learn to trade commodities

www.CarleyGarnerTrading.com and www.DeCarleyTrading.com work tirelessly to provide free futures market articles and videos aimed at helping those willing to accept the risks to learn to trade commodities.  

  • A Trader's First Book on Commodities

    Knowledge is the most valuable commodity!

    A Trader's First Book on Commodities

    www.ATradersFirstBookonCommodities.com

    Amazon

    Barnes & Noble

    Before you trade commodities, you'll need significant practical knowledge of the associated risks and futures market characteristics. That's where this book comes in. You won't find boring theory or bewilderingly complex commodity trading strategies here. Instead, you will find specific guidance on accessing commodity markets cost-effectively, avoiding common beginners' mistakes, and improving the odds of successful futures and options trades.

    Drawing on her extensive experience as a commodity broker, Garner shows how to calculate profit, loss, and risk in commodities, and choose the best futures brokerage firm, service level, data sources, and futures market access for your needs. Garner demystifies the industry's colorful language, helps you clearly understand what you're buying and selling, and walks you through the entire commodity trading process.

    She concludes with a refreshingly new look at topics such as futures trading plans, handling margin calls when trading in commodities, and even maintaining emotional stability as a trader.

    • Know the players, know the language, know the techniques
    • Master the basics painlessly and avoid beginner's mistakes
    • Choose the right commodity brokers, services, trading platforms, and tools
    • Get what you need; don't pay for what you don't need
    • Make sense of confusing commodities quotes
    • Know what you're buying, what it costs, the returns you're earning, and the risk you're taking build a flexible trading plan that works to help predict price, manage risk, and make trades that reflect your analysis.
  • Carley Garner Commodity Education Book Reviews

    Learn to trade futures, options, and FOREX with Carley Garner trading books.

    Carley Garner's futures, options, and FOREX trading books have been reviewed by several national publications.  Here is a sample of some of the trading community book reviews.

  • Carley Garner Futures, Options, and FOREX Trading Books

    Learn to trade futures, options, and FX with Carley Garner books!

    New Futures Trading Book by Carley Garner

    Carley Garner, a futures broker at DeCarley Trading, is the author of multiple trading books.  The intention of the publications is to compile lessons learned as a long-time commodity broker, and deliver them to readers in simplified and efficient educational material for futures, options, and FOREX traders.  

  • Commodity Option Trading Strategies

     

    commodity options book

    In line with our commitment to providing free commodity trading education, we've put together a handful of option trading educational articles.  

    Whether your strategy involves selling options on futures, buying options, or even a combination of both, we believe the articles in this section will be useful to you.  If you would like to expand on these option trading strategy ideas, we encourage you to read "Commodity Options", which covers several option strategies in detail.  

    For more information, visit www.CommodityOptionstheBook.com.

  • Commodity Trading 101

    Learn to Trade Commodity Futures

    Learn to Trade Commodity Futures and Options

    Trading commodity options and futures isn't easy and shouldn't be attempted without completely understanding what you are getting into.  As an experienced commodity broker, I encourage you to take advantage of these free commodity trading education resources. 

    The Commodity Trading 101 section includes several articles for beginning futures traders covering topics from calculating profit and loss in commodities, to establishing a trading plan.  We've included a commodity glossary compliments of the CFTC (Commodity Futures Trading Commission).

     

  • Commodity Trading is Risky Business


    Risk in Commodity Futures TradingDespite what you may have read in commodity trading books, magazines, or even heard on infomercials, trading options and futures entails substantial risks and is not suitable for everyone. 

    On the other hand, trading in futures and options can be financially rewarding, but you must realize that where there is potential opportunity there is a corresponding amount of danger. 

    For this reason, only risk capital (money that you can afford to lose without altering your lifestyle) should be allocated to a commodity trading account. 

    The risk in trading futures stems from the leverage provided by the exchanges, combined with the speculative nature of the commodity markets.  Unlike an investment in stocks or bonds, futures traders aren't buying or selling assets.  Instead, they are buying and selling obligations to make or take delivery of the underlying commodity.  In other words, futures traders don't own anything other than a liability.  Further, commodities don't pay interest or dividends to buffer investment volatility.  As you can image, this sets the stage for a considerable amount of risk and reward.  

    The ability to easily buy or sell futures and options contracts in any order creates opportunity, but it also breeds aggression; and this can sometimes be too much for beginning commodity traders to overcome.  We urge traders to live by the motto "less is more".

    The leverage in commodity trading is created by the ability to share in the profits and losses of a substantial amount of the underlying asset for a relatively small good faith deposit.  Simply put, futures exchanges require a small margin deposit comparative to the total value of the commodity contract being traded, this allows a reasonably small move in the futures price to have a large impact on the value of your trading account.  It is not unlike the leverage most home buyers experience; they put a down payment of 5 to 20% but their capital gains and losses are determined by the full value of the property. 

    With that said, please note that being a successful futures and options trader is challenging yet achievable.  In my experience as a commodity broker, I have found that the only way to "beat the market" is through the ability to overcome emotional and psychological barriers.  Unfortunately, this is something that can only come through practice...unless of course you were lucky enough to be born with the appropriate personality for trading.   

    We at DeCarley Trading hope to play a part in your journey through the markets and insist that you consider both the sides of the coin before choosing to trading options and futures.  We look forward to hearing from you. 

     

  • Day Trading Futures: Risk Averse need not Apply

    Risk in Day Trading FuturesTraders are often lured to into the futures markets with a fascination for day trading. 

    The thought of buying and selling leveraged contracts without overnight risk is appealing to many, but underestimated by most.  As a retail commodity broker, I have had the pleasure, and the pain, of watching futures day traders attempt to profit through strategies ranging from scalping, to "position" intra-day trading, which spans several hours.  

    My observations of the futures markets have led me to the conclusion that day trading is perhaps one of the most difficult strategies to successfully employ.  However, for those that have the perseverance to dedicate themselves to the practice, contain the natural ability to eliminate emotions, and have enough experience under their belt, day trading in the futures market might be one of the most potentially lucrative forms of commodity market speculation. 

    The term day trading can be used to describe an unlimited number of futures trading strategies and approaches that involve buying and selling a commodity contract in the same trading session.   Many are system based, meaning that trading signals are executed according to specific technical analysis set ups; others incorporate a trader's instinct.  The approach that you take in the futures markets should be dependent on your personality and risk tolerances; not necessarily what has worked for somebody else.  Let's face it; there are only about twenty to thirty commonly used technical oscillators available in most trading platforms.  If there were absolute magic to any of them more people would have discovered the Holy Grail to futures trading.  Rather than expecting a technical indicator or a computer generated oscillator to do the work for you, I believe it to be more productive to properly educate yourself to the risks and the rewards of the commodity markets.  This includes the less technical, and thus less talked about, aspects of day trading.  

    Futures Day Trading is Mental

    I believe that becoming a successful day trader in the futures markets come down to instinct and the ability to control emotion.  If you have ever been involved in athletics, you have probably heard the adage that performance is 95% mental and only 5% physical.  I have found this to be true in trading as well, although instead of being physical trading is technical.  Quite simply, it isn't which technical analysis oscillators and indicators you use, it is how you use them.  Perhaps more importantly, how you deal with fear and greed that comes with risk exposure in the commodity markets as you are charting your futures trades.  Here are a few day trading tips that may aid in the mental preparation.


     

    Know the Futures Market Volatility and Accept the Consequences

    You often hear futures traders talk about their need for volatility.   It is a common perception among the trading community that higher volatility is equivalent to higher opportunity, and therefore profit potential.  Call me a "girl", but I happen to be a contrarian when it comes to this point of view.  Sure, if the markets are moving there is an increased chance for you to catch a large move and make history in your trading account.   However, there is another side to the story; let's not forget that if the market goes against your futures trade you could be put in an agonizing position.  Also, if you are a trader that insists on using stop loss orders, increased levels of futures market volatility translates into amplified odds of being stopped out prematurely. 

    I am not suggesting that you avoid the futures markets during times of explosive trade; however, you must fully understand the consequences and be willing to accept the inflated risk of trading accordingly. 

    In my opinion, the most convenient way of measuring commodity market volatility is through the use of Bollinger Bands.  The bands allow a trader to visualize the explosion and contraction of market volatility with similar movements in the bands.  Simply put, as the Bollinger bands get wider, the volatility and market risk is also on the rise.  Conversely, tighter Bollinger bands suggest relatively lower levels of volatility.  Please note that I didn't say lower levels of day trading risk; this was intentional. 

    emini S&P 500 volatility

    Figure 1: E-mini S&P 500 Futures - Traders can visualize futures market volatility through the use of Bollinger Bands.  It is a good idea to do so on a daily chart to get the big picture of market volatility. 

    Narrow bands indicate that futures market volatility is relatively low, but if the contraction is excessive enough it may signal an extraordinary spike in price is imminent.  Markets go through times of quiet trade, but such times are often followed by large and sudden increases in instability.  As you can imagine, being in the futures market at such times could be similar to winning the lottery or they could mean financial peril.  Before executing a futures day trade in a fast moving market, or one that is trading quietly, you must be aware of market tendencies to properly assess the risk of initiating a futures day trade.  Being conscious of all of the potential outcomes of your futures day trade may prevent panic liquidation or the infamous deer in the headlights failure to act. 

    Commodity Trader's Tool Box

    Technology has provided traders with an abundance of readily available information at their fingertips.   Accordingly, I strongly believe that traders should properly understand and utilize the resources available to them.  It doesn't make sense to pick a single indicator or oscillator and expect it to tell you the whole story; instead it should be viewed as a piece to the puzzle.  With that said, it can often be counterproductive to bog yourself down with too much information or guidance; this is often referred to as analysis paralysis. 

    In my opinion, it is a good idea to pick three or four tools that fit your needs and personality.  For example, if you are an aggressive trader with a high tolerance for risk you may opt for a quick oscillator such as the Fast Stochastics.  If you are a slower paced individual, the MACD may better suit your needs as it is a much slower moving indication of trend reversals. 

    It is important to note that after you have entered a trade you shouldn't change the oscillator that you are watching simply because the original isn't telling you what you want to hear, or in this case see.  This can be a tempting practice for traders that are caught in an adversely moving market and are in search of a reason to stay in the trade for fear of taking a loss. 


     

    Mental "Stop Loss"

    As you are probably aware, a stop order (AKA stop loss) is an order requesting to be filled at the market should the named price be hit. A trader long a futures contract may place and stop order below the futures price to mitigate the risk of an adverse price move.  Likewise a trader holding a short futures position may place a buy stop above the current market price as a risk management tool against a possible rally.  Once executed, the trader would be flat the market at or near the named price. 

    Most traders or trading mentors will tell you that you should always use stops; I am not most.  I argue that experienced and disciplined traders may be better off without the use of live stop orders and believe that mental stops may be a better alternative.  Supporting my assumption is the theory that  the dollar amount of the risk on any given trade is conceivably higher through the use of mental stops as opposed to actual working stop orders but the risk in the long rung may be less through the reduction of untimely exits.

    The concept of a mental stop is simply picking out a price level at which it is fair to say that your position may have been an incorrect speculation and manually exiting the market once your pre-determined price is hit.  Using mental stops as opposed to placing an actual stop loss order may prevent the natural ebb and flow of the market from stopping you out at what ultimately becomes premature. 

    I am sure that you have all fallen victim to the stop order that was triggered to exit your trade only moments before the market reversed course and left you behind.   Not only is this a frustrating place to be, but it often has an adverse impact on trading psychology going forward.  Unfortunately, it doesn't seem to be uncommon for inexperienced traders to behave somewhat recklessly in an attempt to get their money back from the very market that took it from them.  It is easy to give in to this mentality, but doing so will almost always end negatively. 

    The use of mental stops requires a considerable amount of discipline and may not be appropriate for all traders and strategies.  If you have a consistent problem controlling your emotions (we all fall victim to fear and greed at some point), stop orders are a must.  Without them you may be put into a position in which a single losing trade can wipe out weeks or months of hard work, or worse put you out of the trading business forever. 

    Even those that have an adequate ability to stay calm during unfavorable market moves may find losses pile up in violent market conditions.  For example, there are times in which it is very difficult to exit a position once the named price is hit without considerable financial suffering.  If you are not mentally capable of accepting this possibility, placing outright stop orders may be a better alternative for you despite its limitations.  Remember, if successful trading is largely determined by the mental capabilities of a trader it is imperative that you know yourself well enough to steer clear of situations that may lead you to behave emotionally as opposed to rationally.   

     

    emini nasdaq futures

    Figure 2: Mini Russell 2000 future - Stop loss orders are a great way to minimize futures market exposure, but I believe them to be a great source of frustration as well.  If you are disciplined it may be better to work without stop loss orders.


     

    Be Creative with Options on Futures

    It is no secret that more retail traders lose money than not in the realm of futures and option trading.  I have observed that day traders could face even more dismal odds of success.  However, don't let this deter you from participating in the commodity markets, instead use it as your incentive to be different.  If a majority of people are day trading futures contracts unproductively, perhaps you should be interested in trading strategies that are a bit out of the norm.  

    Buy Futures Options Instead of using Stop Loss Orders

    During the last few days of the life of a commodity option they time value, and thus the premium, of the instrument has often eroded to affordable levels.  If this is the case, it is sometimes possible to simply purchase a call or put option as an alternative to placing a stop loss order.  This strategy can also be viable in option markets that have more frequent expiration dates; particularly the weekly options written on the stock indices and grains. Keep in mind, however, that during times of excessive volatility even options with little time to expiration can remain too expensive to make them a viable substitute for stop loss orders.  In other words, using long call and put options instead of stop loss orders to limit risk of a futures trade is only situationally beneficial.    

    In essence, the purchased futures option creates a synthetic trade in which the day trade risk is limited to the amount paid for the option plus any difference in the entry price of the futures contract and the strike price of the option.   This is because the futures option will act as an insurance policy against the futures price moving above the strike price of the long call or below the strike price of a long put.  Beyond the strike price of the option, losses in the futures contract are offset with gains in the option at expiration. 

    The premise of such a day trading strategy is to reduce the possibility of being prematurely stopped out of what would eventually become a profitable trade.  However, it is important to realize that using long options as a replacement for stop loss orders should only be done if the risk is affordable.  If the options are relatively expensive to purchase, the risk of loss will be too high; depending on the situation it might render this approach impractical. Keep in mind, the foundation of buying commodity options instead of placing stop orders is to limit risk of loss, not to increase it.  To reiterate, paying more for a protective futures option than you originally intended to risk on the day trade should be a red flag, and lead you to explore other alternatives.


     

    Counter Trend Futures Trading

    Based on observations made during my years of being a futures broker, it seems as though most day trading futures strategies are very simple; identify an intraday trend and "ride" it until it ends.  It sounds easy enough; but is it?  I will be the first to admit that day trading is not my forte.  Nevertheless, through the scrutiny of the futures trading practices of others, compliments of my profession as a futures broker, I strongly believe that intra-day trend trading is much more difficult than one would imagine. 

    The problem with a futures market trend is it is only your "friend" until it ends.  By the time many trend trading methods provide confirmation to execute a futures trade, the market move has already been missed.   Psychologically, I have a difficult time buying a futures contract that has already risen considerably.  Likewise, selling a futures contract after it has already established a down-trend may simply be too late.  After all, the overall objective is to buy low and sell high.  Buying high and selling higher may work at times, but the common theory that commodity markets spend a majority of their time range-bound seems to work against intraday-trend trading in the long run. Only during times of exceptional market moves will it be possible for a futures day trader to ride a trend long enough to recoup what may have been lost on false signals and failed break-outs of the range. 

    Patient day traders might find that they fare better by looking to take advantage of extreme intraday futures price moves in hopes of a temporary recovery to a more sustainable level.  Doing so may provide less profit potential and if done correctly less trading opportunities but may pose better odds of success.

    Identify Extreme Futures Market Prices

    Futures market prices have a tendency to overshoot realistic valuations, only to eventually come back to an equilibrium price.  Emotion plays a big factor in this phenomenon but the running of stop loss orders are also a primary driving force.  Traders often place sell stop orders under known areas of support and buy stop orders above known areas of resistance.  As you can imagine, there are often several stop loss orders placed on futures contracts with identical or similar prices.  Once these orders are triggered, a swift move in prices in the direction of the stop orders takes place but often has a difficult time sustaining itself.  Understanding that stop running can artificially move a market quicker, and in a larger magnitude, than what would have transpired without the stop orders, a trader could attempt to take advantage of the subsequent rebalancing in price. 

    For example, an e-mini S&P trader may notice the market drop five handles in a very quick fashion with little fundamental news to drive the move.  This type of trade may be the result of a market that has simply triggered a batch of sell stops.  As the futures stop loss orders were filled, the buying didn't keep up with the selling and the futures price dropped accordingly.  However, if our assumption was correct and the move was based on sell stop execution, instead of fresh (legitimate) short selling, it is practical to believe that the futures market will rebound some, if not all, of the losses artificially sustained.  A futures day trader may look at this as an opportunity to buy the futures contract in an attempt to capitalize on a partial or full retracement of the drop. 

    wheat futures stop running1

    Figure 3 : Intraday Wheat Futures Chart - Extreme market moves followed by a retracement to an equilibrium level are common as stop loss orders are triggered creating large commodity price spikes.

    Naturally, before entering a futures day trade some technical confirmation must be made.  After all, the theory that a market drop was the result of sell stop running was an assumption not a fact.  Overbought and oversold technical indicators such as Slow Stochastics, Relative Strength Index (RSI), and W%R (Williams Percent R), might be helpful in determining whether or not prices were pushed to a level extreme enough to encourage buying. 

    Most of the available technical analysis oscillators were developed with the intention of identifying overbought and oversold conditions.  In their simplest forms, both overbought and oversold markets are the result of prices overshooting their equilibrium price.  

    Most technical analysis indicators represent extreme prices relatively well.  Thus, traders looking to buy on dips may find them helpful, but shouldn't expect them to be fool proof by any means.  Computer generated oscillators are great tools but they aren't a guarantee.  They can tell you what the market has done, but only you will be able to translate that into what the market may do next. 


     

    Conclusion

    Although day trading in the futures markets is a challenge, there is likely a reason why so many active futures traders of all skill levels and sizes are attracted to the practice.  There are obvious market opportunities in intra-day trading and with enough patience, practice and fortitude you may become one of those that have achieved profitable long-term trading results.   However, there is also rationale as to why we don't all quit our jobs and day trade commodities for a living.  Despite what may be relatively conservative risk on a per trade basis and a lack of overnight event risk, day traders face substantial risk in the long-run through the possibility of several small losses.  If you aren't willing to commit yourself to the labor of futures day trading, I suggest that you consider less labor intensive strategies. 

     

  • FOMC and option expiration on deck, back and filling in ES futures?

    Heavy commodities and light economic data weigh on stocks

    Two consecutive days of sharp crude oil declines reminded traders of the chaos energy markets inflict on the financial markets. As a result, the e-mini S&P suffered moderate losses in overnight trade. However, it was weak economic data that kept prices under pressure throughout the session.

    February retail sales came in at a a negative .1% for both the headline number and ex-auto. Although this was an improvement from January, it is hardly reason to go out and buy stocks. Similarly, the Empire Manufacturing data improved markedly from last month to a positive 0.6, but simply posting a slightly positive number isn't enough to get investors excited. Today's PPI data, reported a decrease in prices at the producer level of .2%. Thus, last month's hint at inflation was dissolved.

    Tomorrow we'll hear about the latest data on consumer prices and housing starts, but I'm not sure it will matter to the market. All eyes are on the FOMC interest rate decision, which will be released at 2:00 Eastern.

  • Futures and Options Glossary

    Courtesy of the CFTC (Commodity Futures Trading Commission) this is the most extensive commodity market glossary that we have found, enjoy. 

     

  • Higher Probability Commodity Trading

    Higher Probability Commodity Trading by Carley Garner

    www.HigherProbabilityCommodityTradingBook.com 

    Amazon

    Barnes & Noble

    Carley Garner, an experienced commodity broker for DeCarley Trading in Las Vegas, has followed up her previous three titles with Higher Probability Commodity Trading, a comprehensive futures and options trading book focused on trading strategy development, commodity market analysis, and much more.  

    The book received rave reviews from some of the top names in the industry, and we are confident you will enjoy it too! Jon Najarian, co-founder of Najarian Family Office and CNBC contributor, believes this book is "A great read for both beginner and advanced commodity traders."  Tobin Smith, CEO & Founder of Transformity Media Inc, and former co-host of Bulls and Bears on Fox News, refers to Higher Probability Commodity Trading as "..an MBA in trading for the price of a few cups of Starbucks!" And Phil Flynn of Fox Business News, has declared "If you are only going to read one book on the futures market this has to be it."

     

  • How to Create a Synthetic Put

    Synthetic Put Option StrategyHow to create a Synthetic Put

    The term synthetic is often used to describe a manmade object designed to imitate or replicate some other object. Futures and options traders can do the same thing by creating a trading vehicle through a combination of futures and options to replicate another trading instrument. You may be asking yourself; why you would go through the hassle of mimicking an instrument instead of simply trading the original? The answer is simple, as the creator of the vehicle, we can customize it to better suit our needs as well as design it to better take advantage of the underlying market.


    Through the creation of a synthetic position, you can actually decrease your delta as well as, in my opinion, increase the odds of success. Let's take a look at an example of a long synthetic put option.

    Synthetic Long Put Option


    Sell a Futures Contract
    Buy an at-the-money Call Option

    When to Use Synthetic Puts


    • When you are very bearish, but want limited risk
    • The more bearish you are the further from the futures (higher strike price) you can buy, although a true synthetic put involves an at the money call option
    • This position is sometimes used instead of a straight long put due to its flexibility
    • Like the long put this position gives you substantial leverage with unlimited profit potential and limited risk

    Profit Profile of a Synthetic Put Strategy


    • Profit potential is theoretically unlimited
    • At expiration the break-even is equal to the short futures entry price minus the premium paid
    • Each point market goes below the break-even profit increases by a point

    The Risk in Trading Synthetic Puts


    • Your loss limited to the difference between the futures entry prices and call strike price plus the premium paid for the option
    • Your maximum loss occurs if the market is above the option strike price at expiration

    Example of a Synthetic Put Option in the Futures Market:


    A commodity trader looking to profit from a decrease in prices but isn't confident enough in the speculation to sell a futures contract, or even construct an aggressive option spread, might look to a synthetic put.
    A synthetic put option strategy has nearly identical risk and reward potential as an outright put option, making it a potentially expensive proposition. However, if the volatility and premium are right it can be a great way to sell a futures contract, while retaining a piece of mind, and the ability to easily adjust the position because the purchased call option provides an absolute hedge of risk above the strike price.


    A trader that is bearish on the U.S. dollar might opt to sell a dollar index futures contract near 96.60 in hopes of weakness. Should the trader prefer to have limited risk, and be willing to pay an “insurance” premium for protection, might purchase a 97.00 call option for 60 ticks, or $600, because each tick in the dollar index futures and options is worth $10 to a commodity trader.

    Click on image to enlarge.

    With a synthetic put option in place, the trader can sleep at night knowing the worst case scenario is a loss equivalent to the distance between the future entry price and the strike price of the call option, in this case $400 ((97.00-96.60) x $10), plus the cost of the long option purchased to insure the trade, or $600 (60 x $10).


    The payout of this trade at expiration may be identical to a long put option, but the flexibility provided to the trader is unmatched. Unlike a long put, a synthetic long put can be pulled apart prior to expiration in an attempt to capitalize on market moves. Please note that doing so greatly alters the profit and loss diagram.


    An example of an adjustment may be to take a profit on the short futures contract and hold the long call in hopes of a subsequent market rally and the possibility of being profitable on both the futures position and the long option. Or, should the trade go terribly wrong from the beginning a trader may look to take a profit on the long call and hold the short futures in hopes of a reversal. Doing so would eliminate the insurance of the long call and leave the trader open for unlimited risk on the upside, but may be justified if the circumstances are right.

    If you are in search of a commodity options book that features this option trading strategy, and others, visit www.CommodityOptionstheBook.com

     

  • Learn to Trade Commodities

    Learn to trade commodities with DeCarley Trading and Carley Garner

    Carley Garner, and DeCarley Trading, have compiled a vast resource of educational material aimed at helping people learn to trade in the commodity markets.  

    Whether you intend to trade futures, futures spreads, options, option spreads, or you haven't determined a commodity market strategy, we believe you will find useful and applicable information here.  In addition to the dozens of futures and options trading articles listed below, we offer visual learners free access to our commodity trading video archive.  Visit DeCarleyTrading.com for details.  

  • Option Volatility Trading with VIX Futures

    Futures Option Volatility Trading with the VIX 

    The adage buy low and sell high was originally used in reference to price, but can also be applied to the practice of trading volatility. In fact, even as a commodity option trader looking to trade market price as opposed to volatility, ignoring measures of potential explosiveness while entering or exiting a market could mean financial peril. While many commodity traders, whether beginner or pro, understand the concept of buying options during times of low volatility and selling them during times of high volatility, emotions often lead a well-planned strategy astray.


    Unlike traders that are looking to profit from a directional move in price, volatility traders are more interested in the pace at which the market is moving than the direction. However, I argue that it is important to chart both price and volatility in a commodity market before speculating in options. Doing so provides trades with a better understanding of the 'big picture'.

    Volatility Index Futures CBOE

    In my opinion, the most efficient means of trading equity market volatility isn't through the VIX index, or any other similar measure. High levels of leverage, a lack of options on futures market, and a tendency for the index value to erode over time are major factors working against the viability of doing so. Instead, I believe that traders should look to buy or sell options on S&P 500 futures, or more specifically the e-mini S&P (symbol ES). The S&P 500 is a broad based stock index and its value is sharply impacted by market sentiment and the corresponding volatility. Thus, a trader that is of the opinion that volatility will increase may look to buy volatility through the purchase of options written on S&P 500 futures and those looking for volatility to decrease may look to sell volatility buy going short options on the index. Accordingly, insiders often refer to the practice of buying or selling options as "going long volatility" or "going short volatility".


    Trading S&P 500 Volatility through Premium Collection in the Futures Market


    As mentioned, one way to speculate on variations in volatility is through the practice of option selling, often referred to as premium collection. It is important to realize that I am referring to trading American style options which allow traders to buy, sell or exercise options at any time prior to expiration. This differs from the European style versions that offer far less flexibility. The increased level of flexibility tends to have a positive impact on the value of the option and thus the amount of premium collected for selling it. In other words, option buyers may get more value using European style options (referred to as end-of-month options in the S&P) due to lower premiums; conversely this concept works in favor of option sellers of American style options.

     


     

    Why Option Selling?


    Option sellers are in the business of collecting premium, much like an insurance company, under the assertion that in the long run the Navigating the Commodity Marketspremium collected should outweigh any potential payouts. This theory is based on the assumption that more options than not expire worthless, which has been suggested by several studies including one conducted by the Chicago Mercantile Exchange. Unfortunately, similar to insurance companies who are sometimes forced to honor their policies on excessive claims, commodity option sellers are vulnerable to monster market moves than can be potentially account threatening. Preventing such disasters ultimately come down to timing of entry along with a good understanding of futures market volatility, market sentiment, and market knowledge. Additionally, experience, instinct and, of course, luck will also come into play. Yet, in my judgment option selling is a superior strategy in the long run.

    Futures options selling advocates and equity market volatility traders seem to migrate to the S&P 500 futures market (e-mini S&P). There are other stock index futures such as the e-mini Dow Jones Industrial Average and the e-mini NASDAQ, but the e-mini S&P offers the most liquidity as well as a broader based index with smoother price movement.

     


     

    CBOE's Volatility Index Futures (VIX)


    CBOE VIX Futures Volatility IndexAn important measure of volatility when referring to the S&P 500 is the now infamous Chicago Board Options Exchange's Volatility Index, often simply referred to as the VIX. According to the CBOE, the VIX is a "key measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices" and has become one of the most prominent measures of market sentiment in the world. In “normal” market conditions, the VIX spends a majority of its time below 20. As chaotic price action in the financial markets heat up, the VIX can see spikes into the 30 or 40 levels. However, in historically extreme circumstances such as the 2008 financial crisis, the VIX can trade into the 70s, or even higher.


    The VIX futures contract is the sole futures offering on the CBOE exchange. As a result, not all futures brokers offer access to trade it. Additionally, receiving real-time VIX quotes in a futures trading platform isn’t necessarily a given.


    The VIX futures market offers contracts expiring each month. The margin to trade VIX futures fluctuates around $3,000 per contract and the point value is $1,000, making it a very volatile holding in any commodity trading portfolio. For instance, fi the VIX moves from 15.00 to 16.00, the trader would have made or lost $1,000 per contract with a margin deposit of just $3,000. If you’ve followed the VIX, you know that it doesn’t take much time to travel a full point. Thus, most traders are probably better suited trading e-mini S&P options, than dabbling with highly levered VIX futures.


    Increased values of VIX are highly correlated with higher option premium in the ES (e-mini S&P) options due to inflated expectations of future volatility built into options on futures prices. Assuming he is willing to accept the risk of participating in such a market, times of inflated expectations of volatility, and therefore over-priced options, are ideal conditions for an experienced option seller.


    The Quest for Implied Volatility in Futures Options


    Unlike the VIX which is derived from the underlying futures price, among other factors, implied volatility is a component of option price. The implied volatility of a futures option, is the amount of volatility implied by the market value, or price, of the option. In other words, the implied volatility is forward looking in that it incorporates the current market precariousness as well as what market participants are expecting at some point in the future.


    You may also find that market emotion and sentiment are a component of futures option implied volatility. As long commodity option traders scramble to “buy” volatility through the purchase of options in an attempt to profit from the latest hype, option premiums can and do explode exponentially. As a sidelined options on futures seller, these types of conditions should be inviting. The premise of this approach is to attempt to sell options to buyers that are simply "late to the party". The key is making sure that as a seller you aren't too early.


    Selling Puts can be Lucrative, but the Option Strategy Comes with a Hefty Price Tag


    It is often the case that selling puts is more lucrative than calls, but the added reward carries baggage in the form of additional risk. Due to the increased levels of risk, timing becomes crucial. By nature an option selling program in the futures markets tend to leave room for error in the execution. Nonetheless, being short puts in a spiraling market can quickly change that.


    The phenomenon of put premium in the stock indices being larger than call premium is often referred to as the volatility smile. The volatility smile is a long observed pattern in which at-the-money options have lower implied volatility than out-of-the-money options along with the idea that there is more value in owning a put relative to an equally distant call. This scenario seemed to be born after the crash of 1987 in the U.S.


    While there are no crystal balls to let us know when a futures market will turn around and how low that it might go before it does, being aware of historical patterns in price, volatility and market sentiment may help to avoid a compromising situation. Let's take a look at the relationship between the VIX and the S&P.


    VIX and the S&P 500


    Looking at the chart below, it is obvious that the S&P 500 has been able to forge recoveries during times of spiked volatility as measured by the VIX. Armed with this knowledge, it may be a viable strategy to look at erratic, and many times irrational, trade as a point of entry for put sellers.


     

    Short Put Option Trading Example

    For example, based on this assumption put sellers may have fared well during the lows in 2001, 2003 and 2007, and 2011. That is of course assuming that the option seller wasn't early in his entry. If a short volatility trader enters a market prematurely, there is a strong possibility that the trader will be forced out of the market prematurely due to lack of financing or margin. Let's take a look at one of the most opportune times in history to be a volatility seller (sell puts in the S&P).


    Beginning in the middle of 2002 and throughout the beginning of 2003, put sellers with savvy timing may have done very well. However, trading is a game of risk and those selling puts during those times were accepting great amounts of risk in order to reap the reward.
    Let's take a look at a continuous S&P 500 futures chart during the 2002/2003 lows. While the VIX is a great indication of volatility and extreme market sentiment, it is also helpful to look at indicators of volatility such as standard deviations. Luckily, the creation of Bollinger Bands allows us to visually determine market volatility through the line plot of two standard deviations from its mean. Times of high volatility are denoted by wider bands, or a larger standard deviation, and times of decreasing volatility result in narrowing bands.

    S&P 500 Volatility Trading and Option Selling

     

    As futures market volatility increases, so will option prices.  During such times, commodity option buyers are forced to pay extremely high prices for options that in theory are more likely to expire worthless than not.  On the other hand, option sellers are provided top dollar for accepting theoretically unlimited risk.


     

       

    Option Selling with Implied Volatility in Options

    Higher premiums collected not only increase a futures market trader’s profit potential but it also increases the room for error. The money collected for a short option can be viewed as "cushion" in that it defines the amount in which the trader can be wrong and still make money by shifting the reverse break even further from the market. The RBE of a short put is calculated as follows:


    RBE = Put Strike Price - Premium Collected + Commissions and Fees


    As you can see, the more money that the option seller collects, the deeper-in-the-money the option can be at expiration without resulting in a loss to the trader. 

    According to the hypothetical data available to us, in July of 2002 with the September futures e-mini S&P price near 780, it may have been possible to sell the August S&P 500 futures 680 put for $4.3 in premium which is equivalent to $215 before commissions and fees (each point in the e-mini S&P is worth $50). If this was the case, a trader could have collected a little over $200 U.S. dollars for an option that was, at the time, approximately 100 points or nearly 13% out-of-the-money.


    $215 per contract before transaction costs might not sound like a lot of money, but considering the margin on the trade (required deposit in a trading account) was under $1,000 most traders could have sold them in reasonable multiples. For instance, selling 5 of the August 680 puts might have brought in a little over $1,000 in premium for a margin requirement of less than $5,000. Those that like to calculate return on margin, it would have been roughly 20% had the option seller held the short futures options to expiration a mere four weeks down the road.

     


     

    Selling options on futures in high volatility  

    *This chart assumes selling a single option in the full-sized S&P futures, which is equivalent to 5 e-mini S&P options. We recommend using the e-mini version of the options due to liquidity and option market transparency benefits.

    At expiration, this trade would yield the maximum profit of $1,075 before commissions and fees if the futures price is above 680. Ignoring transaction costs the reverse break even on the trade is at 675.70. This simply means that this particular trade makes money with the e-mini S&P futures price trade anywhere above 675.70 before commissions and fees. Please note that the amount of commission paid will reduce the premium collected and shift the RBE closer to the market. To look at it in another perspective, the trader can be wrong by 104.3 points after entering the trade still manage to break even. If the trader's goal is to put the odds in their favor, this seems to be a commodity option trading strategy to consider.


    Selling Options on Futures with the VIX can be an Attractive Trading Strategy


    Without regard to transaction costs, futures and options trading is a zero sum game; for every winner there will be a loser. Thus, putting your odds ahead of those of your competition is a must. In my opinion, selling options during times of high volatility, while exercising patience, and incorporating experience, is doing just that.


    With that said, where there is reward there is risk; in efficient markets you cannot have one without the other. A short option strategy in the futures markets should only be attempted by those that have ample risk capital to allow for potential drawdowns as well as the ability to manage fear and greed. Fearful traders are vulnerable to panic liquidation at inopportune times in terms of market volatility and option pricing. Likewise, greedy traders are tempted to sell options closer-to-the-money in hopes of higher payouts but the risk may turn out to be unmanageable. I strongly believe that less is actually more when it comes to premium collection. Trade less, collect less, and hopefully enjoy more success.

  • Placing Futures Orders with a Commodity Broker

    Call orders to your commodity broker.Before calling your commodity broker, or a futures trading desk, you should have a good idea of what you would like to do.

    Naturally, if you are paying for her service you will be able to ask questions and request opinions in regards to the strategy and market speculation. You are paying for her expertise so you should be utilizing the services to the fullest. However, you also need to have an opinion and a plan of your own; after all it is your money not your broker's. 


    You should also be aware of where the futures market is currently trading. Often times, commodity traders will place orders that are already "through their price", this either results in the equivalent of a market order, which is executed immediately; or it simply gets rejected by the exchange. It is also important to realize that if you are placing futures orders during times in which the market is closed you are at risk of being exposed to gapping prices on the re-open of trade.


    Mis-communication causes confusion and can create costly errors for you and your futures broker. While your broker will be able to clarify your intentions and coach you along the way, it is a good idea to be aware of the proper procedures in an attempt to avoid negative consequences for both parties involved.


    Calling Your Futures Broker to place a trade:


    1. State your name and commodity account number
    2. Specify whether you are buying or selling the futures contract, or option, and whether or not it is a spread
    3. State the quantity of contracts you wish to trade
    4. Specify the commodity market
    5. Specify the month and, if applicable, the strike price (option order)
    6. Specify the price and or order type (i.e. Limit, Stop, GTC, etc.)
    7. Specify any contingency orders such as a stop loss once filled, limit orders once filled or OCO orders


    * Not all commodity broker, or futures trading desks, accept contingency orders. This is something you should work out prior to the time you would like to enter the futures market.


    Commodity Trade Placement Examples:


    Hi this is John B. Good


    "For account 36612, I would like to place an order to buy 1 September T-Bond at the market. Once filled, place a stop loss at 112'15"


    "For account 36612, I would like to place an order to buy 5 July Corn 410 puts for 4 cents or better GTC"


    "For account 36612, I would like to place an order to sell 3 December Live Cattle at 135.00 on a stop. Day only."


    "For account 36612, I would like to place an order to sell 2 March Orange Juice at 110.00 GTC"


    Tips and Tricks to Placing Futures Orders by Phone with a Commodity BrokerCorn Futures Trading


    1. All futures, and options on futures, orders are assumed to be “day” orders unless otherwise specified as GTC (Good ‘Til Canceled).


    2. Whether you are entering a futures contract, or exiting the position, the order is placed in the exact same manner. Nevertheless, a good commodity broker will recognize your current position to help ensure you are placing the order correctly relative to your open futures and options trades, but this type of service would be a bonus, not a guarantee, so make sure you are fully aware of your current holdings, intentions and commodity market prices.


    3. Before entering a futures order with a commodity broker, it is a good idea to confirm there will be enough margin in the account to cover the desired position. Because futures markets move quickly and timely order entry is necessary to avoid unnecessary slippage or missing a trade altogether, commodity brokers will typically execute an order placed by a trader first, and assess margin later. In the case of a margin shortage, it might be necessary to offset some or all of the positions executed prior to the close of trade. Obviously, this is inefficient and potentially costly to ill-prepared commodity traders.

     

  • The e-mini S&P finally corrects, 2340ish is key

    the financial futures report by futures broker carley garner

    The First 1% down day in the S&P 500 since October 11th.

    Finally, we are seeing the equity market correct. Traders have been waiting months for this, but I doubt it was everything they had hoped for. Although it is a relatively decent one-day sell-off, today's action was meaningless in comparison to the post-election night rally. Further, selling was orderly and without panic. The good news is, the market is looking healthier. Corrective trade is "normal" and should be expected. As crazy as it sounds, the market needs to be bearish before traders can get comfortably bullish and buying picks up.

    Today's shake-up is being blamed on yesterday's Congressional hearings and today's uncertainty regarding Thursday's health care vote in the House. The Republicans claim they have the 216 votes necessary to pass the bill, but some last minute amendments are raising concerns.

    As we've been stating in this newsletter, the markets had priced in political perfection but governments are designed for flawed operations (checks and balances). The financial markets could get rocky as the new administration attempts to administer change.

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