Surviving the rough times to be present for the big moves is the name of the game in commodity trading. With some luck we can even break even while the other participants are getting chopped to pieces. It requires giving up something to get something else. Learn how a few of the big hits can be avoided for a small price. Read about ways to participate in the long haul moves while still sleeping well at night.Let's say our forecast makes us bullish on the market. We want to check out the possibility of buying a future contract and hedging it by buying a put option. There will always be a choice here - either buying an option spread (as in the previous example) or buying a future with an option hedge. One method will always be better than the other. We need to determine this to get our strategy edge on the market. Much depends on the option premiums. Again, this is where it's handy to have an automated option evaluation program.Now we can get creative and more flexible. Let's say you have faith in your forecast that the market is going to rally within 2 - 3 weeks. If it doesn't happen by then, then the trade is suspect. Let's buy a futures contract and also buy a put option as close to the current market price as possible. Hopefully we pay a reasonable price for the put option. The closer you buy it, the less loss and risk if the futures contract declines sharply against you. However, the option premium will be higher too.The put option becomes a synthetic stop loss order for the futures contract. You will lose until the market hits that option strike price and then no matter how far the market drops, the futures contract loss is fixed and limited. Now here's the trick and edge...Select an option with only a small amount of time, like 30 days or so. The option will cost less because of having a short time remaining. If your future contract moves up within 2-3 weeks as you expect, the put option will lose its value quickly and expire within 30 days anyway. The option is the sacrificial lamb that has done its job for a few weeks and then dies. It has protected you against the big potential hit. We dodged the ball. Now it's up to the futures contract. That's where the profit will come from, if the trade is destined to work out.Once the futures contract gets far away from your entry point under the initial protection of the option, you can then move up the future's stop loss order to break-even. A new option could always be bought later if desired to synthetically lock in some profits. However, this is option overuse and the premiums start to catch up with you. We must take on risk or the market will not pay us. We become parasites if we hedge too much, add no liquidity or load risk onto others. In this example we economically used an option to lay off large risk at a critical time. After that brief, partially-hedged window, we again assumed the risk. There are other ways to do this, but beyond the scope of this article. More later.So far we have discussed entry techniques and ways to lower our risk at critical times when our exposure is the greatest. Remember that we are trying NOT to get hit by the dodge-ball and are happy making singles and doubles. Let the newbies swing for the fences and strike out 90% of the time. The idea here is survival until we identify a big market forecast and the move starts. That's the only time to swing for the fences. You want to play it conservative 90% of the time and swing hard 10% at most. To do otherwise is the road to consistent losses. Trade like a guerrilla warfare fighter. Survival first, shoot at our own time and place...sparingly. Let the others line themselves up and face off to their heart's desire. In another article we will discuss methods of using futures and options for synthetic exit strategies. This will include option granting, and futures hedging of options. Good Trading!
No comments:
Post a Comment