One of the questions that frequently comes up with option traders who have only done the equity side of options is how do I get into trading futures options and what do I need to know before I start? There are several basic things you should know and understand about futures and their option before you get started with live trading of them.
What month should I trade?
One of the first characteristics to consider is that futures do not always have a new contract every month. Many futures, U. S. Treasury bonds for instance, have only a few contract months per year. Treasuries have March, June, September and December only. All the months in between have options only that are traded derivative of the next futures month. Strategies, such as time spreads must be placed carefully to insure that you are trading off the same underlying contract month. Get to know your futures and options expiration periods before you start. Not only the contract months differ from the equity world, trading hours do also so be sure to know when your underlying is being traded during the day and night.
What is the tick size?
Tick size for the different futures and options is different than many equities also. And the tick size of the options and the future itself can be different. Using the bond example again, the future tick size is $31.25 per tick and the options are $15.625 per tick. Futures trading can be larger and highly leveraged, it is important to understand how each tick movement is effecting your position.
What type of strategy should I trade?
Once you have a basic understanding of the future and its options you wish to trade you can begin to look at what strategies to employ. Non-directional or directional strategies such as iron condors and calendars can be used but be careful with the time spreads that you are using the same underlying contract month as I mentioned earlier. From my own experience it seems iron condors either even on each side or sometimes weighted heavier on one side or the other can be a solid month-to-month trade. Sometimes short or long straddles can be appropriate also.
Don’t trade without a PLAN!
Having a PLAN is the most important part of trading any underlying, whether you trade futures or equities. Before you enter any trade you should know and have a plan for how and when you will exit the trade at a profit or a loss and at what point you would adjust or reduce risk a trade that is going against you. In my experience mentoring new traders that is the most common mistake I see being made. You must also stick with your plan and try to control the emotions that would have you staying too long or not long enough in a trade. Your trading PLAN is fundamental. Don’t trade anything without one.
If you follow these steps, you should have a good start to learning how to trade futures and futures options. Trading always involves risk; learn to control it as best you can.
It seems like Apple (NASDAQ:AAPL) has replaced the Dallas Cowboys as “America’s team.” And yes, I know it is a great stock – one that might actually be undervalued. But at the risk of sounding almost un-American, I think it’s time to start getting short AAPL.
Sure, the company just announced record – heck, downright mind-blowing – earnings thanks to iPhone 4S, iPad 2 and international sales. Even Wall Street analysts were impressed with the final numbers.
Unprecedented sales figures for the company aside, I’m a trader and, therefore, looking ahead to what the stock’s going to do next. With all the good news for the company, the stock has been climbing … but it can’t possibly go straight up without any down days.
In other words, even AAPL has to have a few days or weeks to act “human” … and you should get positioned to profit from the pullback when it comes.
As a trader, I am not concerned about AAPL long term. But here in the short- to intermediate-term, it’s quite reasonable and even wise to look for a little healthy downside trading action. Here’s a trade idea for the speculative part of my options portfolio.
Trade Idea: With AAPL trading here around $447, you can “buy to open” 1 April 430 Put (which would cost you about $12) and, at the same time, “sell to open” 1 April 410 Put (for which you would collect $7).
To enter this trade, which is a put debit spread (or a bear-put spread), your total cash outlay would be $5 per share, or $500 per option contract ($12 – $7 x 100).
You could simply buy the April 430 Put on its own, but by selling the $410 put against it, you instantly reduce the amount of money you would otherwise have at risk in the trade.
The spread is costing me $500 and the most I can make is $15 (the difference between the option strikes, or $430 – $410) if the stock is trading at $410 or lower at April expiration.
My total risk in a put debit (or bear-put) spread is the same as being long an option. Whatever I pay, which is $500 in this example, that’s the total risk. The cost of the spread at current prices is closer to $5.30, but I am going to be patient and let it come to me a bit. If the stock goes up a couple bucks from here, I should get filled.
Here, too, I am initiating this spread with 1/3 of my total intended position size. I am starting with one contract here and will work up to my total of three contracts as the stock increases.
Will I wait till April options expiration to get out of this? No way! Once we get a little pullback and the put spread gains some profits, I’ll head for the exits.
I’d like to make a minimum of $2 on this spread. By getting in at a good price, by scaling into the spread at less than my maximum size, and by using options with an April expiration date, I have lots of time to wait for a small pullback. That’s my plan and I’m sticking to it!
If, after I get up to three contracts and there is no pullback, I plan to show you in a future article how you can cut your total risk in half. (Hopefully, I won’t have to show you this adjustment as anything other than a strategy that’s good to know for future trades.)
Whatever happens, I will follow this trade to completion with you. Stay tuned to see if AAPL is really human. I’m betting it is!
I know the title sounds a bit bold, but stay with me. Where is most of your money stashed? I’m not trying to get personal, I promise! But for most of you, I bet it’s in your retirement account. Another question, will the stuff in your retirement account be happy if the market goes up or down?
The answer for most of you is up!
Your portfolio has a strong bullish bias for the majority. 2008 hurt so much because most of your assets were in the market when everything fell apart between September 2008 and March 2009 ( 8 months of torture).
Do I know something you don’t know about the market? Of course not.
What I do know is that your portfolio is probably leaning long, the market is in the upper end of the range, and I’d personally like to start having a few puts around.
I’m going to focus on the SPY. Currently trading at 131.54. The 1,2 and 3 year high is around 135. You still have to respect the trend, which is up, but I’m starting to get some bearish soldiers ready to help out all my bullish soldiers who are getting a bit excited about the upside.
SETUP: Because the trend is up I would scale into some puts. What does that mean? If my size is 9 contracts, I might buy 3 to start , then buy 3 more maybe at 133 in the SPY, and work up to 9.
STRATEGY: With SPY at 131.54, I might start nibbling and buy the March 127 puts at $2.00. Why March expiration? I want to give myself time and the option premiums are cheaper than they usually are. March is over 50 days from expiration. Nibbling means buying maybe 30% of my intended size.
You say, “Dan, the March 127 puts are trading at 2.28, how are you going to get $2?” There is a phrase that says “let it come to papa”. What does that mean? It means if the market is in a bit of a trend don’t be aggressive with the price. When would this order get executed?
Probably when SPY hits between 132 ½ and 133. I might use a GTC order when entering this trade. What do you mean? Because I am entering my price below the market, it make take a few days to execute, so a good till cancelled order means my $2.00 bid will stay active and I don’t have to put in a fresh order every day.
What if the market goes down before I make my put purchase? We miss it! That’s part of the game. This is more of a passive put purchase plan, if I wanted to be more aggressive, I’d pay more. I’d be a little passive, respecting the trend.
Indicator to Watch
If VIX hits 24-25 area, start evaluating your retirement account to see if you need some downside help. Not going to really elaborate on the VIX today, and don’t want you to stop enjoying the upside bliss. But I want you to be aware of when the wind might be changing to the downside. Remember Mary Poppins ! 24-25 area would be an indicator the market is starting to move down, but not out of control yet. Merely a warning worth looking at!
If the trade goes against me, I will discuss a few adjustments I usually use to fix a put gone bad. Have a great day!