FOT200804

April 2008 • Volume 2, No.
FUTURES
STRATEGY:
Intraday and daily
reversal-bar
technique p. 8
THE LATEST
FUTURES
volume
statistics p. 28
VERTICAL
SPREADS:
Credit vs. debit
showdown p. 12
DANGEROUS DANCE: ROGUE TRADER UPDATE

gold above $1,000 p. 38 p. 29
CONTENTS
Futures & Options Watch . . . . . . . . . . . . . . .20

What’s new in the COT report
Dissecting the historical dynamics
between commercial traders and large
speculators in all 45 futures markets.
Options Watch
High-volume Dow components.
News
CME offers $9.4 billion for NYMEX,
hits campaign trail . . . . . . . . . . . . . . . . . . .22
Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Selling the shareholders on the deal is
now the first order of business.
Trading Strategies Jim Kharouf
Key reversal strategy . . . . . . . . . . . . . . . . . .8
Adapting a one-bar pattern for different time Bear Stearns gets a little respect . . . . . .23
frames. Stalwart Wall Street firm Bear Stearns
By Dominic Boyle needed some help from its friends after
being decimated by the sub-prime
Vertical spreads: Credit vs. debit . . . . . .12 mortgage market meltdown.
Both types of vertical spreads can profit By Jim Kharouf
from directional moves while hedging risk.
When should you favor one over the other? MF Global hit by rumor mill . . . . . . . . . . .24
By Darren Chu The fall of Bear Stearns also affected
MF Global.
Futures Snapshot . . . . . . . . . . . . . . . . . . . . . .18 By Jim Kharouf
Momentum, volatility, and volume
continued on p. 4
statistics for futures.
Option Radar . . . . . . . . . . . . . . . . . . . . . . . . . .19

Notable volatility and volume
in the options market.
2 April 2008 • FUTURES & OPTIONS TRADER

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CONTENTS
Nasdaq Options Exchange

gets green light . . . . . . . . . . . . . . . . . . . . . .24
The Nasdaq Options Exchange, the seventh Rogue trader update . . . . . . . . . . . . . . . . .29
options exchange in the U.S., began Rogues’ former employers face tough
operations in March. times in the wake of huge losses.
By Jim Kharouf
Key Concepts . . . . . . . . . . . . . . . . . . . . . . . . . .30
Gold collapses . . . . . . . . . . . . . . . . . . . . . . .25 References and definitions.
Yellow metal plunges back below
$900/ounce. Futures & Options Calendar . . . . . . . . . . . .34
Bold moves by the U.S. Fed . . . . . . . . . .26 Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35

Unprecedented action by the central bank
may calm markets, have unforeseen New Products and Services . . . . . . . . . . . . .36
repercussions.
By Futures & Options Trader Staff Futures Trade Journal . . . . . . . . . . . . . . .38
Last call for the gold express?
U.S. futures volume . . . . . . . . . . . . . . . .28
Recent report shows 2007 volume growth, Options Trade Journal . . . . . . . . . . . . . . .40
continuing into 2008. After a rocky start, this March iron condor
By Chris Peters lands successfully.
Have a question about something you’ve seen

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CONTRIBUTORS
CONTRIBUTORS
A publication of Active Trader ®

Darren Chu is a corporate relations manager for the Montreal
Exchange, servicing institutional and retail traders/brokers and the

For all subscriber services:
www.futuresandoptionstrader.com buy-side. Chu’s prior role at the Montreal Exchange involved edu-
cating retail investors, financial industry professionals, students, and

Editor-in-chief: Mark Etzkorn business groups on exchange-traded derivatives. Previously, Chu
metzkorn@futuresandoptionstrader.com
worked at CMC Markets, where he developed and taught courses on
Managing editor: Molly Flynn
mflynn@futuresandoptionstrader.com CFD and forex trading. While at CMC Markets, Chu also served as a
Senior editor: David Bukey

market analyst, providing market commentary to clients from the
dbukey@futuresandoptionstrader.com
perspective of an active trader in the oil and gold markets. Chu is cur-
Contributing editors: rently a member of the Canadian Securities Institute’s Derivatives
Jeff Ponczak
jponczak@futuresandoptionstrader.com, Board.
Keith Schap
Associate editor: Chris Peters

cpeters@futuresandoptionstrader.com Dominic Boyle is a market strategist with Lind-
Editorial assistant and Waldock, division of MF Global. He began his career

Webmaster: Kesha Green
kgreen@futuresandoptionstrader.com
in the Canadian dollar pit at the Chicago Mercantile
Exchange and has worked in several capacities in the

Art director: Laura Coyle
lcoyle@futuresandoptionstrader.com futures industry. He currently holds series 3, 63, 65, and 7 licenses. He
President: Phil Dorman can be reached at (312) 788-2920 or (888) 800-5373 and via e-mail at
pdorman@futuresandoptionstrader.com
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Ad sales years of experience covering stocks, futures, and options worldwide.

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Classified ad sales: Mark Seger international derivatives exchanges, money managers, and traders
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for a variety of publications.
Volume 2, Issue 4. Futures & Options Trader is pub-
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TRADING STRATEGIES
Key reversal strategy

Building a trading approach around a one-bar price pattern.
BY DOMINIC BOYLE
M any traders crowd their trading screens

with complex indicators to the point that
identifying a trade signal often becomes a
challenge in itself. As a result, simple tools
such as the key reversal pattern are often overlooked.
The key reversal has several definitions, but most of them
are very similar and all have the same implication. It is a
2. Bearish: a bar with a high above the previous
bar’s high and a close below the previous bar’s
low.
Notice these patterns could also be defined as outside

bars with closes above the previous high or below the pre-
vious low, respectively. The implication remains the same,
one-bar pattern that is typically defined by a strong intra- though: After testing the previous bar’s extreme high or
bar reversal that implies further price movement in the low, price reverses and ends the bar strongly enough to
direction of the reversal. It can be used to on any time close beyond the previous bar’s opposite extreme.
frame. Figure 1 shows an example of a daily bearish key rever-
The key-reversal definitions used here are: sal in the E-Mini S&P 500 futures (ES). On Dec. 11, 2007 the
market made a higher high and then closed below the pre-
1. Bullish: a bar with a low below the previous vious day’s low.
bar’s low and a close above the previous bar’s Figure 2 shows a bullish key reversal on a 10-minute
high. crude oil chart from Dec. 19, 2007 at 7:30 a.m. CT. The mar-
ket made a lower low than the pre-
FIGURE 1 — DAILY BEARISH REVERSAL vious bar and closed above that
The daily E-Mini S&P 500 chart gave a bearish key reversal signal on Dec. 11. The bar’s high.
market made a high of 1,527.00 (above the previous day’s high) and closed below Using key reversals as buy or
the previous day’s low of 1,501.00 at 1,478.00. sell signals exploits the immediate
market momentum: A bullish pat-
tern can get you into the market
when momentum is pointing
upward, while a bearish pattern
does the opposite.
The following strategy examples
apply the key reversal pattern on
the 10-minute time frame for intra-
day trading and the daily time
frame for swing trading.
Using the pattern

as a signal
Regardless of the trading approach
or technique, any strategy requires
specific rules that provide objectiv-
ity and discipline. Without disci-
pline and risk-reward parameters
for every trade, you are left to
make decisions based on emotion
which leads to irrational choices
Source: eSignal
and, and ultimately, failure.

FIGURE 2 — BULLISH INTRADAY REVERSAL
The following strategy rules The 10-minute crude oil chart gave a bullish key reversal indicator on Dec. 19 at the
add specific stop-loss and profit- 7:30 a.m. bar. The market made a low of 90.01 and closed at 90.33, above the
taking levels to the basic key rever- previous bar’s high of 90.26.
sal signal.
The rules for the 10-minute
strategy are:
1. When a bullish key reversal

bar forms, buy at the market
and place a sell stop at the
entry price minus the key
reversal bar’s range.
2. Place a limit order to sell at
the entry price plus 1.5 times
the key reversal bar’s range.
The rules are reversed for short

trades:
1. When a bearish key reversal

bar forms, go short at the
market and place a buy stop
at the entry price plus the
key reversal bar’s range.
continued on p. 10 Source: eSignal
FUTURES & OPTIONS TRADER • April 2008 9

TRADING STRATEGIES continued
2. Place a limit order to buy at Pattern test

the entry price minus 1.5
times the key reversal bar’s FIGURE A — REVERSAL PATTERNS, E-MINI S&P 500 10-MINUTE BARS
range. (FEB. 1 TO MARCH 27, 2008)
The rules for the daily-bar strategy are:
1. When a bullish key reversal day

forms, buy market on close (MOC)
and place a good-till-canceled (GTC)
sell-stop order at the entry price
minus 1.5 times the key reversal
day’s range.
2. Place a GTC limit order to sell at the
entry price plus 2 times the key
reversal day’s range.
As with the 10-minute strategy, the

rules are reversed for short trades.
Larger stops are used for the daily key
reversal and smaller stops are used for the
Figure A shows what the E-Mini S&P 500 futures did one, two, six, and 12
10-minute reversals for a specific reason.
bars after 10-minute bullish and bearish reversal bars between Feb. 1 and
The key reversal indicator is not very
common, and markets tend to be more March 27, 2008. Using day-session data only, there were 31 bearish rever-
volatile than usual when a trader is able to sal bars and 32 bullish reversal bars.
take advantage of the indicator. This in The figures represents the median close-to-close gains or losses after
turn means that for traders to capture the reversal bars and the average close-to-close changes for all respective
profits on the daily indicator, they have to one-, two-, six-, and 12-bar moves during the analysis period.
use a larger stop to account for more Overall, the market had a slight downside bias during this period. The
volatility in the market. bearish reversal bars (red line) were followed by slightly more bearish per-
Returning to Figure 1, a short trade formance than average for the first two bars (-0.13 and -.025 vs. -0.04 and
would have been entered at 1,478 on the -0.07, respectively), but the median return was positive after six bars; after
close. The key reversal day’s range was
12 bars it was negative again. However, the average gains six and 12 days
51.50 points, so a GTC buy stop would
out after bearish reversal bars were positive (not shown). This upside bias
have been placed at 1,478 + (51.50*1.50) =
in the data suggests the bearish reversal bars might coincide with volatile
1,555.25. The GTC profit-taking limit
order would have been placed at 1,478 – or “overdone” price action, and the market might have a tendency to
(51.50*2) = 1,375. The trader would still be bounce back after these episodes.
carrying a short position. The results after the bullish reversal patterns are much more consistent.
For the intraday long trade example in Despite the market’s overall bias, the price action after 10-minute bullish
Figure 2, a long trade would have been reversal bars was positive at every interval (if static for the first two bars).
triggered at 90.33, and would have placed Given this study measured only the close-to-close moves and not the
a sell stop at 89.99. The profit limit order extreme moves to the succeeding bars’ highs and lows, the upside bias
to sell would have been placed at 90.84, shown here is worth noting.
and the trader would have exited the Of course, the pattern should be tested on any other market or time
trade with a $540 profit, less fees and com-
frame considered for trading.
missions.
— FOT Staff
Volatility
These key reversal bars are not particularly common and periods of extreme volatility, and using the proper risk and
volatility tends to be quite high when they occur. Traders reward guidelines outlined is essential
should stick to the markets where the indicator works best
— the E-Mini S&P 500, crude oil, soybeans, gold, euro cur- For information on the author see p. 6. Futures trading involves the
rency, corn, mini-sized Dow, and silver. substantial risk of loss and is not suitable for all investors. Past per-
During times of key reversal indicators the markets are in formance is not necessarily indicative of future trading results.

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TRADING STRATEGIES
Vertical spreads:
Credit vs. debit
Picking the right kind of spread requires considering volatility and time decay in light
of how much your position is in or out of the money.
BY DARREN CHU
FIGURE 1 — CISCO SYSTEMS

You could enter a vertical spread in Cisco options by
O ne of the most fundamental questions in purchasing one of these strikes and selling another of the
options trading is whether you should same type (call or put) and expiration date.
simply buy an option or create a vertical
spread by purchasing one and selling
another with the same expiration date.
Traders often debate whether one type of vertical
spread is inherently better than another. Beginners tend
to prefer credit spreads over debit spreads because the
former strategy allows you collect premium, while the
latter requires a cash outlay. If both spreads’ directional
exposure is roughly the same, why buy one when you
can sell one — and collect premium — instead?
Professionals, however, know better than to ignore
debit spreads. They realize credit and debit spreads func-
tion as two sides of the same coin.
To choose the most appropriate vertical spread in a
given situation, you must study all the variables that
influence an option spread’s profitability. Clearly, direc-
tional exposure is important, but other subtle factors Source: eSignal
such as time decay, implied volatility, assignment risk,
and trading costs play a critical role. from Dec. 3, 2007 to Feb. 29, 2008, and Table 1 lists the prices
of March options when CSCO closed at $24.39 on Feb. 29.
Time decay and OTM credit spreads To create a 25-27.5 bull put spread, you would sell one 27.5-
Instead of buying options, many traders prefer to sell them strike put for $3.00 and buy one 25-strike put for $1.02 for a
either outright or in credit spreads, especially in the nearest $1.98 credit.
expiration month. Options sellers assume time decay will The 25 put’s theta (-0.0139) is substantially larger than
work in their favor, but profiting from the passage of time that of the 27.50 put (-0.0043). The 25 put’s theta is larger
with a credit spread isn’t a given. because the option is closer to the money, and at-the-money
Although a credit spread’s short option benefits from (ATM) options have the highest thetas. Because the 25 put
time decay, this process works against the long option. As a is long, its time decay wipes out any benefit from the short
result, you need to know which leg of the spread has a 27.5 put, which means this in-the-money (ITM) credit
higher theta value. An example will help illustrate how spread is hurt by the passage of time.
time decay benefits sellers of out-of-the-money (OTM) By comparison, an OTM bear call spread (short 25 call,
credit spreads. long 27.5 call) benefits from time decay. Because the 25-
Figure 1 shows a daily chart of Cisco Systems (CSCO) continued on p. 14

Vertical spreads
Vertical spreads contain two options of FIGURE A — BULLISH VERTICAL SPREADS
the same type (call or put) and expira-
The put spread offers a credit of $198, while the call spread costs $41, but both
tion, but at different strikes; one option is
positions will gain if Cisco rallies or lose money if CSCO declines (blue and red
long and the other is short. These
lines, respectively).
spreads gain or lose ground based on
the underlying’s direction, and they often
reduce risk in exchange for a limited
profit potential.
A vertical spread can be a viable alter-
native to a long option’s cost, exposure
to time decay, and changes in implied
volatility (IV), but it also has a limited
profit. However, giving up some profit
potential provides a hedge against direc-
tional, time, and volatility risk.
A debit spread costs money to create
because the option you buy costs more
than one you sell; a credit spread places
money in your account since the short
option is more expensive than the long
one. Bullish or bearish vertical spreads
can be constructed with either calls or
puts, but all options must share the Source: OptionVue
same expiration date
Bullish spreads. A bull call spread is
TABLE 1 — MARCH OPTIONS IN CISCO
created by buying one call and selling
another one with the same expiration, The 25-strike options are near the money, so it has higher theta and vega
but higher strike price. The long call pro- values, which are important variables when entering a vertical spread.
vides a bullish directional outlook, while CSCO closed at $24.39 on Feb. 29.
the higher-strike short call captures March options expired on March 21.
some premium and reduces the overall
position’s cost and risk. The spread Options Symbol Bid Ask Close Theta Vega
achieves its maximum profit when the 27.5 put CYQ OY $3.05 $3.20 $3.00 -0.0043 0.0061
underlying trades above the higher
25 put CYQ OE $1.04 $1.01 $1.02 -0.0139 0.0222
strike, while its largest losses occur
24 put CYQ OP $0.48 $0.52 $0.52 -0.0156 0.0225
when the underlying falls below the
lower strike. 22.5 put CYQ OX $0.15 $0.17 $0.16 -0.0106 0.0136
A bull put spread is a credit spread 20 put CYQ OD $0.03 $0.01 $0.02 -0.0032 0.0033
that generates income when you estab-
lish it. It consists of a short put and a 27.5 call CYQ CY $0.03 $0.04 $0.04 -0.0042 0.0061
long, lower-strike put in the same expira- 25 call CYQ CE $0.43 $0.46 $0.45 -0.0164 0.0222
tion month. To earn the maximum profit, 22.5 call CYQ CX $2.01 $2.10 $2.06 -0.0116 0.0136
the underlying must close above the
20 call CYQ CD $4.45 $4.55 $4.50 -0.0036 0.003
short strike at expiration. The spread will
lose money if the underlying closes
below the spread’s lower strike, but losses are limited to the To enter a debit call spread, buy one 25-strike March call
strike-price difference minus any premium collected. and sell one 27.5-strike call. Or you can enter a credit put
Cisco Systems (CSCO) closed at $24.39 on Feb. 29. If you spread by selling one March 27.5 put and buying one 25-strike
were bullish and thought Cisco could rally more than 10 per- put to protect against large losses.
cent within a month, you could enter either a bull call spread or Figure A compares the potential gains and losses of the 25-
bull put spread in March options. continued on p. 14

Vertical spreads continued Implied volatility

27.5 bull call and put spreads. The put spread offers a credit of $198, while the Traders also sell credit spreads to
call spread costs $41, but both positions will gain if CSCO rallies or lose money exploit periods of relatively high
if Cisco declines. (Table 1 lists exact prices for these options.) implied volatility. However, don’t
Bearish spreads. A bear call spread has a moderately bearish directional assume all credit spreads benefit from
outlook. This credit spread includes a short call and a cheaper, higher-strike IV declines. The individual options
call that limits losses if the underlying rallies above it. The goal is for the under- within a spread not only have different
lying to fall below the lower strike, and if the stock closes below that point, you vegas, but each option’s IV changes to
keep the spread’s initial credit.
different degrees.
A bear put spread is a debit spread that contains a long put and a short
Take another look at the 25-27.50
same-month put with a lower strike. The long put benefits from a bearish fore-
bear call spread in Table 2. The 25 call
cast, and the lower-strike short put reduces the spread’s cost and risk. The
spread earns its largest gain if the underlying closes below the lower strike at is near the money, so it has a larger
expiration, while it loses the most ground if the underlying closes above the vega than the 27.5-strike call (0.0222
higher strike. vs. 0.0061, respectively). If each
Suppose Cisco traded at $24.39, and you believed Cisco could continue to option’s IV drops by the same amount,
trade below $25 by March 21 expiration. If you entered a bear call or put the short 25 call should gain more than
spread using the same strike prices as in Figure A (25 and 27.5), your direc- the long 27.50 call loses, which benefits
tional outlook would invert. the spread. However, this scenario
Figure B compares the potential gains and losses of the 25-27.5 bear call isn’t as certain if the short 25 call’s IV
and put spreads. The bear call spread provides a credit of $0.41, and the bear falls by a smaller amount than the 27.5
put spread costs $1.98. Both spreads will gain roughly $50 if CSCO drops
call’s IV.
below 25, or they will lose about $200 if Cisco climbs above 27.5.
To calculate how shifting IVs can
alter a spread’s value, first multiply
FIGURE B — BEARISH VERTICAL SPREADS
each option’s vega by its change in IV.
Both spreads will gain roughly $50 if Cisco continues to trade below 25 at Next, compare how each option is
March 21 expiration. However, if CSCO climbs above 27.5, both positions could affected: If you sell a credit spread, you
lose about $200. want the long option to lose more than
the short one gains; but if you buy a
debit spread, you may benefit from the
opposite scenario (and vice versa).
Fortunately, vertical spreads tend to
be somewhat vega neutral. Implied
volatility changes by roughly the same
amount across both strikes (if they’re
fairly close together, which simplifies
the analysis). In other words, the
vega’s impact on long and short
options tend to offset each other.
Early assignment
When you sell an option you face the
risk of early assignment, which means
an options holder may exercise it and
Source: OptionVue make you buy or sell the underlying
instrument. This is less likely to occur
if you trade a debit spread, because the
strike call is closer to the money, it has a higher theta than the long leg will move into the money before the short leg; and
$27.50 call; if you’re short the 25 call and long the 27.5 call, if the short option moves ITM and is assigned, you can exer-
the spread’s time decay works for you rather than against cise the long one to meet any obligations.
you. Table 2 compares the ITM and OTM spreads. However, a credit spread is more likely to be assigned

TABLE 2 — A TALE OF TWO CREDIT SPREADS
early because the short leg will move Not all credit spreads benefit from time decay. The March 25-27.5 bull put
ITM before the long one. If this hap- spread is hurt by the passage of time because the long 25 put’s theta is larger
pens, you may lose money as you’re than the 27.50 put’s theta. By contrast, the 25-27.5 bear call spread benefits
forced to buy or sell the underlying from the passage of time for the same reason.
stock or contract at an unfavorable
March 25/27.50 bull put spread
price (and pay additional commis-
Position Long or short? Per-share price Theta Vega
sions). If you prefer selling credit
1 March 25 put Long -$1.02 -0.0139 0.0222
spreads, you can minimize the likeli-
1 March 27.5 put Short $3.00 0.0043 -0.0061
hood of early assignment by sticking to
OTM spreads. By contrast, ITM credit
Total: $1.98 -0.0096 0.0161
spreads have a short leg that is ATM or
ITM early in the trade, which increases
March 25/27.50 bear call spread
early assignment risk.
Consider the 25-27.50 March bull call
1 March 25 call Short $0.45 0.0164 -0.0222
(debit) spread in Table 3. Let’s assume
1 March 27.5 call Long -$0.04 -0.0042 0.0061
CSCO will climb to $28 from $24.39
within two weeks. The short 27.50 call
Total: $0.41 0.0122 -0.0161
is ITM by $0.50, so there is a slight
Note: Positive thetas represent a position that benefits from time decay, while nega-
chance of early assignment. However, tive thetas are hurt by the passage of time. Positive vegas represent a position that
early assignment is unlikely, because benefits from IV increases, while negative vegas are hurt by rising IVs.
the 27.50 call still has some time value.
However, if the short 27.50 call is
assigned, you would be forced to sell TABLE 3 — BULL CALL SPREAD
100 shares of CSCO at $27.50. This 25-27.5 bull call spread costs $0.41 and could earn up to $2.09 if Cisco
Fortunately, the long 25 call is ITM trades above $27.50 at expiration. If this happens, the short 27.50 call isn’t at
when the short 27.50 is assigned, so the risk of early assignment, because the long 25 call is ITM and could be exer-
bull call spread has already profited. cised to immediately capture the $2.50 spread between the two strikes.
The long 25 call is ITM by at least $2.50
March 25/27.50 bull call spread
and could be exercised to immediately
capture the $2.50 spread between the
1 March 25 call Long -$0.45 -0.0164 0.0222
two strikes.
1 March 27.5 call Short $0.04 0.0042 -0.0061
Assignment risk is different for cred-
it spreads, though. If the short leg is
Total: -$0.41 -0.0122 0.0161
assigned early, you will probably lose
money. To capture the maximum profit
from Table 2’s 25-27.5 bear call spread, TABLE 4 — BULL PUT SPREAD
Cisco must trade below $25 by March
Unlike Table 2’s 25-27.5 bull put spread, this spread has lower strikes and
22 expiration and let the short 25 call wasn’t at risk of early assignment when Cisco traded at $24.39 on Feb. 29.
expire worthless. But if the stock climbs
March 22.5/24 bull but spread
to $27 just before March options expire,
the 25 call could be assigned as it
1 March 22.5 put Long -$0.17 -0.0106 0.0136
moves into-the-money. If assigned, you
1 March 24 put Short $0.52 0.0156 -0.0225
must sell 100 shares of Cisco at $25; you
could cover that short position by exer-
Total: $0.35 0.0050 -0.0089
cising the long 27.50 call for a loss of
$2.50.
Table 2’s March 25-27.50 bull put spread offers another On the other hand, some credit spreads have less assign-
example. When CSCO closed at $24.39 on Feb. 29, the short ment risk. Table 4 lists the components of a bull put spread
27.50 put was deep ITM, meaning it was at risk of early with lower strikes (long 22.50 put, short 24 put). This
assignment. This risk only eases if CSCO rallies above the spread’s short 24 put was slightly OTM upon entry, and it
27.50 short strike. continued on p. 16

FIGURE 2 — LONG CALL VS. BULL PUT SPREAD

The long 25-strike call risks less than the 25-27.5 bull put spread without
capping any profit potential. tion Friday’s close and the following
Monday’s open. This risk is real even if
an option closes OTM on the last trad-
ing day. If news breaks after the close,
options that were expected to expire
worthless may suddenly become ITM,
triggering losses for options sellers. If
this happens, you may get an assign-
ment notice over the weekend or on
Monday.
Spreads vs. outright options

Spreads aren’t always the answer. In
certain situations simply buying calls
or puts may offer greater profit poten-
tial with less risk. Always compare a
bull put spread with a long call, or
Source: OptionVue compare a bear call spread to a long put
before entering a trade.
won’t be assigned as long as Cisco continues to trade above For example, Table 2 shows that selling a March 25-27.50
$24 by expiration. bull put spread on Feb. 29 offered a credit of $1.98 ($3 short
27.5 put - $1.02 long 25 put). Profits are limited regardless of
Commissions and last-minute assignment how far CSCO climbed above the short 27.50 put’s strike,
Spread traders who want to avoid paying commissions and while the maximum risk was capped at $0.52 ($2.50 strike-
wide bid-ask spreads prefer selling credit spreads, because price difference - $1.98 credit). This spread risks $0.52 to
credit spreads that expire worthless (i.e., the short leg earn $1.98, which translates to a modestly bullish direction-
remains OTM) don’t have to be closed. al outlook on CSCO.
By contrast, to profit from a debit spread you typically Meanwhile, the March 25 call, which was one strike
must close it before expiration, which means paying addi- OTM, was offered at $0.46. Buying this call provided unlim-
tional commissions and slippage. Even if you don’t close an ited profit potential, while its risk was limited to $0.46
ITM debit spread before expiration you will pay more fees ($0.06 less than the risk of selling the March 25-27.50 bull
because most ITM options are exercised automatically. If put spread).
you ignore an ITM debit spread at expiration, your broker Figure 2 compares the potential gains and losses of the 25
may charge two commissions — one due to assignment on long call with the bull put spread (blue and green lines,
the short leg and another to exercise the long leg. respectively). In this example, the long call is the clear win-
Most traders try to buy back short options before expira- ner as it risks less without capping any profit potential.
tion, because short option gamma risk — the possibility of You don’t need to create a risk-profile graph to compare
the options moving ITM — increases as expiration draws both trades, though. You just need to measure the likeli-
near. Beginners often underestimate this risk, which hood of CSCO climbing high enough that the 25 long call’s
involves getting assigned on short positions after they sud- value increases from $0.46 to more than $2.44 ($1.98 spread
denly become ITM just prior to expiration. credit + $0.46 call cost). This represents a larger gain than
Does waiting until expiration to capture a small amount the corresponding 25-27.50 bull put spread offers.
of additional premium justify increased gamma risk and For the long 25 call to earn as much as the spread, CSCO
the cost of holding capital as margin for the short leg? To needs to rally at least 12.5 percent to $27.44. Of course, the
answer this question, you need to know how far OTM the stock could continue rising beyond this threshold, yielding
short options are and how volatile the underlying market larger gains on the long call than the capped profits on the
is. credit spread.
Traders who hold short options at expiration also face
“pin risk,” or the possibility of assignment between expira- For information on the author see p. 6.

Related reading
and bear call spreads, strangles, and butterflies help you take
Darren Chu article advantage of the market without excessive risk.
“The theta-vega relationship” “Controlling risk with spreads”

Futures & Options Trader, January 2008. Options Trader, July 2005.
Focusing on these options “Greeks” can help you avoid mis- Tired of fighting time decay and volatility fluctuations? This bull
steps when trading calendar spreads. call option spread has much lower risk than an outright pur-
chase.
Other articles:
“Trading credit spreads with the MACD” “Reducing risk with vertical spreads”
Futures & Options Trader, December 2007. Options Trader, July 2005.
This Options Lab compares the performance of credit spreads Vertical spreads can help you sidestep the complications of
triggered by two technical indicators — new 20-day highs and changes in implied volatility.
lows and Moving Average Convergence Divergence (MACD)
readings. “Extra credit (spreads)”
Active Trader, February 2002.
“The simplicity of debit spreads” A look at trading credit spreads.
Options Trader, February 2006.
Using spreads instead of buying options outright can reduce “Stepping into options”
risk and increase opportunity. This discussion of “debit” Active Trader, April 2001.
spreads highlights their versatility. When trading options, you have to walk first and run later.
Taking things one step at a time will give you the confidence to
“Options spreads: A lower-risk way use these tools more effectively.
to generate trading capital”
Options Trader, November 2005. You can purchase and download past articles at
If you trade with limited capital, placing low-cost, low-risk http://www.activetradermag.com/purchase_articles.htm.
option spreads could improve your odds of success. Bull put

FUTURES SNAPSHOT (as of March 26)
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).
E- Pit 10-day move/ 20-day move/ 60-day move/ Volatility
Market symbol symbol Exchange Volume OI rank rank rank ratio/rank
E-Mini S&P 500 ES CME 2.27 M 2.06 M 0.87% / 29% -3.42% / 29% -10.35% / 72% .33 / 54%
10-yr. T-note ZN TY CBOT 1.46 M 2.03 M 1.66% / 72% 2.52% / 54% 5.27% / 77% .31 / 52%
5-yr. T-note ZF FV CBOT 812.8 1.06 M -0.76% / 60% 0.23% / 7% 3.62% / 59% .43 / 90%
Eurodollar* GE ED CME 513.5 1.47 M 0.52% / 59% 0.70% / 39% 2.05% / 82% .14 / 45%
30-yr. T-bond ZB US CBOT 480.1 902.1 1.67% / 63% 1.95% / 46% 2.64% / 21% .41 / 57%
E-Mini Nasdaq 100 NQ CME 418.3 365.3 3.41% / 60% 0.75% / 33% -15.07% / 54% .27 / 64%
2-yr. T-note ZT TU CBOT 367.7 576.1 0.01% / 0% 0.82% / 36% 2.73% / 76% .21 / 52%
Crude oil CL NYMEX 299.0 274.0 -2.46% / 33% 7.55% / 37% 11.71% / 35% .60 / 83%
E-Mini Russell 2000 ER CME 280.8 607.5 3.56% / 60% -2.58% / 24% -9.70% / 60% .41 / 76%
Mini Dow YM CBOT 195.8 82.6 1.58% / 29% -2.49% / 26% -7.99% / 63% .37 / 58%
Eurocurrency 6E EC CME 161.7 165.4 3.31% / 70% 5.30% / 83% 7.60% / 81% .37 / 50%
Gold 100 oz. GC NYMEX 141.0 281.5 -2.75% / 0% 0.03% / 0% 12.64% / 24% .50 / 100%
Japanese yen 6J JY CME 124.0 182.9 3.92% / 26% 8.19% / 90% 13.94% / 98% .35 / 52%
Corn ZC C CBOT 101.5 202.3 -2.09% / 50% 4.11% / 11% 21.47% / 51% .25 / 77%
Natural gas NG NYMEX 76.6 100.4 -4.28% / 20% 3.98% / 27% 29.60% / 73% .46 / 82%
British pound 6B BP CME 67.0 78.0 0.25% / 13% 0.45% / 35% 0.06% / 0% .36 / 85%
S&P 500 index SP CME 65.1 496.9 0.72% / 29% -3.43% / 29% -10.36% / 72% .33 / 54%
Soybeans ZS S CBOT 63.5 90.1 -2.90% / 0% -7.81% / 43% 11.51% / 8% .40 / 87%
Sugar SB ICE 62.6 319.9 -9.00% / 54% -15.82% / 100% 11.58% / 52% .44 / 53%
Swiss franc 6S SF CME 49.2 55.9 4.17% / 45% 8.42% / 90% 14.29% / 97% .29 / 43%
Canadian dollar 6C CD CME 47.8 85.8 -2.55% / 70% -4.03% / 100% -4.02% / 60% .62 / 95%
Australian dollar 6A AD CME 42.8 74.3 -0.56% / 9% -2.46% / 83% 3.83% / 33% .59 / 92%
Silver 5,000 oz. SI NYMEX 40.3 74.4 -6.98% / 0% -1.80% / 33% 23.42% / 78% .70 / 98%
RBOB gasoline RB NYMEX 38.4 52.9 0.62% / 0% 7.54% / 27% 11.51% / 43% .51 / 68%
Wheat ZW W CBOT 35.0 58.5 -16.69% / 100% -13.87% / 100% 12.90% / 40% .71 / 85%
Heating oil HO NYMEX 33.8 50.5 1.61% / 16% 8.13% / 38% 15.43% / 51% .41 / 62%
E-Mini S&P MidCap 400 ME CME 31.9 99.3 1.63% / 20% -4.82% / 48% -9.56% / 65% .37 / 52%
Soybean oil ZL BO CBOT 30.5 49.7 -7.75% / 58% -10.14% / 67% 18.49% / 29% .33 / 63%
Soybean meal ZM SM CBOT 27.2 32.8 2.45% / 25% -4.23% / 53% 5.84% / 5% .54 / 100%
Cotton CT ICE 22.6 122.0 -9.22% / 38% -7.16% / 100% 8.87% / 56% .57 / 61%
Mexican peso 6M MP CME 21.2 113.6 0.84% / 67% -0.46% / 14% 1.40% / 55% .43 / 53%
Crude oil e-miNY QM NYMEX 20.5 7.1 -2.62% / 40% 4.98% / 24% 10.31% / 27% .65 / 95%
Gold 100 oz. ZG CBOT 17.6 7.2 -2.76% / 0% 0.02% / 0% 14.09% / 34% .51 / 100%
Coffee KC ICE 17.5 88.4 -12.99% / 62% -17.47% / 82% 0.38% / 2% .81 / 97%
Fed Funds ZQ FF CBOT 17.3 66.6 0.12% / 29% 0.39% / 60% 1.73% / 95% .07 / 33%
Nikkei 225 index NK CME 17.2 77.1 -3.27% / 13% -10.46% / 73% -18.44% / 80% .26 / 43%
Lean hogs HE LH CME 15.0 79.7 -1.50% / 0% -5.47% / 29% -3.12% / 15% .30 / 45%
Live cattle LE LC CME 14.9 68.6 0.28% / 0% -5.60% / 97% -6.26% / 100% .28 / 32%
Cocoa CC ICE 11.0 76.4 -12.81% / 67% -7.94% / 75% 17.28% / 60% .80 / 100%
Mini-sized gold YG CBOT 6.9 3.6 -2.76% / 0% 0.02% / 0% 14.09% / 36% .50 / 100%
U.S. dollar index DX ICE 6.1 33.9 -2.46% / 53% -3.89% / 82% -6.28% / 82% .36 / 43%
Copper HG NYMEX 5.6 15.9 -1.95% / 38% -1.43% / 33% 21.26% / 57% .28 / 42%
Nasdaq 100 ND CME 5.6 43.7 2.97% / 60% 0.75% / 50% -14.81% / 56% .27 / 65%
Natural gas e-miNY QG NYMEX 4.5 3.4 -4.28% / 20% 4.20% / 24% 32.94% / 84% .46 / 80%
Dow Jones Ind. Avg. ZD DJ CBOT 4.5 26.5 1.58% / 43% -2.49% / 30% -7.78% / 62% .37 / 55%
Russell 2000 index RL CME 3.2 37.5 3.59% / 60% -2.58% / 24% -9.70% / 60% .41 / 75%
Silver 5,000 oz. ZI CBOT 2.5 1.5 -6.64% / 0% -1.82% / 28% 26.75% / 80% .67 / 98%
*Average volume and open interest based on highest-volume contract (September 2008).
Legend day moves, 20-day moves, etc.) show the percent means the current reading is larger than
Volume: 30-day average daily volume, in centile rank of the most recent move to a cer- all the past readings, while a reading of 0 per-
thousands (unless otherwise indicated). tain number of the previous moves of the cent means the current reading is smaller than
same size and in the same direction. For the previous readings. These figures provide
OI: Open interest, in thousands (unless other-
example, the rank for 10-day move shows perspective for determining how relatively
wise indicated).
how the most recent 10-day move compares large or small the most recent price move is
10-day move: The percentage price move to the past twenty 10-day moves; for the 20- compared to past price moves.
from the close 10 days ago to today’s close. day move, the rank field shows how the most Volatility ratio/rank: The ratio is the short-
20-day move: The percentage price move recent 20-day move compares to the past term volatility (10-day standard deviation of
from the close 20 days ago to today’s close. sixty 20-day moves; for the 60-day move, the prices) divided by the long-term volatility (100-
60-day move: The percentage price move rank field shows how the most recent 60-day day standard deviation of prices). The rank is
from the close 60 days ago to today’s close. move compares to the past one-hundred- the percentile rank of the volatility ratio over
The “rank” fields for each time window (10- twenty 60-day moves. A reading of 100 per- the past 60 days.
This information is for educational purposes only. Futures & Options Trader provides this data in good faith, but it cannot guarantee its accuracy or timeliness. Futures & Options
Trader assumes no responsibility for the use of this information. Futures & Options Trader does not recommend buying or selling any market, nor does it solicit orders to buy
or sell any market. There is a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.

OPTIONS RADAR (as of March 26)
MOST-LIQUID OPTIONS*
Indices Symbol Exchange Options Open 10-day move / 20-day move / IV / IV / SV ratio —
volume interest rank rank SV ratio 20 days ago
S&P 500 index SPX CBOE 240.0 1.78 M 1.55% / 29% -2.91% / 27% 24.7% / 30.1% 20.8% / 22.4%
S&P 500 volatility index VIX CBOE 115.2 916.4 -1.06% / 14% 19.09% / 64% 58.1% / 154% 84.1% / 93.7%
Russell 2000 index RUT CBOE 72.7 599.9 4.20% / 67% -2.12% / 20% 29.5% / 35.6% 26.4% / 28.8%
E-mini S&P 500 futures ES CME 34.4 140.6 0.87% / 29% -3.42% / 29% 24.2% / 32.8% 20.6% / 24.8%
Nasdaq 100 index NDX CBOE 31.2 167.7 4.38% / 60% 1.45% / 50% 27.5% / 29.9% 25.5% / 27.6%
Stocks
Citigroup C 316.3 2.45 M 2.61% / 0% -11.62% / 49% 60% / 79.6% 43.6% / 51.2%
Apple Inc. AAPL 219.6 1.07 M 13.91% / 85% 21.75% / 100% 45.9% / 47% 42% / 50.6%
Bear Stearns Cos. BSC 148.8 454.3 -82.20% / 63% -87.04% / 89% 79.1% / 219.5% 48.6% / 59%
Lehman Bros. Holdings LEH 135.8 799.7 -8.25% / 25% -25.25% / 91% 83.2% / 110.8% 49.5% / 62%
Clear Channel Comm. CCU 117.5 1.13 M -25.43% / 100% -20.36% / 100% 92.5% / 66.1% 71.9% / 61.2%
Futures
Eurodollar ED-GE CME 703.6 7.06 M 0.52% / 59% 0.70% / 41% 42.6% / 47.9% 43.6% / 21%
10-yr T-notes TY-ZN CBOT 59.3 439.2 1.66% / 59% 2.52% / 52% 8.7% / 9% 8.7% / 7.5%
Crude oil CL NYMEX 50.3 318.3 -2.62% / 40% 4.98% / 26% 36.5% / 38% 32.1% / 35.1%
Corn C-ZC CBOT 39.4 586.9 -2.09% / 50% 4.11% / 11% 47.3% / 36.2% 36.1% / 24.6%
Sugar SB NYBOT 34.9 625.1 -9.00% / 54% -15.82% / 100% 38.6% / 50.3% 38.9% / 43%
VOLATILITY EXTREMES**
Indices - High IV/SV ratio
Eurodollar index XDE PHLX 2.4 29.3 3.38% / 55% 5.79% / 85% 11.1% / 9.4% 8.6% / 6.9%
British pound index XDB PHLX 1.0 31.5 0.14% / 0% 1.10% / 52% 9.7% / 8.7% 7.9% / 6.8%
Indices - Low IV/SV ratio

S&P 500 volatility index VIX CBOE 115.2 916.4 -1.06% / 14% 19.09% / 64% 58.1% / 154% 84.1% / 93.7%
Banking index BKX PHLX 1.2 96.2 0.32% / 0% -6.84% / 36% 45.4% / 63.5% 37.6% / 40.8%
E-mini S&P 500 futures ES CME 34.4 140.6 0.87% / 29% -3.42% / 29% 24.2% / 32.8% 20.6% / 24.8%
Oil Service index OSX PHLX 2.3 27.0 1.46% / 29% -2.71% / 21% 35.3% / 45.8% 31.9% / 43.9%
Broker/Dealer index XBD AMEX 1.2 6.9 -6.33% / 29% -17.75% / 93% 52.3% / 67.7% 37.8% / 41.7%
Stocks - High IV/SV ratio

Bea Systems BEAS 1.2 84.5 -0.31% / 60% 1.22% / 10% 18.1% / 6% 15.6% / 5.6%
Shire ADS SHPGY 6.5 103.0 4.05% / 31% -0.96% / 3% 52.2% / 33% 34.7% / 38.7%
Red Hat RHT 2.7 65.4 4.46% / 50% -1.26% / 20% 51.8% / 32.9% 41.9% / 36.3%
Rambus RMBS 14.3 185.0 40.54% / 100% 38.21% / 100% 79% / 55% 101.6% / 60.5%
Rite Aid RAD 1.1 60.7 20.08% / 100% 7.55% / 22% 93.4% / 66.6% 89% / 75.5%
Stocks - Low IV/SV ratio

Bear Stearns Cos. BSC 148.8 454.3 -82.20% / 63% -87.04% / 89% 79.1% / 219.5% 48.6% / 59%
Thornburg Mortgage TMA 45.2 173.4 -2.56% / 0% -86.71% / 80% 229.6% / 500.7% 56.4% / 81.1%
Anworth Mortgage Asset ANH 1.4 17.9 7.35% / 0% -34.85% / 44% 71.4% / 143% 44.7% / 45%
Annaly Capital Mgmt. NLY 37.0 207.4 -5.91% / 23% -23.00% / 60% 59.7% / 111.9% 31.6% / 32.6%
Fed. Home Loan Bank FRE 71.3 492.1 37.40% / 20% 9.88% / 53% 88.9% / 154.3% 93.1% / 86.6%
Futures - High IV/SV ratio

British pound BP-6B CME 1.4 16.9 0.25% / 13% 0.45% / 29% 11.9% / 6.3% 7.7% / 5.8%
Soybeans S-ZS CBOT 14.1 98.6 -2.90% / 0% -7.81% / 43% 59% / 40.1% 34.3% / 24.4%
Lean hogs LH CME 2.8 46.7 -1.50% / 0% -5.47% / 29% 28.8% / 22% 22.4% / 20.6%
Corn C-ZC CBOT 39.4 586.9 -2.09% / 50% 4.11% / 11% 47.3% / 36.2% 36.1% / 24.6%
Swiss franc SF-6S CME 2.0 5.6 4.17% / 40% 8.42% / 90% 13.8% / 11.2% 9.7% / 7.4%
Futures - Low IV/SV ratio

Cotton CT NYBOT 27.3 197.4 -9.22% / 38% -7.16% / 100% 35.6% / 59.8% 30.6% / 31.2%
Wheat W-ZW CBOT 5.7 39.4 -16.69% / 100% -13.87% / 100% 60.3% / 80.9% 53% / 44.3%
Soybean oil BO-ZL CBOT 12.3 51.4 -7.75% / 58% -10.14% / 67% 27.5% / 36.1% 29.9% / 24.2%
Coffee KC NYBOT 15.3 169.0 -12.99% / 62% -17.47% / 82% 37.5% / 49.2% 35.7% / 32.7%
Sugar SB NYBOT 34.9 625.1 -9.00% / 54% -15.82% / 100% 38.6% / 50.3% 38.9% / 43%
* Ranked by volume ** Ranked based on high or low IV/SV values.
LEGEND:
Options volume: 20-day average daily options volume (in thousands unless otherwise indicated).
Open interest: 20-day average daily options open interest (in thousands unless otherwise indicated).
IV/SV ratio: Overall average implied volatility of all options divided by statistical volatility of underlying instrument.
10-day move: The underlying’s percentage price move from the close 10 days ago to today’s close.
20-day move: The underlying’s percentage price move from the close 20 days ago to today’s close. The “rank” fields for each time window (10-day moves, 20-
day moves) show the percentile rank of the most recent move to a certain number of previous moves of the same size and in the same direction. For example,
the “rank” for 10-day moves shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, the “rank” field shows
how the most recent 20-day move compares to the past sixty 20-day moves.

FUTURES & OPTIONS WATCH
FIGURE 1 — COT REPORT EXTREMES
What’s new in the COT report Extreme differences between commercials and speculators can lead to
price reversals as speculators unwind their positions.
The Commitments of Traders (COT) report published
weekly by the Commodity Futures Trading Commission
(CFTC) breaks down the open positions in futures mar-
kets into three categories of traders: commercial, non-
commercial, and non-reportable.
The commercials, or hedgers, are typically businesses
that actually deal in the cash market (e.g., grain mer-
chants and oil companies, that either produce or con-
sume the underlying commodity).
Figure 1 shows the relationship between the commer-
cials and large speculators on March 18. Extremely pos- For a list of contract names, see “Futures Snapshot.” Source: http://www.upperman.com
itive readings mean that net commercial holdings
(longs-shorts) are much higher than net speculator posi-
tions, based on their five-year historical relationship. By contrast, Legend: Figure 1 shows the difference between net commercial
and net large spec positions (longs - shorts) for all 45 futures mar-
extremely negative readings show the opposite: large speculators hold kets, in descending order. It is calculated by subtracting the current
more contracts than large producers. net large spec position from the net-commercial position and then
comparing this value to its five-year range. The basic formula is:
In the Nikkei 225 index futures (NK), for example, the difference
a1 = (Net commercial 5-year high - net commercial current)
between commercials and speculators is near a five-year high. On the b1 = (Net commercial 5-year high - net commercial 5-year low)
other hand, this relationship is near a five-year low for the Japanese yen c1 = ((b1 - a1)/ b1 ) * 100
futures (JY). These imbalances sometimes occur near market reversals as a2 = (Net large spec 5-year high - net large spec current)
one side unwinds their positions, driving price in the opposite b2 = (Net large spec 5-year high - net large spec 5-year low)
direction. c2 = ((b2 - a2)/ b2 ) * 100
– Compiled by Floyd Upperman x = (c1 - c2)
Options Watch: High-volume Dow components (as of March 25) Compiled by Tristan Yates
The following table summarizes the expiration months available for options on commodity-related ETFs. It also shows each index's average bid-ask spread for
at-the-money (ATM) April 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
2008 2009 2010
Sept.
June
Aug.
Nov.
July
Jan.
Jan.
Apr.
May
Oct.
Bid-ask spreads
Bid-ask
spread as %
Closing of underlying
Stock Symbol Exchange price Call Put price
Oil Services* OIH N/A X X X X X X 167.04 0.30 0.49 0.24%
Market Vectors Gold GDX N/A X X X X X X 46.97 0.11 0.13 0.25%
US Oil Fund USO N/A X X X X X 80.26 0.30 0.25 0.34%
PowerShares
DB Agriculture Fund DBA N/A X X X X X X 37.75 0.18 0.11 0.38%
DJ US Energy IYE N/A X X X X 125.66 0.53 0.55 0.43%
Materials Sector XLB N/A X X X X X X 39.66 0.19 0.16 0.44%
United States
Natural Gas Fund UNG N/A X X X X 45.56 0.28 0.14 0.45%
Powershares DB Commodity
Index Tracking Fund DBC N/A X X X X X X 35.69 0.16 0.19 0.49%
Energy Sector* XLE N/A X X X X X X 72.05 0.47 0.52 0.69%
Market Vectors
Global Agribusiness ETF MOO N/A X X X X 53.5 0.40 0.58 0.91%
PowerShares
DB Base Metals Fund DBB N/A X X X X X X 23.8 0.25 0.24 1.02%
UltraShort Oil & Gas
ProShares DUG N/A X X X X 40.85 0.29 0.65 1.15%
iShares GSCI
Commodity-Indexed Trust GSG N/A X X X X 56.94 0.74 0.66 1.23%
SPDR S&P
Metals & Mining ETF XME N/A X X X X 69.07 1.30 0.83 1.54%
Water Resources PHO N/A X X X X 19.65 0.36 0.36 1.84%
*Penny pilot program participant
Legend:
Call: Four-day average difference between bid and ask prices for the front-month ATM call.
Put: Four-day average difference between bid and ask prices for the front-month ATM put.
Bid-ask spread as % of underlying price: Average difference between bid and ask prices for front-month, ATM call, and put divided by the underlying's closing price.

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INDUSTRY NEWS
CME offers $9.4 billion for NYMEX, hits campaign trail

BY JIM KHAROUF
T he CME Group in March announced a bid to buy

the New York Mercantile Exchange (NYMEX) for
$9.4 billion in cash and stock in March, a deal that
would give the CME Group an energy futures complex and
strong control over precious metal futures. The question
year. The task at hand now for NYMEX leaders is to con-
vince its shareholders that this deal is a good one. It also
includes a buyout of NYMEX’s 816 memberships for about
$612,000 each, or $550 million. That part of the deal requires
a 75-percent approval of the members.
now is, are NYMEX and CME executives’ campaigning Schaeffer acknowledged the task now is to fully inform
skills good enough to convince shareholders to vote for it? the members on the details and benefits of the combined
The deal, if approved by NYMEX shareholders, would exchange.
give the CME control over roughly 98 percent of U.S. “The respective board spent hundreds of hours going
futures volume. The remaining 2 percent is held by over the details of how this transaction makes sense,”
IntercontinentalExchange and grain exchanges in Kansas Schaeffer says. “We have to summarize that now and bring
City and Minneapolis. The CME bought Chicago Board of it to the investors and trading-right owners, and show them
Trade last July for about $11 billion. why it makes sense. We feel comfortable that at the end of
Under the proposal, NYMEX shareholders will receive the day, people will be very supportive of this transaction.”
0.1323 of a CME share and $36 in cash for each NYMEX Whether Schaeffer and his board will be able to sell the
share. In total, the CME is offering 12.5 million shares and deal to shareholders is debatable. NYMEX shareholders
$3.4 billion dollars in cash, giving NYMEX shareholders have been debating whether the CME would be willing to
about 18 percent of the combined company. It also is paying offer more for the exchange.
about a 13 percent premium on NYMEX’s share price, One NYMEX shareholder and longtime member has said
which has been slumping since February in the aftermath of that NYMEX shareholders would be wise to take the deal.
clearing concerns expressed in a comment letter from the NYMEX already uses CME’s Globex as its electronic trad-
U.S. Department of Justice. ing platform, and the price is fair and makes sense for the
The two exchanges expect to save roughly $60 million per exchange.
year in cost synergies and future growth opportunities. “The CME is the only legit merger that could happen,” he
CME Group CEO Craig Donohue and chairman Terry says. “They are paying a reasonable premium to NYMEX
Duffy are expected to remain in their respective positions, shareholders.”
but NYMEX CEO Richard Schaeffer and President Jim However, he added that some shareholders believe
Newsome’s roles in the combined firm have not been decid- NYMEX is worth much more, even though its stock has
ed. Both said they are committed to completing the deal been sliding for months. Many shareholders held onto
and the transition period but gave no firm statement shares because the stock was trading between $130 to
beyond that. almost $150 virtually all of 2007. Shares have tumbled since
CME and NYMEX executives hope to close the deal this January, hitting a low of $74.27. NYMEX shares closed at
$92.10 in late March.
MANAGED MONEY “Some shareholders did not sell shares when they were
Top 10 option strategy traders ranked by February 2008 return. trading around $140, $130 and $120,” he says. “And now
(Managing at least $1 million as of Feb. 29, 2008.) there’s a feeling the market collapse and lack of a premi-
February YTD $ under
um that is being offered for the shares are the fault of
Rank Trading advisor return return mgmt. Rich Schaeffer and NYMEX management. There are a lot
1. Ascendant Asset Adv. (JLDeVore) 38.27 -45.81 4.9M of people who feel stupid for not selling when they
2. Censura Futures Mgmt. 20.43 -4.04 57.4M should have, and now they are going to take it out on
3. Parrot Trading Partners 19.21 5.52 16.1M somebody.”
4. Aksel Capital Mgmt (Growth & Income) 17.21 10.68 5.2M Shareholder discontent over the deal emerged last
5. LJM Partners (Neutral S&P Option) 14.25 0.09 155.0M Monday when a class-action suit was filed on behalf of
6. Ascendant Asset Adv. (Strategic1) 11.59 -75.46 2.8M NYMEX shareholders and Cataldo Capozza, who said in
7. Singleton Fund 10.84 3.40 24.7M a statement he filed the suit against Schaeffer and various
8. Solaris Market Neutral Fund LP 9.91 -0.52 2.0M directors and the CME Group for breach of fiduciary
9. ACE Investment Strategists (ASIPC) 9.03 -8.33 8.1M responsibilities.
10. Crescent Bay Capital (Stock Index) 6.88 4.20 1.5M
“If we sell our shares, we should get a fair and ade-
Source: Barclay Hedge (http://www.barclayhedge.com) quate price, not one that rewards Mr. Schaeffer and his
Based on estimates of the composite of all accounts or the fully funded subset method. cohorts at our expense,” says Capozza, who also
Does not reflect the performance of any single account.
opposed other actions by NYMEX management.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
No date for a vote has been set on the proposed deal.

JP Morgan to the rescue
Bear Stearns gets a little respect
BY JIM KHAROUF
A
mong the history of precipitous falls on Wall considered solid in the U.S. market. The firm is noted for
Street, that of Bear Stearns will go down as among having good employees, many of whom were looking to
the wildest. move to safer jobs elsewhere.
The pre-St. Patrick’s Day bailout proposed by JP Morgan “The industry is not full of second-rate players any-
Chase for $2 per share was considered among the most more,” says one bank executive. “It’s a fairly mature indus-
shocking of all until cooler accounting prevailed a week try and the consolidation is going to continue. We are defi-
later. That’s when JP Morgan came back and upped its bid to nitely seeking people, absolutely. A lot of the producers are
$10 per share for the storied investment bank that had going to find jobs.”
weathered the Great Depression and was considered the JP Morgan moved quickly to try to keep as many quality
“blue-collar” firm in the investment bank community. Bear Stearns staff as possible, but it’s still likely many will
Looking at it another way, JP Morgan boosted its bid leave and bring their customer relationships to other firms.
from $274.5 million to $1.1 billion. The revised deal also had Bear Stearns shareholders filed class action suits for
JP Morgan buying 95 million newly issued shares of Bear alleged securities fraud and one employee filed a suit
Stearns common stock for the $10 price, giving JP Morgan against his firm for failing to properly manage the pension
almost 40 percent of Bear Stearns stock. plan.
It was still uncertain in late March whether that would be Meanwhile, the Securities and Exchange Commission
enough to convince insulted Bear Stearns shareholders to reportedly is examining comments made by Bear Stearns
accept. Bear Stearn’s largest shareholder, billionaire Joe executives prior to the firm’s collapse to see if they were
Lewis, saw his $1.1 billion stake fall to just $120.1 million fraudulent.
under the $10 offer. Lewis told The Times of London that he
was actively seeking another bidder
for the firm or at least exploring legal
action that could block the deal.
News of the dramatic meltdown,
caused by its investments in the sub-
prime mortgage market, has led to a
massive reshuffling of futures busi-
ness. As of Jan. 31, 2008, Bear Stearns
ranked 12th among futures commis-
sion merchants (FCM), according to
Commodity Futures Trading
Commission filings, with $3.54 billion
in customer equity. JP Morgan ranks
third in customer equity with $11.9
billion.
Sources among the top bank FCMs
confirmed that customers were shift-
ing accounts out of Bear Stearns.
“All that business needs to go
somewhere else,” one executive says.
“It’s sad. It’s not going to survive as
is.”
Another FCM executive says “we
are definitely going to pick up some
business, as are many other firms.”
How many Bear Stearns customers
will stay with the bank and potential-
ly shift their business to JP Morgan is
unknown.
Bear Stearns’ FCM business was
FUTURES & OPTIONS TRADER • April 2008

INDUSTRY NEWS continued
Mauled by a Bear (Stearns)

MF Global hit by rumor mill
BY JIM KHAROUF
I n the wake of the Bear Stearns plunge in March, retail

brokerage firm MF Global also took a big hit.
The firm’s stock price lost 65 percent on March 17 as the
company weathered a storm of negative news and inaccu-
against MF Global CEO Kevin Davis and other senior man-
agement members.
The stock price plunge and legal action came just two
weeks after MF Global suffered a $141.5 million loss in
rate rumors about credit lines and investors. MF Global, wheat futures through the actions of a registered MF Global
which went public last July, opened at $16.11 and watched representative trading for his own account. The loss
its share price freefall to a low of $3.64 at one point before amounted to about 6 percent of MF Global’s equity.
rebounding and closing at $6.05. The following day shares Executives from various firms in the industry say the
recovered, gaining 35 percent and adding another 15 per- Bear Stearns contagion may spread to MF Global, even
cent two days later. though there is nothing materially wrong with the firm.
One big reason for the drop was a rumor that Joe Lewis, “This is the madness of crowds,” says the chairman of a
the British billionaire who lost $900 million on his invest- major futures brokerage. “Most of the problems would dis-
ment in Bear Stearns, was also a client of MF Global. MF appear on their own if people didn’t panic.”
Global issued a statement in mid-March saying its credit A stock analysis from KBW said that MF Global’s drop in
lines and operations were in good standing and added that capitalization could force a merger or acquisition.
Lewis is not a client. “However, this rapid deterioration in market value could
The CME Group, New York Mercantile Exchange, become a self-fulfilling prophecy if it drives MF's customers
IntercontinentalExchange, and Commodity Futures to withdraw their brokerage business from MF Global,” the
Trading Commission all issued statements confirming that KBW report says. “We believe the immediate stock price
MF Global’s operations were fine. performance will be crucial to MF Global's survival as an
According to a MF Global statement: “MF Global under- independent entity.”
stands the significant concerns across the markets. Our The CEO adds that MF Global technically appears to be
clients continue to show strong support, and our counter- in good shape. Customer accounts are protected by law and
party relationships are sound. the firm is meeting its operational requirements with
We are seeing no impact on our repo lines. In addition, exchanges.
MF Global has no exposure to sub-prime mortgage-backed “They have plenty of net capital and their management
securities that have been the root cause of the current mar- has been a solid group,” he says.
ket environment.” But he adds that the current environment could open the
Adding to MF Global’s problems was a slew of class- door for a merger or acquisition.
action suits against the company, alleging that the firm’s “They may look for a suitor or a suitor may come to
IPO contained a Registration Statement that was materially them,” he says. “MF Global has been making money and is
false and misleading. a consistent money-making machine.”
The first complaint was filed by law firm Weiss & Lurie
Lucky seven?
Nasdaq Options Exchange gets green light
BY JIM KHAROUF
T
he Nasdaq Options Exchange launched in March as of the Philadelphia Stock Exchange, the number three
the seventh U.S. equity options market with a bet exchange by volume.
that technology will win market share. The Nasdaq exchange opened with just two options
Trading began on the all-electronic market March 31 with classes, the Nasdaq 100 tracking stock (QQQQ) and
a price-time priority model and a price-improvement mech- Applied Materials (AMAT), to get market participants
anism. The Nasdaq still plans to grow its options business accustomed to the market model. It plans to offer 20 more
organically and complement it with the pending acquisition names in the first week of trading and eventually cover the

Gold collapses
Gold bugs found themselves crushed under the heel of a merciless sell-off in the yellow metal
most actively traded options at the outset of April.
classes. As of April 1, gold futures had dropped 15.4 percent from their all-time high of 1033.70 set a
Adam Nunes, vice president mere 10 days earlier. A late-March respite, during which gold rallied from its initial sell-off point
of transaction services at the of $905.20 to $957.10
Nasdaq Stock Market, says the — and which many FIGURE 1 — NO JOKE
new options market fees com- gold traders no doubt
hoped was the begin- Gold fell below $900 on April 1 after the bounce that followed the
pete with any other exchange metal's initial sell-off from its all-time high on March 17.
in the industry and its sub-mil- ning of a new upside
lisecond execution speed is run — was erased by
unparalleled. three days of furious
As the Securities and selling that took the
Exchange Commission (SEC) April futures contract
penny pilot program continues (GCJ08) below $975.
to roll out more names, Nunes The decline is the
says the Nasdaq should able to most dramatic since
benefit because penny incre- May-June 2006 when
ment options trading is more gold sold off after
about speed. The SEC began eclipsing $700 for the
the program in January 2007 first time. During that
with 13 options and added correction, gold drop-
another 22 last September and ped more than 12 per-
28 more in March. cent over the 10 days
“In a market where there is from May 31 to June
true price competition, we 14. Source: TradeStation
have something to add,”
Nunes says. “[Penny pricing]
provided us with a point of entry
where we could come into the market
and pick up market share.”
Nunes adds the Nasdaq also plans
to grow within the U.S. options mar-
ket, where volumes continue to sky-
rocket. Last year 2.8 billion options
were traded, a 41-percent increase
from a year earlier. Whether the
Nasdaq can grab significant market
share from established exchanges
such as the Chicago Board Options
Exchange (which account for 33 per-
cent of the market) or the
International Securities Exchange
(28.1 percent) is unknown.
Similar make-or-take fee structures
and ultra-fast electronic trading mod-
els are also being offered from NYSE
Arca and the Boston Options
Exchange.
“In the make-or-take space, I think
technology is really the differentia-
tor,” Nunes says. “I understand we
have to prove ourselves but technolo-
gy is what allows the Nasdaq to grow
its listed market share.”
FUTURES & OPTIONS TRADER • April 2008

Bold moves by the U.S. Fed

BY FUTURES & OPTIONS TRADER STAFF
FIGURE 1 — MARKET POPS, THEN…?
T
he major U.S. stock indexes
and the U.S. dollar rallied in The U.S. stock market rallied in the immediate aftermath of the Fed’s March
the aftermath of the latest inter- 18 rate cut, sagged the following week, and turned higher again on April 1.
est rate adjustment by the U.S. Federal
Reserve on March 18 — a 0.75 percent
cut (to 2.25 percent) in federal funds
rate (Figure 1). The initial reaction in the
markets might have led many to believe
the latest round of the credit-crunch cri-
sis has been eased and that cooler heads
are starting to prevail, but the sell-off
that concluded the week ending March
28 left things feeling as unstable as ever.
The market’s rally in the wake of the
rate cut could also be interpreted as a
sign the Fed was taking back the initia-
tive in monetary policy instead of being
led by the markets — as some central
bank watchers suggested was the case
when the Fed slashed rates in a seem-
ingly panicky fashion in January. At its
March confab, the Fed let the market
know the FOMC was running the show.
Instead of obliging the markets with the
expected 1-percent cut, they offered up Source: TradeStation
only 75 basis points.
later at its regularly scheduled Jan. 30 meeting, the Fed
Fed: Late to the party? bowed to market expectations and slashed rates another 50
Before focusing more on the March cut, let’s rewind and basis points, a total cut of 1.25 basis points in a mere eight
look back at the action since the beginning of the current days.
easing cycle. In the wake of the first wave of U.S. sub-prime “It’s been a long time since we’ve seen cuts of this speed
issues in August 2007 and concerns of economic slowdown, and magnitude,” notes David Jones, former long-time Wall
the Federal Reserve cut rates 0.50 percent in September Street economist and current president of DMJ Advisors, a
2007, dropping the funds rate from 5.25 to 4.75 percent. That Denver-based consulting firm.
was the first rate shift since June 2006 when the Fed ended Fed watchers’ memories were stretched to recall a time
a tightening cycle. when the FOMC had slashed at such a startling pace. They
The Fed, now under the helm of Ben Bernanke, followed had to reach back to Paul Volcker’s tenure at the Fed in
up with modest 0.25-percent cuts at its October and 1981-1982.
December 2007 meetings. Some analysts, however, say the
Fed may have been a bit late to the game. Behind the scenes action
“Initially, the Fed was behind the curve — they had to In addition to the stunning pace of the decline in the funds
play catch-up,” says Sean Simko, senior portfolio manager rate, Fed governors have gotten very creative behind the
and head of fixed income at SEI. scenes in terms of injecting liquidity into the financial sys-
With the markets’ confidence in Bernanke uncertain, a tem. They have been working overtime in recent months,
global equity market panic unfolded on Martin Luther King and the latest financial crisis, the March 14-17 collapse of
Day in January (when U.S. traders were shut out of the Bear Stearns, no doubt left them busier than ever. With con-
action). On Jan. 22 the Fed surprised Wall Street with an cerns the entire financial system could be vulnerable to a
unexpected inter-meeting emergency 0.75-percent rate cut domino-like collapse from bad mortgage-backed securities
that lowered the funds rate to 3.50 percent. Just a few days positions held at Bear and counter-party risk at other finan-

cial institutions, the Fed engineered a behind-the-scenes Lingering concerns
buyout by JP Morgan Chase. Although most Fed watchers agree Bernanke and Co.’s lat-
The Fed’s focus was to restart movement back into the est moves were laudable and necessary, there are some con-
stalled mortgage-backed securities market. cerns.
“No one was touching mortgage-backed securities, so the As most traders are aware, the Federal Reserve has a dual
answer was to lend them to the Fed for a month and get mandate of preserving price stability and encouraging max-
cash back,” says Tim Rogers, chief economist at imum sustainable employment.
Briefing.com. “They’ve come up with all these things that “They were getting away from their broad economic
have never existed before,” he says of the Fed’s new initia- objective, but it was absolutely necessary,” Jones says.
tives. “Market conditions were so extreme and confidence was
The general idea is to free up market liquidity by allow- shattered.”
ing illiquid mortgage-backed securities to be exchanged Also, some express concerns the Fed is now taking collat-
temporarily for funds from the Fed, he explains. eral in the form of mortgage-backed securities that have
The Fed expanded the Term Auction Facility (TAF), credit risk.
which had first been created in November. Through the “The taxpayers are assuming that credit risk,” Kasriel
TAF, the Fed auctions term funds to banks against collater- says.
al used for discount rate borrowing. Another major shift Naysayers aren’t exclusively looking in from the outside,
was the Fed opened its so-called “discount window” and either. A number of dissenting votes have continued to pop
became a lender of last resort to securities and brokerage up at nearly every FOMC meeting.
firms (rather than banks), something it has never done “We are seeing dissents, obviously because [the
before. dissenting governors] are concerned about inflation,”
Simko says. “It’s not today’s problem, but likely is next
Greasing the wheels year’s problem.”
“The Fed’s job is to make sure there is liquidity in the sys- continued on p. 28
tem — to make sure it is not frozen in
fear,” says Jim Glassman, senior econ-
omist at JP Morgan Chase. “The Fed
holds a portfolio of $800 billion in
Treasury securities. Pumping in $400
billion of intermediate-term money
[through collaterized loans] is a big
step.”
Prior to the March Bear Stearns cri-
sis, only commercial banks were able
to access the privilege of discount
window borrowing.
“There has been a significant
change,” Jones says of the Fed’s
unprecedented actions. “We were on
the brink of total credit market melt-
down. They had to go to an extreme,
and they did.”
“The Fed was throwing a lifeline to
the financial system,” says Paul
Kasriel, chief economist at Northern
Trust Bank. “We are in crisis preven-
tion mode.”
There is one development many
people are loathe to contemplate right
now, but will likely be a result of the
recent market trials.
“When the smoke clears there will
be increased regulation in the finan-
cial system,” Kasriel says.

Looking ahead keep a bit more ammunition in reserve, just in case the
With FOMC meetings on the horizon (April 30 and June 25), recession turns out to be worse than expected.
Fed watchers predict perhaps another 0.25 (or 0.50 percent For now, most market players are at least applauding the
cut at the extreme) at the next meeting or two. But analysts Fed’s decisiveness.
warn the Fed likely will not want to tug the funds rate much “These are some of the most significant Fed actions in
below 1.75 percent in this easing cycle because of the poten- modern monetary policy history,” Jones says. “The Fed is to
tial to stoke inflationary pressures. be commended for them.”
Besides, other sources add, the FOMC likely may want to
TABLE 1 — 2007 US FUTURES TOTAL EXCHANGE VOLUME

U.S. futures Futures volume grew steadily in 2007, with the largest percentage increases recorded on
the Chicago Board of Trade (CBOE) Futures Exchange and the Chicago Climate
volume Exchange (CCX).
Percent of total
BY CHRIS PETERS 2006 2007 Change 2007 volume
CME Group 2,209,148,447 2,804,998,291 26.97% 86.89%
New York Mercantile Exchange 276,152,326 353,385,412 27.97% 10.95%
T
otal U.S. futures and
ICE Futures U.S. 44,667,169 53,782,919 20.41% 1.67%
futures options vol-
OneChicago 7,922,465 8,105,963 2.32% 0.25%
ume in 2007
Kansas City Board of Trade 5,287,190 4,670,955 -11.66% 0.14%
increased 26.82 percent com-
Minneapolis Grain Exchange 1,655,034 1,826,807 10.38% 0.06%
pared to 2006, according to
CBOE Futures Exchange 478,424 1,136,295 137.51% 0.04%
information released by the
Chicago Climate Exchange 28,924 283,758 881.05% 0.01%
Futures Industry Association
US Futures Exchange 135,803 8,111 -94.03% 0.00%
(FIA). The CME group, com-
Totals 2,545,475,782 3,228,198,511 26.82%
prised of the recently
Based on number of futures and options on futures contracts traded in 2007 and 2006
merged Chicago Mercantile
Exchange (CME) and the Source: Futures Industry Association
Chicago Board of Trade
(CBOT), accounted for 87 percent of the total volume in The only decreases from 2006 to 2007 were recorded on
2007, totaling 2.8 billion contracts, 65 percent of which was the Kansas City Board of Trade (KCBOT) and the U.S.
Merc-specific volume (Table 1). Futures Exchange (USFE), falling 11.66 percent and 94.03
The biggest percent change from 2006 to 2007 was record- percent respectively.
ed on the Chicago Climate Exchange (CCX). Futures vol- Much of the 2007 growth carried over into the first
ume on the CCX increased more than 881 percent to 253,758 months of 2008. Total volume for January 2008 was up 1.38
total contracts, but still only accounted for 0.01 percent of percent over January 2007’s total, while February’s volume
total U.S. futures exchange volume. increased 28.63 percent over the previous year (Table 2). The
TABLE 2 — TOTAL JANUARY AND FEBRUARY 2008 VOLUME

Growth remained consistent in the first couple months of 2008. No data was available for U.S. Futures Exchange (USFE)
products in 2007 because of their purchase by Man Group, Plc (now MF Global), and subsequent re-launch later in the year.
Jan-08 Jan-07 Feb-08 Feb-07

total volume total volume % change total volume total volume % change
CME Group 341,991,513 342,625,202 -0.18% 292,630,302 225,754,075 29.62%
New York Mercantile Exchange 38,266,888 36,088,148 6.04% 36,921,160 30,837,180 19.73%
ICE Futures U.S. 8,045,663 3,587,475 124.27% 7,720,079 4,882,926 58.10%
OneChicago 610,111 1,536,984 -60.30% 230,400 951,666 -75.79%
Kansas City Board of Trade 352,893 287,387 22.79% 455,112 363,680 25.14%
Minneapolis Grain Exchange 198,770 119,385 66.49% 190,327 147,330 29.18%
CBOE Futures Exchange 96,743 47,121 105.31% 80,948 46,802 72.96%
Chicago Climate Exchange 55,350 14,511 281.43% 42,580 4,889 770.93%
US Futures Exchange 6,430 na na 2,133 na na
Totals 389,624,361 384,306,213 1.38% 338,273,041 262,988,548 28.63%
Based on number of futures and options on futures contracts traded in January and February 2008
Source: Futures Industry Association

CCX witnessed the biggest gains for both months, increas- Much of the growth has taken place electronically. CME
ing 281 percent in January and 771 percent in February over Globex and e-CBOT volume grew 79 percent in January and
the same months the previous year. 34 percent in February. New York Mercantile Exchange
OneChicago’s (ONE) volume in the first months of 2008 (NYMEX) electronic futures average daily volume
fell compared to 2007’s numbers by 60 percent in January increased 19 percent in January 2008 over of last year and 30
and 76 percent in February. Except for the CME Group’s percent in February, while its Comex division’s electronic
mere 0.18 percent drop in January, volume on most every trade volume grew 163 percent and 99 percent over the
other U.S. futures exchange has continued to grow consid- same months. NYMEX and Comex electronic contracts
erably. trade on the CME’s Globex platform.
FIGURE 1 — SOCGEN’S DECLINE
Rogue trader update Stock in Société Générale has fallen almost 60 percent since
summer 2007. This includes a 30-percent drop from
mid-January, when Kerviel’s trades were discovered.
S
ociété Générale rogue trader Jerome Kerviel
was released from prison on March 18 after
spending well over a month behind bars.
Kerviel is currently the subject of an investigation into
$73 billion worth of unauthorized trades that eventual-
ly led to losses in excess of $7 billion as the French bank
where he worked unwound his positions during turbu-
lent market conditions in late 2007. He is being charged
with breach of trust, forgery, and illegal use of comput-
ers. If convicted Kerviel could face several years in
prison and over a half-million dollars worth of fines.
Following the crippling loss, SocGen, which tumbled
in price (Figure 1), was the focus of several speculated
takeovers, particularly by French rival bank BNP
Paribas. On March 19, however, a BNP Paribas press
release stated that they had ceased considering the
FIGURE 2 — MF GLOBAL’S LOSSES Source: eSignal
In the month after Dooley’s trades were liquidated,

MF Global stock lost nearly 67 percent, despite the takeover, stating, “the conditions, which would have
firm’s efforts to reassure stockholders of its financial allowed it to realize a shareholder value creating merger,
stability. are not met.” French government officials have said they
feel the bank should remain under French control, and have
commented on the possibility of stepping in to block any
foreign acquisition attempts.
Meanwhile, stateside, rogue trader Evan Dooley has yet
to face any formal charges for the unauthorized wheat
trades that ultimately cost MF Global (MF) $141.5 million.
As Dooley fades from the spotlight, MF Global continues to
face challenges resulting from the huge loss.
MF Global stock fell nearly 40 percent in the days follow-
ing the scandal (Figure 2). Since then, the firm has repeat-
edly released statements reaffirming their financial stability
and $1.4 billion in unused committed liquidity facilities.
Prior to the Evan Dooley fiasco, MF Global stock was trad-
ing around $30. (For more on MF Global’s troubles, see “MF
Global hit by rumor mill”.)
To add to their woes, both SocGen and MF Global sepa-
rately face lawsuits from lawyers representing U.S.
investors. Both actions focus on misrepresentation of oper-
Source: eSignal ations and internal controls.

KEY CONCEPTS
The option “Greeks”
American style: An option that can be exercised at any
time until expiration. Delta: The ratio of the movement in the option price for
every point move in the underlying. An option with a
Arbitrage: The simultaneous purchase and sale of similar delta of 0.5 would move a half-point for every 1-point
or identical instruments (often in different geographical move in the underlying stock; an option with a delta of
1.00 would move 1 point for every 1-point move in the
locations) to take advantage of short-term price discrepan-
underlying stock.
cies.
For example, gold trades in several major financial cen- Gamma: The change in delta relative to a change in the
ters around the world — New York, London, Paris, Hong underlying market. Unlike delta, which is highest for
Kong and Tokyo. If gold were trading in New York for $780 deep ITM options, gamma is highest for ATM options
per ounce and $782 per ounce in London, you could, in and lowest for deep ITM and OTM options.
effect, buy gold in New York and immediately sell an equal
Rho: The change in option price relative to the change
amount in the London market and profit $2 per ounce.
in the interest rate.
Why would the metal be $2 higher in London? Short-
term supply and demand fluctuations: Perhaps a European Theta: The rate at which an option loses value each day
jeweler or metal fabricator placed a large order in the (the rate of time decay). Theta is relatively larger for
London market. This short-term demand may cause the OTM than ITM options, and increases as the option gets
price to rise in London relative to New York or other finan- closer to its expiration date.
cial centers.
Vega: How much an option’s price changes per a one-
percent change in volatility.
Assign(ment): When an option seller (or “writer”) is
obligated to assume a long position (if he or she sold a put)
or short position (if he or she sold a call) in the underlying ther does a bar whose high is above the previous high
stock or futures contract because an option buyer exercised by the same amount its low is below the previous low.
the same option.
2. If a bar has positive (negative) directional move-
At the money (ATM): An option whose strike price is ment, the absolute value of the distance between
identical (or very close) to the current underlying stock (or today’s high (low) and yesterday’s high (low) is added
futures) price. to the running totals of +DM (-DM) calculated over a
given lookback period (i.e., 20 bars, 30 bars, etc.). The
Average directional movement index (ADX): absolute value is used so both +DM and -DM are pos-
Measures trend strength, regardless of direction. The high- itive values.
er the ADX value, the stronger the trend, whether the mar-
ket is going up or down. The indicator can be applied to any 3. Calculate the sum of the true ranges for all bars in
time frame, although it is typically used on daily charts. the lookback period.
Although the ADX concept is straightforward, its calcu-
lation is rather lengthy. The indicator was designed by 4. Calculate the Directional Indicator (+DI and -DI) by
Welles Wilder and is described in detail in his book New dividing the running totals of +DM and -DM by the
Concepts in Technical Trading Systems (Trend Research 1978). sum of the true ranges.
Calculation: 5. Calculate the directional index (DX) by taking the

1. Calculate the positive or negative directional move- absolute value of the difference between the +DI value
ment (+DM and -DM) for each bar in the desired look- and the -DI value, dividing that by the sum of the +DI
back period. Bars that make higher highs and higher and -DI values, and multiplying by 100.
lows than the previous bar have positive directional
movement. Bars that make lower highs and lower lows 6. To create the ADX, calculate a moving average of the
than the previous bar have negative directional move- DX over the same period as the lookback period used
ment. throughout the other calculations.
If a bar has both a higher high and a lower low than
the previous bar, it has positive directional Bear call spread: A vertical credit spread that consists
movement if its high is above the previous high more of a short call and a higher-strike, further OTM long call in
than its low is below the previous low. Reverse this the same expiration month. The spread’s largest potential
criterion for negative directional movement. An inside gain is the premium collected, and its maximum loss is lim-
bar (a bar that trades within the range of the ited to the point difference between the strikes minus that
previous bar) has no directional movement, and nei- premium.

Bear put spread: A bear debit ed with holding an investment that for their clients.
spread that contains puts with the include interest, dividends, and the The final COT category is called the
same expiration date but different opportunity costs of entering the non-reportable position category —
strike prices. You buy the higher-strike trade. otherwise known as small traders —
put, which costs more, and sell the i.e., the general public.
cheaper, lower-strike put. Collar: An options spread with three
components — an underlying long Covered call: Shorting an out-of-
Beta: Measures the volatility of an position, a short call, and a long put the-money call option against a long
investment compared to the overall that expires in the same month. It is a position in the underlying market. An
market. Instruments with a beta of one conservative, flexible strategy that example would be purchasing a stock
move in line with the market. A beta profits if the underlying trades within for $50 and selling a call option with a
value below one means the instrument a certain range by expiration. The strike price of $55. The goal is for the
is less affected by market moves and a strategy’s goal is to improve a long market to move sideways or slightly
beta value greater than one means it is position’s odds of success by adding higher and for the call option to expire
more volatile than the overall market. low-cost downside protection without worthless, in which case you keep the
A beta of zero implies no market risk. limiting potential upside profits exces- premium.
sively.
Box spread: A hedged position in Credit spread: A position that col-
which the profit is determined in The Commitments of Traders lects more premium from short
advance. A box contains one long call report: Published weekly by the options than you pay for long options.
and one short put that share the same Commodity Futures Trading A credit spread using calls is bearish,
strike. Also, the spread contains one Commission (CFTC), the while a credit spread using puts is
short call and one long put that share a Commitments of Traders (COT) report bullish.
higher strike price. All four options breaks down the open interest in major
expire at the same time. futures markets. Clearing members, Debit: A cost you must pay to enter
futures commission merchants, and any position if the components you
Bull call spread: A bull debit foreign brokers are required to report buy are more expensive than the ones
spread that contains calls with the daily the futures and options positions you sell. For instance, you must pay a
same expiration date but different of their customers that are above spe-
strike prices. You buy the lower-strike cific reporting levels set by the CFTC.
call, which has more value, and sell the For each futures contract, report
less-expensive, higher-strike call. data is divided into three “reporting”
categories: commercial, non-commer-
Bull put spread (put credit cial, and non-reportable positions.
spread): A bull credit spread that The first two groups are those who
contains puts with the same expiration hold positions above specific report-
date, but different strike prices. You ing levels.
sell an OTM put and buy a less-expen- The “commercials” are often
sive, lower-strike put. referred to as the large hedgers.
Commercial hedgers are typically
Calendar spread: A position with those who actually deal in the cash
one short-term short option and one market (e.g., grain merchants and oil
long same-strike option with more companies, who either produce or
time until expiration. If the spread consume the underlying commodity)
uses ATM options, it is market-neutral and can have access to supply and
and tries to profit from time decay. demand information other market
However, OTM options can be used to players do not.
profit from both a directional move Non-commercial large traders
and time decay. include large speculators (“large
specs”) such as commodity trading
Call option: An option that gives the advisors (CTAs) and hedge funds.
owner the right, but not the obligation, This group consists mostly of institu-
to buy a stock (or futures contract) at a tional and quasi-institutional money
fixed price. managers who do not deal in the
underlying cash markets, but specu-
Carrying costs: The costs associat- late in futures on a large-scale basis

KEY CONCEPTS continued
debit to buy any option, and a spread (long one option,

short another) requires a debit if the premium you collect Intrinsic value: The difference between the strike price
from the short option doesn’t offset the long option’s cost. of an in-the-money option and the underlying asset price. A
call option with a strike price of 22 has 2 points of intrinsic
Debit spread: An options spread that costs money to value if the underlying market is trading at 24.
enter, because the long side is more expensive that the short
side. These spreads can be verticals, calendars, or diagonals. Leverage: An amount of “buying power” that increases
exposure to underlying market moves. For example, if you
Deep (e.g., deep in-the-money option or deep buy 100 shares of stock, that investment will gain or lose
out-of-the-money option): Call options with strike $100 for each $1 (one-point) move in the stock.
prices that are very far above the current price of the under- But if you invest half as much and borrow the other half
lying asset and put options with strike prices that are very from your broker as margin, then you control those 100
far below the current price of the underlying asset. shares with half as much capital (i.e., 2-to-1 buying power).
At that point, if the stock moves $1, you will gain or lose
Delivery period (delivery dates): The specific time $100 even though you only invested $50 — a double-edged
period during which a delivery can occur for a futures con- sword.
tract. These dates vary from market to market and are deter-
mined by the exchange. They typically fall during the Limit up (down): The maximum amount that a futures
month designated by a specific contract - e.g. the delivery contract is allowed to move up (down) in one trading ses-
period for March T-notes will be a specific period in March. sion.
Delta-neutral: An options position that has an overall Lock-limit: The maximum amount that a futures contract
delta of zero, which means it’s unaffected by underlying is allowed to move (up or down) in one trading session.
price movement. However, delta will change as the under-
lying moves up or down, so you must buy or sell Long call condor: A market-neutral position structured
shares/contracts to adjust delta back to zero. with calls only. It combines a bear call spread (short call,
long higher-strike further OTM call) above the market and
Diagonal spread: A position consisting of options with a bull call spread (long call, short higher-strike call). Unlike
different expiration dates and different strike prices — e.g., an iron condor, which contains two credit spreads, a call
a December 50 call and a January 60 call. condor includes two types of spreads: debit and credit.
European style: An option that can only be exercised at Long-Term Equity AnticiPation Securities
expiration, not before. (LEAPS): Options contracts with much more distant expi-
ration dates — in some cases as far as two years and eight
Exercise: To exchange an option for the underlying months away — than regular options.
instrument.
Market makers: Provide liquidity by attempting to prof-
Expiration: The last day on which an option can be exer- it from trading their own accounts. They supply bids when
cised and exchanged for the underlying instrument (usual- there may be no other buyers and supply offers when there
ly the last trading day or one day after). are no other sellers. In return, they have an edge in buying
and selling at more favorable prices.
Float: The number of tradable shares in a public company. Naked (uncovered) puts: Selling put options to collect
premium that contains risk. If the market drops below the
Intermonth (futures) spread: A trade consisting of short put’s strike price, the holder may exercise it, requiring
long and short positions in different contract months in the you to buy stock at the strike price (i.e., above the market).
same market — e.g., July and November soybeans or
September and December crude oil. Also referred to as a Near the money: An option whose strike price is close
futures “calendar spread.” to the underlying market’s price.
In the money (ITM): A call option with a strike price Open interest: The number of options that have not
below the price of the underlying instrument, or a put been exercised in a specific contract that has not yet expired.
option with a strike price above the underlying instru-
ment’s price. Opportunity cost: The value of any other investment

you might have made if your capital wasn’t already in the Overall, these positions are neutral, but they can have a
markets directional bias, depending on the strike prices you select.
Because you sell more options than you buy, the short
Outlier: An anomalous data point or reading that is not options usually cover the cost of the long one or provide a
representative of the majority of a data set. net credit. However, the spread contains uncovered, or
“naked” options, which add upside or downside risk.
Out of the money (OTM): A call option with a strike
price above the price of the underlying instrument, or a put Simple moving average: A simple moving average
option with a strike price below the underlying instru- (SMA) is the average price of a stock, future, or other mar-
ment’s price. ket over a certain time period. A five-day SMA is the sum of
the five most recent closing prices divided by five, which
Parity: An option trading at its intrinsic value. means each day’s price is equally weighted in the calcula-
tion.
Physical delivery: The process of exchanging a physical
commodity (and making and taking payment) as a result of Strike (“exercise”) price: The price at which an under-
the execution of a futures contract. Although 98 percent of lying instrument is exchanged upon exercise of an option.
all futures contracts are not delivered, there are market par-
ticipants who do take delivery of physically settled con- Time decay: The tendency of time value to decrease at an
tracts such as wheat, crude oil, and T-notes. Commodities accelerated rate as an option approaches expiration.
generally are delivered to a designated warehouse; t-note
delivery is taken by a book-entry transfer of ownership, Time spread: Any type of spread that contains short
although no certificates change hands. near-term options and long options that expire later. Both
options can share a strike price (calendar spread) or have
Premium: The price of an option. different strikes (diagonal spread).
Put option: An option that gives the owner the right, but Time value (premium): The amount of an option’s
not the obligation, to sell a stock (or futures contract) at a value that is a function of the time remaining until expira-
fixed price. tion. As expiration approaches, time value decreases at an
accelerated rate, a phenomenon known as “time decay.”
Put ratio backspread: A bearish ratio spread that con-
tains more long puts than short ones. The short strikes are Vertical spread: A position consisting of options with
closer to the money and the long strikes are further from the the same expiration date but different strike prices (e.g., a
money. September 40 call option and a September 50 call option).
For example if a stock trades at $50, you could sell one
$45 put and buy two $40 puts in the same expiration month. Volatility: The level of price movement in a market.
If the stock drops, the short $45 put might move into the Historical (“statistical”) volatility measures the price fluctu-
money, but the long lower-strike puts will hedge some (or ations (usually calculated as the standard deviation of clos-
all) of those losses. If the stock drops well below $40, poten- ing prices) over a certain time period — e.g., the past 20
tial gains are unlimited until it reaches zero. days. Implied volatility is the current market estimate of
future volatility as reflected in the level of option premi-
Put spreads: Vertical spreads with puts sharing the same ums. The higher the implied volatility, the higher the option
expiration date but different strike prices. A bull put spread premium.
contains short, higher-strike puts and long, lower-strike
puts. A bear put spread is structured differently: Its long Volatility skew: The tendency of implied option volatil-
puts have higher strikes than the short puts. ity to vary by strike price. Although, it might seem logical
that all options on the same underlying instrument with the
Ratio spread: A ratio spread can contain calls or puts and same expiration would have identical (or nearly identical)
includes a long option and multiple short options of the implied volatilities. For example, deeper in-the-money and
same type that are further out-of-the-money, usually in a out-of-the-money options often have higher volatilities than
ratio of 1:2 or 1:3 (long to short options). For example, if a at-the-money options. This type of skew is often referred to
stock trades at $60, you could buy one $60 call and sell two as the “volatility smile” because a chart of these implied
same-month $65 calls. Basically, the trade is a bull call volatilities would resemble a line curving upward at both
spread (long call, short higher-strike call) with the sale of ends. Volatility skews can take other forms than the volatil-
additional calls at the short strike. ity smile, though.

FUTURES
GLOBAL & OPTIONS
ECONOMIC CALENDAR
CALENDAR APRIL
MONTH
Legend April 22 FND: May coffee (ICE)
1 FDD: April gasoline, natural gas, and LTD: May crude oil (NYMEX)
CPI: Consumer price index
ECI: Employment cost index crude oil (NYMEX); April aluminum, 23
First delivery day (FDD): copper, palladium, platinum, silver,
The first day on which deliv-
24 FND: May crude oil (NYMEX); May
and gold futures (NYMEX) cotton (ICE)
ery of a commodity in fulfill-
ment of a futures contract can March ISM LTD: May gold options, silver
take place.
2 FND: April propane and heating oil options, copper options, and
First notice day (FND): Also
known as first intent day, this (NYMEX) aluminum options (NYMEX)
is the first day a clearing- Durable goods
house can give notice to a
3
buyer of a futures contract 4 LTD: April currency options (CME); 25 LTD: May heating oil options,
that it intends to deliver a gasoline options, and natural gas
commodity in fulfillment of a live cattle options (CME); May cocoa
futures contract. The clearing- options (ICE) options (NYMEX)
house also informs the seller.
March employment LTD: May soybean options,
FOMC: Federal Open Market soybean products options, corn
FDD: April propane futures (NYMEX)
Committee
options, wheat options, rice options,
GDP: Gross domestic 5
product
and oats options (CBOT)
6
ISM: Institute for supply man- 26
agement 7 FND: April live cattle (CME)
LTD: Last trading day; the
27
first day a contract may trade 8 FDD: April heating oil (NYMEX)
28 LTD: May gasoline, natural gas
or be closed out before the
delivery of the underlying
9 Wholesale inventories (NYMEX); April gold, silver, platinum,
asset may occur. 10 FDD: April live cattle (CME) copper, palladium, and aluminum
PPI: Producer price index (NYMEX)
Trade balance
Quadruple witching Friday:
A day where equity options, 11 LTD: May coffee options (ICE), May 29 FND: May gasoline and natural gas
equity futures, index options, sugar no. 11 options (ICE); May (NYMEX)
and index futures all expire.
cotton options (ICE) FOMC meeting
APRIL 2008 12 30 FND: May gold, silver, copper,

30 31 1 2 3 4 5 platinum, palladium, and aluminum
13
6 7 8 9 10 11 12 (NYMEX); May soybeans, soybean
13 14 15 16 17 18 19
14 LTD: April lean hogs (CME); April products, corn, wheat, rice, and oats
20 21 22 23 24 25 26 lean hogs options (CME) (CBOT)
27 28 29 30 1 2 3 15 PPI LTD: May heating oil and propane
16 LTD: May platinum options (NYMEX) (NYMEX); April live cattle (CME);
CPI May sugar no. 11 (ICE); May lumber

(CME)
17 FND: May cocoa (ICE)
FOMC meeting
LTD: May crude oil options (NYMEX)
GDP
18 LTD: May frozen concentrated
orange juice options (ICE); April
index options
The information on this page is 19
subject to change. Futures &
Options Trader is not responsible
for the accuracy of calendar dates 20
beyond press time.
21
34 April 2008 • CURRENCY TRADER

EVENTS
Event: The Options Initiative Two-day Seminars Event: Traders Expo Los Angeles
Dates: April 10, July 17, Nov. 20 Date: June 18-21
Location: CBOE Options Institute, Chicago Location: Ontario Convention Center
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Strategies and Portfolio Protection Location: Mandalay Bay Resort & Casino, Las Vegas
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Date: May 6 Event: Traders Expo Las Vegas
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Event: Real Trading with Dan Sheridan
Date: April 24 Location: Hilton, Scottsdale, Ariz.
Date: July 24 Location: CBOE Options Institute,
Chicago
For more information: Call (877) THE-CBOE
Event: 30th Annual Law & Compliance Division

Workshop
Date: May 7-9
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Dates: May 22, Oct. 23, Dec. 4
Location: CBOE Options Institute, Chicago
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Options Seminar
Date: May 29
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enable TradeStation clients to paper trade stock, options, scanning for price patterns that exit at the next close fol-
futures, and forex markets in real-time. Clients will now be lowing the pattern formation and adding the results to sys-
able to automate or manually execute, on a simulated basis, tem tracking, and generates code for the patterns. It has
their custom strategies in real-time trading. This release improved back-testing parameter reporting. APS discovers
includes the addition of “Good ‘Til Canceled” and “Good trading systems based on price patterns that fulfill user-
‘Til Date” durations for futures orders, “Reverse Positions” defined performance statistics and risk/reward parameters
(U-Turns) for equities, futures, and forex positions, and by searching historical data in a fully automated way.
other platform optimizations. For more information, visit Technical traders can use APS to develop and analyze stock,
http://www.tradestation.com. futures, and forex trading systems based on price patterns.
The advanced functions of APS are fully automated and no
John Bollinger, the developer of Bollinger Bands, has programming is required. Users can create trading systems
launched a new site: http://www.MarketTechnician.com. using the discovered price patterns and the program can
MarketTechnician provides a variety of historical price track the trading signals generated by those systems. APS
series along with the tools and techniques necessary to ana- generates code for implementing the price patterns it dis-
lyze them. Some of the data dates as far back as 1928. The covers in other popular programs such as Metastock,
indicators and data span daily, weekly, and monthly time Tradestation, Wealth-Lab, and TeleChart.
frames, and the charts are highly customizable, so they can
be adapted to the user’s needs and risk/reward parameters. OptionsHouse, Inc. is providing advanced order
tickets enabling traders to automatically send their trades to
Dow Jones & Company and CQG, Inc. are now market if certain conditions are met. By programming a
providing Dow Jones Capital Markets Report (CMR) to future trade, an investor does not have to constantly moni-
fixed-income and currency professionals through CQG’s tor the markets. OptionsHouse has also added an integrat-
trading platform. Dow Jones Capital Markets Report pro- ed Message Center to its electronic trading platform to help
vides users with real-time news and analysis affecting the customers manage their account activity. Trade confirma-
debt and currency markets, helping traders create market tions, holiday closings, margin alerts, and information
opportunities and make smarter trading decisions. Dow about new features are included in the Message Center.
Jones Capital Markets Report is available beginning with
CQG’s Integrated Client 7.6. For more information about Scottrade has announced Scottrade OptionsFirst, a
Dow Jones Capital Markets Report, visit new advanced options platform. Powered by technology
http://www.djnewswires.com. For more information from OptionsHouse, a Chicago-based online retail and
about CQG, visit http://www.cqg.com. institutional brokerage firm, OptionsFirst will offer the lat-
est in options functionality, allowing customers to place
TradeKing (http://www.tradeking.com) members trades from the quote, option chain, or through an order
can now choose to display their account’s return on invest- ticket. Rolling out to a select number of Scottrade’s options
ment (ROI) along with their Certified Trades for fellow traders this summer, OptionsFirst will be widely available
members to see. TradeKing calculates and displays account this fall. Through the platform, Scottrade will be able to pro-
ROI for five and 15-day, as well as one and three-month vide tools such as the Risk Viewer, where investors will be
periods, with time frames to expand as time goes on. This able to estimate their risk on a position-by-position basis or
deployment of accurate ROI measurement in online trading portfolio wide. Furthermore, OptionsFirst will offer a virtu-
ushers in a new degree of transparency, building upon the al trading tool where investors can learn about options trad-
shared Certified Trades, which TradeKing introduced to the ing or test options trading strategies. For more information,
market in 2006. In addition to showing ROI data within visit http://www.scottrade.com/options.
traders’ profiles, TradeKing publishes a “Leaderboard” on
the community homepage ranking account performance for Note: The New Products and Services section is a forum for industry
those members who have opted into using the ROI feature. businesses to announce new products and upgrades. Listings are adapt-
This enables members to easily track the community’s ed from press releases and are not endorsements or recommendations
superstars and learn from their trading strategies. The from the Active Trader Magazine Group. E-mail press releases to
Leaderboard is updated nightly, giving a daily account of editorial@futuresandoptionstrader.com. Publication is not guaranteed.
who’s up and who’s down.

FUTURES TRADE JOURNAL
Disaster avoided,
but greed wastes a historic move.
TRADE
Date: Friday, March 14, 2008.
Entry: Long the March Mini Gold

futures (YGJ08) at 1,004.60.
Reasons for trade/setup: Having

made several short-term long trades as
gold capped its closely-watched run to
$1,000 (see the Trade Diary on p. 86 of
the May 2008 issue of Active Trader), we
look to buy again after the metal final-
ly eclipsed this level for the first time
yesterday (March 13). Source: TradeStation
Essentially, this position is an exten-
sion of a long trade entered at $995.60 on March 13 that was immediately — thus, another large up move was in the
exited just above $1,005 today. We were going to end the works. So (the thinking went), we might as well pull the exit
session flat, but decided to re-enter the position because of order and let this position run. And when we saw the mar-
the prospect of a news-fueled pop in the market as head- ket trading around $1,020, we thought we’d been proven
lines screamed “$1,000 gold!” for the next 24 hours. right. (We did, however, move the stop just above the entry
price, just in case.)
Initial stop: $990.10, a little below the early morning low. It took gold around 15 minutes to collapse from $1,025 to
our improvised exit at $1,008.70; it would have been too
Initial target: $1,024.90. painful to simply scratch the trade after having so much
open profit. We did, in fact, expect gold to collapse spectac-
ularly at some point. We did not, however, expect the col-
RESULT lapse to develop so decisively within a few hours of estab-
lishing the market’s all-time high.
Exit: $1,008.70.
We ultimately counted ourselves lucky, though. As the
daily chart inset shows, gold plummeted to $905.20 within
Profit/loss: +4.10 (0.41 percent).
72 hours.
Trade executed according to plan? No.
Note: Initial targets for trades are typically based on things such as
Outcome: Why didn’t we get out at the easily reached tar- the historical performance of a price pattern or trading system signal.
get of $1,025 when the market peaked at 1,033.70 the next However, individual trades are a function of immediate market
full day of trading? Greed, pure and simple. behavior; initial price targets are flexible and are most often used as
Being in uncharted territory, we took the market’s move points at which a portion of the trade is liquidated to reduce the posi-
back above $1,000 (after pulling back after the initial pene- tion’s open risk. As a result, the initial (pre-trade) reward-risk ratios
tration of this threshold) as a sign it wouldn’t collapse are conjectural by nature.
TRADE SUMMARY
Date Contract Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
3/14/08 YGJ08 1,004.60 990.1 1,024.90 1.4 1,008.70 3/17/08 4.1 (0.41%) 29.10 -8.60 2 days
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

OPTIONS TRADE JOURNAL
Entering two March butterfly spreads on the Nasdaq 100 Index

turns the trade into a profitable iron condor.
TRADE
options, which expire in two weeks.
Date: Friday, March 7, 2008. Butterflies are non-directional strategies and earn the
most profit if the underlying trades at the middle strike
Market: Options on the Nasdaq 100 Index (NDX). (1,750) at expiration. A butterfly’s price moves in the oppo-
site direction as volatility; butterflies recently became
Entry: March 1,650/1,750/1,850 put butterfly: cheaper as the Nasdaq 100’s volatility climbed, which is one
Buy ten 1,650 puts, sell twenty 1,750 puts, of the reasons for the trade.
and buy ten 1,850 puts for a debit of $41.80. Ideally, the butterfly will profit from time decay and
+ decreasing volatility as March expiration approaches. Each
March 1,550/1,650/1,750 call butterfly: of the three strikes is 100 points apart. Therefore, we didn’t
Buy ten 1,550 calls, sell twenty 1,650 calls, have to pinpoint exactly where NDX may trade at expira-
and buy ten 1,750 calls for a debit of $30.05. tion; the spread can be profitable over a wide range of
underlying prices, which offers some protection against
Reasons for trade/setup: The Nasdaq 100 index wild intraday market swings.
(NDX) began to form a sideways triangle pattern as it bot- Shortly after entering the put butterfly, we became nerv-
tomed out at 1,693 on Jan. 23 and then climbed to 1,864 on ous about a possible sell-off. The position has a downside
Feb. 1. After NDX broke below this triangle and closed at break-even point of 1,691.80 and upside break-even point of
1,745.27 on Feb. 29, it closed at 1,707.50 on March 7 (Figure 1,808.20 at expiration. Because NDX traded only slightly
1). above 1,700, more flexibility on the downside was needed.
At that point, it appeared the Nasdaq 100 index would The best way to lower the downside break-even point was
trade in a wide but controlled range until the Federal Open to buy another butterfly with lower strikes.
Market Committee (FOMC) meeting on March 18. Given Roughly 20 minutes later, we bought a March call butter-
the market’s tendency to rally after Fed rate cuts, we also fly with strikes of 1,550, 1,650, and 1,750. To create the
had a slightly bullish bias. spread, we bought ten 1,550 calls, sold twenty 1,650 calls,
First, we entered a March 1,650/1,750/1,850 put butterfly and bought ten 1,750 calls in March options. The combined
when NDX traded around 1,700 on March 7 for a debit of position is an iron condor, a non-directional position with a
$41.80. To create this butterfly, we bought ten 1,650 puts, wider profit zone and a total cost of $71.85.
sold twenty 1,750 puts, and bought ten 1,850 puts in March Figure 2 shows the iron condor’s potential gains and
losses on three dates: trade entry
(March 7, dotted line), halfway
FIGURE 1 — BETTING ON A SIDEWAYS MARKET until expiration (March 14, dashed
After the Nasdaq 100 index broke below this sideways triangle on Feb. 29, the index line), and expiration (March 20,
seemed likely to trade in a wide range until the Fed meeting on March 18. We solid line). The condor will earn
legged into a non-directional iron condor in March options that gained 29 percent up to $28,150 if the Nasdaq 100
within two weeks. trades between 1,650 and 1,750 at
expiration. And it risks up to
$71,850 if NDX either closes below
1,550 or above 1,850; its break-
even points are 1,621.85 and
1,778.15.
Adding the call butterfly lowers
the profit zone. Now, NDX could
move 80 points in either direction
without hurting the trade. The
goal is to simply wait two weeks
until expiration, because the con-
dor benefits from the passage of
time (assuming the Nasdaq 100
Source: TradeStation
trades between 1,650 and 1,750).

FIGURE 2 —RISK PROFILE — IRON CONDOR
At first, we entered a slightly bullish 1,650/1,750/1,850 put butterfly in March

options, but we soon added an overlapping 1,550/1,650/1,750 call butterfly to
lower its profit zone. The combined position is an iron condor that will make
money if the Nasdaq 100 doesn’t climb or drop more than 4 percent by March
Greeks 20 expiration (solid line).
Because we plan to hold this trade
until expiration, the option “Greek”
values, which measure different types
of risk, aren’t that important.
Butterflies and iron condors are delta-
neutral positions, and this spread was
placed in the middle of its profit zone.
Delta will only start to work against
the trade if the Nasdaq 100 starts mov-
ing in either direction. At that point,
NDX is more likely to move beyond
the condor’s profit zone, the position
will develop a directional bias, and it
will lose value.
Meanwhile, the trade has a positive
theta since it will benefit from the pas-
sage of time (as long as it trades with-
in both breakeven points). The condor
is also short volatility, because as
volatility drops, the Nasdaq 100 is Source: OptionVue
more likely to trade with its profit
zone, and the position will increase in value. pared for a downside move before entering the put butter-
fly. Luckily, we had time to adjust the position to protect it
Initial stop: Hold until expiration unless NDX moves against a larger downside move.
past expiration breakeven points of 1,621.85 and 1,778.15 You need patience to trade butterflies and condors suc-
and the position’s unrealized loss exceeds $10,000. cessfully. Although both break-even points were tested, it
made sense to simply hold on until March options
Initial target: Hold to March 20 expiration. expired.
Outcome: After placing the trade, we weren’t con-

TRADE SUMMARY
cerned about the Nasdaq 100’s daily moves, just its
overall trading range. In the trade’s first week, NDX
dropped from 1,700 to 1,672 and then bounced back Entry date: March 7, 2008
to a high of 1,760 (see Figure 1). Although the Nasdaq Underlying security: Nasdaq 100 index (NDX)
100 seemed poised to exceed the trade’s break-even
points, it remained within the expected range. Position: Iron condor
Expiration week tested nerves again as NDX 10 long March 1,650/1,750/1,850 put butterfly + 10 long
dipped to 1,668 on March 17 — the day before the Fed March 1,550/1,650/1,750 call butterfly
cut interest rates 0.75 percent (to 2.25 percent). The
Nasdaq 100 spiked to 1,772 in the wake of the Fed’s Initial capital required: $71,850
announcement. Initial stop: Break-even points and $10,000 loss
However, NDX fell on March 19 — index options’
last trading day — and closed at 1,715.59, well with- Initial target: Hold until March expiration
in the iron condor’s profit zone. NDX settled at 1,723 Trade length (in days): 13
the next day, and the trade earned $28,150 (excluding
commissions). P/L: $28,150 (39% of debit)
Although the trade was profitable, its entry was Expiration break-even points: 1,621.85 and 1,778.15
too rushed. We didn’t intend to enter two butterflies
with overlapping strikes, and we should have pre-

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April 2008 • Volume 2, No.

DANGEROUS DANCE: ROGUE TRADER UPDATE

Futures & Options Watch . . . . . . . . . . . . . . .20

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Key reversal strategy

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FUTURES & OPTIONS TRADER • April 2008 9

2. Place a limit order to buy at Pattern test

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Vertical spreads continued Implied volatility

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FUTURES & OPTIONS TRADER • April 2008 15

FIGURE 2 — LONG CALL VS. BULL PUT SPREAD

Spreads vs. outright options

16 April 2008 • FUTURES & OPTIONS TRADER

“The theta-vega relationship” “Controlling risk with spreads”

FUTURES & OPTIONS TRADER • April 2008 17

18 April 2008 • FUTURES & OPTIONS TRADER

Indices - Low IV/SV ratio

Stocks - High IV/SV ratio

Stocks - Low IV/SV ratio

Futures - High IV/SV ratio

Futures - Low IV/SV ratio