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Selling Options on Futures?
Started:July 19th, 2011 (06:16 PM) by ron99 Views / Replies:568,106 / 5,727
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Selling Options on Futures?

Old November 22nd, 2014, 06:03 PM   #3821 (permalink)
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CafeGrande View Post
You're thinking the right way about ways to limit the risk on the short March call, but to add some context:

- Look at some price charts for last year and previous years. Make sure you look at DAILY charts all the way back to at least 2003 to see how bad things can get in nearby futures in late winter. I highlight daily because if you look at some of the weekly continuation charts that roll before contract expiration, you'll miss March futures hitting $6.49 one or two days before expiration last year. Near expiration it also had a couple of 50 cent or more ranges ($5000) in a day.

- Same with "cash" at the Henry Hub. If you just look at a weekly settlement (Friday) you might miss a couple of days where it settled at ~$8.00

- Look at some implied volatility charts from last year. March ATM IV got up to 85 to 100% and there was a steep skew, which means a $7.00 call could have been 125% or more (I don't have them at my fingertips). Make sure you look at April 2014 IV charts too - not just ATM, but skew charts.

- Make sure your account is well capitalized because if it gets a little crazy again, the CME may raise margins a couple of times a week and your broker might add something on top.

- A trade for the time period you are discussing (Mar and Apr) is called the widow maker in the futures markets. Do some research; there's even a book about it.

Thanks for your suggestions. One of the important issues according to my experience is to roll (or close) the option before it gets the nearby one. (In so far I trade it differently than other options I sell.) In case it gets warmer in December and price and volatility are reduced a bit, I will be out anyway. I consider a profit of approx. 50 % in a couple of weeks an excellent result.

Another important issue is to watch the weather outlook daily. The extreme cold last year was announced, and at that time it was possible to exit short calls at a reasonable price. One of the big mistakes in OTM option selling is assuming that nothing can happen, because they were sold so far OTM. And to stay in all trades.

I will let you know how I procede.

Best regards, Myrrdin

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Old November 22nd, 2014, 06:04 PM   #3822 (permalink)
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After last year, I will NEVER sell naked Nat Gas calls again. EVER. It could be just as crazy this year as it was last year.

My play this year is looking to the upside: I bought Mar 5.0 Calls, and sold Mar 5.5 Calls. If I hit max profit, reward/risk of about 7.

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Old November 22nd, 2014, 06:10 PM   #3823 (permalink)
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CafeGrande View Post
I forgot to mention:

To get an understanding of what these Nat Gas contracts have done in the past, check out Barchart.com - Commodity, stock and forex; quotes, charts & analysis

Type in a symbol like NGH14 - click on "technical chart" and scroll down a bit to add "study/indicator" section. Select implied volatility and make the IV window "medium"

You can go back several years -- NGH13, NGJ12, etc and see price and IV in one place. To get historical skew, moneyness or IV charts for a particular strike, I think you'll have to buy them.

Thank you.

I work with data from MRCI for longterm volatility and Trade Navigator for price data. But I will have an additional look at Barchart data.

I just saw that you use the same brokers than myself, RJO and IB. My experience is that selling FOTM options works significantly better with RJO. Here I never had problems, at IB again and again. But IB is excellent for trading stocks.

Best regards, Myrrdin

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Old November 22nd, 2014, 06:21 PM   #3824 (permalink)
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CafeGrande View Post
A few weeks ago when I posted the first chart, a 2 Std Dev move for March futures based on futures price, days to expiration and ATM implied volatility was about 7 bucks.

Now it's about 9 bucks. Even though time was whittling away the range of possible outcomes, it was far outweighed by changes in price and implied volatility. That's neither here nor there, just a reminder to those selling far OTM options that it doesn't take a crazy period like we had in Jan/Feb 2014 to have a position go against you.
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Notes:
The blue line is a monthly average of Henry Hub spot/cash as reported by the EIA. I have updated it through Friday, Nov 21.
The price range is very narrow for Dec 2014 option expiration - it's Monday, Nov 24.

The Natural Gas Roller Coaster Thread


SMCJB on Nov20 View Post
ATR's for Natgas this month
20th 25.2c or 5.8%
19th 31.4c or 7.4%
Average last 3 days (18-20) 25.1c or 5.8%
Average last 5 days (14-20) 23.4c or 5.9%
Average last 10 days (7-20) 21.7c or 4.9%
Average November (14 days) 21.1c or 5.4%


SMCJB and on Nov 21st View Post
And the 21st another impressive 29.2c or 6.5% range.
Monday is penultimate and is options expiration so probably expect more of the same.


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Old November 22nd, 2014, 06:33 PM   #3825 (permalink)
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Futures Edge on FIO

Are you a NinjaTrader user?

 
Monday is option expiration day for NGZ.

I do not expect higher prices as all the stikes of 4.25 or higher show a significant higher OI for Calls than for Puts. Between 4 and 4.25 I would consider it neutral, and at 4 and below there are more Puts.

Best regards, Myrrdin

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Old November 22nd, 2014, 06:46 PM   #3826 (permalink)
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myrrdin View Post
I sold some NGH C7 a couple of days ago for 1500 - 1600 US$.

The distribution of volatility over time in your chart brought me to the thought to buy low volatility cheap NGJ C5 or C6 options to protect the spread. They closed at 430 or 130 US$, respectively. Obviously it is a bear spread, the closer option being sold, and the further out option being bought. But does volatility change everything ? For the current price of the NGH C7 of 1180 you could buy a NGJ C4.3 or C4.4. In the first quarter of 2014 the maximum spread of NGH-NHJ futures was 1.2, thus buying the NGJ C5 would give a good cushion.

Cost would be about 25 or 30 % of the profit, but the result would be a good sleep. (And margin requirement would be reduced.)

Margin would be reduced a little but my advice would be not to consider this as a hedge.

myrrdin View Post
Can it be expected that high volatility will "roll out" into April in case of very low temperatures in January ? Does anybody remember how it was last year ?

No. Well at least not significantly enough to protect you.
If we run out of gas in March we still have plenty in April and are refilling for next year.
If we don't run out of gas in March we still have plenty in April and are refilling for next year.
Same result.


CafeGrande View Post
- A trade for the time period you are discussing (Mar and Apr) is called the widow maker in the futures markets. Do some research; there's even a book about it.

^^^^ This guy knows what I'm talking about.

kevinkdog View Post
After last year, I will NEVER sell naked Nat Gas calls again. EVER. It could be just as crazy this year as it was last year.

My play this year is looking to the upside: I bought Mar 5.0 Calls, and sold Mar 5.5 Calls. If I hit max profit, reward/risk of about 7.

And this guy ^^^^

@myrrdin There's about 20 pages in this thread back in Dec'13-Feb'14 that spends a lot of time talking about NatGas, March Calls, and March/April. If you haven't already you may want to go back and read them. Lots of interesting discussion. I'm not saying don't do it, in fact many years you'll make money if you do short calls, BUT you'll probably need balls of steel and lots of free cash for those margin calls before you do.

To quote myself (again :-))...

https://futures.io/options-cfd-trading/12309-selling-options-futures-262.html#post375470


SMCJB View Post
One thing you need to remember is that not only is Natural Gas a real commodity, with real supply and demand, but it's also an essential commodity. If we run out of natural gas, power plants shut down and houses go dark, grandma's heater doesn't switch on and people can die. While this might sound sensationalist, rolling blackouts in the summer have caused people to die on several occasions, and the fear is real for many people. (Although I don't recall us ever actually running out of Gas in the winter). For this reason you can see scarcity pricing occur in Natural Gas (and even more so Electricity) that you will never see in other commodities. This also effects implied volatility and skew in ways you rarely see in other markets as well.

PBS did a documentary back in 2001, where they interviewed several Natural Gas traders including Bo Collins who would later become President of the NYMEX before it was bought by the CME. You can watch the show and see the transcript here. At one point Bo tries to explain scarcity pricing to the reporter by equating it to a man in a desert.
BO COLLINS: If you don't have water to drink, on your first hour of not having water, what will you pay for it?
PAUL SOLMAN: Well, I start to...
BO COLLINS: You don't care that much.
PAUL SOLMAN: Right, I don't care.
BO COLLINS: In... 12 hours later, you're a little thirsty; what's the value of water?
PAUL SOLMAN: It's getting there.
BO COLLINS: Two weeks later, if you're still alive, you'll probably give everything that you have in your bank account for that glass of water.
Interestingly Foster Smith another trader interviewed in the documentary makes the following comments about some 2001 price moves...
FOSTER SMITH: We basically traded from $5.70 up to $6.94 in two days, a pretty large move. We're talking about, you know, a 20 percent move in two days, which... that would be like the Dow going up 2,000 points in two days. That'd be a talkable event.
PAUL SOLMAN: And when the forecast changed just over the weekend...
FOSTER SMITH: Prices came off almost immediately. We opened up at $6.20 yesterday, which was down almost 60 cents, and it went down to $5.70 in about 30 minutes. So we lost everything we'd gained in two days in about 45 minutes.
Back to Natural Gas ... In the US, we use a lot more Natural Gas in the winter than we do in the summer. Since production is relatively balanced year round, we inject massive amounts of natural gas into underground storage April thru October and then remove it December through March. (At it's peak US Natural Gas stoarge represents approximately 15% of annual demand.)

Consumption is very weather dependant but nearly always highest in Januray, followed by December & February. Hence its not surprising that January is the peak of the curve when you look at prices on a forward basis. But if we have a very cold winter, and storage starts running low, it's not January you need to be worried about but March. No matter how cold it gets in January, there will always be enough gas in storage to meet demand. If we were ever to run out of gas in the Winter, it would probably be because of demand in January & February but we would actually run out in March. Hence we have the phenominoum that all the fear factor is pushed into March.

April on the other hand, is the first month of next years injection season. If we run out of gas in March, prices will be higher in April and through out the summer than normal, but not that high, and we will never run out of gas in April. Hence April always has to price itself as the first injection month for the following winter. Hence March prices have the potential to completely detach from April and beyond pricing.

Now consider what happens if we get to March and we have plenty of natural gas. The gas in storage that won't get used now has to price itself to stay in storage for the following winter. Hence March drops to a discount to April! As you can see the dynamics of the March-April spread can vary enormously! If the price dynamics of March seem like they can be a roller coaster - just imagine what the implied volatility can do! To make things even more interesting, CME and ICE both trade and clear, spread options on the March-April spread.

When Bo Collins left his position of NYMEX President he set up a hedge fund called Motherrock. After some early impressive gains the Hedge Fund went down in 2006, rumored to having lost over $200M trading March-April NG spreads and associated option contracts. They were squeezed out by Brian Hunter and Amaranth. In the next 12 months Amaranth went on to lose $6.6 Billion, a lot of which was again lost in March-April spreads (and also Oct-Jan spreads). The big winners were rumored to be Centaurus (aka John Arnold), Citadel and JP Morgan. If you would like to see some interesting implied vols try and get some historical quotes for upside March'06 and March'07 calls.

March-April is the ultimate fear trade, short squeeze trade, and path dependent trade. Every year it trades at a significant premium, and in most years it settles at flat or more often negative (2003 settled $1.74). The question is, can you handle the drawdowns before this happens. Even this year with the much smaller 40c moves, lots of money is rumored to have changed hands.

I know this sounds very sensationalist, and in reality the current increased supply picture means the prices we saw in March-April in the 2000's probably won't materialize again soon. But the facts are Billions have been lost trading this spread over the years.

March April through the Years ($/MMBtu)
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March April through the Years (March % Premium to April)
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I'll try and update those charts so everybody can see last year as well.

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Old November 23rd, 2014, 05:49 PM   #3827 (permalink)
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effective View Post
What if one spreads between the two, ATM vs "pitchfork" equivalent?


Sorry, I don't follow. Long the atm combo against the short PF?

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Old November 23rd, 2014, 06:51 PM   #3828 (permalink)
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convexxx View Post
Sorry, I don't follow. Long the atm combo against the short PF?

The other way, but yes. here is what it would like for crude - short ATM and long PF https://drive.google.com/file/d/0B2dj-Bcb8hAIYUtPT2Jrak5wbXc/view?usp=sharing


Last edited by effective; November 23rd, 2014 at 06:57 PM.
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Old November 24th, 2014, 09:47 AM   #3829 (permalink)
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Sell Crude Oil Puts

I intend to sell puts on crude oil futures.

Arguments pro:
Implied volatility is rising and now at the highest level for appox. two years.
Seasonals show a significant low at this time of the year.
Price gets close to an area were some production technologies get problems to make money, and where some governments (eg. Russia, Iran) feel uncomfortable.

Arguments con:
There will be an important OPEC meeting in a couple of days. (This might be a reason for the high volatility.) I expect them to reduce production to get prices higher, but I might be wrong.
Trend is still downwards.

My favorites are the CLK P60 or 65. Delta as of Friday 11.4 % or 18.7 %, respctively. Option premium 1060 US$ or 1870 US$. I prefer the May contract as I expect a longterm rise in crude oil prices. Seasonally it should go upwards until spring.

Any comments on the trade as such, on entry conditions, and on alternative trades are welcome.

Best regards, Myrrdin

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Old November 24th, 2014, 09:52 AM   #3830 (permalink)
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myrrdin View Post
I intend to sell puts on crude oil futures.

Arguments pro:
Implied volatility is rising and now at the highest level for appox. two years.
Seasonals show a significant low at this time of the year.
Price gets close to an area were some production technologies get problems to make money, and where some governments (eg. Russia, Iran) feel uncomfortable.

Arguments con:
There will be an important OPEC meeting in a couple of days. (This might be a reason for the high volatility.) I expect them to reduce production to get prices higher, but I might be wrong.
Trend is still downwards.

My favorites are the CLK P60 or 65. Delta as of Friday 11.4 % or 18.7 %, respctively. Option premium 1060 US$ or 1870 US$. I prefer the May contract as I expect a longterm rise in crude oil prices. Seasonally it should go upwards until spring.

Any comments on the trade as such, on entry conditions, and on alternative trades are welcome.

Best regards, Myrrdin

I've learned the hard and expensive way not to fight the trend.

If you have any questions please send me a Private Message or use the futures.io "Ask Me Anything" thread
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