FOT200910

October 2009 • Volume 3, No.
10
TRADING FUTURES TESTING A

with implied “double-butterfly”
volatility p. 10 system p. 20
BEYOND THE GOLDEN

CREDIT SPREAD: opportunity p. 31
Diagonal put spreads p. 14
BULL PUT SPREAD
pays off p. 32
FUTURES BASICS:
Front and
back months p. 22
CONTENTS
Managed Money . . . . . . . . . . . . . . . . . . . . .18

Top 10 option strategy traders ranked by August
2009 return.
Options Trading System Lab

Double butterflies on the S&P 500 . . . . .20
Trading two butterfly spreads with a short-term
outlook has been surprisingly effective since
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6 2004.
By Steve Lentz and Jim Graham
Market Movers . . . . . . . . . . . . . . . . . . . . . . . .8
Futures market roundup. Futures Basics
Front and back months . . . . . . . . . . . . . . .22
Trading Strategies Learn the difference between the different
Implied volatility: An overlooked tool contract months in your market.
for stock and futures traders . . . . . . . . . .10 By FOT Staff
Implied volatility is usually associated with
options trading, but futures and stock traders New Products and Services . . . . . . . . . . . . .23
can use this information too.
By Keith Schap
Diagonal put spreads:

Beyond the basic credit spread . . . . . . .14
How to profit from volatility surges and time
decay with a put spread that encompasses
different expiration months.
By John Summa
continued on p. 4
2 October 2009 • FUTURES & OPTIONS TRADER

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CONTENTS
Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .24

Momentum, volatility, and volume
statistics for futures.
Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .25

Notable volatility and volume
in the options market.
Futures & Options Watch:

COT extremes . . . . . . . . . . . . . . . . . . . . . . . . .26
A look at the relationship between commercials Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29
and large speculators in 45 U.S. futures markets.
Futures & Options Calendar . . . . . . . . . . . .30
Options Watch:
Stocks and ETFs with Futures Trade Journal . . . . . . . . . . . . . . .31
high options volume . . . . . . . . . . . . . . . . . . .26 Jumping on the gold bandwagon.
Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .27 Options Trade Journal . . . . . . . . . . . . . . .32

References and definitions. Riding a bull put spread into the winner’s circle.
Have a question about something you’ve seen

in Futures & Options Trader?
Submit your editorial queries or comments to webmaster@futuresandoptionstrader.com.
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CONTRIBUTORS
CONTRIBUTORS
A publication of Active Trader ®
For all subscriber services:

www.futuresandoptionstrader.com
Editor-in-chief: Mark Etzkorn

metzkorn@futuresandoptionstrader.com
Managing editor: Molly Goad

mgoad@futuresandoptionstrader.com
Senior editor: David Bukey

dbukey@futuresandoptionstrader.com Keith Schap is a freelance writer specializing in risk man-
agement and trading strategies. He is the author of numerous
Contributing writers: Keith Schap,
Chris Peters
articles and several books on these subjects, including The
cpeters@futuresandoptionstrader.com Complete Guide to Spread Trading (McGraw-Hill, 2005). He was a
senior editor at Futures magazine and senior technical market-
Editorial assistant and
webmaster: Kesha Green ing writer at the CBOT.
kgreen@futuresandoptionstrader.com
John Summa is an economist, author, and professional options trader.
Art director: Laura Coyle
lcoyle@futuresandoptionstrader.com In 1997 he founded OptionsNerd.com, where he teaches traders how to
become successful option sellers. He also publishes an option trading adviso-
President: Phil Dorman
ry. He is the author of Trading Against The Crowd: Profiting From Fear and Greed
pdorman@futuresandoptionstrader.com
in Stock, Futures and Option Markets (John Wiley & Sons, 2004) and the co-
Publisher, author of Options on Futures: New Trading Strategies (John Wiley & Sons, 2001).
Ad sales East Coast and Midwest:
Bob Dorman
He currently operates a portfolio of managed account programs which
bdorman@futuresandoptionstrader.com employ his philosophy of selling options on equity futures options.
Ad sales
Jim Graham (advisor@optionvue.com) is the product
West Coast and Southwest only:
Allison Chee manager for OptionVue Systems and a registered investment
achee@futuresandoptionstrader.com advisor for OptionVue Research.
Classified ad sales: Mark Seger

seger@futuresandoptionstrader.com Steve Lentz (advisor@optionvue.com) is a well-estab-
lished options educator and trader and has spoken all over the
U.S., Asia, and Australia on behalf of the CBOE’s Options
Volume 3, Issue 10. Futures & Options Trader is pub-
lished monthly by TechInfo, Inc., 161 N. Clark St., Institute, the Options Industry Council, and the Australian
Suite 4915, Chicago, IL 60601. Copyright © 2009
TechInfo, Inc. All rights reserved. Information in this Stock Exchange. As a mentor for DiscoverOptions.com, he
publication may not be stored or reproduced in any
form without written permission from the publisher. teaches select students how to use complex options strategies
The information in Futures & Options Trader magazine and develop a consistent trading plan. Lentz is constantly developing new
is intended for educational purposes only. It is not
meant to recommend, promote, or in any way imply
the effectiveness of any trading system, strategy, or
strategies on the use of options as part of a comprehensive profitable trading
approach. Traders are advised to do their own
research and testing to determine the validity of a trad-
approach. He regularly speaks at special events, trade shows, and trading
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future group organizations.
results.

Futures_Options_Trader-TOMS09_Layout 1 8/19/09 10:14 AM Page 1
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MARKET MOVERS
Mixed bag for commodities

At the beginning of October, commodity futures were hovering near the
middle of the range they established between the July lows and the June
and August highs. After rallying off the March lows — along with most
other global financial markets — commodity futures (represented here by
the Rogers International Commodity Index TRAKRS), peaked in early
June, pulled back, challenged the June high in August, and then sagged
again through the end of September.
Energies and grains were notable drags on the market as summer
wound down, while precious metals were one of the strong spots.
On the financial side, stock-index futures kept their rally alive — albeit
less confidently — while interest-rate futures also edged higher. A U.S.
dollar nosedive sent the benchmark dollar index futures into the toilet
while buoying many foreign currency futures.
Source for all: TradeStation For momentum, volatility, and volume data for the top U.S. futures con-
tracts, see the Futures Snapshot.
Metals
Gold reclaimed $1,000 in September after staging a strong
rally in late August. December gold (GCZ09) climbed 9
percent from an Aug. 17 close of 935.80 to a Sept. 16 close
of 1020.20 before pulling back.
And once again, gold’s upthrust overshadowed an even more powerful
move in silver. The December contract (SIZ09) rocketed more than 25 per-
cent during the same period.
Copper, which launched a summer rally earlier than its higher-profile
counterparts, extended the rounded consolidation it began in mid-August.
The December contract (HGZ09) was trading around 2.770 on Oct. 1 —
pretty much where it had been in early August.
Grains
For the most part, the re-
cent downtrend in Energy
grains slowed in
September, but the sec- As October ar-
tor failed to make any rived, energy fu-
decisive move to the upside. tures were still
Wheat was the weakest market, trading in chop-
with the December contract (WZ09) py, slightly bear-
falling to new lows (below 440) in ish fashion in the
late September and early October. wake of their late-July rallies. December
December corn (CZ09) stabilized crude oil (CLZ09), after pushing above $75
after falling to 300 in early September, bouncing in August, gradually stuttered lower to
back above 340 by the end of the month. $65.55 on Sept. 24.
November soybeans (SX09) followed a jagged While gasoline and heating oil basically
path in recent months, leaping higher in late July followed crude’s lead, natural gas bucked
only to fall back near contract lows by the sector’s trend (or rather, lack thereof) by
September. rallying off its lows in early September. The
November rice (RRX09), which had bucked December contract (NGZ09), which had
the bearish grain trend during part of the sum- failed to rebound in the spring with the rest
mer, seesawed lower in August and September, of the sector, closed at 4.486 on Sept. 7, but
but as of Oct. 1 was still well above its late-June subsequently jumped more than 26 percent
low. to close at 5.666 on Sept. 25.

Softs
The soft com-
modities have Wood
been split recent- and fiber
ly, with cocoa and especially
sugar mounting bullish sum- November lumber (LBX09)
mer-fall campaigns while cof- extended its summer downtrend
fee and orange juice flailed into fall, pushing lower in late
wildly in July, August, and September after having stabilized
September. to a degree over the preceding
Both January sugar (SBF10) month. The close around 170 at the
and December cocoa (CCZ09) end of September was nearly 25
were in the process of chal- percent below the mid-June high
lenging their recent highs close above 225.
after correcting at the end of December cotton (CTZ09) con-
September. tinued its wide-ranging consolida-
On Oct. 1 December coffee tion through September, pulling
(KCZ09) found itself smack back from resistance around 65 to close the month around 63.
dab in the middle of its July
low close around 118 and its
August high close of 141,
while November orange juice Treasuries
(OJX09) was in a similar con-
dition, having pulled back Treasury futures
from above 110 in August to rallied in recent
the low 90s at the beginning weeks despite the stock market’s
of the month. overall gains. In late September
the December 10-year T-note
contract (TYZ09) broke out of a short-term consolidation and
pushed above 119 by Oct. 1 — just as stocks were beginning to
show some instability.
Meats
After staging their first real
rebound from the swine-flu Stock
induced collapse, Dec- indices
ember lean hogs (LHZ09)
turned lower again — but December E-Mini
not dramatically — in mid- S&P 500 (ESZ09) began to level
September, falling back off in late September after a sum-
below 50 after having mer rally that took it from a close
topped 52. of 869.75 to 1067.25 on Sept. 22.
February pork bellies Several days of up-and-down trading followed before the con-
(PBG10), which had turned tract opened October with a sharp sell-off.
higher after hogs (and more
sharply), also corrected.
Interestingly, live cattle
(LCZ09), which had suf- Currencies
fered the least from the
meat malaise earlier in the After a virtually
year, trended decidedly uninterrupted decline since late
lower in August and April, the December U.S. dollar
September. The December index futures (DXZ09) caught their
contract (LCZ09), which breath a bit in late September, but not
had closed above 95 on July before the most recent downthrust
20, fell nearly 7 percent to took the contract from a high close of 79.10 on Sept. 1 to 76.29 on
the Sept. 22 low of 84.45 Sept. 23 — around 15 percent below the market’s spring high.
before bouncing slightly. For more coverage of the foreign exchange market, go to
Currency Trader magazine.
FUTURES & OPTIONS TRADER • October 2009 9

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Implied volatility:
An overlooked tool for stock and futures traders
Implied volatility isn’t just for option players — it can provide useful market estimates
and forward-looking support and resistance levels for all traders.
BY KEITH SCHAP
Note: A version of this article originally FIGURE 1 — E-MINI DOW FUTURES PRICES
appeared in the April 2006 issue of
This chart shows the December 2004-March 2006 individual contract price data
Active Trader magazine.
for the mini Dow futures (YM).
lmost all futures-related
A documents carry the warn-

ing, “Past performance is no
guarantee of future results,”
or words to that effect. Most traders
and analysts turn their backs on that
warning by repeatedly using measures
of past performance, such as historical
volatility, to predict future results.
The past is a notoriously unreliable
indicator of the future, especially in
markets. Relying on historical volatili-
ty is comparable to driving a car while
looking only in the rearview mirror.
The same can be said for many other
market statistics.
Implied volatility, in contrast, is a
forward-looking market estimate of
what the volatility of a market will be
at option expiration. Because of this,
implied volatility has predictive con- Say you want to know where the mini Dow futures prices
tent. It is not absolute, to be sure; after all, markets change. might be seven or 21 days forward given a 10,900 futures
But with a little work, implied volatility can be useful. price and 11 percent ATM call option implied volatility.
Make the volatility numbers meaningful 1. Locate the number of seven or 21-day periods in a year
Suppose the E-Mini Dow futures (YM) are trading at 10,900, by dividing 365 by seven or 21:
and the implied volatility for an at-the-money (ATM) call
on these futures is 11 percent. This implied volatility value 365/7 = 52.14 365/21 = 17.38
means the market is saying there is a 68-percent probability
the futures price one year from now will fall somewhere in 2. Find the square root of the number of periods:
a range plus or minus 11 percent from the current price.
Given the 10,900 futures price, 11 percent is 1,199, so one 52.14 = 7.22 17.38 = 4.17
year forward there is a 68-percent probability the futures
price will fall somewhere between 12,099 and 9,701. 3. Convert the volatility to decimal form (11 percent
For traders, this is not particularly useful information. becomes 0.11) and divide by the square root:
Traders typically deal with shorter trade horizons.
Fortunately, a little arithmetic can make the information 0.11/7.22 = 0.0152 0.11/4.17 = 0.0264
more relevant to specific trade planning.

4. Multiply the current futures price by the factor Figures 3 and 4 are based on 28-day periods. For example,
resulting from the third step: on Sept. 1, 2004, the December mini Dow futures price was
10,166, and the implied volatility was 14.91 percent. These
10,900 * 0.0152 = 165.68 10,900 * 0.0264 = 287.76 values produce the following calculations:
5. Round the results from the fourth step to the nearest 365/28 = 13.04
whole number (the mini Dow futures prices do not 13.04 = 3.61
have fractions) and add them to and subtract them 0.1491/3.61 = 0.0413
from the current price: 10,166 * 0.0413 = 419.88, round to 420
10,166 + 420 = 10,586
10,900 + 166 = 11,066 10,900 + 288 = 11,188 10,166 - 420 = 9,746
10,900 - 166 = 10,734 10,900 - 288 = 10,612
These upper and lower boundaries predict a 68-percent
The prices resulting from the final step in the left column probability the price 28 days forward will fall between
indicate a 68-percent probability the futures price seven 10,586 and 9,746. Sept. 1, 2004, was a Wednesday and 28
days forward will fall somewhere between 11,066 and days forward was Wednesday, Sept. 29. On that day, the
10,734. They offer the same level of confidence the futures December mini Dow price was 10,123, which was within
price 21 days forward will fall somewhere between 11,188 the predicted range.
and 10,612. Finally, Figures 3 and 4 show the results of carrying out
In a normal distribution, this 68-percent probability will this forward placement of the implied volatility predictions
encompass plus or minus one standard deviation of all val- for the entire 16-month period covered in the figures. There
ues (prices). Plus or minus two standard deviations produces are only a few places where the current price traded over or
approximately 95 percent confidence. To find this wider under the one standard deviation boundaries. Based on
range, simply double the factors resulting from the fourth these charts, these implied volatility predictions seem to
step to 332 for seven days and 576 for 21 days. This indicates have some value.
there is a 95 percent probability the futures price seven days
forward will fall somewhere between 11,232 and 10,568. The Using implied volatility predictions
price 21 days forward is this likely to fall somewhere These predictions can be useful in a variety of ways. They can
between 11,476 and 10,324. help traders evaluate the claims of analysts concerning what
continued on p. 12
Testing the predictions
Using implied volatility to make pre- FIGURE 2 — 10-YEAR TREASURY NOTE FUTURES PRICES
dictions such as these is one thing,
knowing whether they prove out in This chart shows the December 2004-March 2006 contract prices for the
10-year T-note futures (TY).
practice is another. To test these pre-
dictions, let’s consider two markets —
the E-Mini Dow and 10-year T-note
futures (TY) — from Sept. 1, 2004, to
Jan. 3, 2006.
Figures 1 and 2 show the prices for a
sequence of contracts in each market.
For example, the Sept. 1 to Nov. 30,
2004, segment in Figure 1 tracks
December mini Dow futures (YMZ4),
the Dec. 1, 2004, to Feb. 28, 2005 seg-
ment tracks March futures (YMH5),
and so on. Figure 2 provides similar
data for 10-year T-note futures.
Figures 3 and 4 make the futures
prices from Figures 1 and 2 continu-
ous. (This results from collapsing six
columns into one on a spreadsheet to
make the volatility calculations sim-
pler to manage.) Also, the one stan-
dard deviation boundaries shown on

TRADING STRATEGIES
FIGURE 3 — IMPLIED VOLATILITY 28-DAY RANGE, CBOT MINI DOW FUTURES

The lines one standard deviation above and below price are forecasts based on Two current situations
implied volatility. Suppose on Sept. 29 of this year you had
tuned into one of the financial news
channels and one of the “experts” said
the Dow would top 12,500 by late 2009.
That seems preposterous, but this per-
son seems very sure of his forecast and
works for one of the most prestigious
trading firms. Still, you want to check
out this claim. To do so, you note the cur-
rent price of 9,670 for the December E-
Mini Dow futures and a 20-percent
implied volatility.
Using a target date 90 days forward,
this price and implied volatility lead to a
68-percent probability the price 90 days
from Sept. 29 will fall somewhere
between 10,630 and 8,710. Based on this,
a 12,500 Dow futures price seems a rela-
tively low-probability event. If you take
the prediction out to two standard devi-
ations by doubling the result of the
fourth step of the process, you get at a
levels a certain market or stock is likely to achieve in a spec- 95-percent probability that the price 90 days forward will
ified time period. fall somewhere between 11,590 and 7,750. This puts a 12,500
A corollary of this is the possibility of using implied Dow way out on the tail of a normal distribution array and
volatility predictions to set goals for trades. They seem to gives it roughly a 2.5-percent probability of occurrence.
improve on other methods of estimating support and resist- Forget that expert view.
ance levels. This kind of evaluation can apply to any market, of
course. Suppose on the same day (Sept.
FIGURE 4 — IMPLIED VOLATILITY 28-DAY RANGE, 10-YEAR T-NOTE FUTURES 29) an oil analyst claims crude oil —
The implied volatility bands are penetrated infrequently. For the most part, they which had sold off nearly $10 over the
provide dynamic support and resistance levels. preceding several days — would go back
above $70 per barrel in October — quite
likely above $75. Armed with a $67.01
per barrel November futures price and a
25-percent ATM call option implied
volatility, you can discover a price range
for 30 days forward of $71.81 to $62.21.
While a $75 price is far from a sure thing,
because these predictions make no direc-
tional claim, the oil man’s number seems
reasonable given the current data.
Forward-looking support and

resistance estimates
These implied volatility predictions can
also provide a better way of estimating
where a market will find support or
resistance.
Traders have long used “pivot point”
prices as a “quick-and-dirty” way of esti-
mating support and resistance levels. To

TABLE 1 — A PIVOT POINT APPROACH TO SUPPORT
find the pivot point price, you sum the high, low, and clos- AND RESISTANCE
ing prices and divide by three. Table 1 lays out a typical set Pivot-point calculations are commonly referenced techni-
of data for mini Dow futures, specifies the formulas for first cal tools, but there’s no underlying reason why they would
and second levels of pivot point support and resistance, and identify viable support and resistance levels, and no solid
shows the prices for each level. Armed with these values, evidence they provide any real trading value.
traders assume the market will rebound if it hits either sup-
High 11,034
port level during the next day or fall back if it hits either
resistance level. Low 10,993
This approach looks back one day to predict a next-day Close 11,001
result, and the more thoughtful veterans of the trading Sum 33,028
floor suggest it performs even this limited task poorly. In Pivot point 11,009
2006 Chicago Board of Trade senior economist Leo Murphy Formula Level
said in all his years on the trading floor, he had never heard 2nd resistance Pivot + (High-Low) 11,050
a credible claim concerning why these numbers should be 1st resistance Pivot + (Pivot-Low) 11,025
considered valid. 1st support Pivot – (High-Pivot) 10,984
Another common approach is to calculate a standard 2nd support Pivot – (High-Low) 10,968
deviation. However, it is hard to know how far back to look.
For example, by using the prices from the last seven trading
days prior to the day used to calculate the pivot point price, ward focus and the richness of the market data from which
you can discover one standard deviation prices close to the they are derived. An option implied volatility estimate, after
second support and resistance levels of Table 1. This raises a all, comes from much more than just a price or a sequence of
question whether seven prices are enough for a valid meas- prices.
ure. This could easily be a bogus number given the small Nevertheless, it is important to remember the use of such
amount of data. terms as “implied volatility estimate” and “68 percent prob-
The greater problem with both of these measures is their ability” in discussing these predictions. These predictions
backward focus. It’s the rearview mirror all over, and the convey good information and are based on a sound empiri-
forward thrust is only one day — hardly useful if your typ- cal foundation. But they make no promises — they are not
ical trade horizon is a week or longer. sure things.
In contrast, the implied volatility prediction is forward look- The absence of promises, however, should not deter any-
ing, and it gives you a way of looking at any time horizon you one from putting implied volatility predictions to work.
like. They can be valuable tools for planning and managing
Consider Figure 4 in this regard. In most cases, when the trades in all the markets.
futures price trades close to the upper boundary, it soon
turns back down. Similarly, when the price trades close to For information on the author see p. 6.
the lower boundary, it most often turns back up. During the
period studied in Figures 3 and 4, the futures prices traded
through the upper and lower boundaries only a few times.
Further, they seemed never to trade very far through the
Related reading:
boundaries and to head the other way in a relatively short “Tracking VIX swings,” Active Trader, January 2006.
time. The VIX has been a widely discussed stock market barom-
Given this observation, it seems reasonable to use these eter, but how reliably does it identify market turning points?
boundaries as a way of defining support and resistance. If This study turned up a few surprises in analyzing how the
this is a valid way to define support and resistance, it is rea- S&P 500 tracking stock (SPY) responded to VIX highs and
sonable to use these implied volatility boundaries as one lows.
means of deciding when to buy or sell a market. After all, if
you are long 10-year T-note futures and the current price is “Putting volatility to work,” Active Trader, April 2001.
close to the 28-day upper boundary (or the boundary Get a handle on the essential concepts and learn how to
defined by whatever time interval you are using), this trade improve your trading with practical volatility analysis and
trading techniques.
would seem to have little more to offer in the way of profit
potential — at least in the near term. “VIX-based system,” Active Trader, January 2006.
This system tries to find oversold situations in the S&P by
A probability is not a promise identifying VIX spikes.
The advantage of implied volatility predictions are their for-

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Diagonal put spreads:

Beyond the basic credit spread
Expanding the conventional “vertical” credit spread to incorporate different expiration months
results in a position with enhanced profit potential.
BY JOHN SUMMA
Note: A version of this article originally appeared in the March 2005 ronments such as the one the market was in during much of
issue of Active Trader magazine. 2004 (which carries the possibility of a sudden volatility
increase), offer a special edge not available with a conven-
“vertical” credit spread consists of a short out- tional vertical credit spread.
A of-the-money (OTM) call or put option and a

long call or put that is farther out of the money.
“Vertical” refers to the fact that the spread uses
options with the same expiration month. Option spreads
using different expiration months are sometimes called
In the examples that follow, options on S&P 500 futures
are used. They are the most attractive vehicles for stock
index option writers because, among other things, they
offer more premium bang for the margin buck. Most pro-
fessional traders use S&P 500 futures options rather than
“horizontal.” OEX or SPX stock index options for selling strategies.
Because you are selling the more expensive option
(which is closer to the money) and buying the cheaper one The vertical put credit spread
(the more distant option), you are taking in more premium A standard vertical put credit spread is a popular strategy
than you are spending –– i.e., a “credit” is created in your to profit from time value decay, or theta. The strategy is
trading account, which is also your maximum potential known as a bull put spread because it profits from a bullish
profit on the trade. move in the underlying instrument. It can also profit if the
During bull markets, option sellers often like to sell ver- underlying remains range-bound or even declines moder-
tical put credit spreads, a strategy that has worked well ately.
when the stock market has either traded higher or side- A bullish move will reduce the position’s value (creating
ways. Although this strategy has good profit potential (and a profit for the seller) as the underlying market moves far-
limited risk), it cannot make more than the credit received ther from the options’ strike prices, thus causing the spread
at the outset of the trade. between the premiums of the short and long puts to shrink.
However, there is a way to alter a put credit spread that On the other hand, in a range-bound or moderately
creates the potential to make more than the initial credit, declining underlying market, the spread shrinks because of
and also to profit from rising volatility. Instead of selling a theta, which accelerates as expiration approaches. The clos-
vertical spread, you can construct a “diagonal” put spread er the expiration date, the less time premium the options
by using options with different expiration months. have, which reduces the spread and produces a profit
Diagonal credit spreads, especially in low-volatility envi- (assuming the market has not dropped too far).
TABLE 1 — VERTICAL PUT CREDIT SPREAD TABLE 2 — PROFITING FROM TIME DECAY
Because you are selling a more expensive option and buying Because the position’s net theta is positive, it means the
a cheaper one, the vertical put spread creates a net credit. spread profits from time decay as expiration approaches.
Vertical Strike Premium Vertical Strike Theta

put spread price put spread price
Long put Dec. 1135 -.80 Long put Dec. 1135 -23.7
Short put Dec. 1155 +1.95 Short put Dec. 1155 +68.4
Option premium credit = +1.15 ($287.50) Position theta = +44.70

TABLE 3 — DIAGONAL PUT CREDIT SPREAD TABLE 4 — DIAGONAL SPREAD THETA
The vertical put credit spread is transformed into a Because it is more distant from expiration, the long
diagonal spread by replacing the December 1135 long put January 1070 put has a much lower theta than the long
with a January 1070 long put. Although this reduces the December 1135 put from the vertical spread. As a result,
spread’s net credit to .65, it gives the position the ability the diagonal spread’s theta has increased to $51.10.
to generate additional profits.
Diagonal Strike Premium Diagonal Strike Theta

put spread price put spread price
Long put Jan. 1070 -1.25 Long put Jan. 1070 -17.30
Short put Dec. 1155 +1.95 Short put Dec. 1155 +68.40
Option premium credit = +.65 ($162.50) Position theta = +51.10
Typically, most S&P 500 futures-option spreaders will $68.40 in time decay per day, which means the spread is
write options with two to six weeks remaining until expira- profiting at a rate of $44.70 per day. Because time value
tion and strike prices at least one standard deviation from decays at an accelerating rate, the potential gains increase
the underlying price. These parameters generally provide with each passing day, all other factors remaining the same.
for the necessities of position management while offering Because the options can only decline to zero, regardless
enough premium relative to transaction costs. However, of the time decay rate, the maximum profit potential of the
should the underlying move too far, there is potential for standard vertical put spread is always the initial net credit.
large losses if position adjustments are not made. Assuming both options remain out of the money, the profit
Table 1 shows an example of a vertical put spread. With before commissions and fees would be $287.50. This is the
the December 2004 S&P 500 futures (SPZ04) at 1189.40, the shortcoming of this strategy –– you can only achieve this
spread consisted of a long December 1135 put and a short profit if these options expire worthless, regardless of the
December 1155 put for a credit of 1.15, or $287.50. (Each volatility level or underlying price movement.
point of S&P 500 option premium is worth $250.) The short continued on p. 16
leg of the spread is just
less than 35 points out of FIGURE 1 — PROFITABILITY AND PROBABILITY
the money, which is just
shy of two standard devi- The diagonal put spread has an expected profit of $388, $100 or so more than the original
vertical put spread. Also, as you move lower along the price axis, the positions vega increases.
ations. (The hypothetical
position expired prof-
itably on Friday, Dec. 16,
2004, 10 trading days
after they were selected.) Profit/loss
At the prevailing volatili- at December
ty levels and distance expiration
from the money (approx-
imately two standard
deviations), this trade has
an expected probability
of profit of 97 percent.
Table 2 shows the theta
values for each option in
the spread and under-
scores how this strategy
makes money. The long
December 1135 put loses
$23.70 in time decay per
day but the short Source: OptionVue5 Option Analysis Software (www.optionvue.com)
December 1155 put gains

TRADING STRATEGIES
FIGURE 2 — RESPONDING TO VOLATILITY
If the S&P is at 1160 at expiration (which represents an approximately 3-percent drop from
where the index was when the diagonal spread was established), the maximum profit
increases to $900 from the original vertical spread’s $287.50 profit. The increased profit If the S&P corrects,
occurs because the January 1070 put can capitalize on both the additional volatility and say, 1 to 3 percent, as it
downside price movement. has periodically through-
out the past few years
since its bullish move off
the 2002 lows, any mod-
est volatility spikes
Profit/loss
(volatility rises when
at December
expiration equity futures decline)
can quickly add value to
put options. A diagonal
put spread has the ability
to turn these events into
potential profits, while a
vertical put spread
remains limited to the
premium collected when
the spread was placed.
Diagonal put credit

spread
Source: OptionVue5 Option Analysis Software (www.optionvue.com)
Table 3 shows how a ver-
tical put credit spread is
FIGURE 3 — ADDING A LEG transformed into a diag-
onal spread: The
By keeping the original December 1135 long put and adding the long January 1070 put December 1135 long put
(creating a three-legged vertical-diagonal combination trade), the trade’s margin requirement has been replaced with a
drops to $3,800, about $500 below the original put spread’s margin.
January 1070 long put.
This has reduced the
spread’s net credit to .65
($162.50).
However, this smaller
credit does not necessari-
ly mean less potential
profit. The diagonal
spread is a “time” spread
(also known as a calen-
dar spread), which
means the options expire
in different months.
Therefore, a time-decay
differential exists
between the two options.
Table 4 shows the
theta of the diagonal
spread and its compo-
nent options. Because it
Source: OptionVue5 Option Analysis Software (www.optionvue.com)
has more time until expi-

ration, the long January 1070 put has a enhanced ability to profit from a with about a 30-point drop in the S&P
much lower theta than the previous volatility increase, as shown in Figure 500 futures. If the S&P was at 1160 at
long December 1135 put, which had a 2. (Both Figures 1 and 2 show at-expi- expiration (which is an approximately
theta of -23.7. As a result, the position ration data, which is located below the 30-point drop from the point this trade
theta has increased to $51.10 from solid profit/loss function. The dotted was established), the maximum profit
$44.70, or an additional $17.40 per day lines represent interim profit/loss increases to $900 from the original ver-
in time decay — this, despite the fact periods.) Figure 1 shows the position tical spreads $287.50.
the initial credit received from writing has turned vega-positive at the expira- The increased profit results from the
this spread decreased to $162.50. tion of the December put, with a posi- January 1070 put capitalizing on the
Looking at the profit/loss dynamics tion vega of 57.2 at the current price additional volatility and gaining from
of this diagonal put spread in Figure 1, level. downside price movement. Because it
the probability of profit is 98 percent, As we move lower along the price expires in January rather than Dec-
with an expected profit of $388, $100 or axis, the position’s vega increases. ember, this option has additional time
so more than the original vertical put What does this mean in terms of volatil- value at the expiration of the
spread. ity changes? Figure 2 simulates a rise in December short put. If the December
However, the real advantage of the entire volatility structure by 3 per- 1155 short put option expires worth-
going diagonal comes in the form of an centage points, which would occur continued on p. 18
TRADING STRATEGIES
FIGURE 4 — THREE-LEGGED SPREAD WITH VOLATILITY INCREASE

The expected profit for the revised spread in the event of a three-percent volatility increase is
$540.
less, you can pocket the
gain on the long January
put.
Profit/loss at If you recall, this
December
spread was established
expiration
for .65 or $162.50. At the
expiration of the
December 1155 put (with
the December futures set-
tling at 1160), the spread
will widen to $1,062.50 ––
a $900 profit (before com-
missions and fees).
Although we are assum-
ing the January futures
contract trades at the
same premium as
December futures (there
Source: OptionVue5 Option Analysis Software (www.optionvue.com) is typically a stable ratio
in equity index futures
during short-term time
frames, such as the one described
MANAGED MONEY here), the expected profit with a rise
in volatility now increases to $626, up
Top 10 option strategy traders ranked by August 2009 return. from the $380 in Figure 1, and up
from the $287.50 in the vertical
(Managing at least $1 million as of Aug. 31, 2009.)
spread.
August 2009 YTD $ under
Rank Trading advisor return return mgmt. Disadvantages, risks, and
another leg
1. CKP Finance Associates (Masters) 15.96% 174.59% 2.0 Margin requirements are higher
2. NEOS Advisors (Special Opportunities) 7.88% 8.36% 47.4 (about twice the level of initial margin
requirements) for the diagonal put
3. Washington (Singleton Fund) 7.58% 35.95% 55.7
spread, so the higher expected profit
4. ACE Investment Strat (ASIPC INST) 5.39% 26.08% 1.3 essentially requires equal additional
5. LJM Partners (Aggr. Premium Writing) 4.75% 21.20% 26.0 risk to obtain.
However, if you keep the original
6. ACE Investment Strategists (ASIPC) 4.53% 27.26% 3.6 December 1135 long put bought at .80
7. Kingsview Mgmt (Retail) 4.25% 16.00% 3.0 and add the long January 1070 put
(creating a three-legged vertical-diag-
8. ACE Investment Strategists (DPC) 4.19% 64.42% 16.3
onal combination trade), the margin
9. Oak Investment Group (Ag Options) 4.18% 47.35% 4.4 requirement drops to $3,800, about
10. Nantucket Hedge Fund - CTA 3.40% -4.97% 4.4 $500 below the vertical put spread’s
original margin requirement. Figure 3
reveals that the expected probability
Source: Barclay Hedge (www.barclayhedge.com) Based on estimates of the composite of all
of profit remains the same at 98 per-
accounts or the fully funded subset method. Does not reflect the performance of any single account.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
cent, with an expected profit of $258
with no volatility change, and $540 in
the event of a three-percent volatility

Related reading:
“Option spreads:
The reinsurance approach”
Active Trader, July 2004.
An analysis of option credit spreads
increase (Figure 4). from the perspective
Thus, by leaving in place the origi- Getting more out of of playing the odds the way
nal December 1135 long put and going volatility and time decay insurers and casinos do.
diagonal with the January 1070 put, The traditional vertical credit spread
the expected $540 profit (with a mod- has limited risk but limited profit “Timing events with the
est correction to 1160) can be obtained potential as well. However, by con- calendar spread”
Active Trader, October 2003.
on margin that does not exceed $4,500 structing a diagonal put spread, addi-
The calendar spread offers a way
for this trade. This represents a 12-per- tional profit can be extracted from to capitalize on aspects of time,
cent profit-to-margin ratio. If the time decay and volatility increases. market direction and volatility.
unchanged-volatility expected profit is (But not without an equal increase in
used, the rate of return on margin is risk.) “Controlling risk with spreads”
5.7 percent. But, if you leave the original vertical Active Trader, March 2003.
For the original vertical credit put spread structure in place and add Trading the bull call-option spread.
spread, the return on margin of $4,700 a January long put to create another
“Extra credit (spreads)”
(which is the maximum requirement version of a diagonal spread (a three-
Active Trader, February 2002.
down to 1160 on the S&P 500) is 6.1 legged vertical-diagonal combination Another look at trading credit
percent. While the unchanged-volatil- strategy), there is a potential jump spreads.
ity profit on margin is slightly lower from 6.1-percent to 12-percent in prof-
for the diagonal spread, there is an it on margin. This result stems from a “Spreading
additional profit potential of 6 percent hypothetical increase in volatility aris- your charting options”
from a rise in volatility, which more ing from a modest correction in the Active Trader, July 2000.
How to know what strategies are
than compensates for the commission S&P 500.
appropriate for different market
costs of the purchase of the additional conditions.
For information on the author see p. 6.
long December 1135 put.
Three good tools for targeting customers . . .
— CONTACT —
Bob Dorman Allison Chee Mark Seger
Ad sales East Coast and Midwest Ad sales West Coast and Southwest Account Executive
bdorman@activetradermag.com achee@activetradermag.com seger@activetradermag.com
(312) 775-5421 (415) 272-0999 (312) 377-9435

OPTIONS TRADING
TRADING SYSTEM
OPTIONS STRATEGY
OPTIONS SYSTEM
LAB LAB
LAB
Double butterflies
on the S&P 500
Market: Options on the S&P 500 FIGURE 1 — DOUBLE LONG BUTTERFLY SPREAD
index (SPX). This strategy could This double long butterfly risks $4,870 and has a maximum potential profit of more
also be applied to other equity than 200 percent at expiration. But the strategy aims for 10-percent profits each
month.
indices, ETFs, and stocks with liq-
uid options contracts.
System concept: This Options

Lab places two butterfly spreads
simultaneously and treats them as
one trade. On the second Friday of
each month, two out-of-the-money
(OTM) butterflies are placed on
the S&P 500 index (SPX) — each
centered one-half standard devia-
tion away from the current price.
The higher butterfly uses call
options and the lower butterfly
uses put options.
Long butterfly spreads sell
options at one strike price and
then buy half as many contracts at Source: OptionVue
equidistant strike prices both
above and below that strike. The between 11 to 14 days in this test.
position’s long options cost more than the short ones, so it In theory, the underlying could move around enough
requires a net debit. To manage risk, each trade is held until after the trade is placed so that neither exit rule is hit and
it gains 10 percent or the underlying hits either butterfly’s then move back to the entry price, facing large losses as all
far long strike. options expire worthless. However, this scenario never hap-
Figure 1 shows the potential gains and losses of a double pened in the five-year test period.
long butterfly entered on Aug. 14, 2009 and held through
Sept. 1, 2009. The total position contained five long 1000 Trade rules:
calls, 10 short 1030 calls, five long 1060 calls, five long 940
puts, 10 short 970 puts, and five long 1000 puts — all expir- Place a double butterfly spread on the second Friday of
ing in September. The position resembles two tents, because the month:
at expiration, there are two points of maximum profit (970
and 1030) and four breakeven points. 1. Sell 10 calls one-half standard deviation above the
However, this system doesn’t wait until expiration to current price.
exit. Notice Figure 1’s dashed line, which represents prof- 2. Buy five at-the-money (ATM) calls.
itability 18 days in the future. This line is gently rounded 3. Buy five calls that same distance further OTM.
and peaks at 30 percent around the S&P’s closing price 4. Sell 10 puts one-half standard deviation below
(1004.10) when the spread was entered. At that point, the the current price.
trade is profitable when SPX trades between the breakeven 5. Buy five ATM puts.
points of 954.68 and 1037.57. 6. Buy five puts that same distance further OTM.
This system tries to take advantage of the faster time 7. All options are in the second expiration month
decay of the short options, which is why it exits well before available in the S&P 500 index.
the options expire. In fact, the average trade was held

FIGURE 2 — BUTTERFLIES SPREAD THEIR WINGS
Close both butterflies if: The vast majority of this strategy’s trades (81 percent) made money, helping the
1. The entire position gains approach gain 154 percent since January 2004.
10 percent, or
2. The market touches either
distant OTM strike.
Starting capital: $20,000.
Execution: Option trades were

executed at the average of the bid
and ask prices at the daily close, if
available; otherwise, theoretical
prices were used. Daily closing
prices were used. Testing used SPX
options with 10-point strikes only.
Standard deviations were calculat- Source: OptionVue
ed using the implied volatility (IV)
of the ATM call. Commissions were strategy’s average loss ($1,714.23) was considerably bigger
$5 per trade plus $1 per option. than its average gain ($946.52), but its high winning per-
centage was largely responsible for its success.
Test data: The system was tested on cash-settled S&P 500
index (SPX) options at the CBOE. — Steve Lentz and Jim Graham of OptionVue
Test period: Jan. 9, 2004 to Sept. 1, 2009.

Option System Analysis strategies are tested using OptionVue’s
Test results: Figure 2 tracks the double butterfly strate- BackTrader module (unless otherwise noted).
gy’s performance, which gained $30,720 (154 percent) over
If you have a trading idea or strategy that you’d like to see tested,
five and a half years. Overall, the strategy traded 69 times please send the trading and money-management rules to
since January 2004 and 81 percent were profitable. The Advisor@OptionVue.com.
STRATEGY SUMMARY LEGEND:

Initial capital — Starting account value.
Initial capital: $20,000.00 Net gain — Gain at end of test period.
Net gain: $30,720.00 Percentage return — Gain or loss on a percentage basis.
Percentage return: 154% Annualized return — Gain or loss on a annualized percentage basis.
Annualized return: 27.2% No. of trades — Number of trades generated by the system.
No. of trades: 69 Winning/losing trades — Number of winners and losers generated by the system.
Winning/losing trades: 56/13 Win/loss — The percentage of trades that were profitable.
Win/loss: 81% Avg. trade — The average profit for all trades.
Avg. trade: $445.22 Largest winning trade — Biggest individual profit generated by the system.
Largest winning trade: $3,260.00 Largest losing trade — Biggest individual loss generated by the system.
Largest losing trade: -$3,540.00 Avg. profit (winners) — The average profit for winning trades.
Avg. profit (winners): $946.52 Avg. loss (losers) — The average loss for losing trades.
Avg. profit (losers): $1,714.23 Avg. hold time (winners) — The average holding period for winning trades (in days).
Avg. hold time (winners): 11 Avg. hold time (losers) — The average holding period for losing trades (in days).
Avg. hold time (losers): 14 Max consec. win/loss — The maximum number of consecutive winning and losing
Max. consec. win/loss: 15/2 trades.

FUTURES BASICS
Front and back months

In the futures market, contract months have a specific hierarchy.
BY FOT STAFF
n the futures market, “front January contract stops trading on the tract (followed by the first back
I month” describes the contract

month that is nearest to expira-
tion and “back month(s)” refer to
the subsequent contract months avail-
able for trading in a particular market.
business day prior to the 15th of the
month (Jan. 14 in the case of the
January 2010 soybean contract), the
March contract officially becomes the
new front month.
month), this is not always the case. In
the Eurodollar futures, for example,
volume is actually higher in some of
the back months than the front month
because of the unique nature of the
Contract-month cycles differ from In practice, however, the nearest market.
market to market. Many popular back month (usually simply referred Sometimes, the front month is called
financial futures, including stock- to as “the” back month) effectively the “nearby” month or the “current”
index and Treasury futures, use a becomes the front month before the month.
March, June, September, and expiring front month actually stops
December quarterly cycle. Crude oil trading, in that the majority of volume
futures, however, have contracts for transfers to the first back month in the
every month of the year. Soybean cycle before the expiring contract’s last
futures have January, March, May, trading day. In stock-index futures, for
July, August, September, and example, the majority of trading shifts
November contracts. to the upcoming contract month when
For example, during the month of there is about a week left in the current
December, January is the front-month contract’s life. The timing of this tran-
contract for soybeans, with March sition is market specific.
being the first back month. When the In most futures markets, although
several contract months are listed for
trading at any given time, the majority
of trading typically occurs in the front
Futures glossary: month, which represents the “price of
Cars record” on any given day — the offi-
cial price for that market. For example,
“Car” is shorthand for contract, used although many contract months of
to refer to the number of contracts in crude oil futures were trading on Sept.
a trade — e.g., “I bought 10 cars of 10, the October 2009 contract (which
December crude oil.” The term orig- stopped trading on Sept. 22) was the
inated because the amount of grain front-month contract and provided the
represented by one futures contract price the financial news reported as
(grains were the underlying market the crude oil closing price for the day.
for the first exchange-traded futures The October contract closed at 71.94,
in the U.S.) filled one railroad car. while the first back month, November,
The term spread to apply to any closed at 72.27. The October futures
futures contract, although it tradi- traded around 310,000 contracts that
tionally has been used mostly by day, while the November futures trad-
floor traders. ed around 145,000 contracts.
Although the majority of volume
usually occurs in the front-month con-

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European gasoil (ICE) futures contract. This contract allows scanner cuts search time down by alerting traders automat-
CME Group customers to gain margin and capital efficien- ically to low initial money risk set-ups. The five main auto-
cies by hedging their risk to both European gasoil and Brent matic MTPredictor set-ups are identified with a visual and
crude oil futures along with the benchmark WTI and heat- audible alert. For more information, visit
ing oil futures contracts, all on a single exchange. The com- www.mtpredictor.com.
modity code for this contract is 7F, and it is listed for 36 con-
secutive months with the first contract month of September BCS Financial Group, a direct market access equity
2009. CME Group also launched three new financially set- and derivatives broker, has partnered with CQG to provide
tled five decimals natural gas liquids swap futures con- its 400 customers and internal trading desks in Russia
tracts. These contracts offer CME Group customers the abil- access to CQG’s trading platforms. Customers clearing
ity to price at an eighth of a cent (five decimal places). The through BCS will have access to CQG’s leading decision-
contracts and commodity codes for the new swap futures making tools, accurate consolidated market data, and
are Mont Belvieu LDH propane five decimals (OPIS) (B0); advanced electronic trading via the CQG Trader and CQG
Mont Belvieu ethane five decimals (OPIS) (C0); and Mont Integrated Client platforms. BCS traders will be able to
Belvieu normal butane five decimals (OPIS) (D0). The first route orders to many exchanges. For more information visit
listed month is the September 2009 contract. The propane www.cqg.com.
contract is listed for up to 48 consecutive months and the
Note: The New Products and Services section is a forum for industry
other contracts are listed for 36 consecutive months. For
businesses to announce new products and upgrades. Listings are adapted
more information visit www.cmegroup.com/clearport. from press releases and are not endorsements or recommendations from
the Active Trader Magazine Group. E-mail press releases to
TradeTheNews.com has introduced a new market editorial@futuresandoptionstrader.com. Publication is not guaranteed.

FUTURES SNAPSHOT (as of Sept. 25)
The following table summarizes the most actively traded U.S. futures contracts. The information does NOT constitute trade signals. It is
intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for expla-
nations of the different fields. Volume figures are for the most active contract month in a particular market and may not reflect total volume
for all contract months.
Note: Average volume and open-interest data includes both pit and side-by-side electronic contracts (where applicable).
10-day move/ 20-day move/ 60-day move/ Volatility
Market Symbol Exchange Volume OI rank rank rank ratio/rank
E-Mini S&P 500 ES CME 1.88 M 2.30 M 0.36% / 6% 1.14% / 4% 16.54% / 79% .17 / 5%
10-yr. T-note TY CME 761.5 1.02 M 0.00% / 0% -0.58% / 54% 0.90% / 26% .21 / 63%
5-yr. T-note FV CME 399.3 724.7 -0.03% / 0% -0.68% / 45% 0.10% / 4% .22 / 38%
Crude oil CL CME 281.2 202.3 -4.72% / 50% -8.93% / 74% -1.06% / 13% .52 / 100%
E-Mini Nasdaq 100 NQ CME 278.1 291.5 0.80% / 17% 3.54% / 33% 17.42% / 73% .14 / 14%
Eurodollar* ED CME 252.5 660.8 -0.10% / 100% 0.22% / 27% 0.34% / 59% .21 / 7%
30-yr. T-bond US CME 231.5 669.2 0.10% / 38% 0.15% / 8% 1.67% / 28% .25 / 58%
Eurocurrency EC CME 206.7 133.0 0.49% / 11% 2.03% / 58% 4.56% / 41% .20 / 45%
2-yr. T-note TU CME 198.1 695.0 -0.01% / 0% -0.09% / 65% 0.01% / 11% .23 / 35%
E-Mini Russell 2000 TF CME 137.7 332.8 1.15% / 7% 3.16% / 19% 20.13% / 75% .20 / 12%
E-Mini Dow YM CME 129.6 59.2 0.92% / 21% 0.87% / 6% 16.72% / 83% .14 / 2%
Natural gas NG CME 127.2 118.2 34.63% / 60% 31.39% / 90% 10.69% / 89% .54 / 42%
Gold 100 oz. GC CME 103.0 293.7 -1.47% / 100% 4.68% / 63% 5.34% / 59% .30 / 37%
British pound BP CME 101.8 81.9 -4.49% / 100% -2.14% / 84% -2.94% / 100% .49 / 100%
Japanese yen JY CME 91.2 95.3 0.73% / 5% 4.01% / 77% 6.53% / 92% .28 / 20%
Corn C CME 90.3 368.1 4.51% / 45% 3.41% / 56% -3.36% / 8% .20 / 38%
Australian dollar AD CME 79.2 97.9 0.37% / 11% 2.59% / 43% 8.83% / 34% .16 / 50%
Canadian dollar CD CME 65.5 84.1 -1.42% / 100% -0.73% / 32% 6.29% / 41% .31 / 82%
Sugar SB ICE 57.1 294.0 5.03% / 25% -1.49% / 0% 31.80% / 65% .11 / 2%
Soybeans S CME 55.1 165.7 2.55% / 33% -16.89% / 91% -19.76% / 77% .17 / 7%
Swiss franc SF CME 37.0 42.4 0.68% / 11% 2.73% / 66% 5.07% / 58% .19 / 18%
RBOB gasoline RB CME 35.0 53.7 -7.92% / 33% -20.23% / 97% -9.51% / 47% .60 / 98%
E-Mini S&P MidCap 400 ME CME 34.1 94.1 0.25% / 6% 2.37% / 10% 19.88% / 76% .19 / 7%
S&P 500 index SP CME 33.3 332.4 0.37% / 7% 1.33% / 4% 16.55% / 78% .17 / 5%
Heating oil HO CME 32.5 42.9 -3.10% / 29% -9.79% / 69% -1.44% / 8% .42 / 80%
Wheat W CME 29.7 147.0 -3.77% / 62% -5.35% / 39% -15.01% / 62% .13 / 12%
Silver 5,000 oz. SI CME 28.9 67.7 -3.83% / 50% 12.94% / 62% 16.72% / 77% .35 / 45%
Copper HG CME 22.8 65.8 -3.72% / 67% -3.79% / 58% 18.87% / 14% .22 / 57%
Mexican peso MP CME 20.2 66.2 -1.39% / 19% -3.41% / 74% -2.80% / 71% .50 / 83%
Live cattle LC CME 13.3 59.0 -1.35% / 63% -1.74% / 76% 0.35% / 3% .33 / 52%
Soybean oil BO CME 12.6 32.2 1.55% / 100% -5.99% / 30% -3.68% / 17% .18 / 5%
Soybean meal SM CME 12.0 28.3 3.10% / 33% -23.69% / 98% -24.33% / 77% .18 / 20%
Lean hogs LH CME 11.7 42.8 -4.81% / 100% 4.28% / 22% -15.70% / 72% .17 / 18%
Crude oil e-miNY QM CME 11.4 4.5 -4.72% / 50% -9.24% / 75% 0.64% / 1% .53 / 100%
Nikkei 225 index NK CME 10.7 34.7 -2.35% / 92% -3.50% / 76% 4.67% / 9% .17 / 20%
Coffee KC ICE 8.9 57.1 0.91% / 8% 5.23% / 47% 7.27% / 59% .44 / 62%
U.S. dollar index DX ICE 7.8 26.4 0.16% / 100% -1.75% / 58% -4.32% / 36% .18 / 57%
Cocoa CC ICE 6.9 55.2 0.26% / 0% 9.29% / 67% 23.12% / 88% .16 / 2%
New Zealand dollar NE CME 6.6 23.3 1.58% / 37% 3.84% / 53% 13.80% / 65% .22 / 82%
Mini-sized gold YG CME 6.6 4.7 -1.39% / 100% 4.48% / 59% 5.44% / 64% .31 / 38%
Fed Funds** FF CME 5.7 54.5 -0.01% / 20% 0.02% / 2% 0.19% / 69% .10 / 12%
Natural gas e-miNY QG CME 4.9 8.6 67.16% / 100% 63.14% / 100% 37.25% / 100% 1.00 / 97%
Nasdaq 100 ND CME 2.7 18.0 0.80% / 17% 3.54% / 33% 17.42% / 73% .14 / 13%
E-Mini eurocurrency ZE CME 2.0 2.2 0.49% / 17% 2.64% / 76% 4.56% / 42% .20 / 45%
Mini-sized silver YI CME 1.7 1.9 -3.84% / 50% 12.51% / 59% 16.88% / 79% .36 / 46%
Dow Jones Ind. Avg. DJ CME 1.1 8.5 0.92% / 21% 0.87% / 6% 16.72% / 83% .14 / 2%
Feeder cattle FC CME 0.8 3.9 -2.60% / 87% -2.25% / 49% -6.91% / 100% .35 / 60%
*Average volume and open interest based on highest-volume contract (September 2010). **Average volume and open interest based on highest-volume contract (February 2010)
Legend
day moves, 20-day moves, etc.) show the per- larger than all the past readings, while a read-
Volume: 30-day average daily volume, in thou- centile rank of the most recent move to a certain ing of 0 percent means the current reading is
sands (unless otherwise indicated). number of the previous moves of the same size smaller than the previous readings. These fig-
OI: Open interest, in thousands (unless other- and in the same direction. For example, the ures provide perspective for determining how
wise indicated). rank for 10-day move shows how the most relatively large or small the most recent price
10-day move: The percentage price move from recent 10-day move compares to the past twen- move is compared to past price moves.
the close 10 days ago to today’s close. ty 10-day moves; for the 20-day move, the rank Volatility ratio/rank: The ratio is the short-term
20-day move: The percentage price move from field shows how the most recent 20-day move volatility (10-day standard deviation of prices)
the close 20 days ago to today’s close. compares to the past sixty 20-day moves; for divided by the long-term volatility (100-day stan-
the 60-day move, the rank field shows how the dard deviation of prices). The rank is the per-
60-day move: The percentage price move from most recent 60-day move compares to the past
the close 60 days ago to today’s close. centile rank of the volatility ratio over the past
one-hundred-twenty 60-day moves. A reading 60 days.
The “rank” fields for each time window (10- of 100 percent means the current reading is
This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & Options
Trader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buy
or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.
OPTIONS RADAR (as of Sept. 28)
MOST-LIQUID OPTIONS*
Indices Symbol Exchange Options Open 10-day move / 20-day move / IV / IV / SV ratio —
volume interest rank rank SV ratio 20 days ago
S&P 500 index SPX CBOE 165.4 1.40 M 1.30% / 31% 3.31% / 28% 22.9% / 17.3% 21.8% / 17.1%
S&P 500 volatility index VIX CBOE 117.2 2.06 M 4.27% / 38% 0.48% / 5% 90.6% / 81.6% 155.8% / 71.9%
Russell 2000 index RUT CBOE 60.8 481.9 2.20% / 38% 5.75% / 39% 28.1% / 24% 26.3% / 22.7%
E-Mini S&P 500 futures ES CME 27.7 135.4 1.49% / 41% 3.07% / 20% 22.9% / 19.6% 21.9% / 21%
Nasdaq 100 index NDX CBOE 16.1 146.2 1.82% / 33% 4.95% / 43% 23.5% / 18.3% 23% / 19.3%
Stocks
General Electric GE 200.0 3.01 M 9.19% / 44% 19.03% / 70% 47.2% / 49.8% 40% / 34.3%
Bank of America BAC 130.9 2.96 M 1.35% / 13% -4.23% / 64% 51.7% / 40.2% 49.8% / 44.9%
Apple Inc. AAPL 99.9 734.4 7.16% / 75% 9.47% / 49% 36.1% / 26% 30.8% / 22.7%
Altria Group MO 88.3 322.1 -1.78% / 40% -3.02% / 40% 22.2% / 18.2% 20.4% / 17.5%
Research in Motion RIMM 65.5 460.4 -18.39% / 100% -10.01% / 65% 49.6% / 35.1% 48.1% / 35.4%
Futures
Eurodollar ED CME 102.6 5.23 M 0.05% / 30% -0.06% / 78% 123.4% / 139% 103.7% / 56.5%
Corn C CME 40.1 560.0 6.61% / 83% 5.48% / 71% 34.8% / 47.3% 35% / 41.7%
E-Mini S&P 500 futures ES CME 27.7 135.4 1.49% / 41% 3.07% / 20% 22.9% / 19.6% 21.9% / 21%
Soybeans S CME 16.1 149.4 1.14% / 33% -19.04% / 98% 29.3% / 34.3% 36.2% / 34.6%
10-year T-notes TY CME 13.3 230.7 0.75% / 86% 0.04% / 5% 7.6% / 5.9% 7.9% / 6.8%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
S&P 100 index OEX CBOE 14.1 87.3 1.48% / 44% 2.92% / 26% 21.5% / 15.6% 20.7% / 16.1%
Dow Jones index DJX CBOE 5.9 151.7 1.68% / 47% 2.57% / 24% 20.1% / 14.6% 19.8% / 16.1%
S&P 100 index (European style) XEO CBOE 4.0 46.3 1.48% / 44% 2.92% / 26% 20.8% / 15.6% 19.9% / 16.6%
S&P 500 index SPX CBOE 165.4 1.40 M 1.30% / 31% 3.31% / 28% 22.9% / 17.3% 21.8% / 17.1%
S&P 500 futures SP CME 12.4 69.9 1.49% / 40% 3.85% / 37% 23.5% / 17.9% 19.8% / 17.2%
Indices - Low IV/SV ratio

Gold/silver index XAU PHLX 2.4 20.1 -4.72% / 67% 5.74% / 34% 47.3% / 48.1% 37.5% / 37.1%
Stocks - High IV/SV ratio

CIT Group CIT 20.5 613.9 14.38% / 67% -0.60% / 0% 178.7% / 84.1% 188.3% / 186.7%
Cell Therapeutics CTIC 1.5 86.4 -7.30% / 50% -18.59% / 89% 136.4% / 73.7% 147.6% / 73.6%
Qualcomm QCOM 20.6 577.9 -0.56% / 0% -2.65% / 42% 32.6% / 22.9% 29.4% / 22.7%
Research in Motion RIMM 65.5 460.4 -18.39% / 100% -10.01% / 65% 49.6% / 35.1% 48.1% / 35.4%
Exxon Mobil XOM 22.9 837.1 -0.59% / 27% -0.76% / 16% 24.3% / 17.5% 25.4% / 20.7%
Stocks - Low IV/SV ratio

Delta Petroleum DPTR 4.3 44.7 -52.24% / 100% -3.21% / 10% 135.4% / 201.2% 105.6% / 72.7%
Futures - High IV/SV ratio

5-year T-notes FV CME 1.0 25.4 0.10% / 13% -0.65% / 43% 4.9% / 2.5% 5.1% / 4.2%
Eurocurrency EC CME 2.7 21.2 -0.16% / 50% 2.12% / 61% 10.7% / 7.5% 9.9% / 8.1%
S&P 500 futures SP CME 12.4 69.9 1.49% / 40% 3.85% / 37% 23.5% / 17.9% 19.8% / 17.2%
10-year T-notes TY CME 13.3 230.7 0.75% / 86% 0.04% / 5% 7.6% / 5.9% 7.9% / 6.8%
Live cattle LE CME 2.0 133.1 -1.09% / 13% -0.66% / 48% 15.4% / 12.8% 13.6% / 12.9%
Futures - Low IV/SV ratio**

30-yr T-bonds US CBOT 2.8 51.5 1.57% / 100% 0.87% / 27% 12.9% / 24.3% 12.9% / 11.7%
Corn C CME 40.1 560.0 6.61% / 83% 5.48% / 71% 34.8% / 47.3% 35% / 41.7%
Soybean meal SM CME 2.3 47.9 1.84% / 33% -25.45% / 100% 29.8% / 39.8% 31.1% / 38.1%
Wheat W CME 7.9 93.1 0.35% / 0% -2.44% / 19% 30.6% / 38.5% 32.9% / 39%
Soybeans ZS CME 1.1 149.4 1.14% / 33% -19.04% / 98% 28.9% / 34.3% 36.8% / 34.6%
* Ranked by volume ** Ranked based on high or low IV/SV values.
LEGEND:
Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).
Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).
IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.
10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.
20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-day
moves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example, the “rank”
for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows how the most
recent 20-day move compares to the past sixty 20-day moves.

FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
Natural gas and platinum The largest positive readings represent markets in which commercial
positions (longs-shorts) exceeded speculator holdings in September.
near COT extremes And the largest negative values represent the opposite relationship —
speculator positions exceeded commercial positions.
The Commitments of Traders (COT) report is published each
week by the Commodity Futures Trading Commission
(CFTC). The report divides the open positions in futures mar-
kets into three categories: commercials, non-commercials,
and non-reportable.
Commercial traders, or hedgers, tend to operate in the
cash market (e.g., grain merchants and oil companies that
either produce or consume the underlying commodity).
Non-commercial traders are large speculators (“large
specs”) such as commodity trading advisors and hedge
funds — professional money managers who don’t deal in the
underlying cash markets but speculate in futures on a large-
scale basis. Many of these traders are trend-followers. The For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
non-reportable category represents small traders, or the gen-
eral public. Legend: Figure 1 shows the difference between net commer-
Figure 1 shows the relationship between commercials and large speculators on cial and net large spec positions (longs - shorts) for all 45 futures
Sept. 22. Positive values mean net commercial positions (longs-shorts) are larger markets, in descending order. It is calculated by subtracting the
current net large spec position from the net commercial position
than net speculator holdings, based on their five-year historical relationship. and then comparing this value to its five-year range.
Negative values mean large speculators have bigger positions than the commer- The formula is:
cials. a1 = (net commercial 5-year high - net commercial current)
In September, commercial positions continued to outnumber speculator posi- b1 = (net commercial 5-year high - net commercial 5-year low)
tions in natural gas futures (NG), a bullish relationship that has held for more c1 = ((b1 - a1)/ b1 ) * 100
than two months. On the other side, speculators held more positions than com- a2 = (net large spec 5-year high - net large spec current)
mercials in platinum (PL), palladium (PA), and gold futures (GC), a bearish sign. b2 = (net large spec 5-year high - net large spec 5-year low)
This bearish situation in platinum has existed for at least two months, while the c2 = ((b2 - a2)/ b2 ) * 100
relationship in palladium and gold futures grew more bearish in September.
x = (c1 - c2)
— Compiled by Floyd Upperman
Options Watch: Stocks and ETFs with high options volume (as of Sept. 29) Compiled by Tristan Yates
The following table summarizes the expiration months available for 20 stocks and ETFs with the largest options volume (measured in dollars). It
also shows each stock’s average bid-ask spread for at-the-money (ATM) October options. The information does NOT constitute trade signals. It is
intended only to provide a brief synopsis of potential slippage in each option market.
Option contracts traded

2009 2010 2011
Bid-ask
March
spread as %
Sept.
June
April
Dec.
Dec.
Dec.
Nov.
Feb.
Jan.
Jan.
Jan.
Oct.
May
Stock of underlying
Stock Ticker price Call Put price
S&P 500 tracking stock SPY X X X X X X X X 106.00 0.04 0.04 0.04%
Apple Inc. AAPL X X X X X X 185.38 0.08 0.10 0.05%
PowerShares QQQ Trust QQQQ X X X X X X X X 42.22 0.03 0.03 0.07%
Google GOOG X X X X X X 498.53 0.33 0.38 0.07%
Baidu Inc. BIDU X X X X X X 394.92 0.33 0.25 0.07%
Bank of America BAC X X X X X X 17.16 0.02 0.01 0.07%
iShares Russell 2000 index IWM X X X X X X X X X X 60.99 0.05 0.06 0.08%
Research in Motion RIMM X X X X X X 67.64 0.08 0.08 0.12%
Priceline.com PCLN X X X X X X 167.00 0.25 0.28 0.16%
American International Group AIG X X X X X X 45.22 0.11 0.13 0.26%
Citigroup C X X X X X X 4.70 0.01 0.01 0.27%
Vanguard FTSE All-World Ex-US VEU X X X X X X 43.04 0.31 0.29 0.70%
Thomson Reuters Corp. TRI X X X X 33.42 0.19 0.33 0.77%
Doctor Reddy's Lab RDY X X X X 19.25 0.16 0.18 0.88%
SLM Corp. SLM X X X X X X 8.91 0.09 0.08 0.91%
Cabot CBT X X X X 23.73 0.23 0.21 0.92%
HRPT Properties Trust HRP X X X X 7.86 0.16 0.15 1.99%
Monarch Casino & Resort MCRI X X X X 10.90 0.21 0.23 2.01%
RPC Inc. RES X X X X X 10.49 0.43 0.29 3.40%
Proshares Dynamic Small Cap Growth PWT X X X X 12.02 NA NA NA
Legend:
Call: Four-day average difference between bid and ask prices for the front-month ATM call.
Put: Four-day average difference between bid and ask prices for the front-month ATM put.
Bid-ask spread as % of underlying price: Average difference between bid and ask prices for front-month, ATM call, and put divided by the underlying's closing price.

KEY CONCEPTS The option “Greeks”
Delta: The ratio of the movement in the option price for
American style: An option that can be exercised at any every point move in the underlying. An option with a
time until expiration. delta of 0.5 would move a half-point for every 1-point
move in the underlying stock; an option with a delta of
Assign(ment): When an option seller (or “writer”) is 1.00 would move 1 point for every 1-point move in the
obligated to assume a long position (if he or she sold a put) underlying stock.
or short position (if he or she sold a call) in the underlying
stock or futures contract because an option buyer exercised Gamma: The change in delta relative to a change in the
the same option. underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
At the money (ATM): An option whose strike price is and lowest for deep ITM and OTM options.
identical (or very close) to the current underlying stock (or
futures) price. Rho: The change in option price relative to the change
in the interest rate.
Backspreads and ratio spreads are leveraged posi-
tions that involve buying and selling options in different Theta: The rate at which an option loses value each day
proportions, usually in 1:2 or 2:3 ratios. Backspreads con- (the rate of time decay). Theta is relatively larger for
tain more long options than short ones, so the potential OTM than ITM options, and increases as the option gets
profits are unlimited and losses are capped. By contrast, closer to its expiration date.
ratio spreads have more short options than long ones and
have the opposite risk profile. Vega: How much an option’s price changes per a one-
Note: These labels are not set in stone. Some traders percent change in volatility.
describe either position as option trades with long and
short legs in different proportions.
kers are required to report daily the futures and options
Bear call spread: A vertical credit spread that consists positions of their customers that are above specific report-
of a short call and a higher-strike, further OTM long call in ing levels set by the CFTC.
the same expiration month. The spread’s largest potential For each futures contract, report data is divided into three
gain is the premium collected, and its maximum loss is lim- “reporting” categories: commercial, non-commercial, and
ited to the point difference between the strikes minus that non-reportable positions. The first two groups are those
premium. who hold positions above specific reporting levels.
The “commercials” are often referred to as the large
Bear put spread: A bear debit spread that contains puts hedgers. Commercial hedgers are typically those who actu-
with the same expiration date but different strike prices. ally deal in the cash market (e.g., grain merchants and oil
You buy the higher-strike put, which costs more, and sell companies, who either produce or consume the underlying
the cheaper, lower-strike put. commodity) and can have access to supply and demand
information other market players do not.
Bull call spread: A bull debit spread that contains calls Non-commercial large traders include large speculators
with the same expiration date but different strike prices. (“large specs”) such as commodity trading advisors (CTAs)
You buy the lower-strike call, which has more value, and and hedge funds. This group consists mostly of institution-
sell the less-expensive, higher-strike call. al and quasi-institutional money managers who do not deal
in the underlying cash markets, but speculate in futures on
Bull put spread (put credit spread): A bull credit a large-scale basis for their clients.
spread that contains puts with the same expiration date, but The final COT category is called the non-reportable posi-
different strike prices. You sell an OTM put and buy a less- tion category — otherwise known as small traders — i.e.,
expensive, lower-strike put. the general public.
Calendar spread: A position with one short-term short Covered call: Shorting an out-of-the-money call option
option and one long same-strike option with more time against a long position in the underlying market. An exam-
until expiration. If the spread uses ATM options, it is mar- ple would be purchasing a stock for $50 and selling a call
ket-neutral and tries to profit from time decay. However, option with a strike price of $55. The goal is for the market
OTM options can be used to profit from both a directional to move sideways or slightly higher and for the call option
move and time decay. to expire worthless, in which case you keep the premium.
Call option: An option that gives the owner the right, but Credit spread: A position that collects more premium
not the obligation, to buy a stock (or futures contract) at a from short options than you pay for long options. A credit
fixed price. spread using calls is bearish, while a credit spread using
puts is bullish.
The Commitments of Traders report: Published
weekly by the Commodity Futures Trading Commission Debit spread: An options spread that costs money to
(CFTC), the Commitments of Traders (COT) report breaks enter, because the long side is more expensive that the short
down the open interest in major futures markets. Clearing side. These spreads can be verticals, calendars, or diagonals.
members, futures commission merchants, and foreign bro- continued on p. 26

KEY CONCEPTS
Delivery period (delivery dates): The specific time Physical delivery: The process of exchanging a physical
period during which a delivery can occur for a futures con- commodity (and making and taking payment) as a result of
tract. These dates vary from market to market and are deter- the execution of a futures contract. Although 98 percent of
mined by the exchange. They typically fall during the all futures contracts are not delivered, there are market par-
month designated by a specific contract — e.g. the delivery ticipants who do take delivery of physically settled con-
period for March T-notes will be a specific period in March. tracts such as wheat, crude oil, and T-notes. Commodities
generally are delivered to a designated warehouse; T-note
Diagonal spread: A position consisting of options with delivery is taken by a book-entry transfer of ownership,
different expiration dates and different strike prices — e.g., although no certificates change hands.
a December 50 call and a January 60 call.
Premium: The price of an option.
European style: An option that can only be exercised at
expiration, not before. Put option: An option that gives the owner the right, but
not the obligation, to sell a stock (or futures contract) at a
Exercise: To exchange an option for the underlying fixed price.
instrument.
Put ratio backspread: A bearish ratio spread that con-
Expiration: The last day on which an option can be exer- tains more long puts than short ones. The short strikes are
cised and exchanged for the underlying instrument (usual- closer to the money and the long strikes are further from the
ly the last trading day or one day after). money.
For example, if a stock trades at $50, you could sell one
In the money (ITM): A call option with a strike price $45 put and buy two $40 puts in the same expiration month.
below the price of the underlying instrument, or a put If the stock drops, the short $45 put might move into the
option with a strike price above the underlying instru- money, but the long lower-strike puts will hedge some (or
ment’s price. all) of those losses. If the stock drops well below $40, poten-
tial gains are unlimited until it reaches zero.
Intrinsic value: The difference between the strike price
of an in-the-money option and the underlying asset price. A Put spreads: Vertical spreads with puts sharing the same
call option with a strike price of 22 has 2 points of intrinsic expiration date but different strike prices. A bull put spread
value if the underlying market is trading at 24. contains short, higher-strike puts and long, lower-strike
puts. A bear put spread is structured differently: Its long
Naked option: A position that involves selling an unpro- puts have higher strikes than the short puts.
tected call or put that has a large or unlimited amount of
risk. If you sell a call, for example, you are obligated to sell Simple moving average: A simple moving average
the underlying instrument at the call’s strike price, which (SMA) is the average price of a stock, future, or other mar-
might be below the market’s value, triggering a loss. If you ket over a certain time period. A five-day SMA is the sum of
sell a put, for example, you are obligated to buy the under- the five most recent closing prices divided by five, which
lying instrument at the put’s strike price, which may be well means each day’s price is equally weighted in the calcula-
above the market, also causing a loss. tion.
Given its risk, selling naked options is only for advanced
options traders, and newer traders aren’t usually allowed Straddle: A non-directional option spread that typically
by their brokers to trade such strategies. consists of an at-the-money call and at-the-money put with
the same expiration. For example, with the underlying
Naked (uncovered) puts: Selling put options to collect instrument trading at 25, a standard long straddle would
premium that contains risk. If the market drops below the consist of buying a 25 call and a 25 put. Long straddles are
short put’s strike price, the holder may exercise it, requiring designed to profit from an increase in volatility; short strad-
you to buy stock at the strike price (i.e., above the market). dles are intended to capitalize on declining volatility. The
strangle is a related strategy.
Near the money: An option whose strike price is close
to the underlying market’s price. Strangle: A non-directional option spread that consists of
an out-of-the-money call and out-of-the-money put with
Open interest: The number of options that have not the same expiration. For example, with the underlying
been exercised in a specific contract that has not yet expired. instrument trading at 25, a long strangle could consist of
buying a 27.5 call and a 22.5 put. Long strangles are
Out of the money (OTM): A call option with a strike designed to profit from an increase in volatility; short stran-
price above the price of the underlying instrument, or a put gles are intended to capitalize on declining volatility. The
option with a strike price below the underlying instru- straddle is a related strategy.
ment’s price.
Strike (“exercise”) price: The price at which an under-
Parity: An option trading at its intrinsic value. lying instrument is exchanged upon exercise of an option.

Time decay: The tendency of time value to decrease at an {(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67
accelerated rate as an option approaches expiration.
The more varied the prices, the higher their variance —
Time spread: Any type of spread that contains short the more widely distributed they will be. The more varied a
near-term options and long options that expire later. Both market’s price changes from day to day (or week to week,
options can share a strike price (calendar spread) or have etc.), the more volatile that market is.
different strikes (diagonal spread). A common application of variance in trading is standard
deviation, which is the square root of variance. The stan-
Time value (premium): The amount of an option’s dard deviation of 8, 9, and 10 is: .667 = .82; the standard
value that is a function of the time remaining until expira- deviation of 2, 9, and 16 is: 32.67 = 5.72.
tion. As expiration approaches, time value decreases at an
accelerated rate, a phenomenon known as “time decay.” Vertical spread: A position consisting of options with
the same expiration date but different strike prices (e.g., a
Variance and standard deviation: Variance meas- September 40 call option and a September 50 call option).
ures how spread out a group of values are — in other
words, how much they vary. Mathematically, variance is the Volatility: The level of price movement in a market.
average squared “deviation” (or difference) of each number Historical (“statistical”) volatility measures the price fluctu-
in the group from the group’s mean value, divided by the ations (usually calculated as the standard deviation of clos-
number of elements in the group. For example, for the num- ing prices) over a certain time period — e.g., the past 20
bers 8, 9, and 10, the mean is 9 and the variance is: days. Implied volatility is the current market estimate of
{(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667 future volatility as reflected in the level of option premi-
ums. The higher the implied volatility, the higher the option
Now look at the variance of a more widely distributed set premium.
of numbers: 2, 9, and 16:
EVENTS
Event: Financial Markets World’s Location: Sydney Convention & Exhibition Centre
Risk Management for Non-Quants For more information: Go to
Date: Oct. 7-8 http://tradingandinvestingexpo.com.au
Location: Bayards, New York City
For more information: Visit www.fmwonline.com Event: Lawrence G. McMillan’s
Intensive Options Seminar
Event: FXstreet’s International Traders Conference Date: Nov. 7
Date: Oct. 14-16 Location: New York City, Marriott Marquis
Location: Barcelona, Spain For more information: Go to
For more information: www.traders-conference.com www.optionstrategist.com and click on “Seminars”
Event: TradeStation Futures Symposium Event: The Fifth Middle East Forex Trading Expo and
Date: Oct. 15-17 Conference 2009
Location: Costa Mesa, Calif. Date: Nov. 17-18
Date: Dec. 10-12 Location: Jumeirah Emirates Towers Hotel, Dubai
Location: Naples, Fla. For more information: www.meforexexpo.com
For more information: Visit
www.tradestation.com/strategy Event: International Traders Expo
Date: Nov. 18-21
Event: SunGard’s City Day: What Happens Next? Location: Mandalay Bay Resort & Casino, Las Vegas
Date: Oct. 19 For more information: www.tradersexpo.com
Location: Chicago Marriott Downtown
For more information: Go to Event: International Traders Expo
www.sungard.com/citydays Date: Feb. 13-16
Location: Marriott Marquis Hotel, New York, N.Y.
Event: Sydney Trading & Investing Expo For more information: www.tradersexpo.com
Date: Oct. 30-31

FUTURES & OPTIONS CALENDAR OCTOBER/NOVEMBER
MONTH
October 20 FND: November crude oil futures

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

FUTURES TRADE JOURNAL
Gold gambit comes up empty.
TRADE
Date: Tuesday, Sept. 22, 2009.
Entry: Long December gold (GCZ09) at

$1015.70.
Reason for trade/setup: This paper

trade was based on a bias and a general
characteristic. The bias was the expecta-
tion of a continued up move in the
already bullish gold market, which
recently topped $1,000 again, and man-
aged to hold above that psychological
threshold. This bias was based on the
expectation of a pullback in the overheat-
ed U.S. equity market, which would have
the potential to drive gold even higher Source: TradeStation
because of remaining nervousness of the
stability of the economy and stocks (espe-
cially in September and October). Outcome: Perhaps this trade is a lesson about basing
The general characteristic was the slight correction on trades on general principles rather than hard facts and test-
Sept. 18-21, which fulfilled the expectation for a “test” of ed patterns. After one day of inside trading with a down
$1,000 (the market fell to $996.30 before rallying to close close on Sept. 23, gold broke back below $1000 decisively on
around $1,005). When price jumped the next day, we inter- Sept. 24, and followed through with more selling on Sept.
preted the move as a sign that, rather than retreating from 25.
resistance and pulling back again from a high level, the We were obviously too eager to get into the market, and
market was going to break out to new highs. We entered gold is notoriously choppy. We paid the price for buying
when price retreated from the intraday high of $1,021.50. strength near all-time highs. The downside risk far out-
weighed the upside potential. Given the market’s overheat-
Initial target: $1,031, just above the next round-number ed condition, it would have been more prudent to wait for
price above the Sept. 17 high. a pullback at least to the mid-970s (the August high) to put
on this trade.
Initial stop: $998.70.
Note: Initial targets for trades are typically based on things such as the
RESULT historical performance of a price pattern or trading system signal.
However, individual trades are a function of immediate market behavior;
Exit: 998.70. initial price targets are flexible and are most often used as points at which
a portion of the trade is liquidated to reduce the position’s open risk. As a
Profit/loss: -17.00 (1.67 percent). result, the initial (pre-trade) reward-risk ratios are conjectural by nature.
TRADE SUMMARY
P/L
Date Contract Entry Initial stop Initial target IRR Exit Date Point % LOP LOL Length
9/22/09 GCZ09 1,015.70 998.70 1,031.00 .90 998.70 9/24/09 -17 -1.67% 5.30 -17 2 days
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

OPTIONS TRADE JOURNAL
FIGURE 1 — MARKET RALLIES AS EXPECTED
This bull put spread on SPY SPY climbed 2.6 percent within two days of entering the bull put spread. The
position remained in profitable territory during expiration week, and we earned
benefits from an expiration-week rally. 12.5 percent when options expired on Sept. 19.
TRADE
Date: Tuesday, Sept. 15.
Market: Options on the S&P 500

tracking stock (SPY).
Entry: Sell two September 103 puts

for $0.39 each.
Buy two September 101 puts
for $0.14 each.
Reasons for trade/setup: After

pulling back from its late August high,
the S&P 500 index rebounded 5.25 percent
from Sept. 2 to Sept. 10 and closed above
a resistance level around 1030-35. Such a Source: OptionVue
strong response to a pullback convinced
us this rally, which began in March and reignited in July, 101-strike puts for $0.14 each — a total credit of $0.25 per
has room to run. spread. Is collecting such a small amount pointless?
To profit from an uptrend, we normally buy in-the- Perhaps, but SPY traded at 105.31 when we entered the
money (ITM) calls, which have high deltas and tend to spread, so price must fall 2.2 percent in just four days before
move roughly in-line with the underlying stock. However, the position will lose money (see Figure 2). Given its timing
September options will expire in four days, so entering a and strike-price location, the spread has an 83-percent
bullish position that sells front-month options seems like a chance of success.
good idea. Figure 1 shows the bull put spread’s potential gains and
One possibility is a bull put spread — a vertical credit losses on three dates: trade entry (Sept. 15, dotted line),
spread that sells puts with out-of-the-money (OTM) strike halfway until expiration (Sept. 17, dashed line), and expira-
prices, which are below the market, and buys puts with tion (Sept. 19, solid line). Note the position has leeway on
even lower strike prices in the same expiration month.
Bull put spreads are appealing because you collect options TRADE SUMMARY
premium, which you keep if the underlying closes above
the short strike at expiration. More importantly, the Entry date: Sept. 15, 2009
spread’s maximum loss is limited to the distance between Underlying security: S&P 500 tracking stock (SPY)
the two strikes, so even if the market tanks, the spread Position: Bull put spread
offers some protection. Two short September 103 calls
When the stock market opened on Sept. 15, we entered Two long September 101 calls
September bull put spreads in SPY by selling September Initial capital required: $400
103-strike puts for $0.39 each and purchasing September Initial stop: Exit if SPY drops to short strike (103).
Initial target: Hold four days until options
expire worthless.
TRADE STATISTICS
Initial daily time decay: $7.15
Date: Sept. 15 Sept. 18 Trade length: 4 days
Delta: 27.39 1.67 P/L: $50 (12.5%)
Gamma: 13.08 -2.38 LOP: $50
Theta: 7.15 1.09
LOL: $0
Vega: -3.06 -0.28
Probability of profit: 83% 100% LOP — largest open profit (maximum available profit during life of trade).
LOL — largest open loss (maximum potential loss during life of trade).
Breakeven point: $102.75 $102.75

the downside as SPY must fall by almost one stan- FIGURE 2 — RISK PROFILE — BULL PUT SPREAD
dard deviation (pink bar) before it loses ground. This September 103-101 bull put spread on SPY has an 83-percent
The plan is to hold the spreads until options expire chance of success. It collected $50 in premium, which we will keep as
on Sept. 19, but exit if SPY drops to the short strike long as SPY doesn’t drop below the 103 short strike within four days.
(103) before expiration.
Initial stop: Exit if SPY falls to 103 by Sept. 18.
Initial target: Hold four days until September

options expire.
RESULT
Outcome: Figure 2 shows SPY continued to rally

after we entered the bull put spread, so it was never
in danger. The market climbed 2.6 percent to hit 108
on Sept. 17 before easing lower as expiration week
wound down. When September options expired,
we kept the entire premium of $50 (12.5 percent).
This bull put spread example isn’t ideal, because
the credit received was fairly small. However, this
strategy is attractive in rallying markets because it
Source: eSignal
risks less than buying the underlying outright.
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October 2009 • Volume 3, No.

TRADING FUTURES TESTING A

BEYOND THE GOLDEN

Managed Money . . . . . . . . . . . . . . . . . . . . .18

Options Trading System Lab

Diagonal put spreads:

2 October 2009 • FUTURES & OPTIONS TRADER

What’s a Binary Option?

At Nadex we’ve made it easy to trade what you want. Nadex

090706_273x206_FOT.indd 1 29/06/2009 13:28:54

Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .24

Options Radar . . . . . . . . . . . . . . . . . . . . . . . . .25

Futures & Options Watch:

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .27 Options Trade Journal . . . . . . . . . . . . . . .32

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FUTURES & OPTIONS TRADER • October 2009 9

lmost all futures-related

A documents carry the warn-

10 October 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • October 2009 11

FIGURE 3 — IMPLIED VOLATILITY 28-DAY RANGE, CBOT MINI DOW FUTURES

Forward-looking support and

12 October 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • October 2009 13

Diagonal put spreads:

A of-the-money (OTM) call or put option and a

Vertical Strike Premium Vertical Strike Theta

14 October 2009 • FUTURES & OPTIONS TRADER

Diagonal Strike Premium Diagonal Strike Theta

FUTURES & OPTIONS TRADER • October 2009 15

FIGURE 2 — RESPONDING TO VOLATILITY

Diagonal put credit

16 October 2009 • FUTURES & OPTIONS TRADER

FIGURE 4 — THREE-LEGGED SPREAD WITH VOLATILITY INCREASE

18 October 2009 • FUTURES & OPTIONS TRADER

Three good tools for targeting customers . . .

FUTURES & OPTIONS TRADER • October 2009 19

System concept: This Options

20 October 2009 • FUTURES & OPTIONS TRADER