.

She could just buy a December call. The December call premium, however, will be expensive due to the amount of time left in that option.

She can offset some of that premium by selling a shorter-term call. This is referred to as buying the calendar spread: Sell 1 September 2440 call and buy 1 December 2440 call for a net premium of 33.75.

In the best-case scenario, the market stays stable until after September expiration.

Let’s look at a few possibilities.

Exploring the possible outcomes in September

It’s now September and the underlying futures have fallen dramatically to 2000. The trader’s short call expires worthless – allowing her to keep the premium collected from the short leg of the spread. She still is long the December call, but the value has decreased due to the market drop.

Her maximum loss is only 33.75 – the initial cost of the spread. Had she purchased the December call only, the loss would have been 70.50.

Conversely, if the market rose to 3000 before September expiration, her short September call would be worth 560.00, and her long December call would be trading close to parity at 560.00. The spread is worth zero, and she is out the premium of 33.75. In this case, had she purchased the December call only, it would have been very profitable.

Say we’re at September expiration, and the futures prices have not moved. In this case, the September call expires worthless. The December call is at the money with three months remaining. It still would be worth about 50.00 – minus the spread cost of 33.75, netting the trader a profit of 16.25 if she sold the December call, thus closing out her position.

Possible outcomes at December expiration

Following her initial instinct, she keeps the December call, hoping for a rally. Come December, let’s look at the different scenarios.

If the underlying future dropped to 2000, the December call expires worthless. She would net lose the 33.75 from the spread versus losing the 70.50 premium had she bought the December call alone.

This also would be the case if the futures didn’t move and stayed around 2400. She would lose 33.75 on the spread versus the 70.50 had she bought the December call alone.

We had said the best-case scenario would be the market stabilizing until after the September expiration. If futures rose to 3000, the December call would be worth 560, Less the spread cost of 33.75, this nets her a gain of 526.75.

Conclusion

As we’ve seen, the trader can design a spread position that minimizes her loss potential while leaving open the possibility of tremendous profit.

Another trader may sell the calendar spread if they feel the underlying will have dramatic moves in the near term and stabilize on a longer time horizon.

Traders may have a complex view of future market activity and implied volatility.

Calendar spreads are one tool for traders to express their views within a certain timeframe.

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

Regards,
Peter Knight Advisor

—————————————————————-

Option Ratio Spreads

Another commonly traded strategy is the ratio spread. A ratio spread consists of long and short options, the quantities of which are in simple mathematical ratios such as 2 to 1 or 3 to 2. Traders will refer to these spreads as a 1 by 2, or 2 by 3.

Ratio spreads generally consist of all calls or all puts, with the same expiration and the same product. There certainly can be exceptions to this.

How the spreads are structured

These are not just random combinations of strikes. They are frequently a function of the deltas of the options in the spread. For example, a trader may want to buy upside exposure to the market. The trader will buy two of the 23 delta calls and sell one – 46 delta call to help finance the purchase.

The 375 strike has a 46 delta. The 405 strike has a 23 delta. The 405 option will need to be far enough in the money to overcome the loss from the 375 option. Therefore, the market will need to have a considerable upward move.

Examining the three instruments involved

Because this trade consists of three separate instruments, let’s look at each of them. Looking at te short 375 strike first, the payoff for that leg will look like a short call position.

Profit earning

Now let’s look at the 405 strike, these options both will have a long call payoff. The first 405 call that the traders bought will cap the loss on the 375 call that they sold.

As the market moves higher, any further losses incurred by the short 375 strike will be counterbalanced by gains on the 405 strike.

When we include the second 405 call, the payoff profile will look like this.

The trader receives a net credit of 0.75 for the ratio spread. Because he sold one option for 13 6/8, or 13.75, he bought two options for 6 4/8 or 6.50 each. Let’s look at this spread’s breakeven points.

If the market ends below 375, the trader will keep his .75 credit because all the options expire worthless.

Loss reducing

If the market ends at 375.75, the payout he must make due to the short call’s being .75 in the money equals the credit he had received for the spread. This is the lower breakeven point.

If the market ends at 405, this is the point of his maximum loss: the 405 calls expire worthless, and he owes the market 30 for the short 375 call. If we subtract his original credit for the spread of .75, this lowers his loss to 29.25.

If the market ends above 405, both the 375 and 405 calls are in the money. Any further increases in the market that make the 375-call increase in value will also make the 405 call increase the same amount. Being short one and long the other, the trader is no longer affected by the upward market movement.

The second 405 call needs to overcome the max loss of 29.25 for the spread to be profitable.

Therefore, the market must reach 434.25 for our spread to reach its upper breakeven point. Anything above 434.25 is unlimited profit.

Conclusion

Ratio spreads can have multiple results based on market outcomes. Traders can express their view of the market with unlimited upside potential and limited downside exposure. Ratio spreads can be a capital efficient method for market participation.

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

Regards,
Peter Knight Advisor

—————————————————————-

Option Butterfly

We have learned about both the similarities and differences between a straddle and strangle. Now we will look at a commonly traded strategy, referred to as a butterfly. Going long a butterfly, the trader buys a call of a low strike, sells two calls of a middle strike, and buys a call of a high strike. The three strikes are equidistant. The options have the same expiration and the same underlying product.

For example, if we bought a 2395 call, sold two of the 2420 calls and bought a 2445 call, this would be referred to as the 95, 20, 45 fly. The cost of the butterfly in this example would be 1.75. The 2395 and 2445 strikes are referred to as the wings, while the 2420 is known as the body of the butterfly.

Trading a Butterfly

Traders will buy the butterfly if they expect the market to stagnate. In our example, we are expecting the market to be around 2420.

You might be asking, if I expect the market to stagnate – why wouldn’t I just sell the 2420 straddle? As we learned, selling the straddle is a possible way to profit from a stagnating market, but the straddle’s loss potential is unlimited. That could be very costly for a trader.

The wings of the butterfly protect the trader from the unlimited risk of the straddle. Buying a butterfly limits the risk of being wrong to the cost of the butterfly.

If we sold the straddle by selling the 2420 call and put, we receive 105 from the buyer. Therefore, the maximum profit is 105 if the market is at 2420 at expiration.

The cost breakdown of the butterfly is:

Buy 2395 call at 69.75
Sell 2420 call twice for 53.25 each
Buy 2445 call at 38.50
For a cost of 1.75

In that same scenario, we can calculate the maximum profit from our butterfly.

The 2395 expires 25 points in-the-money. The short 2420 calls expire worthless. The long 2445 call also expires worthless. Less our initial cost of 1.75, we will make a profit of 23.25.

Butterfly versus Straddle

Compare the breakeven points between a straddle and a butterfly. The breakeven points are where the payoff equals the original premium for each strategy. For the straddle, they are the strike plus or minus the premium received. For the butterfly, the breakeven points are the lower strike plus the premium paid and the upper strike minus the premium paid.

In our example, we bought the butterfly for 1.75. The low strike of the fly is 2395. Adding 1.75 to that strike gives us our first breakeven point of 2396.75. Our high strike of the fly is 2445. If we subtract the butterfly’s premium of 1.75 from that our high breakeven point is 2443.25. Recall that the maximum profit for the butterfly is 23.25 and the maximum profit for the straddle is 105.

Time Decay

The time decay of a butterfly is greatly dependent upon the current level of the market. Near the short strikes, time decay is in your favor. Near the wings, time decay works against you.

Looking at our chart, we can see the butterfly has a lower cost, lower maximum profit potential but a much lower loss potential.

	Sell Straddle	Buy Butterfly
Maximum Loss	Infinite	Cost of butterfly
Cost	Receive 105	Pay 1.75
Maximum Profit	105	23.25
Breakeven – Upside	2525	2445
Breakeven –Downside	2313	2443.25

In our example, the straddle’s breakeven range is much greater than the butterfly. Although that range for the underlying market to land is greater than the butterfly’s, if the market does not land there, the potential loss could be detrimental.

Utilizing the butterfly allows traders to profit on their view that the market will be at a certain point at expiration; and the wings limit the loss if they are incorrect.

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

Regards,
Peter Knight Advisor

—————————————————————-

Option Strangles

Long Strangle

In a long strangle, the trader buys a call and put of different strikes, the same expiration and the same underlying product. You may note the similarity to a straddle, but the difference is that with a strangle, the call and the put are different strikes versus the same strike used in a straddle.

For example, if we bought a 2395 put and a 2445 call, this would be referred to as the 95-45 strangle. The cost of the strangle in this example would be 82.00. Traders will buy the strangle if they expect the market to start moving but are not sure which way.

In our example, the E-mini futures contract would be around 2420, we expect the future to move up or down but we are not sure which way. This is almost like a straddle, but the market must move further in either direction for the options to finish in the money. The profit potential is much larger than the cost of the strangle in either direction. But since the overall potential profit is still lower than a straddle, strangles will cost less than straddles.

For our example, at expiration, the break-even points are 2313 and 2527. These are the call strike plus the strangle cost and the put strike minus the strangle cost. Loss is limited to the cost of spread. Maximum loss occurs if the market is anywhere between the two strikes at expiration. Because the strangle is composed of only long options, it loses option premium due to time decay. Time decay is most costly if the market is between the two strikes.

Short Strangle

Traders will sell a strangle when they expect the market is going to stagnate. Because the traders are short the strangle, they profit as the options decay, provided the market does not move too far beyond either strike. As previously discussed, the break-even points are 2313 and 2527. The break-even points are the same regardless if you are long or short the strangle. For a short strangle, profit is maximized if the market is between the two strikes 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 applicable. Because being short the strangle 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 strangle holder loses. Again, time decay is most profitable if the market is between the strikes.

When it comes to options strategies, strangles are a potential tool for managing your position.

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

Regards,
Peter Knight Advisor

—————————————————————-

Option Straddles

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.

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

—————————————————————-

Understanding Covered Calls

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

—————————————————————-

Currency Education Home Page

Fundamentals and FX Futures

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

—————————————————————-

Currency Education Home Page

Euro FX Futures

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

—————————————————————-