You are here: Home / 2011 / Archives for June 2011
June 7, 2011 by Leave a Comment

Locking in Profit by Purchasing Options

One of the most common things you’ll hear a futures trader say is, “Make sure you lock in profits with stops!”  One thing some traders don’t realize is that you can lock in profits with options as opposed to using just a stop loss order.  This article will focus on how locking in profits is done and when it may be a useful strategy.

How it works

The most common way to lock in profits using options is done by purchasing an out-of-the-money call or put wherever you’d like to lock in profit.  An option gives you the right to buy or sell a futures contract from a specified price.  If you are long a market, you would want to purchase a put to lock in profit.  If you are short a market, you would want to purchase a call to lock in profit.  The amount of profit you will lock in is determined by the strike price plus the premium paid.

When This Strategy is Appropriate

A trader can use options to lock in profits any time they would like to.  However, they can be especially useful when a trader is expecting high volatility in the market they are trading.  Let’s say you are in a long futures position in the corn market and a crop progress report is due out in a few days.  You think there may be a short term correction in the market before it continues on its bullish trend.  You can simply purchase a put at whatever point you would like to lock in profits (remember to keep premium paid in consideration here).  If the market report comes out bearish and the market doesn’t continue in the bullish trend, simply exercise the put option to offset your long futures position at the strike price purchased.

Example

Frank is a speculator who is currently trading the corn market.  He has been long July 2011 corn from a price of $6.72.  July corn last traded at $7.50 and Frank would like to lock in some profit.  Since he is long the corn market, he knows he will need to purchase a put to lock in profits using options.  Frank would like to lock in around $2000 of his profits.  A $7.30 July corn put option is currently trading at 19 cents premium.  Each cent is equal to $50 in the corn futures and options market.  Knowing this, Frank decides to purchase the $7.30 put to lock in profits.

$7.30 (Put option purchased)
-0.19 (Cost of put option)
$7.11 (Price locked in after difference in strike and premium paid)
-6.72 (Initial long position)
$0.39 of profit locked in, or $1,950 (39 * 50)

Summary

Using options to lock in profits is a simple alternative to using futures positions.  They can give you the ability to ride out volatility swings with a defined exit point without having your position offset like you might with a futures stop loss.

Free Futures and Options Strategy Guide

Discover how to structure your trades for maximum profit potential with these 21 futures and options trading strategies.  Download your Futures and Options Strategy Guide.

Spreads Risk Disclosure:  A spread is defined as the sale of one or more futures or option contracts and the purchase of one or more offsetting futures or option contracts.  It should be recognized, though, that the loss from a spread can be as great as – or even greater than – that which might be incurred in having an outright futures or options position.  An adverse widening or narrowing of the spread during a particular time period may exceed the change in the overall level of futures or option prices, and it is possible to experience losses on both of the futures or options contracts involved (that is, on both legs of the spread).  In addition, spread trading increases transaction costs because the customers will be charged commissions on each leg of the spread.

Options Risk Disclosure:  An option on a commodity futures contract is a right, purchased for a certain price, to either buy or sell a commodity futures contract during a certain period of time for a fixed price.  Although successful commodity options trading requires many of the same skills as does successful commodity futures trading, the risks involved are somewhat different.  For example, if a customer buys an option (either to sell or purchase a futures contract or commodity), the customer will pay a “premium” representing the market value of the option.  Unless the price of the futures contract underlying the options changes and it becomes profitable to exercise or offset the option before it expires, the customer’s account may lose the entire amount of such premium (together with the costs of commissions and fees incurred to purchase such options).  Conversely, if a customer sells an option (either to sell or purchase a futures contract or commodity), the customer will be credited with the premium but will have to deposit margin due to its contingent liability to take or deliver the futures contract underlying the option in the event the option is exercised.  The writer of the option is however at unlimited risk with respect to the call option written, and risk on the put option of the amount should the price of the futures contract drop to zero.  Sellers of options are subject to the loss which occurs in the underlying futures position (less any premium received).  The ability to trade in or exercise options may be restricted in the event that such trading on U.S. commodity exchanges is restricted by both the CFTC and such exchanges, and it has been at certain times in the past.

Stop Orders Risk Disclosure:  This website may make certain references to the use of stop orders as means of limiting losses or protecting profits.  Please note that there is no guarantee that any stop loss order will be executed at the stop price.  Therefore, there can be no guarantee that placing a stop order will limit losses or protect profits.  Accordingly, no representation is being made that the trading in customers’ accounts will be profitable or will not result in losses as the result of placing stop orders.

Filed Under: Options, Strategies Tagged With: , , , ,
June 6, 2011 by 1 Comment

US Treasury Bonds and Notes: A Beginner’s Guide

All eyes are on the debt market these days.  Volatility in the debt market is forcing investors and traders to shift their assets as the global markets spin out of control.  News of Greece defaulting on its bonds, the US raising its debt ceiling, and economic activity in the Far East have traders and investors scrambling.  One way to take advantage of the changing interest rates and market fluctuation is through trading United States Treasury note and bond futures.  Whether using Treasury bond futures to hedge one’s portfolio or speculate on market fluctuation, US debt futures offer an ideal way to take advantage of market volatility and manage risk.  Below I will explain some basics of the US debt market, specifications of US Treasury bond futures, and an example of a 30-year Treasury bond future trade.

Debt Market Basics

The United States government has outstanding debt that exceeds 14 trillion dollars.  Since 1962 the debt ceiling has been raised 74 times.  The United States government issues debt to fund expenditures that exceed revenues.  Simply put, the United States debt market exists because of the United States government obligation to its lenders.  US government debt levels affect everything in our society.  Inflation, interest rates, economic growth, and the taxes that are levied are directly linked to debt levels.  The United States dollar is the world’s reserve currency.  Further, the United States has never defaulted on a debt payment or failed to meet an obligation on its bonds.  For these reason, United States Treasury bonds are considered the safest investment in the world (this also allows the US government to borrow at some of the lowest interest rates in the world).

When there are shocks or bad news in the market, investors flock to the US t-bonds for a safe haven to protect their capital.  This is referred to as a “flight to quality” and usually drives interest rates lower.  However, when the economy faces good news, investors abandon the safety of Treasury bonds and invest in other products that offer more attractive yields.  This causes prices to drop and interest rates to rise.  A key factor to understanding bonds is that prices are inverse to rate.  When interest rates rise, prices on bonds fall (and vice versa).  The higher the price of a bond, the lower the interest rate is on the bond.  Safe investments traditionally produce lower yields as investors sacrifice yields for safety.

Traders use Treasury bond futures because they are able to place trades instantly while only needing the proper margin in ones account to place the trade.  Traders also have confidence that the exchange guarantees all trades.  This is essential for traders to manage risk or speculate on fluctuating interest rates.  There may be no other tradable asset that offers such a direct link for exposure to economic events and interest rate exposure with liquidity and transparency.

United State Treasury Bond and Note Specifications

The 30-year bond, 10-year note, and 5-year note are some of the most heavily traded futures contracts in the world.  These debt products are traded both electronically and on the trading floor at the Chicago Mercantile Exchange.  The futures are based on $100,000 pare values and traded in tics and points.  There are 32 tics in each point.  Each point is worth $1,000 and each tic is worth $31.25 ($31.25 x 32=$1,000.00).  The 5-year note is traded in 1/4 tics ($7.8125) and the 10-year note is traded in 1/2 tics ($15.625).

You can view the full contract specifications on the main Daniels Trading website.

The 30-year t-bond is the traditionally the most volatile contract in the yield curve.  Because investors cannot foresee events going forward for 30 years, the contract has the largest price movement.  Conversely, the 5-year note is much less volatile as investors are locked into the maturity for a shorter period of time.  Long term interest rates can be extremely difficult to forecast and the longer the maturity of the bond, the more affected the bond will be economic events.

Basic Trade Examples

To get a better understanding of how a trade works with Treasury bonds futures, we can follow the story of Trader Pete.  Trader Pete is concerned that interest rates have remained low for too long and is concerned that inflation is around the corner.  Pete has charted the markets and read research indicating that the economy may be picking up steam.  Pete sees that the 30-year Treasury bond is trading at a price of 125 09/32.  Technically, Pete sees this as a good level to short the market and his fundamental research of rising economic activity supports this idea.  Pete decides to place a trade to sell one US Treasury bond at a price of 125 09/32.  Because Pete is discipline he adds a stop loss order at the price of 126 05/32 in the market in the event that his analysis is incorrect.

If Pete is correct and inflationary pressure mounts due to improving economic news, the price of Treasury bonds will fall and trader Pete will profit from the trade.  Pete sees that the price of Treasury bond futures has fallen to 122 17/32 and decides to close his position out for a profit of $2,750 (minus commissions).  However, if Pete is incorrect and the economy remains sluggish and actually gets worse, Treasury bond prices will rise.  Because Pete has a stop above the market at 126 05/32 he will be stopped out losing $625.00 (plus commissions).

Summary

Treasury bond futures are an excellent way for investors, hedgers, and traders to manage risk and get the exposure to changing economic events that affect everyone in our society.  They offer the flexibility of trading from the short side or long side while offering market access and liquidity.  Treasury bond futures offer traders the ability to trade and take advantage of world events, and understanding the characteristics of this asset class is important.

Free eBook: How to Make Your First Futures Trade

If you’ve always wanted to get involved in the commodity market but were unsure how, this guide will turn that mountain into a molehill.  Download “How to Make Your First Futures Trade”.

Stop Orders Risk Disclosure:  This website may make certain references to the use of stop orders as means of limiting losses or protecting profits.  Please note that there is no guarantee that any stop loss order will be executed at the stop price.  Therefore, there can be no guarantee that placing a stop order will limit losses or protect profits.  Accordingly, no representation is being made that the trading in customers’ accounts will be profitable or will not result in losses as the result of placing stop orders.

Filed Under: Getting Started, Market Analysis Tagged With: , , , ,
June 3, 2011 by Leave a Comment

Want to be an All-Star Technical Trader? Consider Fundamental Analysis

A five-tool baseball player is said to be a potential All-Star when he has a well-rounded offensive and defensive skill set.  The ability to hit for power and average, run, throw, and field gives him the opportunity to excel in every facet of the game.

In trading, the ability to interpret charts, understand indicators, draw trend lines, and recognize support and resistance levels gives the technical trader an opportunity to excel in the markets.  However, one tool may be missing to become a potential All-Star Trader – fundamental analysis.  While one does not need to be an expert at fundamental analysis, paying closer attention to it will make a technical trader well-rounded.

The recent trade in Live Cattle is an example of keeping the fundamentals in mind.  Let’s go directly to the charts for an example.  On May 16th a breakout trade occurred in the August 2011 Live Cattle futures market.  With recent lows and a trend line surpassed an opportunity to short the contract presented itself.  Upon setting up the trading plan a downside target was determined with numerous technical factors taken into consideration.  Potential support at the 107.825 low (1/04/11), 106.750 high (12/07/10) or 104.125 low (12/08/10).  A 200-day simple moving average at 108.050.  A 50% Fibonacci Retracement level of the bull move dating back almost a year at 106.800.  MACD, Rate of Change and Stochastics were also considered.  It was determined to place the downside target at 104.200, just above the 12/08/10 low.  This target price was reached on May 23rd – I could have exited this trade at my initial target but I had chosen to cancel that profit target order.  Why?

I canceled the order because of fundamental information that potentially gave the opportunity to transform a good trade into a better trade.  On May 20th a Cattle on Feed report was released after the close of trade.  The report had extremely bearish information about the size of the cattle herd.  Analysts said that a limit down move ($3.00 below the previous day’s settlement price) the following trading session was not out of question.  The next session’s limit down price (104.100) would have been below the original target price (104.200).  On May 23rd the August Live Cattle traded and closed limit down to settle at 104.100.  The market opened lower the next session (103.875) and traded as low as 103.475 allowing the trade to accrue more profit potential by leaving the target open.  The stop loss was immediately lowered to 105.250 but the trade could have been liquidated for profits beyond the original target profit.

Traders need to be well-rounded in their approach and trade in the context of the bigger picture.  Once in a while fundamental analysis can help transform an average trader into an All-Star.

Free Trial to GBE Trade Spotlight

Each night we study the charts, using the GBE methodology.  When we find trade setups, we e-mail them to our subscribers.  We will identify one or two spotlight trade setups per week.  These e-mails are specific trade recommendations, with a defined stop loss and profit targets, so you have the facts you need to make a decision. Start your free trial to GBE Trade Spotlight.

Stop Orders Risk Disclosure:  This website may make certain references to the use of stop orders as means of limiting losses or protecting profits.  Please note that there is no guarantee that any stop loss order will be executed at the stop price.  Therefore, there can be no guarantee that placing a stop order will limit losses or protect profits.  Accordingly, no representation is being made that the trading in customers’ accounts will be profitable or will not result in losses as the result of placing stop orders.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW.  NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.  IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.  ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT.  IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING.  FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS.  THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

Filed Under: Strategies, Technical Analysis Tagged With: ,
June 2, 2011 by Leave a Comment

Using Covered Calls and Puts to Gain Trade Management Flexibility

What is a Covered Call or Covered Put?

A covered call/put is an option strategy used by traders who hold a long/short futures position and sell a call/put option on the same underlying futures.  If the trader is long the futures contract, the trader will sell an out of the money call.  If the trader is short the futures contract, the trader will sell an out of the money put.

Why Do Traders Use This Strategy?

This strategy provides traders with an opportunity to earn additional income when the market consolidates and provides some extra cushion if the underlying futures moves against them.  Under most circumstances, the strategy will be used when a trader has a directional opinion of the market.  The idea behind the strategy is to take a directional position on the futures and sell an option that is out of the money to a level they feel the market will have a difficult time reaching.  This allows the trader to hold their long or short position as well as take advantage of the options time decay.

Covered Call Example

Bob feels that the price of corn will increase over the next few months.  Currently corn is trading at $7.00 per bushel.  Bob buys one futures contract at $7.00.  Bob feels demand for corn is very strong at $7.00, but feels that this strong demand will begin to ration if/ when the price exceeds $8.00.  Based on this assumption, Bob decides to sell an $8.00 call option.  By selling the $8.00 call, Bob collects 25 cents ($1,250).  The sale of the option provides Bob with a 25-cent cushion in case of an adverse move in corn.  This will give Bob a breakeven price of $6.75 on his futures contract ($7.00-$0.25= $6.75).  If the market sells off beyond $6.75, Bob will be at a loss on the trade.  If the market moves higher, Bob will be at a profit but will be limited to a max profit of $1.00 ($8.00-$7.00).

Trade Management Flexibility

This strategy provides Bob with some flexibility on how he manages the trade.  If the market sells off, Bob can roll down his $8.00 call option to a call at a lower strike price.  This would allow Bob to collect additional premium and lower his breakeven.  For example, let’s say corn sells off by 40 cents and is now trading at $6.60.  The delta on Bob’s $8.00 call is 0.25, which means that his option will decrease at a rate of 0.25 for every 1.00 point move in the futures.  So if corn were to sell off 40 cents, Bob’s call option would drop in value by about 10 cents (40*.25= 10).  You can learn more about an option’s delta by reading my article “Going Greek: Understanding Your Option’s Delta”.  In this example, Bob will buy back his $8.00 call at 15 cents locking in a profit of 10 cents on the trade (25-15=10).  Bob can then sell a $7.75 call and collect an additional 20 cents.  Between the profit taken on the sale of his $8.00 call (10 cents) and the additional premium collected from the sale of his $7.75 call (20 cents), Bob’s new breakeven on the futures is $6.70 ($7.00-0.30= $6.70).  This will also reduce the max profit on his position to 75 cents ($7.75-$7.00= $0.75).  By using this strategy Bob is only down 10 cents on the trade.  Bob’s new breakeven is $6.70 and the futures is now trading at $6.60.  Had Bob only bought the futures at $7.00, Bob would be down $0.40 cents on the trade.

As you can see, this strategy does not remove all risk from the trade, but it does provide an alternative to trading the outright futures contract only. Like any trading strategy, it is important to enter the trade with a predetermined game plan, remain disciplined and stick to the plan.  Managing risk will still be a key component to your overall success as a trader, but this strategy can be used to help hedge your position’s risk.

Free Futures and Options Strategy Guide

Discover how to structure your trades for maximum profit potential with these 21 futures and options trading strategies.  Download your Futures and Options Strategy Guide.

Spreads Risk Disclosure:  A spread is defined as the sale of one or more futures or option contracts and the purchase of one or more offsetting futures or option contracts.  It should be recognized, though, that the loss from a spread can be as great as – or even greater than – that which might be incurred in having an outright futures or options position.  An adverse widening or narrowing of the spread during a particular time period may exceed the change in the overall level of futures or option prices, and it is possible to experience losses on both of the futures or options contracts involved (that is, on both legs of the spread).  In addition, spread trading increases transaction costs because the customers will be charged commissions on each leg of the spread.

Options Risk Disclosure:  An option on a commodity futures contract is a right, purchased for a certain price, to either buy or sell a commodity futures contract during a certain period of time for a fixed price.  Although successful commodity options trading requires many of the same skills as does successful commodity futures trading, the risks involved are somewhat different.  For example, if a customer buys an option (either to sell or purchase a futures contract or commodity), the customer will pay a “premium” representing the market value of the option.  Unless the price of the futures contract underlying the options changes and it becomes profitable to exercise or offset the option before it expires, the customer’s account may lose the entire amount of such premium (together with the costs of commissions and fees incurred to purchase such options).  Conversely, if a customer sells an option (either to sell or purchase a futures contract or commodity), the customer will be credited with the premium but will have to deposit margin due to its contingent liability to take or deliver the futures contract underlying the option in the event the option is exercised.  The writer of the option is however at unlimited risk with respect to the call option written, and risk on the put option of the amount should the price of the futures contract drop to zero.  Sellers of options are subject to the loss which occurs in the underlying futures position (less any premium received).  The ability to trade in or exercise options may be restricted in the event that such trading on U.S. commodity exchanges is restricted by both the CFTC and such exchanges, and it has been at certain times in the past.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW.  NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.  IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.  ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT.  IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING.  FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS.  THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

Filed Under: Options Tagged With: , , ,
June 1, 2011 by Leave a Comment

Getting Started with Technical Trading

Now more than ever, traders and investors are looking for ways to gain portfolio exposure in areas that are non-correlated to the stock market.  The commodity futures markets offer an arena to meet this investment objective, and trading in the futures markets can be a very rewarding experience.  While there are many different ways to approach trading futures, it is essential for all traders to have a trading plan that can help them gain confidence in being able to analyze the futures markets and market trends.  As a result, many traders turn to the use of technical analysis to help in the quest to stay on top of the markets.

What is Technical Analysis?

Technical analysis is simply the use of charts and trading indicators for the purpose of formulating a trading plan and strategy for the markets.  There is no question that the use of technical analysis in the world of futures trading gives traders access to relevant information about trend patterns in the markets.  Using technical analysis is one way traders and investors choose to analyze the markets to help them identify trade setups and potential opportunities.

How Can I Use Technical Analysis in My Trading?

There are many ways a trader can use technical analysis to his or her advantage.  An essential aspect of technical analysis is the use of charts.  A trader can look at a chart many different ways.  Depending on the trading strategy, a trader may look at a chart that changes minute by minute.  A trader may also look at a chart that shows data month by month.  There is no one right way to analyze a chart.  It is purely dependent on what kind of trading strategy the trader is using to position himself in the market.  To help identify market patterns, many technical traders choose to add key analytical trading indicators to their charts.  There is a wide variety of technical indicators that can help traders in many different ways.  Technical indicators give traders a way to help understand market trends.  Here at Daniels Trading, we have a variety of tools and resources to help traders utilize technical analysis.  You can refer to our Technical Analysis Learning Center for more information.

Don’t Overcomplicate Things with Too Many Indicators

Because technical analysis can be used in many different ways, the most important thing to consider about technical trading is to keep it simple.  Traders often think they need to use a lot of different indicators in order to be successful.  This is not necessarily the case!  The best approach to technical trading is to find two or three indicators that you understand, feel confident in, and trust.

There are always opportunities present in the futures markets.  The task at hand is being able to confidently recognize them.  Working with us at Daniels Trading and utilizing our technical analysis trading resources can help potentially help give you an edge with your futures trading.  If you would like to know more about Daniels Trading and technical trading in the futures markets, please contact us directly at 800-800-3840.

Futures Trading Simplified:  How to Gain Confidence & Learn the Process of Trading Commodities

Want to learn more about futures trading?  This is the guide for you.  We’ll make the mountain of learning a molehill with our informed “Roadmap to Trading”.  We know the route and have marked the way… all you need to do is follow!  Download your free “Futures Trading Simplified” eBook.

Filed Under: Getting Started, Technical Analysis Tagged With: , , ,
Newer Posts»