The Options Trading Checklist: Things Not to Forget
There are several important factors to think about when trading options on futures contracts and while the ability to have market savvy about the underlying futures market is extremely helpful, it is by no means a reason to consider your work done when establishing a position in options on futures contracts. There are many ways to improve ones chances of making money when initiating and a position and here are some items worth considering:
1) Establishing goals- analyze entry and exit points, examine volatilities of different contracts and choose from a multitude of options strategies in order to pick the type of options position which is most likely to help you meet your trading goals
2) Risk Reward Ratio- is the contract big enough and are the potential gains large enough to cover commissions and slippage? If one trades small contracts and the costs of trading are too high as a percentage of the potential gains, it is very difficult to make money in the long run
3) Liquidity- if there isn't depth to the market, it's not worth putting on a position. It will be too costly to get in and out of the position. Execution costs must be examined when considering the profitability outlook. Getting sample quotes and understanding the potential execution prices can determine whether a futures and options contract is the right one to trade
4) Implied vs. Historical Volatility- whether you are getting long or short options it is important to gain insight into the relative value of the options you are trading. Implied Volatility is the market's expectation of future volatility but it must be analyzed in terms of the market's Historical Volatility
5) Skew- the skew enables a trader to create interesting trading opportunities that would not exist in a market that had a flat implied volatility curve. By analyzing the skew, a trader can initiate a position that meets his or her trading objectives and provides a theoretical advantage in establishing the position. S&P, Crude Oil and Coffee are three markets that currently provide advantages to establishing positions using the skew creatively
6) Gamma- when establishing a position in futures and options, understanding the gamma of your position is essential in understanding the ramifications of your risk-reward profile. Gamma provides one who is long options tremendous opportunity to experience delta changes due to price changes in the underlying market. Managing these changes can provide tremendous opportunities for profit. On the short side, negative gamma has blown out many traders. Gamma must be considered and understood when establishing large options positions
7) Vega- When selling options, the trader must understand the potential risk to the position due to changes in implied volatility. Due to large increases in implied volatility, traders often have trouble meeting margin requirements which are caused by movements in vega. Analysis of this is important before the position is established. Certain markets have histories of large volatility explosions. Selling large quantities of volatility in these markets, when the implied volatility is not historically high, can be a disaster
These are some of the issues that should be considered when establishing a position. The Checklist is meant a guide to making certain choices for trading options on futures contracts, not as a replacement for trader's intuition. I work with traders in numerous markets. If you are interested in discussing your current market ideas, call me for a no cost discussion at 212-383-9453.
All options on futures strategies involve implied and historical volatility and skew analysis. Vega, gamma and delta calculations are also monitored. In addition, understanding slippage is essential. Please call me to be sure you are using the correct strategy for your needs. You can call me directly at 212-383-9453 or reach me at firstname.lastname@example.org. You can also visit our website at www.libanman.com.
FUTURES AND OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.