November 4, 2011 - Issue #608

In This Issue

1. Futures Options Trading 101
2. Wheat Price Map
3. Economic Calendar

1. Futures Market | Futures Options Trading 101

Futures Options Trading First Steps:

1. 100% of Futures Options lose all their 'time value.
2. When Futures Options expire, they are worthless.
3. Most of the time, Futures Markets have no trend.

Futures Options Writing

Most futures options expire worthless and out of the money. Therefore, the option writer is collecting the premium the option buyer paid. There are three ways to win as an option writer. A market can go in the direction you thought, it can trade sideways and in a channel, or it can even go slowly against you but not through your strike price. The advantage is time decay. The writer believes the futures contract will not reach a certain strike price by the expiration date of the option. This is known as naked option selling. To hedge against a futures position. For example: someone who goes long cocoa at 850 can write a 900 strike price call option with about one month of time until option expiration. This allows you to collect the premium of the call option if cocoa settles below 900, based on option expiration. It also allows you to make a profit on the actual futures contract between 851 and 900. This strategy also lowers your margin on the trade and should cocoa continue lower to 800, you at least collect some premium on the option you wrote. Risk lies if cocoa continues to decline because you only collect a certain amount of premium and the futures contract has unlimited risk the lower it goes. Cannon Trading Company Inc. believes in writing futures options, but advises against doing it without the advice and expertise of a knowledgeable broker or specialist. Be strict when choosing which futures options to write and don't believe in writing futures options as your only strategy. Using the same strategy every month on a single market is bound to burn you one month, because you end up writing futures options when you shouldn't. Cannon Trading Co. Inc. believes you should treat option writing just like futures trading. We believe you should stay with the major trend when writing futures options, with rare exceptions. Use market pullbacks to support or resistance as opportunities to enter with the trend, by writing futures options which best fit into your objectives.

Volatility is another important factor when determining which futures options to write, it's generally better to sell over valued futures options then under valued futures options. Remember not to get caught up with only volatility, because futures options with high volatility could always get higher. The bottom line is, pick the general market direction to become successful over the long-term. We also believe in using stops based on futures settlements, not based on the value of the option. If a market settles above or below an area you believed it shouldn't and the trend appears to have reversed based on the charts, it's probably a good time to exit your positions. We can help you understand the risks and rewards involved, as well as how to react to certain situations, i.e.,: if/then trading scenarios. We can either assist your option writing style or recommend trades and strategies we believe are appropriate, using the above guidelines.

Option Buying & Spreads

A common strategy we implement involves the writing and buying of futures options at the same time, known as bull call or bear put spreads. Ratio and calendar spreads are also used and are recommended at times. Please do not hesitate to call for help with any of these strategies or explanations. Here are a few examples we use often:

If coffee is trading at 84, we can buy 1 coffee 100 call and write 2 135 calls with the same expiration dates and 30 days of time until expiration. This would be in anticipation of coffee trending higher, but not above 135 in 30 days. We'd be collecting the same amount of premium as we're buying, so even if coffee continued lower we'd lose nothing. Our highest profit would be attained at 135 based on futures options expiration. To determine risk we'd take the difference between 135 and 100, which is 35 points and divide it by two, because we sold two calls for every one purchased. You'd then add the 17.5 points to 135 and this would give you the approximate break-even point based on option expiration. Risk lies if coffee rises dramatically or settles over 152.50, based on expiration.

A typical calendar spread strategy we use often would be to write 1 option with about 25 days left until expiration and buy 1 with 60 days left. Example: If coffee was trading at 84 and we thought prices might be heading slowly higher. We can write 1 130 coffee call with less time and buy 1 coffee 130 call with more time in the anticipation that the market will trend higher, but not above the 130 strike before the first futures options expiration. Some additional risk here lies in the difference between the two contract months. The objective is, if coffee trades higher over the next month but not above the 130 strike price, we'd collect the premium of the option we sold by letting it expire worthless. In addition, the option we purchased may also profit if coffee rises higher, but it may lose some value due to time decay if coffee doesn't rally enough.

*Note: Some futures options trade based on different futures contract months and should always be considered in your trading. Don't hesitate to call for help with any of these strategies or explanations. Remember, the key is still going to be picking the general market direction correct. Therefore, you must analyze and study each market situation with several different trading scenarios and determine which one best suits your risk parameters.

The art of trading these strategies is deciding when, where, which futures markets, and what ranges to use. If you are an inexperienced options trader use these strategies through the broker assisted program.

For more information, contact one of our commodities brokers

Disclaimer:

Trading commodity futures and options involves substantial risk of loss. The recommendations contained in this letter is of opinion only and does not guarantee any profits. These are risky markets and only risk capital should be used. Past performances are not necessarily indicative of future results. This is not a solicitation of any order to buy or sell, but a current futures market view provided by Cannon Trading Inc. Any statement of facts herein contained are derived from sources believed to be reliable, but are not guaranteed as to accuracy, nor they purport to be complete. No responsibility is assumed with respect to any such statement or with respect to any expression of opinion herein contained. Readers are urged to exercise their own judgment in trading!

2. Wheat Price Map

DEC '11 WHEAT ** NEUTRAL POSITIVE SHIFT **

- Technically the MKT has produced a positive signal against a negative trend. On the SELL side accept BREAKOUT, FADE and REVERSAL strategies off major inflection points with the expectation that the negative momentum is going to resume. UP REVERSAL strategies are recommended over a FADE, which should have at least 1 if not 2 challenges to its integrity before executing a short sale against it. A better approach to a straight DP BREAKOUT strategy is to FADE a positive "squeeze" reaction after a negative breakdown signal against the DIR. - On the BUY side avoid DIR and DP FADE strategies until after the previous session high point or major resistance has been taken out to confirm a break in momentum. Until then, a better opportunity will be a DP REVERSAL strategy. UP BUY BREAKOUT strategies can be profitable but they are aggressive and should look to take profits and potentially REVERSE short at resistance targets.

JS Services Price Map in Action

3. Economic Calendar

Source: Moore Research Center, Inc.

* Please note that the information contained in this letter is intended for clients, prospective clients, and audiences who have a basic understanding, familiarity, and interest in the futures markets.

** The material contained in this letter is of opinion only and does not guarantee any profits. These are risky markets and only risk capital should be used. Past performances are not necessarily indicative of future results.

*** This is not a solicitation of any order to buy or sell, but a current market view provided by Cannon Trading Inc. Any statement of facts herein contained are derived from sources believed to be reliable, but are not guaranteed as to accuracy, nor they purport to be complete. No responsibility is assumed with respect to any such statement or with respect to any expression of opinion herein contained. Readers are urged to exercise their own judgment in trading!