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Author Topic: Lean Hogs (HEM19) : 18 April 2019  (Read 278 times)

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Lean Hogs (HEM19) : 18 April 2019
« on: April 18, 2019, 02:51:36 pm »

Lean Hogs is trading at extremely high Implied Volatility - an ideal condition for shorting options and taking profit on time decay.  With the Easter weekend ahead of us, US markets will be closed Friday, Saturday and Sunday - at least three days of time decay in the options that we can bank.

Here is Lean Hogs (looking at the June contract; the May contract will work as well, maybe even better, depending on the strategy that you would like to implement):



Lean Hogs has entered a trading range - characterised by the typical /\/\ pattern.  We do not know how long it will stay in this range before breaking out to one side.  Neither do we know which side it will break out to when it breaks out.  All we know at the moment is that it is trading in this range.

The strategy below makes profit when prices are trading in a trading range.



The strategy is to short both a Call option and a Put option.  The market can at most take out one of these two positions (it can either go up or down, it cannot move up and down simultaneously).  Therefore we use the premium on the one position to buy us some space on the other position; then we wait for time to run out - the time decay on the option, because of the high IV, is quite severe.  The longer this market stays level (in a range) the more money we will make.  We exit this trade when prices break out of the trading range (or when prices threaten our break-even lines).

There are five ways to setup this trade.  The first three are Master strategies, the final two Advanced strategies; the first two is better done on the June contract (simply because there is not enough liquidity in the futures market for May); the remaining three will work equally well in the June as well as the May contract - with faster time decay in the May contract (thus more advantageous - note the June contract shown in the picture above). 

To guide your strategy - remember that you want to sell both a Call and a Put option, for strategies 1,2&4, they need to be ATM (at the money), for strategy 3 they need to be ITM (in the money), for strategy 5 they are OTM (out the money, the further out you move, the less the risk, but also the less the potential profit.  Trade them according your experience (and comfort) level:
  • Short two Put Options ATM, then Short the Futures (shown in graph above)
  • Short two Call Options ATM, then Long the Futures
  • Short a Call ITM, Short a Put ITM
  • Short a Call and a Put ATM
  • Short a Call OTM, Short a Put OTM - you need to move about 15 strike-intervals OTM on each option before you start reducing the risk vs. any of the other 4 strategies above, profit drops from a potential $4600 to $1200

Strategies 1 & 2 employs an advanced strategy where we combine an option and the futures to form a synthetic option; they give us more flexibility to manage the trade when things start to go wrong - but for this we need liquidity in the futures market - hence the move to the June contract.
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Re: Lean Hogs (HEM19) : 18 April 2019
« Reply #1 on: April 23, 2019, 05:19:08 pm »

My implementation of this trade idea went as follows:



When I entered, LH were trading at around 96.5, which was in the middle between two strikes.  Being unable to determine the ATM strike, I went short a 97 Call and a 96 Call respectively.  I went Long the futures on receiving the second fill (second option) - which happened to be at 96.65.

The weekend saw the Volatility drop quite fast and the trade was sitting at $420 profit overnight (the opening up of our trading funnel is typical for a drop in IV with short options).  Price threatened the bottom range of the trading range, but I decided to stay in, see whether price will go back up into the trading range.  The open today saw prices gap down below the trading range.  As this was beyond the envelope in which prices were trading, and the structure we were targeting, it was a sign for me to get out.  I waited until after the opening jitters, then went out on a stop order with the Futures.  The moment the futures was filled I tried to get out of the two call options. 

I feel I was a bit bullied by the market at that point.  Theoretical profit in the position was around $330.  When eventually I got out, I only pocketed a profit of $220.  I am not happy with that, somehow the market bullied me out of $100.  But I'll take my $220 - it is not bad for a weekend trade.

To put this trade into perspective:  Margin requirement for this trade was $2075.  Profit was $220 in 6 days.
This is a return on margin of (220/2075) = 10.6% Return on Margin in 6 days (or 645% Annualised Return on Margin)
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