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.

Hopefully, most of you are still enjoying the summer vacation.

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We haven't seen this type of summer doldrum trade for quite a while. This hasn't happened since the summer of and is historically rare. The one thing I do know is this won't last. Investors and traders have grown complacent, and that is precisely the environment that breeds chaos. It isn't a matter of if, it is a matter of when volatility rears its ugly head. This isn't a notable news week, but the FOMC minutes released tomorrow afternoon could see a reaction.

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'. In my opinion, the most efficient means of trading equity market volatility isn't through the VIX index, or any other similar measure.

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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. Accordingly, insiders often refer to the practice of buying or selling options as "going long volatility" or "going short volatility". 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. Option sellers are in the business of collecting premium, much like an insurance company, under the assertion that in the long run the premium collected should outweigh any potential payouts.

Options On Futures

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.

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 financial crisis, the VIX can trade into the 70s, or even higher. As a result, not all futures brokers offer access to trade it.

The VIX futures market offers contracts expiring each month.

Futures vs options: what are the key differences?

For instance, fi the VIX moves from 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. 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 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. 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.

Trade the Smalls

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 in the U. 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. 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.

For example, based on this assumption put sellers may have fared well during the lows in , and , and 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. Beginning in the middle of and throughout the beginning of , 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. 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. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification.

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