Hedging Options » Risk

Upside Trading Strategies: Using Options for High Profits with Low Risk

admin — Sat, 17 Jul 2010 16:58:29 +0000

About the Actor

Andy was a successful small business owner who discovered a passion for trading in the 1980s. He became a technical analyst for CTS Financial Publishing and during his time there he was CTS Editor In Chief, overseeing the Futures, Futures Options, and Stock Options publications and advisory services. During his tenure at CTS, Andy also wrote, recorded, and published the Daily Trend Watch, a daily futures advisory, the Daily Trend Watch Classroom, an educational futures service, and the MR2 Alert, a combination advisory and tutorial specifically related to futures options. Since leaving in 2001, he has been working as an independent trader and analyst for private individuals and corporations.

Using a tried and true methodology, Andy Chambers will show you how the basic tenets of technical analysis can translate into big gains for you in futures options. During this 90-minute DVD, Andy will review his favorite trade setups, explain h (more…)

Managing Commodity Risk: Using Commodity Futures and Options (Kindle Edition)

admin — Sun, 17 Jan 2010 14:30:45 +0000

Most businesses will face commodity risk in some form. It is how the company manages this risk that will help to determine the success of the firm. In this highly practical book, John J. Stephens explains in a clear concise manner the best techniques for managing such risks. Aimed at the ordinary businessperson, this book is a practical primer for those who wish to manage and minimise the risk to their industry, through instruments such as commodity futures, without wishing to have the technical knowledge of professional financiers. This book provides the ideal starting point for the good manager not only to minimise commodity risk but to gain benefit also.

From the Inside Flap

Commodity risk and commodity futures are not merely used by financial traders, they can also be an invaluable tool for the everyday business manager. This book examines, in a balanaced and objective fashion, the extent to which the commodity futures markets can be used to the (more…)

Hedging â What is It, and Itâs Uses in Risk Management

admin — Thu, 14 Jan 2010 19:27:06 +0000

The second of a two part articleâ¦. Before I discuss the use of hedging to off-set risk, we need to understand the role and the purpose of hedging. The history of modern futures trading begins in Chicago in the early 1800âs. Chicago is located at the base of the Great Lakes, close to the farmlands and cattle country of the U.S. Midwest making it a natural center for transportation, distribution and trading of agricultural produce. Gluts and shortages of these products caused chaotic fluctuations in price. This led to the development of a market enabling grain merchants, processors, and agriculture companies to trade in contracts to insulate them from the risk of adverse price change and enable them to hedge. The first commodity exchange was the creation of the Chicago Board of Trade, CBOT in 1848. Since then, modern derivative products have grown to include more than the agricultural industry. Products include Stock Indices, Interest Rates, Currency, Precious Metals, Oil and Gas, Steel and a host of others. The origins of the commodity and futures exchange was created to support hedging. The role of speculators is beneficial as they add trading volume and important volatility to what would otherwise be a small and illiquid market place. You can view a complete listing of the worlds different exchanges at: http://www.genuinecta.com/World_Exchanges_Commodities_Trading_Advisors.htm A bona-fide hedger is someone with an actual product to buy or sell. The hedger establishes an off-setting position on the futures or commodity exchange, thereby instituting a set price for his product. Someone buying a hedge is known as being âLongâ or âTaking Deliveryâ. Someone selling a hedge is known as being âShortâ or âMaking Deliveryâ. These positions known as âContractsâ are legally binding and enforced by the exchange. Entering your trades either for speculation or hedging is done through your broker. Commodity Trading Advisor, Genuine Trading Solutions President Dwayne Strocen, states that âCommodity and Futures exchanges are distinct from Stock Exchanges, although they operate using the same principals. They are regulated by different agencies such as the Commodity Futures Trading Commission who are responsible for regulation of retail brokers in the USA as well as Commodity Trading Advisors such as us.â Now letâs view some real life examples of hedging or mitigation of risk by using exchange traded derivatives. Example 1: A mutual fund manager has a portfolio valued at $10 million closely resembling the S&P 500 index. The Portfolio Manager believes the economy is worsening with deteriorating corporate returns. The next two to three weeks are reports of quarterly corporate earnings. Until the report exposes which companies have poor earnings, he is concerned of the results from a short term general market correction. Without the privilege of foresight, he is unsure of the magnitude the earnings figures will produce. He now has an exposure to Market Risk. The manager thinks of his options. The greatest risk is to do nothing, if the market falls as expected, he risks giving up all recent gains. If he sells his portfolio early, he also risks being wrong and missing further rallyâs. Selling also incurs substantial brokerage fees with additional fees to buy back again later. Then he realizes a hedge is the best option to mitigate his short term risk. He begins by calling his CTA (Commodity Trading Advisor) and after consultation places an order to sell short the equivalent of $10 million of the S&P 500 index on the Chicago Mercantile Exchange âCMEâ. Now his result is when the market falls as expected, he will off-set any losses in the portfolio with gains from the Index hedge. Should the earnings report be better than expected, and his portfolio continues upward, he will continue making profits. Two weeks later the fund manager calls his CTA and closes the hedge by buying back the equivalent number of contracts on the CME. Regardless of the resulting market events, the mutual fund manager was protected during the period of short term volatility. There was no risk to the portfolio. Example 2: An electronics firm ABC has recently signed an order to deliver $5 million in electronic components of next years model to an overseas retailer located in Europe. These components will be built in 6 months for delivery two months after that. ABC instantly realizes they are exposed to two risks. 1. the rising and volatile price of copper in 6 months may result in losses to the firm. 2. the fluctuation in the currency could easily add to those losses. ABC being a young firm cannot absorb these losses in view of the highly competitive market from others in the field. Losses from this order would result in lay-offs and possibly plant closures. ABC telephones their CTA and after consultation places an order for two hedges, both for an expiry in 8 months, the date of delivery. Hedge #1 is to buy long $5 million of copper effectively locking in todayâs price against further price increases. ABC has now eliminated all price risk. The risk of plant closures is greater than the lure of increased profit should copper price fall. After all, ABC is not in the business of speculating on copper prices. Hedge #2 is to sell short the equivalent of Euro Currency vs US Dollars. Since ABC is effectively accepting EC in payment, a rising US dollar and a weak EC would be detrimental and erode profits further. The result of the hedge is no risk and no surprises to ABC in either copper or currency levels. A risk free transaction and full transparency is the result. In 8 months with the order completed and the customer accepting delivery, ABC notifies the CTA to close the hedge by selling the copper and buying back the Euro Currency contacts. Many examples exist to demonstrate the mitigation of risk to an institution or financial portfolio. Dwayne Strocen states that new products are constantly created and available on both over-the counter and exchange traded markets. If would be wise to consult with a qualified Commodity Trading Advisor or broker to discuss the analysis for an on-going risk management solution or a one time only hedge.

Option Hedging: Dynamic and Static Replication of Standard and Barrier Options, and Risk Management of Options on More Accurate Sensit (Impulse) (Hardcover)

admin — Mon, 11 Jan 2010 18:38:50 +0000

No description for this product could be found, but have a look over at Amazon for reviews and other information.

Equity Option Cycles

admin — Wed, 06 Jan 2010 21:01:06 +0000

Beginning options traders often are confused about the organization of option chains. This paper covers the basic concepts surrounding which options are available at any given point in time, and how that may affect the options you trade.Equity options always have options available for the current month and the following month. In addition, two more months will be available; but those two months will vary, depending upon which of three option cycles your option falls within: the January, February, or March quarterly cycles. For an option in the January cycle, Jan, Apr, July, and Oct are the months that will be used; for the February cycle, the months of Feb, May, Aug, and Nov are used; for the March cycle, the months of Mar, Jun, Sep and Dec are used. So, in January, for an option in the January cycle, the Jan and Feb options (current and next months) will be available plus two additional months: Apr and July. By contrast, an option in the February cycle will have the following options available in January: Jan, Feb, May, and Aug. Similarly, an option in the March cycle will have the following options available in January: Jan, Feb, Mar, and Jun. We can illustrate how this works for a year with Apple Computer (AAPL) in the January cycle: In January, the Jan and Feb options (current and next months) will be available plus two additional months: Apr and July. In March, the Mar and Apr options (current and next months) will be available plus two additional months: Jul and Oct. In June, AAPL will offer the Jun and July options (current and next months) plus two additional months: Oct, and, since we have run out of months for the January cycle, we add Jan. Since AAPL offers LEAPS options, a new LEAPS option is added, and the nearest LEAPS option is converted to the January option with a new ticker symbol. For stocks without LEAPS options, the Jan option is added at that time. The root of the ticker symbol, the first three letters, is different for the LEAPS options; for example, with AAPL, the short term options all start with APV, as in APVFH for the June $140 calls. The LEAPS options use the root of VAA, as in VAAAH for the Jan 2011 $140 LEAPS call.Index options are similar, but have some unique features. Most index options offer the front month plus the next two months, plus three more months from the March option cycle. However, several exceptions exist, e.g., the OEX has four near months available plus one more month from the March cycle.In general, more months are available for index options because institutional traders use these options to hedge large stock portfolios. Check the web site of the exchange that produces the index option of interest for the details of the months offered, e.g., see the CBOE web site for SPX and OEX, but the ISE web site for MID, the S&P Mid Cap 400 index.This is probably more detail than needed by the average options trader. The key information to keep in mind is that any equity options chain will always have options available for the front month, next month, and two additional months. Those additional months will vary depending on the option cycle of which it is a member. A smaller subset will also have the LEAPS options available.

Trading the Infamous Iron Condor

admin — Sat, 02 Jan 2010 07:08:02 +0000

Placing iron condor spreads on the broad market indexes is a relatively conservative, non-directional trading strategy that may be used for consistent income generation. This strategy profits as long as the index trades within the channel formed by the two spread positions. It is best used during sideways or slowly trending markets.Condor SpreadsA condor spread is a debit spread, established by placing a bear call spread at or above resistance and placing a bull call spread at or below support. The condor may also be established using puts with a bear put spread above and a bull put spread below. The iron condor is a variation on this trade by using a bear call spread above and a bull put spread below the price of the underlying stock or index. The iron condor is a credit spread and achieves maximum profitability if the price of the underlying closes between the short options (the strike prices we sold) of the two spreads at expiration. In that case, all options expire worthless and you achieve the maximum profit, i.e., the credits originally collected. The profitability of the iron condor is assisted by the fact that the broker only requires margin for one of the credit spreads, effectively doubling the return on investment.Condor spreads are effective when the underlying is expected to trade within the channel defined by the spreads during the life of the options. The closer one places the spreads to the current price of the underlying, the higher the returns; however, this comes with a higher risk of the price of the underlying stock or index entering one of the spreads and causing a loss on that spread.Trading the stock indexes with condors is effective for several reasons: 1) the indexes generally move slower than most individual stocks, 2) the indexes are less affected by an individual stock’s bad news, 3) the premiums of the index options are generally much higher than individual stock options, 4) index options trade in high volume because large institutional investors use these options to hedge their portfolios; this results in high liquidity, and 5) 60% of the gains with broad index options are taxed at long term capital gains rates, regardless of the length of time in the trade. Money ManagementMoney management refers to the rules used for determining the amount of capital devoted to a trade and spreading risk among strike prices and time. Determine the total dollar value you wish to devote to this strategy. For this example, we will assume we have a $100,000 account we will exclusively trade using the iron condor strategy. Take 40% of the total portfolio ($40,000) and divide by $1000 to get 40. This is the total number of contracts you will trade in this strategy each month (40 contracts total in the bear call spreads and 40 contracts total in the bull put spreads). This approach lessens your exposure during any particular month and leaves you room in the account to put on next month’s positions before last month’s positions have expired. This also reserves an additional 20% of capital as a safety margin and for possible use in trade adjustments. IMPORTANT: when learning this or any options trading strategy, start very small with one or two contracts and gradually increase your size as your experience and confidence grow.Money management also includes the concept of limiting your losses. Playing iron condors on the indexes as outlined in this paper are conservative, high probability trades. However, the potential loss is quite large, even though the loss has a low probability of occurrence. Therefore, one loss may wipe out several months of profits. Stop loss and adjustment rules and the discipline to strictly follow them are critical to the success of trading iron condors. Those stop loss and adjustment systems are taught in detail in the Advanced Options Trading Strategies course offered by Parkwood Capital, LLC.Timing (Days to Expiration)You can establish your condor position sometime in the range of 40 to 50 days until expiration. The precise time is not critical. The trade-offs are as follows: the earlier I put on my spread positions, the more time premium is present in the options and therefore I can receive the minimum credit I am willing to accept farther out from the current levels of the index; therefore, more safety margin is achieved. However, the more time I use in the spread, the more time that exists for the market to move against me; thus, I am incurring more risk. As time decay reduces the option premiums, I must move my spreads in closer to achieve a reasonable credit, reducing my safety margin and increasing my risk. It is also possible to trade the iron condor starting at about 30 days to expiration, but the system rules and adjustments must be adjusted accordingly.Determining Optimal Entry PointsSome traders place the call spreads when the index is hitting resistance and appears to be turning down, and place the put spreads when the index is hitting support and appears to be turning back upward. This will maximize the size of your credits. However, if the index continues to move in that direction, your position could be in trouble quickly and you will not have the compensating spread position helping to hedge your position. For this reason, I generally establish both the call spreads and put spreads on the same day.Choosing the StrikesWe can apply basic statistics to our deciding which strike prices are “far enough” out to be safe. The classic “bell shaped curve” we have seen in various contexts is the mathematical function known as a normal or Gaussian distribution. If we assume that future moves of the index price will be random and similar in frequency and absolute size to previous fluctuations up and down, then we can calculate the probability of the index price being at a particular price on a particular date in the future. I calculate the standard deviation for the index, based upon its level of implied volatility and the time left to expiration. The call spreads are placed just outside one standard deviation above the index price and the put spreads are placed just below one standard deviation below the index price. This results in an iron condor position with a probability of success of approximately 80-85%. The details of this methodology are taught in the Equity and Index Options course offered by Parkwood Capital, LLC.Entering the Order and Getting FilledNow that we have determined the strike prices for our spread, we need to calculate the credit we are going to ask for in our order. Compute the natural price for the credit spread, the natural debit spread price, and the midpoint of the spread (most online brokers calculate this for you).Enter your order at a credit limit at the midpoint and wait to see if the order is filled. After a few minutes, adjust the credit downward by $0.05. Repeat until both spread orders are filled. But do not drop below the lower quartile of the bid/ask spread.Never place an order for less than $0.60 to $0.70 in credit; trading commissions become too large a factor for smaller credits. My spread credits normally range from $0.60 to $1.05 per spread or about $1.20 to $2.10 per iron condor.Stop Losses and AdjustmentsThe topics of setting stop losses and the variety of adjustment methodologies available are beyond the scope of this paper. An effective, but simple, risk management technique is to monitor the debit spread necessary to close your condor spreads, and when that debit is double the original credit received for that spread, close that side of the condor. This technique will close out positions more frequently, but it will result in very small losses or near breakeven results in the “bad” months when the index moves against you.Index Option SettlementIndex options are cash settled options; there is no underlying instrument like stock shares to be called away or put to you. You simply lose or gain the dollar value at expiration, e.g., you hold 10 contracts of the $1400 call and the SPX settlement price is $1405; your account will be credited with $5,000 ((1405 – 1400) x 100 x 10). If you were short the $1400 calls, your account would be debited $5,000.Most index options are somewhat unusual in that they cease trading for the month at market close (4:15 pm ET) on the Thursday before expiration, but the settlement price is not that closing price on Thursday or the opening price Friday morning. Therefore, all final adjustments to positions must be done on Thursday before the close. On Friday morning, the settlement price will be computed based upon the opening prices of each of the stocks that make up that index. Since each stock may not trade immediately at the open, the settlement value may not be available until later that Friday morning. Since the settlement price may vary several dollars up or down from Thursday’s close, one must be cautious about going into settlement with any spread positions remaining open.Expected ReturnsIf you are placing your spreads for credits of $0.70 or more, then the returns for that iron condor will be about 15% for the month (remember that margin is only charged for one half of the iron condor). If we are using roughly half of our capital for an iron condor each month, then you can expect to average returns of about 6% to 8% per month. Of course, you may have to defensively close one of the spreads a few times per year and that will reduce the annualized return of this strategy. SummaryThe iron condor trading strategy is a relatively conservative, non-directional options strategy that may be used for consistent income. However, this strategy is typical of low return strategies with high probabilities of success. The probability of a loss is small, but one large loss will wipe out several months of profits. Thus, the key to success for trading iron condors is solid risk management rules for entry and exit, stop losses, and adjustments. When deployed conservatively as outlined herein, this strategy should reasonably be expected to return 5% or more per month.

Managing Commodity Risk: Using Commodity Futures and Options (Hardcover)

admin — Tue, 15 Dec 2009 15:48:42 +0000