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11

Trading Analysis / Re: SYNTHETIC OPTIONS

« Last post by TradingAdmin on December 03, 2019, 07:35:28 pm »

HOW TO SET IT UP?

Think about the Delta! 

• A Long Futures is +1
• A Short Futures is -1

Now combine that with the delta on your option to swap from a positive delta to a negative delta, or vice versa from a negative delta to a positive delta!!

Therefore:

• A LONG CALL (positive delta, less than 1) combined with [ -1 ] (short futures) will give you a negative delta!  Long Call at 0.4 delta, PLUS Short Futures at -1 delta = 0.4 - 1 = -0.6  The OTM Long Call became an ITM Long Put
• A LONG PUT (negative delta, larger than -1) combined with [ +1 ] (long futures) will give you a positive delta!  Long Put at -0.6 delta, PLUS Long Futures at +1 delta = -0.6 + 1 = 0.4  The ITM Long Put became an OTM Long Call
• A SHORT CALL (negative delta, larger than -1) combined with [ +1 ] (long futures) will give a positive delta!  Short Call at -0.45 delta, PLUS Long Futures at +1 delta = -0.45 + 1 = 0.55  The Short Call became a Short Put
• A SHORT PUT (positive delta, smaller than 1) combined with [ -1 ] (short futures) will give a negative delta!  Short Put at 0.55 delta, PLUS Short Futures at -1 delta = 0.55 - 1 = -0.45  The Short Put became a Short Call

WARNING:  Be careful if your delta's are very small !!  A 0.1 delta will become -0.9 : you go from FOTM to DITM!  Where your risk exposure was 10%, it is now 90% !!  It may be better to stick to 0.4 - 0.6 delta options to limit the risk when you switch!!

12

Trading Analysis / Re: SYNTHETIC OPTIONS

« Last post by TradingAdmin on December 03, 2019, 07:10:42 pm »

A SYNTHETIC OPTION, if used correctly, is a very handy tool to have in your arsenal.  It simply says - instead of setting up the option (Long or Short; Call or Put) directly by buying / selling the option - we setup the exact same position using the opposite option in combination with a Futures.

Therefore instead of Buying a Put, we Buy a Call (the opposite) and then Short the Futures.  Or instead of Shorting a Put, we Short a Call (opposite) and then Long the Futures.

Before I show it to you..- WHY IN THE WORLD WOULD I WANT TO DO THAT !?
In essence, we are reversing direction without getting out of the market!  If I am long a futures and then go short a futures, the two cancels each other out and I am out of the market.  However if I am Long a Call option and go short the futures, the Call becomes a Put - I am now long a Put.  Where before I profited when prices went up, I am now profiting when prices goes down!  I have reversed my position in the market!

WHEN DO WE WANT TO DO THAT?

• I do it frequently trading for example Crude Oil intraday on a 15 minutes chart.  Crude can very quickly switch direction.  It really likes to make large moves in a direction and then late afternoon reverse direction.  I like to ride it in the one direction using an ATM option (maybe slightly OTM, like a 0.45 delta), then when it reverses direction - on a 1-2-3 on a 15 minute chart, or after a reversal bar, I trade directly in the futures to also switch direction.  For example I buy a 55.5 Put when the market trades at 55.9.  the market drops to 54.5 - I have roughly $500 profit at this point.  It now looks like it wants to reverse, so I Long a Futures.  The market goes back up to 55.0.  I take $500 on my long futures and $225 on my long Put.  If I am wrong, I am very quick to get out of the futures again and then take profit on the Put.
• It works well for a level market, where it whips up-and-down-and-up-and-down!  When at the bottom you buy a call, when at the top you short the futures, swapping to a long put, at the bottom you buy out of the futures again you are back into a long call.  This way you ride the market all the way - as it goes up and down, you ride it up and down as well.  Note this is if the IV is low.  With a high IV, you Short a Put when it is at the bottom of the range, when at the top of the range you Short the Futures (swapping to a Short Call) etc.
• It works well if we are not 100% certain of market direction - or we want to attempt to get in early - not waiting for an actual signal - thus we get in into one direction and then be prepared to immediately switch direction if we are wrong about the market!For example the market made an extraordinary long bar down - you know typically after such a move it tends to correct back up, so you buy a call (or short a put) then enter an order to short the futures directly below the low of the long bar - in other words if you are wrong and the downwards move continues, you switch direction on your option, giving you a chance to get out with a small loss, or maybe even a profit.  If you were right, your futures order would never have triggered and you will make good money on the correction!
• I also use it to setup trading strategies, for it gives me more control.  Say I would like to short strangle the market (neutral market) - which is selling a call above the market and selling a put below.  The market is at the top of the range.  Instead of selling a Put and a Call; I Short 2 x Calls and Long the Futures (the one short Call is the [Short Call] part of my trade.  The other Short Call combined with a Long Futures is a Synthetic Short Put and forms the [Short Put] part of my trade.  INSTEAD though:  I Short the two Calls and then enter the Long Futures as a stop order above my market range.  If the market immediately drops, I make profit on two Short Calls, I am a happy trader.  If the market instead trades up, my Long Futures will trigger converting into the strangle !!

Once you have mastered the technique, you will find there are many more strategies where you may employ this principle - it is a VERY HANDY tool!!  (But that said, it is an advanced topic - you have to really understand about long and short and calls, puts and futures combinations)

13

Trading Analysis / SYNTHETIC OPTIONS

« Last post by TradingAdmin on December 03, 2019, 06:26:59 pm »

I have a user who posted two questions:

• Please explain with examples how to use Synthetic Options
• Please explain with examples how a Calendar Spread works

I will address these in two separate discussion topics - please feel free to participate.

Herewith the Synthetic Option...

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Trading Ideas using Options Explorer / Re: Lean Hogs (HEM19) : 18 April 2019

« Last post by TradingAdmin 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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Trading Ideas using Options Explorer / Lean Hogs (HEM19) : 18 April 2019

« Last post by TradingAdmin 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.

16

Trading Ideas using Options Explorer / Market Update: 12 April 2019

« Last post by TradingAdmin on April 12, 2019, 02:24:55 pm »

We are monitoring the markets, but at this point in time there are just simply no trades.  We are looking at Lean Hogs, Coffee, Bean Oil in particular, keeping Cotton in mind; the energy complex. 

At the moment however there are no actionable opportunities, so we stay out of the markets..

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Trading Ideas using Options Explorer / Re: Cotton #2: Friday 15 March 2019

« Last post by TradingAdmin on April 02, 2019, 04:14:52 pm »

We are out of Cotton...

Anything from here onwards is purely theoretical.  This is the situation at the moment:



Our options strategy are still containing the move in Cotton.  Profit at the moment would be $75

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Trading Ideas using Options Explorer / Re: Coffee (KCK19): 15 March 2019

« Last post by TradingAdmin on April 02, 2019, 04:09:20 pm »

Last week we decided to hold on a bit more, hoping for an upwards correction in Coffee, which did not happen.

This week the position looks like this:



Coffee continued down.  Our profit increased from $420 to $440 - not really worth the extra week of risk we took.  At this point in time there is not really any point in keeping the trade, just take your money and get out.  (Yes, there is still a chance that Coffee can go back up, but (1) there is no indication from the price chart that such a move is likely and (2) there are very little time left before expiry)

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Trading Ideas using Options Explorer / Re: Cocoa (CCK19): 15 March 2019

« Last post by TradingAdmin on April 02, 2019, 04:04:20 pm »

This trade was closed.  I took $90 profit on it a long time ago already.  The previous post has shown that if you were willing to hold on a little longer, you could have banked $320.  Currently it looks like this:



There is hardly any profit left in this position.  BUT what I want you to notice is how the options trading strategy gave you a huge amount of space in which to capture profit.  From the day that we opened this trade until today, the position was never in a loss.  There was a lot of time for you to decide to take your money and get out.  Only if you were greedy and never got out will you no be facing a breakeven position.  It is no longer worth the risk to stay in the trade...!

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Trading Ideas using Options Explorer / Re: Corn (ZCK19): 21 March 2019

« Last post by TradingAdmin on April 02, 2019, 03:57:47 pm »

On Corn you had the choice to take the $330 profit on the table, or hold out for more.  This is what happened with Corn:



There is still $100 profit in this trade, but to hold out any longer is foolish - the risk is too high that you will turn what was a winner into a loser.  So if you still in it, get out. 

Bit of advice:  I was taught to look at the annualised return on your investment.  If the market is giving you a huge return in a very short period of time, do not push you luck, take the money and get out of there, there are always other opportunities