FOT200906

June 2009 • Volume 3, No.
TRADING ORDER
flow with market
profile p. 12
STRADDLES VS.
STRANGLES
p. 20
SPREADING
your charting
options p. 26
TRADING
PULLBACKS
with options p. 30
BEING RIGHT VS.

MAKING MONEY
p. 43
NEW CFTC HEAD

confirmed p. 32
CONTENTS
Options Trading System Lab

Buying calls on pullbacks
in S&P 500 futures . . . . . . . . . . . . . . . . . . .30
A simple options strategy shows buying
on dips has promise.
By Steve Lentz and Jim Graham
News
Gensler approved as CFTC head . . . . . .32
Nominee Gary Gensler convinces a couple of
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6
senators to vote in his favor by proposing a new
direction for derivatives regulation.
Market Movers . . . . . . . . . . . . . . . . . . . . . . . .8
Futures market roundup. Penny Pilot Program’s
future uncertain . . . . . . . . . . . . . . . . . . . . . .33
Trading Strategies Mixed results leave questions about how to
Trading order flow with proceed with the option penny-pricing program.
Market Profile . . . . . . . . . . . . . . . . . . . . . . . .12
How to interpret Market Profile charts. CME Group combines
By Robin Mesch NYMEX trading floors . . . . . . . . . . . . . . . .33
The CME takes the next step in assimilating the
Another look at straddles NYMEX by moving the energy and metals trading
and strangles . . . . . . . . . . . . . . . . . . . . . . .20 pits onto a single floor.
A common dilemma for volatility traders is
continued on p. 4
whether to trade an options straddle or strangle.
This second excerpt from Guy Cohen’s book
Volatile Markets Made Easy: Trading Stocks and
Options for Increased Profits compares both
approaches.
By Guy Cohen
Spreading your charting options . . . . . .26

How chart analysis can improve your options
trading.
By Thomas Stridsman
2 June 2009 • FUTURES & OPTIONS TRADER

ads0709 5/11/09 2:00 PM Page 15
CONTENTS
Key Concepts . . . . . . . . . . . . . . . . . . . . . . . .34

References and definitions.
Futures Snapshot . . . . . . . . . . . . . . . . . . . .38

Momentum, volatility, and volume
statistics for futures.
Options Radar . . . . . . . . . . . . . . . . . . . . . . .39

Notable volatility and volume
in the options market.
Futures & Options Watch Futures & Options Calendar . . . . . . . . . . . .42

COT extremes . . . . . . . . . . . . . . . . . . . . . . .40
A look at the relationship between commercials Futures Trade Journal . . . . . . . . . . . . . . .43
and large speculators in U.S. futures markets. Volatility abounds near stock market top.
Options Watch: Options Trade Journal . . . . . . . . . . . . . . .44

Telecom stocks . . . . . . . . . . . . . . . . . . . . . . . .40 Buying the bounce in Procter and Gamble.
New Products and Services . . . . . . . . . . . . .41 Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45
Have a question about something you’ve seen

in Futures & Options Trader?
Submit your editorial queries or comments to webmaster@futuresandoptionstrader.com.
Looking for an advertiser?

Click on the company name below for a direct link to the ad
in this month’s issue of Futures & Options Trader.
Ablesys Global Futures
eSignal NinjaTrader
E*TRADE FINANCIAL RS of Houston
Forex & Options Expo TraderPlanet

ads0709 5/8/09 12:28 PM Page 5
CONTRIBUTORS
CONTRIBUTORS
Guy Cohen has extensive experience in the options stock markets, and
his clients include NYSE Euronext, the largest stock exchange in the world.
Cohen is also the creator of Flag-Trader, OptionEast, and Illuminati-Trader.
Specializing in trading applications, he has developed comprehensive trading
A publication of Active Trader ® and training models. Cohen has an MBA in finance from Cass Business
School, London.
For all subscriber services:
www.futuresandoptionstrader.com
Thomas Stridsman (optisizer@gmail.com) is a private
trader, trading-strategy developer, and lecturer. Previously, he
Editor-in-chief: Mark Etzkorn
metzkorn@futuresandoptionstrader.com was the senior researcher for Rotella Capital in Chicago, a com-
modity trading advisor with more than $1 billion under man-
Managing editor: Molly Goad agement. He also is a long-time contributing editor for Active
mgoad@futuresandoptionstrader.com
Trader magazine and a former editor at Futures magazine. He has authored
two books: Trading Systems that Work (McGraw-Hill, 2000) and Trading Systems
Senior editor: David Bukey
dbukey@futuresandoptionstrader.com and Money Management (McGraw-Hill, 2003). He has a degree in macro eco-
nomics from Uppsala University, Sweden.
Contributing editor:
Keith Schap
Robin Mesch has worked with traders worldwide, pro-
Associate editor: Chris Peters viding market education for the professional trader based on
cpeters@futuresandoptionstrader.com the RMA Methodology. Her innovative methodology and
analysis of the market have been featured on CNBC and have
Editorial assistant and
webmaster: Kesha Green
been profiled in books such as Bloomberg’s New Thinking in Technical Analysis;
kgreen@futuresandoptionstrader.com Bulls, Bears, and Millionaires; The Outer Game of Trading; The Day Traders
Advantage; The Tao of Trading; Women of the Pits; and most recently,
Art director: Laura Coyle
Breakthroughs in Technical Analysis: New Thinking from the World’s Top Minds.
lcoyle@futuresandoptionstrader.com
Mesch’s proprietary software is currently licensed to a select group of trading
President: Phil Dorman firms and fund managers with offices in Chicago and New York. In addition,
pdorman@futuresandoptionstrader.com Mesch serves as a unit trust portfolio consultant for Van Kampen
Investments. Mesch is a Brown University graduate and currently resides in
Publisher,
Ad sales East Coast and Midwest: Portland, Ore.
Bob Dorman
bdorman@futuresandoptionstrader.com Steve Lentz (advisor@optionvue.com) is a well-estab-
lished options educator and trader and has spoken all over the
Ad sales
West Coast and Southwest only: U.S., Asia, and Australia on behalf of the CBOE’s Options
Allison Chee Institute, the Options Industry Council, and the Australian
achee@futuresandoptionstrader.com Stock Exchange. As a mentor for DiscoverOptions.com, he
teaches select students how to use complex options strategies and develop a
Classified ad sales: Mark Seger
seger@futuresandoptionstrader.com consistent trading plan. Lentz is constantly developing new strategies on the
use of options as part of a comprehensive profitable trading approach. He
Volume 3, Issue 6. Futures & Options Trader is pub- regularly speaks at special events, trade shows, and trading group organiza-
lished monthly by TechInfo, Inc., 161 N. Clark St.,
Suite 4915, Chicago, IL 60601. Copyright © 2009 tions.
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any
form without written permission from the publisher.
Jim Graham (advisor@optionvue.com) is the product
The information in Futures & Options Trader magazine
is intended for educational purposes only. It is not manager for OptionVue Systems and a registered investment
meant to recommend, promote, or in any way imply
the effectiveness of any trading system, strategy, or advisor for OptionVue Research.
approach. Traders are advised to do their own
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of
risk. Past performance does not guarantee future
results.

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MARKET MOVERS
Surging energies lead bullish commodity futures arena

Breaking out of an early-spring slump, commodity
futures mostly jumped in May and early June, with gains
in energy and metal futures highlighting the charge.
After gaining ground in early May, the Rogers
International Commodity TRAKRS (RCTY) consolidated
before jumping again in the final week of the month and
at the beginning of June — the first day of the month
being conspicuously bullish. Virtually all commodity
contracts enjoyed some upside action, with the notable
exception of livestock futures, which suffered through
renewed selling in the aftermath of the swine flu scare.
Financial futures were highlighted by the continued
rally in stock index futures and the pullback in Treasury
contracts.
Source for all: TradeStation
Metals
After some sloppy trading in April — and despite the
continued stock-market rally — precious metals swung
to the upside in May. July silver (SIN09) paced the group
with a nearly 36-percent gain from the April 20 low of 11.77
to the June 1 high of 15.97. June gold
(GCM09) posted a more modest gain
Energy of approximately 15 percent during
the same period, but nonetheless
Crude oil, gaso- traded to a three-month high of
line, and heating 988.10 as June trading began.
oil shot higher in Meanwhile, July copper (HGN09),
May, with July which had begun rallying in late
crude (CLN09) February, consolidated for much of
making a strong May but burst out to the upside on
move above $60 June 1, tagging 2.3285 and reaching
and eventually its highest level since October 2008.
topping $68 by
June 1. A choppy
natural gas market
was the odd man
out; the July con-
tract (NGN09) ral-
lied sharply in
early May, but
gave back almost
all its gains
toward the end of
the month before
bouncing again.
Grains
Grains were another
strong sector in May,
with wheat and corn
catching up to an already strong
soybean market. July beans (SN09)
were closing in on the teens by
June 1, trading as high as 1227,
while July wheat (WN09) hit 677
and July corn (CN09) topped 445.

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MARKET MOVERS
Meats
After regaining
nearly all their
losses from the
Fiber
immediate aftermath of the and wood
swine-flu outbreak, pork futures
turned back down in mid-May Cotton pulled back from its
and were still selling as June robust rally in the latter
arrived. July lean hogs (LHN09) half of May. After hitting 61.67 on May 12, the July contract
pushed to fresh contract lows (CTN09) retreated to 54.16
below 63.00 on June 2, while July on May 28 before bounc-
pork bellies (PBN09) wallowed ing back to 58 on June 1.
near their contract nadir. August July lumber (LBN09)
live cattle futures (LCQ09) were continued to swing in a
challenging their March and wide trading range,
February lows at the end of May falling to the level of its
and beginning of June. March and April lows
around 170 on May 21
before bouncing back
above 200 before the end
of the month.
Softs
Coffee’s 27-per-
cent rally from late
April to early June
paced the soft-com-
modity market. July coffee
(KCN09) rallied to 142.90 on
June 2 after trading as low as
112.75 on April 21, while July Treasuries
sugar (SDN09) remained near
the upper end of its May trad- T-note and T-bond
ing range and a relatively futures sold off sharply
weak July cocoa contract in late May and opened
(CCN09) managed to jump on June with more selling.
the bullish bandwagon in mid- The June 10-year T-note
May. July orange juice (OJN09) contract (TYM09),
extended its rally to 97.55 on which traded above 126
May 29 after falling as low as on March 18, broke
87.20 in mid-May. below the 120 level deci-
sively in late May and,
Stock after a two-day bounce,
traded below 117 on
indices June 1.
The U.S. stock mar-

ket toyed with bulls
and bears for most of May
before bursting to the
upside in the final minutes
of trading on May 29 and
then following through
with a huge gain on June 1. Currencies
June E-Mini S&P 500 futures
(ESM09) jumped around 3 June dollar index
percent on the first trading futures (DXM09)
day of June to 947.25 — the broke to the down-
highest level since side in May and extended their losses at the outset of
November 2008 — which June, trading below 79.00 — a roughly 12-percent
extended the gain from the early-March low to more than 42 percent. drop from the contract’s March high.

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Trading order flow

with market profile
Market Profile charts display aspects of trade activity other charts cannot. Deciphering this data
and the “four steps of market activity” can help gauge what the market is doing.
BY ROBIN MESCH
Note: A version of this article originally appeared in the May 2005 geared toward organizing, processing, and structuring a
issue of Active Trader magazine. market’s buy-and-sell order flow.
We’ll explain how to interpret Market Profile charts and
A ssume you’re trying to find the nearest coffee

shop, and a Starbucks delivery van pulls up next
to you. Do you: a) ask the driver for directions, b)
follow the delivery van, or c) ask the van?
Surely none of us would chase the van or ask the vehicle
their four steps of market activity, as well as illustrate pat-
terns that can be used for trade setups.
What is Market Profile?

Market Profile is a database that organizes market activity
itself, but these two choices symbolize what traders all too in terms of order flow. Figure 1a is a monthly bar chart of
consistently select when determining market direction. the Euro Bobl futures (FGBM), which reflects German gov-
For many traders, the central focus for determining mar- ernment bond prices.
ket moves is price, which has become equated with order Organizing the data into a bar chart helps highlight
flow. However, price and order flow are as different as the important patterns, but the bar chart captures only one
van and the driver. Price is merely an effect — a distribution dimension of the market — price. Order flow is a two-
vehicle — but traders routinely chase it looking for market dimensional creature and is best expressed as how much
direction. If you really want to know where the market is time a market spends at a given price.
headed, you need to understand order flow. Figure 1b is the same data organized into “profiles” that
Traders can tap into order flow with Market Profile, capture the natural process of the auction. For a detailed
which is a database, a methodology, and a mindset all discussion of Market Profile theory and how it organizes
FIGURE 1 — BAR CHART VS. MARKET PROFILE
This comparison of a monthly Bobl bar chart to a Market

Profile chart covering the same time period shows how
Market Profile highlights the most frequently traded price
levels (i.e., the mode line) since 1999.
Source: CQG

TABLE 1 — THE FOUR STEPS OF MARKET ACTIVITY
A typical Market Profile cycle includes four steps that range from strong vertical
movement (always present) to building a bell-shaped curve.
market data, see “Understanding
Market Profile.” Here, we’ll focus on Step 1: Strong vertical movement
identifying a profile’s unique patterns. • The only non-random step.
The profile data format shows exact- • The most profitable trading opportunity.
ly how much time a market spends at • Represents a market imbalance: A large shift of capital into or out of
a given price and Figures 1a and 1b the market.
clearly show all prices are not created Step 2: Stops the directional move
equal. Figure 1a shows the Bobl • Step 2 begins to build the first standard deviation.
futures spent quite a bit of time at cer- • It’s usually recognized by failing to set a lower low, and the start of a
tain prices (i.e., from 105 to 107 high horizontal ratio such as a 4x4.
between August 2000 and August Step 3: Forms a “p” or “b” shape
2002, and around 111.00 from August • The market begins to move sideways, or “develop.”
2002 to January 2004), creating bulges • A “p-” or “b-” shaped profile forms, with the first standard deviation
in the profile, which indicates the mar- near the top if step 1’s move was up, and near the bottom if it was down.
ket felt those price areas were “fair.” • Prices rotate around what will become the control price (or mode) of this
The Bobl spent little time at price general area.
levels traders considered relatively Step 4: The bell-shaped curve
unfair, creating hollow portions in the • The market tries to move toward efficiency.
Profile. The widest part of the curve • The first standard deviation of prices migrates toward the middle of the
(the “mode” line) is where the market range that began with step 1.
spent the most time and built the most • The combined profile becomes bell-shaped.
volume. This is often referred to as the
consensus point, or the most “fair” FIGURE 2 — STEPS 1 AND 2
price in a time period.
Left to its natural order, the market auction process seeks Step 1 is a typically strong price move that breaks out of
a fair price. First, a non-random order-flow imbalance cre- the prior profile’s mode line (Feb. 9). Step 2 begins when
ates a strong initial vertical move. Then, a somewhat ran- this vertical move ends and price starts trading sideways.
dom consensus-building (i.e., horizontal) phase follows
and establishes a new fair price.
Most of the trades within each profile (70 percent) occur
within its “value” area. To calculate the value area, add all
Time Price Opportunity intervals (TPO) in a profile, find its
mode, and then count out 70 percent of these TPOs on
either side of this mode. In Figure 2, for example, there are
184 TPOs and the mode is 109.14. Start at this level and
count the 129 TPOs that are centered around this price.
First, compare the line above the mode line to the one
below it; include the widest line as part of the value area. In
Figure 2, the line below the first profile’s mode (y to H) is
fatter than the one above, so we include that line. Next,
compare the line above to the next line below and select the
widest one. Repeat this process until all 129 TPOs are
included. Figure 2 shows a Market Profile chart of the
Chicago Board of Trade’s (CBOT) March 2005 five-year T-
note futures (FVH05) from Feb. 4 to Feb. 10. The blue lines
to the right of each profile in Figure 2 represent their value
areas (from 109.09 to 109.15 in the above example).
This process creates a bell-shaped curve typical of ran-
dom activity around underlying order. Profiles follow the
same structure and begin when a large price move carries
the market out of an established range. Here, time is an arti- Source: CQG
ficial organizing principal; the more organic principal
becomes a completed cycle of market activity as reflected in curve) consists of up to four steps (see Table 1). Step 1,
the formation of a bell curve and the beginning of a new which is always present, is the non-random move — a rapid
vertical move out of its mode line. rally or decline that starts off a cycle. Step 1 represents a
market imbalance; a large amount of capital comes into or
Four steps of market activity out of the market. This first step generally offers the most
Each cycle of market activity (i.e., the completion of a bell continued on p. 14
FUTURES & OPTIONS TRADER • June 2009 13

TRADING STRATEGIES
Key statistics
The mean (or average) of a set of values is the sum of the values divided
profitable trading opportunity. by the number of values in the set. If a set consists of 10 numbers, add
Figure 2’s bell-shaped curve marked the high- them and divide by 10 to get the mean. For example, the mean of 1, 2, 3,
volume region from Feb. 4 to Feb. 8. The step-1 4, 5, 6, 7, and 200 is 28.5 (228/8).
move came out of the mode line in a typical pat- The median of a data set is its middle value (when the set has an odd
tern. As long as each successive bar is setting a new number of elements) or the mean of the middle two elements (when the set
low and there is very little horizontal activity, the has an even number of elements). The median is less susceptible than the
market is in step 1. mean to distortion from extreme, non-representative values. The median of
An order flow imbalance cannot go on indefi- 1, 2, 3, 4, 5, 6, 7, and 200 is 4.5 ((4+5)/2), which is much more in line with
the majority of numbers in the set.
nitely — ultimately it will dry up. This leads to step
The mode is the value that appears most often in a data set. In the
2, which occurs when the vertical move has gone
above example, all numbers appear one time, which means it has no dis-
far enough in one direction to shut off the buying or
tinct mode. A data set can have either one or several modes. For example,
selling — that is, when it reaches a price too high to the mode of 1, 1, 2, 3, 4, 5 is 1, but the modes of 1, 2, 2, 3, 3, 4, 5 are 2
attract more buyers or too low to attract more sell- and 3.
ers. This step begins with a bar that does not set a Variance measures how spread out a group of values are — in other
new low or a new high and starts to show signs of words, how much they vary. Mathematically, variance is the average
short-term horizontal activity. squared “deviation” (or difference) of each number in the group from the
Figure 2 shows step 2 began at the “y” bar on group’s mean value, divided by the number of elements in the group. For
Feb. 10. This step is typically marked a “4x4” pat- example, for the numbers 8, 9, and 10, the mean is 9 and the variance is:
tern, or a high horizontal-to-vertical ratio that starts
to suggest the buy or sell order flow imbalance is {(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = .667
ending. It’s easy to pick out a 4x4 on a 30-minute
bar chart — just check whether you can draw a hor- Now look at the variance of a more widely distributed set of numbers: 2,
izontal line that crosses four consecutive bars. 9, and 16:
On the shortest time frame, the existence of a 4x4
{(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67
is evidence of random activity, or horizontal
motion. A 4x4 has a 100-percent horizontal ratio of The more varied prices, the higher their variance — the more widely dis-
possible to actual width. A high 100-percent hori- tributed they will be. The more varied a market’s price changes from day to
zontal ratio (i.e., an 8x8 or 10x10) is evidence of day (or week to week etc.), the more volatile that market is.
extreme randomness on a very short-term basis. A common application of variance in trading is standard deviation,
Figure 3 shows the five-year March 2005 T-note which is the square root of variance. The standard deviation of 8, 9, and 10
futures from Feb. 9 to 11. A strong directional move is .667 = .82; the standard deviation of 2, 9, and 16 is 32.67 = 5.72.
emerged from the area with a very high 100-percent
horizontal ratio (11x11). The 100-percent horizontal
FIGURE 3 — 100-PERCENT HORIZONTAL RATIO
ratio helps us determine not only when the vertical
phase of market activity is ending, but also when a One-hundred-percent horizontal ratios are easy to find — look for four
horizontal phase is ripe for a directional move — or more filled columns — and typically signal a vertical move. This
when a market establishes extreme randomness, it 11x11 ratio (letters H to D) occurred between Feb. 10 and 11 before
usually signals a directional move. In this case, the the expected selloff began at “D.”
market started to decline at “D” right out of the
mode line, which is the typical pattern.
Developing the profile

A vertical move is followed by a development peri-
od, which is the third step of market activity. In step
3, the market moves horizontally while it builds the
first standard deviation at one end of the previous
move. For a detailed explanation of standard devi-
ation, see “Key statistics.”
In step 3, the market typically doesn’t develop all
the way back to the origin of the vertical move.
Instead, one end of the move is developed, which
results in a p- or b-shaped profile. This step nor-
mally continues until it builds up a bell-shaped
curve with a distinct mode and often a high 100-
percent horizontal ratio, such as the 11x11 that
occurred in Figure 3.
Figure 4 shows the five-year T-note futures on Source: CQG

FIGURE 4 — STEP 3 “P” SHAPE
“P”-shaped patterns typically occur after the market halts a
prior upswing (step 1) and begins to develop around the first
Feb. 9 and illustrates a typical p-shaped pattern. Figures deviation of the move’s end.
5a and 5b show the “p” and “b” patterns as they devel-
oped: from Feb. 14 to 19 (b) and Feb. 20 to 24 (p), out-
lined in red and blue, respectively. Figure 5b combines
this data to more clearly illustrate the “b” and “p”
shapes. Putting both step 3s together begins the creation
of the bell-shaped curve.
During step 4, the final step of market activity, the
market begins to form a bell-shaped curve over the
entire range of step 1. As this happens, the mode begins
to float from one end toward the center of the range,
returning to step 1’s initiation point (see Figure 6). Step 4
is complete when the data develops a bell-shaped curve,
or a capital-D shape.
Trading profile
Now that we have an overview of the complete market
cycle, we can try to put what we’ve learned together in a
trade strategy. Figure 7 shows a long-term profile of the
March 2005 S&P 500 futures (SPH05) from Jan. 19 to Jan.
25, 2005. During that period, the S&P ranged from 1192
to 1164, and the value area was between 1179 and 1166.
What step do you think the S&P is and where would
you expect it to develop next? Actually, Figure 7’s shad-
ed area is a step 4, which is still underdeveloped. In this
profile, we would not expect a directional move to occur
until the entire profile reverts into a more fully devel-
continued on p. 16 Source: CQG
FIGURE 5 — STEP 3 “B” AND “P” SHAPES

The “b”-shaped pattern formed from Feb. 14 to 19 before the “p” devel-
oped over the next three days. Figure 5b shows the same data consoli-
dated into more recognizable shapes. These two patterns often form a
completed bell curve, or “d”-shaped pattern.
Source: CQG

TRADING STRATEGIES
Understanding Market Profile

Market Profile, which was developed by Peter Steidlmayer at the bine Figure B’s TPOs from Feb. 22 to Feb. 24, the profile will
Chicago Board of Trade (CBOT) in the 1980s, measures order look different than a daily one.
flow and is based on two assumptions: Although Figure B’s lettering scheme (A to M, or 9:30 a.m. to
First, the market is an auction process, which moves up or 3 p.m. ET) is easy to follow, there are no solid rules about this
down until buy and sell demand are equal. format. For example, different data providers, markets (i.e., pit
Second, the market moves either sideways or vertically vs. electronic), and securities may use other letters. As you build
depending on whether the current buy/sell demand is relatively in composite profiles, the key is to recognize larger patterns
or out of balance. When buying demand roughly matches selling instead of focusing on a profile’s letters.
demand, the market tends to move horizontally; when this rela- (To learn more about Market Profile, visit the Chicago Board
tionship is out of line (i.e., more buyers than sellers or vice versa), of Trade’s Web site:
a vertical price move is imminent. http://www.cbot.com/cbot/pub/page/0,3181,1168,00.html.)
A large price move is fairly easy to identify on a price bar
chart, but a sideways move, which implies buy and sell demand — Active Trader Staff
is in equilibrium, can be tough to interpret.
Steidlmayer realized these horizontal moves FIGURE A — STANDARD DEVIATION
tended to form Gaussian (bell-shaped) curves,
which group prices around that curve's peak, or its The Gaussian (or “bell”) curve shows the standard deviation of values
mode (i.e., the most frequent price). Sixty-eight around the mean. The curve’s peak also represents the mode.
percent of these prices are also within one stan-
dard deviation of the mean — see Figure A. A
Market Profile chart organizes price data accord-
ing to this principle, except it turns the bell curve
on its side (90 degrees).
Figure B shows a 30-minute Market Profile chart
of the S&P 500 index from Feb. 14 to Feb. 24, 2005.
Each letter represents the S&P’s price range during
one 30-minute time interval and is called a TPO, or
Time Price Opportunity. For example, there are 13
TPOs (letters A to M) each day in Figure B, which
represent the trading day’s 13 half-hour trading peri-
ods: Letter A shows the S&P price from 9:30 to 10
a.m. ET, letter B shows its price from 10 to 10:30
a.m., and so on.
Market Profile charts plot each TPO to as far to
the left as possible in each day, so if price overlaps
during two TPO intervals, (e.g., letters A
and B), that row includes both letters. FIGURE B — MARKET PROFILE CHART
Therefore, the widest sections of the pro-
file represent areas where the market This 30-minute chart shows that the S&P 500 traded in a fairly tight range on
traded most frequently. The chart plots Feb. 18, creating a wide profile, before it sold off the next day. (Vertical moves
additional rows as subsequent TPOs result in narrower profiles.)
trade outside the prior interval’s range.
According to Figure B, for example, the
S&P 500 traded between 1196 and 1199
from 9:30 to 10 a.m. ET on Feb. 22, and
traded within that range for much of the
next 30 minutes before breaking above
the 1200 level from 10:30 to 11 a.m.
However, the S&P sold off below 1190 in
the final two hours of the day (letters J
through M).
Figure B’s 30-minute TPOs are organ-
ized by day, which makes it more intuitive
to understand at first, but more significant
patterns tend to appear as you consoli-
date a day’s 13 TPOs into larger, com-
Source: http://www.erlangerquote.com
posite profiles. For example, if you com-

FIGURE 6 — STEP 4 COMPLETING FIGURE 7 — S&P 500 TRADE SETUP
THE BELL CURVE
On Jan. 25, this underdeveloped step 4
The final step of market activity occurred as (see circled area) suggested that the S&P
the five-year T-note futures fell and returned to futures would be range-bound until a more
oped bell curve. its initiation point (step 1). complete bell curve developed. At this
There is much more point, sell the top and buy the bottom of
development necessary to the shaded value area until holes in the
transform this step 4 into a bell curve fill in.
fully ripe D-shaped pat-
tern. Combining the pro-
files so far shows the mar-
ket-auction process wasn’t
complete in the S&P’s
middle region (see circled
areas).
Look for holes in the
profile that need to be
filled. You have an oppor-
tunity to trade the top and
bottom of the developing
value area until those
holes are filled in. The pro-
file needs to develop in
the circled area to form a
bell-shaped curve.
Figure 8 shows this is
exactly what happened
over the next several days.
The strategy of buying
around 1167 and selling Source: CQG
FIGURE 8 — TRADING THE “VALUE” AREA

The S&P traded between 1166 and 1179 from Jan. 25 to 28, which
confirms that the strategy suggested in Figure 7 (i.e., selling the top
and buying the bottom of this range) would have been profitable.
Source: Capital Flow Software 3.85
toward 1177 (i.e., the developing value area)

worked quite well until Jan. 28 as the low vol-
ume areas filled in.
Trading a completed
bell-shaped pattern
Figure 9 shows when the data is put into a
composite profile, the market has formed a
completed bell-shaped curve. Finally, the cup
is full and ready to spill. The market has
formed a complete bell-shaped curve and step
4 is ready to become a new step 1. But in which
direction?
At this point, our strategy must shift away
from buying the bottom and selling the top of
the value area. The steps of market activity
show us when to use a congestion trading
strategy (Figure 8) vs. a trend-following strate-
gy (Figure 9).
When trading the steps of market activity,
don’t lose sight of the larger picture, which
will start to influence market direction once
continued on p. 18

TRADING STRATEGIES FIGURE 9 — BELL CURVE COMPLETE
This composite profile contains the same
data as Figures 7 and 8 and shows the
bell curve has been completed over this
the shorter time frames have complet- Buying the bottom of value (1166) time period (Jan. 19 to 28). This indicates
ed their market activity cycles. toward the end of January and hold- we must change our strategy to anticipate
Figure 10 shows the shorter-term ing, or buying the mode of the short- trends from buying and selling the value
bell curve (i.e., Jan. 19 to 28, middle) term profile (around 1172), would be area.
in the context of data going back to a fairly low-risk strategy since we’d
Dec. 3, 2004 (left), which suggests the anticipate the larger “d” shape bell
recent price action is part of a larger curve to form. Figure 10’s right sec-
underdeveloped bell curve (see cir- tion, which began on Jan. 28, shows
cled area). the market rallied as expected.
There are important clues in terms
of the steps of market activity and Bottom line
volume analysis to help us determine The bell-curve database taps into the
a buy-and-sell strategy and the next two-dimensional nature of order flow.
directional move of the market. The This represents a unique paradigm for
completed short-term profile (middle) understanding and anticipating mar-
tells us to no longer play for a range ket activity. The key is to stop trading
trade, but for a step-1 directional in terms of price and start organizing
move instead. (Typically, those moves trades according to market structure.
start out of the high-volume area.) Overall, this approach calls for a
Also, if you compare Figure 10’s change in mindset wherein you trade
shorter-term price action to its longer- market time, not clock time, and you
term profile, (i.e., the underdeveloped buy time in your trade, not price.
step 4, which began on Dec. 3), it
would be safe to assume the S&P will For information on the author see p. 6.
head higher.
FIGURE 10 — SHORT- VS. LONGER-TERM PATTERNS

Analyzing completed short-term bell curves over longer-term periods can reveal
clues about the market’s next move. Here, Figure 9’s bell curve (Jan. 19 to 28, middle) is shown within the context of a
larger pattern, which began on Dec. 3, 2004. The circled area suggests this longer-term bell curve will fill in the upper
section of its pattern, which occurred (as expected) after Jan. 28.

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TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Another look at
straddles and strangles
BY GUY COHEN
Note: The following article is the second installment of a chapter ate gambler. My game plan is to buy low volatility and sell
adapted from the book Volatile Markets Made Easy: Trading higher. It isn’t to buy high volatility and hope it’ll get high-
Stocks and Options for Increased Profits (FT Press, 2009). er still. I should emphasize that what I’ve just described is
The first article, published the May 2009 issue of Futures & completely different from buying a stock that is reaching
Options Trader, described the mechanics of two non-directional new highs — that’s okay if it breaks out of a consolidation
options strategies — straddles and strangles. For a review of how pattern such as a flag (see “Flag patterns”).
these positions work, see “Straddle and strangle components.”
This excerpt compares the benefits and drawbacks of both Breakeven points
approaches. The expiration breakeven point of the trade is something of
a moot point because we never hold on to expiration any-
T he decision of whether to buy the straddle, stran-

gle or both, is a function of the cost of the trade,
their breakeven points, expected stock price
behavior, and the expected volatility of both the stock and
the options. Let’s break these down.
way. However, we still pay close attention to it as it gives us
a guide to how our breakevens will behave even before
expiration. Nice Systems (NICE) was trading at $40.05 on
Nov. 2, 2007. Let’s look at the February 40.00 straddle and
then the 35-45 strike strangle and see how they compare
purely in terms of breakevens at expiration (Table 1).
Cost of the trade Remember we wouldn’t hold the trade to expiration, but
The lower the cost of the trade, the less stock price move- we’d still use the calculation as part of our analysis to com-
ment is required to make the trade profitable. Also, the pare the straddle with the strangle.
lower the cost of the trade, the lower the implied volatility
(IV) has been in buying the options and the less they can •For the straddle, the 40-strike puts are trading at 2.65-
decline by, at least in theory. I tend not to pay more than 2.95, and the calls are at 3.30-3.60. If we buy at the ask,
around 10 percent or so (straddle cost / stock price) for then our trade cost is 6.55.
straddles with less than two months to expiration. I don’t •For the strangle, the 35-strike puts are trading at 0.90-
like to go much over 15 percent for straddles with between 1.10, and the 45-strike call are at 1.35-1.55. If we buy at
two to three months to expiration and 20 percent for strad- the ask, then our trade cost is 2.65.
dles with between three and four months to expiration.
These figures are simply a guideline I like to keep, and The strangle breakevens are both 1.10 wider than the
while it’s not particularly scientific, it does tend to keep me straddle breakevens. That means if you kept the trades
out of trouble, particularly from rapidly declining implied open until expiration, the stock would have to move an
volatility that may occur after entering a trade. extra 1.10 either way in order for the strangle to breakeven
During bearish market phases, stocks can be highly as compared with the straddle. Although you’d never hang
volatile, which is reflected both in stock price action and the on to expiration anyway, it gives you a rough guide as to the
options premiums because of higher implied volatilities. relative probability of the strangle’s likelihood to break
During these market phases, there tends to be fewer of the even compared with the straddle. The wider apart the
sort of trades I like, so I simply have to stay away from them breakevens are, the less probability the trade will break
until things return to a semblance of normalcy. The worst even, and vice versa.
thing you can do is “chase” the opportunity like a desper- In this case, if your analysis strongly indicates a stock is
going to make a massive move, then I
wouldn’t be put off by a difference of only
TABLE 1 — BREAKEVEN EXAMPLE
1.10 on either side with the stock price
around $40.00. Typically, I look for the
Calls Puts Cost Breakeven down Breakeven up
strangle to be around half the cost of the
Straddle 3.60 2.95 6.55 [40 - 6.55] = 33.45 [40 + 6.55] = 46.55 straddle with the breakevens not too far
Strangle 1.55 1.10 2.65 [35 - 2.65] = 32.35 [45 + 2.65] = 47.65 away from the straddle breakevens. In this
example I’m okay with the strangle as a
Source: Volatile Markets Made Easy: Trading Stocks and Options
complementary trade to the straddle, based

Straddle and strangle components
more likely one of the options will be
Straddle in-the-money (ITM) and the other
A (long) straddle is a non-directional trading that profits from either a large under- OTM, but it’s highly unlikely that the
lying price move (up or down) or an increase in implied volatility (IV). The (long)
stock will end up on the single strike at
straddle involves two steps:
expiration, leaving both call and put
Step 1: Buy at-the-money (ATM) strike puts. with no intrinsic value.
Step 2: Buy ATM strike calls with the same expiration date. Because the strangle has a lower
base cost than the straddle, the poten-
As you can see in tial percentage gain is also greater than
Figure A, the strategy
FIGURE A — STRADDLE COMPONENTS the straddle. A 100-percent gain in the
has two breakeven straddle can mean a 300-percent gain
points, one below and in a good-value strangle. That happy
one above the strike scenario is facilitated by a massive
price. The call and put + = move in the stock. In my experience
share the same strike
these massive moves have often been
price, which should be Buy put Buy call Straddle
as near to the money
predicated by flag patterns about one
(i.e., as close to the week before an earnings announce-
Source for Figures A and B: Volatile Markets Made
current stock price) as Easy: Trading Stocks and Options for Increased Profits ment. The strangle has greater lever-
possible. It’s not age than the straddle because of the
always possible to lower base cost. If the stock doesn’t
FIGURE B — STRANGLE COMPONENTS
trade a straddle move, the strangle will lose a bigger
when the stock percentage, but if the stock moves a
price is nailed on a lot, the strangle can make a far greater
strike price, so one + = percentage profit.
side is bound to be When I’m anticipating a large move
slightly skewed in Buy OTM put Buy OTM call Strangle in the stock, I try to have a strangle on
favor and vice
versa.
it, sometimes in isolation and some-
The straddle times with the straddle — that’s just a
can expose you to significant time decay (if executed poorly) because you are continued on p. 22
long ATM calls and puts which have no intrinsic value. However, it needn’t be a
high-risk strategy, even if the anticipated volatile price action doesn’t materialize.
Strangle
Essentially the strangle is identical to the straddle, except that the put has a lower
strike, the call has a higher strike, and the stock price is typically in between,
preferably equidistant between the two. The (long) strangle involves two steps:
Step 1: Buy OTM strike puts.

Step 2: Buy OTM strike calls with the same expiration
date.
The strangle can expose us to significant time decay because we are long OTM
calls and puts, which have no intrinsic value. Because of this, the strangle is
cheaper than the straddle where the calls and puts are ATM. The other significant
difference is the risk profile has two turning points, one for each of the strikes.
From the outset, the put strike is typically below the stock price, and the call
strike is typically above the current stock price (Figure B). In order to have direc-
tion neutrality from the outset of the trade, preferably both put and call strikes are
equidistant from the stock price when the trade is initiated. In most cases, stran-
gles will have wider breakevens to straddles, and this is something we need to
compare thoroughly when assessing whether to take the straddle, strangle, or
both.
purely on the breakeven criteria. gle. While the strangle is cheaper

because of the out-of-the-money
Expected stock price behavior (OTM) options, the breakevens, as we
As suggested earlier, the expectation of just saw, are typically slightly widerck
stock price behavior is a major factor in in between the strikes, so both options
comparing the straddle with the stran- are still OTM. With a straddle, it’s

TRADING STRATEGIES
FIGURE X — BULL FLAG

Flag patterns
A flag pattern occurs after a thrusting
surge (the flagpole) consolidates to
form the actual flag. The thrust can
occur in either an upward (bullish) or
downward (bearish) direction. A flag
occurs during a persistent and domi-
nant trend and temporarily interrupts
that trend before it resumes. The flag
itself consists of the price pattern
rebounding off two parallel interim
trendlines before breaking out in the
direction of the dominant trend.
Source: TC2000.com. Courtesy of Worden Brothers Inc.
Bull flag
With bull flags, our entry is a buy FIGURE Y — BEAR FLAG
order, and our stop loss is a sell order
(see Figure X). We anticipate a rising
stock price and enter your buy order
at either point A or B. Point A is at the
level of the top of the flag. This is the
most conservative entry point
because it is where the price is mak-
ing new highs. You must make sure
volume is increasing as the new high
is made. Increasing volume means
there is conviction behind the move,
which makes it more likely to be sus-
tainable. Point B is where the price
breaks out of the flag itself. This is
more aggressive than point A and Source: TC2000.com. Courtesy of Worden Brothers Inc.
again requires increasing trading vol-
ume to demonstrate conviction in the move. loss is a buy order to close the position (Figure Y). We antic-
If the entry is activated, then you need a stop loss. Point C ipate a falling stock price. We enter our sell (short) order at
is the level where, if you were already in the trade, you’d exit either point A or B. Point A is at the level of the bottom of the
with a small loss. This is your basic trading plan for a bull flag flag. As such it is the most conservative entry point because
within the context of an upward trend. it is where the price is making new lows. Point B is where the
price breaks below the flag itself.
Bear flag
With bear flags, our entry is a sell (short) order, and our stop
personal quirk due to my past experience. There are times of shorter ranged bars. The hope is that this consolidation
when the stock moves enough to make the straddle prof- will be followed by a resumption of increased volatility,
itable (owing to the tighter breakevens), but the strangle hopefully in a decisive manner one way or the other. In
doesn’t quite get there, so at least I’m hedged to an extent other words, I want the stock to explode up or down and
in that my straddle pays for the strangle in such circum- then keep going in that direction.
stances. The implied volatility of the options is more complex.
There are scenarios where the stock is consolidating, yet the
Expected volatility implied volatility of the options is increasing. This seems
On a similar theme, in order to consider the strangle, I also counterintuitive, and it is. Surely if the stock price is con-
like to have evidence that the expected volatility of both the solidating and the historical volatility is decreasing, the
stock and the options will increase after I’ve put on my implied volatility of the options should follow suit. Not
trade. In terms of the stock itself, I like to see well-formed necessarily … otherwise this would all be too easy. It’s not
flag patterns with a good flag pole followed by a few days uncommon for implied volatility to rise sharply, say, a few

days before an earnings announce- news announcements have a huge
ment. This occurs as a result of an • Stocks with earnings impact on volatility trades. We can tar-
anticipated increase in volatility from approaching get a news event as our catalyst for a
the earnings announcement, and • Flag patterns big move, but we need to ensure that
therefore option premiums rise to • Straddle cost as a proportion of implied volatility hasn’t risen too far
compensate the option sellers for the the stock price range over a by the time we place the trade.
increased risk of being exercised similar time period as the time Ideally, you enter the trade before
because of a major move. to expiration any IV spike occurs. There’s no hard
Remember, option sellers have • Straddle cost compared with the and fast rule as to when pre-earnings
unlimited risk. Implied volatilities can stock price or other pre-news-event implied
also rise prior to a news announce- • IV not having ramped up before volatility spikes will occur, but typical-
ment simply because the sellers know earnings ly it will be noticeable the week before
they can get away with driving up the • And reasonably priced options the event. That requires placing the
premiums; such will be the demand in in terms of implied volatility, straddle well before this; however, this
the lead up to earnings. The trick is, of i.e., the IVs of ATM options means you may be in the trade for a
course, to avoid such options because being not significantly greater week or so longer, so time decay could
after the earnings report, the IVs (and than its average over other be a factor unless you give yourself
therefore the premiums) can come relevant time periods. For this sufficient time until expiration. In the
crashing down, crunching all those I’ll compare IV readings on a event the stock price moves strongly
who are long. This can be devastating chart from previous earnings after the news event, you don’t want
to straddle and strangle buyers if the cycles as well as standard time decay ruining your trade, so it’s
stock didn’t make a move. Therefore, I monthly, bi-monthly, and better to look at options with two to
like to find opportunities where quarterly comparisons. four months to expiration, but prefer-
implied volatilities haven’t yet started ably three.
to make the pre-earnings rise. Look for News events One popular strategy is to buy the
the following criteria: Earnings reports and other corporate continued on p. 24
TRADING STRATEGIES
straddle well in advance of FIGURE 1 — APOLLO GROUP

earnings, say one month
before, and then sell it after
the implied volatility spike
(assuming it happens) but
before the earnings announce-
ment, thereby avoiding any
risk of a post earnings implied
volatility collapse. This is a
smart strategy, but in order to
execute it properly you must
be able to find the opportuni-
ties based on past and present
implied volatility patterns.
This is a formidable task
unless you have access to soft-
ware that can easily reduce
the study to a relatively small
list of stocks. Source: TC2000.com. Courtesy of Worden Brothers Inc.
Time decay
Time decay is the enemy of the FIGURE 2 — TECHNE CORP.
long volatility trader. We
already know time decay
increases exponentially during
the final month before expira-
tion, and you don’t want to
own straddles during that final
month. Therefore, look for
option expirations where (a)
your planned exit is timed well
before the start of the final
month and (b) where time
decay wouldn’t be a huge fac-
tor between the time you place
the trade and the planned exit
date.
Source: TC2000.com. Courtesy of Worden Brothers Inc.
Straddle cost
Of course, the lower the cost of the straddle, the lower the tion. Again, it’s all about buying low and selling high and
risk, the tighter the breakevens, the greater the probability obeying the criteria that conform.
of profit, the greater potential percentage profit, and so on. Let’s look at two charts and see which is “prettier”
However, don’t think that going for cheap front-month (Figures 1 and 2). The object of the exercise is to see which
straddles is the answer — it’s not. The “front month” is the chart is easier on the eye and from which you could identi-
nearest expiration month, which can range from four weeks fy a chart pattern and form a trading plan. It shouldn’t be
to a single day. Either way, the front month is subject to the too difficult to notice that Figure 1 is much prettier; the bars
most extreme ravages of time decay, and that’s no good for are steady with the occasional big jump. We can see it tends
long volatility traders. to move in steps and flags and it’s currently forming a con-
solidation pattern. In the following three weeks (not
Stock chart patterns shown), Apollo Group (APOL) jumped to a peak of $65, an
Before entering into a volatility trade, you want to see an increase of 25 percent. By contrast, Figure 2 is messy. There
easily identifiable chart pattern. This can often represent the is no discernable trend or pattern, and the bars are highly
calm before the storm of volatility that may ensue after inconsistent in terms of their length.
you’re in the trade. Ideally, you want to see evidence in the
past that the stock can make a sharp move in either direc- For information on the author see p. 6.

TRADING STRATEGY
OPTIONS STRATEGIES
LAB
Spreading
your charting options
How do you trade options effectively? Know which strategies go with different market conditions.
Here’s how to use chart patterns to determine the best option strategy to use in a particular situation.
BY THOMAS STRIDSMAN
Note: A version of this article originally appeared in the July 2000 issue rise, but you still want some protection against a potential
of Active Trader magazine. drop. Instead of just buying a call option, you could buy
one call option and sell one call option with a higher strike
O ne basic disadvantage to only trading stocks from

the long side, or by using futures for selling short,
is the limited risk protection and decreased ability
to tailor a position to suit your specific needs. One way to
“customize” your positions is to use a set of basic and easy-
price to limit your risk.
This position is called a vertical debit call spread. The green
line in Figure 1 shows what the profit potential for this posi-
tion looks like. (“Debit” means it will cost money to put on
one of these spreads; you cannot lose more money than the
to-implement option strategies that complement a few equal- cost of the position.)
ly basic technical analysis chart patterns. Granted, the profit potential will also be limited, but why
Of course, if you believe the market will go up you could aim for a higher profit — and thereby also take on more risk
simply buy a call option and limit your risk to the amount — than your market analysis deems reasonable? To estab-
paid, or buy a put option if you believe the market will go lish a similar position in anticipation of falling prices, you
down. But what if you could weigh the possibilities of a cer- could put on a vertical debit put spread, consisting of one long
tain scenario actually happening — say on a three-grade put option and one short put option with a lower strike.
scale (e.g., unlikely, likely, very likely) — and then tailor an To implement a vertical debit call spread, you should
options position to fit the scenario and the potential risk- choose the strike for the short option to be at or slightly above
reward ratio you’re willing to take on? (below for a put spread) the targeted price for the underlying
The probabilities of chart-pattern analysis can help you stock. The two options should not be more than two strikes
choose an appropriate option strategy for a given trading apart because options too far out-of-the-money tend to
situation. become very illiquid.
The advantage of a strategy like a vertical debit spread is
Vertical jump
Consider a situation in which you think the market may
FIGURE 2 — THE VERTICAL DEBIT CALL SPREAD
A modified vertical debit call spread: The position is
FIGURE 1 — THE VERTICAL DEBIT CALL SPREAD
established with two long calls and two short calls; one
The vertical debit call spread consists of a long call and a of the short options is bought back when the market
short call at a higher strike price. moves up, increasing the position’s upside bias.

FIGURE 3 — THE LONG STRADDLE
The long straddle consists of a call and put with the
same strike price and expiration.
that you don’t have to hold it until expiration. Depending on
how the market unfolds, you can get rid of one half of the
position or add even more options to either side of the strat-
egy.
For instance, if you place a vertical debit call spread in
anticipation of the penetration of a resistance line, you can
easily buy back the previously shorted option once the mar-
ket has moved in your favor, ending up with an outright
long call position (the blue line in Figure 1). Or, if the mar-
ket goes against you, sell the long option to end up with a
short call position that will allow you to take a small profit
out of the declining market (the red line in Figure 1).
Because it doesn’t matter how many total options the
spread consists of, as long as it has an equal number on
both sides, buying and selling more than one option only
adds to the position’s flexibility. FIGURE 4 — A MODIFIED STRADDLE WITH TWO
For example, say you bought two call options and sold LONG CALLS AND ONE LONG PUT
two call options with a higher strike. Figure 1 shows a ver-
tical debit call spread will become profitable earlier than an This modified straddle performs more favorably if the
market moves higher.
outright long option. Once your position has moved into
profitable territory, you could then buy back one of the
short options to end up with the position defined by the
green line in Figure 2.
As you can see, this position will not be as profitable as
an outright long call position if the market moves very
strongly in your favor. However, because it becomes prof-
itable sooner, it will take a substantial move by the under-
lying stock before the outright long position will start to
outperform this modified vertical debit call spread. Further,
if and when this happens, you can always buy back the last
remaining short option and end up with two outright longs.
Straddling volatility
A vertical debit spread is a useful position when you have a
fairly clear opinion about what the market will do next. But
what about when you’re not so sure — when you think it can short side.
take off in either direction? Now let’s take a look at the kinds of chart patterns that
That’s when a long straddle would come in handy. A long offer trading opportunities for the option strategies we’ve
straddle consists of one or more long calls and an equal discussed.
number of long puts with the same strike price. (See
“Trading volatility,” Active Trader, June 2000, p. 52). The Chart patterns and directional bias
green line in Figure 3 shows what this position will look like When you get right down to it, there are only four types of
compared with the performance of an individual long put chart patterns: those that favor a strong move either up or
and long call. As you can see, the straddle will make money down; those that favor a more modest move up or down;
if the market makes a substantial move in either direction, those that imply a strong move in either direction; and
but will lose money if volatility decreases and the market those that don’t favor a move in either direction (i.e., price
drifts in a narrow trading range will continue to move sideways).
As with the vertical debit spread, the straddle allows you Most traders are probably better off avoiding the last
to get rid of the side of the position that loses money once type. The profit potential is very limited, unless you’re a
the market takes off; the more options you use for the initial trader who specializes in volatility plays without any
position, the more flexibility you’ll have as the price action regard to the actual price of the underlying market.
unfolds. Figure 4 shows what a long straddle (initially con- Among the patterns that favor strong moves in a certain
sisting of two call options and two put options) would look direction are top and bottom formations such as head-and-
like after selling one of the put options. As you can see, it’s shoulders, double tops and bottoms, and wedges. In Figure
now slightly easier to earn a profit on the long side than the continued on p. 28

TRADING STRATEGIES continued
5, the formation during the fall of 1998 is an example of a between the two lows of the pattern, which also happens to
double bottom with its most important resistance (often coincide with the bottom of a consolidation pattern preced-
referred to as the “neckline”) at point 1 (the relative high ing the double bottom).
An upward sloping wedge, which
FIGURE 5 — CHARTING YOUR OPTIONS STRATEGIES implies a potential top and trend reversal,
consists of two upward sloping, converg-
The various support and resistance levels that developed over an 18-month
ing trendlines. In Figure 5, this pattern is
period in the S&P 500 provide clues to the direction and magnitude of price
moves. This information can then be used to select appropriate option strategies forming between trendlines 5 and 8. A
at different points. downward sloping wedge formed
between trendlines 4 and 7.
Other patterns with a strong directional
bias are consolidation patterns within
trends, such as flags and pennants (See
“Waving the pennant,” Active Trader, May
2000, p. 60). Because these occur within
the context of an established uptrend, the
consolidation patterns at points 2a, 2b,
and 2c in Figure 5 all favor a break (con-
tinuation) to the upside — in the direction
of the previous trend. (Such patterns are,
in fact, often referred to as continuation
patterns.)
For these patterns, the magnitude of the
subsequent move depends not only on
other support and resistance levels pres-
ent in the market, but also on the move
leading into the pattern. To get a rough
estimate, look for the move out of the pat-
tern to be similar in size to the move lead-
ing into the pattern. That turned out to be
fairly accurate for the patterns in Figure 5.
Source: TradeStation
The patterns on this chart all represent
support or resistance of one degree or
FIGURE 6 — OPTION STRATEGY MAP another. The next step is to consider which
A breakdown of different options strategies based on the expected price option strategies to use to capitalize on the
direction and level of volatility. price action they imply.
Combining pattern and strategy

The way to trade these patterns is to place a
vertical debit spread in anticipation of the
move through the support or resistance line
in question, then liquidate the losing half of
the position after the breakout has
occurred.
Ideally, though, you should wait until the
market pulls back slightly from the break-
out before eliminating the losing half.
However, because the market sometimes
takes off without looking back, waiting
might prevent you from getting out of the
unprofitable side. As a result, it’s a good
idea to consider working with a total of
four options. This way, you can get rid of
half the losing position as the breakout
begins — giving you a position looking like
the one in Figure 2 — and the other half at

TABLE 1 — MATCHING UP: CHART PATTERNS AND OPTION STRATEGIES
Different chart patterns and the option strategies to use to capitalize on them.
Volatility Strategy Implementation Suggested chart patterns

Long call: Buy one or more calls with After breaking through a neckline and
Higher the same strike price. (preferably) also after a test of support.
volatility Vertical debit Buy one or more calls and sell In anticipation of breaking through a
expected call spread: an equal number of calls with a neckline or consolidation pattern.
higher strike price.
Long straddle: Buy one or more calls and an In anticipation of a breakout of a horizontal
equal number of puts with the consolidation area or symmetrical triangle
same strike price and expiration. (either direction), or a test of a major
trendlines.
Vertical debit Buy one or more puts and sell In anticipation of breaking through a
put spread: an equal number of puts with neckline or consolidation pattern.
a lower strike price.
Long put: Buy one or more puts with After breaking through a neckline and
the same strike price. (preferably) also after a test of resistance.
Short put: Sell one or more puts with the After breaking through a neckline and
Lower same strike price. (preferably) also after a test of support.
volatility Vertical credit Buy one or more puts and sell In anticipation of breaking through a neckline
expected put spread: an equal number of puts with or consolidation pattern.
a higher strike price.
Short straddle: Sell one or more calls and an When moving into (or when expecting to
equal number of puts with the stay within) a horizontal consolidation area
same strike price and expiration. or symmetrical triangle.
Vertical credit Buy one or more calls, and sell In anticipation of breaking through a neckline
call spread: an equal number of calls with a or consolidation pattern.
lower strike price.
Short call: Sell one or more calls with the After breaking through a neckline and
same strike price. (preferably) also after a test of resistance.
the pullback, giving you two outright long options. test both support at about 1,300, and trendlines 4 and 5. It
In the event of a failed breakout, you have two choices: also would have been possible to add a vertical debit call
Stay with your recently modified position, or scale it back spread to this position in anticipation of a breakout through
further so it consists of one long and one short option, which the resistance at trendline 6 and the wedge at trendline 7.
you can sit on in anticipation of a second breakout attempt. No matter how you might have handled the outcome and
When the market is about to test a major trendline or sup- modified the positions as the market unfolded, these two
port or resistance level without any other kind of formation strategies would have positioned you to profit from sizable
(such as any of the ones mentioned here) to indicate possi- moves.
ble direction, price is equally likely to take off in either Given the apparent longer-term wedge developing
direction — and usually in a rather swift move with large, between trendlines 5 and 8, it could (at the time this was
short-term profit potential for the correctly positioned trad- written) be a good place for a vertical debit put spread in
er. The magnitude of the move is usually limited to previ- anticipation of a breakthrough of trendline 5 and a move
ously defined support or resistance levels and the other back to support at 1,350. This would be an acceptable move
extreme of the price channel, such as the ones marked by if the market continued down over the next couple of days.
trendlines 9a and 9b in Figure 5. But if this test failed the first time, the market would be
Another directionally unbiased pattern is the (preferably very close to the meeting point of trendlines 5 and 10 — a
symmetrical) triangle, which forms with the intersection of more neutral pattern that would call for a long straddle.
two major trendlines, such as trendlines 5 and 10. Figure 6 and Table 1 give you a quick overview of how and
Directionally neutral patterns like this are opportunities to when to place these and a few other basic option strate-
put on straddles. gies.
One excellent opportunity to place a long straddle
occurred in October 1999, when the market attempted to For information on the author see p. 6.

OPTIONS TRADING
TRADING SYSTEM
OPTIONS STRATEGY
OPTIONS SYSTEM
LAB LAB
LAB
Buying calls on pullbacks

in S&P 500 futures
Market: Options on the S&P 500 futures (SP). trading system — from picking markets, uncovering trade
opportunities, testing and interpreting performance, con-
System concept: This year, an article series in Active trolling risk, and finally, trading with real money. The
Trader is exploring the challenging process of designing a selected strategy identifies short-term pullbacks, or weak-
ness, in daily prices of the S&P 500
FIGURE 1 — LONG CALL — RISK PROFILE tracking stock (SPY) and goes long in
anticipation of a quick rebound.
The pullback system bought a March 710 call when the S&P 500 futures traded at
When picking markets, we dis-
710.20 on March 3, 2009. The trade will be profitable on the March expiration date
as long as the S&P 500 is above 742. missed stock options because of their
complications — time value, strike-
price selection, and illiquidity. But this
Options Lab tests whether the basic
pullback pattern could be profitable by
purchasing at-the-money (ATM) calls
on the S&P 500 futures (SP) from
March 2001 to March 2009. (For a test
of E-Mini S&P 500 futures, see “Nerves
of steel pullback system,” Futures &
Options Trader, October 2008.)
The system’s original entry rule has
two parts: a series of lower highs,
lower lows, and lower closes, and a 2-
percent decline from the low two days
ago to today’s low. Together, the rules
are designed to enter trades after con-
secutive down moves, culminating in
a large drop (2 percent) that should
identify an oversold market.
Source: OptionVue The system exits using a simple
seven-day momentum calculation
FIGURE 2 — PULLBACK PERFORMANCE (below) or it exits after 10 trading
The basic pullback system gained 38.5 percent during the eight-year test period, days. Momentum signals appear
although it suffered a 28.6-percent drawdown from August 2008 to January 2009. when the current close is above the
close seven days ago and is in the
upper 25 percent of the high-low
range of the past seven days:
Seven-day momentum =
(close today-lowest(low,7))/
(highest(high,7)-lowest(low,7))
Figure 1 shows the potential

gain and loss of a March ATM call
on the S&P 500 futures (SPH09)
bought at the open on March 3,
2009 and closed eight days later
(dotted and dashed lines, respec-
tively). The solid line shows the
trade if it was held until March 20
Source: OptionVue
expiration. March S&P 500 futures

LEGEND: STRATEGY SUMMARY
Net return – Gain or loss at end of test period.
Percentage return – Gain or loss on a percentage basis. Net return: $36,608.00
Annualized return – Gain or loss on a annualized percentage
basis. Percentage return: 38.5%
No. of trades – Number of trades generated by the system. Annualized return: 4.8%
Winning/losing trades – Number of winners and losers
No. of trades: 53
generated by the system.
Win/loss – The percentage of trades that were profitable. Winning/losing trades: 29/24
Avg. trade – The average profit for all trades. Win/loss: 55%
Largest winning trade – Biggest individual profit generated by
the system.
Avg. trade: $690.72
Largest losing trade – Biggest individual loss generated by the Largest winning trade: -$17,363.00
system. Largest losing trade: -$12,387.00
Avg. profit (winners) – The average profit for winning trades.
Avg. loss (losers) – The average loss for losing trades. Avg. profit (winners): $4,869.47
Avg. hold time (winners) – The average holding period for Avg. loss (losers): -$4,358.60
winning trades (in days).
Avg. hold time (winners): 5
Avg. hold time (losers) – The average holding period for losing
trades (in days). Avg. hold time (losers): 12
Max consec. win/loss – The maximum number of consecutive Max. consec. win/loss: 4/4
winning and losing trades.
opened at 710.20 on March 3, and the system purchased one • ATM is defined as the call option with the most time
March 710 call with 17 days remaining to expiration. To premium.
simply break even, the underlying must rally 19.05 points • Daily closing prices were used. Trades were executed
(2.68 percent) during the next eight days, assuming volatil- at the bid and ask, when possible. Otherwise,
ity doesn’t change; otherwise, the position will lose money. theoretical prices were used.
The trade’s odds of success are just 34 percent. • Commissions were $5 plus $1 per option trade.
Trade rules: Test data: System was tested on the CME’s S&P 500
futures options.
Buy one ATM call in the first expiration month with at least
10 days remaining on the next day’s open when: Test period: March 23, 2001 to March 11, 2009.
1. Today’s low is below yesterday’s low and yesterday’s Test results: Figure 2 tracks the pullback system’s per-
low is below the previous day’s low. formance since March 2001. It remained profitable, but
2. Today’s high is below yesterday’s high and endured a large drawdown of $53,608 from late July 2008 to
yesterday’s high is below the previous day’s high. early March 2009.
3. Today’s close is below yesterday’s close, yesterday’s Statistically, if you buy an ATM call, you should make
close is below the previous day’s close, and the money only 33 percent of the time, but this system gained
previous day’s close is below the close the day before ground more often than expected (55 percent). This sug-
that. gests it has a trading edge, although traders need to figure
4. Today’s low is at least 2 percent below the low two out how to manage the risk of its large drawdowns, a
days ago. dilemma we addressed in the August issue of Active Trader.
5. Take up to five consecutive signals.
Note: This test included minimal commissions, but larger fees and
6. Exit when the seven-day momentum calculation is
bad fills will likely affect performance.
0.75 or higher.
7. Exit any remaining open positions after 10 days on — Steve Lentz and Jim Graham of OptionVue
the close.
Option System Analysis strategies are tested using OptionVue’s
Test details:
BackTrader module (unless otherwise noted).
• Continuous daily chart for E-Mini S&P 500 futures If you have a trading idea or strategy that you’d like to see tested,
was used to generate entry and exit signals. please send the trading and money-management rules to
• The initial account size was $95,000. Advisor@OptionVue.com.

INDUSTRY NEWS
Gensler approved as CFTC head

President Obama’s nominee cleared a roadblock to Senate approval by making some big promises for
the CFTC. A new bill could put those promises to the test.
T he U.S. Senate voted May 19 to approve Gary

Gensler as chairman of the Commodity Futures
Trading Commission (CFTC). The full Senate confir-
mation hearing had been delayed for months because a hold
on the process by dissenting senators.
requirements as U.S. exchanges.
Cap-and-trade regulation
Approved by the House Committee on Energy and
Commerce on May 21, the Waxman-Markey bill, also known
Any senator can delay a Senate vote by placing a “hold” on as “The American Clean Energy and Security Act,” could pro-
a confirmation hearing, prompting further discussion. Sen. vide Gensler and the CFTC with the means to turn many of
Bernie Sanders, I-Vt., who issued a hold on Gensler’s nomi- his regulatory goals into reality. The bill, which outlines a
nation vote, said he did so because of Gensler’s 18 years framework for a U.S. carbon cap-and-trade system, takes new
working as an executive with Goldman Sachs and for his role strides in permitting CFTC oversight of energy derivatives
in deregulating the financial services industry during his markets. A cap-and-trade system places a limit on the amount
tenure at the Treasury Department, where he worked as of carbon pollution a business can emit, but allows them to
Under Secretary of Domestic Finance, from 1999 to 2001. buy permits to exceed these limits from other businesses that
“I did not believe that Mr. Gensler was the right person at emit less than the pollution threshold.
the right time to help this country out of the financial crisis we Scheduled for a full house vote by the end of the summer,
are in today,” Sanders said in a statement he released on the the bill would extend CFTC authority to all energy derivatives
day of Gensler’s approval. Sanders’ hold had been seconded transactions, including swaps and OTC transactions, and
by Sen. Maria Cantwell, D-Wash. would render any energy-market exemptions issued prior to
The senators eventually lifted their holds after Gensler the enactment of the bill null and void. Also, unless a transac-
addressed several key issues in discussions with Sanders. In tion is granted exemption from the CFTC after the bill is in
his response, Gensler wrote, “I believe we must urgently place, all transactions will be settled and cleared through
move to enact a broad regulatory regime that covers the entire CFTC-regulated exchanges.
over-the-counter-derivatives marketplace.” The CFTC would also be charged with setting position lim-
Gensler also suggested several reforms for derivatives- its and publicly publishing the names of entities that exceed
dealer regulation, including conservative capital and margin those limits. Furthermore, the bill would completely ban
requirements, and stricter requirements for record keeping naked credit default swaps, which are transactions involving
and reporting. Gensler also stated he would work to mandate entities that do not have an actual stake in the corresponding
the registration of hedge-fund advisors, review all previously market — one of the smoking guns of the 2008 financial col-
granted registration exemptions, and close the “London loop- lapse. The bill would also extend the CFTC’s new authority to
hole” by requiring foreign futures exchanges operating in the foreign exchanges transacting U.S. energy derivatives.
U.S. to comply with U.S. position limits and
adhere to the same reporting and transparency
MANAGED MONEY
Top 10 option strategy traders ranked by April 2009 return.
PFG buys Alaron (Managing at least $1 million as of April 30, 2009.)
April 2009 YTD $ under
O n May 20 futures brokerage

Peregrine Financial Group (PFG)
agreed to purchase the customer
accounts of competitor Alaron Trading
Corporation for an undisclosed amount. Both
Rank Trading advisor
1.
2.
3.
Carter Road LLC
ACE Investment Strategists (DPC)
Washington (Singleton Fund)
18.1
16.36
10.12
return return
24.54
35.25
19.73
mgmt.
1.8
10.5
44.3
4. LJM Partners (Aggr. Premium Writing) 8.75 12.87 25.6
firms are based in Chicago and have been in
business nearly 20 years. The deal will report- 5. Kingsview Mgmt (Retail) 7.49 12.03 1.4
edly give PFG roughly $425 million in customer 6. LJM Partners (LJM Fund Ltd) 5.75 13 5.1
assets. 7. Kingdom Trading (Short Option) 4.44 9.99 1.1
Peregrine says it intends to keep at least 8. Harbor Assets 4.3 11.87 3.8
some of Alaron’s employees, including CEO 9. Quiddity (Earnings Diversification) 3.5 8.56 30.0
and chairman Steve Greenberg. The acquired 10. Censura Futures Mgmt. (TEOW) 3.25 7.91 20.9
customer accounts will be folded into a new Source: Barclay Hedge (http://www.barclayhedge.com) Based on estimates of the composite of all
division called ATD. 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.

Penny Pilot Program’s future uncertain
Options exchanges have conflicting views on how the program should continue.
T
results.
he current option Penny Pilot Program, which test-
ed trading equity option in penny increments, was
scheduled to expire in March, but termination was
pushed back to July because of differing opinions about its
tomer volume growth has generally lagged overall volume
growth.
Based on these results, the CBOE’s report suggests intro-
ducing penny pricing for all option contracts, but reducing
the penny-quote threshold from $3 to $1. According to the
The Securities and Exchange Commission (SEC) initiated CBOE, expanding the program with the original $3 thresh-
the program in January 2007 with 13 equity options in a old would flood the exchanges with quote data and would
move to tighten spreads and reduce transaction costs. be detrimental to the industry: “[I]n this time of economic
Options priced below $3 began being quoted in pennies, unrest and uncertainty, CBOE believes that an aggressive
while those costing more than $3 were quoted in nickels. expansion of the Pilot Program in its current form, as some
Stocks have been quoted in penny increments since 2001. are recommending, would be imprudent and could have a
Initial results were promising, and the program expand- potentially long-term negative impact on the options indus-
ed over time to include more than 60 stocks and exchange- try.”
traded funds. However, the NYSE Arca, an options trading arm of
However, according to the Chicago Board Option NYSE Euronext, which reported similar results in its
Exchange’s (CBOE) March report on the program, results reports on the program, has requested the SEC continue the
are mixed. For example, although the exchange found the program as-is, and to also add the top 300 most actively
program had a positive impact on spreads in the review traded option classes not already in the program. This plan
period from August 2008 through January 2009, liquidity at would be implemented by phasing in 75 new classes at a
best bid/offer prices actually decreased. The report also time over four quarters beginning in July.
stated that volume increases in the program’s participating The SEC is accepting comments on the NYSE’s propos-
options has mostly come from market makers, while cus- al.
CME Group combines

NYMEX trading floors
T he CME Group completed the inte-

gration of the NYMEX’s energy and
metals futures and options trading
pits onto a single floor on May 18. The
Chicago-based CME Group acquired the New
York exchange in a multi-billion dollar deal in
August 2008. The floor merger keeps the
exchange on schedule for the integration time-
line proposed when the acquisition was com-
pleted last year.
“We are confident that combining several
markets into our trading rings will give mem-
bers and customers access to greater liquidity
on our New York trading floor,” CME Group
Chairman Terry Duffy said in a statement.
The next step is to merge the two
exchanges’ clearing services, a process
scheduled for completion in the third quarter.
Since the August acquisition, the exchanges’
combined average daily volume has dropped
16.8 percent through April. However, CME
Group’s first-quarter financial results posted 4-
percent growth over the previous year.

KEY CONCEPTS
The option “Greeks”

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

The final COT category is called the non-reportable posi-
tion category — otherwise known as small traders — i.e., Diagonal spread: A position consisting of options with
the general public. different expiration dates and different strike prices — e.g.,
a December 50 call and a January 60 call.
Correlation coefficient, sometimes referred to simply
as correlation, refers to the degree of similarity between two European style: An option that can only be exercised at
variables. In the markets, correlation is typically used to expiration, not before.
measure how close the relationship is between two price
series (e.g., two distinct stocks or markets), between an indi- Exercise: To exchange an option for the underlying
vidual stock (or trading fund) and an index, and so on. instrument.
Correlation coefficients range between -1.00 and +1.00,
with +1.00 representing perfect positive correlation (i.e., Expiration: The last day on which an option can be exer-
two variables moving precisely in tandem); -1.00 represents cised and exchanged for the underlying instrument (usual-
perfect negative correlation (i.e., two variables moving ly the last trading day or one day after).
exactly opposite to one another). A correlation coefficient of
zero means the two variables have no discernible relation. In the money (ITM): A call option with a strike price
The site http://davidmlane.com/hyperstat/index.html below the price of the underlying instrument, or a put
offers relatively easy-to-digest definitions of this and other option with a strike price above the underlying instru-
statistical terms. ment’s price.
Covered call: Shorting an out-of-the-money call option Intrinsic value: The difference between the strike price
against a long position in the underlying market. An exam- continued on p. 36
ple would be purchasing a stock for $50
and selling a call option with a strike
price of $55. The goal is for the market
to move sideways or slightly higher
and for the call option to expire worth-
less, in which case you keep the premi-
um.
Credit spread: A position that col-

lects more premium from short options
than you pay for long options. A credit
spread using calls is bearish, while a
credit spread using puts is bullish.
Debit spread: An options spread

that costs money to enter, because the
long side is more expensive that the
short side. These spreads can be verti-
cals, calendars, or diagonals.
Delivery period (delivery dates):

The specific time period during which
a delivery can occur for a futures con-
tract. These dates vary from market to
market and are determined by the
exchange. They typically fall during the
month designated by a specific contract
— e.g. the delivery period for March T-
notes will be a specific period in March.

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

example, increased demand for a stock will cause its price the-money S&P 100 (OEX) options (calls and puts) using the
to rise, creating an uptrend. But when price has risen to a Black-Scholes options pricing model.
certain level, traders and investors will take profits and The VIX underwent a major transformation in late 2003.
short sellers will come into the market, creating “resistance” The current index is derived from both at-the-money and
to further price increases. Price may retreat from and out-of-the-money S&P 500 (SPX) calls and puts to make the
advance to this resistance level many times, sometimes index better represent the full range of volatility. At the
eventually breaking through it and continuing the previous same time the CBOE applied the new calculation method to
trend, other times reversing completely. the CBOE NDX Volatility Index (VXN), which reflects the
Support and resistance should be thought of more as gen- volatility of the Nasdaq 100 index.
eral price levels rather than precise prices. For example, if a The exchange still publishes the original VIX calculation,
stock makes a low of 52.15, rallies slightly, then declines which can be found under the ticker symbol VXO. For more
again to 52.15, then rallies again, a subsequent move down information about the VIX and its calculation, visit
to 52 does not violate the “support level” of 52.15. In this http://www.cboe.com/vix.
case, the fact that the stock retraced once to the exact price
level it had established before is more of a coincidence than Volatility: The level of price movement in a market.
anything else. Historical (“statistical”) volatility measures the price fluctu-
ations (usually calculated as the standard deviation of clos-
Time decay: The tendency of time value to decrease at an ing prices) over a certain time period — e.g., the past 20
accelerated rate as an option approaches expiration. days. Implied volatility is the current market estimate of
future volatility as reflected in the level of option premi-
Time spread: Any type of spread that contains short ums. The higher the implied volatility, the higher the option
near-term options and long options that expire later. Both premium.
options can share a strike price (calen-
dar spread) or have different strikes
(diagonal spread).
Time value (premium): The

amount of an option’s value that is a
function of the time remaining until
expiration. As expiration approaches,
time value decreases at an accelerated
rate, a phenomenon known as “time
decay.”
Vertical spread: A position con-

sisting of options with the same expi-
ration date but different strike prices
(e.g., a September 40 call option and a
September 50 call option).
VIX: The Volatility Index (VIX) meas-

ures the implied volatility of S&P 500
index options traded on the Chicago
Board Option Exchange (CBOE). The
VIX is designed to reflect the market
expectation of near-term (in this case,
30-day) volatility and is a commonly
referenced gauge of the stock market’s
“fear level.”
The original VIX, launched in 1990,
was derived from eight near-term at-

FUTURES SNAPSHOT (as of May 27)
The following table summarizes the trading activity in the most actively traded 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 explanations 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 2.34 M 2.56 M -1.57% / 25% 4.78% / 23% 26.51% / 100% .16 / 0%
10-yr. T-note TY CME 626.4 1.03 M -3.25% / 100% -3.34% / 100% -3.26% / 97% .75 / 100%
5-yr. T-note FV CME 336.3 797.9 -1.54% / 100% -1.56% / 92% -2.35% / 95% .58 / 100%
E-Mini Nasdaq 100 NQ CME 313.3 276.6 1.37% / 17% 3.20% / 19% 29.28% / 100% .23 / 10%
Crude oil CL NYMEX 250.6 256.7 7.82% / 40% 27.10% / 83% 58.03% / 93% .29 / 58%
Eurodollar* ED CME 196.6 973.2 0.07% / 10% 0.25% / 63% 0.59% / 43% .29 / 67%
30-yr. T-bond US CME 190.3 675.9 -4.75% / 100% -5.71% / 98% -6.46% / 71% .51 / 100%
Eurocurrency EC CME 166.5 114.0 2.05% / 32% 5.86% / 72% 10.71% / 100% .51 / 88%
Mini Dow YM CME 164.4 53.4 -1.65% / 67% 4.14% / 22% 22.19% / 100% .15 / 12%
E-Mini Russell 2000 TF CME 149.8 393.0 3.19% / 18% -0.02% / 0% 36.74% / 100% .20 / 5%
2-yr. T-note TU CME 126.1 477.8 0.01% / 0% 0.06% / 53% -0.69% / 59% .20 / 7%
Corn C CME 108.5 283.1 -0.33% / 0% 13.60% / 85% 21.64% / 96% .16 / 0%
Soybeans S CME 84.0 162.0 6.23% / 53% 19.97% / 100% 40.64% / 100% .23 / 25%
British pound BP CME 79.8 86.4 5.07% / 88% 9.75% / 100% 14.31% / 100% .67 / 100%
Gold 100 oz. GC NYMEX 78.2 209.7 3.39% / 70% 6.89% / 96% 1.62% / 10% .37 / 97%
Japanese yen JY CME 77.4 80.6 1.23% / 15% 1.23% / 25% 2.68% / 7% .17 / 18%
Natural gas NG NYMEX 75.3 81.5 -18.23% / 86% 5.76% / 26% -12.38% / 9% .49 / 95%
Sugar SB ICE 54.9 295.5 0.32% / 5% 12.32% / 55% 23.69% / 98% .23 / 13%
Canadian dollar CD CME 54.2 69.8 4.20% / 63% 9.33% / 100% 15.47% / 100% .62 / 83%
Australian dollar AD CME 48.4 77.5 2.41% / 21% 10.83% / 93% 24.06% / 100% .29 / 28%
Wheat W CME 39.4 127.2 5.57% / 32% 22.57% / 100% 23.64% / 100% .40 / 45%
Soybean oil BO CME 36.0 100.2 -4.71% / 88% 8.34% / 47% 24.62% / 91% .16 / 0%
E-Mini S&P MidCap 400 ME CME 35.3 111.9 -0.93% / 11% 3.20% / 7% 32.27% / 100% .21 / 2%
Swiss franc SF CME 33.8 31.2 1.70% / 21% 5.15% / 91% 8.31% / 100% .52 / 90%
RBOB gasoline RB NYMEX 33.7 50.9 13.42% / 56% 35.34% / 94% 47.08% / 79% .32 / 68%
Soybean meal SM CME 31.0 62.5 11.39% / 95% 23.82% / 98% 48.08% / 100% .38 / 63%
Heating oil HO NYMEX 30.2 39.6 3.63% / 31% 18.61% / 89% 35.66% / 100% .36 / 75%
S&P 500 index SP CME 25.6 431.8 -1.58% / 25% 4.78% / 23% 26.51% / 100% .16 / 0%
Silver 5,000 oz. SI NYMEX 18.3 47.7 4.57% / 17% 19.63% / 100% 13.73% / 41% .32 / 65%
Copper HG NYMEX 14.8 57.3 1.68% / 13% 10.67% / 42% 39.91% / 71% .15 / 5%
Live cattle LC CME 12.2 51.2 -0.99% / 31% 0.52% / 14% -1.88% / 20% .15 / 0%
Nikkei 225 index NK CME 11.0 28.3 0.21% / 0% 8.50% / 58% 32.67% / 100% .18 / 15%
Mexican peso MP CME 10.0 46.4 0.33% / 8% 5.41% / 57% 17.18% / 100% .21 / 22%
Crude oil e-miNY QM NYMEX 10.0 4.3 7.82% / 40% 27.10% / 85% 58.03% / 93% .29 / 60%
Coffee KC ICE 8.7 51.0 6.19% / 32% 18.76% / 100% 21.94% / 98% .50 / 42%
Mini-sized gold YG CME 5.8 3.7 2.83% / 55% 6.25% / 96% 1.05% / 5% .35 / 93%
Lean hogs LH CME 5.7 17.9 -5.30% / 10% 3.12% / 26% 8.30% / 60% .19 / 2%
Cocoa CC ICE 5.6 41.0 5.55% / 100% 4.37% / 21% 13.38% / 55% .40 / 65%
U.S. dollar index DX ICE 5.4 24.3 -2.67% / 40% -5.01% / 86% -9.67% / 98% .53 / 83%
Fed funds FF CME 4.3 45.7 -0.01% / 0% 0.00% / 0% 0.09% / 18% .05 / 40%
Natural gas e-miNY QG NYMEX 2.7 5.6 -18.23% / 86% 5.76% / 26% -12.38% / 10% .47 / 95%
Nasdaq 100 ND CME 2.6 23.0 1.37% / 17% 3.20% / 19% 29.28% / 100% .23 / 10%
New Zealand dollar NE CME 2.3 16.4 2.15% / 6% 10.82% / 69% 25.51% / 100% .37 / 65%
E-Mini eurocurrency ZE CME 2.2 1.9 2.05% / 32% 5.86% / 72% 10.71% / 100% .51 / 88%
Mini-sized silver YI CME 1.9 1.8 3.82% / 6% 18.66% / 100% 12.72% / 38% .33 / 67%
Dow Jones Ind. Avg. DJ CME 1.6 12.2 -1.65% / 67% 4.14% / 22% 22.19% / 100% .15 / 12%
Mini-sized soybeans YK CME 1.4 5.0 6.23% / 53% 19.97% / 100% 40.64% / 100% .23 / 25%
*Average volume and open interest based on highest-volume contract (Sept. 2009).
Legend day moves, 20-day moves, etc.) show the percent means the current reading is larger than
Volume: 30-day average daily volume, in centile rank of the most recent move to a cer- all the past readings, while a reading of 0 per-
thousands (unless otherwise indicated). tain number of the previous moves of the cent means the current reading is smaller than
same size and in the same direction. For the previous readings. These figures provide
OI: Open interest, in thousands (unless other-
example, the rank for 10-day move shows perspective for determining how relatively
wise indicated).
how the most recent 10-day move compares large or small the most recent price move is
10-day move: The percentage price move to the past twenty 10-day moves; for the 20- compared to past price moves.
from the close 10 days ago to today’s close. day move, the rank field shows how the most Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move recent 20-day move compares to the past term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. sixty 20-day moves; for the 60-day move, the prices) divided by the long-term volatility (100-
60-day move: The percentage price move rank field shows how the most recent 60-day day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. move compares to the past one-hundred- the percentile rank of the volatility ratio over
The “rank” fields for each time window (10- twenty 60-day moves. A reading of 100 per- the past 60 days.
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 May 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 155.4 1.26 M 2.59% / 56% 3.80% / 15% 27.8% / 24.8% 32.7% / 32.6%
S&P 500 volatility index VIX CBOE 80.8 1.36 M -5.88% / 6% -12.22% / 42% 85.2% / 82.3% 68.4% / 75.5%
Russell 2000 index RUT CBOE 44.5 474.0 4.32% / 20% 0.15% / 0% 37.1% / 35.1% 43% / 44.4%
E-Mini S&P 500 futures ES CME 36.5 117.7 2.23% / 40% 4.14% / 13% 27.8% / 29.4% 32.8% / 36.8%
Nasdaq 100 index NDX CBOE 14.1 147.1 6.01% / 75% 2.74% / 14% 28% / 26.4% 33.4% / 30.6%
Stocks
Citigroup C 635.3 12.69 M 7.62% / 15% 17.63% / 42% 110.4% / 94.6% 124% / 158.7%
Bank of America BAC 334.8 3.57 M 2.63% / 0% 30.18% / 39% 76.6% / 108.1% 127.5% / 171.3%
General Motors GM 130.6 2.22 M -7.44% / 40% -38.12% / 76% 257.5% / 177.2% 218% / 143.6%
General Electric GE 97.5 2.55 M 2.17% / 13% 7.94% / 8% 52.4% / 52% 62% / 79.2%
Wells Fargo WFC 75.5 1.24 M 2.36% / 13% 24.04% / 28% 68.7% / 95.7% 106.9% / 123.6%
Futures
Eurodollar ED CME 151.1 5.54 M 0.08% / 10% 0.27% / 70% 81.5% / 68.9% 55.7% / 40.1%
10-year T-notes TY CME 50.9 651.9 -3.36% / 100% -3.20% / 98% 10.4% / 6.9% 8.7% / 6.4%
10-year T-notes TY CME 31.4 653.6 -3.30% / 100% -3.14% / 95% 10.9% / 8.5% 8.6% / 7.8%
Corn C CME 31.3 529.8 0.52% / 0% 6.83% / 33% 40.5% / 36% 43.7% / 34%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
S&P 100 Index OEX CBOE 11.9 80.7 1.84% / 44% 3.86% / 24% 26.9% / 22.1% 32% / 29.3%
S&P 500 futures SP CME 9.9 60.1 2.24% / 40% 4.14% / 13% 28.2% / 23.4% 32.9% / 31%
Dow Jones index DJX CBOE 5.2 144.5 1.44% / 44% 2.66% / 11% 25.1% / 22.1% 29.7% / 29%
S&P 500 index SPX CBOE 155.4 1.26 M 2.59% / 56% 3.80% / 15% 27.8% / 24.8% 32.7% / 32.6%
S&P 100 index (European style) XEO CBOE 3.6 43.8 1.84% / 44% 3.86% / 23% 25.7% / 23.7% 30.9% / 31.1%
Indices - Low IV/SV ratio

Banking index BKX PHLX 3.6 83.6 0.85% / 0% 9.61% / 10% 60.2% / 86.1% 83.3% / 114.8%
Mini Nasdaq 100 index MNX CBOE 8.3 253.0 6.01% / 75% 2.74% / 13% 27.8% / 31.7% 33% / 32.9%
Stocks - High IV/SV ratio

Savient Pharma SVNT 7.7 92.7 13.41% / 100% 8.90% / 43% 211.6% / 67.4% 182.8% / 75.3%
Fannie Mae FNM 1.2 51.4 -6.49% / 27% -8.86% / 36% 149.3% / 65.6% 151.7% / 110.1%
Star Scientific STSI 3.7 97.5 18.41% / 100% -3.45% / 8% 212.7% / 103% 194.5% / 72.6%
Sun Microsystems JAVA 8.6 696.9 1.23% / 20% -0.98% / 11% 16.3% / 8.4% 17% / 76.2%
Tivo Inc. TIVO 2.5 44.4 -13.47% / 89% -15.05% / 91% 78.9% / 50.4% 84.7% / 47.8%
Stocks - Low IV/SV ratio

Data Domain DDUP 1.6 83.9 47.34% / 82% 53.32% / 89% 25.2% / 56.4% 43.2% / 69%
Genworth Financial GNW 8.5 89.8 24.82% / 19% 133.33% / 83% 108.2% / 190.9% 127.5% / 153.3%
Regions Financial RF 35.3 361.8 -14.47% / 46% -13.73% / 23% 102.8% / 177.2% 142.4% / 208.1%
Vanda Pharma VNDA 3.7 35.9 11.57% / 22% 1331.68% / 100% 102.3% / 173.7% NA / 130.9%
MGM Mirage MGM 25.7 244.9 -17.93% / 40% 15.53% / 0% 106.2% / 178.5% 199.1% / 244.4%
Futures - High IV/SV ratio

5-year T-notes FV CME 5.3 122.6 -1.65% / 100% -1.51% / 87% 6.6% / 3.5% 5% / 3.3%
10-yr T-notes TY CME 50.9 651.9 -3.36% / 100% -3.20% / 98% 10.4% / 6.9% 8.7% / 6.4%
30-year T-bonds US CME 14.7 142.9 -4.31% / 94% -4.26% / 83% 17.6% / 11.7% 15.7% / 11%
Coffee KC ICE 3.5 70.0 7.59% / 60% 17.42% / 96% 44.3% / 32.3% 38.7% / 30.8%
Japanese yen JY CME 1.1 3.5 -1.46% / 100% 0.73% / 20% 14.3% / 10.8% 14.8% / 12.1%
Futures - Low IV/SV ratio

Orange juice OJ ICE 5.2 28.1 1.55% / 35% 13.68% / 84% 37.7% / 42.6% 34.5% / 37.7%
Soybean oil BO CME 4.0 84.5 -3.45% / 63% 5.82% / 24% 30% / 33.5% 34% / 34.4%
Cotton CT ICE 3.5 53.3 -8.15% / 86% 1.67% / 4% 34% / 37.2% 36.4% / 41.5%
Australian dollar AD CME 1.4 8.0 4.32% / 55% 8.00% / 69% 18.2% / 19.3% 19.5% / 18.9%
* 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
COT extremes The largest positive readings represent markets in which net commercial
positions (longs-shorts) exceed net fund holdings in May. By contrast, the
The Commitments of Traders (COT) report is published largest negative values represent markets in which net fund holdings
each week by the Commodity Futures Trading surpass net commercial positions.
Commission (CFTC). The report divides the open posi-
tions in futures markets into three categories: commer-
cials, non-commericals, 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 do not deal
in the underlying cash markets but speculate in futures
on a large-scale basis. Many of these traders are trend-fol-
lowers. The non-reportable category represents small
For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
traders, or the general public.
Figure 1 shows the relationship between commercials Legend: Figure 1 shows the difference between net commer-
and large speculators on May 19. Positive values mean net commercial posi- cial and net large spec positions (longs - shorts) for all 45 futures
tions (longs-shorts) are larger than net speculator holdings, based on their five- markets, in descending order. It is calculated by subtracting the
current net large spec position from the net commercial position
year historical relationship. Negative values mean large speculators have big- and then comparing this value to its five-year range.
ger positions than the commercials. The formula is:
In copper and British pound futures (HG and BP, respectively) in May, the a1 = (net commercial 5-year high - net commercial current)
commercials held larger positions than speculators, a positive sign. On the other b1 = (net commercial 5-year high - net commercial 5-year low)
hand, in Nikkei 225 and soybean futures (NK and S), this relationship was c1 = ((b1 - a1)/ b1 ) * 100
switched as speculators held bigger positions than commercials, which could be a2 = (net large spec 5-year high - net large spec current)
viewed as bearish. Despite these patterns, commercial-speculator relationships b2 = (net large spec 5-year high - net large spec 5-year low)
in all markets failed to reach historical extremes (i.e., readings of 100 or -100). c2 = ((b2 - a2)/ b2 ) * 100
– Compiled by Floyd Upperman x = (c1 - c2)
Options Watch: S&P telecom industry index stocks (as of May 27) Compiled by Tristan Yates
The following table summarizes the expiration months available for the 21 stocks in Standard and Poor’s telecommunications industry index
(SPSITE), the best-performing market year-to-date among the S&P’s 19 industry indices (as of May 18). It also shows each stock’s average bid-
ask spread for at-the-money (ATM) June options. The information does NOT constitute trade signals. It is intended only to provide a brief synop-
sis of potential slippage in each option market.
Option contracts traded

2009 2010 2011 Bid-ask spreads
Bid-ask
spread as %
Sept.
June
Aug.
Dec.
Nov.
July
Jan.
Jan.
Oct.
Closing of underlying
Stock Ticker price Call Put price
Qualcomm Inc. QCOM X X X X X 42.43 0.03 0.03 0.06%
Verizon Communications VZ X X X X X 28.95 0.02 0.02 0.06%
AT&T Inc. T X X X X X 24.07 0.02 0.02 0.07%
Cisco Systems CSCO X X X X X 18.22 0.02 0.02 0.08%
Motorola Inc. MOT X X X X X 5.92 0.02 0.02 0.34%
American Tower Corp. AMT X X X X X 30.63 0.13 0.10 0.37%
Juniper Networks JNPR X X X X X 24.14 0.10 0.09 0.39%
F5 Networks Inc. FFIV X X X X X 30.03 0.11 0.13 0.40%
Corning Inc. GLW X X X X X X 14.62 0.06 0.09 0.51%
Polycom Inc. PLCM X X X X X 17.25 0.10 0.10 0.58%
Crown Castle Intl. Corp. CCI X X X X X 23.70 0.16 0.11 0.58%
Leap Wireless International Inc. LEAP X X X X X 41.05 0.23 0.30 0.64%
MetroPCS Communications Inc. PCS X X X X 17.00 0.14 0.11 0.74%
Harris Corp. HRS X X X X X X 30.79 0.26 0.34 0.97%
NII Holdings Inc. NIHD X X X X X X 18.79 0.16 0.21 1.00%
Brocade Communications Systems BRCD X X X X X 7.19 0.06 0.09 1.04%
SBA Communications Corp. SBAC X X X X X X 24.87 0.30 0.26 1.13%
Sprint Nextel Corp. S X X X X X X 5.07 0.06 0.09 1.48%
Tellabs Inc. TLAB X X X X X X 5.41 0.08 0.10 1.62%
Telephone & Data Systems TDS X X X X 30.78 0.59 0.55 1.85%
TW Telecom Inc. TWTC X X X X 11.82 0.23 0.21 1.85%
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.

NEW PRODUCTS AND SERVICES
E*TRADE FINANCIAL has released E*TRADE Mobile Pro CME Globex electronic trading platform. Grain calendar spread
for Apple’s iPhone and iPod touch. The application provides options will be available on CME Globex and on the trading
many of the same interface, security, trading, and banking fea- floors in the corn, wheat, soybean, soybean meal, and soybean
tures available on etrade.com to customers via their iPhone or oil options pit. These contracts are listed with, and subject to, the
iPod touch. The application is available at no additional cost to rules and regulations of the Chicago Board of Trade.
all E*TRADE Securities customers via the Apple App Store.
Mobile Pro reduces the steps needed to perform various tasks IntercontinentalExchange (ICE) has introduced a
and provides customers with confirmation of transactions one-minute tradable marker facility for ICE Brent Crude futures
before they are completed. Mobile Pro functionality includes and the ICE Gasoil futures contracts during the Asian trading
access to bank and brokerage account details; free real-time day. The new markers are the Singapore Brent and Singapore
streaming stock and options quotes; the ability to trade stocks Gasoil markers. Timing of the markers will be the minute pre-
and options, including conditional orders; and the ability to ceding 16:30 local Singapore time (08:30 GMT/09:30 BST) and
transfer funds between brokerage and bank accounts, including will be tradable for the front-three contract months. A marker
transfers from outside financial institutions. To learn more and price called the “Singapore Minute marker” for both Brent and
see a demo of the platform, visit http://www.etrade.com/ Gasoil futures will be a volume trade weighted average price of
iphone. trades executed between 16:29:00 and 16:29:59 hours local
Singapore time (08:30 GMT/09:30 BST), and will be published
Open E Cry, LLC, a direct access brokerage firm, launched for the front-three contract months. Singapore marker trades
OEC FX, an online foreign exchange trading service. With OEC executed up to and including 16:29:59 local Singapore time will
FX, Open E Cry now supports futures, futures options, and forex be named “one minute Singapore Brent Marker Trades” and
trading on a single platform. GAIN Capital provides Open E Cry “one minute Singapore Gasoil Marker Trades” and will be
with forex clearing and custody services. Open E Cry’s propri- reflected in both the ICE Electronic Trading System (ETS) and
etary trading software, OEC Trader, provides streaming quotes, the Trade Registration System (TRS) in a format similar to settle-
depth of market, more than 15 advanced order types, and built- ment trades. In addition to the markers, ICE is introducing a
in charting tools. End user access is achieved through a down- facility to allow premium and discount trades to be applied to
loadable software interface or through a proprietary API. the markers, mirroring what is currently in existence for Trade at
Traders can register for a free trial of OEC trader at Settlement trades. ICE is also launching a tradable U.S. Gasoil
https://www.openecry.com (click on Software > Free Practice marker at 19:30 UK time (14:30 EDT). A premium and discount
Account). trade facility will also be enabled for the London 16:30 Brent
Crude futures tradable marker in response to customer demand.
Charles Schwab announced new options trading capabil-
ities for active traders with several upgrades to its trading plat- TraderInterviews.com, an online media site that fea-
forms, including new charting and screening tools. New features tures audio interviews with active traders, is offering a member-
include: several new charting studies for options-specific techni- ship product. Members get access to more than 100 audio inter-
cal data (Implied Volatility and Put/Call Ratio); new options views in the archives as well as free reports on setting profit tar-
screening capabilities for the Customizable Options Screener gets and improving price forecasting skills. Recent interviews
including covered call, delta, and implied volatility screening; include a discussion with news trader Peter Farmer. Others
new historical option price charts and strategy profit/loss include a discussion of popular chart indicators a hedge-fund
charts; and multi-leg trading enhancements, including No Bid manager is using during the volatile first and last hour of trad-
and Good Till Canceled multi-leg orders. For more information ing, and an options trader who uses Excel spreadsheets to help
about the active trading services at Charles Schwab, visit determine which expiration month and strike price to buy or
http://www.schwabat.com. sell. Visitors can sample free interviews and transcripts at
http://www.TraderInterviews.com.
CME Group has launched clearing services for five new
petroleum swap futures contracts, new national balancing point TraderPlanet.com, an interactive social networking site
Henry Hub swap futures and options contracts, a new PJM for active traders and investors, has partnered with
Western Hub 50 MW peak calendar month real-time LMP swap Barchart.com to expand TraderPlanet’s offering of educational
futures contract, and calendar spread options for corn, wheat, resources. The content provided by Barchart.com consists of
soybeans, soybean meal, and soybean oil futures. The petroleum charts and market quotes. In exchange, TraderPlanet.com is pro-
swap futures contracts and their commodity codes will be: viding Barchart.com with market commentary from Jim
ethanol (Platts) T1 FOB Rotterdam excluding duty (2M); ethanol Wyckoff and Darrell Jobman, senior analysts at
(Platts) T2 FOB Rotterdam including duty (Z1); Singapore TraderPlanet.com. The commentary will also be syndicated for
Mogas 92 unleaded (Platts, 1N); Singapore Mogas 92 unleaded InsideFutures, a subsidiary of Barchart.com.
(Platts) BALMO (1P); and FAME 0 (Argus) biodiesel FOB
Rotterdam (2L). Henry Hub commodity codes will be E2 for the Note: The New Products and Services section is a forum for industry
futures contract and V1 for the options contract. The PJM businesses to announce new products and upgrades. Listings are adapted
Western Hub 50 MW peak calendar month real-time LMP swap from press releases and are not endorsements or recommendations from
code is 4SN. These contracts are listed with, and subject to, the the Active Trader Magazine Group. E-mail press releases to
rules and regulations of NYMEX, and will be available on the editorial@futuresandoptionstrader.com. Publication is not guaranteed.

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

FUTURES TRADE JOURNAL
A prudent, favorable entry is

destroyed by the need to be right.
TRADE
Date: Thursday, May 7, 2009.
Entry: Short the June Mini Dow futures

(YMM09) at 8423.
Reasons for trade/setup (long trade):

The new high and sharp intraday sell-off in
the Dow on May 7 (the Nasdaq 100 had
peaked the day before and dropped sharply
on May 7) hinted at a chink in the recent
uptrend’s armor and implied the potential
for a correction.
Because the June Mini Dow futures had
tumbled from an 8570 high to a low of 8315
(nearly 3 percent) in the regular trading ses-
Source: TradeStation
sion, we waited for a bounce to enter short.
The after-hours upthrust that took the
futures as high as 8441 by 5:30 p.m. provided the opportuni- Of course, this led us to believe we had weathered the shake-
ty, and we went short at 8423. out and the original forecast was intact. No sooner had this
thought settled in when the market turned abruptly higher
Initial stop: 8479. and continued to push toward the previous day’s high. Now
convinced the May 7 sell-off was a feint to flush out weak
Initial target: 8306, a little above the May 6 low. longs, we exited at 8543 … and compounded the problem in
the worst way by going long — and doubling position size
— at 8542. Luckily, we exited this trade relatively quickly (at
RESULT 8520), but not before it added psychological insult to finan-
cial injury.
Exit: 8543. The next trading day (Monday, May 11), the market fell
below 8400, and as low as 8231 by May 13. The damage of
Profit/loss: -120 (1.42 percent). this trade was partially offset by a successful short position
on May 11 in the E-Mini Nasdaq 100 futures (see the Trade
Outcome: This trade couldn’t have been handled worse. Diary in the August issue of Active Trader magazine), but this
We blew off the initial stop, which should have been closer, was yet another reminder of how emotions — and the need
anyway, given we entered on a 100-point bounce and the to be correct — can get the best of you if you’re not careful.
trade was predicated on immediate follow-through.
However, when price rallied to the initial stop, we ration- Note: Initial targets for trades are typically based on things such as the
alized that a move to challenge the previous day’s high of historical performance of a price pattern or trading system signal.
8570 had to be expected. Problem: We didn’t want to sit However, individual trades are a function of immediate market behavior;
through that much adverse price action. After rallying above initial price targets are flexible and are most often used as points at which
8500, the market shot lower — seemingly in answer to our a portion of the trade is liquidated to reduce the position’s open risk. As a
prayers — all the way to 8413. 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
5/7/09 YMM09 8423 8479 8306 2.09 8543 5/8/09 -120 -1.42% 10 -130 1 day
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
OPTIONS TRADE
TRADE JOURNAL
JOURNAL
FIGURE 1 — RISK PROFILE — LONG CALLS

This long-call trade in Procter and Gamble had a delta of 144, meaning it resembled
144 PG shares.
A long-call trade makes money

when Procter and Gamble
peaks in late May.
TRADE
Date: Wednesday, May 20.
Market: Options on Procter and

Gamble (PG).
Entry: Buy 2 June 52.5 calls for

$2.15 each.
Reasons for trade/setup: Source: OptionVue

Dow component Proctor and
Gamble (PG) was upgraded by Barclays Capital before the Procter and Gamble traded at $53.90 at 9:40 a.m. Figure 1
May 20 open, a short-term bullish signal. Stocks in the Dow shows the calls’ possible gains and losses that day. The
Jones Industrial Average (DJIA) open much higher and con- trade has a total delta of 144, meaning it will initially resem-
tinue to rally after analyst upgrades, according to historical ble a long position of 144 shares. The goal is to hold the calls
research (see “Playing the ratings game,” Active Trader, until the close, but we plan to exit early if PG drops 3 per-
September 2007). cent to the previous day’s low of $52.27.
These stocks are more likely to gain ground if the broad-
er market is climbing, and June E-Mini S&P 500 futures Initial stop: Sell calls if PG falls 3 percent to yesterday’s
(ESM09) gained about 1.25 percent before the U.S. stock low ($52.27).
market opened that day.
There are many ways to exploit a potential bullish move Initial target: Exit at the close.
with options — trading vertical or diagonal spreads or
even selling puts. But purchasing in-the-money (ITM) calls TRADE SUMMARY
is the easiest approach. PG opened at $53.74 on May 20,
trading 1.5 percent above the previous days’s close. At first, Entry date: May 20, 2009
we tried to buy June 50-strike calls, but their volume was Underlying security: Procter and Gamble (PG)
only eight contracts — too illiquid to buy at a reasonable Position: 2 long June 52.5 calls
price (i.e., between the bid and ask prices). Initial capital required: $430
Instead, we bought June 52.5 calls for $2.15 each when Initial stop: Exit if PG drops below yesterday’s low.
Initial target: Hold until today’s close.
TRADE STATISTICS
Initial daily time decay: $3.50
May 20 9:40 a.m. 10:10 a.m. Trade length (in days): 1 day
Delta: 144.1 149.8 P/L: $60 (14%)
Gamma: 27.06 20.13
LOP: $60
Theta: -3.50 -3.81
LOL: $0
Vega: 11.20 10.83
LOP — largest open profit (maximum available profit during life of trade).
Probability of profit: 42% 45%
LOL — largest open loss (maximum potential loss during life of trade).
Breakeven point: 54.65 54.65

FIGURE 2 — QUICK PROFITS
After we bought June ITM calls, PG climbed 1 percent within 25

minutes on May 20. We sold the calls at a profit of $0.30 per
RESULT contract (14 percent).
Outcome: Figure 2 shows we entered at the right

time. After pausing briefly, Procter and Gamble
jumped about 1 percent within 25 minutes, and we
sold the calls for $2.45 each, ditching the original
plan. PG rallied another 0.7 percent that afternoon,
so we probably exited too soon. However, Procter
and Gamble slid and closed slightly above our entry
price. If we waited until the stock market closed,
any open profits would have vanished.
Note: the historical research, which ranged from
June 1997 to June 2007, is outdated. Have Dow
stocks really continued to rally after analyst
upgrades as the financial crisis unfolded over the
past two years? Source: eSignal
EVENTS
Event: International Derivatives Expo Event: Lawrence G. McMillan’s

Date: June 9-10 Intensive Options Seminar
Location: The Brewery, Chiswell Street, London Date: Nov. 7
For more information: http://www.idw.org.uk Location: New York City, Marriott Marquis
For more information: Go to
Event: The Forex and Options Trading Expo http://www.optionstrategist.com and click on “Seminars”
Date: Aug. 2-4
Location: Caesars Palace, Las Vegas Event: The Fifth Middle East Forex Trading Expo and
For more information: Go to Conference 2009
http://www.moneyshow.com and click on Events Date: Nov. 17-18
Location: Jumeirah Emirates Towers Hotel, Dubai
Event: International Investors’ Trade Fair For more information: http://www.meforexexpo.com
Date: Sept. 4-6
Location: Düsseldorf, Germany Event: International Traders Expo
For more information: http://www.mdna.com Date: Nov. 18-21
Location: Mandalay Bay Resort & Casino, Las Vegas
Event: Melbourne Trading & Investing Expo For more information: http://www.tradersexpo.com
Date: Oct. 2-3
Location: Melbourne Convention & Exhibition Centre
Event: Sydney Trading & Investing Expo
Date: Oct. 30-31
Location: Sydney Convention & Exhibition Centre
For more information on both expos: Go to
http://tradingandinvestingexpo.com.au

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June 2009 • Volume 3, No.

BEING RIGHT VS.

NEW CFTC HEAD

Options Trading System Lab

Spreading your charting options . . . . . .26

2 June 2009 • FUTURES & OPTIONS TRADER

Key Concepts . . . . . . . . . . . . . . . . . . . . . . . .34

Futures Snapshot . . . . . . . . . . . . . . . . . . . .38

Options Radar . . . . . . . . . . . . . . . . . . . . . . .39

Futures & Options Watch Futures & Options Calendar . . . . . . . . . . . .42

Options Watch: Options Trade Journal . . . . . . . . . . . . . . .44

New Products and Services . . . . . . . . . . . . .41 Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

Have a question about something you’ve seen

Looking for an advertiser?

in this month’s issue of Futures & Options Trader.

Ablesys Global Futures

E*TRADE FINANCIAL RS of Houston

Forex & Options Expo TraderPlanet

4 June 2009 • FUTURES & OPTIONS TRADER

6 June 2009 • FUTURES & OPTIONS TRADER

Surging energies lead bullish commodity futures arena

8 June 2009 • FUTURES & OPTIONS TRADER

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10 June 2009 • FUTURES & OPTIONS TRADER

Trading order flow

A ssume you’re trying to find the nearest coffee

What is Market Profile?

FIGURE 1 — BAR CHART VS. MARKET PROFILE

This comparison of a monthly Bobl bar chart to a Market

12 June 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • June 2009 13

Developing the profile

14 June 2009 • FUTURES & OPTIONS TRADER

FIGURE 5 — STEP 3 “B” AND “P” SHAPES

FUTURES & OPTIONS TRADER • June 2009 15

Understanding Market Profile

16 June 2009 • FUTURES & OPTIONS TRADER

FIGURE 8 — TRADING THE “VALUE” AREA

toward 1177 (i.e., the developing value area)

FUTURES & OPTIONS TRADER • June 2009 17

FIGURE 10 — SHORT- VS. LONGER-TERM PATTERNS

Source: Capital Flow Software 3.85

18 June 2009 • FUTURES & OPTIONS TRADER

Attend and Gain the Ultimate Insight on Today's

Discover Dozens of Forex and Options Strategies from Profitable Traders

Attend and Take Home Valuable Expert Knowledge

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T he decision of whether to buy the straddle, stran-

20 June 2009 • FUTURES & OPTIONS TRADER

Step 1: Buy OTM strike puts.

purely on the breakeven criteria. gle. While the strangle is cheaper

FUTURES & OPTIONS TRADER • June 2009 21

FIGURE X — BULL FLAG

22 June 2009 • FUTURES & OPTIONS TRADER

straddle well in advance of FIGURE 1 — APOLLO GROUP

24 June 2009 • FUTURES & OPTIONS TRADER

O ne basic disadvantage to only trading stocks from

26 June 2009 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • June 2009 27

Combining pattern and strategy

28 June 2009 • FUTURES & OPTIONS TRADER