Futures & Options Trader 2007-07 Oct

Strategies, analysis, and news for futures and options traders
October 2007 • Volume 1, Issue 7
CRUDE OIL
OPPORTUNITIES:
Using spreads to find
outright trades p. 8
EARNINGS REPORTS
AND COVERED CALLS
p. 20
SHORT-TERM
T-BOND TRADING
p. 14
FUTURES TRADING
SYSTEM:
Gap closer p. 32
TRADING BREAKOUTS
with option credit
spreads p. 26
TRADING THE FED

RATE CUT
p. 52
CONTENTS
Bear put ladders . . . . . . . . . . . . . . . . . . . . .26

Another look at ladder spreads focuses
on bearish positions.
By Philip Budwick
Futures Strategy Lab . . . . . . . . . . . . . . . .32

Consecutive gap closer
By Volker Knapp
Options Strategy Lab . . . . . . . . . . . . . . . .36

Refining a 20-day breakout system
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6 By Steve Lentz and Jim Graham
Trading Strategies Book Excerpt . . . . . . . . . . . . . . . . . . . . . . . .38

Using spreads to find The man who buys crashes
back-month crude oil trades . . . . . . . . . . . .8 In this excerpt from their book “Millionaire
There’s more to spread analysis than meets Traders: How Everyday People Are Beating Wall
the eye. This approach identifies situations Street at Its Own Game,” Kathy Lien and Boris
in which back-month crude oil futures are Schlossberg talk to a trader who specializes
likely to trend higher or lower. in buying intraday crashes in individual stocks.
By Keith Schap By Kathy Lien and Boris Schlossberg
T-bond trading characteristics . . . . . . . .14 continued on p. 4

The ins and outs of the T-bond futures’
short-term behavior.
By FOT Staff
Earnings reports
and covered calls . . . . . . . . . . . . . . . . . . . .20
Using a covered call strategy on stocks
that are nearing an earnings report can
be a good idea — but only if you choose
the proper stock at the right time.
By Mike Phillips
2 October 2007 • FUTURES & OPTIONS TRADER

CONTENTS
News
Citadel: Volume, liquidity issues
surround penny pricing pilot . . . . . . . . . .40
One of the nation’s largest options traders
thinks the SEC needs to modify its plan
for penny pricing.
By Jim Kharouf
Turf war between CFTC, FERC looms . .41

Two different regulatory groups have
filed market manipulation charges against
failed hedge fund Amaranth, but there is Option Radar . . . . . . . . . . . . . . . . . . . . . . . . .45
some debate as to whether one group is Notable option volatility and volume.
overstepping its bounds.
Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .46
TT, eSpeed clash in court . . . . . . . . . . . . .41 References and definitions.
Trading Technologies’ lawsuit against rival
software firm eSpeed didn’t take long to get
contentious. Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49
By Jim Kharouf
Options Watch: Global ETFs . . . . . . . .42 Futures & Options Calendar . . . . . . . . . . . .50
Tracking bid-ask spreads on country and
regional ETF options.
Futures Trade Journal . . . . . . . . . . . . . . .52
New Products and Services . . . . . . . . . . . . .43 The Fed’s Sept. 18 rate cut results in
market fireworks.
Futures Snapshot . . . . . . . . . . . . . . . . . . . .44 Options Trade Journal . . . . . . . . . . . . . . .54

Momentum, volatility, and volume statistics A bear call spread on Goldman Sachs
for futures. falls short.
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CONTRIBUTORS
CONTRIBUTORS
Keith Schap is a freelance writer specializing in risk management
and trading strategies. He is the author of numerous articles and sev-
eral books on these subjects, including The Complete Guide to Spread
Trading (McGraw-Hill, 2005). He is a former senior editor at Futures
magazine and senior technical marketing writer at the Chicago Board
of Trade.
Philip Budwick is co-author of The Option Trading Handbook:

A publication of Active Trader ®
Strategies and Trade Adjustments (Wiley, 2004) and the director of the
capital markets trading room at George Washington University. He
For all subscriber services: actively trades options and futures, consults as a trading coach, and
www.futuresandoptionstrader.com runs online discussions on option trading basics. He can be reached at
pbudwick@gainllc.com.
Editor-in-chief: Mark Etzkorn Kathy Lien is the chief currency strategist at DailyFX.com, a pop-
metzkorn@futuresandoptionstrader.com ular FX news and research resource. She is also an internationally pub-
lished author of Day Trading the Currency Market (John Wiley & Sons,
Managing editor: Molly Flynn 2006) and the new book Millionaire Traders: How Everyday People Beat
mflynn@futuresandoptionstrader.com Wall Street at Its Own Game (Wiley, September 2007). Lien is frequent-
ly quoted by Bloomberg, Reuters, and Marketwatch, and has
Senior editor: David Bukey
appeared on CNN, CNBC, CBS, and Bloomberg Radio. Her new blog
dbukey@futuresandoptionstrader.com
is located at http://www.kathylien.com and the Web site for her new book is
http://www.millionairetradersbook.com.
Contributing editors:
Boris Schlossberg serves as the senior currency strategist at FXCM in New
Jeff Ponczak York where he shares editorial duties with Kathy Lien for DailyFX.com. Schlossberg
jponczak@futuresandoptionstrader.com, is frequently quoted by Dow Jones MarketWatch, Reuters, and Bloomberg. He also
Keith Schap provides weekly currency analysis for CNBC Squawk box, as well as CNBC Europe
and CNBC World. Schlossberg is the author of the book Technical Analysis of the
Editorial assistant and Currency Market (Wiley Trading, 2006) and has written numerous articles in the
Webmaster: Kesha Green financial press.
kgreen@futuresandoptionstrader.com
Mike Phillips has worked the past three years for Power Financial Group, Inc.
Art director: Laura Coyle He is involved in the support and development of PowerOptions, a Web site for find-
lcoyle@futuresandoptionstrader.com ing stock option strategies, and PowerOptionsApplied, a site providing an option-
trading newsletter. He has been trading for 10 years and has an MBA in finance from
President: Phil Dorman Santa Clara University and a masters in electrical engineering from the University of
pdorman@futuresandoptionstrader.com Texas at Arlington. He helped develop software and semiconductors for electronic
equipment for many years and has been a key contributor to several start-up compa-
Publisher, nies. Phillips leverages his engineering expertise and applies it to his analysis and
Ad sales East Coast and Midwest: trading.
Bob Dorman
bdorman@futuresandoptionstrader.com Tristan Yates writes and consults on leveraged indexed investment strategies.
He graduated from the INSEAD MBA program in Singapore and now manages the
Ad sales Index Roll, an investment advisory, research group, and Web resource created to help
West Coast and Southwest only: individual investors build and manage long-term leveraged index portfolios. He can
Allison Ellis
be reached at tristan@indexroll.com.
aellis@futuresandoptionstrader.com
Volker Knapp has been a trader, system developer, and
researcher for more than 20 years. His diverse background encom-
Classified ad sales: Mark Seger
passes positions such as German National Hockey team player,
mseger@futuresandoptionstrader.com coach of the Malaysian National Hockey team, and president of
VTAD (the German branch of the International Federation of
Volume 1, Issue 7. Futures & Options Trader is pub-
Technical Analysts). In 2001 he became a partner in Wealth-Lab Inc.
lished monthly by TechInfo, Inc., 150 S. Wacker Drive, (http://www.wealth-lab.com), which he is still running.
Suite 880, Chicago, IL 60606. Copyright © 2007
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any Jim Graham (advisor@optionvue.com) is the
form without written permission from the publisher. product manager for OptionVue Systems and a registered investment
The information in Futures & Options Trader magazine advisor for OptionVue Research.
is intended for educational purposes only. It is not
meant to recommend, promote or in any way imply the
effectiveness of any trading system, strategy or Steve Lentz (advisor@optionvue.com) is executive vice president
approach. Traders are advised to do their own of OptionVue Research, a risk-management consulting company. He
research and testing to determine the validity of a trad-
ing idea. Trading and investing carry a high level of also heads education and research programs for OptionVue Systems,
risk. Past performance does not guarantee future including one-on-one mentoring for intermediate and advanced traders.
results.

TRADING STRATEGIES
Using spreads
to find back-month crude oil trades
A practical approach to analyzing spread relationships can be used to
locate outright trade opportunities in crude oil.
TABLE 1 — SPREADS AS PREDICTORS

The hypothesis that a lower deferred-month crude oil price predicts BY KEITH SCHAP
lower prices in the future was correct only three of 10 times.
Sept. Dec.
contract contract Spread Prediction Actual
7/31/95 17.56 17.19 -0.37 Lower Higher
10/31/95 17.64
Y
Dec difference 0.45 ear in and year out, crude oil
traders trade various intermonth
7/31/96 20.42 19.22 -1.20 Lower Higher futures spreads to take advantage
10/31/96 23.35
of the relationships between the
Dec difference 4.13
different contract months in this market. Many
7/31/97 20.14 20.16 0.02 Higher Higher traders don’t know these spreads can signal
10/31/97 21.08 outright trade opportunities in the deferred
Dec difference 0.92 (back) months of the spreads — as long as
traders don’t succumb to an all-too-too com-
7/31/98 14.21 15.06 0.85 Higher Lower
10/30/98 14.42 mon misconception about a spread’s “mes-
Dec difference -0.64 sage.”
For several years the price of crude oil has
7/30/99 20.53 20.22 -0.31 Lower Higher been central to discussions concerning the
10/30/99 21.75
inflation risk in the U.S. economy. From time to
Dec difference 1.53
time a Federal Reserve statement or an econo-
7/31/00 27.43 27.00 -0.43 Lower Higher mist’s forecast will suggest the inflationary
10/31/00 32.70 potential of the oil market is less than many
Dec difference 5.70 people think because the futures market is pro-
jecting lower crude oil prices. These people
7/31/01 26.35 25.59 -0.76 Lower Lower
10/31/01 21.18 note the price of the December crude contract,
Dec difference -4.41 for instance, is lower than the price of the near-
by September contract.
7/31/02 27.02 26.03 -0.99 Lower Higher The apparent logic behind this argument is
10/31/02 27.22 that a futures price denotes a future price.
Dec difference 1.19
Accordingly, a lower December contract price
7/31/03 30.54 29.32 -1.22 Lower Lower amounts to a market prediction of lower crude
10/31/03 29.11 prices in the future, while a higher December
Dec difference -0.21 price forecasts higher prices to come (this rela-
tionship never seems to be explicitly men-
7/30/04 43.80 41.99 -1.81 Lower Higher
tioned, though).
10/29/04 51.76
Dec difference 9.77 This isn’t what a futures price is, but let’s
come back to that in a moment.

TABLE 2 — EVALUATING POSSIBLE DECEMBER
CRUDE OIL FUTURES TRADES
The revised spread interpretation produced seven winning trades in 10
years.
A sample of the evidence Sept. Dec. 1-contract

Evidence supporting this claim should be easy contract contract Spread Action result
to find. The monthly crude oil (CL) contracts 7/31/95 17.56 17.19 -0.37 Buy Dec
10/31/95 17.64
expire on the third business day before the 25th
Dec difference 0.45 $450
calendar day of the month preceding the deliv-
ery month. The last trading day for the 7/31/96 20.42 19.22 -1.20 Buy Dec
September contract is around Aug. 20; the last 10/31/96 23.35
day for the December contract is around Nov. Dec difference 4.13 $4,130
20.
7/31/97 20.14 20.16 0.02 Sell Dec
Price behavior during the final week or two 10/31/97 21.08
of a contract’s life is often erratic, though, so to Dec difference -0.92 -$920
avoid this noise the analysis checks the prices
of the September and December contracts on 7/31/98 14.21 15.06 0.85 Sell Dec
the last trading day of July and calculates the 10/30/98 14.42
Dec difference 0.64 $640
spread (price difference) on that day. Then, the
December contract price is noted a second time 7/30/99 20.53 20.22 -0.31 Buy Dec
on the last trading day of October, and the dif- 10/30/99 21.75
ference between the two December prices is cal- Dec difference 1.53 $1,530
culated.
7/31/00 27.43 27.00 -0.43 Buy Dec
If the hypothesis is correct — that a lower 10/31/00 32.70
deferred-month crude oil price predicts lower Dec difference 5.70 $5,700
prices in the future — when the spread is nega-
tive at the end of July, the December price 7/31/01 26.35 25.59 -0.76 Buy Dec
should be lower at the end of October. (In the 10/31/01 21.18
Dec difference -4.41 -$4,410
New York futures markets, this is called a
“backwardated” market; in the Chicago futures 7/31/02 27.02 26.03 -0.99 Buy Dec
markets, it is called an “inverted” market.) By 10/31/02 27.22
the same logic, if the spread is positive at the Dec difference 1.19 $1,190
end of July (in New York, a “contango” market;
7/31/03 30.54 29.32 -1.22 Buy Dec
in Chicago, a “carry” market), the December
10/31/03 29.11
price should be higher at the end of October. Dec difference -0.21 -$210
Table 1 displays the results of this analysis
for the 10 years from 1995 through 2004. The 7/30/04 43.80 41.99 -1.81 Buy Dec
“prediction” was correct three of 10 times 10/29/04 51.76
(1997, 2001, and 2003), which won’t win any Dec difference 9.77 $9,770
forecasting competitions. The March-June and
November-February intermonth spreads had similar suc- the market will motivate inventories to be put into storage
cess rates during the same 10 years — 30-percent accuracy by bidding up the back-month prices relative to the nearby
for the November-February spread and 40 percent for the month. As a result, the spreads will be positive (for exam-
March-June spread. ple, the +0.85 spread on July 31, 1998 in Table 1). The eco-
Either intermonth spreads have little predictive value, or nomic limit on how positive the spread can be is the full
this interpretation of the spread is mistaken. “carrying cost” for the oil, which includes storage fees,
insurance, financing cost, and shrinkage estimate.
A more realistic spread interpretation When crude oil demand exceeds available supplies, or
First, traders and economists should realize a futures price when refiners and other market participants anticipate a
is not a future price. Rather, a futures price is a kind of for- supply interruption, the market will bid up the nearby-
ward price — a price agreed upon today for delivery at a month price relative to the back-month prices. This results
specified future time — say, December. An intermonth in negative spreads (for example, the -1.81 spread on July
spread conveys information about the market’s supply- 30, 2004).
demand situation, not future prices. Of course, certain complications make this a somewhat
When crude oil supplies are plentiful relative to demand, continued on p. 10
FUTURES & OPTIONS TRADER • October 2007 9

TRADING STRATEGIES continued
tially the correct way to interpret these spreads:

TABLE 3 — USING THE NOVEMBER-FEBRUARY CRUDE OIL A negative spread indicates concerns about
SPREAD TO LOCATE TRADES IN FEBRUARY FUTURES supply adequacy and sends an anti-storage sig-
Although the three losing trades were each larger than $3,000 per nal. A positive spread indicates an abundance
contract, the profits from the seven winning trades resulted in a net
of supply and signals a desire to defer delivery
gain of $12,080.
— that is, to store crude oil for later needs.
Nov. Feb. 1-contract As Table 1 suggests, the most important
contract contract Spread Action result
implication for traders is that the intermonth
9/29/95 17.54 17.10 -0.44 Buy Feb
12/29/95 19.55 crude oil spread can guide decisions about out-
Feb. difference 2.45 $2,450 right trading in the spread’s back-month con-
tract. The logic is:
9/30/96 24.38 22.60 -1.78 Buy Feb
12/31/96 25.92 1. A negative spread suggests a supply
Feb. difference 3.32 $3,320
shortage, or fears a shortage might
9/30/97 21.18 20.95 -0.23 Buy Feb develop.
12/31/97 17.64 2. Shortages tend to drive prices higher.
Feb. difference -3.31 -$3,310 3. A negative September-December spread
on the last trading day of July is a buy
9/30/98 16.14 16.34 0.20 Sell Feb
signal for December crude oil futures.
12/31/98 12.05
In the case of positive spreads, the logic runs
9/30/99 24.51 23.09 -1.42 Buy Feb this way:
12/30/99 25.60
1. A positive spread suggests a supply
9/29/00 30.84 30.34 -0.50 Buy Feb surplus.
12/29/00 26.80 2. Surpluses tend to drive prices lower.
Feb. difference -3.54 -$3,540 3. A positive September-December spread
on the last trading day of July is a sell
9/28/01 23.43 23.84 0.41 Sell Feb
signal for December crude oil futures.
12/31/01 19.84
A logical approach to finding oil
9/30/02 30.45 29.16 -1.29 Buy Feb futures trades
12/31/02 31.20 This makes it easy to know whether to buy or
Feb. difference 2.04 $2,040 sell a spread’s back month. Unwinding the
9/30/03 29.20 28.08 -1.12 Buy Feb trade is just as easy: Simply exit the position on
12/31/03 32.52 the last trading day of October (for the
Feb. difference 4.44 $4,440 December crude oil contract). Let’s take a look
at some examples.
9/30/04 49.64 47.96 -1.68 Buy Feb The 1995 September-December spread was -
12/30/04 43.45
0.37 on July 31, 1995, prompting a long position
Feb. difference -4.51 -$4,510
in the December contract at 17.19. On Oct. 31
that year the December contract (CLZ95) price
oversimplified picture. Crude oil doesn’t store well for long was 17.64, which translates into a 0.45 ($450) gain for a one-
periods, as do gasoline or corn — and storage capacity for contract trade. This is a meager gain for a three-month
crude oil is not large relative to other commodity markets, trade, but let’s see how other trades in other years per-
anyway. As a result, crude oil futures typically exhibit back- formed.
wardation. Of course, an alternative to storage is to leave Table 2 shows whether the appropriate trade was to buy
the stuff in the ground. This accomplishes the same thing. or sell December crude oil futures and multiplies the
When crude oil futures exhibit a contango condition, it may “December difference” by 1,000 to show the one-contract
be less a matter of plentiful supply than of refinery capaci- result in dollar terms.
ty constraints. Again, the cause may be different but the Three of the trades would have suffered losses, the
message is essentially the same: We don’t need more crude largest being the -$4,410 hit in 2001. While that’s a stunning
oil right now; save it for later. result on the negative side, there were three winning trades
Complexities aside, this supply-demand model is essen- greater than $4,000 — the $9,770 trade in 2004 being the

TABLE 4 — WHEN THEY WERE BAD, THEY WERE HORRID
The four losing trades were big in this sequence, and the 10-trade net
return was -$3,320.
largest. The sum of all 10 trades is $17,870,
which isn’t bad. March June 1-contract
Tables 3 and 4 contain the trade results for contract contract Spread Action result
the November-February and March-June 1/31/95 18.39 18.07 -0.32 Buy June
spreads. Of the 10 trades summarized in Table 4/28/95 20.38
3, three were losers — all of them well over June difference 2.31 $2,310
$3,000 per contract. But the profits from the 1/31/96 17.74 17.09 -0.65 Buy June
seven winning trades resulted in a net gain of 4/30/96 21.20
$11,690 for the entire 10-trade sequence. June difference 4.11 $4,110
The Table 4 results are a different story. Only
four of the June trades were losers, but the loss- 1/31/97 24.15 22.74 -1.41 Buy June
4/30/97 20.21
es were big: The 2002 trade lost more than
June difference -2.53 -$2,530
$7,000, while the 1999 and 2003 trades lost
more than $5,000 each. The 10-trade net return 1/30/98 17.21 17.71 0.50 Sell June
was -$3,320. 4/30/98 15.39
Of the 10 losing trades in Tables 2, 3, and 4, June difference 2.32 $2,320
seven exceeded $3,000, which would seem to
1/29/99 12.75 12.96 0.21 Sell June
call into question the validity of this approach 4/30/99 18.66
(at least in terms of timing the exit). June difference -5.70 -$5,700
Improving the results 1/31/00 27.64 25.32 -2.32 Buy June

4/28/00 25.74
A few times the exit days in the tables repre-
June difference 0.42 $420
sented nearly optimal times to get out of these
positions. In many cases, however, they did 1/31/01 28.66 26.99 -1.67 Buy June
not. Let’s see if there’s a way to improve 4/30/01 28.46
returns. June difference 1.47 $1,470
Look at the 2004 September-December
1/31/02 19.48 20.23 0.75 Sell June
spread and the December futures trade that 4/30/02 27.29
year (Table 2). The spread was -1.81 on July 30, June difference -7.06 -$7,060
2004. A trader who bought December crude oil
futures that day at 41.99 and sold on Oct. 29, 1/31/03 33.51 30.86 -2.65 Buy June
2004, at 51.76 would have earned $9,770 for a 4/30/03 25.80
June difference -5.06 -$5,060
one-contract trade — an excellent result. But
suppose this trader had sold on Oct. 8 when 1/30/04 33.05 30.98 -2.07 Buy June
the December contract was trading at 52.94. At 4/30/04 37.38
this price, a one-contract trade would have June difference 6.40 $6,400
earned $10,950.
Different tools can be used to improve trade
exits. For example, Figure 1 tracks December
2004 crude oil futures prices from the beginning Related reading
of that year. It also includes a 30-day moving
average with a two-standard-deviation (SD) “Trading today’s T-note futures” Futures & Options Trader,
boundary above the average. The prompt for the September 2007.
Oct. 8 unwinding is the futures price touching A look at patterns in the 10-year T-note futures: intraday volatility,
the upper two-SD boundary. closing tendencies, and more.
The kind of analysis shown in Figure 1 can
even help traders avoid losses. Consider Figure “Beyond the glitter” Futures & Options Trader, August 2007.
2, which tracks the December 2001 crude oil con- Breaking down the gold market’s day-to-day and intraday performance
tract throughout that year. Table 2 shows the characteristics highlights trading opportunities in this always surprising
September-December spread had its biggest loss market.
in 2001 — $4,410. However, a trader who
unwound on Sept. 14 — when the futures price You can purchase and download past articles at
peaked well above the upper two-SD boundary http://www.activetradermag.com/purchase_articles.htm.
continued on p. 12

FIGURE 1 — DECEMBER 2004 CRUDE OIL FUTURES
Price touching the upper two-SD boundary signals the exit to a trade on Oct. 8.
on, however, prices trended sharply

higher. Traders who put on this trade
would have had to bail out wherever
they could find a relatively soft land-
ing place. For example, traders who
bought June futures at 22.04 on Feb. 28
could have escaped with only a $1,180
loss, which is still a big improvement
over a $7,060 loss.
Nonetheless, a study of Table 5 sug-
gests a simple analytical approach to
locating exit points, as opposed to a
purely mechanical one, could have
turned all but two of the 10 losing
trades into at least slightly positive
trades.
The three columns headed
“mechanical” repeat the dollar results
— could have sold at 29.67 for a $4,080 gain on a one-con- from Tables 2, 3, and 4. The “analytical” columns display
tract trade. This amounts to an $8,490 swing. the results of the statistical boundaries shown in Figures 1,
Not every trade can be saved, no matter what analytical 2, and 3 to find alternative exit points. The “difference”
tools traders may use. Figure 3 displays June 2002 crude oil columns result from subtracting the mechanical values
futures prices from June 1, 2001, to the end of its trading in from the analytical values.
May 2002. On Jan. 31, 2002, the March-June spread was In three cases (the February contract trades in 1995 and
+0.75 — a prompt to sell June futures. From that moment 1996 and the June contract trade in 2004), the final day of
Table 3 or 4 was the optimal moment
for unwinding the trade. The analyti-
FIGURE 2 — DECEMBER 2001 CRUDE OIL FUTURES cal result is essentially a wash in the
Unwinding the trade on Sept. 14 — when the futures price peaked well above June 1995 trade. Elsewhere, the
the upper two-SD boundary — would have turned a losing trade into a $4,080 improvement was significant.
gain.
Looking forward
This basic analysis makes using crude
oil intermonth spreads to locate out-
right trading opportunities appear to
be a promising approach. Certainly,
there are many potential variations to
this approach, all of which should be
tested thoroughly before trading.
Even month-to-month spreads have
the potential to generate profits. For
example, during the 10-year analysis
period, a January-February spread
could have helped locate trades in the
February crude oil contract that would
have generated a $13,550 net gain
using the mechanical approach. This
trade series would have had three los-

TABLE 5 — COMPARING THE MECHANICAL AND ANALYTICAL APPROACHES
Applying the simple analytical exit approach outlined here could have turned all but two of the 10 losing trades into at least
slightly positive trades.
December February June
crude oil crude oil crude oil
Mechanical Analytical Diff Mechanical Analytical Diff Mechanical Analytical Diff
1995 450 920 470 2,450 2,450 0 2,310 2,340 30
1996 4,130 4,330 200 3,320 3,320 0 4,110 5,710 1,600
1997 -920 680 1,600 -3,310 170 3,480 -2,530 -1,110 1,420
1998 640 1,540 900 4,290 4,740 450 2,320 3,790 1,470
1999 1,530 4,150 2,620 2,510 2,930 420 -5,700 1,040 6,740
2000 5,700 7,780 2,080 -3,540 4,220 7,760 420 5,340 4,920
2001 -4,410 4,080 8,490 4,000 5,780 1,780 1,470 2,980 1,510
2002 1,190 4,420 3,230 2,040 3,560 1,520 -7,060 -1,180 5,250
2003 -210 2,670 2,880 4,440 5,670 1,230 -5,060 3,810 8,870
2004 9,770 10,950 1,180 -4,510 3,750 8,260 6,400 6,400 0
Sum 17,870 41,520 11,690 36,590 -3,320 29,120
ing trades, the largest being the 2000 February and January-February the grains and the refined petroleum
trade which would have lost $6,080. spreads involves how much time products, do not tend to reward this
However, the analytical approach to traders have to work with. The longer- approach. Non-seasonal markets such
locating exit moments could have range spreads create a three-month as the metals might reward it.
improved the results in seven of the 10 window of opportunity, as opposed to
years and reduced the year 2000 loss to the one-month window of the January- For information on the author see p. 6.
$3,840. The total gain could have been February spread.
$24,020 for the 10 years, assuming the Obviously, it will be good to test
better exit moments could have been more markets and more years of data.
recognized. Initial analysis of corn and unleaded
The big difference between the gasoline spreads indicates markets
trades based on the November- with pronounced seasonality, such as
FIGURE 3 — JUNE 2002 CRUDE OIL FUTURES

The short June futures position in place here had virtually no chance of being a
winning trade.

TRADING STRATEGIES
T-bond trading characteristics

The T-bonds may have been eclipsed by the T-notes among futures traders,
but there’s still plenty of volume — and intraday volatility — for short-term traders.
FIGURE 1 — THE DAILY ANALYSIS PERIOD

T-bonds futures swung in a wide range for much of the analysis period before selling off BY FOT STAFF
into June and jumping back up to around 112 at the end of August.
A
t one time the 30-year
Treasury bond (US)
was the contract trad-
ed at the Chicago
Board of Trade (CBOT). It has since
surrendered top position to the 10-
year T-note (TY), which has a matu-
rity that corresponds to other coun-
tries’ benchmark fixed-income
instruments.
The average daily volume for the
30-year bond traded on the e-CBOT
(the Chicago Board of Trade’s elec-
tronic trading platform) in August
2007 was just less than 446,000 con-
tracts, while the 10-year T-note’s
average daily volume during this
Source: CQGNet (http://www.cqg.com) period was more than 1.527 million
contracts.
FIGURE 2 — DAILY RANGES On the other hand, volatility is important to
traders, and the T-bond has an edge in this
Sorting the daily ranges from the smallest to largest reveals a surge in
department. The T-bond’s August 2007 average
size once the T-bond futures have moved more than a full point.
daily range was around 28/32nds ($875 per
contract) while the average daily range in the
10-year T-note was around 17/32s ($531.25 per
contract). In short, the T-bond still offers good
opportunities for traders.
This study breaks down the bond futures’
price behavior (using the electronic contract,
which trades from 6:00 p.m. CT to 4:00 p.m. CT
the next day). The analysis period begins Sept.
1, 2006 and ends Aug. 31, 2007. First, daily range
and close-to-close changes are analyzed to
determine the market’s day-to-day tendencies.
Also, characteristics of up-closing and down-
closing sessions are explored to give an idea of
the kind of price action traders can expect on
these days.
Finally, three months of intraday trading

T-bond characteristics
Insights from the Sept. 1, 2006 through Aug. 31, 2007 review:
activity using 60-minute bars is analyzed 1. The average daily range was 0.7272 points (23.27/32nds).
to determine when the market tends to 2. The daily range was under 0.9375 points (30/32nds) 82 percent of the
provide the most volatility for intraday time.
traders. 3. The daily range was 0.75 points (24/32nds) or less 62 percent of the time.
4. The daily range exceeded 0.9375 points (30/32nds) 45 out of 252
Together, these statistics provide the
sessions (eighteen percent). Of those, the range was between 0.9375 and
foundation for individual trades as well
one point 16 times. The daily range exceeded one full point 29 times
as strategies.
(12 percent).
Figure 1 is a daily chart of the analysis
5. Seventy-one percent of the time the low for up closing sessions was
period. During the first two-thirds, T- between down 1/32 and 10/32nds from the previous session’s close.
bond futures traded in a broad range, 6. Sixty-two percent of the time the session’s high was between plus 1/32 up
sold off sharply, and then rallied just as to and including 10/32nds for down-closing sessions.
briskly through the end of August 2007. 7. Intraday analysis from June 1, 2007 through Aug. 31, 2007 shows the
highest average range for the 60-minute bars occurred during the 7:00,
T-bond daily ranges 8:00, and 9:00 hours (CT). The largest average hourly range (11.6/32nds)
Figure 2 is a chart of the daily ranges sort- occurred during the 7:00 hour.
ed from the smallest to the largest. The
average daily range during the analysis period
FIGURE 3 — DISTRIBUTION OF DAILY RANGES
was 0.7272 points (23.27/32nds), which nearly
matched the August average daily range cited The daily range was 0.75 points (24/32nds) or less 62 percent of the time.
earlier. The median daily range was 0.69 points
(22.08/32nds).
The smallest daily range, which occurred four
times, was 0.28125 (9/32nds). The largest daily
range was 1.96875 (1-31/32nds) on Feb. 27,
2007. This is indicative of the decreased volatili-
ty in the financial markets over the past five
years; in years past the daily limit for bonds was
three points. During the review period, the mar-
ket did not generate a daily range as large as
two points, and today, the exchange does not
enforce a daily limit rule for T-bonds.
In Figure 2 the slope of the daily ranges from
left to right is relatively steady until the one-
point mark, when the rate of the increase in
daily ranges accelerates. This might be evidence
of a kind of psychological threshold — i.e., if the
daily range exceeds one point, the fundamen- FIGURE 4 — DISTRIBUTION OF CLOSE-TO-CLOSE CHANGES
tals driving the daily trend are considered to be
The greatest number of close-to-close changes were in the 7/32nds to
very one-sided. 8/32nds category (0.25 points).
Figure 3 is a frequency distribution of the
daily ranges that shows how often ranges of dif-
ferent sizes occurred. The vertical axis shows
the number of occurrences and the horizontal
axis represent daily ranges (in 0.0625, or
2/32nd, increments). For example, the daily
range was greater than 0.5000 points (16/32nds)
up to and including 0.5625 (18/32nds) 21 times
— that is, 17/32nds or 18/32nds — as shown by
the fifth bar from the left, labeled “0.5625.”
The daily range was 0.9375 points (30/32nds)
or less 82 percent of the time and 0.75 points
(24/32nds) or less 62 percent of the time. The
daily range exceeded 0.9375 points (30/32nds)
only 45 times (18 percent) — 16 of which were
continued on p. 16

FIGURE 5 — UP-CLOSING SESSIONS

The deeper the intraday low for the up-closing session, the lower the high.
Treasury refresher
Treasury bonds and notes are debt securities
issued by the United States Treasury. They
are considered debt instruments because by
purchasing them you are loaning money to
the Treasury department, which then pays
you interest (determined by a “coupon rate”)
on a semiannual basis and returns the princi-
ple when the bond or note matures on the
maturity date. T-bonds and T-notes are called
“fixed-income” securities because of the fixed
coupon payment an investor receives while
holding the bond or note.
T-notes are issued in maturities of two,
three, five, and 10 years; T-bonds have matu-
rities greater than 10 years. The minimum
FIGURE 6 — DISTRIBUTION OF LOWS FOR UP-CLOSING SESSIONS bond or note size is $1,000. For example, if
For up-closing sessions, the low was between 1/32nd and 10/32nds you purchased a $1,000 10-year T-note with
below the previous session’s close 71 percent of the time. a 4-percent coupon, you would receive $20
every six months, totaling $40 per year; the
$1,000 would be paid back to you on the
maturity date 10 years from now. A bond or
note’s yield is its coupon payment divided by
the price — in this case, 4 percent
($40/$1,000).
Treasury futures prices indicate a percent-
age of “par” price, which for any Treasury
bond or note is 100. T-bond prices consist of
the “handle” (e.g., 100) and 32nds of 100. For
example, 98-14 is a price that translates to
98-14/32nds or $984.38 for a $1,000 T-bond.
T-notes are priced in a similar fashion, except
they can include one-half of a 32nd — for
example, 98-14+ is 98-14.5/32nds, or 984.53
for a $1,000 T-note.
ranges between 0.9375 and one point. The remaining 29 ses- Up-closing vs. down-closing days
sions were larger than one full point. Analyzing the difference between the daily low and the pre-
vious day’s close for up-closing sessions and the difference
Close-to-close moves between the daily high and the previous day’s close for
What is the range and typical close-to-close behavior? down-closing sessions can be helpful for identifying intra-
Figure 4 is a frequency distribution analysis of the close-today-trade risk.
close changes. Figure 5 displays a bar chart of up-closing sessions. The
The session closed within a range of -0.53125 points data is adjusted to use the previous day’s close as the open-
(-17/32nds) to 0.5000 points (+16/32nds) 84 percent of the ing price. In addition, the bars are sorted by the most
time. In other words, only 16 percent of the time did the extreme up-closing-day loss to the smallest loss, which
market close lower than -17/32nds or close with a gain of were sessions that the market never traded down (this
more than 16/32nds. The market closed with a one-point or occurred eight times).
larger loss just five times and a one-point or larger gain four The market closed up 121 times during the review peri-
times. od. A slight bias is visible in the chart: more extreme lows
for up-closing sessions produced lower highs. The median

Related reading
“Trading today’s T-note futures”
FIGURE 7 — DOWN-CLOSING SESSIONS
Futures & Options Trader, September 2007.
A look at patterns in the 10-year T-note futures:
Compared to the up-closing session high-to-low relationships, the low- intraday volatility, closing tendencies, and more.
to-high relationship for down-closing sessions is more pronounced.
“Dissecting T-note futures:
Tendencies and characteristics”
Active Trader, July 2005.
A detailed understanding of a market’s price history
and characteristics allows you to craft trade strate-
gies founded on statistical reality rather than casual
observation. The following analysis takes the pulse
of the T-note futures market. Note: This article is
also contained in the discounted compilation, “Thom
Hartle Strategy and Analysis Collection, Vol. 2.”
“Short-term T-bond trading”
Active Trader, October 2002.
This strategy takes quick intraday profits using rules
determined by the daily trend. Using a combination
of indicators, it is possible to trade T-bond futures
on a short-term basis when the bond market is in a
trend or trading range. This technique uses a multi-
ple time frame approach: Two indicators applied to
high for the left-hand side of the chart is 0.46875 points (15/32nds) daily bars work together to determine the trend; two
and the median high for the right-hand side is 0.5625 points others, Bollinger Bands and the moving average
(18/32nds). convergence-divergence (MACD) indicator, identify
Figure 6 is a frequency distribution of the lows for up-closing entry and exit signals on an intraday basis.
sessions. The low for up-closing sessions was between 1/32 and
“Treasury bonds and notes”
10/32nds from the previous session’s close 71 percent of the time. Active Trader, June 2005.
The low was unchanged or higher 20 percent of the time. The mar- Trading Basics: A primer on the U.S. Treasury
ket traded down by more than 10/32nds and still recovered to market.
close up for the session only nine percent of the time; the most
extreme low was -31/32nds for the day. “The TUT spread:
Figure 7 shows the sessions that closed down for the day. As in An active spread for active traders”
continued on p. 18 Active Trader, October 2005.
The spread between 10-year and two-year T-note
contracts offers a vehicle for taking advantage of
FIGURE 8 — DISTRIBUTION OF HIGHS interest rate shifts.
FOR DOWN-CLOSING SESSIONS Note: This article is also contained in the discounted
On down-closing days, the intraday high was between 1/32 and compilation, “Keith Schap: Futures Strategy collec-
10/32nds above the previous close 74 times (62 percent). tion, Vol. 1.”
“The hidden factor in treasury futures pricing”
Active Trader, March 2006.
Those looking for insights into the treasury market
should analyze the interesting relationships between
the cash and futures market, as well as interest rate
movements.
“The 2-year/10-year Treasury spread
and the S&P 500”
Active Trader, September 2006.
Traders often infer stock market behavior
from developments in the 2-year/10-year T-note
spread, but there might be less to this
relationship than many think.
You can purchase and download past articles at
http://www.activetradermag.com/purchase_articles.htm.

FIGURE 9 — INTRADAY ANALYSIS PERIOD: JUNE 1, 2007 THROUGH AUG. 31, 2007
Sixty-minute bars were analyzed to find out what part of the trading session has the
most volatility.
is -0.60 points (-19.2/32nds)

and the median low for the
right-hand side is -0.3950
points (-12.64/32nds). This is
a more pronounced bias than
Figure 5’s analysis.
Figure 8 is the frequency
distribution of the highs for
down-closing sessions. The
market closed down 119 times
during the review period.
Twenty sessions or 17 percent
of the down-closing sessions
the market did not trade
above the previous session’s
close.
The market had a high
between 1/32 and 10/32nds
74 times (62 percent). It had a
high of more than 10/32nds
and still closed down 25 times
(21 percent). The most
extreme high for a down-clos-
ing session was a gain of 1-
1/32nds.
Intraday analysis
Three months of intraday
trading activity using 60-
minute bars is reviewed to
determine when the market is
likely to be most volatile.
Figure 9 shows the 60-minute
chart for June 1, 2007 through
Aug. 31, 2007.
Figure 10 sorts the average
and median 60-minute ranges
by time (CT). The peak aver-
age range is 0.3626 or
11.6/32nds and the median is
0.3125 points or 10/32nds and
occurs during the 7:00 hour.
This coincides with the
release of key economic statis-
Source: CQGNet (http://www.cqg.com) tics such as the employment
report, producer price index
Figure 5, the data is adjusted to use the previous day’s close data, and the consumer price index data.
as the opening price and the bars are sorted by the lowest Interestingly, if the average range for the individual ses-
high to the highest high. sions during the 12-month review period was 23.27/32nds,
If we divide Figure 7’s data by two segments to deter- then the average range of 11.6/32nds for the 7:00 hour
mine how low the market went relative to how high, we implies there is room for the market to move depending on
find that the median low for the left-hand side of the chart what the session’s range was before the release of a report.

FIGURE 10 — 60-MINUTE RANGES SORTED BY TIME
The 7:00 a.m. CT bar — which includes the most important economic
report releases, such as unemployment and inflation — had the peak
average hourly range.
Figure 11 shows all of the hourly ranges for

the 7:00-9:00 hours. The hourly range exceed-
ed 0.5000 points (16/32nds) nine times in the
7:00 hour. This only occurred five times dur-
ing the 8:00 hour and six times in the 9:00
hour.
Figure 12 is a frequency distribution of the
hourly ranges for the 7:00-9:00 hours. The
most common hourly range is 8/32nds,
which occurred 48 times. The hourly range
was greater than 8/32nds and up to 16/32nds
98 times.
What to do?
First, put the analysis in a frame of reference FIGURE 11 — HOURLY RANGES FOR THE 7-9 A.M. HOURS
— Figure 1 is the place to start. This analysis
was done over a period when the bond mar- The largest hourly ranges occur in the 7:00 hour, including one
ket traded sideways for eight months in a occurrence of a range exceeding a full point.
wide range, then dropped precipitously, only
to reverse and climb back above the prices
seen at the start of the review period. In other
words, the market was not in a sustained up
or down trend during the review period,
which would likely have led to different
results. Therefore, the analysis does not have
a trend bias, which is a positive.
Probably, the most valuable information is
the price behavior for up- vs. down-closing
sessions. A trading system could be built
upon this analysis. A trend indicator, such as
a three-day moving average could be
employed; if the three-day average is rising,
the trend is up.
An intraday strategy could be tested using
momentum studies for identifying bullish
FIGURE 12 — DISTRIBUTION OF THE HOURLY RANGES
divergences within the typical session’s range
for lows; this was between -1 and 10/32nds 71 The most frequently occurring hourly range was 8/32nds (0.25000).
percent of the time. If the market trades down
by more than 10/32nds, the likelihood of an
up close is more remote, and the three-day
trend may be turning down. Stop looking for
a buy set-up. The same concept could be
applied for short sale entries if the three-day
moving average is headed down.
Traders new to the markets can easily
assume the volatility they witness is normal.
However, volatility does change and the
results detailed here will also change. To stay
on top of typical price behavior for a market,
this analysis needs to be performed quarterly.
From there, trading strategies can be updat-
ed.

TRADING STRATEGIES
Earnings reports and covered calls

The odds of success of a covered call strategy depend on the “quality” of the stock and whether there
are earnings reports looming on the horizon.
BY MIKE PHILLIPS
S
ome surprises can be nice — birthday parties, that’s not necessarily the case. Analysis of stocks (with trad-
tax refunds, a winning lottery ticket. But others able options) from 2000 until the first half of 2007 revealed
— car repairs, tax audits, root canals — are less that a stock’s price is, on average, more likely to go up than
welcome. down after earnings reports: 52 percent of the stock prices
The stock market also has its surprises. Public companies went up after earnings came out, while 47 percent declined
are required to publish their earnings results quarterly, and (Table 1).
if a number is not in line with expectations, it’s considered The results for 2000 are not so surprising, as 2000 wasn’t
an “earnings surprise,” which can significantly impact a a bad year for stocks (overall, the decline was offset by the
stock’s price, positively or negatively. rally early in the year). However, 2001 and 2002 were dis-
Options traders need to pay particular attention to earn- mal years for the stock market, but optionable stocks were
ings reports because the results of earnings surprises are still more likely to rise following an earnings report in those
magnified in the option world: An earnings surprise that years.
results in a 10-percent move in a stock’s price might move
options on that stock significantly more. The covered call strategy
One of the most popular stock-options strategies is the cov-
Unconventional wisdom ered call, which consists of selling a call option against a
Although conventional wisdom may say a stock’s price is long stock position. The covered call is a neutral-to-bullish
more likely to go down than up after an earnings report, strategy that is profitable as long as the stock price increas-
es or stays about the same.
The stock component of the covered call position can
TABLE 1 — GOING UP decrease slightly and the position will remain profitable,
Although conventional wisdom might suggest otherwise, but if the stock price drops more than the covered call posi-
analysis of stocks since the year 2000 shows they were tion’s downside protection threshold, it may experience a
more likely to rise in value after an earnings report. loss. A stock price at or above the strike price of the call
option for a covered call position is necessary in order to
Down Up No change realize the maximum potential return. Also, a covered call’s
2000 46.3% 52.4% 1.3% potential return is limited. For stock prices higher than the
2001 42.9% 54.7% 2.3% call option’s strike price, the covered call position will con-
2002 48.0% 50.6% 1.4% tinue to generate the same ultimate return.
On the surface, earnings reports would seem positive for
2003 44.6% 53.5% 1.9% covered call positions, since a stock is more likely to go up
2004 48.5% 53.5% 1.0% than down after an earnings report. But the covered call
2005 45.9% 53.5% 0.6% position is not a two-way street, since the potential down-
2006 49.0% 49.9% 1.0% side loss for the position is very large and the upside poten-
tial is limited.
2007* 49.5% 49.2% 1.3% For example, Figure 1 shows the profit/loss chart for a
*partial year covered call position for Wal-Mart (WMT). Entering a cov-
ered call position for Wal-Mart requires purchasing 100

FIGURE 1 — PROFIT POTENTIAL
The covered call strategy on Wal-Mart would earn the most if
shares of Wal-Mart stock at $43.06 per share for a cost of WMT stayed where it was at the time the covered call was
$4,306. Also, the position requires selling one Wal-Mart entered.
October 42.50 call option (WMTJV OCT 42.5) at $1.75 for a
total selling price of $175.
The maximum profit from the covered call is realized as
long as the price of WMT is at or above the short call
option’s strike price of $42.50 at option expiration in
October. The maximum profit is represented by the call
option’s selling price minus the difference between the pur-
chased stock price and the call option’s strike price:
Purchase price of WMT stock per share: 43.06

Strike price of call option WMTJV: -42.50
—————
Purchase price/strike price difference: 0.56
Selling price of call option: 1.75

Purchase price/strike price difference: -0.56
—————
Maximum potential profit per contract: 1.19
The maximum potential return for a covered call is deter-

mined by the maximum potential profit divided by the
maximum risk. Maximum risk represents the maximum Source: PowerOptions
potential loss of a position. The maximum risk for a cov-
ered call position is the purchase price of the stock minus for the next month’s expiration.
the selling price of the call option: Covered call positions for companies not publishing a
quarterly earnings report or an annual earnings report dur-
Purchase price of WMT stock per share: 43.06 ing the holding period were segregated and analyzed in the
Selling price of call option: -1.75 “Not holding position during earnings report” group (Table
—————— 2). Conversely, covered call positions for companies with
Maximum risk: 41.31 quarterly or an annual earnings reports during the holding
period were segregated and analyzed in the “Holding posi-
Maximum potential profit tion during earnings report” group.
Maximum potential return = ——————————— The holding period for this investment methodology is
Maximum risk generally about 30 days, allowing for only one potential
quarterly or annual earnings report during the time period.
Wal-Mart maximum potential return: 1.19/41.31 = 2.9% The average monthly returns for holding and not holding
the positions during an earnings report were significantly
If a company releases a positive earnings report and its different: 0.7 percent vs. 1.1 percent, respectively. The
stock price increases significantly, the covered call position cumulative returns were much better for the covered calls
will experience a much smaller return than that of the stock. that weren’t held (13 percent vs. 8.6 percent). Also, the win-
On the other hand, if a company has a negative earnings ning percentage for not holding a position was nine percent
report and its stock price decreases significantly, the cov- greater (78 percent vs. 69 percent). For the period of this
ered call position will experience a large loss. This makes it analysis, a covered call strategy investing in the broad mar-
difficult to produce sizable returns using covered calls. ket would have been better off not holding a position dur-
To find the potential of covered call positions, all in-the- ing an earnings report.
money covered calls with potential returns above 3 percent
and open interest greater than 300 were tested from July Covered calls vs. S&P 500
2006 to July 2007, in two categories: holding a position The S&P 500 returned 22 percent from July 2006 to July 2007
through an earnings report, and not holding a position. — more then either broad-market covered call strategy.
Positions were entered the Monday after options expiration continued on p. 22

TABLE 2 — BETTER OFF BEING OUT

Since July 2006, covered call positions in the broad market have fared better when no earnings reports on the underlying
stock were released.
Not holding position during earnings report Holding position during earnings report
Broad market Broad market
Covered Number Covered Number
Entry Exit call Success of Entry Exit call Success of
date date % return rate positions date date % return rate positions
7/24/2006 8/18/2006 3.1 90 68 7/24/2006 8/18/2006 1.4 78 147
8/21/2006 9/15/2006 0.7 74 149 8/21/2006 9/15/2006 1.8 71 7
9/18/2006 10/20/2006 2.4 86 158 9/18/2006 10/20/2006 2.9 92 36
10/23/2006 11/17/2006 1.4 84 55 10/23/2006 11/17/2006 2.0 83 172
11/20/2006 12/15/2006 2.1 83 128 11/20/2006 12/15/2006 -2.1 45 11
12/18/2006 1/19/2007 -0.4 66 140 12/18/2006 1/19/2007 2.1 73 15
1/22/2007 2/16/2007 3.9 95 55 1/22/2007 2/16/2007 1.7 81 100
2/20/2007 3/16/2007 -7.2 39 66 2/20/2007 3/16/2007 -5.7 43 49
3/19/2007 4/20/2007 3.3 93 132 3/19/2007 4/20/2007 4.4 97 30
4/23/2007 5/18/2007 0.2 69 138 4/23/2007 5/18/2007 -0.9 67 15
5/21/2007 6/15/2007 2.9 80 112 5/21/2007 6/15/2007 1.6 60 10
6/18/2007 7/20/2007 0.6 76 150 6/18/2007 7/20/2007 -0.7 40 5
Average 1.1 78 Average 0.7 69
Cumulative 13.0 Cumulative 8.6
Source: PowerOptions SmartHistoryXL
TABLE 3 — HOLD ‘EM

When considering only S&P 500 stocks, it’s been more profitable to be in a covered call during the period of an earnings release.
Not holding position during earnings report Holding position during earnings report
S&P 500 S&P 500
Covered Number Covered Number
Entry Exit call Success of Entry Exit call Success of
date date % return rate positions date date % return rate positions
7/24/2006 8/18/2006 4.0 100 22 7/24/2006 8/18/2006 3.0 93 29
8/21/2006 9/15/2006 -1.2 68 19 8/21/2006 9/15/2006 4.9 100 2
9/18/2006 10/20/2006 1.3 90 21 9/18/2006 10/20/2006 2.5 93 15
10/23/2006 11/17/2006 3.5 100 11 10/23/2006 11/17/2006 1.6 82 34
11/20/2006 12/15/2006 2.8 88 8 11/20/2006 12/15/2006 3.1 100 1
12/18/2006 1/19/2007 -0.9 57 14 12/18/2006 1/19/2007 0.9 63 8
1/22/2007 2/16/2007 3.4 100 1 1/22/2007 2/16/2007 1.9 78 18
2/20/2007 3/16/2007 -2.3 67 3 2/20/2007 3/16/2007 -0.9 50 2
3/19/2007 4/20/2007 3.9 100 15 3/19/2007 4/20/2007 2.9 90 10
4/23/2007 5/18/2007 2.5 85 13 4/23/2007 5/18/2007 4.0 100 3
5/21/2007 6/15/2007 0.1 50 12 5/21/2007 6/15/2007 -0.9 33 3
6/18/2007 7/20/2007 2.3 88 16 6/18/2007 7/20/2007 0
Average 1.6 83 Average 2.1 80
Cumulative 19.5 Cumulative 23.1

TABLE 4 — BEWARE OF BIOTECH
Although covered calls on biotech stocks present an opportunity for outsized returns, on average it’s not a particularly prof-
itable strategy.
Highest potential return biotechnology covered call positions

% %
Stock Option unchanged assigned Actual
Entry date Exit date Company name symbol symbol return return return
5/22/2006 6/16/2006 Onyx Pharma. ONXX OIQFD 9.3% 9.3% -13.1%
6/19/2006 7/21/2006 NeoPharm Inc. NEOL UOEGU 12.8% 36.9% -17.3%
7/24/2006 8/18/2006 Genitope Corp. GTOP GWYHU 30.5% 63.5% -45.3%
8/21/2006 9/15/2006 Hollis-Eden Pharma. HEPH QGQIU 11.8% 18.1% -8.3%
9/18/2006 10/20/2006 Hollis-Eden Pharma. HEPH QGQJA 10.4% 10.4% 10.4%
10/23/2006 11/17/2006 Renovis Inc. RNVS JHUKC 39.0% 42.9% -67.4%
11/20/2006 12/15/2006 Northfield Laboratories Inc. NFLD DHQLV 13.1% 13.1% 13.1%
12/18/2006 1/19/2007 Northfield Laboratories Inc. NFLD DHQAC 24.8% 30.8% -65.1%
1/22/2007 2/16/2007 BioCryst Pharmas. Inc. BCRX BIUBB 6.7% 6.7% 6.7%
2/20/2007 3/16/2007 Hollis-Eden Pharma. HEPH QGQCA 9.9% 9.9% -28.6%
3/19/2007 4/20/2007 Dendreon Corp. DNDN UKODA 22.8% 62.9% 62.9%
4/23/2007 5/18/2007 Dendreon Corp. DNDN UKOEW 30.3% 35.9% -52.9%
5/21/2007 6/15/2007 Cypress Bioscience Inc. CYPB QGYFU 36.4% 36.4% 36.4%
6/18/2007 7/20/2007 Encysive Pharmas. Inc. ENCY IQEGZ 9.4% 17.9% -3.3%
Average 19.1% 28.2% -12.3%
Table 3 shows the results of running the same test exclu- biotech industry. In most other industries, a company not
sively on S&P 500 stocks, again comparing holding a posi- hitting on all cylinders can still generate a profit and even
tion and not holding through an earnings report. experience a small growth rate. However, stocks of biotech
This test produced results directly opposite to the first companies are generally either hitting on all cylinders or
test. Holding the position returned 23.1 percent — a return have blown their engines and are headed for the junk yard.
that slightly outperformed the S&P — vs. 19.5 percent for For example, selecting the highest potential return cov-
not holding the position. For the time period used in this ered-call position each month starting in May 2006 revealed
analysis, a covered-call strategy in high-quality stocks such an average maximum potential of 19.1 percent, but those
as the S&P 500 would have performed better if specifically positions would have actually yielded an average loss of
applied to companies with upcoming earning reports. 12.3 percent (Table 4). Although the potential returns for
biotech covered-call positions can be very high, the odds of
Big potential returns in biotech success are very low.
The biotechnology arena is a potential minefield for cov- It’s not difficult to identify a reason for such erratic
ered call traders. The covered call strategy for biotech stocks results, as the FDA approval process is long and complex.
produced an average potential return, starting in May 2006, However, the profit potential for a new drug with patent
of around 11 percent. However, the corresponding actual protection can be very lucrative, and the stocks of compa-
average return for an investment in all of the available nies with successful drugs are often compensated hand-
biotechnology covered call positions for the same time peri- somely. As a result, the potential returns for biotech covered
od would have resulted in a net return of zero. call positions are relatively high, but the odds of capturing
Investing in biotech is extremely risky, which is the rea- this high return are not favorable.
son potential returns for biotech-related covered calls are so
elevated. The prospects for biotech companies are hit-or- To invest or not to invest
miss — either a product is approved by the Food and Drug Should covered call investors consider biotech as taboo and
Administration (FDA) or it isn’t, and the price of the com- avoid the industry, or is there an approach for generating
pany’s stock reacts accordingly. profits? Testing biotech positions beginning in May 2006 for
This hit-or-miss phenomenon is almost exclusive to the continued on p. 24

Related reading
“Covered calls vs. cash-covered short puts”
Futures & Options Trader, July 2007
TABLE 5 — HIGH RISK, HIGH REWARD
“Early earnings guidance,” Active Trader, May 2007
Sticking to biotech stocks with a minimal profit will also
help keep potential losses to a minimum. “The earnings guidance game,” Active Trader, April 2007
Biotechnology covered calls by % if unchanged “Rolling profitable covered calls”
Potential return Number of Success Actual Futures & Options Trader, April 2007
range positions rate return
“Calendar spreads surrounding earnings news”
3.00-3.33% 29 72% 1.6% Options Trader, March 2007
3.33-3.66% 23 78% 2.6%
“Solving the earnings puzzle,” Active Trader, March 2007
3.66-4.00% 39 74% 2.2%
4.00-4.33% 26 69% 1.5% “Selling OTM puts just before an earnings release pays off”
4.33-4.66% 22 64% 0.9% Options Trader, December 2006
4.66-5.33% 31 55% -3.3% “Starbucks earnings announcement trade”
5.33-6.00% 31 68% 2.4% Options Trader, September 2006
6.00-7.00% 23 65% -1.0% “Calendar spreads after earnings releases”
7.00-12.00% 34 59% 0.3% Options Trader, September 2006
12.00-40.00% 20 50% -10.6%
“Writing covered calls and puts”
Options Trader, June 2006
profitability, and breaking the profit potential down by dif-
“Covered calls: stocks vs. LEAPS”
ferent return categories, returned the results shown in
Options Trader, June 2006
Table 5.
Breaking down the positions by profit potential yielded “Short put earnings announcement trade”
some interesting results. The apparent optimum range is Options Trader, April 2006
3.33-3.66 percent. This range yielded an average actual
“Earnings announcement bull put spread”
return of 2.6 percent with a success rate of 78 percent vs.
Options Trader, March 2006
significant losses (-10.6 percent) and poor success rate (50
percent) for positions selected with potential returns in the “Max Ansbacher: The options seller”
12-40-percent range. Options Trader, January 2006
In this analysis, a covered call strategy investing in “Earnings announcement bear call spread”
biotechnology would have been better off entering posi- Options Trader, December 2005
tions with lower potential returns, generally in the 3-4-per-
cent range. In general, the higher potential returns for “Earnings season short put trade”
biotechnology covered call positions do not adequately Options Trader, November 2005
compensate for the higher risk. “Sharpen your trading edge with earnings dates”
Active Trader, October 2004
Plan accordingly
Investors considering a covered call strategy should care- “Technicals meet fundamentals in the earnings flag”
Active Trader, February 2004
fully evaluate the timing of company earnings reports and
the potential dangers of investing in biotech before enter- “A new look at naked puts,” Active Trader, August 2002
ing a position. Holding a covered call position during an
“Productivity: driving earnings, driving stocks”
earnings report for the overall stock market appears to
Active Trader, August 2002
have a negative impact on a covered call’s return.
Conversely, holding a covered call during an earnings “Earnings-season option strategies”
report for high-quality companies, such as S&P 500 stocks, Active Trader, March 2001
appears to have a positive impact on the strategy.
“Taking cover with options,” Active Trader, May 2000
A covered call investor investing in the broad market
should search for covered call positions without an earn- You can purchase and download past articles at
http://www.activetradermag.com/purchase_articles.htm.
ings report before options expiration to avoid nasty nega-
tive earnings surprises, and investors focusing on covered
call positions for high-quality companies such as the S&P risks. Although covered calls in biotech generally have very
500 may potentially achieve superior results by selecting high potential returns, the odds of success for generating
positions in companies with an upcoming earnings report. high returns in biotech are dismal.
Additionally, investors considering investing in biotech
covered calls should carefully evaluate the high-potential For information on the author see p. 6.

TRADING STRATEGIES
Bear put ladders

Ratio spreads are hard to beat — if the market closes exactly at the short strike price at expiration.
Option ladders often offer more opportunities to profit.
BY PHILIP BUDWICK
W hen the stock market swooned in late ent strikes below the market.
July, traders saw the upward trend had “Bull call ladders” (Futures & Options Trader, August
reversed. The S&P 500 initially plunged 2007) compared ratio call spreads to bull call ladders, both
5.8 percent in less than two weeks — of which face large losses if the market rallies sharply. By
hardly a subtle shift.
However, traders soon discovered
that identifying a market bottom was
contrast, the following put spreads can lose money if the
more difficult. After falling to a four- TABLE 1 — RATIO PUT SPREAD

month low in early August, the S&P As long as Apple trades above the breakeven point ($131.60), this spread will
bounced back above 1,500 within two gain between $3.40 and $8.40.
days. Still, the market dropped anoth-
Components Long/short Credit/debit
er 8.9 percent before the sell-off even-
1 November 145 put Long -$7.60
tually lost steam.
2 November 140 puts Short $11.00
Options traders could have chosen Net credit: $3.40
among dozens of bearish positions to Scenario (at Nov. 17 expiration):
profit from this downturn, but the AAPL trades above $145 long strike “Worst-case” gain: $3.40
ratio put spread (long put, short multi- AAPL drops to $140 short strike Max. gain: $8.40
ple lower-strike puts) may not have Breakeven point: $131.60
been a good choice, for two reasons: Its
biggest potential gain occurs solely at
the short strike price, and it faces large Strategy snapshot
losses if the market drops much below
it. If you’re not confident about when Strategy: Bear put ladder
the market will stop falling, this strate- Components: ATM or OTM long put + OTM short put + second lower-strike
gy is risky. short put.
However, ratio put spreads have
several advantages. If you enter the Logic: Profit if the underlying falls 5 to 10 percent by expiration.
position for a credit, you can be slight- Lower ratio put spread’s downside risk in exchange for
ly wrong about direction and still a smaller credit.
make money. And, if the market closes Criteria: Use puts that expire in less than two months.
at its short strike at expiration, the
spread will gain more than other simi- Best-case Market drops and trades between the two short strikes
lar strategies. scenario: by expiration.
Bear put ladders offer more down- Worst-case
side protection in exchange for a small- scenario: Market falls far below the lowest short strike.
er net credit. They resemble ratio put
spreads, but instead of selling two or Possible If market rallies, buy one put below the lowest short strike to
more puts at a lower strike, they sell adjustments: remove all downside risk. Put must cost less than initial
the same number of puts at two differ- credit received.

FIGURE 1 — RISK PROFILE — RATIO PUT SPREAD
market tanks. Both types of positions
offer similar potential gains and loss- Ratio spreads capture their largest gain if the market trades at the short strike
es, but on opposite sides of the mar- ($140) at expiration. Most profits appear in the final weeks before expiration.
ket.
What is a ratio spread?

Creating a ratio spread involves sell-
ing more options than you buy in the
same expiration month. The long
option’s strike is closer to the money,
the short options’ strike is further out-
of-the-money (OTM), and the ratio is
fixed at 1:2 or 1:3 (long to short).
The S&P 500 traded at 1,522 on
Sept. 26. To enter a ratio put spread,
you could buy one October 1,520 put
and sell two October 1,500 puts. Or
you could enter a ratio call spread by
purchasing one 1,520 call and selling
two 1,540 calls. Either spread might
offer a net credit, because although
the short options are cheaper, you are Source: OptionVue
selling more contracts than you buy.
This credit protects the spread on
one side of the market. If you entered
a 1,520-1,540 ratio call spread for a
credit and the S&P 500 fell 10 percent
by Oct. 19 expiration, all the calls
would expire worthless, and you
would keep any premium collected.
Similarly, if you established a 1,520-
1,500 ratio put spread for a credit and
the S&P jumped 10 percent by
October expiration, all the puts would
expire worthless. Meanwhile, you
keep the credit, which removes any
upside risk.
However, additional short options
expose ratio spreads to potential loss-
es on the other side. For instance, the
1,520-1,500 ratio put spread will hit its
maximum profit if the S&P closes at
1,500 at expiration, but it will lose
money quickly if the S&P drops much
below that threshold.
Ratio put spread example

Apple Inc. (AAPL) traded at $148 on
Sept. 24. If you thought AAPL might
pull back roughly five percent within
two months, you could buy one
November 145 put at 7.60 and sell two
continued on p. 28

OTM November 140 puts for 5.50 each

TABLE 2 — BEAR PUT LADDER
— 3.40 credit ($340).
This ladder offers a smaller credit and lower maximum profit, but its breakeven Table 1 lists the 145-140 put ratio
point is lower and its largest gains occur within a wider price range ($135-$140).
spread’s details, and Figure 1 shows
Components Long/short Credit/debit its potential gains and losses on three
1 November 145 put Long -$7.60 dates: trade entry (Sept. 24, dotted
1 November 140 put Short $5.50
line), halfway until expiration (Oct. 21,
dashed line), and expiration (Nov. 17,
Net credit: $1.80
Scenario (at Nov. 17 expiration): solid line). Notice the spread’s largest
AAPL trades above $145 long strike “Worst-case” gain: $1.80 gains appear in the final month before
AAPL trades between $140 and $135 short strikes Max. gain: $6.80 expiration as the short puts’ time
Breakeven point: $128.20 decay accelerates.
The spread’s maximum profit
occurs if Apple slips to $140 by Nov. 17
FIGURE 2 — RATIO SPREAD VS. LADDER expiration. The short puts will expire
The ratio put spread (blue line) outperforms the bear put ladder (pink line) if worthless, so you will keep the 3.40
Apple doesn’t drop below $140. But the bear put ladder protects against credit. Also, the $145 put will be worth
steeper declines. 5.00 — a total gain of 8.40.
If Apple trades above $145 at expira-
tion, all puts will expire worthless and
you keep the 3.40 credit received.
Therefore, you can still make money
even if AAPL falls 3.4 percent. When
AAPL declines below $140, however,
the extra short put works against you
and profits dwindle until Apple hits its
breakeven point ($131.60).
Ideally, the market will close at the
short strike at expiration, but this is
unlikely. Therefore, ratio-spread
traders often hope the market closes
between the long and short strikes at
expiration. Losses can mount when the
market falls below a put ratio spread’s
downside breakeven point, but a lad-
der position offers more protection.
Source: OptionVue Descending the ladder

Placing the ratio spread’s short puts at
TABLE 3 — ITM BEAR PUT LADDER two different OTM strikes has three
Moving the ladder’s three strikes up $5 raises the breakeven point, but boosts benefits: it widens the maximum prof-
its net credit and maximum profit. it area, lowers the breakeven point,
and slows the rate at which losses
Components Long/short Credit/debit accumulate below it. The trade-off is
1 November 150 put Long -$10.00
that you collect less premium because
you are selling a put even further
Net credit: $3.10
below the market.
Scenario (at Nov. 17 expiration): To place a put ladder on AAPL, buy
AAPL trades above $150 long strike “Worst-case” gain: $3.10 one November 145 put at 7.60, sell one
AAPL trades between $145 and $140 short strikes Max. gain: $8.10 November 140 put at 5.50, and sell
Breakeven point $131.80 another one strike below it (135) at 3.90
— a credit of 1.80. Table 2 shows the

FIGURE 3 — ITM VS. WIDE-STRIKE LADDER
Choosing an ITM ladder makes sense if you don’t expect Apple to drop more
than five percent (green line). But if you expect AAPL to slide further, a wider-
145-140-135 ladder’s components, and strike ladder offers more downside protection (blue line).
Figure 2 compares its potential gains
and losses with the 145-140 ratio put
spread’s (pink and blue lines, respec-
tively).
If Apple trades above $145 at expi-
ration, all puts still expire worthless,
and you keep the initial credit of 1.80.
The largest profit occurs when AAPL
trades between $140 and $135 at expi-
ration. In this case the 135 short put
expires worthless and the remaining
puts — long 145 and short 140 strikes
— form a bear put spread worth 5.
Overall, the ladder will gain 6.80 (5
from vertical spread + 1.80 credit).
The ladder collects 1.60 less premi-
um, meaning its upside profit is
reduced by this amount. But you still
have no upside risk. Also, the ladder’s
downside breakeven point dropped to Source: OptionVue
$128.20 from $131.60 and its maxi-
mum profit zone widened to $135-
$140 from just $140.
Moving into the money,

skipping strikes
Put ladders are good examples of how
flexible options strategies can be.
Table 2’s 145-140-135 ladder has an at-
the-money (ATM) put with two short
strikes at equal distances below it. But
you can always adjust each strike to
better suit a specific directional fore-
cast.
For example, if you don’t expect
Apple to drop more than five percent,
you could move the ladder’s long
strike slightly into-the-money (ITM)
and still collect premium upon entry.
When Apple traded at $148 on Sept.
24, you could buy one November 150
put for $10.00, sell one same-month
145 put for 7.60, and sell one 140 put
for 5.50 — a total credit of 3.10. Table 3
lists the 150-145-140 ladder’s details.
Each strike is $5 higher, raising the
downside breakeven point to $131.80
from $128.20. However, if AAPL
trades between $145 and $140, the
position’s maximum gain climbs to
continued on p. 20

Related reading TABLE 4 — SKIPPING STRIKES

Phil Budwick articles:
Widening the distance between short strikes adds flexibility to bear put ladders.
“Bull call ladders” This ladder offers a smaller credit, but its range of maximum profit ($135-$145)
Futures and Options Trader, August 2007 is doubled.
If you plan to trade a call ratio spread, check
out this strategy first. Ladders might offer less Components Long/short Credit/debit
premium, but they can boost your odds of suc- 1 November 150 put Long -$10.00
cess. 1 November 145 put Short $7.60
“Squeezing extra profits from long calls” Net credit: $1.50
Futures and Options Trader, May 2007. Scenario (at Nov. 17 expiration):
Before selling a winning long call, consider AAPL trades above $150 long strike “Worst-case” gain: $1.50
converting it into a spread to enhance its AAPL trades between $145 and $135 short strikes Max. gain: $6.50
potentialprofit. Breakeven point: $128.50
“Calendar spreads surrounding
earnings news”
Options Trader, March 2007. FIGURE 4 — REMOVING RISK
Trading options on stocks just before a com- Put ladders are simply long condors with a missing lower wing (brown line). If
pany reports earnings isn’t always a great Apple climbs roughly five percent within a week, you could buy a 130 put to
idea, but this strategy takes advantage of the create a 150-140-135-130 put condor (pink line). This adjustment removes all
market’s uncertainty in these situations. risk without giving up all profit potential.
“Avoiding options trading mistakes”
Options Trader, February 2007.
Some of the most popular option trades are
based on faulty assumptions about how
options behave. This discussion of common
mistakes and misconceptions might surprise
you.
“Directional butterfly spreads”
Options Trader, December 2006.
Butterflies aren’t just market-neutral strategies.
They can be used to make directional bets
with better risk-reward ratios than outright
option purchases or simple vertical spreads.
“Combining call calendar spreads with
stock” Options Trader, October 2006.
Adding a calendar spread to an underlying
position instead of simply creating a covered
call offers some surprising benefits. The com-
bined strategy helps lock in profits without
sacrificing further upside gains.
Source: OptionVue
“Selling premium with a twist”
Options Trader, August 2006.
Ratio put spreads offer more potential profit 8.10 (5 from 150-145 vertical spread + could buy one 150 put at $10, sell one
than other premium selling strategies such as
3.10 credit). 145 put at 7.60, and then skip a strike
naked puts or simple credit spreads. And
You don’t have to place a ladder’s to sell one 135 put at 3.90 — a credit
these trades are more flexible than they initial-
ly seem. strikes at equal distances, so feel free of 1.50. Now the ladder will reach its
to experiment with different strikes. maximum profit (6.50) if AAPL
“Ratio call spreads” However, you should still try to trades in a wider range ($145-135) at
Options Trader, June 2006. enter the position for a credit, expiration.
Ratio call spreads can enhance an underlying
because it removes all upside risk. Table 4 lists the 150-145-135 put
position’s potential gains at no extra cost, or in
many cases, for a net credit.
Stretching the distance between ladder’s details, and Figure 3 com-
short strikes widens the maximum pares the risk profiles of the ITM lad-
You can purchase and download past articles at profit zone. If you believe Apple der with this trade (green vs. blue
http://www.activetradermag.com/purchase_articles.htm could drop up to 9 percent, you lines, respectively).

Fly like a condor TABLE 5 — CONVERTING INTO A LONG CONDOR
A bear put ladder resembles a long put
condor with the lower “wing,” or pro- If Apple jumps to $155 by Oct. 1, you could buy a 130 put for $1.40 and remove
tective put, missing. You can significant- all risk from the 150-145-135 put ladder. The new condor position will gain
ly reduce (or remove) a put ladder’s risk $5.10 if AAPL trades between $135 and $145 at Nov. 17 expiration.
by buying a same-month put with an Components Long/short Credit/debit
even lower strike. To convert a 1 November 150 put Long -$10.00
November 150-140-135 put ladder into a 1 November 145 put Short $7.60
condor, simply buy a same-month 130 1 November 135 put Short $3.90
put. Net credit: $1.50
This is a good idea if you believe the Scenario:
market could fall below the ladder’s AAPL rises to $155 within a week (Oct. 1).
lowest strike by expiration. Although To create 150-140-135-130 put condor:
Buy 1 November 130 put $1.40
you can make this adjustment any time,
Net credit/”worst-case” gain: $0.10
try to buy the put when it costs less than
Maximum profit: $5.10
the ladder’s initial credit (1.50). At that
point, the combined position becomes a
risk-free condor that could gain at least market to drop slightly. Ladders are more flexible than ratio
$5 when Apple trades between the short strikes. spreads, offer better breakeven points, and provide wider
If AAPL climbs from $148 on Sept. 24 to $155 on Oct. 1, profit zones. But don’t forget that these positions contain
you could buy the November 130 put for roughly $1.40. naked puts, which boost risks and margin requirements.
This step removes all downside risk and still leaves room
for profit if Apple trades from $135 to $140 on Nov. 17. Table For information on the author see p. 6.
5 shows how to convert the ladder
into a 150-140-135-130 put condor, and
Figure 4 compares both positions.
Keeping an eye on implied

volatility
Both ratio spreads and ladders feature
naked short options, which means
changes in implied volatility (IV) can
have dramatic consequences. If IV
spikes after you enter either position,
the short calls’ premium will climb,
hurting the spread. Therefore, you
must ensure IV is not near multi-year
lows before entry.
Increases in implied volatility are a
greater threat on the put side, because
IV tends to rise when markets fall.
Over the past 11 years, the CBOE’s
volatility index (VIX) moved inversely
with the S&P 500 79 percent of the
time. In other words, when the S&P
500 fell, the VIX climbed and vice
versa.
This relationship may hurt posi-
tions with short puts, because if the
market declines as IV rises, you may
be forced to buy back short puts at a
loss.
Despite this caveat, bear put lad-
ders may work well if you expect the

FUTURES TRADING SYSTEM LAB
FIGURE 1 — SAMPLE TRADES

The system fades the second of two consecutive opening gaps in the same
Consecutive
direction and exits on the entry day.
gap closer
Market: Futures.
System concept: The May 2003

Futures Trading System Lab (“Gap
closer”) tested the trading axiom, “All
gaps are eventually closed.” The fol-
lowing test explores a variation of this
simple rule — trading with the expec-
tation of a filled gap after consecutive
“opening gaps.”
An “opening gap” occurs when
price opens above the previous high or
below the previous low. An EliteTrader
(http://www.elitetrader.com) member
(username: “Pekelo”) claimed that
opening gaps in the same direction as a
gap the previous day almost always
close the same day.
The system enters when price gaps
above (or below) the previous high (or
low) the day after a gap in the same
direction. In other words, if the market
Source: Wealth-Lab had an upward opening gap yesterday
and another upward opening gap
FIGURE 2 — EQUITY CURVE today, price is likely to fill today’s
The equity spiked a few times, but could not withstand the burden of low- opening gap before the end of the trad-
expectancy trades. Short trades performed a little better than long ones. ing session.
The system uses two rules to prevent
trading against strong market momen-
tum in the direction of the opening
gaps.
1. The first gap cannot have been

filled on the first day (evidence
of strength).
2. The second gap’s range must
be smaller than the first gap’s
(evidence of a loss of
momentum).
Also, the strategy slightly expands

the trade’s profit potential by setting
the profit target at the previous day’s
close (rather than the previous day’s
high or low). If the trade remains open,
it is exited with a market-on-close
(MOC) order.
Strategy rules:
1. Enter long today at the market
when:
Source: Wealth-Lab
a) today’s open is below

FIGURE 3 — ANNUAL RETURNS
Annual performance was inconsistent, at best.
LEGEND:
Avg. hold time — The average holding period

for all trades.
Avg. hold time (losers) — The average hold-

ing time for losing trades.
Avg. hold time (winners) — The average hold-

ing time for winning trades.
Avg. loss (losers) — The average loss for los-

ing trades.
Avg. profit/loss — The average profit/loss for

all trades.
Avg. profit (winners) — The average profit for

winning trades.
Avg. return — The average percentage for the

period.
Best return — Best return for the period.
Exposure — The area of the equity curve

exposed to long or short positions, as
opposed to cash.
Longest flat period — Longest period (in

days) between two equity highs.
Source: Reports-Lab
Max consec. profitable — The largest number
of consecutive profitable periods.
yesterday’s low and yesterday’s open is above
yesterday’s open is below the previous day’s high; Max consec. unprofitable — The largest num-
the previous day’s low; b) yesterday’s low is above ber of consecutive unprofitable periods.
b) yesterday’s high is below the previous day’s high; Max consec. win/loss — The maximum num-
the previous day’s low; c) today’s gap is smaller ber of consecutive winning and losing trades.
c) today’s gap is smaller than yesterday’s gap (in Max. DD (%) — Largest percentage decline in
than yesterday’s gap points). equity.
(in points).
Net profit — Profit at end of test period, less
3. Exit position:
commission.
2. Enter short today at the a) today with a limit order
market when: at yesterday’s closing No. trades — Number of trades generated by
a) today’s open is above price, or the system.
yesterday’s high and b) today at the close. Payoff ratio — Average profit of winning
continued on p. 34 trades divided by average loss of losing
trades.
STRATEGY SUMMARY Percentage profitable periods — The percent-
age of periods that were profitable.
Profitability Trade statistics
Profit factor — Gross profit divided by gross
Net profit: $120,327.86 No. trades: 1,063
loss.
Net profit: 12.03% Win/loss: 65.48%
Recovery factor — Net profit divided by max.
Profit factor: 1.04 Avg. profit/loss: 0.05%
drawdown.
Payoff ratio: 0.60 Avg. holding time (days): 1.00
Sharpe ratio — Average return divided by
Recovery factor: 0.33 Avg. profit (winners): 0.69%
standard deviation of returns (annualized).
Exposure: 0.41% Avg. hold time (winners): 1.00
Win/loss (%) — The percentage of trades that
Drawdown Avg. loss (losers): -1.16%
were profitable.
Max. DD: -26.52% Avg. hold time (losers): 1.00
Longest flat period: 3,516 days Max consec. win/loss: 16/8 Worst return — Worst return for the period.

FUTURES TRADING SYSTEM LAB continued
FIGURE 4 — DRAWDOWN
Money management: Risk two percent of
The system spent most of its time in lengthy drawdowns.
account equity per position.
Starting equity: $1,000,000. Deduct $8 for

commission and two ticks of slippage per trade.
(Slippage is increased from the usual one tick
because of market orders the system uses.)
Test data: The system was tested on the Active

Trader Standard Futures Portfolio, which contains
the following 20 futures contracts: British pound
(BP), soybean oil (BO), corn (C), crude oil (CL),
cotton #2 (CT), E-Mini Nasdaq 100 (NQ), E-Mini
S&P 500 (ES), 5-year T-note (FV), euro (EC), gold
(GC), Japanese yen (JY), coffee (KC), wheat (W),
live cattle (LC), lean hogs (LH), natural gas (NG),
sugar #11 (SB), silver (SI), Swiss franc (SF), and
T-Bonds (US). The test used ratio-adjusted
data from Pinnacle Data Corp.
(http://www.pinnacledata.com).
Test period: September 1987 to August 2007.
Test results: This system’s results parallel

those of the “Gap closer” system tested four years
ago. The system’s 65-percent winning percentage
confirms consecutive, or “continuation,” gaps are
likely to be filled. Activity was moderate (an Source: Reports-Lab
average of 54 trades per year).
The nearly horizontal equity curve reflects the system’s on this tendency. A system can be “profitable” but still not
net profit of 12 percent over 20 years, which is less than one worth trading.
percent annualized. Even considering the system was in the
market infrequently and for no longer than a day at a time, — Volker Knapp of Wealth-Lab
this return is simply too low.
Also, the annual returns were unstable (see Figure 3 and
the Periodic Returns table) and the drawdowns increased in For information on the author see p. 6.
size and duration as the test progressed (Figure 4). Futures Lab strategies are tested on a portfolio basis (unless otherwise noted)
Like its predecessor, this system had a large number of using Wealth-Lab Inc.’s testing platform. If you have a system you’d like to see
small winning trades, but a small number of large losses. tested, please send the trading and money-management rules to
Although only seven losers were larger than 5 percent (and editorial@activetradermag.com.
just one was larger than 10 percent), the system was not
strong enough to return a reasonable gain. A profit factor Disclaimer: The Futures Lab is intended for educational purposes only to
provide a perspective on different market concepts. It is not meant to rec-
slightly above 1.0 would be hopeless for any system. ommend or promote any trading system or approach. Traders are advised
to do their own research and testing to determine the validity of a trading
Bottom line: Gaps may have a tendency to get filled, but idea. Past performance does not guarantee future results; historical testing
a one-day trade approach such as this could not capitalize may not reflect a system’s behavior in real-time trading.
PERIODIC RETURNS
Percentage Max Max

Avg. Sharpe Best Worst profitable consec. consec.
return ratio return return periods profitable unprofitable
Monthly 0.07% 0.03 18.03% -12.90% 60.83 10 4
Quarterly 0.21% 0.05 17.38% -14.96% 55.56 5 4
Annually 0.92% 0.10 23.93% -21.51% 71.43 6 2

OPTIONS TRADING SYSTEM LAB
Refining a 20-day breakout system

Market: Options on the S&P 500
index futures (SP). This strategy FIGURE 1 — BEAR CALL SPREAD RISK PROFILE
could also be applied to other Out-of-the-money credit spreads have daunting reward-risk ratios. This August
instruments with liquid options 1,620/1,670 bear call spread risks $12,160 to make just $338. But adding strict exit
contracts. rules can reduce risk considerably.
System concept: Trend-follow-

ing systems typically wait for price
to move beyond a previous high or
low and then enter the market in
that direction. The idea is to buy
market strength and sell weakness
with the expectation price will con-
tinue to trend higher or lower.
For instance, one of the most
basic breakout systems, first intro-
duced by Richard Donchian, goes
long after a market hits a new 20-
day high and sells short after it falls
to a new 20-day low. A past Options
Trading System Lab (“Trading 20-
day breakouts with credit spreads,”
Options Trader, April 2006) showed
that entering credit spreads (bull
put or bear call spreads) in the
direction of these moves had merit.
Source: OptionVue
The original test compared two
approaches: trading the underlying
market (in this case, the S&P 500 FIGURE 2 — TRADING CREDIT SPREADS ON S&P 500 FUTURES
tracking stock, SPY) vs. placing This credit-spread breakout system gained 186 percent in less than seven years —
credit spreads when the system the best performing strategy tested in the Options Trading System Lab.
generated a bullish or bearish sig-
nal. The credit-spread approach
beat trading SPY outright by a wide
margin — 70 percent vs. 3 percent,
respectively.
The following refinement of the
system tries to improve the credit-
spread technique by moving its
components out of the money
(OTM), which lowers the premium
collected but should also boost the
strategy’s success rate.
The original system created a
credit spread by selling an at-the-
money (ATM) option and buying
another one 25 points OTM. By con-
trast, this system sells an option one
standard deviation (SD) above or Source: OptionVue
below the current price and buys
another one 50 points further OTM. gered a bear call spread: short one August 1,620 call and
This system uses signals from the S&P 500 index (SPX) long one August 1,670 call for a total credit of $338 includ-
and trades options on the S&P 500 futures. For example, the ing commissions (Figure 1).
S&P 500 hit a new 20-day low on July 20, so the system trig- The credit received represents the spread’s highest poten-

tial profit if the S&P moves in the right direction. The aver- STRATEGY SUMMARY
age capital to place each trade was roughly $5,000. If the
Net loss: $27,946.50
market reverses, however, this approach can lose a great
deal of money: You would lose $12,160 if you held this Percentage return: 186%
1,620/1,670 bear call spread until expiration and the S&P Annualized return: 28.1%
500 finished above 1,670. Therefore, adding exit rules to cut No. of trades: 72
losses short is critical. Winning/losing trades: 64/8
To reduce losses, the test unwinds each spread if the mar- Win/loss (%): 89%
ket exceeds the opposite threshold. For instance, Figure 1’s Avg. trade: 388.15
actual risk is the potential loss when the market surpasses Largest winning trade: $1,288.00
its current 20-day high, triggering an exit the next day. If Largest losing trade: -$2,799.00
that occurs, the 1,620/1,670 bear call spread would lose Avg. profit (winners): 645.33
about $650 (including commissions) — a more reasonable
Avg. loss (losers): -1,669.31
reward-risk ratio of roughly 1:2.
Avg. hold time (winners): 34
Avg. hold time (losers): 21
Trade rules:
When the S&P 500 index (SPX) climbs to a new 20-day Max consec. win/loss : 16/2
high:
1. Sell an OTM bull put credit spread at the close trading 20-day breakouts with credit spreads could be prof-
using the first expiration month with at least 21 days itable. But by selling the spreads one standard deviation
remaining. To create the spread, sell a strike one SD OTM, trades were held for 32.5 days, on average — enough
below the current price and buy a strike 50 points time to profit from time decay.
further OTM. Commissions and slippage will likely affect this strate-
2. Exit the spread at the close if the S&P 500 drops to a gy’s performance, so you should always include accurate
new 20-day low. Otherwise, let both options expire brokerage fees and consider the effect of bad fills before
worthless. actually trading any idea.
When the S&P 500 index (SPX) drops to a new 20-day — Steve Lentz and Jim Graham of OptionVue
low:
1. Sell an OTM bear call credit spread at the close LEGEND:
using the first expiration month with at least 21 days Net gain/loss – Gain or loss at end of test period, less
remaining. To create the spread, sell a strike one SD commission.
above the current price and buy a strike 50 points Percentage return – Gain or loss on a percentage basis.
further OTM. Annualized return – Gain or loss on an annualized percentage
2. Exit the spread at the close if the S&P 500 index rises basis.
to a new 20-day high. Otherwise, let both options No. of trades – Number of trades generated by the system.
expire worthless. Winning/losing trades – Number of winners/losers generated
by the system.
Test details: Win/loss (%) – The percentage of trades that were profitable.
• The test account began with $15,000 in capital. Avg. trade – The average profit for all trades.
• Standard deviation was calculated using the implied Largest winning trade – Biggest individual profit generated
volatility of the ATM option. by the system.
• Daily closing prices were used. Largest losing trade – Biggest individual loss generated by
• Trades were executed at the bid and ask, when the system.
available. Otherwise, theoretical prices were used. Avg. profit (winners) – The average profit for winning trades.
• Commissions were $5 base fee plus $1 per option.
Avg. loss (losers) – The average loss for losing trades.
Avg. hold time (winners) – The average holding time for winning
Test data: The system was tested using options on S&P
trades.
500 futures at the CME.
Avg. hold time (losers) – The average holding time for losing
trades.
Test period: Jan. 2, 2001 to Aug. 18, 2007.
Max consec. win/loss – The maximum number of consecutive
winning and losing trades.
Test results: Figure 2 shows the system gained 186 per-
cent in six and a half years, an average annualized return of Option System Analysis strategies are tested using OptionVue’s
28.1 percent — the most successful options strategy tested BackTrader module (unless otherwise noted).
in the Options Trading System Lab. Only eight of 72 trades If you have a trading idea or strategy that you’d like to see tested,
were losers — an 89-percent win/loss rate. please send the trading and money-management rules to
A previous Options Trading System Lab showed that Advisor@OptionVue.com.

BOOK EXCERPT
The man who buys crashes

The following is an excerpt from Kathy Lien and Boris Schlossberg’s new
book, Millionaire Traders: How Everyday People Are Beating Wall Street at
Its Own Game, in which they interview stock, options, forex, and futures
traders who turned modest stakes (as little as $1,000) into six to seven
digit fortunes.
BY KATHY LIEN AND BORIS SCHLOSSBERG
E
ver since he was a boy, Dana “Dan” Allen was Q: Was this trade some-
fascinated with trading. He started reading thing fundamentally re-
the Wall Street Journal at age nine and opened searched or was it frankly
his own commodity trading account by the just luck that you caught a
time he was 21. really nice move and then managed to hold on to it? What
Allen’s trading career has been characterized by one made you go long copper at that point?
overarching theme — the uncanny ability to buy a dollar’s A: Well, I thought it was undervalued, and then I watched
worth of value for a nickel. Be it commodities, stocks, or the chart and it dipped down; it looked like it washed out
options, Allen has succeeded in finding deep value in what- and lost its downward momentum. Premiums on options
ever instrument he trades, often increasing his initial invest- became very small, and so I thought quite a bit about it and
ment tenfold. He thrives on making bids when most other got lucky. I’ve done that a couple times.
market participants are running for the exits.
Q: When did you say to yourself, “I’m going to be a full-time
Q: When [did you] start trading commodities? trader?”
A: I was still in college, and I was trading mostly copper A: I really buckled down in 2002. I saw some very interest-
because I was a geology student. Like most people, I starting automated trading models and [started using]
ed with the minimum account size of $3,000 (laughs). And TradeStation. That’s when I really started applying systems
sure enough, you always blow up when you have such a and doing it as a full-time job.
tiny account.
Q: Why did automated trading attract you?
Q: How long did it take? A: A lot of people say you can never have a completely
A: Oh, I think six months. That’s pretty good when you’re automated system that will work, but we all know one of
trading commodities with 3,000 bucks (laughs). the greatest enemies of trading is emotion. People have a
tendency to sell at the worst possible moment. I’m no dif-
Q: That’s pretty good — you really held out. What hap- ferent. But if you back-test something, I think it’s just natu-
pened after you blew up the account? ral for you to do a better job.
A: Well, for a while I didn’t do all that good. I’d refill the
account, then blow it up again. But later, in 1988 or 1989, I Q: So currently most of your trading is systems driven?
played the options on copper, and I turned $2,000 into A: It is, but I don’t have it fully automated yet — I’m work-
$40,000 in about six months. ing on that now. I can get into positions automatically.
I have one system that is very hectic — basically a crash-
Q: Did you catch a big trend? What happened in the copper buying system — and you don’t know what stock you’re
market? going to be in. It buys the worst crashes from a list of over
A: It went from about 57 to 85. I was very happy with the 200 stocks. It can go into many different stocks at the same
move because I was buying 70-cent options when copper time on bad market days, so I have to manage the positions.
was at 50 cents and they had a December expiration. I think The system works, but it feels like you’re losing money
I bought them in May. (Author’s note: Dana was buying the until you add it all up at the end day and find you’re posi-
right to purchase copper at 70 cents a ton when it was only trad- tive.
ing at 50 cents/ton. This is a highly speculative strategy that
assumes a very large price move over a short period of time.) Q: We’re curious about the crash-based system. Clearly the

system searches the market using whatever algorithm you Q: When you’re in the midst of holding six, seven, or eight
have programmed and puts you in a position. But once positions, do you have either a mental or an automatic hard
you’re in a position are you managing the exits manually? stop that serves as your risk control? For example, is it a
A: Yes, and while you’re watching one [position], another five-percent move down from your entry price or is every-
might be dropping another two to three percent before you thing discretionary at that point?
look back over to that screen. So I don’t enjoy it (laughs). A: It tends to be more toward the discretionary side, but I
Clearly it would be better automated. also use a time stop — I don’t want to be in the trade
I have basic rules for how to get out, but I just haven’t overnight.
been able to get them into the computer. I think that with
back-testing I will find a better way of getting out of a posi- Q: Generally, you’re either going to stop yourself out on
tion than by watching each stock individually. Wealth-Lab time or you’re going to hopefully have a net positive move
is what I use now — their back testing is superb. before the end the day and take profits.
A: Yes. In effect, I’m buying extreme fear and [waiting for
Q: It sounds like the system buys dips. Does it also sell ral- the] point where that fear tends to bottom out and a little
lies? optimism comes in. When that happens, you get out. There
A: My back-testing indicates it doesn’t work as well on the are four or five distinct types of behavior in these crashes.
short side. When [stocks] rip up, they continue to go up. My And from experience, you can see them on a one-minute
testing indicates it is two or three times better to buy crash- chart.
es. I’m talking about intraday crashes — you’re not buying But I consider myself an “omnivore trader.” I use many
something that’s been going down for a week. It’s more of different methods, including some long-term trades in
an extreme intraday crash and then picking up hints the things like oil and gas stocks. Since 2003 I’ve sometimes
crash is coming to an end. held positions for [as long as] nine months. I do some pure
And I’ll give you a valuable piece of advice: The most value investing, and I throw trading on top of that as I
dangerous stocks are biotech. I avoid them because they can watch a stock and get to know it. I might buy in and sell out
just go down and down and down. 5 percent of the position during the day from the intraday
patterns that I’ve noticed.
Q: Because it’s very hard to gauge value in those stocks,
right? The remainder of this book excerpt will appear in the December
A: Exactly, they are very emotional stocks. issue of Active Trader magazine. For more information about the
authors and the book, see p. 6.
INDUSTRY NEWS
More indices, fewer equities
Citadel: Volume, liquidity issues

surround penny pricing pilot
BY JIM KHAROUF
T he ongoing rollout of the penny pricing pilot pro- ative trading volume have dropped in eight of the 10 single-
gram among options exchanges raised more stock options classes in the pilot.”
debate in September as hedge fund and financial Nagel says volume in Microsoft options fell 35 percent,
behemoth Citadel urged changes. Texas Instruments 34 percent, and Whole Foods 38 percent.
In a Sept. 12 comment letter to the Securities and The comment letter also pointed out that liquidity at the
Exchange Commission, Citadel said the penny pilot pro- national best bid or offer (NBBO) was down an average of
gram is failing on individual options and should measure 85 percent and that the average depth of book in the penny
success based on relative trading volume (i.e., volume classes at the International Securities Exchange has fallen 61
growth/decline compared to overall volume percent.
growth/decline) for penny-listed options. The firm also “Gauging by changes in relative trading volume, it
advocated more penny pricing on index options. appears that the drastic drop in liquidity is much more
The penny pilot program, launched with 13 classes in harmful to single-stock options classes than it is to index
January, has come under increasing scrutiny in recent and sector products,” Nagel wrote.
months over several shortcomings including reduced trad- Citadel, which said it represents 20 percent of U.S.
ing volumes, a drop in the contracts per trade, and a decline options volume, is pushing for penny pricing on liquid
in liquidity. The SEC introduced another 22 options on Sept. index products such as ETF options on the S&P 500 (SPY)
28 and plans to add another 28 next March. and Dow Jones (DIA) tracking stock. Other ETF options
In his SEC comment letter, Citadel’s director and associ- such as those on the Russell 2000 (IWM), the Nasdaq 100
ate general counsel John Nagel said “both liquidity and rel- (QQQQ), and the semiconductor HOLDRS (SMH) have
seen relative trading volume
increase 41 percent in the penny
pilot. The letter also points out,
MANAGED MONEY however, that liquidity plunged 87
percent in those index options.
Top 10 option strategy traders ranked by August 2007 return Citadel’s letter also recommends
(Managing at least $1 million as of Aug. 31, 2007.) the SEC replace Microsoft, Texas
2007 Instruments, and the other single
August YTD $ under options with more liquid index or
Rank Trading advisor return return mgmt. sector products.
1. Ascendant Asset Adv. (Strategic1) 15.67 56.17 3.9M The letter points to a concern
2. Ascendant Asset Adv. (JLDeVore) 12.55 55.62 6.6M among some in the options indus-
try that penny pricing is harming
3. Harbor Assets 11.00 -9.74 1.5M
long-standing efforts to attract and
4. K4 Capital Management (MVS) 10.85 11.4 14.9M keep institutions in the U.S. options
5. Trading Concept (TC Chronos K ) 10.18 5.05 1.4M market.
6. Ascendant Asset Adv. (Strategic2) 9.20 23.09 29.1M “While it is helpful that there is
still enough liquidity in pilot class-
7. LJM Partners (Neutral S&P Option) 8.50 -3.65 101.9M
es to fill average retail-sized orders,
8. Goodnight Cap Mgmt (S&P Option) 8.39 4.58 2.7M we are deeply concerned that the
9. Parrot Trading Partners 7.74 15.91 9.0M quoted size is dropping to levels
10. K4 Capital Management (MVS Lite) 7.49 8.55 8.1M that are sub-optimal or inadequate
for institutional-sized orders,”
Source: Barclay Trading Group (http://www.barclaygrp.com)
Nagel wrote. “Derivatives markets
Based on estimates of the composite of all accounts or the fully funded subset method.
are a critical risk-management and
Does not reflect the performance of any single account.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
investment tool for institutional
investors.”

Who’s in charge?
Turf war between CFTC, FERC looms
I n the aftermath of the Amaranth hedge fund debacle,

where bad trades in energy futures led to $6 billion in
losses, the Commodity Futures Trading Commission
(CFTC) filed charges against the fund, claiming head trader
Brian Hunter attempted to manipulate the price of natural
(D-N.C.), the chairman of a House Agriculture subcommit-
tee. In addressing the panel before the hearing, he said, “I
don’t know why the FERC chose to take an enforcement
action which has called its own authority into question.”
Etheridge also said that if the CFTC isn’t given exclusive
gas futures. jurisdiction over the matter, that “would equal a failure to
Also filing charges was the Federal Energy Regulatory uphold the will of Congress.”
Commission (FERC), a regulatory group whose main juris- Damgard also disagreed with Kelliher’s contention of a
diction is the physical energy markets (e.g., pipelines, regulatory gap.
hydroelectric projects, interstate sale of gas of energy). “The CFTC has comprehensive, time-tested futures price
While Hunter will likely reach a settlement with the anti-manipulation authority,” he said. “It vigorously
CFTC, he is fighting the charges from FERC, saying the enforces the law. FERC and the CFTC should work togeth-
group lacks the necessary jurisdiction to file such a claim. er. Each has enormous and important responsibilities. By
Ironically, one of his biggest supporters in that fight might double-teaming futures trading, however, FERC is actually
be the CFTC. diverting resources from those duties.”
At a Congressional hearing in late September, CFTC and The cases against Amaranth went to court in early
other officials said they think the FERC overstepped its October, although the court will have to rule as much on
bounds when it got involved in a case that primarily affects jurisdiction as it will actual guilt by Amaranth. Those who
the futures markets. side with the FERC, including California Senator Dianne
“Exclusive jurisdiction was created in the House Feinstein, believe a battle between the FERC and the CFTC
Agriculture Committee in 1974 to make sure that only the in court will weaken both groups and restrict the govern-
CFTC would regulate futures trading activity and conduct ment’s ability to oversee market manipulation.
by futures exchanges, futures professionals, and futures
market participants,” said John Damgard, president of the
I was here first!
Futures Industry Association. “Congress made crystal clear
in 1974 that the CFTC’s jurisdiction, where applicable,
supersedes the authority of other federal agencies.” TT, eSpeed clash in court
As the hearing was primarily designed to discuss reau-
thorization of the CFTC, no representative of the FERC was BY JIM KHAROUF
on the panel. However, FERC Chairman Joseph Kelliher
told reporters earlier in the month that any perceived lack
of authority would endanger natural gas buyers, as gas
prices could be affected by the price of gas futures being
manipulated.
“We will not be able to protect those customers,” he said.
T he Trading Technologies (TT) patent infringement
trial against eSpeed, a pivotal case in the trading
software industry, finally began in September.
TT’s lead attorney Paul Berghoff told the Federal District
Court’s 10-person jury that eSpeed clearly copied MD
“There will be a regulatory gap.” Trader’s (TT’s software program) patented static ladder
However, New York Mercantile Exchange president display of prices and presented a number of internal e-
James Newsome says there is no ambiguity in the law. mails from eSpeed and Ecco, a trading firm acquired by
“To vary from this prudent regulatory structure would eSpeed, as proof.
only create confusion, inconsistency, and uncertainty, ulti- “After MD Trader was on the market for three years,
mately harming the vitality and effectiveness of derivatives eSpeed copied many of the patented features of TT’s soft-
markets as well as the broader economy relying upon such ware,” Berghoff said. “eSpeed customers were telling them
markets for price discovery and hedging of risk,” Newsome they had to copy it because if they didn’t they were at a
testified. competitive disadvantage.”
Newsome’s concerns were that if the FERC is allowed to TT estimates the damages for infringement over a four-
enforce action against Amaranth, there’s nothing stopping month period by eSpeed and Ecco amount to $4.6 million,
the Agriculture Department from nosing in on corn, wheat, a figure eSpeed strongly disputes. And, eSpeed not only
rice, and other grain and livestock futures, and the Treasury denies it infringed on TT’s patents but presented alleged
Department could attempt to monitor bond, currency, and evidence of “prior art,” a legal term for an invention that
other financial futures. pre-dates a patent. If such evidence matches TT’s invention,
The CFTC appears to have an ally in Rep. Bob Etheridge continued on p. 42

INDUSTRY NEWS continued
it would invalidate its patents. ered in December 1998 to customers as part of a bundled
eSpeed lead attorney George Lombardi told the jury that trading software package called GL Win version 4.31, he
TT’s invention is nothing new in the world of futures and said.
that several other pieces of prior art were in existence long TT challenged the dates and Jollant’s recollection of infor-
before TT filed for its patents on March 2, 2000. He added mation, saying that they could not find any information
that TT is trying to expand the scope of its patents well about TradePad 4.31 in GL Win’s trading manuals. TT con-
beyond its legal boundaries. tended that it was not until June 1999 that GL introduced
“TT is overreaching in this case and by that I mean grab- TradePad as part of GL Win 4.50. In a terse exchange with a
bing for more than they are entitled to,” Lombardi said. TT attorney who questioned why TradePad didn’t show up
“Everything in their patent is something that has been out in earlier trading manuals, Jollant held that TradePad was
there and used before TT used it.” part of GL Win 4.31 and was in customer hands in late
The crux of the case centers around the date TT CEO December 1999 and certainly by January 2000.
Harris Brumfield invented the MD Trader software. “I know for a fact that TradePad existed in 4.31,” Jollant
Brumfield testified that he came up with the idea in March said.
1999 and filed his first patent application with the U.S. eSpeed also presented a letter dated Jan. 27, 1999 from the
Patent and Trademark Office on March 2, 2000. TT filed a Chicago Mercantile Exchange (CME), which was using GL’s
second patent application on June 1, 2000, with some mod- software. In it, CME was not impressed with TradePad, call-
ified wording on more mouse click functions. ing it “useless” for its traders. Despite the rebuke, it could
But eSpeed jumped on those dates with evidence that be key proof that shows TradePad existed prior to TT’s MD
French trading software firm GL Trade created a similar Trader.
piece of software named TradePad in September 1998 and The question for the jury is whether TradePad meets all
revised that software in 1999. Jean-Cedric Jollant, the for- the criteria needed to invalidate TT’s patents as prior art.
mer trading application manager for GL during that time, GL presented other prior art as well, including the trading
testified that he and another GL colleague came up with the screen used by the Tokyo Stock Exchange.
idea of TradePad, which featured a static ladder display of Brumfield, who has said he searched the globe for prior
prices with bids and offers on each side. art as part of his patent application, testified he was not
Jollant also presented a stack of CDs he said were back- aware of GL’s TradePad, nor the Tokyo Stock Exchange
up copies of the software he helped create. On each dated screen prior to creating MD Trader.
CD is an updated version of TradePad. TradePad was deliv- The case was scheduled to conclude in early October.
Options Watch: Global ETFs (as of SEPT. 25) Compiled by Tristan Yates
The following table summarizes the expiration months available for the 17 optionable exchange-traded funds (ETFs) that track Morgan Stanley Capital International
(MSCI) regional indices. It also shows each ETF's average bid-ask spread for at-the-money (ATM) October options. The information does NOT constitute trade signals.
It is intended only to provide a brief synopsis of potential slippage in each option market.
Option contracts traded
2007 2008 2009
Oct. Nov. Dec. Jan. Feb. March April June Dec. Jan. Dec. Jan. Bid-ask spreads
Bid-ask
spread as %
Closing of underlying
Country or region Sym price Call Put price
U.S. SPY X X X X X X X 151.39 0.18 0.15 0.11%
China FXI X X X X X X 174.15 0.30 0.26 0.16%
Emerging Markets EEM X X X X X X 146.25 0.46 0.34 0.27%
South Korea EWY X X X X X X 67.38 0.19 0.20 0.29%
EAFE* EFA X X X X X X 80.98 0.30 0.24 0.33%
Canada EWC X X X 32.27 0.21 0.12 0.51%
Brazil EWZ X X X X 71.25 0.40 0.49 0.62%
Spain EWP X X X 59.24 0.42 0.34 0.64%
Germany EWG X X X 34.00 0.21 0.23 0.65%
Hong Kong EWH X X X 20.78 0.16 0.13 0.70%
Japan EWJ X X X X X X 13.91 0.08 0.12 0.72%
Sweden EWD X X X 35.72 0.28 0.25 0.74%
Australia EWA X X X 30.96 0.22 0.24 0.74%
Taiwan EWT X X X 16.39 0.14 0.12 0.79%
South Africa EZA X X 132.48 1.90 1.66 1.34%
Malaysia EWM X X X 11.82 0.17 0.15 1.35%
UK** EWU X X X 25.31 0.52 0.53 2.07%
* Europe, Australasia, and the Far East
** Incomplete data due to illiquid market. Options on the Mini FTSE 100 (UKX) may be a better alternative.
Legend
Call: Five-day average difference between bid and ask prices for the front-month ATM call.
Put: Five-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
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FUTURES SNAPSHOT (as of Sept. 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). Price activity for CME futures
is based on pit-traded contracts, while price activity for CBOT futures is based on the highest-volume contract (pit or electronic).
Pit E- 10-day % 20-day % 60-day % Volatility
Market Sym Sym Exch Vol OI move Rank move Rank move Rank ratio/rank
E-Mini S&P 500 ES CME 1.89 M 1.76 M 3.10% 61% 5.39% 88% 0.54% 1% .49 / 58%
10-yr. T-note TY ZN CBOT 1.21 M 2.11 M -0.08% 17% 0.11% 6% 3.74% 77% .24 / 23%
5-yr. T-note FV ZF CBOT 704.0 1.29 M 0% 0% 0.73% 18% 2.88% 77% .17 / 0%
Eurodollar* ED GE CME 427.0 1.63 M 0.15% 0% 0.69% 100% 0.57% 94% .41 / 25%
E-Mini Nasdaq 100 NQ CME 359.3 351.9 4.80% 63% 8.20% 92% 6.89% 59% .58 / 76%
30-yr. T-bond US ZB CBOT 350.7 858.1 -0.98% 17% 0.01% 0% 3.69% 69% .45 / 88%
2-yr. T-note TU ZT CBOT 323.9 764.0 0.07% 33% 0.15% 33% 1.88% 90% .12 / 3%
E-Mini Russell 2000 ER CME 251.8 538.3 4.31% 79% 3.71% 81% -4.20% 37% .45 / 46%
Crude oil CL NYMEX 220.6 316.7 3.48% 20% 12.75% 88% 16.06% 76% .22 / 17%
Mini Dow YM CBOT 158.9 78.3 3.46% 65% 5.21% 91% 2.49% 18% .61 / 88%
Eurocurrency EC 6E CME 141.6 181.0 1.89% 60% 3.75% 93% 3.87% 79% .50 / 55%
Japanese yen JY 6J CME 133.7 178.1 -0.51% 11% 0.55% 4% 5.75% 72% .16 / 3%
British pound BP 6B CME 67.6 95.0 -0.20% 0% 0.37% 15% 0.37% 3% .39 / 38%
S&P 500 index SP CME 63.9 511.6 3.11% 61% 5.40% 88% 0.55% 1% .49 / 58%
Corn C ZC CBOT 63.0 305.0 11.54% 79% 19.84% 100% 20.81% 100% .45 / 80%
Natural gas NG NYMEX 59.3 82.8 14.76% 86% 23.97% 100% 2.44% 22% .41 / 55%
Swiss franc SF 6S CME 50.2 84.5 1.07% 22% 2.75% 72% 3.64% 83% .39 / 35%
Canadian dollar CD 6C CME 44.7 113.2 3.05% 68% 6.14% 97% 5.86% 50% .50 / 87%
Sugar SB NYBOT 42.2 263.3 8.95% 100% 7.22% 44% 6.77% 43% .60 / 93%
Australian dollar AD 6A CME 41.6 72.9 4.77% 94% 7.69% 100% 2.88% 13% .69 / 83%
Soybeans S ZS CBOT 40.7 134.3 7.20% 35% 17.54% 88% 18.65% 90% .25 / 8%
RBOB gasoline RB NYMEX 37.9 48.6 2.32% 7% 6.09% 65% -7.49% 31% .24 / 25%
E-Mini S&P MidCap 400 ME CME 32.5 81.1 3.32% 68% 4.62% 84% -2.52% 18% .33 / 32%
Wheat W ZW CBOT 31.7 121.5 10.41% 42% 25.74% 90% 63.28% 100% .23 / 50%
Heating oil HO NYMEX 30.1 48.5 1.49% 0% 9.30% 66% 8.41% 29% 27 / 52%
Silver 5,000 oz. SI NYMEX 23.6 63.4 7.61% 79% 13.64% 79% 7.57% 70% .66 / 80%
Fed Funds FF ZQ CBOT 18.3 112.2 0.24% 100% 0.31% 91% 0.56% 100% .72 / 47%
Mexican peso MP 6M CME 16.1 69.9 1.56% 83% 1.11% 79% -1.57% 50% .55 / 70%
Nikkei 225 index NK CME 14.8 63.5 6.13% 100% 3.57% 89% -7.07% 50% .31 / 40%
Live cattle LC LE CME 11.6 61.4 2.35% 38% -1.17% 82% 7.70% 68% .40 / 67%
Coffee KC NYBOT 11.5 79.6 7.96% 63% 10.94% 84% 15.93% 93% .58 / 65%
Crude oil e-miNY QM NYMEX 10.9 4.5 3.48% 20% 12.75% 88% 16.06% 76% .25 / 25%
Lean hogs LH HE CME 10.7 55.2 -9.94% 100% -13.06% 100% -17.13% 100% .47 / 85%
Soybean meal SM ZM CBOT 10.3 18.6 10.64% 90% 20.34% 95% 21.58% 90% .36 / 15%
Soybean oil BO ZL CBOT 10.0 24.5 1.30% 10% 9.43% 82% 9.13% 32% .22 / 35%
Cocoa CC NYBOT 6.5 55.0 11.72% 95% 12.46% 74% -1.50% 18% .78 / 88%
Copper HG NYMEX 6.0 16.2 7.45% 61% 8.90% 57% 1.60% 22% .65 / 80%
Nasdaq 100 ND CME 5.9 54.4 4.80% 63% 8.20% 92% 6.89% 59% .58 / 75%
Dow Jones Ind. Avg. DJ ZD CBOT 4.9 29.5 3.46% 65% 5.21% 91% 2.49% 18% .61 / 88%
Silver 5,000 oz. ZI CBOT 4.8 5.2 7.64% 79% 13.64% 79% 7.67% 70% .66 / 81%
LIBOR EM CME 4.4 38.3 0.42% 22% 0.40% 100% 0.26% 96% .76 / 14%
Natural gas e-miNY QG NYMEX 4.4 5.8 14.76% 57% 23.97% 79% 2.44% 14% .42 / 52%
Gold 100 oz. GC NYMEX 4.4 30.6 3.02% 21% 9.44% 94% 11.64% 94% .35 / 10%
U.S. dollar index DX NYBOT 4.2 24.9 -1.34% 45% -3.11% 93% -3.77% 90% .42 / 47%
New Zealand dollar NE 6N CME 3.7 21.9 4.93% 62% 6.41% 100% -4.07% 35% .48 / 65%
10-year interest rate swap NI SR CBOT 3.3 60.2 -0.18% 0% 0.78% 19% 3.83% 73% .34 / 80%
Russell 2000 index RL CME 2.4 45.2 4.31% 79% 3.71% 81% -4.20% 30% .45 / 47%
*Average volume and open interest based on highest-volume contract (March 2008).
Legend (10-day moves, 20-day moves, etc.) show the of 100 percent means the current reading is
Vol: 30-day average daily volume, in thou- percentile rank of the most recent move to a larger than all the past readings, while a read-
sands (unless otherwise indicated). certain number of the previous moves of the ing of 0 percent means the current reading is
same size and in the same direction. For smaller than the previous readings. These fig-
OI: Open interest, in thousands (unless other-
example, the “% Rank” for 10-day move ures provide perspective for determining how
wise indicated).
shows how the most recent 10-day move relatively large or small the most recent price
10-day move: The percentage price move compares to the past twenty 10-day moves; move is compared to past price moves.
from the close 10 days ago to today’s close. for the 20-day move, the “% Rank” field shows Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move how the most recent 20-day move compares term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. to the past sixty 20-day moves; for the 60-day prices) divided by the long-term volatility (100-
60-day move: The percentage price move move, the “% Rank” field shows how the most day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. recent 60-day move compares to the past the percentile rank of the volatility ratio over
The “% Rank” fields for each time window one-hundred-twenty 60-day moves. A reading 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 Sept. 27)
MOST-LIQUID OPTIONS*
Options Open 10-day % 20-day % IV/SV IV/SV ratio —
Indices Symbol Exchange volume interest move rank move rank ratio 20 days ago
Nasdaq 100 index NDX CBOE 620.9 342.8 4.89% 72% 7.24% 93% 19.2% / 17.3% 21.9% / 25.5%
S&P 500 index SPX CBOE 121.0 2.33 M 3.20% 67% 4.62% 84% 15.6% / 16.4% 21.6% / 24.6%
S&P 500 volatility index VIX CBOE 29.8 787.3 -31.34% 100% -28.60% 95% 96.9% / 109.1% 112.3% / 176.6%
Russell 2000 index RUT CBOE 21.3 686.6 4.31% 79% 3.39% 82% 21.2% / 19.3% 27.6% / 29.6%
E-mini S&P 500 futures ES CME 16.7 132.1 3.10% 61% 5.39% 88% 15% / 17% 21.9% / 28.2%
Stocks
United Therapeutics UTHR 4.24 M 244.2 -0.13% 0% -2.56% 35% 87% / 19.9% 51.7% / 24.2%
T Rowe Price Group TROW 3.64 M 15.9 4.44% 21% 9.53% 92% 31.2% / 42.6% 38% / 62.1%
Sirius Satellite Radio SIRI 2.43 M 604.0 -0.87% 33% 20.42% 81% 58.3% / 49.9% 60.8% / 39.2%
Transocean RIG 2.43 M 297.2 5.79% 68% 9.59% 62% 28% / 28.3% 29.8% / 45.6%
FreightCar America RAIL 2.42 M 11.5 -6.68% 23% -13.34% 70% 36.6% / 36.1% 34.3% / 51.5%
Futures
Eurodollar ED-GE CME 723.8 12.48 M 0.15% 0% 0.63% 100% 22% / 17.4% 20.5% / 15.7%
10-year T-notes TY-ZN CBOT 90.0 386.8 -0.08% 17% 0.11% 6% 5.9% / 6.2% 5.4% / 5.4%
Crude oil CL NYMEX 50.4 518.0 3.48% 15% 12.98% 88% 26.5% / 25% 26.6% / 29.8%
5-yr. T-note FV-ZF CBOT 46.3 288.3 0% 0% 0.73% 18% 4.2% / 4.6% 4.1% / 4.4%
30-year T-bonds US-ZB CBOT 30.5 255.0 -0.98% 17% 0.01% 0% 8% / 8.5% 7.6% / 6.9%
VOLATILITY EXTREMES**
Indices — High IV/SV ratio
Nasdaq 100 index NDX CBOE 620.9 342.8 4.89% 72% 7.24% 93% 19.2% / 17.3% 21.9% / 25.5%
Russell 2000 index RUT CBOE 21.3 686.6 4.31% 79% 3.39% 82% 21.2% / 19.3% 27.6% / 29.6%
S&P 500 futures SP CME 9.2 90.1 3.11% 61% 5.40% 88% 15.6% / 14.6% 20.7% / 23.9%
Gold/silver index XAU PHLX 3.0 27.1 6.19% 10% 21.55% 77% 36.8% / 34.8% 34.8% / 43.6%
Mini-Nasdaq 100 index MNX CBOE 8.6 894.7 4.89% 72% 7.24% 93% 19.4% / 18.5% 21.4% / 25.7%
Indices — Low IV/SV ratio

S&P 500 volatility index VIX CBOE 29.8 787.3 -31.34% 100% -28.60% 95% 96.9% / 109.1% 112.3% / 176.6%
Dow Jones index DJX CBOE 4.5 166.4 3.64% 76% 4.70% 91% 13.7% / 15.2% 19.4% / 21.9%
Banking Index BKX PHLX 1.1 94.1 1.21% 10% 0.93% 31% 22.9% / 25.3% 31.9% / 36.5%
Mini Dow YM CBOT 1.4 8.1 3.17% 59% 5.29% 94% 13.9% / 15.3% 19.8% / 23.2%
Stocks — High IV/SV ratio

Harman Intl Industries HAR 1.3 4.3 -26.60% 80% -26.76% 94% 42% / 11.2% 20.4% / 24.2%
ASM Lithography Hldg N ASML 1.7 15.6 7.46% 56% 10.80% 67% 57.4% / 29.1% 51.5% / 33.4%
Amylin Pharmas AMLN 1.6 165.2 3.76% 100% 3.14% 23% 57% / 28.9% 43.3% / 38.4%
SLM Corp SLM 12.8 522.7 1.80% 20% -1.11% 7% 43.1% / 22.1% 45.8% / 37.1%
Boston Scientific BSX 3.3 508.3 5.69% 61% 8.33% 63% 40.1% / 23.6% 39.5% / 39%
Stocks — Low IV/SV ratio

Accredited Home Lender LEND 4.6 137.1 8.16% 11% 87.16% 74% 25.2% / 86.5% 200% / 234.5%
Lehman Bros Holdings LEH 9.8 541.9 4.78% 0% 14.88% 93% 36.8% / 58.9% 47.3% / 85.9%
Morgan Stanley MS 4.7 230.3 -3.35% 88% 5.46% 63% 30.3% / 45.4% 38.3% / 55.7%
Goldman Sachs Group GS 633.3 480.8 15.02% 85% 24.79% 93% 26.5% / 39.4% 39.8% / 58.6%
Alcan AL 1.0 90.3 1.15% 45% 2.19% 22% 4.6% / 6.8% 13.5% / 18.4%
Futures — High IV/SV ratio

Eurocurrency EC-6E CME 5.1 50.1 1.89% 60% 3.75% 93% 7% / 5.5% 7.1% / 6.3%
Heating oil HO NYMEX 2.2 7.7 1.49% 0% 9.99% 71% 26.7% / 21.1% 28.7% / 27.9%
Eurodollar ED-GE CME 723.8 12.48 M 0.15% 0% 0.63% 100% 22% / 17.4% 20.5% / 15.7%
Soybean oil BO-ZL CBOT 6.4 83.4 1.30% 10% 9.43% 82% 19.9% / 15.9% 20.8% / 19.3%
Live cattle LC CME 2.7 51.6 2.35% 38% -1.17% 82% 13.2% / 10.7% 13.4% / 14.4%
Futures — Low IV/SV ratio

Corn C-ZC CBOT 26.7 775.7 11.54% 79% 19.84% 100% 27.7% / 33.3% 26.8% / 36.5%
Cotton CT NYBOT 10.5 252.5 10.66% 95% 19.95% 77% 27.5% / 32% 24.2% / 26.3%
Mini Dow YM CBOT 1.4 8.1 3.17% 59% 5.29% 94% 13.9% / 15.3% 19.8% / 23.2%
5-yr. T-note FV-ZF CBOT 46.3 288.3 0% 0% 0.73% 18% 4.2% / 4.6% 4.1% / 4.4%
*Ranked by volume **Ranked by high or low IV/SV values.
LEGEND:
Options vol: 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 asset.
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 exam-
ple, 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.

KEY CONCEPTS The option “Greeks”
American style: An option that can be exercised at any Delta: The ratio of the movement in the option price for
time until expiration. every point move in the underlying. An option with a
delta of 0.5 would move a half-point for every 1-point
move in the underlying stock; an option with a delta of
Assign(ment): When an option seller (or “writer”) is 1.00 would move 1 point for every 1-point move in the
obligated to assume a long position (if he or she sold a put) underlying stock.
or short position (if he or she sold a call) in the underlying
stock or futures contract because an option buyer exercised Gamma: The change in delta relative to a change in the
the same option. underlying market. Unlike delta, which is highest for
deep ITM options, gamma is highest for ATM options
and lowest for deep ITM and OTM options.
At the money (ATM): An option whose strike price is
identical (or very close) to the current underlying stock (or Rho: The change in option price relative to the change
futures) price. in the interest rate.
Theta: The rate at which an option loses value each day

Average and median: The mean (or average) of a set of
(the rate of time decay). Theta is relatively larger for
values is the sum of the values divided by the number of OTM than ITM options, and increases as the option gets
values in the set. If a set consists of 10 numbers, add them closer to its expiration date.
and divide by 10 to get the mean.
A statistical weakness of the mean is that it can be dis- Vega: How much an option’s price changes per a one-
torted by exceptionally large or small values. For example, percent change in volatility.
the mean of 1, 2, 3, 4, 5, 6, 7, and 200 is 28.5 (228/8). Take
away 200, and the mean of the remaining seven numbers is enter a bull call ladder, buy an ATM or ITM long call and
4, which is much more representative of the numbers in this sell two calls at different, higher strike prices. The goal is to
set than 28.5. profit from a moderately bullish outlook without too much
The median can help gauge how representative a mean upside risk. Ideally, the market will rally and close between
really is. The median of a data set is its middle value (when the two short strikes at expiration. But if the market jumps
the set has an odd number of elements) or the mean of the far above the highest short strike, potential losses could be
middle two elements (when the set has an even number of unlimited.
elements). The median is less susceptible than the mean to
distortion from extreme, non-representative values. The Bull call spread: A bull debit spread that contains calls
median of 1, 2, 3, 4, 5, 6, 7, and 200 is 4.5 ((4+5)/2), which is with the same expiration date but different strike prices.
much more in line with the majority of numbers in the set. You buy the lower-strike call, which has more value, and
sell the less-expensive, higher-strike call.
Bear call spread: A vertical credit spread that consists
of a short call and a higher-strike, further OTM long call in Bull put spread (put credit spread): A bull credit
the same expiration month. The spread’s largest potential spread that contains puts with the same expiration date, but
gain is the premium collected, and its maximum loss is lim- different strike prices. You sell an OTM put and buy a less-
ited to the point difference between the strikes minus that expensive, lower-strike put.
premium.
Butterfly: A non-directional trade consisting of options
Bear put spread: A bear debit spread that contains puts with three different strike prices at equidistant intervals:
with the same expiration date but different strike prices. Long one each of the highest and lowest strike price options
You buy the higher-strike put, which costs more, and sell and short two of the middle strike price options.
the cheaper, lower-strike put.
Calendar spread: A position with one short-term short
Beta: Measures the volatility of an investment compared option and one long same-strike option with more time
to the overall market. Instruments with a beta of one move until expiration. If the spread uses ATM options, it is mar-
in line with the market. A beta value below one means the ket-neutral and tries to profit from time decay. However,
instrument is less affected by market moves and a beta OTM options can be used to profit from both a directional
value greater than one means it is more volatile than the move and time decay.
overall market. A beta of zero implies no market risk.
Call option: An option that gives the owner the right, but
Bull call ladder: A variation of the bull call debit spread not the obligation, to buy a stock (or futures contract) at a
that profits if the underlying market doesn’t rally too far. To fixed price.

Carrying costs: The costs associated with holding an Diagonal spread: A position consisting of options with
investment that include interest, dividends, and the oppor- different expiration dates and different strike prices — e.g.,
tunity costs of entering the trade. a December 50 call and a January 60 call.
Condor: A non-directional trade with options at four dif- Double diagonal spread: A double diagonal resembles
ferent strike prices at equidistant intervals: Long one each an iron condor (call credit spread + put credit spread), but
of the highest and lowest strike price options and short two the long side of each spread expires in a later month. This
options with strikes in between these extremes. position combines two diagonal spreads on either side of
the market and tries to exploit the time decay of the short,
Continuous futures data (sometimes referred to near-term options. It collects the most profit if the market
as “nearest futures”): Unlike stock (or spot currency) trades sideways by expiration.
prices, which are unbroken price series, futures prices con- To construct a double diagonal, enter two spreads simul-
sists distinct contract months that begin and end at specific taneously: a call spread, which consists of a short out-of-
points in time. To perform longer-term analysis or system the-money call and a long, higher-strike call in a further
testing you need a continuous, unbroken price series, simi- month; and a put spread, which consists of a short OTM put
lar to stock prices. However, because of the price differen- and a long, lower-strike put in a more-distant month. Both
tial between different contract months in the same futures spread’s short options share the same expiration month,
market, moving from the prices in one month to the next and the long options expire together at least one month
creates a fractured price series that doesn't accurately reflect later.
the market’s movement.
Continuous futures data are prices that have been adjust- European style: An option that can only be exercised at
ed to compensate for the price gaps between successive expiration, not before.
contract months. Typically, the data is “back adjusted” by
raising or lowering all previous prices in the series by the Exercise: To exchange an option for the underlying
difference between the last price in the continuous series instrument.
and the new data to be added to the series. The result is an
unbroken price series that accurately reflects the day-to-day Expiration: The last day on which an option can be exer-
(or week-to-week) price changes in a market, but not the cised and exchanged for the underlying instrument (usual-
actual price levels. ly the last trading day or one day after).
Covered call: Shorting an out-of-the-money call option Intermonth (futures) spread: A trade consisting of
against a long position in the underlying market. An exam- long and short positions in different contract months in the
ple would be purchasing a stock for $50 and selling a call same market — e.g., July and November soybeans or
option with a strike price of $55. The goal is for the market September and December crude oil. Also referred to as a
to move sideways or slightly higher and for the call option futures “calendar spread.”
to expire worthless, in which case you keep the premium.
In the money (ITM): A call option with a strike price
Credit spread: A position that collects more premium below the price of the underlying instrument, or a put
from short options than you pay for long options. A credit option with a strike price above the underlying instru-
spread using calls is bearish, while a credit spread using ment’s price.
puts is bullish.
Intrinsic value: The difference between the strike price
Deep (e.g., deep in-the-money option or deep of an in-the-money option and the underlying asset price. A
out-of-the-money option): Call options with strike call option with a strike price of 22 has 2 points of intrinsic
prices that are very far above the current price of the under- value if the underlying market is trading at 24.
lying asset and put options with strike prices that are very
far below the current price of the underlying asset. Iron condor: A market-neutral position that enters a bear
call spread (OTM call + higher-strike call) above the market
Delta-neutral: An options position that has an overall and a bull put spread (OTM put + lower-strike put) below
delta of zero, which means it’s unaffected by underlying the market. Both spreads collect premium, and profit when
price movement. However, delta will change as the under- the market trades between the short strikes by expiration.
lying moves up or down, so you must buy or sell All options share the same expiration month.
shares/contracts to adjust delta back to zero. continued on p. 48

KEY CONCEPTS continued
Limit up (down): The maximum amount that a futures closer to the money and the long strikes are further from the
contract is allowed to move up (down) in one trading ses- money.
sion. For example if a stock trades at $50, you could sell one
$45 put and buy two $40 puts in the same expiration month.
Lock-limit: The maximum amount that a futures contract If the stock drops, the short $45 put might move into the
is allowed to move (up or down) in one trading session. money, but the long lower-strike puts will hedge some (or
all) of those losses. If the stock drops well below $40, poten-
Long call condor: A market-neutral position structured tial gains are unlimited until it reaches zero.
with calls only. It combines a bear call spread (short call,
long higher-strike further OTM call) above the market and Put spreads: Vertical spreads with puts sharing the same
a bull call spread (long call, short higher-strike call). Unlike expiration date but different strike prices. A bull put spread
an iron condor, which contains two credit spreads, a call contains short, higher-strike puts and long, lower-strike
condor includes two types of spreads: debit and credit. puts. A bear put spread is structured differently: Its long
puts have higher strikes than the short puts.
Long-Term Equity AnticiPation Securities
(LEAPS): Options contracts with much more distant expi- Ratio spread: A ratio spread can contain calls or puts and
ration dates — in some cases as far as two years and eight includes a long option and multiple short options of the
months away — than regular options. same type that are further out-of-the-money, usually in a
ratio of 1:2 or 1:3 (long to short options). For example, if a
Market makers: Provide liquidity by attempting to prof- stock trades at $60, you could buy one $60 call and sell two
it from trading their own accounts. They supply bids when same-month $65 calls. Basically, the trade is a bull call
there may be no other buyers and supply offers when there spread (long call, short higher-strike call) with the sale of
are no other sellers. In return, they have an edge in buying additional calls at the short strike.
and selling at more favorable prices. Overall, these positions are neutral, but they can have a
directional bias, depending on the strike prices you select.
Naked (uncovered) puts: Selling put options to collect Because you sell more options than you buy, the short
premium that contains risk. If the market drops below the options usually cover the cost of the long one or provide a
short put’s strike price, the holder may exercise it, requiring net credit. However, the spread contains uncovered, or
you to buy stock at the strike price (i.e., above the market). “naked” options, which add upside or downside risk.
Open interest: The number of options that have not Straddle: A non-directional option spread that typically
been exercised in a specific contract that has not yet expired. consists of an at-the-money call and at-the-money put with
the same expiration. For example, with the underlying
Outlier: An anomalous data point or reading that is not instrument trading at 25, a standard long straddle would
representative of the majority of a data set. consist of buying a 25 call and a 25 put. Long straddles are
designed to profit from an increase in volatility; short strad-
Out of the money (OTM): A call option with a strike dles are intended to capitalize on declining volatility. The
price above the price of the underlying instrument, or a put strangle is a related strategy.
option with a strike price below the underlying instru-
ment’s price. Strangle: A non-directional option spread that consists of
an out-of-the-money call and out-of-the-money put with
Parity: An option trading at its intrinsic value. the same expiration. For example, with the underlying
instrument trading at 25, a long strangle could consist of
Premium: The price of an option. buying a 27.5 call and a 22.5 put. Long strangles are
designed to profit from an increase in volatility; short stran-
Put option: An option that gives the owner the right, but gles are intended to capitalize on declining volatility. The
not the obligation, to sell a stock (or futures contract) at a straddle is a related strategy.
fixed price.
Strike (“exercise”) price: The price at which an under-
Put ratio backspread: A bearish ratio spread that con- lying instrument is exchanged upon exercise of an option.
tains more long puts than short ones. The short strikes are

Time decay: The tendency of time value to decrease at an etc.), the more volatile that market is.
accelerated rate as an option approaches expiration. A common application of variance in trading is standard
deviation, which is the square root of variance. The stan-
Time spread: Any type of spread that contains short dard deviation of 8, 9, and 10 is: .667 = .82; the standard
near-term options and long options that expire later. Both deviation of 2, 9, and 16 is: 32.67 = 5.72.
options can share a strike price (calendar spread) or have
different strikes (diagonal spread). Vertical spread: A position consisting of options with
the same expiration date but different strike prices (e.g., a
Time value (premium): The amount of an option’s September 40 call option and a September 50 call option).
value that is a function of the time remaining until expira-
tion. As expiration approaches, time value decreases at an Volatility: The level of price movement in a market.
accelerated rate, a phenomenon known as “time decay.” Historical (“statistical”) volatility measures the price fluctu-
ations (usually calculated as the standard deviation of clos-
Variance and standard deviation: Variance meas- ing prices) over a certain time period — e.g., the past 20
ures how spread out a group of values are — in other days. Implied volatility is the current market estimate of
words, how much they vary. Mathematically, variance is the future volatility as reflected in the level of option premi-
average squared “deviation” (or difference) of each number ums. The higher the implied volatility, the higher the option
in the group from the group’s mean value, divided by the premium.
number of elements in the group. For example, for the num-
bers 8, 9, and 10, the mean is 9 and the variance is: Volatility skew: The tendency of implied option volatil-
ity to vary by strike price. Although, it might seem logical
{(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = 0.667 that all options on the same underlying instrument with the
same expiration would have identical (or nearly identical)
Now look at the variance of a more widely distributed set implied volatilities. For example, deeper in-the-money and
of numbers: 2, 9, and 16: out-of-the-money options often have higher volatilities than
at-the-money options. This type of skew is often referred to
{(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67 as the “volatility smile” because a chart of these implied
volatilities would resemble a line curving upward at both
The more varied the prices, the higher their variance — ends. Volatility skews can take other forms than the volatil-
the more widely distributed they will be. The more varied a ity smile, though.
market’s price changes from day to day (or week to week,
EVENTS
Event: FIMA 2007 For more information:
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Date: Nov. 15-18
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Location: Mandalay Bay Resort and Casino,
Las Vegas, Nev.

FUTURES & OPTIONS CALENDAR OCTOBER/NOVEMBER
MONTH
October (NYMEX)
Legend The New York Board of Trade no longer exists. It 23
is now part of the IntercontinentalExchange; all
CPI: Consumer Price Index contracts that were previously NYBOT are now ICE.
24 FND: November crude oil futures
(NYMEX)
ECI: Employment cost index 1 September ISM
First delivery day (FDD): FND: October sugar futures (ICE) 25 September durable goods
The first day on which deliv- FDD: October coal, natural gas, and LTD: November aluminum, copper,
ery of a commodity in fulfill- crude oil futures (NYMEX); October silver, and gold options (NYMEX);
ment of a futures contract can aluminum, platinum, palladium, copper, October feeder cattle futures and options
take place. silver, and gold futures (NYMEX); (CME)
First notice day (FND): Also October soybean products futures 26 LTD: November T-bond options (CBOT);
known as first intent day, this (CBOT); October sugar futures (ICE); November coal, natural gas, gasoline,
is the first day a clearing- October cotton futures (ICE) and heating oil options (NYMEX);
house can give notice to a 2 FND: October propane, gasoline, and November soybean options (CBOT)
buyer of a futures contract heating oil futures (NYMEX) 27
that it intends to deliver a
commodity in fulfillment of a
3 28
futures contract. The clearing- 4 LTD: September milk options (CME) 29 LTD: November natural gas futures
house also informs the seller. FDD: October propane futures (NYMEX) (NYMEX); October aluminum, platinum,
FOMC: Federal Open Market 5 September employment palladium, copper, silver and gold
Committee LTD: October currency options (CME); futures (NYMEX)
October U.S. dollar index options (ICE); FND: November coal futures (NYMEX)
GDP: Gross domestic
product November cocoa options (ICE); October 30 FOMC meeting
live cattle options (CME) FND: November natural gas futures
ISM: Institute for supply man-
agement 6 FDD: October gasoline and heating oil (NYMEX)
LTD: Last trading day; the futures (NYMEX) 31 FOMC meeting

first day a contract may trade 7 Third quarter GDP (advanced)
or be closed out before the September ECI
delivery of the underlying
8 FND: October live cattle futures (CME) LTD: November propane, gasoline, and
asset may occur. 9 LTD: October cotton futures (ICE) heating oil futures (NYMEX); October
live cattle futures (CME)
PPI: Producer price index 10 FND: November aluminum, platinum,
Quadruple witching Friday: 11 FDD: October live cattle futures (CME) palladium, copper, silver, and gold
A day where equity options, futures (NYMEX); November rice and
equity futures, index options,
12 September PPI
September retail sales soybean futures (CBOT)
and index futures all expire.
LTD: October soybean products futures November
(CBOT); October lean hog futures and
options (CME); November sugar and
1 October ISM
OCTOBER 2007 LTD: October milk options (CME)
coffee options (ICE)
30 1 2 3 4 5 6 FND: November orange juice futures
13 (ICE)
7 8 9 10 11 12 13
14 FDD: November natural gas, coal, and
14 15 16 17 18 19 20 crude oil futures (NYMEX); November
21 22 23 24 25 26 27 15 LTD: October Goldman Sachs aluminum, palladium, platinum, copper,
Commodity Index options (CME) gold, and silver futures (NYMEX);
28 29 30 31 1 2 3
16 November rice and soybean futures
(CBOT)
17 September CPI
LTD: November crude oil options
NOVEMBER 2007
(NYMEX); November platinum options 2 October employment
28 29 30 31 1 2 3 (NYMEX) LTD: December cocoa options (ICE)
4 5 6 7 8 9 10 18 FND: November propane, gasoline, and
11 12 13 14 15 16 17 heating oil futures (NYMEX)
19 LTD: All October equity options; October
18 19 20 21 22 23 24 S&P options (CME); October Nasdaq 3
25 26 27 28 29 30 1 options (CME); October Russell options 4
(CME); October Dow Jones options
(CBOT); November orange juice options 5
(ICE) 6 FDD: November propane futures
The information on this page is 20 (NYMEX)
subject to change. Futures &
Options Trader is not responsible 21 7 First quarter productivity and costs
for the accuracy of calendar dates (preliminary)
beyond press time. 22 LTD: November crude oil futures

FUTURES
FOREX TRADE JOURNAL
DIARY
The big move in the wake of

the Fed’s September interest-rate
meeting rescues a trade on
the brink of being stopped out.
TRADE
Date: Friday, Sept. 14, 2007.
Entry: Long December 2007 E-Mini

Nasdaq 100 futures (NQZ07) at 2,027.25.
Reasons for trade/setup: The intra-

day recovery and high close on Sept. 14
and the Federal Reserve interest rate meet-
ing looming on Sept. 18.
The action on Sept. 14 appears to be the Source: TradeStation
bottom of a small pullback after the
bounce off the Sept. 10 low. As detailed in
“The Fed effect” (Active Trader, January 2004), the stock Trade executed according to plan? No.
market’s response to Fed meetings is, on the whole, posi-
tive. The only fly in the ointment this time is the uncertain- Outcome: The entry day turned out not to be the low of
ty of whether the Fed would cut rates a quarter point or a the pullback after all. The market traded down to 2,000.25
half point. Based on past market behavior, this is an oppor- on Sept. 17 — which looked like a sign market players were
tunity to get in the next leg of the market’s current upswing losing confidence the Fed would cut rates — but after a
off the Aug. 16 low. slight pullback after the open on Sept. 18, price shot higher
when the news came out that the Fed had cut rates a half
Initial stop: 1,996.25, which is 9.50 below the low of the point.
entry bar. The higher volatility level in the current market The trade was exited early because we often enter a limit
calls for widening stop amounts. exit order two to three percent from the most recent close,
with the idea the market is likely to retrace at least some of
Initial target: 2,060, which is the round-number price such a big intraday move — better to get out with an out-
just below the Sept. 4 high of 2,063. sized profit in an emotional market and re-enter after a cor-
rection.
On Sept. 18 we put a resting order in at 2,055.00, which
RESULT was 2.4 percent above the previous close. In retrospect, low-
ering the target five points was meaningless, but the previ-
Exit: 2,055.00. ous day’s price action had prodded us toward more conser-
vative goals. The market traded precisely 1.25 points above
Profit/loss: +27.25 (1.37 percent). our original target level.
TRADE SUMMARY
Date Contract Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
9/14/07 NQZ07 2,027.25 1,996.25 2,060.00 1.06 2,055.00 9/18/07 +27.25 (1.4%) 34 -27 2 days
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

OPTIONS
FOREX TRADE JOURNAL
DIARY
FIGURE 1 — GOLDMAN LOSES ITS LUSTER

A tight stop-loss eases
After climbing to an all-time high on May 31, Goldman Sachs plunged 33 percent in
the pain after a directional less than three months. Historical testing showed another decline was likely before
GS reported earnings on Sept. 20.
forecast fails.
TRADE
Date: Tuesday, Sept. 11.
Market: Options on Goldman

Sachs (GS).
Entry: Sell 10 September 210 calls

for $0.50 each.
Buy 10 September 220 calls Source: eSignal

for $0.20 each.
Reasons for trade/setup: FIGURE 2 — RISK PROFILE — BEAR CALL SPREAD

Goldman Sachs (GS) jumped 83 per- This 210-220 September bear call spread risks $9,700 to keep $300 in premium, but
cent in 2006 and the first half of 2007, it has a 92-percent chance of success.
hitting an all-time high on May 31. But
the stock subsequently fell 33 percent
by Aug. 16, in part because of large
losses at its Global Alpha hedge fund
(Figure 1).
In early September GS bounced
back somewhat, but historical testing
showed Goldman could drop again
before it released quarterly earnings
on Sept. 20: Since May 1999 the stock
has fallen further than it has rallied (an
average of -4.61 percent vs. 3.69 per-
cent) in the seven days before earnings
reports. It also fell an average of 0.90
percent over the two days after earn-
ings.
In anticipation of a pre-earnings
slump, a bear call spread was entered
when GS traded at $186.26 on Sept. 11.
The credit spread’s 210 short strike is Source: OptionVue
nearly 13 percent out-of-the-money
(OTM); the trade would be profitable if Goldman doesn’t expect to keep the spread’s $0.30 premium ($300).
rally sharply in the next eight days. September options will Figure 2 shows the vertical spread’s potential gains and
expire the day after Goldman releases earnings, and we losses on three dates: trade entry (Sept. 11, dotted line),

FIGURE 3 — NO PAIN, NO GAIN
halfway until expiration
(Sept. 17, middle dashed The trade got stopped out early with a $250 loss, but it would have been profitable at expiration.
line), and expiration (Sept.
22, solid line). The trade has
a 92-percent chance of suc-
cess, but it risks $9,700 to
keep $300 — a poor risk-
reward ratio.
Initial stop: Exit spread if

GS rallies 4.33 percent (its
average close-to-high up
move during this period)
before September expira-
tion.
Initial target: Hold until

expiration. Source: eSignal
TRADE SUMMARY
RESULT
Entry date: Sept. 11, 2007
Outcome: At first Goldman Underlying security: Goldman Sachs (GS)
moved in the right direction: It
Position: Bear call spread
declined 1.50 percent by Sept. 11’s
10 short September 210 calls
close and skidded another 1 per-
10 long September 220 calls
cent the next morning (Figure 3).
Initial capital required: $10,000
But GS rallied 4.6 percent within
two days, resulting in a roughly Initial stop: Exit if GS climbs 4.33 percent by Sept. 21.
$100 open loss. Initial target: Hold until Sept. 22 expiration.
Goldman fell 2.3 percent within
Initial daily time decay: $75.02
the first hour of trading on Sept.
17, rebounded slightly, and closed Trade length (in days): 7
1.56 percent lower on the day. At P/L: -$250 (-2.5 percent)
that point, we could have exited
LOP: $100
with a $100 profit, but we stuck to
the plan. GS gained momentum on LOL: -$250
Sept. 18 and jumped 4.2 percent by LOP – largest open profit (maximum available profit during lifetime of trade);
1:30 p.m., which triggered the LOL – largest open loss (maximum potential loss during life of trade).
stop-loss. We exited the trade with
a $250 loss (-2.5 percent).
Should we have held the spread until expiration? TRADE STATISTICS
Goldman closed just $0.02 below the 210 short strike on
Sept. 21 — the last day before September options expired Date: Sept. 11 Sept. 18
— so the spread expired worthless, and we would have Delta: -50.11 -80.95
kept the $300 premium. Gamma: 5.87 -9.62
However, GS surged 10.33 percent on Sept. 18 and 19 —
Theta: 75.02 159.4
its biggest two-day jump in five years — and the 210 calls
we sold for $0.30 traded as high as $3.80 after Goldman Vega: -29.83 -27.26
released better-then-expected earnings on Sept. 20. Probability of profit: 92% 32%
Holding the spread would have yielded profits, but we Breakeven point: 185.19 190.54
would have first faced an unrealized loss of $2,300.

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Strategies, analysis, and news for futures and options traders

October 2007 • Volume 1, Issue 7

TRADING THE FED

Bear put ladders . . . . . . . . . . . . . . . . . . . . .26

Futures Strategy Lab . . . . . . . . . . . . . . . .32

Options Strategy Lab . . . . . . . . . . . . . . . .36

Trading Strategies Book Excerpt . . . . . . . . . . . . . . . . . . . . . . . .38

T-bond trading characteristics . . . . . . . .14 continued on p. 4

2 October 2007 • FUTURES & OPTIONS TRADER

Turf war between CFTC, FERC looms . .41

Futures Snapshot . . . . . . . . . . . . . . . . . . . .44 Options Trade Journal . . . . . . . . . . . . . . .54

Have a question about something you’ve seen

Looking for an advertiser?

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

CBOE OptionsMentoring Trader’s Expo Las Vegas

4 October 2007 • FUTURES & OPTIONS TRADER

Philip Budwick is co-author of The Option Trading Handbook:

6 October 2007 • FUTURES & OPTIONS TRADER

TABLE 1 — SPREADS AS PREDICTORS

8 October 2007 • FUTURES & OPTIONS TRADER

A sample of the evidence Sept. Dec. 1-contract

FUTURES & OPTIONS TRADER • October 2007 9

tially the correct way to interpret these spreads:

10 October 2007 • FUTURES & OPTIONS TRADER

Improving the results 1/31/00 27.64 25.32 -2.32 Buy June

FUTURES & OPTIONS TRADER • October 2007 11

FIGURE 1 — DECEMBER 2004 CRUDE OIL FUTURES

on, however, prices trended sharply

12 October 2007 • FUTURES & OPTIONS TRADER

FIGURE 3 — JUNE 2002 CRUDE OIL FUTURES

FUTURES & OPTIONS TRADER • October 2007 13

T-bond trading characteristics

FIGURE 1 — THE DAILY ANALYSIS PERIOD

14 October 2007 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • October 2007 15

FIGURE 5 — UP-CLOSING SESSIONS

16 October 2007 • FUTURES & OPTIONS TRADER

FUTURES & OPTIONS TRADER • October 2007 17

is -0.60 points (-19.2/32nds)

18 October 2007 • FUTURES & OPTIONS TRADER

Figure 11 shows all of the hourly ranges for

FUTURES & OPTIONS TRADER • October 2007 19

Earnings reports and covered calls

20 October 2007 • FUTURES & OPTIONS TRADER

Purchase price of WMT stock per share: 43.06

Selling price of call option: 1.75

The maximum potential return for a covered call is deter-

FUTURES & OPTIONS TRADER • October 2007 21

TABLE 2 — BETTER OFF BEING OUT

TABLE 3 — HOLD ‘EM

22 October 2007 • FUTURES & OPTIONS TRADER

Highest potential return biotechnology covered call positions

FUTURES & OPTIONS TRADER • October 2007 23

24 October 2007 • FUTURES & OPTIONS TRADER

Bear put ladders

more difficult. After falling to a four- TABLE 1 — RATIO PUT SPREAD

26 October 2007 • FUTURES & OPTIONS TRADER

What is a ratio spread?

Ratio put spread example

FUTURES & OPTIONS TRADER • October 2007 27

OTM November 140 puts for 5.50 each

Source: OptionVue Descending the ladder

28 October 2007 • FUTURES & OPTIONS TRADER

Moving into the money,

Futures & Options Trader 2007-07 Oct

Futures & Options Trader 2007-07 Oct