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Buying both OTM call and put options to protect from unexpected wipeout


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Buying both OTM call and put options to protect from unexpected wipeout

  #1 (permalink)
ClearTrades
Yakima WA
 
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So here's the thing, I want to trade futures because of the leverage, but at the same time I am terrified of the leverage. A personal friend of my father lost his house and everything he owned because his futures trade went unexpectedly in the wrong direction. I told my father about my interest in trading futures and he is strongly opposed to it and told me "there is unlimited loss potential and stay as far away from them as you can. You never know if your stop loss won't get filled and you get suck with major losses like if your stop doesnt fill in a limit-up or limit-down type of scenario.

So my question to you who do trade futures for a living, is what do you do to protect yourself from this risk? I was thinking that the unlimited loss potential can be limited by buying out of the money calls and puts. Is this the best strategy? Can anyone give me an example of how i can "safely" trade futures?

Is my dad correct? Or is buying options a good way to cover yourself and get around this risk?

For example the CL contract. Let's say it is $60 per barrel and you have 4 contracts and all of the sudden the market slams $10 down to $50 nd your stop loss doesn't get filled. You have just lost $40,000. Is there a way to effectively mitigate this risk to say a max loss of $10,000 in this situation with options?

I appreciate any insight you have to share.

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  #3 (permalink)
 
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 shodson 
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Your dad is right, and options are the most reliable way to protect yourself. Stops are not guaranteed to be filled at or even near your stop price, and if the market limits up/down, or there's a nuclear attack, or who knows what else, you could be toast. Most active intra-day retail traders usually don't worry about this since they feel comfortable with the risk, believing they can quickly get out when things start to go bad because they are watching the market all of the time. But sometimes the market doesn't respond to your actions, and you're stuck with an account-killing position. Most institutional traders have some sort of hedging strategies in place, but sometimes not enough to prevent bankruptcy.

In stocks/ETFs I've seen a short stock position in PCG halt trading, then re-open 2x higher than my entry price...in a few minutes, or a long position in SVXY lose 80-90% of its value in less than 15 minutes, so these sort of moves are real and need to be mitigated with small position sizing and some sort of "black swan" insurance. Protection costs money, but you can pay for all of most of it using option collars, only if you're ok limiting your gains when a black swan event goes in your favor...

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  #4 (permalink)
ClearTrades
Yakima WA
 
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shodson View Post
Protection costs money, but you can pay for all of most of it using option collars, only if you're ok limiting your gains when a black swan event goes in your favor...

Yes, that is what I mean.
I would rather pay $20 a day (or whatever the option cost?) to have peace of mind and limit my gain or loss per day to $5000 a day than save $20 a day and be at risk of a coin flip on gaining or losing $50,000.

I want to play the game by my own rules.

So you say collars are the best way to do this? Thanks for the info. An example would be great if you can. Trying to get an idea how much it would cost to do this effectively.

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  #5 (permalink)
 
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 shodson 
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Follow the link in my post, there is an example there

https://www.investopedia.com/terms/c/collar.asp



ClearTrades View Post
Yes, that is what I mean.
I would rather pay $20 a day (or whatever the option cost?) to have peace of mind and limit my gain or loss per day to $5000 a day than save $20 a day and be at risk of a coin flip on gaining or losing $50,000.

I want to play the game by my own rules.

So you say collars are the best way to do this? Thanks for the info. An example would be great if you can. Trying to get an idea how much it would cost to do this effectively.


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  #6 (permalink)
ClearTrades
Yakima WA
 
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shodson View Post
Follow the link in my post, there is an example there

https://www.investopedia.com/terms/c/collar.asp

I don't think a collar is quite right. i think what I am envisioning and describing is the "Long Strangle" option strategy. Curious if anyone has experience using this to mitigate wipeout risk.

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  #7 (permalink)
 myrrdin 
Linz Austria
 
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ClearTrades View Post
I don't think a collar is quite right. i think what I am envisioning and describing is the "Long Strangle" option strategy. Curious if anyone has experience using this to mitigate wipeout risk.

It looks like your knowledge about futures and options trading is limited. Thus, I suggest reading through some relevant threads here, and studying some good books. You will find recommendations in the threads.

For your information: Most people here who make a significant income from trading sell options instead of buying them. There are ways to limit risk. You will find them in some of the threads here (eg. "Seling options on futures" and "Diversified option selling portfolio").

Good luck !

Best regards, Myrrdin

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  #8 (permalink)
zxcv64
London, UK
 
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@ClearTrades, I invite you to read this wonderful thread....



Additionally, spend a few weeks reading through this forum, esp this folder :
https://nexusfi.com/commodities-futures-trading/

and this one:
https://nexusfi.com/options-futures/.

It's time well spent - I learnt more from these than I did from any Futures book I came across.

Best regards.

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  #9 (permalink)
 
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 Bookworm 
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Being continually long protective options will almost certainly severely limit if not eliminate the profits from trading the underlying futures. Try doing a backtest.

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  #10 (permalink)
Harvard16
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CT,

If trading futures outright makes you that nervous, ( and I understand where you are coming from)you may consider structuring an options trade that will let you sleep each night without worry but still allow for a decent opportunity for profit potential.

You asked for examples so here is one from me, in June CL I put on a ratio option spread on Dec 31st 2018, when CL vol. was still quite high, buying the 50 Call, selling 3 60 calls , which paid for most of the cost of the 50C, and buying 2 65C, to cover the tail risk to the acceptable initial premium debit, these were far enough out of the money to be relatively cheap insurance, that trade is doing really well at present with the price gently grinding up to under the 60 level, of course a lot can happen between now an expiry.

I know from experience if I was trading the futures outright, I would have probably been shaken out by now on the 3-4$ pullbacks on the way up, but with an options trade like this the point is that it is much much easier to hold and let things develop over time and your tail risk, the thing you describe as fearing the most is absolutely managed.

The key is to have a longer term outlook, which in this game is not too common, but it allows one to create trades with relatively wide ranges of price in which to potentially profit. In this case the potential is $10000 per spread less the initial premium debit, still a very attractive figure. If the time frame is too short you just can't get enough distance between the strikes to make it viable.

You may find given your temperament and risk tolerance that a style like this maybe worth considering.

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Last Updated on April 3, 2019


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