Derivatives Options » Derivative

The Role of a Cta, Commodity Trading Advisor

admin — Tue, 22 Dec 2009 00:42:47 +0000

Commodity Trading Advisor, Genuine Trading Solutions, a registered CTA with the CFTC, says the role today of a CTA is constantly evolving.

Dwayne Strocen, President of Genuine Trading Solutions says once upon a time a Commodity Trading Advisor was content to be known as a Portfolio Manager trading commodities and futures for a managed futures fund. There is no question today’s investor has become more sophisticated. In response, today’s selection of investment products has become ever more complex and varied, the need for the CTA to understand the uses and management of these products becomes even more acute.

So what exactly is the role of today’s Commodity Trading Advisor. Certainly trading of derivative products for a managed futures fund continues to be as important as before. A CTA has also become more involved with derivative analytics. This role is essentially focused upon becoming an analyst to structure and analyze the more multi-faceted requirements demanded by hedge funds, pension funds and structured products.

The use of derivative analytics to manage the adverse risk of an equity or bond portfolio brought about by adverse market conditions is critical in preserving asset growth. The uses of hedging to prevent volatility has long been understood by the largest institutions but is now available to the smaller sized company and to the individual investor. No doubt as products continue to evolve so too will the CTA evolve to meet the need of today’s professional money manager.

Derivative products are no longer limited to exchange traded commodities futures and options. There continues to be an ever expanding list of over-the-counter derivative products. These are SWAPS. SWAPS and privately transacted products transacted without the use of a recognized exchange. The difficulty is the buyer and seller must find each other to undertake such an arrangement, not always easy. The second problem is no liquidity. There is no one to sell this too should one of the parties wish to terminate the transaction prior to the agreed upon date.

A Commodity Trading Advisor’s role is no longer sufficient to be limited to trading. It is now imperative to understand the industry in a new light so to understand the changing investment environment. Analysis now becomes the catalyst to include a value added service to retain customers. This includes structured products, risk management and OTC derivatives. Continuing education has been and continues to be the hallmark of the best in the industry.

Option Trading Strategy: Back Spread

admin — Thu, 19 Nov 2009 00:25:17 +0000

Option is a very popular derivative because its price is cheaper than other derivative such as future. Blue chip stock is a very volatile stock but it is very expensive. However, by buying option of the blue chip stock, we could earn profit just similarly like buying the stock. Investing and trading option seem to be very easy just like buying stock. However, due to the existence of time value and also the expiration date of the option, buying naked option is very risky. This is because if the stock price is going down a lot just after you have bought the naked option, after a certain period of time, although the stock price has gone up, the option price may still below the ask price that you have used to buy this option. That why we need strategy to invest or trade option. Option is a very powerful tool in investing and trading stock. By utilizing option, we could earn profit from the stock that moves upside, downside and sideway. Moreover, option also could be used to execute arbitrage strategy to earn a profit no matter the stock price is going up, down or sideway.
Back spread is one of the option trading strategies that is quite popular. This strategy is quite similar to a Chinese gambling called big and small. In this gambling, when we stake big and the three dices after shook and opened show the total point is big, we will win one fold of the money that we have staked. That means if we stake 100, we will get back one more 100. But if we loss, we will loss 100. Back spread strategy is quite similar to this gambling game. That means if we invest USD 1000, we either get back one more USD 1000 or loss USD 1000 that has been staked in. The maximum profit and loss is USD 1000. That has fixed. You won’t loss more that that. Actually, back spread is the reversal of the ordinary spread. The maximum profit and loss is not always the same. Sometimes, it will differ a little bit and depend to current price of the stock.
This strategy could be executed by buying out-of-the-money option and selling in-the-money option. Because the price of the in-the-money option is more than out-of-the-money option, the amount of money that has been received after selling in-the-money option will be enough to buy the out-of-the-money option. Although like this, we still need to put an amount of deposit in our trading account and the amount usually is equivalent to the maximum loss that you could incur if the stock price goes to the reverse direction. So, if we are expecting the stock price will go up in the near future, we should buy out-of-the-money and in-the-money put option. Conversely, if we are expecting the stock price will go down in the near future, we should buy out-of-the-money and in-the-money call option. Just for easy to understand, we try an example. Table below shows a list of put options for MMM company stock, which will expire in Apr 07. http://www.makemoneystocks.com/back-spread-table1.jpg
Table 1: List of put options for MMM company stock.
Current price of the stock is USD 80.94. Put option with its strike price more than current price is in-the-money option and less than current price is out-of-the-money option. If we are expecting the stock price will go up in the near future, we will buy one contract of 80 put option (MMMPP) and sell one contract of 85 put option (MNZPQ). When we sell option, we will receive an amount of money that is equivalent to the bid price multiplying with the number of unit that has been purchased. The amount of money that has been received per unit option is USD 5.2 and the amount of money that we need to pay per unit option when we buy out-of-the-money option is USD 2.7. Therefore, the net amount in your trading account after executing this strategy is USD 2.5 per unit option. That means there will be USD 250 net in your trading account. The maximum profit and loss are calculated as follow:
Maximum profit = In-the-money option bid price Out-of-the-money option ask price
Maximum loss = (upper level strike price lower level strike price) (In-the-money option bid price Out-of-the-money option ask price)
Upper level strike price is 85 and lower level strike price is 80. In-the-money option bid price is USD 5.2 and the out-of-the-money ask price is USD 2.7. After substituting all values into the equations above, we will know that the maximum profit is USD 2.5 and the maximum loss is also USD 2.5. So, if we buy one contracts each of the in-the-money and out-of-the-money option, the maximum profit is USD 250 and the maximum loss is also USD 250. The breakeven point for this strategy could be calculated using equation as follow:
Breakeven point = Upper level strike price maximum profit
Or Breakeven point = Lower level strike price + maximum loss.
In this case, the breakeven point is 82.5. As long as the stock price goes up more than 82.5, we will earn a profit from this strategy. We only could earn the maximum profit if we keep the position until the expiration date. If we sell off early before the expiration date, we could not earn the maximum profit. But we still can earn money but with a little bit lesser than if we could keep the position until the expiration date. This is due to the incomplete gaining of the time value of the sell off in-the-money option.
So, by utilizing this option trading strategy, you could earn a profit as long as your prediction accuracy is more than 50 %. That means you have to be accurate for at least six bets within ten bets. From here, the maximum continuous loss is four times. Therefore, in order that you won’t lose all your money until you could not continue to bet, you have to keep four back up moneys or more. So, if you lose one bet, you still have the money to continuously stake for the following bet. Like this, as long as you could keep your prediction accuracy more than 50 %, your money will continuously grow along the time. So, if you interested to know more about option trading strategy, just drop by our homepage and we will show you how to utilize option to maximize your profit.

Understanding Equity Options

admin — Mon, 16 Nov 2009 12:41:48 +0000

Welcome to the wonderful world of equity options. You may have heard that option trading is high risk, and indeed it is, for much the same reasons that spread betting is high risk. The instruments themselves are derivatives from the cash markets, and are highly geared, but options themselves were originally introduced to the US markets in the mid 1970’s as a tool for hedging risk. In other words they were a form of insurance. You paid a premium, a bit like car insurance, which covered you in the case of an accident. In the financial markets you bought some protection in case the market went in the opposite direction. In this article we look at equity options, which are those derived from the cash market share or stock.

In the early years, the options market was very small, with only a handful available on the larger blue chip stocks in the Dow 30 and other major indices. Today, the American market is enormous, with over 12,000 equity options available to trade. In the UK it is just under 100 (the blue chip shares mainly) which can be rather limiting, but if your trading is mainly in UK shares it is not a bad place to start.

OK, let me start with some definitions, and I will try to keep this as simple as possible (not because you will not understand) but because the terminology can be very confusing for newcomers. It took me 6-9 months to get comfortable with this so do not expect to pick it up straight away. Firstly there are two type of options as follows :

A Call Option – A contract representing the right for a specified time to BUY a specified security at a specified price

A Put Option – A contract representing the right for a specified time to SELL a specified security at a specified price

An option is a contract which gives the buyer the right, but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date. Right, let me try and explain. Suppose you are buying a classic second-hand car. You visit the owner, love the car, and agree a price, but explain that you will not have the cash for 4 weeks. The owner agrees to hold the car and the price for you for only 4 weeks, but on condition that you pay a small non – refundable premium for his trouble (this is in addition to the full price of the car)

This is what an option contract is – the car owner has effectively written an options contract to give you, the contract holder, the right to buy the car within the four week period, at the agreed price. Now, as the option buyer ( or holder ) you have an option to buy, but you do not have to if you change your mind. Which is why in the above definition it says ‘ the right but not the obligation’ – if you change your mind you just walk away. All you have lost is your premium which the buyer keeps (even if you do decide to go ahead). The car owner, who has written the contract, has a contractual obligation to deliver the car at the agreed price, and he or she must deliver.

In summary, as an options buyer, you have choices – you can exercise the contract or walk away. As an options seller, you do not have any choices – if the contract is exercised you must deliver the asset. If we take the example a stage further (I know its not ideal but I hope it gives a feel for what these things are all about). Let us assume that whilst you are waiting for the bank to supply the cash, so that you can go ahead and buy the car, the original factory where the cars were made is destroyed by fire. Suddenly these cars increase in value sharply. You, however, have a contract in writing at an agreed price, provided you buy within the next four weeks. Now, you as the buyer or holder of the contract have two choices. Firstly, you exercise your contract by paying the seller the agreed price, and immediately put the car on the market and sell at a profit, or alternatively you sell your contract on to someone else, as it now has a higher ‘premium’ value due to the increase in value of the underlying asset (the car )

Now, as the seller of the car ( the writer of the contract option )you have no idea who will exercise the contract, which could have been bought and sold many times over during the 4 week period. But one thing is constant. If it is exercised, you will have to deliver the asset at the price agreed.It is a contract. This is how the options market works.

If we now look at some of the unique features of options these are as follows:The contract is for a specified time, normally 4 weeks, but there are options called LEAPS which extend for years. As there is a specified time, this is a wasting asset. If you buy an option it will be worthless in 4 weeks if not exercised. Each has an agreed contract price fixed for the life of the option. This is based on the underlying asset ( the share ). The option carries a premium. This is paid to the seller of an option by the buyer and is always kept by the seller. CALL options increase in value as the underlying asset increases, whilst PUT options increase as the underlying value of the asset decreases.

OK, lets just recap the above. When you buy an option the purchase price is called a PREMIUM. If you sell an option, the premium is the amount you receive. As a buyer you have rights, but no obligation. As a seller you have an obligation to deliver the terms of the contract. An option seller is also called a WRITER. Options are a derivative product, they are derived from something else. Equity options are derived from the equities market so the underlying asset is the share or stock price. The premium will vary minute by minute, up and down as the underlying value of the asset changes in the cash market. Options are leveraged instruments and therefore higher risk. Most equity options are ‘Physical Delivery’ which means that shares must change hands if the contract is exercised. Now one last point before we move on and it is simply this – as an option writer (seller ) you do of course have one choice – you can buy yourself out of the obligation by buying the contract back – this will naturally cost you more if the premium has increased in value! ( if the premium has decreased you may want to close out the contract for a small profit, or just leave it to expire for 100% profit on the premium ) As you can see from the above, the same option can be bought and sold many times before it is either exercised or expires worthless. Whatever happens, the option seller keeps the premium received from the initial buyer 1. As you can imagine all this trading has to be tightly controlled to ensure that buyers and sellers are matched correctly, and that contracts are fulfilled by sellers. In the UK, the options exchange is called LIFFE ( London International Financial Futures and Options Exchange ) and this is where all equity options are managed and traded. In the US there are several exchanges, but the principle ones are CBOE ( Chicago Board of Options Exchange ), AMEX and Philadelphia Exchange. Everything to do with trading, managing and exercising the options is conducted by the exchanges. You do not have to worry about actually doing anything – it all happens automatically. So if, for example, you have sold a call, and the contract is exercised, this will all happen automatically and the broker will transfer the shares out of your account at the agreed contract price and replace with cash. Finally there are two ’styles of options’ – American style and European style. American style options can be exercised at any time as in our example above, whilst European can only be exercised only at expiry. Most equity Options will be American style but please check and make sure beforehand.

Whilst the terminology of equity options may seem strange at first, it is worth the effort. In their simplest form they can simply be bought and sold like any other financial instrument. Remember however that these are assets with a time value, they cannot be held for long periods as they all have an expiry date as part of the contract. Many traders simply buy and sell options throughout the trading day, making their money from the increase or decrease in the options value. Others use them in combination with the underlying stock to write calls. There are many ways to benefit from an understanding of these sophisticated instruments and I would urge you to dip a toe in the water!