STRATEGY
FUTURES & OPTIONS
GUIDE
Introduction
Using futures and options, whether separately or in combination, can offer countless trading opportunities. The 21 strategies in this publication are not intended to provide a complete guide to every possible trading strategy, but rather a starting point. Whether the contents will prove to be the best strategies and follow-up steps for you will depend on your knowledge of the market, your risk-carrying ability and your trading objectives.
Interested in learning more about futures? The Chicago Mercantile Exchange® (CME®) Education Department offers a full range of courses and seminars designed to meet your needs, whether you’re
still learning the basics or looking for advanced instruction in options strategies or technical analysis. Courses are offered in classrooms at the Exchange as well as online. Please visit the Education section of the CME Web site, www.cme.com, to see current educational offerings and upcoming class schedules. You may also call the Education Department at 312-930-6937or e-mail us at edu@cme.com.
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ii Chicago Mercantile Exchange www.cme.com
How to Use This Guide
This publication was designed, not as a complete guide to every possible scenario, but rather as an easy-to-use manual that suggests possible trading strategies. One way to use it effectively is to follow these simple steps:
1. Determine Your Market Outlook.
Are you generally bullish, bearish, or undecided on future market moves?
2. Determine Your Volatility Outlook.
Do you feel that volatility will rise, fall, or are you undecided?
3. Look Up the Corresponding Strategy on the Appropriate Table.
Whether you are initiating a position or trying to follow up a current position, line up the correct row and column on the proper table to find a strategy that will help you make the most of your outlook.
4. Determine the “Best” Strike Price.
By analyzing your market and volatility outlook further you should be able to select the option strike that provides the best opportunity. The Guide does not go into detail on selecting the best strikes. You can do this by calculating a few “What-If” scenarios.
Some Things You Should Be Aware Of:
• In addition to breaking down market analysis into two main questions (“What is your market outlook?” and “What is your volatility outlook?”), you must also consider margin requirements, commission costs, taxes and execution costs, as well as other possible factors.
• The follow-up strategies in this Guide are usually “One Trade” changes. In other words, we asked: “How can a trader transform a position into a more desirable position with just one trade?” We did, however, bend this rule a little when one trade produced no acceptable strategy.
• Although you may be able to transform a trade with just one transaction, the resulting position can contain options at strikes that may or may not be appropriate for your new outlook.
• The ratio spreads and ratio backspreads are strategies that do not fit neatly into one of the nine scenarios. Therefore, a trader MUST analyze these strategies in greater depth. The strikes chosen bear greatly on the resulting profit/loss. Do several “What-If” scenarios before using these strategies.
• There are many other strategies, such as: calendar spreads, condors, Christmas trees, and option strips that are not addressed here. While they are all valid strategies, they do not fit neatly into this approach.
• The suggested strategies on the following pages are just that—suggestions. Because of limited space, the strategies suggested may or may not the “best” ones for your trading plan.
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How to Use the Tables
On the next page is a table suggesting strategies to use when “Initiating a Market Position.” Let’s go through an example: A trader has been watching a major increase in the value of the S&P 500® futures contract and feels the market is poised for a minor downward move. A small market drop with volatility dropping and futures leveling off is this trader’s outlook.
The market scenario is bearish.
The trader looks across the top of the page and finds “BEARISH.”
The volatility scenario is down.
The trader looks down the left of the page and finds “VOLATILITY FALLING.”
The trader lines up the BEARISH colum with the VOLATILITY FALLING row and finds two possible suggested market scenarios:
Number 6, SHORT CALL, and Number 18, RATIO PUT SPREAD.
The trader now does a number of “What-If” scenarios to determine the best strike, the profit objective and loss tolerance before making any trading decisions.
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Initiating a Market Position
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Buy a call
19*
CALL RATIO BACKSPREAD
Sell a call and buy two higher strike calls
7
LONG PUT
Buy a put
20*
PUT RATIO
BACKSPREAD
Sell a put and buy two lower strike puts
13
LONG STRADDLE Buy a call and buy a put at same strike
15
LONG STRANGLE
Buy a call and buy a put at different strikes
8
SHORT PUT
Sell a put
17*
RATIO CALL
SPREAD
Buy a call and sell two higher strike calls
6
SHORT CALL
Sell a call
18*
RATIO PUT
SPREAD
Buy a put and sell two lower strike puts
14
SHORT
STRADDLE
Sell a call and sell a put at same strike
16
SHORT STRANGLE
Sell a call and sell a put at different strikes
1
LONG FUTURES
Buy a futures
9
BULL SPREAD
Buy a call and
sell a call at a
higher strike OR
buy a put and
sell a put at a higher strike
2
SHORT FUTURES
Sell a futures
10
BEAR SPREAD
Buy a put and
sell a put at a
lower strike OR
buy a call and
sell a call at a lower strike
21
BOX/ CONVERSION
Use one of the
many combina-
tions of futures
and options that take advantage of mispricing to lock in a profit.
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
1
1 Long Futures
5.0 4.0 3.0 2.0 1.0 0.0
– 1.0
– 2.0
– 3.0
– 4.0
– 5.0
(1 Long April Live Cattle Futures)
68 69 70 71 72 73 74 75 76 77 78 April Live Cattle Futures
Scenario:
This trader feels that Live Cattle futures are poised for a rally. The implied volatility of the options is relatively high, but the trader does not expect it to come down soon. Therefore, he decides to buy one futures contract.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
April Live Cattle 73.00
75
55
16.2%
Long 1 Futures
73.00 (original futures price)
Unlimited; losses increase as futures fall. Unlimited; profits increase as futures rise.
Changes in implied volatility have no effect on this position. If the trader has an opinion on volatility, he may consider another strategy. Another strategy may increase potential profits and/or reduce potential losses. Check the next page for suggested follow-up strategies.
2 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Buy a put
7
LONG PUT
Liquidate futures and buy a put
20*
PUT RATIO
BACKSPREAD
Sell a call and buy two puts
at a lower strike
13
LONG STRADDLE
Buy two puts
8
SHORT PUT
Sell a call
6
SHORT CALL
Liquidate futures and sell a call
18*
RATIO PUT SPREAD
Sell two calls and buy a call at a higher strike
14
SHORT STRADDLE
Sell two calls
1
LONG FUTURES
Hold on
2
SHORT FUTURES
Sell two futures (one liquidates original position)
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
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2
Short Futures
5.0 4.0 3.0 2.0 1.0 0.0
– 1.0
– 2.0
– 3.0
– 4.0
– 5.0
(1 Short September Euro FX Futures)
.96 .97
.98 .99
1.00 1.01
September Euro FX Futures
1.05 1.06
1.02 1.03 1.04
Scenario:
This trader is a technician. He sees a major turnaround in the price of Euro FX Futures. He points out that chart patterns suggest a big downward move, the short-term moving average crossed under the long- term moving average, even the fundamentals look bearish. He has looked at the options market, but feels that a short futures position would be the best.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
September Euro FX 1.0100
65
55
14.9%
Short 1 Futures
1.0100 (original futures price) Unlimited; losses increase as futures rise. Unlimited; profits increase as futures fall.
Implied volatility has no effect on this position. If the trader has an opinion on volatility, he may consider another strategy. Other strategies may increase the reward and/or reduce the risk. Check the following page for follow-up strategies.
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Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Liquidate futures and buy a call
19*
CALL RATIO BACKSPREAD
Sell a put and buy two calls at a higher strike
7
LONG PUT
Buy a call
13
LONG STRADDLE
Buy two calls
8
SHORT PUT
Liquidate futures and sell a put
17*
RATIO CALL SPREAD
Sell two puts and buy a put at a lower strike
6
SHORT CALL
Sell a put
14
SHORT STRADDLE
Sell two puts
1
LONG FUTURES
Buy two futures (one liquidates original position)
2
SHORT FUTURES
Hold on
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
5
3
Synthetic Long Futures (Split Strike)
2.0 1.5 1.0 0.5
0
– 0.5
– 1.0
– 1.5
– 2.0
(1 Long Mar CD Call @ .6450; 1 Short Put @ .6350) (Dashed Line = Current; Solid Line = Expiration)
61.5 62 62.5
63 63.5 64
March Canadian Dollar Futures
66 66.5
64.5 65 65.5
Scenario:
Normally a trader enters into this position only as a follow-up strategy. Suppose the trader had a short strangle that he wanted to convert to a long futures. He can buy 2 calls (one liquidates the original short call). This nearly creates a synthetic long futures (long call, short put); however, it does so at different strike prices. The only difference in the risk/reward profile is the flat area between strikes—where little
is gained or lost (depending upon the premiums and the exact strikes chosen).
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
March Canadian Dollar .6400
30
20
5.0%
Long 1 Mar .6450 Call Short 1 Mar .6350 Put
– .0020 ($200) + .0019 ($190) – .0001 ($ 10)
.6451 (.6450 strike + 0.0001 debit)
Unlimited; losses mount as futures fall past .6350 strike. Unlimited; profits increase as futures rise past .6451 breakeven.
This position is not normally affected by changes in implied volatility. It is nearly the same as a long futures position except for the flat area between strikes. The flat area below the current futures price allows for some downside movement without loss. However, the trader gives away a little upside potential. Check the next page for follow-up strategies.
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Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Liquidate short put
7
LONG PUT
Buy two puts (one liquidates original short put) and liquidate long call
15
LONG STRANGLE
Buy two puts (one liquidates original short put)
8
SHORT PUT
Liquidate long call
6
SHORT
CALL
Sell two calls
(one liquidates original long
call) and liquidate short put
16
SHORT STRANGLE Sell two calls (one liquidates
original long call)
3
SYNTHETIC LONG FUTURES (SPLIT STRIKE) Hold on
10
BEAR SPREAD
Sell a futures
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
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4
Synthetic Short Futures (Split-Strike)
1.2 1.0 0.8 0.6 0.4 0.2
0
– 0.2
– 0.4
– 0.6
– 0.8
– 1.0
– 1.2
(1 Long Mar ED Put @ 92.50; 1 Short Call @ 92.75) (Dashed Line = Current; Solid Line = Expiration)
91.5 91.75 92
92.25 92.5
March Eurodollar Futures
92.75 93
93.25 93.5
93.75 94
Scenario:
This trader feels that Eurodollar prices are going to drop (interest rates to rise). He has no opinion on volatility. He considers a straight short futures, but decides that there is a slight chance that EuroDollar futures will rise a little. He therefore decides to try a split-strike synthetic short futures position.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
March Eurodollar futures 92.70
59
40
23.2%
Long 1 Mar 92.50 Put Short 1 Mar 92.75 Call
– 0.14 ($ 350) + 0.20 ($ 500) + 0.06 ($ 150)
92.81 (92.75 strike + 0.06 credit)
Unlimited; losses mount above 92.81 breakeven. Unlimited; profits increase as futures fall past 92.50 strike.
Implied volatility changing normally has no effect on this strategy. Therefore, if the trader has an opinion on volatility, he may find another strategy with a better risk/reward profile. Watch this position carefully; just like a short futures, this position has unlimited risk. Check the next page for follow-up strategies.
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Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Buy two calls (one liquidates original short call) and liquidate long put
7
LONG PUT
Liquidate short call
15
LONG STRANGLE
Buy two calls (one liquidates original short call)
8
SHORT
PUT
Sell two puts
(one liquidates original long
put) and liquidate short call
6
SHORT
CALL
Liquidate long put
16
SHORT STRANGLE Sell two puts
(one liquidates original long put)
9
BULL SPREAD
Buy a futures
4
SYNTHETIC SHORT FUTURES (SPLIT STRIKE) Hold on
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
9
5
Long Call
20 15 10
5
0 –5 – 10 – 15 – 20
(1 Long Dec S&P 500 Call @ 905) (Dashed Line = Current; Solid Line = Expiration)
875 880 885
890 895 900
December S&P 500 Futures
905 910 915 920 925
Scenario:
A trader projects that stock market futures are poised for a large upward move in a short period of time. An increase in the underlying futures to 1315.00 or greater, and an increase in implied volatility by 4 percentage points, also seem likely. Consequently, the trader decides to buy a call.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
December S&P 500 900
45
45
18.1%
Long 1 Dec 905 Call
– 5.40 ($1350)
910.40 (905 strike + 5.40 premium)
Below 910.40; with maximum loss, at 905 or below, of 5.40. Unlimited; profits continue to increase as futures rise above 910.40.
The trader will lose the volatility effect if this position is held to expiration. As soon as implied volatility rises to the expected level the trader may consider liquidating or transforming this position. Check the next page for appropriate follow-up strategies.
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Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Hold on
7
LONG PUT
Sell a futures
13
LONG STRADDLE
Buy a put at same strike
15
LONG STRANGLE
Buy a put at a different strike
8
SHORT PUT
Liquidate long call and sell a put
17*
RATIO CALL SPREAD
Sell two higher strike calls
6
SHORT CALL
Sell a call
14
SHORT
STRADDLE
Sell two calls
(one liquidates
original long
call) and sell a put at same strike
16
SHORT STRANGLE
Sell two calls
(one liquidates
original long
call) and sell a put at different strike
9
BULL SPREAD
Sell a higher strike call
1
LONG FUTURES
Sell a put at same strike
10
BEAR SPREAD
Sell a lower strike call
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
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6
Short Call
1.0 0.8 0.6 0.4 0.2 0.0
– 0.2
– 0.4
– 0.6
– 0.8
– 1.0
(1 Short Jun Eurodollar Call @ 92.00) (Dashed Line = Current; Solid Line = Expiration)
90.75 91
91.25 91.5
91.75 92
June Eurodollar Futures
92.75 93
93.25
92.25 92.5
Scenario:
After a large increase this trader now believes the Eurodollar market is in for a consolidation and a mild downward fall. Implied volatility is approaching all-time highs. Premiums, therefore, are relatively large. The trader wants to capture the inflated premium through the sale of one 92.00 call.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk:
Potential Gain:
Things to Watch:
June Eurodollar 91.97
30
30
34.4%
Short 1 Jun 92.00 Call
+ 0.30
($750)
92.30 (92.00 strike + 0.30 premium)
Unlimited; losses continue to increase as futures rise above 92.30 breakeven.
Limited to the premium received. Maximum profit below 92.00 strike.
Although the trader is highly compensated for the risk assumed (with implied volatility high), the trader must watch this (and all) unlimited risk positions closely. Consider another strategy if the futures and/or volatility continue to rise. A review of the trade should occur at some predetermined place.
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Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG
CALL
Buy two calls (one liquidates original short call)
19*
CALL RATIO BACKSPREAD
Buy two higher strike calls
7
LONG PUT
Liquidate short call and buy a put
20*
PUT RATIO
BACKSPREAD
Buy a futures and buy two puts at a lower strike
13
LONG STRADDLE
Buy two calls
(one liquidates
original short
call) and buy a put at same strike
15
LONG STRANGLE
Buy two calls
(one liquidates original short
call) and buy a put at a different strike
8
SHORT PUT
Buy a futures
6
SHORT CALL
Hold on
14
SHORT STRADDLE
Sell a put at same strike
16
SHORT STRANGLE
Sell a put at a different strike
9
BULL SPREAD
Buy a call at a lower strike
10
BEAR SPREAD
Buy a call at
a higher strike
2
SHORT FUTURES
Buy a put at same strike
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
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7
Long Put
20 15 10
5
0 –5 – 10 – 15 – 20
(1 Long Feb Pork Belly Put @ 76.00) (Dashed Line = Current; Solid Line = Expiration)
60 64 68 72 76 80 84 88 92 96 100 February Pork Belly Futures
Scenario:
Pork Bellies have been trading at contract highs of between 75 and 85 cents per pound. The trader feels that a major decline is very likely. However, the trader is not sure when it will come. He decides to buy a long-term put option. By doing this he initially has very little time decay. He can ride out a temporary upward move and still be in for the big break.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk:
Potential Gain:
Things to Watch:
February Pork Bellies 80.15
210
180
33.2%
Long 1 Feb 76 Put
– 5.10
($2040)
70.90 (76.00 strike – 5.10 premium)
Limited to the premium paid. Loss above 70.90 with maximum loss of 5.10 above 76.00.
Unlimited, with profits increasing as the futures fall further and further past 70.90 breakeven.
This trader must be very bearish, with volatility increasing, to make this trade profitable. If held to expiration, the futures would have to fall more than 10% by expiration just to break even. Check the follow-up strategies if the futures fall or volatility rises to the levels expected before expiration.
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Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Buy a futures
7
LONG PUT
Hold on
13
LONG STRADDLE
Buy a call
at same strike
15
LONG STRANGLE
Buy a call at different strike
8
SHORT PUT
Sell two puts (one liquidates original
long put)
6
SHORT
CALL
Liquidate long put and sell a call
18*
RATIO PUT SPREAD
Sell two puts at a lower strike
14
SHORT
STRADDLE
Sell two puts
(one liquidates
original long
put), and sell a call at same strike
16
SHORT
STRANGLE
Sell two puts
(one liquidates
original long
put) and sell a call at different strike
9
BULL SPREAD
Sell a put at
a higher strike
10
BEAR SPREAD
Sell a put at a lower strike
2
SHORT FUTURES
Sell a call at same strike
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
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8
Short Put
5.0 4.0 3.0 2.0 1.0 0.0
– 1.0
– 2.0
– 3.0
– 4.0
– 5.0
(1 Short Mar Australian Dollar Put @ 0.5500) (Dashed Line = Current; Solid Line = Expiration)
50 51 52 53 54 55 56 57 58 59 60 March Australian Dollar Futures
Scenario:
This trader feels very strongly that Australian Dollar futures will not fall. He thinks, though, that the market has an equal chance of going up or leveling out. He also expects implied volatility to fall about 11%. The trader decides to sell a put option.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
March Australian Dollar 0.5500
50
40
14.1%
Short 1 Mar 0.5500 Put
+ .0111
($1110)
0.5389 (0.5500 strike – 0.0111 credit)
Unlimited; with losses increasing as futures fall past 0.5389 breakeven. Limited to the premium received 0.0111 ($1110). This occurs when futures is above 0.5500 strike at option expiration.
As with all unlimited risk situations, the trader must watch this position carefully. Special consideration must be give to foreign currency trading, due to foreign and domestic central bank policy changes. The worst scenario is to be in this position with volatility rising and futures falling. Always re-evaluate this position at some predetermined point.
16 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Liquidate short put and buy a call
19*
CALL RATIO
BACKSPREAD
Sell a futures and buy two calls at a higher strike
7
LONG PUT
Buy two puts (one liquidates original
short put)
20*
PUT RATIO BACKSPREAD
Buy two puts at a lower strike
13
LONG STRADDLE
Buy two puts
(one liquidates
original short
put) and buy a call at same strike
15
LONG STRANGLE
Buy two puts
(one liquidates
original short
put and buy call at a different strike
8
SHORT PUT
Hold on
6
SHORT CALL
Sell a futures
14
SHORT STRADDLE
Sell a call
at same strike
16
SHORT STRANGLE
Sell a call at different strike
9
BULL SPREAD
Buy a put at a lower strike
1
LONG FUTURES
Buy a call at same strike
10
BEAR SPREAD
Buy at put at a higher strike
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
17
9
Bull Spread
10.0 8.0 6.0 4.0 2.0 0.0
– 2.0
– 4.0
– 6.0
– 8.0 – 10.0
(1 Long Nov Lumber Call@200; 1 Short Call@210 ) (Dashed Line = Current; Solid Line = Expiration)
170 175 180
185 190 195
November Lumber Futures
215 220
200 205 210
Scenario:
The trader feels bullish on Lumber, but volatility is in question. He could try futures as an alternative, but wants the comfort of a limited loss position. He decides on a bull spread with the higher strike written at the top of his expected trading range of 210.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk:
Potential Gain:
Things to Watch:
November Lumber 193.00
60
40
18.6%
Long 1 Nov 200 Call Short 1 Nov 210 Call
– 2.10
+ 0.50 ($ 75) – 1.60 ($240)
201.60 (200.00 strike + 1.60 debit)
Limited to premium paid. Losses increase below 201.60
to a maximum loss below 200.00 of 1.60 ($240).
Limited to difference between strikes less debit paid (10.00 – 1.60) 8.40 ($12,600). Gains mount above 201.60 with maximum profit at 210.00.
Volatility changes affect this spread very little. Therefore, if the trader has an opinion on volatility, one of the other strategies may work better. Check the next page for follow-up strategies.
($315)
18 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG
CALL
If bull spread is
constructed
with calls then
liquidate short call; if bull spread
is constructed with puts then liquidate short put and buy futures
7
LONG PUT
If a bull spread
is constructed
with puts then
liquidate short put; if bull spread is constructed with calls then liquidate short call and sell futures
12
SHORT BUTTERFLY
Add a bear spread at lower strikes
8
SHORT PUT
If bull spread
is constructed
with puts then
liquidate long put; if bull spread is constructed with calls then liquidate long call and buy futures
6
SHORT CALL
If bull spread
is constructed
with calls then
liquidate long call; if bull spread is constructed with puts then liquidate long put and sell futures
11
LONG BUTTERFLY
Add a bear spread at higher strikes
9
BULL SPREAD
Hold on
4
SYNTHETIC SHORT FUTURES (SPLIT STRIKE) Sell a futures
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
19
10
Bear Spread
0.0300 0.0200
0.0100
0.0000
– 0.0100
– 0.0200
– 0.0300
(1 Long June BP Put @ 1.5800; 1 Short Put @ 1.5600) (Dashed Line = Current; Solid Line = Expiration)
1.48 1.50 1.52
1.54 1.56 1.58
June British Pound Futures
1.66 1.68
1.60 1.62 1.64
Scenario:
This trader is convinced the British Pound market is going to fall. The trader does not expect a sharp
drop, just a gradual decline to about put at the target price.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk:
Potential Gain:
Things to Watch:
1.5600 US$/pound. He decides on a bear spread with the written
June British Pound 1.5850
80
70
12.0%
Long 1 Jun 1.5800 Put Short 1 Jun 1.5600 Put
1.5690 (1.5800 strike – .0110 debit)
Losses start above 1.5690, but limited to the debit paid. Maximum loss above 1.5800.
Gains mount as futures fall below 1.5690. Maximum profit of .0090 ($562.50) at or below 1.5600 (the difference between strikes .0200 – debit .0110).
– .0320
+ .0210
– .0110 ($ 687.50)
($2000.00) ($1312.50)
If the trader had a target price in mind, this would be an effective strategy. Why should the trader pay for an option with unlimited potential when he thinks the move is limited? Selling an option at the target price will reduce the cost of an outright long option.
20 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG
CALL
If bear spread is
constructed
with calls then
liquidate short call; if bear spread
is constructed with puts then liquidate short put and buy futures
7
LONG PUT
If a bear spread
is constructed
with puts then
liquidate short put; if bear spread is constructed with calls then liquidate short call and sell futures
12
SHORT BUTTERFLY
Add a bull spread at higher strikes
8
SHORT PUT
If bear spread
is constructed
with puts then
liquidate long put; if bear spread is constructed with calls then liquidate long call and buy futures
6
SHORT CALL
If bear spread
is constructed
with calls then
liquidate long call; if bear spread is constructed with puts then liquidate long put and sell futures
11
LONG BUTTERFLY
Add a bull spread at lower strikes
3
SYNTHETIC LONG FUTURES (SPLIT STRIKE) Buy a futures
10
BEAR SPREAD
Hold on
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
21
11
Long Butterfly
3 2
1
0
–1
–2
(1 Long LHZ Call@52; 2 Short Calls@54; 1 Long Call@56) (Dashed Line = Current; Solid Line = Expiration)
–3
49 50 51 52 53 54 55 56 57 58 59
December Lean Hog Futures
Scenario:
The trader currently has a #17 Ratio Call Spread. He thinks this is still a good position. However, he is worried that the futures may increase dramatically on the upside, leaving him with a substantial loss. He adds a long call and converts the position into a long butterfly.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
December Lean Hogs 52.50
74
45
21.5%
Long 1 Dec 52.00 Call Short 2 Dec 54.00 Calls Long 1 Dec 56.00 Call
– 1.825 + 0.950 – 0.450 – 0.375
($547.50) ($285.00) ($135.00) ($112.50)
Downside: 52.375 (52.00 strike + 0.375 debit).
Upside: 55.625 (56.00 strike – 0.375 debit).
Losses start above 55.625, or below 52.375, but limited to the debit paid. Maximum loss above 56.00 strike or below 52.00 strike. Gains peak at strike of written calls. Maximum profit of
1.625 ($487.50).
There is not much risk in this position. Volatility has little effect. Avoid follow-up strategies unless you are quite certain of a particular move. Nearly every follow-up to this strategy requires more than one trade—possibly incurring large transaction costs.
Chicago Mercantile Exchange
www.cme.com
22
Profit / Loss
Follow-up Strategies†
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
If the long butterfly is constructed
with calls, then liquidate all options but one long call
7
LONG PUT
If the long
butterfly is
constructed
with puts, then liquidate all options but one long put
15
LONG STRANGLE
If the long
butterfly is
constructed with two calls and two puts, then liquidate the short call and the short put
8
SHORT PUT
If the long
butterfly is
constructed
with puts, then liquidate all options but one short put
6
SHORT CALL
If the long
butterfly is
constructed
with calls, then liquidate all options but one short call
11
LONG BUTTERFLY
Hold on
9
BULL SPREAD
Liquidate a bear spread
10
BEAR SPREAD
Liquidate a bull spread
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
†
It is very difficult to convert a butterfly into another strategy with one or even two transactions. Normally,
for off-floor-traders, this trade would not be entered into as transaction costs can be substantial. Also, follow-up trades can add to commission costs, making it very difficult to realize a profit.
23
12
Short Butterfly
0.0200
0.0100
0.0000
– 0.0100
– 0.0200
(1 Short SFM Call@.69; 2 Long Calls@.70; 1 Short Call@.71) (Dashed Line = Current; Solid Line = Expiration)
.675 .68 .685
.69 .695 .70
June Swiss Franc Futures
.705 .71 .715 .72 .725
Scenario:
This trader currently has a #19 Call Ratio Backspread, but now feels that the underlying futures will not explode on the upside. Instead, the trader feels that the market has an equal chance of going up or down, and thus converts the position into a short butterfly.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven:
Loss Risk: Potential Gain:
Things to Watch:
June Swiss Franc 0.7000
30
20
12.2%
Short 1 Jun 0.6900 Call Long 2 Jun 0.7000 Calls Short 1 Jun 0.7100 Call
+ 0.0129
– 0.0068 ($ 850.00) x 2 + 0.0031 ($ 387.50)
+ 0.0024 ($ 300.00)
Downside: 0.6924 (0.6900 strike + 0.0024 credit).
Upside: 0.7076 (0.7100 strike – 0.0024 credit).
Losses bottom at 0.7000 strike. Maximum loss of 0.0076 ($950). Gains top out at original net credit of 0.0024 ($300). This occurs when futures rise above 0.7100 strike, or fall below 0.6900 strike.
There is not much risk in this position. Volatility has little effect. You should avoid follow-up strategies unless you are quite certain of a particular move. Nearly every follow-up to this strategy requires more than one trade—possibly incurring large transaction costs.
($1612.50)
Chicago Mercantile Exchange
www.cme.com
24
Profit / Loss
Follow-up Strategies†
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
If the short butterfly is constructed
with calls, then liquidate all options but one long call
7
LONG PUT
If the short
butterfly is
constructed
with puts, then liquidate all options but one long put
12
SHORT BUTTERFLY
Hold on
8
SHORT PUT
If the short
butterfly is
constructed
with puts, then liquidate all options but one short put
6
SHORT CALL
If the short
butterfly is
constructed
with calls, then liquidate all options but one short call
16
SHORT
STRANGLE
If the short
butterfly is
constructed
with two calls and two puts, then liquidate the long call and the long put
9
BULL SPREAD
Liquidate a bear spread
10
BEAR SPREAD
Liquidate a bull spread
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
†
It is very difficult to convert a butterfly into another strategy with one or even two transactions. Normally,
for off-floor-traders, this trade would not be entered into as transaction costs can be substantial. Also, follow-up trades can add to commission costs, making it very difficult to realize a profit.
25
13
Long Straddle
5 4 3 2 1 0
—1 —2
—3 —4 —5
(1 Long May Feeder Cattle Call @ 82; 1 Long Put @ 82) (Dashed Line = Current; Solid Line = Expiration)
77 78 79 80 81 82 83 84 85 86 87 May Feeder Cattle Futures
Scenario:
This trader looks at the low implied volatility and feels that options are relatively inexpensive. The expectation here is that this market is poised for a big move. However, the trader is not sure which way it will be. So a decision is made to buy both a call and a put.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
May Feeder Cattle 81.00
20
20
8.4%
Long 1 May 82.00 Call Long 1 May 82.00 Put
– 0.25 – 1.25 – 1.50
($110.00) ($550.00) ($660.00)
Downside: 80.50 (82.00 strike – 1.50 debit).
Upside: 83.50 (82.00 strike + 1.50 debit).
Losses bottom out at 82.00 strike with a maximum loss of
1.50 ($660).
Unlimited; gains begin below 80.50 breakeven and increase as futures fall. Also, gains increase as futures rise past 83.50 breakeven.
This is primarily a volatility play. A trader enters into this position with no clear idea of market direction, but a forecast of greater movement (risk) in the underlying futures.
26 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Liquidate the long put
7
LONG PUT
Liquidate the long call
13
LONG STRADDLE
Hold on
8
SHORT
PUT
Liquidate long
call and sell
two puts
(one liquidates original long put)
6
SHORT
CALL
Liquidate long
put and sell
two calls
(one liquidates original long call)
14
SHORT STRADDLE
Sell two calls
(one liquidates
original long call)
and sell two puts (one liquidates original long put)
1
LONG FUTURES
Sell two puts (one liquidates original
long put)
2
SHORT FUTURES
Sell two calls (one liquidates original
long call)
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
27
14
Short Straddle
0.0500 0.0400 0.0300 0.0200 0.0100 0.0000
– 0.0100
– 0.0200
– 0.0300
– 0.0400
– 0.0500
(1 Short Sep JY Call @ 0.8600; 1 Short Put @ 0.8600) (Dashed Line = Current; Solid Line = Expiration)
.81
.82 .83
.84 .85 .86
September Japanese Yen
.90 .91
.87 .88 .89
Scenario:
This trader finds a market with relatively high implied volatility. The current feeling is the market will stabilize after having had a long run to its present level. To take advantage of time decay and dropping volatility this trader sells both a call and a put at the same strike price.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Options Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
September Japanese Yen 0.8600
40
30
12.6%
Short 1 Sep 0.8600 Call Short 1 Sep 0.8600 Put
+ 0.0100 ($1250.00) + 0.0100 ($1250.00) + 0.0200 ($2500.00)
Downside: 0.8400 (0.8600 strike – 0.0200 credit).
Upside: 0.8800 (0.8600 strike + 0.0200 credit).
Unlimited; losses increase as futures fall below 0.8400 breakeven or rise above 0.8800 breakeven.
Limited to credit received; maximum profit of 0.0200 ($2500) achieved as position is held to expiration and futures close exactly 0.8600 strike.
This is primarily a volatility play. A trader enters into this position with no clear idea of market direction but a forecast of less movement (risk) in the underlying futures. Be aware of early exercise. Assignment of a futures position transforms this strategy into a synthetic short call or synthetic short put.
28 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG
CALL
Buy two calls (one liquidates
original short
call) and liquidate short put
7
LONG
PUT
Buy two puts (one liquidates
original short
put) and liquidate short call
13
LONG STRADDLE Buy two calls (one liquidates original short
call) and buy two puts
(one liquidates original short put)
8
SHORT PUT
Liquidate short call
6
SHORT CALL
Liquidate short put
14
SHORT STRADDLE
Hold on
1
LONG FUTURES
Buy two calls (one liquidates original
short call)
2
SHORT FUTURES
Buy two puts (one liquidates original
short put)
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
29
15
Long Strangle
0.0500 0.0400 0.0300 0.0200 0.0100 0.0000
– 0.0100
– 0.0200
– 0.0300
– 0.0400
– 0.0500
(1 Long Dec EC Call @ 1.0200; 1 Long Put @ 1.0000) (Dashed Line = Current; Solid Line = Expiration)
.96 .97 .98
.99 1.00 1.01
December Euro FX Futures
1.05 1.06
1.02 1.03 1.04
Scenario:
This trader looks at the low implied volatility and feels that options are relatively cheap. The thinking here is that this market will have a very big move. However, the trader is not sure which way it will be, so he decides to buy both a call and a put. The trader saves on premiums by buying both options out-of- the-money. However, the trader must get an even larger move than a long straddle to make this strategy profitable by expiration.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
December Euro FX 1.0100
65
55
11.3%
Long 1 Dec 1.0200 Call Long 1 Dec 1.0000 Put
– 0.0500 ($ 625.00) – 0.0048 ($ 600.00) – 0.0098 ($1225.00)
Downside: 0.5002 (1.0000 strike – 0.0098 debit). Upside: 1.0298 (1.0200 strike + 0.0098 debit).
Losses bottom at 0.0098 with a maximum loss between 1.0200 and 1.0000 strikes.
Unlimited; gains begin below .9902 and increase as futures fall. Also, gains increase as futures rise past 1.0298.
This is primarily a volatility play. A trader enters into this position with no clear idea of market direction but a forecast of greater movement in the underlying futures.
30 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Liquidate long put
7
LONG PUT
Liquidate long call
15
LONG STRANGLE
Hold on
8
SHORT
PUT
Sell two puts
(one liquidates original long
put) and liquidate the long call
6
SHORT
CALL
Sell two calls
(one liquidates original long
call) and liquidate the long put
16
SHORT STRANGLE Sell two calls (one liquidates original long
call) and sell two puts
(one liquidates original long put)
3
SYNTHETIC
LONG
FUTURES
(SPLIT
STRIKE)
Sell two puts (one liquidates original long put)
4
SYNTHETIC
SHORT
FUTURES
(SPLIT
STRIKE)
Sell two calls (one liquidates original long call)
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
31
16
Short Strangle
10 8 6 4 2 0 –2 –4 –6 –8 – 10
(1 Short Mar LB Call @ 200; 1 Short Put @ 170) (Dashed Line = Current; Solid Line = Expiration)
160 165 170
175 180 185
March Lumber Futures
190 195 200 205 210
Scenario:
This trader finds current implied volatility at relatively high levels. The expectation now is for a very lackluster trading month with no trend, and reduced volatility. The trader could sell a straddle, but feels more comfortable with the wider range of maximum profit of the short strangle.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
Long 1 Dec 1.0000 Put
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
March Lumber 185.00
65
45
19.4%
Short 1 Mar 200.00 Call Short 1 Mar 170.00 Put
+ 0.80
+ 0.60 ($ 90.00) + 1.40 ($210.00)
Downside: 168.60 (170.00 strike – 1.40 credit).
Upside: 201.40 (200.00 strike + 1.40 credit).
Unlimited; losses continue to mount as futures fall below 168.60 breakeven or rise above 201.40 breakeven.
Maximum gains occur between strikes (a 30.00 range of maximum profit).
There is a high probability that futures will expire in this range, thereby yielding the maximum profit. However, the profit received is relatively small for the amount that could be at risk if futures were to rally or drop sharply. Assignment of a futures position transforms this strategy into a synthetic short call or synthetic short put.
($120.00)
32 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Buy two calls
(one liquidates original short call) and liquidate short put
7
LONG PUT
Buy two puts
(one liquidates original short put) and liquidate short call
15
LONG STRANGLE
Buy two calls
(one liquidates
original short call) and buy two puts (one liquidates original short put)
8
SHORT PUT
Liquidate short call
6
SHORT CALL
Liquidate short put
16
SHORT STRANGLE
Hold on
3
SYNTHETIC
LONG
FUTURES
(SPLIT
STRIKE)
Buy two calls (one liquidates original short call)
4
SYNTHETIC
SHORT
FUTURES
(SPLIT
STRIKE)
Buy two puts (one liquidates original short put)
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
33
17
Ratio Call Spread
0.0400 0.0300 0.0200 0.0100 0.0000
– 0.0100
– 0.0200
– 0.0300
– 0.0400
(1 Long June BP Call @ 1.58; 2 Short Calls @ 1.60 ) (Dashed Line = Current; Solid Line = Expiration)
1.53 1.54 1.55
1.56 1.57 1.58
June British Pound Futures
1.62 1.63
1.59 1.60 1.61
Scenario:
This trader finds current implied volatility at relatively high levels. Analysis of this market leads this trader to conclude that British Pound futures will trend very slowly up to about $1.60/pound. Also, there is a small chance that the pound may fall dramatically. The trader, therefore, likes the risk/reward profile of the ratio call spread with this outlook.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
At Expiration:
Breakeven:
Loss Risk: Potential Gain:
Things to Watch:
June British Pound 1.5800
35
25
14.1%
Long 1 Jun 1.5800 Call Short 2 Jun 1.6000 Calls
– 0.0232
+ 0.0146 ($ 912.50) x 2 + 0.0060 ($ 375.00)
1.6260 (1.6000 strike + 0.02 difference between
strikes + 0.0060 credit).
Unlimited; losses continue to mount as futures rise above 1.6260. Maximum gain of 0.0260 ($1625.00) peaks at 1.6000 strike.
Do not enter into this position when there is a chance of an explosive upward move. In this particular situation, a profit is realized if futures fall. However, depending on the strikes chosen, a small loss may also occur.
($1450.00)
34 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL
Liquidate the two short calls
7
LONG
PUT Liquidate the
two short calls and sell futures
13
LONG STRADDLE Liquidate the two short calls
and buy a put at
same strike as original long call
17*
RATIO CALL SPREAD
Hold on
6
SHORT CALL
Liquidate long call and liquidate one short call
14
SHORT STRADDLE
Sell a put at same strike as original long call
11
LONG BUTTERFLY
Buy a call at
an even higher strike than the original position
9
BULL SPREAD
Liquidate one short call
4
SYNTHETIC
SHORT
FUTURES
(SPLIT
STRIKE)
Liquidate one short call and sell futures
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
35
18
Ratio Put Spread
3 2 1 0
–1 –2 –3
(1 Long Feb LC Put @ 62; 2 Short Puts @ 60) (Dashed Line = Current; Solid Line = Expiration)
57 58 59 60 61 62 63 64 65 66 67 February Live Cattle Futures
Scenario:
This trader feels that current implied volatility is at relatively high levels. The thinking here is that the market should consolidate after its big drop. The trader now believes reduced volatility and a slow downward drifting of price are likely. Consequently, an order to execute a ratio put spread is placed with the broker.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
Long 1 Dec 1.0000 Put
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
February Live Cattle 62.50
30
20
15.5%
Long 1 Feb 62.00 Put Short 2 Feb 60.00 Puts
– 0.675
+ 0.150 ($ 60.00) x 2 – 0.375 ($150.00)
58.375 (60.00 strike – difference between strikes + 0.375 debit). Unlimited; losses continue to mount as futures fall below 58.375. Maximum gain of 1.625 ($650) peaks at 60.00 strike.
Be very sure that prices will not go into a sharp decline. But, if a slow drop is anticipated this may be a good strategy. A rally will produce a small gain or loss depending on the strikes chosen.
($270.00)
36 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
5
LONG CALL Liquidate the
two short puts and buy futures
7
LONG PUT
Liquidate the two short puts
13
LONG STRADDLE Liquidate the two short puts
and buy a call at
same strike as original long put
8
SHORT PUT
Liquidate one short put and liquidate
long put
18*
RATIO PUT SPREAD
Hold on
14
SHORT STRADDLE
Sell a call
at strike of original long put
11
LONG BUTTERFLY
Buy a put
at an even lower strike than the original positon
3
SYNTHETIC
LONG
FUTURES
(SPLIT
STRIKE)
Liquidate one short put and buy a futures
10
BEAR SPREAD
Liquidate one short put
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
37
19
Call Ratio Backspread
1.0 0.8 0.6 0.4 0.2 0.0
– 0.2
– 0.4
– 0.6
– 0.8
– 1.0
(1 Short Mar ED Call @ 90.00; 2 Long Calls @ 90.25) (Dashed Line = Current; Solid Line = Expiration)
88.75 89 89.25
89.50 89.75 90
March Eurodollar Futures
90.75 91
91.25
90.25 90.50
Scenario:
This trader notices the low implied volatility of the options. The expectation now is for the Eurodollar market to rally. But, the trader does not want to lose money if the market moves the other way. A strategy that fits this outlook fairly well is the call ratio backspread.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
Long 1 Dec 1.0000 Put
At Expiration:
Breakeven: Loss Risk: Potential Gain:
Things to Watch:
March Eurodollar 90.00
60
40
14.6%
Short 1 Mar 90.00 Call Long 2 Mar 90.25 Calls
+ 0.19 ($475.00)
– 0.09 ($225.00) x 2 + 0.01 ($ 25.00)
90.49 (90.25 strike + 0.25 difference between strikes – 0.01 credit). Limited to 0.24 ($600); occurs only at 90.25 strike.
Unlimited; gains mount as futures rise above the 90.49
breakeven point.
drifting of the price up toward the strike of purchased calls.
The worst situation would be a slow
Increased volatility helps this position, so the trader wants large upward price moves.
38 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
19*
CALL RATIO BACKSPREAD
Hold on
20*
PUT RATIO BACKSPREAD
Buy a put at
same strike as
the short call
and sell a call at an even higher strike than the original position
13
LONG STRADDLE
Buy a put at strike of original short call
12
SHORT BUTTERFLY
Sell a call at an even higher strike than original position
8
SHORT PUT
Liquidate two long calls and buy futures
6
SHORT CALL
Liquidate the two long calls
14
SHORT
STRADDLE
Liquidate two
long calls and
sell a put at
same strike as original short call
16
SHORT STRANGLE
Liquidate two
long calls and
sell a put at
different strike than the original short call
3
SYNTHETIC
LONG
FUTURES
(SPLIT
STRIKE)
Liquidate one long call and buy a futures
10
BEAR SPREAD
Liquidate one long call
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
39
20
Put Ratio Backspread
20 15 10
5
0 –5 – 10 – 15 – 20
(1 Short Dec S&P 500 Put @ 930; 2 Long Puts @ 920) (Dashed Line = Current; Solid Line = Expiration)
895
900 905
910 915 920
December S&P 500 ® Futures
940 945
925 930 935
Scenario:
The trader is getting very nervous about the stock market. He is sure that the market is overvalued, but not sure when the break will occur. Also, the trader does not want to stand in front of a runaway bull market. This trader is will to NOT participate in upside gains to be certain that the position will be held
when the market drops dramatically.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
Long 1 Dec 1.0000 Put
At Expiration:
Breakeven: Loss Risk:
Potential Gain:
Things to Watch:
He consequently enters into a put ratio backspread.
December S&P 500 940
105
105
16.2%
Short 1 Dec 930 Put Long 2 Dec 920 Puts
+ 7.10 ($1775.00)
– 4.00 ($1000.00) x 2 – 0.90 ($ 225.00)
909.10 (920.00 strike – 10.00 difference between strikes – 0.90 debit). Limited; losses bottom out at strike of long puts. At 920.00 the maximum loss of 10.90 ($2725.00) occurs.
Unlimited; gains mount as futures fall past 909.10 breakeven.
Depending on the exact strikes chosen, a trader could come away with a small gain or loss if futures continued their rally. The worst scenario is to have a mild bear market with volatility dropping.
40 Chicago Mercantile Exchange www.cme.com
Profit / Loss
Follow-up Strategies
BULLISH
BEARISH
UNDECIDED
19*
CALL RATIO BACKSPREAD
Buy a call at
same strike as
the short put
and buy a put at an even lower strike than original position
20*
PUT RATIO BACKSPREAD
Hold on
13
LONG STRADDLE
Buy a call at same strike as original short put
12
SHORT BUTTERFLY
Sell a put at
an even lower strike than original position
8
SHORT PUT
Liquidate two long puts
6
SHORT CALL
Liquidate two long puts and sell futures
14
SHORT
STRADDLE
Liquidate two
long puts and
sell a call at
same strike as original short put
16
SHORT STRANGLE
Liquidate two
long puts and
sell a call at
different strike than the original short put
9
BULL SPREAD
Liquidate one long put
4
SYNTHETIC
SHORT
FUTURES
(SPLIT
STRIKE)
Liquidate one long put and sell futures
Liquidate position
VOLATILITY RISING
VOLATILITY FALLING
VOLATILITY UNDECIDED
*
All ratio spreads and ratio backspreads need more analysis. These strategies do not fit neatly into any of the nine market scenarios. Define your market expectation more closely and work out examples with different market scenarios before choosing these strategies. Also, ratio strategies are sometimes done at ratios other than one by two.
41
21
Box or Conversion / Reversal
2
1
0
–1
(1 Short Feb PB Futures; 1 Long Call @ 68; 1 Short Put@ 68) (Dashed Line = Current; Solid Line = Expiration)
–2
63 64 65 66 67 68 69 70 71 72 73
February Pork Belly Futures
Scenario:
This trader wants to take advantage of mis-pricing between futures and options. There are many ways that combinations of futures and/or options can generate a locked-in profit from mis-pricing. In this case, though, the synthetic long futures (long call + short put at same strike) is cheaper than the under- lying futures. This trader can buy the synthetic futures and sell the actual futures to lock in a profit equal to the mis-pricing.
Specifics:
Underlying Futures Contract: Futures Price Level:
Days to Futures Expiration: Days to Option Expiration: Option Implied Volatility: Option Position:
Long: Synthetic Futures Short 1 Feb Futures Locked-In Profit
At Expiration:
February Pork Bellies 68.30
35
10
Call = 34%; Put 37.5% Long 1 Feb 68 Call Short 1 Feb 68 Put
68.125
68.300
+0.175 ($ 70.00)
– 1.675 ($670.00) + 1.550 ($620.00) – 0.125 ($ 50.00)
Profit is “locked in” with amount received equal to the 0.175 ($70) less commission costs.
Things to Watch:
Rarely will the mis-pricing be great enough for off-floor traders to capitalize on it. Unwinding the position can create problems if all of the positions are not liquidated at exactly the same time. Also, be aware of the possible forced early assignment of the short option.
42 Chicago Mercantile Exchange www.cme.com
Profit / Loss
“S&P 500®” is a trademark of The McGraw-Hill Companies, Inc. and has been licensed for use by Chicago Mercantile Exchange Inc.
Copyright © 1999 – 2004 Chicago Mercantile Exchange Inc.
This information has been compiled by Chicago Mercantile Exchange (CME) for general information purposes only. Although every attempt has been made to ensure the accuracy of the information, CME assumes no responsibility for any errors or omissions. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME rules. Current CME rules should be consulted in all cases concerning contract specifications.
M417/3K/0504