Choosing Options Strategy Guide

7/31/2019 Choosing Options Strategy Guide

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The private client division of R.J.OBrien & Associates

r jofutures.com 800.441.1616

Choosing anOptions Trading

StrategyCommon Strategies to TradingOptions on Futures

IMPORTANT INFORMATION ABOUT TRADING FUTURES

The risk of loss in trading commodity futures and options is substantial. Before trading, you

should carefully consider your financial position to determine if futures trading is appropriate for you.

When trading futures and/or options, it is possible to lose more than the full value of your account.

All funds committed should be risk capital. Trading advice is based on information taken from trades

and statistical services and other sources which RJ OBrien believes are reliable.

We do not guarantee that such information is accurate or complete and it should be relied upon as such.

Trading advice reflects our good faith judgment at a specific time and is subject to change without notice.

There is no guarantee that the advice we give will result in profitable trades. All trading decisions

will be made by the account holder. Past performance is not necessarily indicative of future trading result


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Introduction....................................................................................................................................3Getting Started.............................................................................................................................4

Bull Call Spread............................................................................................................................5

Bear Put Spread............................................................................................................................6

Long Straddle...............................................................................................................................7

Short Straddle..............................................................................................................................8

Long Strangle...............................................................................................................................9

Short Strangle.............................................................................................................................10

Calendar Call Spread.................................................................................................................11

Ratio Call Spread.........................................................................................................................12

Ratio Put Spread........................................................................................................................13

Strategies at a Glance................................................................................................................14

Quiz Yourself..........................................................................................................................15-17

About the Author........................................................................................................................18

Additional Free Resources........................................................................................................19

Table of Contents

2

RJO Futures 800-441-1616 / 312-373-5478 www.rjofutures.com


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Thank you for your interest in the RJO Futures Introduction to Options TradingStrategies.

Many traders turn to options for their leveraging power, limited risk, and potential for higher returns. They can also be

a versatile alternative, providing the ability to take advantage of price movements in commodities, foreign currencies,

stocks and interest rates.

This guide is meant to complement the RJO Futures Introduction to Options Trading Guide, by taking you to the next

step in understanding options trading: Determining which options strategy might be best for you. It provides denitions,

charts and examples to help you get started.

Although options can offer an opportunity to diversify your portfolio, options traders are still exposed to risk and trading

options is not suitable for all investors. You should work with an RJO Futures Sr. Trading Advisor to determine i f options

trading is right for you.

The guide was written by RJO Futures Sr. Trading Advisor Donna Heidkamp, applying her 12-plus years of industry

knowledge and experience. As you study the content, we encourage you to contact Donna or any RJO Futures Sr.

Trading Advisors or Trading Consultants with questions or comments. Its our goal to help you understand how to apply

the information within.

Regards,

RJO Futures Sr. Trading Advisors

Phone: 800-441-1616 or 312-373-5478

Email: [email protected]

Introduction


The risk of loss in trading commodity futures and options can be substantial. Before trading, you should carefully

consider your nancial position to determine if futures trading is appropriate for you. When trading futures and/or

options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past

performance is not necessarily indicative of future results.


4/19

The RJO Futures Introduction to Options Trading

Strategies guide focuses on specic types of common

option strategies to help you further understand real

uses of options and your potential risk and reward in the

market. Although this guide does not include all possible

strategies, the most common strategies are included.

The purpose of this guide is to offer a bridge between

the RJO Futures Introduction to Options Trading Guide

and actually trading options in the market.

Reading the Graphs

The included graphs provide examples of various option

strategies that you may nd helpful. Please note that

the strategies are not current market recommendations.

They were simply compiled to give you a visual aid to

various option strategies. The underlying price, the

market volatility, interest rates, and time value (days

until expiration, or DTE) all contribute to the value of the

option strategy. In the accompanying graphs, the red

line depicts that value of the option strategy today. The

green line illustrates the value of the option strategy at

expiration. As time value decays, the red line and green

line gradually convergeassuming the volatility and

interest rates stay the same until expiration. The X-axis

is the underlying price of the contract. The Y-axis is the

potential reward/risk for each strategy in price units.

Risks of Trading Options

It is also important to note that the risks of trading option

strategies are often underestimated, because it is very

difcult to calculate the exact time frame and size of a

market move. Traders often refuse to cash in prior to

expiration, and wind up losing their investment.

How Much Time Do You Haveto Monitor the Markets?

For traders with limited time to evaluate the markets,

limited risk option strategies may be just what you are

looking for. Many limited risk option strategies allow

you to participate in the market without watching and

evaluating the markets as closely as if you were trading

straight futures. However, you should always be aware

of the underlying market, and analyze possible trend

changes to help you time entry and exit levels for your

strategy. If you have limited time to analyze the markets,

you may want to work with RJO Futures Senior Trading

Advisors to help you monitor the market. Communication

is the key to a successful full service trading relationship,

and they can be reached at 1-800-441-1616 or through

www.rjofutures.com.

Margins on Unlimited Risk Strategies

Another factor to consider when trading options includes

possible SPAN margin requirements (standardized

portfolio analysis of risk) set by the exchange. Limited

risk strategies typically do not have additional margin

requirements from the exchange. However, unlimited

risk strategies do. The SPAN margins can change daily

as market conditions change and the underlying price

uctuates. Therefore, if you are trading an unlimited

risk option strategy, you should always maintain plenty

of margin excess in the account to avoid the risk

of becoming overleveraged. If you have a question

regarding the SPAN margins and you are a current

customer, I recommend that you contact your RJO

Futures representative to request a hypothetical SPAN

calculation.

Getting Started

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Bullish Limited Risk Strategy

The bull call spread allows you to capture potential prot

in a market, with limited risk to the net premium paid

+ commission and fees. You would be purchasing (pay

the premium) a lower strike call and writing (collect the

premium) a higher strike call simultaneously. The lower

strike call will always be worth more than a higher strike

call, because the odds of the lower strike being in the

money and having value at expiration is higher.

EXAMPLE:

Long 1 December Corn 450 Call for 152

Short 1 December Corn 500 Call for 56

Days to Expiration: 43

Net Premium = 152 - 56 = 94 cents (9 cents in

laymans terms)

10 (1 cent) in the Corn = $50

Net Premium in $ value = 9 * $50/tick = $475

Bull Call Spread

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Bearish Limited Risk Strategy

The bear put spread allows you to capture potential prot

in a market with limited risk to the net premium paid +

commission and fees. You would be purchasing (pay

the premium) a higher strike put, and writing (collect the

premium) a lower strike put simultaneously. The higher

strike put will always be worth more than a lower strike

put, because the odds of the higher strike being in the

money and having value at expiration is higher.

EXAMPLE:

Long 1 December Corn 400 Put for 194

Short 1 December Corn 350 Put for 60


Net Premium = 194 - 60 = 134 cents (13 1/2 cents

in laymans terms)

10 (1 cent) in the Corn = $50

Net Premium in $ value = 13 1/2 * $50/tick = $675

Bear Put Spread

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No Directional Bias Strategywith Limited Risk

A long straddle buys a call and put with the same

strike simultaneously. This scenario is ideal for tightly

consolidated markets with low volatility and the

likelihood of breaking one direction or anotherand are

perceived to have increasing volatility. The risk is limited

to the premium paid for both the call and the put. The

maximum market risk is recognized at expiration, if the

market closes at the strike price.

EXAMPLE:

Long 1 March Crude Oil 8600 Call for 1214

Long 1 March Crude Oil 8600 Put for 952


1 tick in the crude oil = $10

Premium Paid in $ value = 1214 + 952 = 2166 *

$10/tick = $21,660

Prot potential above = 8600 + 2166 = 10766

Prot potential below = 8600 2166 = 6434

Long Straddle

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No Directional Bias Strategywith Limited Risk

A long strangle buys a call and put with the different

strike prices simultaneously. This scenario is ideal for

markets that are currently trading at lower volatility

levels in a range, but are expected to break out of the

range and to increase in volatility. The risk is limited to

the premium paid for both the call and the put. Maximum

risk is recognized if the market closes at or between the

two strike prices at expiration.

EXAMPLE:

Long 1 December 2008 Gold 970.00 Call for 28.3

Long 1 December 2008 Gold 850.00 Put for 37.0


1 tick (10) in the gold = $10

Premium Paid in $ value = 28.3 + 37.0 = (65.3*100)

= $6530

Potential prot at expiration above = 970.0 + 65.3

= 1035.3

Potential prot at expiration below = 850.0 65.3

Long Strangle

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No Directional Bias Strategywith Unlimited Risk

A short strangle sells a call and put with the different

strike prices simultaneously. This scenario is ideal for

markets with high volatility that are likely to trade in a

longer-term range and expected to decrease in volatility.

The risk is unlimited if the market moves above or below

the strike price + or - the total premium collected. In this

scenario, you are always at risk on either the call or

the putdepending on which direction the underlying

market is going. In this example, you would be at risk of

loss if the market rallied above 1242.0 or below 658.0 at

expiration. Maximum prot potential exists if the market

closes between the strikes at expiration.

EXAMPLE:

Short 1 December 2009 Gold 1050.00 Call at 89.5

Short 1 December 2009 Gold 850.00 Put at 102.5


1 tick (.10) in the gold = $10

Premium Collected in $ value = 89.5 + 102.5 =

(192.0/.10) * $10/tick = $19,200

Risk of loss at expiration above = 1050.0 + 192.0

= 1242.0

Risk of loss at expiration below = 850.0 192.0 =

658.0

Short Strangle

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Bullish Strategy with Limited Risk

In this strategy, the calendar call spread is buying an

option with more time value, and selling a near-term

option to help pay for the longer-term option. In this

example, I used the same strike priceswhich can also

be referred to as a horizontal spread. However, you can

choose to use this strategy using different strike prices.

The chart below displays the reward/risk of the spread

at the near-term option expiration. This is a limited risk

strategy, because the option leg with more time value

(the long leg) should retain some extrinsic and time

value. At expiration of the spread, the maximum prot

potential would be the value of the long option minus the

net premium paid for the spread. It is also important to

note that a near-term squeeze for a commodity could

negatively impact the spread relationship as well, which

could reduce protability and create additional risk.

EXAMPLE:

Sell 1 December 08 Crude Oil 8400 Call at 772

Buy 1 March 09 Crude Oil 8400 Call for 1314

Days to Expiration of the December option leg:

39

1 tick = $10

Premium Paid in $ value = 1314 772 = 642 * $10/

tick = $6,420

Calendar Call Spread

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12/19

Bullish Strategy with Unlimited Risk

A ratio call spread buys a call and sells multiple higher

strike calls than what was purchased. This type of

strategy is ideal if you believe that the bias is for a higher

move, with a ceiling at the higher strike price. It is also

important to note that the time value to expiration and

volatility can have a negative effect on the spread,

which is often underestimated. Therefore, you should

always have plenty of excess capital to withstand market

movements.

EXAMPLE:

Buy 1 December 08 Crude Oil 8500 Call for 644

Sell 2 December 08 Crude Oil 10000 Calls at 222


1 tick = $10

Premium paid in $ value = 644 (222 * 2) = 200 *

$10/tick = $2,000

In this example, we are using a 1 X 2 ratio call spread.

Maximum prot potential exists at expiration if the

underlying is trading at the higher strike price or 10000

in this example. For a 1 X 2 ratio spread, unlimited

risk exists at expiration if the market moves above

the higher strike price by more than the difference in

strikes less the premium paid.

10000 (higher strike) 8500 (lower strike) 200

(premium paid) = 1300 + 10000 = 11300. Unlimited

risk of loss exists at expiration on a close above

11300.

Ratio Call Spread

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Bearish Strategy with Unlimited Risk

A ratio put spread buys a put and sells multiple lower

strike puts than what was purchased. This type of strategy

is ideal if you believe that the bias is for a lower move,

with a oor at the lower strike price. It is also important

to note that the time value to expiration and volatility can

have a negative effect on the spread prior to expiration,

which is commonly underestimated. Therefore, you

should always have plenty of excess capital to withstand

market movements.

EXAMPLE:

Buy 1 December 08 Crude Oil 8000 Put for 348

Sell 2 December 08 Crude Oil 6800 Puts at 135


1 tick = $10

Premium paid in $ value = 348 (135 *2) = 78 * $10/

tick = $780

In this example, we are using a 1 X 2 ratio put spread.

Maximum prot potential exists at expiration if the

underlying is trading at the lower strike price or 6800

in this example. For a 1 X 2 ratio spread, unlimited

risk exists at expiration if the market moves below

the lower strike price by more than the difference in

strikes less the premium paid.

8000 (higher strike) 6800 (lower strike) - 78

(premium paid) = -1122 + 6800 = 5678

Risk of loss exists in this example at expiration if

the market is trading below 5678.

Ratio Put Spread

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14/19

Bullish Strategy with Limited Risk

In trading options, money can be made whether the

market moves up, down, sideways or not at all. But in

order to choose your options strategy, you will need to

decide which direction you think the market is moving in.

This quick at-a-glance guide can assist you in deciding

which strategy to usewhether you are bullish, bearish,

or neutral the market.

Strategies at a Glance

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Option Strategy Market Expectation Risk Reward

Bull Call Spread Buy = BullishSell = Neutral/bearish

Buy = Premium paidSell = Difference between strikeprices premium received

Buy = Difference between strikeprices premium paid

Sell = Premium received

Bear Put Spread Buy = BearishSell = Neutral/bullish

Buy = Premium PaidSell = Difference between strikeprices premium received

Buy = Difference between strikeprices premium paidSell = Premium received

Long Straddle Anticipating increase in volatility Premium paid Unlimited outside of strikes +

premium paid

Short Straddle Limited trading range Unlimited outside of strikes +

premium received

Premium received

Long Strangle Anticipating increase in volatility Premium paid Unlimited outside of strikes +premium paid

Short Strangle Limited trading range Unlimited outside of strikes +

premium received

Premium paid

Calendar Call Spread Neutral/Bullish Premium paid for your call -

premium received for the short call

Premium received for selling the call

Ratio Call Spread Bullish Risk is unlimited if market falls

below the sum of the prot and

the higher strike price

Upside maximum prot is limited by

difference in strike premium paid

Ratio Put Spread Bearish Risk is unlimited if market rises

above the difference between the

lower strike price and the prot

Upside maximum prot is limited by

difference in strike premium paid


15/19

1. Which of these entails selling a call and put with the same strike

simultaneously?a. Bull call spread

b. Bear put spread

c. Long straddle

d. Short straddle

e. None of the above

2. Which of these entails buying a call and put with different strike pricessimultaneously?

a. Bull call spread

b. Bear put spread

c. Long straddle

d. Short straddle


3. Which of these entails purchasing a lower strike call and writing a higher

strike call simultaneously?a. Bull call spread

b. Bear put spread

c. Long straddle

d. Short straddle


4. A long straddle entails buying a call and put with the same strike

simultaneously.a. True

b. False

5. A calendar call spread buys an option with more time value, and sells a near-term option to help pay for the longer-term option.a. True

b. False

Quiz Yourself:Are You Ready to Advance to

the Next Step or Do You Need to Review?

RJO Futures 800-441-1616 / 312-373-5478 www.rjofutures.co

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17/19

Answers

1 (d), 2 (e), 3 (a), 4 (a), 5 (a), 6 (a), 7 (c), 8 (a), 9 (b), 10 (d)

Each correct answer equals 1 point.

My score:__________

Scoring (out of 10 possible points)

8-10 = You Understand These Options Strategies

Contact an RJO Futures representative at 800-441-1616 now, and learn how you can turn your new

knowledge into possible trading opportunities. We can help.

6-7 = You May Want to Revisit the Material

Youve learned a fair amount about options strategies. But we recommend you revisit the material to fully

grasp the concepts. Once you have it down, you may be ready to apply what youve learned to your

trading.

1-5 = Denitely Revisit the Material, and Take the Quiz Again

No worries. You simply need to reread the material and/or contact an RJO Futures Trading Consultant

at 800-441-1616 for assistance. Well be happy to walk you through any parts of this guide to help you to

better understand the content. And we offer many other resources to help you along the way.

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Donna Heidkamp

Donna is a Senior Trading Advisor with RJO Futures in Chicago, Illinois. Donna graduated from Texas Tech University

with a bachelors degree in Agricultural Economics, and completed the Chicago Mercantile Exchange Agricultural

Broker Training Program, which enabled her to work with experienced oor traders and develop a strong understanding

of the intricacies of trading in the futures markets. Since completing the training program in 1995, she has continued

to gain a well-rounded knowledge of the industry by working as an order clerk, trading desk manager, and broker

for RJO Futures and now focuses her efforts on helping clients meet their trading goals. Donna also completed amasters degree in nancial markets and trading from the Illinois Institute of Technology in May of 1999 to better serve

her customers in an ever-evolving and dynamic industry. Donna is a regularly featured commentator on CNBC TV and

Bloomberg.

About the Author



19/19

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The risk of loss in trading commodity futures and options can be substantial. Before trading, you should carefully

consider your nancial position to determine if futures trading is appropriate for you. When trading futures and/or

options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past

performance is not necessarily indicative of future results.

Documents

Choosing Options Strategy Guide