THENONONSENSEGUIDETOBUYINGANDSELLINGOPTIONS

LEARNWHENANDWHYTOBUYORSELLOPTIONSONFUTURESCONTRACTS.

MichaelK.Smith

Copyright©2014MichaelK.SmithAllrightsreserved.

ISBN-10:1497305306ISBN-13:9781497305304

FORWARD

Thisbookcontainsnopictures,nocharts,nographsandmostimportantlynononsense. Itwaswritten inanattempt tocut throughallof themisinformationthat somanyoptionbuyers andoption sellers find so frustrating.Youwillnotneed a PhD. in mathematics or know the Greek alphabet to understand thecontentsofthisbook.

Most books on options paint unrealistic pictures of tradersgetting rich and they usually employ improbable cherry-picked examples ofwinningtradesandtradingstrategies.Thosebooksoftenavoidorminimizethefact thatmanyoption investors losemoney.This book attempts to capture therealityoftradingoptionsonfuturescontractsfromtheperspectiveofalongtimeoptiontraderandcondenseitdowntoitssimplestform.

Thisbookwaswrittenbya20plusyearveteranofthefuturesandoptionsmarketswhohasmadejustabouteverymistakethatthereiswhenitcomestooptiontrading.Hehaslearnedhislessonsthehardwayandhopefullyyou can learn fromhismistakes.He is the founder of the futures and options

brokeragecompanyT&KFuturesandOptions,Inc.andisquotedfrequentlyonvarious investmentnewsmediaoutlets suchasBloomberg,ThompsonReuters,TheWallStreetJournal,MarketWatchandTheStreet.com.Hehasworkedoneononewithfuturesandoptionstradersfromaroundtheworld.

Fordecadeshehasheardoptionsellersspeakabouthowdim-witted it is to buy optionswhen the odds are so disproportionately skewed intheir favor. Then the option buyers retort that option sellers are dim-wittedbecausetheytakeunlimitedriskpositionsforafiniteandoftenverysmallprofitpotential.Thefactofthematteristhatbothlongandshortoptionscanbeuseddepending upon the underlying market conditions. This book will attempt toshowyouwhenandwhytochoosetobeeitherasellerorabuyerofoptionsonfuturescontracts.

Thisbookwaswrittenasaseriesofverysuccinctlessonsandwas kept short and simple on purpose. It is best suited for beginners andintermediate investorswho have had some stock or commodity option tradingexperienceinthepast.Itwillalsohelphedgerstomanagetheirfuturepriceriskusingoptions.Hopefully,thebrevityofthisbookwillmotivateyoutoreadallofthelessonsanddevelopyourveryownwrittentradingplan.

TABLEOFCONTENTS

Part1THEBASICSLesson#1Optionsareveryriskyinvestments.Lesson#2VolatilityPremiumLesson#3TimeDecayLesson#4IntrinsicandExtrinsicValueLesson#5ChoosemoreliquidoptionmarketsLesson#6Thetrendisyourfrienduntilitends.Lesson#7PositionTradersversusDayTradersLesson#8Fundamental,technicalandseasonalanalysisshouldallbeconsidered

beforemakinganoptiontrade.Lesson#9Startwithenoughriskcapital.

Part2BUYINGOPTIONSLesson#1LongOptionMechanicsLesson#2Buyat-the-moneyoptionsifpossible.

Part3SELLINGOPTIONSLesson#1RiskManagementLesson#2Donotoverleverageyouraccount.Lesson#3UnderstandSPANMarginLesson#4Donotusemorethan5%ofyourequityonanyonetradingidea.Lesson#5Spreadoutyourtradesbetweenmultiplenon-correlatedmarkets.Lesson#6Youonlyneedtolearn3strategiestoselloptions.

Part4DEVELOPAWRITTENTRADINGPLANLesson#1Createapersonalwrittentradingplan.Lesson#2Createachecklistforyourwrittentradingplan.

1)Trade#12)Trade#23)Trade#34)Trade#4

Part5HEDGINGWITHOPTIONSLesson#1Hedging101Lesson#2HedgingwithoptionsversusfuturesLesson#3Optionscanbeusedtohedgeyourstockportfolio.

Lesson#4Optionscanbeusedtohedgecommodityprices.

Part6FINDAGOODBROKERAGEFIRM.Lesson#1Findabrokerwhoknowshowtoserviceyourspecifictradingneeds.

Part7RISKREITERATIONSLesson#1Alwaysexpecttheunexpected.

CONCLUSION

GLOSSARYOFTERMS

CONTRACTSPECIFICATIONS

PART1THEBASICS

LESSON#1OPTIONSAREVERYRISKYINVESTMENTS.

Thereisnosuchthingasasafeoptioninvestment.Optionbuyersareatriskfor the entire premium paid plus commissions and fees. Option sellers havetheoretically unlimited risk. Don’t ever let anyone mislead you into thinkingoptionsarealowriskinvestment.

Thereare two typesofoptionsand theyarecallsandputs.Acalloptiongivestheholdertherightbutnottheobligationtobuytheunderlyingfuturescontractataspecificprice(strikeprice)foraspecifictimeperiod.Aput

option gives the holder the right but not the obligation to sell the underlyingfuturescontractataspecificpriceforaspecifictimeperiod.

As with all investments, option investors must manage theirrisk.Thestructureofapurchasedoptionmanagesyourrisktothefinitelevelofzerobuttheoddsareusuallyagainstoptionbuyers.Optionsellersmustactivelymanagetheirtheoreticallyunlimitedriskbuttheoddsareusuallyintheirfavor.Whetheryouareabuyerorasellerofoptionsyoumustactivelymanageyourrisktobesuccessful.

LESSON#2VOLATILITYPREMIUM

Itisthistrader’sopinionthatthemostimportantfactorwhendecidingtobeabuyeror seller of anoption is impliedvolatility.Thepremiumof anoption isincreased when the underlying asset’s volatility increases. This is the pointwhere most books would confuse you with ridiculous amounts of the Greekalphabetandcomplicatedmathematicalequations.

Asimplewaytoguesshowmuchvolatilitypremiumhasbeenaddedtoorsubtractedfromanoptionisbycalculatingthepremiumvalue.Whenthistraderisdecidingwhetherornottobuyorsellanoptionhewillconsiderthecosts of the options as a volatility premium indicator. Keep in mind somecommodities have higher option costs most of the time. This occurs becausesomefuturescontractsaremorevaluableandmorevolatilethanothersmostofthetime.

Cost can be an excellent indicator for option investors as towhentobeabuyerorsellerofoptions.Yourgoalasanoptiontraderistofindovervaluedoptionstosellandundervaluedoptionstobuy.Theideaistolearntobuyorselloptionsonlywhenyouhaveanadvantage.Ifyoucannotfindtradesthatmeetyourbuyingandsellingcriteriayouwillnottrade.

(Whenbuyingorsellingoptions,thistraderpreferstousea4-6monthtimehorizon.)

Let’s cover this trader’s overly simplistic, often ridiculedapproachtochoosingpotentialoptionstobuyorsellbasedentirelyonprice.Ifyoucanbuy an at-the-moneycall or putoptionwith4-6monthsof timeuntilexpiration for less than $1,500 thismight be the time to consider buying thatoption.That’sit.

Now let’s apply this price based strategy to selling options.Yourgoalis tofindanoptiontosell that isat least25%out-of-the-moneyandhas4-6monthsuntilexpirationandissellingforatleast$500inpremium.Iftheoptionmeetsthesecriteria,youmayconsidersellingthatoption.

Let’s be redundant to stress the importance of volatilitypremium.Thelogicbehindthepricebasedoptionbuyingandsellingrelatestotheamountofvolatilitypremiumthathasbeenaddedtoorsubtractedfromthepremiumoftheoption.Itisnotoftenthatvolatilityishighenoughtoenableyoutosellanoption that is25%out-of-the-moneywith4-6monthsof timebeforeexpiration for $500. This forces you to trade onlywhen option sellers have aclear advantage over option buyers. Conversely, it is only during periods oflowervolatilitythatthemarketswillallowanoptionbuyertofind4-6month,at-the-moneyoptionswithapremiumcostlessthan$1,500.Againthisforcesyouto be disciplined and buy options onlywhen you have a clear advantage overoptionsellers.

(Wewill cover later in this book a specific trading plan andchecklist.Usingaminimumandmaximumoptionpriceisacomponentofthatplan. Youmaywant tomodify these numbers based on your own goals, risktolerance and trading abilities. The idea is to use option price as one specificelementofyourdisciplinedwrittentradingplan.)

LESSON#3TIMEDECAY

Optionsarewastingassets.Eachandeverydaytheirpremiumisbeingerodedby timedecay.Timedecay is thebest friendof theoptionsellerand theworstenemy of the option buyer. As an option ages its premium is eroded morequicklyandthisisespeciallytrueduringthelast60daysofanoption’slifespan.

(Thisisoneofthemainreasonswhyoptionsellersoftenhaveanadvantageoveroptionbuyers.)

LESSON#4INTRINSICANDEXTRINSICVALUE

T he intrinsic value of an option refers to the amount an option is in-the-money.Let’suseahypotheticalexampletocalculatetheintrinsicvalueofanin-the-moneycrudeoil call option.Thepremiumvalueof theoption is currently$3,125.Thecalloptionhasastrikepriceof$100andtheunderlyingcrudeoilfuturescontractpriceiscurrently$100.45perbarrel.(Theoptionis45centsin-the-money.)Crude oil is a 1,000barrel contract and eachone cent is equal to$10. The intrinsic value of the crude oil call option is $450. The rest of theoption’spremium($2,675)consistsofextrinsicvalue.

The extrinsic value of an option is made up of mainly timevalue and volatility premium. (Most investment glossaries disagree with thisdefinitionanddefineextrinsicvalueasbeingthesameastimevalue.Thistraderdoes not understand why volatility premium is not mentioned in thosedefinitions. Volatility premium plays a very critical role in the expansion andcontractionofanoption’spremium.Thisisespeciallytruewhentheoptionsareout-of-the-moneyandtheirvaluesconsistof100%extrinsicvalue.)

High demand for the specific strike price of an option canexpand itspremiumaswell.Quiteoftenevennumberedstrikepricesaremorepopular than odd numbered strike prices. In the crude oil example above the$100strikepricewillmost likelyhavemoreopeninterest than the$101strikepriceandthe$99strikeprice.

LESSON#5CHOOSEMORELIQUIDOPTIONMARKETS

Myfavoritemarketsare theEuroCurrency, JapaneseYen,eminiStandardand Poor’s Index, Treasury Bonds, WTI Crude Oil, Natural Gas, Corn,Soybeans,Wheat, FeederCattle,LiveCattle,LeanHogs,Gold, Silver,CoffeeandSugar.Thesemarketsareliquidenoughtotradeeffectivelymostofthetime.Thisliquidityallowsyoutradeinandoutofyouroptionseasilyandefficiently.

Sometimes Cotton, Cocoa, Copper, RBOB Unleaded Gas,ULSDHeatingOil andOrange Juice canbe liquid enough to easily enter andexit with your option trades but the liquidity of these markets changes

periodically.Thisliquidityincreasecanoccurwhenacommoditymarketattractsthe attention of large speculators such as hedge funds and large commoditytrading advisors. Their buying and selling will increase the liquidity of theunderlying futuresmarket. This can often help to increase the liquidity in theoptionsoftheunderlyingfuturescontract.

Another variable that can increase the liquidity of normallyilliquidmarkets ismediaattention.Sometimesthefundamentalsofaparticularcommodityattract themedia’sattentionwhich in turncan lead largeandsmallspeculators to thosemarkets.This often addsmore liquidity to those typicallyilliquid markets. It is during these times of increased attention and tradingactivity that the volumes and open interest in these markets can make themliquidenoughtotradeoptionseffectively.

An example of a very illiquid market becoming relativelyliquidduringcertaintimesoftheyearistheorangejuicemarket.Weathereventssuch as freezing temperatures or a potential hurricane affecting Florida canincentivizeamuchhigherthannormalnumberofoptioninvestorstospeculateinorange juiceoptioncontracts.This increases the liquidityof thoseoptionsandcanmakethisfrequentlyinefficientanddangerousmarketmuchmoretradable.

Another example is the RBOB unleaded gas market. Duringmostof theyear thismarkethas lowvolumesandopen interestbutduring thespring and summer months speculators often begin to pile into unleaded gasoptions.Theyusuallydothistotryandtakeadvantageofthe“drivingseason”whenmostAmericansgetintotheircarsandtraveltotheirvacationdestinations.During the spring and summermonths theoptions in theunleadedgasmarketregularlybecomemuchmoreliquidandefficient.

Usually, you do notwant to get into amarketwith very lowopeninterestandvolumebecausequiteoftenyouwillgettakenadvantageofbya largebid/askspreadwhenenteringandexitingyouroptionpositions.This isoften glaringly evident when buying and selling deep-out-of-the-money anddeep-in-the-money options because there is often very little demand for thoseoptions.

Yourgoal is tobediversifiedbetweendifferent sectorsof thecommodity markets and different markets within those various sectors.Makesure that the markets and strike prices that you want to invest in are liquidenoughtotrade.

(SeetheCONTRACTSPECIFICATIONSsectionattheendofthebooktolearnmore.)

LESSON#6THETRENDISYOURFRIENDUNTILITENDS.

Youdonothavetobeaprofessionaltechnicalanalysttotellwhetheratrendisdown,uporsideways.Stickwiththetrend.Mostofthistrader’scountertrendoption tradeswere losers.Picking the topsandbottomsofamarket isa fool’serrand.Thistraderrecommendsusingweeklychartstoseethetrendforoptiontrades. Weekly charts eliminate the hourly and daily “noise” in the marketsallowingyoutomoreeasilyuncoverthemacrotrendsthatyouareseeking.

LESSON#7POSITIONTRADERSVERSUSDAYTRADERS

Thisbookwaswrittenmore fromaposition trader’smindset than thatof adaytrader’s.Thereareprosandconstobothofthesetradingstylesandyouwillhavetodecidewhichonefitsyourpersonalitytypethebest.

Aposition trader isseekinga longtermtrendtofollow.Theyarequiteoftenmuchmoreinterestedinthelongtermsupplyanddemandpictureforthecommoditiesthattheytradethantheshorttermchartsanddailytechnicalanalysis.This typeof traderwill often stay in their trades forweeks andevenmonths at a time. They are typically not as concerned with the day to day

happeningsintheunderlyingfuturesmarketsasadaytradermightbe.A day trader on the other hand views the markets using a

trading timehorizonofseconds,minutesandhours.Theywillexit their“day”tradesbeforethecloseofthemarketsonanygivenday.Thismeansthattheydonotholdtheirtradesovernight.Thesetradersareusuallyveryadeptattechnicalanalysisandusetheirtechnicalindicatorstofacilitatetheirtrading.Daytradersquiteoftencouldn’tcarelessaboutthelongtermsupplyanddemandpictureforthecommoditiesthattheytrade.Theyareusuallyonlyconcernedaboutthedailymarketpricetrends.

LESSON#8FUNDAMENTAL,TECHNICALANDSEASONALANALYSISSHOULDALLBECONSIDEREDBEFOREMAKINGANOPTIONTRADE.

FundamentalAnalysis

Supplyanddemandaretheultimatedriversofallcommoditymarketsintheend.Overtheneartermhedgefunds,largecommoditytradingadvisorsandlargecommercialtraderscanmovethemarketswiththeirmoneybutintheendsupplyanddemandwilldictatethepriceofacommodity.Therefore,youneedtoknowthe fundamentals of themarket that youwant to trade. There aremany greatresourcesontheinternetforFREE.TheUnitedStatesDepartmentofAgricultureandTheDepartmentofEnergyaregreatresourcesandhaveweeklyandmonthlyreports. A simple internet search can find you the association or government

entityforjustaboutanycommodityoutthere.Youcanfindaconsolidatedlistofusefullinksforfundamentalanalysisatwww.tkfutures.com/links.htm.

TechnicalAnalysisThistraderusesweeklybarchartstofindamacrotrendinaspecificcommodity.Charts are very useful andwill oftenmirror the underlying fundamentals of amarket.Look for situationswhere the supply anddemandpicturematches theweeklycharts.Forexample,whenthesupplyanddemandnumbersarebearishfor a particular commodity and the charts agree and are showing you adowntrend,lookforbearishoptionstrategiestoimplement.

SeasonalAnalysisSeasonal analysis is often misunderstood and misused. There are some verystrongseasonalpatternsthatshouldbeacknowledgedwhenchoosinganoptiontrade.Anexampleofaseasonal tendencythatmightwarrantsomecredence isthetendencyforsoybeanstofindabottomsometimeintheSeptember/OctobertimeframeastheU.S.harvestincreasesthesupplyofsoybeansonthemarket.Thisdoesnothappeneveryyear andweather andother factorswill obviouslyaffect this pattern but historical tendencies should be taken into considerationwhen lookingforopportunities inoptions.Therearea fewcompanies thatsellthisinformation.Aninternetsearchof“seasonalfuturespatterns”willfindyoualistofcompaniestochoosefrom.

This trader recommends choosing trades in which thefundamentalsarereflectedcorrectlybythemarket’strend.Iftheseasonaltrenddoesnotmatchupitisnotnecessarilyadealbreakerbutitshouldcertainlybetakenintoconsideration.Whentheseasonaltrendmatchesthefundamentalandtechnicaltrendsofamarket,buyingorsellingoptionscanbeconsidered.

LESSON#9STARTWITHENOUGHRISKCAPITAL.

Makesurethatyouhaveenoughriskcapitalbeforegettinginvolvedinoptiontrading.This traderhasseen toomanyunderfundedoption traders losemoney.Thisprobablyoccursforafewdifferentreasons.

1) Smaller accounts usually have to risk toomuchoftheirequitypertrade.Iftheyloseontheirfirsttradeortwoitcantakethemoutofthegamebefore theygetachance tohaveawinningtrade.2) Smaller accounts are not able to properlydiversify into multiple non-correlatedmarkets. As with any type of investment,diversificationiswiseforoptioninvestorsaswell.Itisveryprudenttospreadthetraderiskbetween multiple markets to help minimizetheexposuretoapotentiallylosingtrade.3)Smalleraccountsdonothavetheabilitytocontroltheirpositionsizesandscaleintoandout of trades. This trader often recommendsscaling into and out of your winning andlosing trades. This is not possible if you donot have enough funds in your account toenterintomultipleoptioncontractsatatime.

Thisdoesnotmeanthatsmalleraccountsdonotmakemoneysome of the time. However, being properly funded allows you to build a

diversifiedoptionportfolioinsteadof“rollingthedice”onatradeortwo.Thistraderbelievesthataninvestorplanningonbuildingaportfoliobasedonbuyingandsellingoptionswillneedatleast$50,000toallowforproperdiversificationand the implementation of risk management procedures. This allows fordiversification between multiple sectors of the futures markets and multiplemarketswithinthosesectors.

(Remember that selling options has similar risk to a futurescontractandmargincallscananddooccur.Youwillwanttohaveplentyofcashcushion in your account when the inevitable short option trade “blow up”occurs.)

PART2BUYINGOPTIONS

LESSON#1LONGOPTIONMECHANICS

T he purchaser of an option is at risk for the premium paid (to the optionseller)andthecommissionsandfeeschargedbythebroker,exchangesandtheNational Futures Association. Purchased options are also called long options.Theprofitpotentialofacalloptionbuyer is theoreticallyunlimited.Theprofitpotentialofaputoptionbuyeris limitedtowhateverthedifferenceisbetweenthe strike price and zero. This is because a commodity cannot be worth anegativenumber.Itisabsurdtothinkthatanoptiontraderwillhaveaprofitofinfinityobviously;wearetalkingintheoreticalterms.

(Thepersonthatsellsanoptionbuyertheirlongoptionshastheothersideofthetradeandisconsideredtobeshortthoseoptions.Optionsellersarealsocalledoptiongrantorsoroptionwriters.)

LESSON#2BUYAT-THE-MONEYOPTIONSIFPOSSIBLE.

A fter years of trying complicated option buying strategies such as bull callspreads,bearputspreads, ratiospreads,straddlesandstrangles this tradernowbelievesinthekeepitsimplemethodtochoosingoptionstrategies.Thesedaystheoptionbuyingstrategymostoftenrecommendedbythistraderisbuyingat-the-moneycallandputoptions.

At-the-moneyoptionsareoptionswhosestrikepriceisexactlythesameastheunderlyingfuturecontract’sprice.Buyingat-the-moneyoptionsis not always feasible because the underlying futures contract is usually inmotion.Let’sassumethatyouhavedoneyourhomeworkanddecidedthatitistimetobuyanat-the-moneyDecembercorncallbutwhenyouareabouttoplacethe trade you see that the underlying futures price is at $4.04 ½ cents. Yourchoicesofstrikepricesarethe$4.00andthe$4.10.

(Your purchased option does not need to be exactly at-the-money. You can choose the $4.00 call that is 4 ½ cents in-the-money or the$4.10strikepricethatis5½centsout-of-the-money.)

ExampleFor this example let’s assume that the $4.00 call option costs $1,460 and the$4.10 call costs $1,225. This traderwouldmost likely recommend the in-the-moneystrikepricebecause it isstillunder the$1,500maximumpremiumrulementionedearlier.

(Youcouldhavealsochosenthe$4.10strikeprice.Oneortwostrikepricesarenotveryimportanttothetradingplanthatwillbeoutlinedlaterbut do not go more than three strike prices out-of-the-money when buyingoptions.)

AdvantagesThe advantage to buying options is the limited risk profile and the profitpotential.

DisadvantagesAlongoptioncanlosemoneyafewdifferentways:

1) If the underlying futures market tradessideways the time decay will erode yourpremiumandcauseyoutolosemoney.2)Ifthemarketmovesagainstyoutheoptionwilllosemoney.3)Themarketcanalsomoveinthedirectionthat you expected it to and your option canstill lose money. This can happen if themarket does not move in your favor byenough to offset the commissions, fees, andtimedecayofyouroption.4) A reduction in volatility can shrink thevolatilitypremiumwithinyouroptionandcanalsocauseyoutolosemoney.

PART3SELLINGOPTIONS

LESSON#1RISKMANAGEMENT

Sellingoptionsonfuturescontractshasasimilarriskprofiletoalongorshortfutures position. In the futures markets, traders often use stop orders to limittheirlosses.Optionsellerscanusestopordersaswelloramentalstopiftheyaredisciplined enough to do it thatway.Many option sellerswill cut losses (buyback)optionsthathavedoubledinvalueorbeginscalingoutoftheirpositionsasthemarketbeginstomoveagainstthem.

ExampleHere isahypotheticalexampleofanaturalgasoption trade.Yousolda$5.50natural gas call for$500and theoption is nowworth$1,000.Youwouldbuybacktheoptionfor$1,000andtakethe$500loss.Thisismucheasiersaidthandonebecausethemarketsdonotalwaysmoveinanorderlyfashion.

(Thistraderrecommendsthatyouscaleoutoflosingtrades.)

ExampleLet’susethenaturalgasexampleabovetoshowyouwhatitmeanstoscaleoutof a losing trade.You are short 6 short natural gas calls and thepremiumhasmovedagainstyouby25%.Youdecide tobuyback3ofyouroptions to limityour risk exposure. Let’s assume again that your 3 remaining positions havemovedagainstyoubyanother25%.Youmaydecidetobuybackanotheroneofyouroptionsandsoonandsoforth.

(Thisisthedecisionofthetraderandwillofcoursehavetobemodified based on the risk tolerance of the individual. The idea is to have awrittenlosspreventionplaninplacebeforetheactualtradesareeverinitiated.)

LESSON#2DONOTOVERLEVERAGEYOURACCOUNT.

Thistraderbelievesthatusingapproximately50%ofyourmarginableequity

is the maximum any option selling account should use. In other words, a$100,000accountshouldnotusemorethan$50,000oftheavailableequity.Theideaistokeepenoughmoneyincashtoavoidmargincallswhentheinevitableoption trade mishap occurs in one of your short option trades. This moneymanagementtechniquecanhelpkeepyououtoftrouble.

LESSON#3UNDERSTANDSPANMARGIN

SPANmarginreferstothemathematicalformulausedbyallU.S.exchangestofigureoutwhatmarginrequirements investorsneedforshort (sold)options.SPANmarginchangesonadailybasisandissetbytheexchanges.TheSPANmarginrequirementisapproximately150to200%ofpremiumcollected.

Let’slookatahypotheticalexample.Youjustsoldagoldcalloption and collected $600 in premium and the SPAN margin requirement is$1,700.Take the totalmargin requirement of $1,700 and subtract the $600 ofpremium collected and this will equal $1,100. Youwill need to have at least$1,100incashtosellthatgoldcalloption.

(SPAN margin correlates closely to premium value of youroption.Iftheoptionpremiumofthegoldcallthatyousoldintheaboveexampleincreases by $200, then the chances are that your SPAN margin requirementincreasedbyapproximately$200aswell.)

LESSON#4DONOTUSEMORETHAN5%OFYOUREQUITYONANYONETRADINGIDEA.

Let’s assume that you have $100,000 in your account and youwant to sellNovember soybean calls for $700 each. Hypothetically, the SPAN marginrequirement is $1,700 for each option. Take the total margin requirement of$1,700andsubtractthe$700premiumcollectedandthiswillequal$1,000.Thismeansthatyoucanonlysell5ofthoseNovembersoybeancallswithoutgoingover5%ofyouraccountequity.

(Obviously, if themarketmoves against youor the exchangeraises itsmargin rates youwill exceed your 5% equity level.Once the equitylevel reaches the 7-8% range, begin scaling out of your positions to get yourequity level back below the 5% maximum. Margins rates are determined bymarketriskandthevalueoftheunderlyingcontract.)

LESSON#5SPREADOUTYOURTRADESBETWEENMULTIPLENON-CORRELATEDMARKETS.

IfyouchoosefromtherecommendedmarketsintheBASICSsectionofthis

book, it should not be hard to find 5-6 decent non-correlated tradingopportunities at anygiven time.Thekey is tomake sure that themarketsyouchoosetotradearetrulynon-correlatedtoeachotherorattheveryleastexhibitalowcorrelation.

Some markets are very highly correlated to each other andshould not be considered separate trading ideas. Crude oil, heating oil andunleadedgasareveryhighlycorrelatedtoeachother.Heatingoilandunleadedgasaredistilledfromcrudeoilandarethereforeaffectedinasimilarwaybyanypricemovements in crudeoil.For instance, sellingputs in crudeoil, unleadedgasandheatingoilshouldbeconsideredonetradingideaandyourequityshouldbedispersedaccordingly.

Soybeansandcornareoftencorrelatedbecause theyarebothfeed substitutes for each other and they are planted in the same geographicalregions which makes them susceptible to damaging weather eventssimultaneously.

Goldandsilverarealsocorrelatedtoeachotherattimes.Bothare considered precious metals and are often substitutes for each other wheninvestorsare seekingahedgeagainst inflation,currency risk,geopolitical risk,interestraterisk……

Quite often it is hard to find 10 different good tradingopportunities. IT IS OKAY TO TRADE LESS. IT IS OKAY TOUSE LESSTHAN5%OFYOUREQUITYONANYGIVENTRADE. IT ISOKAYTOUSELESSTHAN50%OFYOURTOTALEQUITY.

Ifyoudecidetobecomeanoptionselleryouwillbegladthatyouarenotoverleveragedonthedayalocklimitmoveintheunderlyingfuturescontract of your short options is against you. If you trade options for longenough thiswillmost likelyoccurat somepoint. Insteadof ignoring this fact,youshouldplanaheadforit.Thatiswhypositionsizeanddiversificationaresoimportantwhenbuildinganoptionportfolio.

(All U.S. dollar denominated commodities have an inversecorrelationtotheU.S.dollarwhichbydefinitionmeansthattheyallcorrelatetoeachothertosomeextent.AstrongU.S.dollarisoftenbearishforcommoditiesin general because itmakes itmore expensive for foreign buyers to purchaseU.S. commodities. On the other hand, a weakU.S. dollar is often bullish forcommoditiesfortheoppositereason.Thisisusuallyaloosecorrelationbutthiscorrelationdoesexistandshouldbetakenintoconsideration.)

LESSON#6YOUONLYNEEDTOLEARN3STRATEGIESTOSELLOPTIONS.

CreditSpreads

Thecreditspreadisactuallyalimitedrisktrade.Wewillcovertwotypesofcreditspreads.TheyaretheBearCallSpreadandtheBullPutSpread.Eachofthesecreditspreadsconsistofashortoptionandalongoptionfurtherout-of-the-money. The purchased option changes the risk profile from theoreticallyunlimited toone that is finite.This tradersuggestsusingcredit spreadsonly iftheshortoptionhas4-6monthsuntilexpirationandisat least25%out-of-the-moneyandallowsyoutocollectatleast10%ofthetotalrisktaken.

ExampleLet’s look at an example of aBearCallSpread and let’s also assume that thefuturespriceoftheunderlyingsoybeancontractisat$10perbushel.Youbelievethatsoybeanpricesaregoingtogodown.

Hypothetically, you sold a $12.50 soybean call (25% out-of-the-money) andcollected$2,000.Thenyou bought a $14.50 soybean call andpaid$1,000.Yourendresultisapremiumcreditof$1,000.

The riskprofileof this trade is limited to the spreadbetweenthe strike prices minus the premium collected. The contract size for soybeanfutures is 5,000bushels and eachone cent is equivalent to$50.There is a $2differencebetweenthetwostrikepriceswhichisequalto$10,000.Thisleavesatotalriskof$9,000plusthecommissionsandfeesthatyoupaid.Youcollectedapproximately$1,000andtheriskis$9,000whichmeansyourrisktopremiumcollectionratioisabovethe10%minimum.

ExampleThe bullish credit spread to use is the Bull Put Spread. This spread is the

opposite of the Bear Call Spread outlined above. Let’s use the hypotheticalsoybeanexampleabove.Youwouldsellthe$7.50soybeanput(25%out-of-the-money)andbuythe$5.50put.

(The premiums collected and the strike prices are somewhatridiculous for thesecredit spreadexamples. Itwould requireextremevolatilityforyoutobeabletocollect$2,000forasoybeancallorputthatis25%out-of-the-money.ThestrikepricesontheBullPutSpreadarealsounrealisticbecausesoybeansmay never see a price below $5.50 again. However, the example ismeanttobeoverlysimplisticandisusefulbecauseitoutlinestoyouhowthesetwo credit spreads would be structured if you did decide to implement thisstrategywithinyouroptiontradingportfolio.)

AdvantagesThere are a fewadvantages to credit spreads.Theyare limited risk trades andtherefore are charged lower margin rates. They also allow you more stayingpowerthananakedoptionstrategybecausethepurchasedoptionoffsetssomeofthe losses thatwill accrue if themarketmovesagainstyou.Remember, as thesoybeanmarket rallies higher, your purchased call in the Bear Call Spread isaccruinginvaluewhiletheshortcallislosingmoneyandviceversafortheBullPutSpread.

DisadvantagesThemaindrawbacktoacreditspreadis thetimehorizonforholdingontothistrade.Youwillusuallyhave toholdcreditspreads longer than theothernakedoptionsellingstrategiesthatwewillcovertooptimizeprofits.

(Nakedoptionsellersoftenbuybacktheoptionsthattheysoldtolockinprofitsbeforeexpiration.Creditspreadtradersoftenstayinthetradeuntilexpirationdayortheyexitafewdaysbeforewhenthereisverylittletimevalue left in the option premium. To fully maximize credit spreads, shortstrangles and sellingnaked calls andputs youwould have to hold the optionsuntilexpiration.)

Riskmanagementstrategiesforcreditspreadsaresimilartothenakedoption strategies.Youwill cutyour losses if thepositionmovesagainst

you causing your premium collected to double or you will scale out of yourspreads.

ShortStranglesAshortstrangleisoftenusedinmarketstradinginawelldefinedpricerange.Itconsistsof sellinganout-of-the-moneycall andanout-of-the-moneyput.Thistradersuggestsusingthisstrategyonlyifyoucanselloptionswith4-6monthsuntilexpirationthatareatleast25%out-of-the-moneyandallowyoutocollectatleast$500.

ExampleLet’s use the crude oil market for this hypothetical example. The underlyingcrudeoilfuturescontract isat$100andyousolda$125calloptionanda$75putoption.Thecalloptioncollected$700andtheputoptioncollected$500.

(It is often the case that call premiums are higher than putpremiumsbecausethereistypicallyahigherdemandforcalloptions.)

AdvantagesTheadvantagestoshortstranglesincludelowermarginratesandoffsettingpricemovements. Because you are playing both sides of themarket, the exchangesoftenviewastrangleasamoreconservativetradethansellingnakedoptionsonone side of themarket or the other. This strategy canworkwell in sidewaystrendingmarkets.

Short strangles can also offset each other as the underlyingmarket moves up or down. Let’s assume that you entered into the crude oilstrangleaboveandthemarketbegins torallyhigher.Obviously, this isbadforthecalloptionthatyousoldbuttheputoptionwillhelptooffsetsomeofthoselossesbecauseitisgainingasthecalloptionislosing.

DisadvantagesThemain drawback of the short strangle is the vulnerability of an increase involatility of the underlying futures contract.A rapid increase in volatilitywillmostlikelyincreasethevolatilitypremiumonboththecallandtheputthatyousoldandbothsidesofthetradecanmoveagainstyou.

Youmightalsohaveahugepricebreakoutononesideortheother. This might quickly double the premium received and your riskmanagementstrategiesmustbeimplementedasquicklyaspossible.

Usethedoublingofpremiumriskmanagementstrategytolimitanylossesinshortstranglesorthescalingoutprocedures.Intheexampleabove,$700wascollectedontheshortcall.Cutyourlossesifthepremiumreachesthe$1,400 level for thatoptionorbegin scalingoutof theposition.Theshortputcollected$500.Cutyourlossesifthepremiumreachesthe$1,000levelorbeginscalingoutofthepositionsforevery25%thattheymoveagainstyou.

NakedCallsandPutsSellingnakedcallsandputsbringschills to thespinesofmanyoption traders.Sellinganakedcallwhenyouarebearishamarketorsellinganakedputwhenyouarebullishamarket is thesimplestoptionsellingstrategythatexists.Thistradersuggestsusingthisstrategyonlyifyoucanselloptionswith4-6monthsuntilexpirationthatareatleast25%out-of-the-moneyandallowyoutocollect$500.

AdvantagesThemainadvantagetothisstrategyisitssimplicity.Thisstrategycanbeusedinmarketswithadefinedupordowntrend.

DisadvantagesThe main drawback is the risk profile. At any time the underlying futurescontractcansustainahugepricebreakoutagainstyourpositions.Theunlimited

riskprofileofthistradeshouldagainbemanagedbyincorporatingthedoublingofpremiumorthescalingoutproceduresmentionedbefore.

PART4DEVELOPAWRITTENTRADINGPLAN

LESSON#1CREATEAPERSONALWRITTENTRADINGPLAN.

Itisthistrader’sbeliefthatapersonalwrittentradingplanisthemostcrucialcomponentofanoptiontrader’stoolbox.Eachtradershoulddeveloptheirownwritten trading plan that will be followed at all times. Quite often the singlebiggestinhibitorofanoptiontraderisthemselves.Thesemarketsareveryadeptatexposingone’scharacterdeficienciesandawrittentradingplanhelpstradersstaydisciplinedduringthetoughtimes.

Somanyoption traders lack the ability todetach emotionallyfrom the markets and their trades. They lack discipline and often hold theirloserswaytoo longandexit theirwinnerswaytooearly.Theiregosandpridecan often cloud their judgment to the point of paralysis. Soon the trader has

arrivedat thepointwhenwishes,hopesand faithbecomepartof their tradingplan. This in turn quite often leads to those portfolio killing trades that cannegatemonthsandyearsofprofitsinaperiodofhoursanddays.

Manytraderswilldevelopaverywellthoughtoutandpracticaltrading plan for choosing and entering their trades but they never give anythoughts to exit strategies. DEVELOP A WRITTEN TRADING PLANCOMPLETE WITH ENTRY AND EXIT STRATEGIES FOR BOTHWINNINGANDLOSINGTRADES.

LESSON#2CREATEACHECKLISTFORYOURWRITTENTRADINGPLAN.

Eachindividualtradermustdeveloptheirownwrittentradingplanbasedontheiruniquerisktolerancesandabilities.Thisismucheasiersaidthandonebutitisabsolutelynecessary.Use the tradingchecklistexamplebelowtohelpyoucreateyourownoptiontradingchecklist.

OptionTradingChecklist1)Checkthetechnicals.2)Checkthefundamentals.3)Checktheseasonals.

4)Findacontract4-6monthsout.5)Checkoptionprices.6)Chooseyouroptionstrategy.7)Deviseanentrystrategy.8) Devise an exit strategy for losses andprofits.9) Confirm that your trading ideas are non-correlated.10)Placeyourtrades.

Let’s go through a hypothetical example of the thoughtprocessesyoumightusetochooseyourvariousoptiontradesusingyourwrittentradingplanandtradingchecklist.

ExampleYou just opened a self directed trading account and deposited $100,000. Youhave been using a “demo” account version of the trading platform that yourbrokerageoffersforthelasttwoweeks.Youarenowcomfortableenoughtogo“live”withyourtradesandusethe“live”tradingplatform.

(DemoaccountswillbecoveredinmoredetailintheFINDAGOODBROKERAGEFIRMsectionlaterinthebook.)

TRADE#1

1)Youlookthroughtheweeklychartsofthecommoditiesthatyoufollowandyouseea downtrend beginning in the sugar market.(Bearish)2)Youdoyourfundamentalanalysisandfindthatthereisaglobalsurplusofsugaranddemandiscurrentlyfalling.(Bearish)3) You checkyour seasonal chart forsugar and find out that sugar often sells offthis time of year coinciding with the sugarcaneharvestinBrazil.(Bearish)4) You check the available contractmonths for sugar and find the July contracthas 150 days left until expiration. (This fitsnicely into your 4-6 month option timehorizon.)5)Youcheckthecalloptionstrikeprice25% out-of-the-money and it is only sellingfor $112. (This does not meet your $500minimum for selling options rule.)You thencheck the at-the-money put strike price andthe premium is $950. (This does meet yourless than$1,500at-the-moneyoptionbuyingrule.)6)Youdecidethatthebestoptionstrategyforthis particular instance is purchasing at-the-moneyputs.7) Youdecide thatyoureally like thistradeandyouwillgoallin.Becauseyouarea disciplined option trader, all in to youmeansupto5%ofyourequity.Youdecidetobuy5oftheat-the-moneyJulysugarputsfora total cost of $4,750 plus commissions andfees. (This meets the 5% or less of your

equityruleforatradingidea.)8)Youdecidethatyourlossstrategywillbe to exit all 5 of your put options if thepremiumgoesdownby50%.Youdecidethatyourexitstrategyforprofitswillbeagradualscaling out of the positions for each 25%incrementthattheoptionsaccrueinvalue.(3at25%,1at50%and1at75%)9)Thisisyourfirsttradesothereisnoneed todecide if it is non-correlated toyourothertradingideas.10) You open your trading platform andplaceyourveryfirstoptiontrades.

Areyoureadytolookforanothertrade?

TRADE#2

1)Whileyouwerecheckingthechartsof your favorite commodity list you noticedthat natural gas has been trading in a welldefined sidewayspatternwith approximatelya$2.00pricerange.(Sidewaystrend)2)Yourfundamentalanalysiscomesupwith the recent Energy Information

AdministrationreportfromlastThursdaythatshowed the underground supplies of naturalgas are right in the middle of their 5 yearaverage. The demand numbers are veryaverageaswell.(Sidewaystrend)3) The seasonal chart on natural gasshows a tendency for natural gas to rally atthis time of year. (Bullish) You check theprice charts and see that natural gas is nearthetopof itsrecent tradingrangebut isnowbeginning to sell off. (Bearish-You decidethat these two contradictory bullish seasonalandbearishtechnicaltrendsoffseteachotherand fit into the sideways trend idea that youaretryingtotakeadvantageof.)4) You check the available contractmonthsfornaturalgasandfindacontactwith132daysuntilexpiration.(Thisfitsintoyour4-6monthsoptiontimehorizon.)5)Youcheckthecalloptionsfornaturalgas 25% out-of-the-money and they areselling for $700. (This fits your $500minimum for selling options.You check theput options 25% out-of-the-money and theyaresellingfor$500.Thisalsofitsyour$500minimumforsellingoptions.)6)Youdecidethatthebeststrategyforthisparticularinstanceisashortstrangle.Youcheck themargin requirements and after thepremiums are collected they will total $900perstrangle.7)Youlikethetradebutyourememberhowvolatilenaturalgascanbesoyoudecideto enter into only 3 short strangles in theApril natural gas market. The initial marginrequirementis$2,700plusyourcommissionsandfees.(Thismeetsthelessthan5%ofyourequityrule.)8)Youdecidethatyourlossexitstrategy

willbetoscaleoutofoneoptionatatimeifthey move against you by 25% increments.Your profit exit strategy is to simply let theoptionsexpireworthless.

(Yourealizethatthereisachancethatonesideofthisstranglemaymoveagainstyouwhile theother sideprofits.This iswhyyour loss exitstrategyisbasedoneachindividualoptionandnoteachindividualstrangle.)

9) Sugar prices do not correlate tonatural gas prices. (Non-correlationconfirmed)10)It’stimetoplaceyourtrades.

TRADE#3

1)Asyoucontinuetoperusetheweeklychartsofthecommoditiesthatyoufollowyounotice thatcrudeoilseemstohavebottomedandisnowtrendinghigher.(Bullish)2) You check the weekly crude oilenergy reports and discover that crude oilsuppliesarevery lowascompared to their5year average and the demand season forunleadedgasiscomingsoon.(Bullish)3) Youcheckyourseasonalchartsand

discover that crudeoil oftenbottoms aroundthistimeoftheyear.(Bullish)4) You check for available contractmonths and find a contract with 149 daysuntil expiration. (This fits into your 4-6monthoptiontimehorizon.)5) You check the at-the-money calloptions and the premium is $2,450. (Thisdoes not meet your less than $1,500 at-the-moneyoptionbuyingrule.)Youchecktheputoptions 25% out-of-the-money and find thattheyaresellingfor$630.(Thisisaboveyour$500minimumruleforsellingoptions.)6) You decide that the best optionstrategyforthisparticularinstanceisanakedput.You check themargin requirements andthey are $1,450 per naked put after thepremiumsarecollected.7)Youdecidetosell3nakedMaycrudeoil puts. The initial margin on this trade is$4,350.(Thismeetsthelessthan5%ofyourequityrule.)8)Youdecidethatyourlossexitstrategywillbetoscaleoutofoneoptionatatimeifthey move against you by 25% increments.Your profit exit strategy will be to let theoptionsexpireworthless.9) Crude oil prices typically do notcorrelate to natural gas and sugar. (Non-correlationconfirmed)10)It’stimetoplaceyourtrades.

TRADE#4

1)Youcheckthechartsagainandfindapotential trend change in the July soybeancontract. Soybeans seem to have made abottom in February and are now trendinghigher.(Bullish)2) You check themost recentUnitedStatesDepartmentofAgriculture supplyanddemand reports and find that the carry overstock piles are low and the stocks-to-usageratio is also very tight. Chinese demand forU.S. soybeans has been robust and isexpectedtocontinue.(Bullish)3) You check the seasonal chart forsoybeansandfindthatoftensoybeansdotakea “February break” and rally afterwards.(Bullish)4) TheJulysoybeanoptionshave131daysuntilexpiration.(Thisfits intoyour4-6monthtimehorizon.)5) You check the at-the-money calloptions and theyhave apremiumof$1,480.(This meets your less than $1,500 at-the-moneyoptionbuyingrule.)6)YoudecidethebestoptionstrategyistobuyJulysoybeanat-the-moneycalls.7)Youdecidetobuy3Julysoybeancallsfor$4,440pluscommissionandfees.(Thismeetsthelessthan5%ofyourequityrule.)8)Youdecidethatyourlossexitstrategywill be to cut losses on all 3 options if theymove against you by 50%. You decide thatyourprofitexitstrategywillbetoscaleoutofyour positions one at a time for each 25%

increaseinpremium.9) Soybeanprices donot correlate tosugar, crude oil or natural gas. (Non-correlationconfirmed)10) It’s time to place the trades for youraccount.

PART5HEDGINGWITHOPTIONS

LESSON#1HEDGING101

Sofar thisbookhasfocusedonusingoptionsforspeculationpurposesonly.However, options are quite often used for hedging purposes. Producers andconsumersofcommoditiesoftenuseoptions toprotect themselves fromfutureprice risk. Derivatives of exchange traded futures contracts “options” did notcome intoexistence in theUnitedStatesuntil the late1970sbut thehistoryofhedging using exchange traded futures contracts began more than a centuryearlier.

In themiddlepart of the1800s the first futures exchanges in

theUnitedStateswerecreated.ThesefuturesexchangesweretheChicagoBoardof Trade (est. 1848) and the New York Cotton Exchange (est. 1870). Theseexchanges facilitated price discovery and price stability for corn and cottonbuyersandsellers.Thishelpedboth theproducersand theconsumersof thosetwo commodities hedge their price risks more effectively. Before long manyotheragriculturalfuturescontractswerecreatedtomeetthegrowingdemandforthesehedgingmechanisms.

Tofullyappreciatetheimportanceofhedgingonecanenvisionthe United States in the 1800’s as an agrarian based society dependent uponfarming for its survival. During harvest times there was typically such anabundanceofacommodityversusthedemandthatthefarmermaybeforcedtosellhiscropsforlittleornoprofit.Conversely,duringplantingtimestherewasoftena lower supplyofacommodityversus thedemandand the farmercouldchargeexorbitantprices.Thesepotentially largepriceswingscouldaffectboththeproducersandtheconsumersofacommodityadversely.

The advent of the futures markets allowed commodityproducers to lock ina sellingprice for theircropsbefore theywereharvested.Thisenabledthemtomoreefficientlybudgettheirmoneyforinputcostssuchasseeds, fertilizer, bank loan interest payments, storage and distribution. Theconsumersofthecommodityalsobenefittedfromthefuturesmarketsbyhavingtheabilitytolockinthepricethattheywerewillingtopaybeforethecropswereplanted.Theabilitytohedgetheirfuturepriceriskandtherelativepricestabilitythatthefuturesmarketscreatedhelpedboththeconsumersandtheproducersofacommodity.

LESSON#2HEDGINGWITHOPTIONSVERSUSFUTURES

H edging with options does have advantages over hedging with futurescontracts. Hedging with a futures contract locks in a forward price for thespecificcommodity.Ifthecommoditybeinghedgedmovestoamorefavorableprice level after the hedge is initiated the hedger cannot capitalize on thatfavorablepricemovementbecausehehasalreadylockedinhispricelevelwithhis futures contracts.Usingoptions tohedge ismore likebuyingan insurancepolicy.Itprotectsthehedgerif themarketmovesadverselyagainstthembutitalsoallowsthehedgertoreapthebenefitsofafavorablemoveintheunderlyingcommoditybeinghedged.

Hedgingwith futures contracts also involves postingmargin.Margin is a good faith deposit that must be posted to the account before thefuturestradescanbeinitiated.Iftheunderlyingfuturesmarketmovesagainstthehedge,thehedgermayberequiredtoaddmoremarginmoneytotheaccounttoholdontothefuturescontracts.Futurescontractshaveatheoreticallyunlimitedriskprofile.On theotherhand, thepurchaserofanoptioncontracthaspaid infull up front and there is no risk of amargin call. Thismeans that the optionhedger knows in advance the entire cost of the option hedge and entire riskexposureaswell.

ExampleLet’s look at an example of how a corn farmer who expects to have 5,000bushelsofcorntosellcansetapricefloorforhiscornusingat-the-moneyputoptions. The formula for establishing a price floor is (strike price) plus (basisforecast)minus (premium paid for the put). Let’s say that theDecember cornfuturespriceis$5.00andtheputoptionstrikepriceis$5.00aswell.Let’salsoassumethattheexpectedbasisis.06centsandthatthepremiumcostoftheputoptionis.30cents.

(Basisisthedifferencebetweenthecashpriceandthefuturespriceofthecommodity.)

The price floor formula for the hypothetical example abovewouldbe$5.00plus .06centsminus .30cents=$4.76.Thepricefloorforthecornfarmerwouldbesetat$4.76perbushel.

Nowlet’s imagine that4monthshavepassedsince thehedgewas initiated and it is November 21st which is the expiration date for theDecember put option. It is time for the farmer to sell his physical corn. The

futurespriceofDecembercornisnowat$4.40perbushelandthecashpriceis$4.46perbushel.(Futurespriceplusthe.06centsbasis)

The intrinsic value of the $5.00 corn putwould be .60 cents.($5.00strikepriceminus$4.40currentfuturesprice=.60cents)

Thefarmerpaid.30centsinpremiumfortheoption.Thiscostwillbesubtracted fromthe intrinsicvalue. (.60cents intrinsicvalueminus .30centspremiumcost=.30cents)

Addthese.30centstothecurrentcashpriceof$4.46andthefarmer’s price floor of $4.76 still holds true.He successfully hedgedhis pricerisk toreceiveaminimumof$4.76forhis5,000bushelsofcorn.Hecannowsellhisphysicalcornandexithisoptionhedgeandcollect$4.76perbushelforhiscorn.

LESSON#3OPTIONSCANBEUSEDTOHEDGEYOURSTOCKPORTFOLIO.

Manysavvyinvestorsuseoptionstohedgetheriskintheirstockportfolios.Longputoptionscanbeusedasahedgeagainstpotentialstockmarketdeclines.Let’s assume that you want to hedge your stock portfolio from an expecteddecline.Below is a hypothetical example of your effort to hedge a portion ofyourstockportfolio.

Let’ssaythatyouwereluckyenoughtoenjoya25%returninyour stock portfolio last year. It is now January and you believe a 10%

correction is imminent over the next 6months. For this hypothetical examplelet’salsoassume that theStandardandPoor’s Index (S&P) isat1750.A10%correctionwouldsendthemarketdowntothe1575level.

For thisexampleofastockportfoliohedgewewilluse theeminiS&Poptioncontracts.Thecontract specifications for the eminiS&Pare$50multipliedbytheindex.Eachonepointisworth$50.Let’sassumethateachput option costs $2,900. (As a hedger you are using options as a method ofbuyinginsuranceforportfolioprotectionandnotspeculating.Thereforethelessthan$1,500premiumruleforpurchasingoptionsdoesnotapply.)

ExampleYoudecidetobuy5June1750eminiS&Pputsforatotalcostof$14,500.Yourgoalistooffsetsomeofyourpotentiallossesinyourstockportfolioifyouareright about the coming stock market correction. You calculate that your putoptionswillbeworth$43,750 if theStandardandPoor’sIndexsellsoff to the1575levelbeforetheexpirationofyourJuneputoptions.

Let’sreviewthemath.1750minusa10%correction=15751750minus1575=175points175pointsmultipliedby$50=$8,750peroptioncontract5putoptionsmultipliedby$8,750=$43,750

(This would be your intrinsic value of your options atexpiration if the underlying futures market is at 1575. If the 1575 level isreached before expiration there will be extrinsic value added into the optionpremiumaswell.)

The portfolio hedging strategy in the hypothetical exampleabovehadatotalcostof$14,500.Ifyouarewrongandthecorrectiondoesnot

come within the 6 month time horizon you will lose the $14,500 that youinvested. (This potential loss example assumes that you do not cut losses andholdontotheoptionsuntilexpiration.)However,ifyouarecorrectyoureminiS&Pputhedgewillhelpoffsetyourportfoliolossesby$29,250.

LESSON#4OPTIONSCANBEUSEDTOHEDGECOMMODITYPRICES.

Manyknowledgeableproducersandconsumersofcommoditieshedge theirprice riskbyusingcallandputoptions.Aproducerofacommoditysuchasafarmer,rancher,oildriller,goldmineretc. ismostworriedabout thepricesforthe commodities that they produce going down. They can buy put options toprotectthemselves.

Theconsumersofthosecommoditiessuchasafoodprocessingplant,arefinery,ajeweleretc.aremostworriedaboutpricesgoinghigher.Theycan buy call options to protect themselves against adverse price movements.Options can be used as a form of price risk insurance for both producers andconsumersofcommodities.

Let’slookatahypotheticalexampleofacornfarmertryingtohedge the price risk of his upcoming crop. For this example let’s assume thatDecember corn futures prices are at $5.50 per bushel and that it is the end ofMayandhehasjustfinishedplantinghisavailableacreage.Thisfarmerexpectsto harvest 100,000 bushels of corn this year. Each contract of corn leverages

5,000 bushels and each one cent per bushel move equals $50. The farmerremembersthe$3.00perbusheldeclinethathappenedafewyearsagoandheisworriedthatcorncangoaslowas$4.50perbushelthisyear.

ExampleHedecidestobuy10Decembercorn$5.50putoptionstoprotectaportionofhisexpected harvest. The total cost of these options is $14,000. If theDecembercorncontractgoesdowntothe$4.50levelhecalculatesthathiscornputswillbeworth$50,000.

Let’sreviewthemath.$5.50minus$4.50=$1(100cents)100multipliedby$50=$5,000perputoptioncontract$5,000multipliedby10contracts=$50,000

(This would be the intrinsic value of the farmer’s options atexpiration if theunderlying corn futures contract is at $4.50per bushel. If the$4.50pricelevelisreachedbeforeexpirationtherewillbeextrinsicvalueaddedtotheoptionpremiumsaswell.)

Theproducerhedgein thehypotheticalexampleabovewouldcostthefarmeratotalof$14,000.Ifheiswrongandthe$1.00correctiondoesnot occur by the expiration of theDecember corn puts hewill lose a total of$14,000. (Thispotential lossexampleassumes that thefarmerdoesnotcuthislossesatsomepoint.)However, ifheiscorrecthiscornputhedgewillhelptooffsetthelossesofhisphysicalcornby$36,000.

Let’slookatahypotheticalexampleofaconsumerhedge.Thisexamplefeaturesajewelryfabricatorwhowillneedtopurchase1000ouncesofgoldoverthenext90daysandisworriedaboutanincreaseingoldprices.Thegoldmarkethasbeenveryvolatilelatelyandhewantstoprotecthimselffroma

potential$100perouncepricemove to theupside thathebelievesmayoccur.Goldisa100ouncecontractandeachonedollarmoveperounceequals$100.ThecurrentpriceoftheJunegoldfuturescontractis$1,250perounce.

ExampleThejewelerdecidestopurchase10Junegold$1,250calloptionsforatotalcostof $23,000.He calculates that if goldprices rally by$100per ounceover thenext90dayshiscalloptionswillbeworth$100,000.

Let’sreviewthemath.$1,350minus$1,250=$100perounce$100multipliedby$100=$10,000percalloptioncontract$10,000multipliedby10contracts=$100,000

(Thiswouldbetheintrinsicvalueofthejeweler’scalloptionsatexpirationiftheunderlyinggoldfuturescontractisat$1,350perounce.Ifthe$1,350level is reachedbeforeexpiration therewillbeextrinsicvalueaddedtotheoptionpremiumsaswell.)

Theconsumerhedgeinthehypotheticalexampleabovewouldcost the jeweler $23,000. If he iswrong and the $100move in gold does notoccur by the expiration of the June gold calls hewill lose a total of $23,000.(Thispotentiallossexampleassumesthatthejewelerdoesnotcuthislossesatsomepoint.)However, ifhe is righthisgoldcallhedgewillhelp tooffset thelossesinhisphysicalgoldpurchaseby$77,000.

PART6FINDAGOODBROKERAGEFIRM.

LESSON#1FINDABROKERWHOKNOWSHOWTOSERVICEYOURSPECIFICTRADINGNEEDS.

SelfDirectedTraders

Thistraderhasfoundthatmostselfdirectedtradersarenotfullyautonomousandneedhelpeverynowandagain.Thisisespeciallytruewhentheyfirststartusingthetradingplatform.Ifthisisthecategorythatyoufitintothenyouwillwanttonotonlyfindafaircommissionrateandagoodtradingplatformbutalsoaseasonedbrokertotalktoifyouhaveaproblemorconcern.Youwillusuallyhavetopayacoupleofdollarsmorefortheservicesofaveteranbrokerbuttheycan be extremely valuable if youmake a tradingmistake and need their help.Makesuretofindoutifyoucanhaveabrokerwhoisdedicatedtoyouraccountsoyoucanspeaktothesamepersoneverytimeyouhaveaquestionorconcern.

Agoodbrokercanactasasecondpairofeyesforyouraccount.

Agoodbrokermayalso:CallyoutomakesurethatyoudidnotforgettheGTCorderinyouraccounteventhoughyoujustoffsetallofyouropenpositionsinthatmarket;Checkyouraccounteverymorningtomakesuretherewerenotanytradingerrorsfromthepreviousday’strades;Callyouwhenyouaregettingclosetoamargincall;CallyoutoaskwhyallofasuddenyouaretradingsoybeansinsteadoftheeminiS&Ps thathavebeen theonlymarket thatyouhave traded for thelast fewyears;Didyouhit theS insteadofESor is the account numberwrongonthetrade?Alertyou to the fact that it isFirstNoticeDaysoyoudon’thave to takedeliveryofaboxcarfullofwheat;Enterandexitatradeforyouifyourcomputercrashes……..

Most tradingplatforms are similar in the attributes theyofferbutsomehavehighermonthlyplatformfeesthanothers.Makesuretofindoutwhatplatformcostsareinvolvedbeforeopeningyouraccount.Higherplatformsfeesdonot necessarily indicate that a tradingplatform is better than a tradingplatformwith lower fees.There are someprofessionalgrade tradingplatformsthat are very inexpensive so shop around before opening an account with abrokeragethatchargeshighplatformfees.

Many commodity brokerages offer a free practice demoaccountforyoutouseforatleasttwoweeks.Thesedemoaccountsareusuallyfundedwith$50,000ofphonyvirtualequity.Thisenablesyoutopracticeyourtradingandgetfamiliarwith themarketsandthetradingplatformwithnorealfinancial consequences. Typically, these demo accounts will give you limitedreal timequotesbutmostquoteswillbedelayedby15-20minutes.Makesurethatthebrokeragecompanythatyouchooseoffersafreedemoaccountfortheirtradingplatform.Itisveryimportantforyoutobecomfortablewithyourtradingplatformbeforegoing“live”withyourtrading.Anerrantclickonbuyinsteadofselloron100contractsinsteadof10contractscanbeaveryexpensivetradingmistake.

BrokerAssistedTradersA broker assisted account is for traders who want to be hands on with theirtradingbutlackthetime,knowledgeorinclinationtotradetheirownaccounts.Yourbrokerwill suggest trades and riskmanagement strategiesbasedonyourindividualrisktolerancesandcomfortlevels.

Theseaccountsarenon-discretionarywhichmeans thebrokerwillnotdoany tradesat theirowndiscretionand therefore theymustapproveeachtradewithyoubeforeplacingthem.Ifthisisthetypeoftraderthatyouarethenyouwillwanttofindabrokerwhohasatleast5-10yearsofactualtradingexperienceandunderstandsbothsellingandbuyingoptions.

(Veryfewbrokersarecomfortabledoingbothwithinthesameportfoliosomakesuretoaskthemwhat theirfavoriteoptiontradingstrategiesareforbuyingandsellingoptionsonfuturescontracts.Somebrokeragefirmsdonot allow their brokers to suggest option selling strategies because of thepotentialmargincallissuesthatcanoccur.)

The broker will be qualifying you by asking you questionsabout your investment experience, risk tolerance and available risk capital somake sure to ask him your list of questions too. It is a twoway interview inwhicheachofyouisdecidingwhetherornottodobusinesswiththeother.Makesuretoaskthebrokeriftheyhaveawrittentradingplanfortheirbrokerassistedclients. If they do not have awritten trading plan call another brokerage untilyoufindonethatdoes.

PART7RISKREITERATIONS

LESSON#1ALWAYSEXPECTTHEUNEXPECTED.

Riskhasbeencoveredtimeandtimeagainthroughoutthisbookbecauseitisso important tomanage your risk exposurewhen trading options. The futuresmarkets are truly a 24 hour globalmarketplace and can be affected by eventsanywhereintheworldatanytime.Aterroristattackoranaturaldisasterontheothersideoftheworldcanturnyourprofitsintolosseswhileyouaresleeping.Itisveryimportantforyoutostayuptodatewithyourmarkets.

You must look at option trading from a risk management

perspectiveandactivelymanagetheriskinyourportfolioonadailyandtradebytradebasis.Thisdoesnotmeanthatyouwillhavetobegluedtoyourcomputerscreenalldaytoeffectivelymanageyouroptionportfolio.Itdoesmeanthatyoushould check your trades at least once or twice a day. In this age of hyperconnectivityinwhichsmartphonesareubiquitoustherearenottoomanytimesduring the day when the normal option trader is totally unplugged fromtechnology.

This trader has tested his connectivity from the top of theRockyMountainsinColoradoandfromthemiddleofEvergladesNationalParkonaflatsboatandwasstillabletousehiscellphone.ThepointisthatthereareveryfewcellulardeadspotsintheUnitedStatesanymore.Thesedaysthereisnoreasonnottocheckuponyourtradesatleastoncedaily.Stayingintunewiththemarketsisonemorewayforyoutomanageyourportfoliorisks.

(Risk and profit potential are proportional to each other. Inotherwords,foryoutomakeaboveaverageprofitsyouwillbydefinitionhavetotakeaboveaveragerisks.)

CONCLUSION

Theoriginalgoalofthisbookwastocreateatruthfulandusefulbooktohelpoptiontradersbecomemoresuccessful.Itistheauthor’ssinceresthopethatthisbook has added some clarity for you regarding the real world of buying andsellingoptionsonfuturescontracts.Itwouldbeagreatcomplimentifyoufindthisbookusefulenoughtouseitasadeskreferenceandapplyits lessonsasaguidelinetocreateyourveryownwrittentradingplan.

*Iftheharshrealitiesandtheriskdisclosurescontainedwithinthisbookdidnotscareyouawayfrombuyingandsellingoptions,thenturnthe

pageandyouwill findevenmoreoptionson futureseducational resources forFREE.

For more FREE educational resources visitwww.tkfutures.com

Visitthiswebsiteandyouwillfind:ChartsandquotesContractspecificationsCurrentmarginratesTradinghoursOptioncontractmechanicsFuturescontractmechanicsFuturesandoptiontradingstrategiesDetailedinformationonyourfavoritecommoditymarketsFreePracticeDemoAccountsLinkstovariousgovernmentandprivatefundamentalnewsresourcesAndmuch,muchmore…….

GLOSSARYOFTERMS

At-the-moneyoption-Anoptionwithastrikepricethatisequaltothecurrentmarketpriceoftheunderlyingfuturescontract.

Ask-Thepriceatwhichapartyiswillingtosell.Alsoreferredtoasthe“offer”.

Backwardation- A futures market in which the distant contract months arehigherinpricethanthenearbymonth.

Basis-Thedifferencebetweenthecurrentcashpriceandthefuturespriceofthesame commodity. Unless otherwise specified, the price of the nearby futurescontractmonthisgenerallyusedtocalculatethebasis.

BarChart-Achartthatgraphsthehigh,lowandsettlementpricesforaspecifictradingsessionoveragivenperiodoftime.

BearMarket-Aperiodofdecliningprices.

Bid- An expression indicating a desire to buy a commodity at a given price,oppositeofask.

Broker-A company or individual that executes futures and options orders onbehalfoffinancialandcommercialinstitutionandthegeneralpublic.

BullMarket-Aperiodofrisingprices.

CallOption-Anoptionthatgivesthepurchasertherightbutnottheobligationto purchase (go long) the underlying futures contract at the strike price on orbeforetheexpirationdate.

CarryingCharge-Forphysicalcommoditiessuchasgrainsandmetals,thecostofstoragespace,insurance,andfinancechargesincurredbyholdingaphysicalcommodity.Ininterestratefuturesmarkets, itreferstothedifferentialbetweenthe yield on a cash instrument and the cost of funds necessary to buy theinstrument.Thisisalsoreferredtoasthecostofcarryorjustcarry.

ClosingPrice-Thelastpricepaidforacommodityonanytradingday.

CMEGroup- Chicago based exchange that is theworld’s largest futures andoptionsexchange.Itwasformedin2007throughamergerbetweentheChicagoMercantileExchangeandtheChicagoBoardofTrade.

Commercial-Termusedtodescribefuturestraderswhoseprimarybusinessisintheunderlyingphysicalcommoditymarkets.

Commodity Futures Trading Commission- A federal regulatory agencyestablishedundertheCommodityFuturesTradingCommissionActof1974thatoverseesfuturestradingintheUnitedStates.

Consensus- (Often called “bullish consensus”) The perceived opinion-eitherbullishorbearish-oftradersinaspecificmarket.Ifasubstantialmajorityofthemarket is perceived to bebullish, thismaybe an indication that themarket isoverbought and should therefore be sold. The opposite is true if a substantialmajorityisperceivedtobebearish.

Consumer Price Index (CPI)- A major inflation measure computed by theUnitedStatesDepartmentofCommercethatmeasuresthechangeinpricesofafixedmarketbasketof385goodsandservicesofthepreviousmonth.

ContractMonth-Aspecificmonthinwhichdeliverymaytakeplaceunderthetermsofafuturescontract.

CostofCarry(orCarry)-Forphysicalcommoditiessuchasgrainsandmetals,thecostofstoragespace, insurance,andfinancecharges incurredbyholdingaphysicalcommodity.Ininterestratefuturesmarkets, itreferstothedifferentialbetween theyieldonacash instrumentand thecostof fundsnecessary tobuytheinstrument.

Crop Reports- Reports compiled by the United States Department ofAgriculture released throughout the year covering planted acres, yield, andexpectedproduction.Italsosuppliesacomparisonofproductionfrompreviousyears.

CustomerMargin-Within the futures industry, there are financial guaranteesrequired of both buyers and sellers of futures contracts and sellers of optionscontracts to ensure contract obligations are fulfilled.FCMsare responsible foroverseeing customermargin accounts.Margins are determined on the basis ofmarket risk and contract value. This is also referred to as performance bondmargin.

Daily Trading Limit- The maximum price range set by the exchanges for afuturescontract.

DayTraders-Traderswho takepositions in futuresandoptionsandexit thembeforethecloseofthattradingday.

DeliverableGrades-Thestandardgradesofcommoditiesorinstrumentslistedintherulesoftheexchangesthatmustbemetwhendeliveringcashcommoditiesagainst futures contracts. Grades are often accompanied by a schedule ofdiscounts and premiums allowable for delivery of commodities of lesser orgreaterqualitythanthestandardcalledforbytheexchange.

Delivery- The transfer of the cash commodity from the seller of a futurescontract to thebuyerof a futures contract.Each futures exchangehas specificprocedures for delivery of a cash commodity. Some futures contracts, such asstockindexfuturescontractsaresettledincash.

Delta-Ameasureofhowmuchanoptionpremiumchangesgivenaunitchangein theunderlying futurescontract. (Delta isoften interpretedas theprobabilitythattheoptionwillbein-the-moneybyexpiration.)

Exercise-Theactiontakenbytheholderofacalloptionifhewishestopurchasetheunderlyingfuturescontractorbytheholderofaputoptionifhewishes toselltheunderlyingfuturescontract.

ExpirationDate-Optionsonfuturescontractstypicallyexpireonaspecificdateduringthemonthprecedingthefuturescontractdeliverydate.Forexample,anoptiononaMarchfuturescontractusuallyexpiresinFebruarybutisreferredtoasaMarchoptionbecauseitsexercisewouldresultinaMarchfuturescontractposition.

ExtrinsicValue-Thesumofthepremiumvalueofanoptionminusanyintrinsicvalue.Out-of-the-moneyoptionsaremadeupentirelyofextrinsicvalue.

FinancialInstrument-Therearetwobasictypesoffinancialinstruments.Thereisadebtinstrument,whichisaloantopaybackfundswithinterestoranequityinstrumentthatisashareofstockinacompany.

First Notice Day- The first day on which a notice of interest to deliver a

commodityinfulfillmentofagivenmonth’sfuturescontractcanbemadebytheclearinghouse to a buyer.The clearinghouse also informs the sellerswho theyhavebeenmatchedupwith.

FundamentalAnalysis-Amethodofanticipatingfuturepricemovementusingsupplyanddemandinformation.

FuturesContract-Thisisalegallybindingagreementmadeonthetradingfloorof a futures exchange to buy or sell a commodity or financial instrumentsometimeinthefuture.Thesearestandardizedaccordingtothequality,quantity,anddeliverytimeanddeliverylocationforeachcommodity.Theonlyvariableispriceandthisisdiscoveredontheexchangetradingfloor.

GLOBEX- A global after-hours electronic trading system created by theChicagoMercantileExchange.

GMOGrain-GMOisanacronymforgeneticallymodifiedorganism.Generallyused to describe grain that has been genetically modified to producecharacteristics such as resistance to drought as well as weed and pesticidecontrol.SuchgrainsareveryprevalentintheUnitedStatesbutarediscouragedorevenbannedbytheEuropeanUnion,Japanandothers.

Gross Domestic Product (GDP)- The value of all final goods and servicesproducedbyaneconomyoveraparticulartimeperiod,typicallyoneyear.

Hedger- An individual or company owning or planning to own a cashcommodity, corn, soybeans, wheat, U.S. Treasury Bonds, notes, bills etc. andconcerned that the cost of the commoditymaychangebefore eitherbuyingorsellingitinthecashmarket.Ahedgerachievesprotectionagainstchangingcashprices by purchasing (selling) futures contracts of the same or similarcommodity and later offsetting that position by selling (purchasing) futurescontractsofthesamequantityandtypeastheinitialtransaction.

ICE- Short for the Intercontinental Exchange which is an Atlanta-basedelectronicexchange.

ImpliedVolatility-Theforwardlookingtheoreticalvalueofthevolatilityoftheunderlyingfuturescontractasitrelatestotheincreaseordecreaseinanoption’spremiumcausedbytheincreaseordecreaseintheunderlyingfuturescontract’schangesinvolatility

In-the-money-option-Anoptionhavingintrinsicvalue.

InitialMargin-Theamounta futuresmarketparticipantmustdeposit intohis

marginaccountatthetimeheplacesanordertobuyorsellafuturescontractorshortanoption.

IntrinsicValue-Theamountanoptionisin-the-money.

IntroducingBroker-Apersonororganizationthatsolicitsoracceptsorderstobuyorsellfuturescontractsandoptionsonfuturescontractsbutdoesnotacceptmoneyorotherassetstosupportsuchorders.

Lagging Indicators- Market indicators showing the general direction of theeconomyandconfirmingordenyingthetrendimpliedbytheleadingindicators.

LastTradingDay-Thisisthelastdaythattradingmayoccurinagivenfuturesor options contractmonth. Futures contracts outstanding at the end of the lasttradingdaymustbesettledbythedeliveryoftheunderlyingcommodity.

LeadingIndicators-Marketindicatorsthatsignalthestateoftheeconomyforthe coming months. Some of the leading indicators include: averagemanufacturingworkweek,initialclaimsforunemploymentinsurance,ordersforconsumer goods and material, percentage of companies reporting slowerdeliveries,andchangeinmanufacturers’unfilledordersfordurablegoods,plantand equipment orders, new building permits, index of consumer expectations,

changeinmaterialprices,pricesofstocks,changeinmoneysupply.

Liquid-Acharacteristicofacommoditymarketwithenoughunitsoutstandingtoallowlargetransactionswithoutasubstantialchangeinprice.

Long-Onewhohasboughtfuturescontracts,optionscontractsorownsacashcommodity.

Margin- There aremany financial safeguards that have been implemented toensure that clearing members perform on their customers’ open futures andoptions contracts.Clearingmargins are distinct fromcustomermargins in thatindividualbuyersandsellersoffuturesandoptionsarerequiredtodepositwithbrokers.Marginsaredeterminedbymarketriskandcontractvalue.

Margin Call- A call from a clearinghouse to a clearing member or from abrokeragefirmtoitscustomertobringmargindepositsuptoaminimumlevel.

MarketOrder-Anordertobuyorsellafuturesoroptionscontractofagivendeliverymonthtobefilledatthebestpossiblepriceandassoonaspossible.

National Futures Association (NFA)- The NFA is the industry wide, self-regulatoryassociationfortheUnitedStatesfuturesindustry.

OPEC-Organization of PetroleumExportingCountries emerged as themajorpetroleumpricingpower in1973,when theownershipofoilproduction in theMiddleEasttransferredfromtheoperatingcompaniestothegovernmentsoftheproducing countries or to their national oil companies.Members are:Algeria,Indonesia, Iran, Iraq,Kuwait, Libya,Nigeria,Qatar, SaudiArabia, theUnitedArabsEmiratesandVenezuela.

Open Interest- The total number of futures and options contracts of a givencommodity that have not yet been offset by an opposite futures or optionstransaction.

Option-Acontractthatconveystherightbutnottheobligationtobuyorsellaparticularitematacertainpriceforalimitedtime.

OptionPremium-Thesumofmoneythattheoptionbuyerpaysandtheoptionsellercollectsfortherightsgrantedbytheoption.

Out-of-the-moneyoption-Anoptionwithnointrinsicvalue.

Position Trader- An approach to trading in which the trader holds onto apositionforanextendedperiodoftime.

PutOption-Anoptionthatgivesthepurchasertherightbutnottheobligationtoselltheunderlyingfuturescontractatthestrikepriceonorbeforeexpiration.

SeasonalAnalysis-Anticipating futurepricemovementsusinghistorical priceadvances and declines of certain commodities to find a time line as to whenthosemovesaremostlikelytooccurduringtheyear.

SerialMonth-Ashorttermoptiononafuturescontractinwhichtheunderlyingexpiresinaforwardmonth.

Spreading-Thesimultaneousbuyingandsellingof tworelatedmarkets in theexpectationthataprofitwillbemadewhenthepricedifferencebetweenthetwomarketseitherwidensornarrows.Examplesinclude:sellingonefuturescontractandbuying another futures contract of the samecommoditybutwithdifferentdelivery months: buying and selling the same delivery month of the samecommodityondifferentfuturesexchanges;buyingagivendeliverymonthofonefutures market and selling the same deliverymonth of a different but relatedfuturesmarket.

StopOrder-Thisisanordertobuyorsellwhenthemarketreachesaspecifiedpoint.Astopordertobuybecomesamarketorderwhentheunderlyingfuturescontract is at or above the strike price.A stoporder to sell becomes amarketorderwhentheunderlyingfuturescontractisatorbelowthestrikeprice.

StrikePrice- The price atwhich the futures contract underlying a call or putoptioncanbepurchased(ifacall)orsold(ifaput).

Technical Analysis- Anticipating future price movements using historicalprices, trading volume, open interest and other trading data to study pricepatterns.

Tick-Thesmallestallowableincrementofpricemovementforacontract.

TimeDecay-Theratioofthechangeinanoption’spremiumtothedecreaseintimeuntilexpiration.

Volatility-Ameasurementoftherateofchangeinpriceoveragivenperiod.Itisoften expressed as a percentage and computed as the annualized standarddeviationofthepercentagechangeindailyprice.

Volume- The number of purchases or sales of commodity futures or optionscontractsforonetradingday.

YieldCurve-Achartinwhichtheyieldlevelisplottedontheverticalaxisandthetermtomaturityofdebtinstrumentsofsimilarcreditworthinessisplottedonthehorizontalaxis.Theyieldcurveispositivewhenlong-termratesarehigherthan short-term rates; however the yield curve is negativewhen the long-termratesarelowerthanshort-termrates.

CONTRACTSPECIFICATIONS

CurrenciesCMEGroupEuroFXCurrencycontractsize=125,000EurosContractMonths-March,June,September,December,SerialandWeeklyMinimumFluctuation.0001=$12.50

CMEGroupJapaneseYencontractsize=12,500,000YenContractMonths-March,June,September,December,SerialandWeeklyMinimumFluctuation.000001=$12.50

FinancialsCMEGroupTreasuryBondcontractsize=$100,000ContractMonths-March,June,September,DecemberandSerialMinimumFluctuation1/64=$15.626

Indices&StocksCMEGroupS&P500Eminicontractsize=$50multipliedbytheindexContractMonths-March,June,September,DecemberandSerialMinimumFluctuation.25=$12.50

EnergiesCMEGroupWTICrudeOilcontractsize=1,000barrelsContractMonths-AllMinimumFluctuation.01=$10

CMEGroupNaturalGas,HenryHubcontractsize=10,000mmBtuContractMonths-AllMinimumFluctuation.001=$10

CMEGroupRBOBUnleadedGascontractsize=42,000gallonsContractMonths-AllMinimumFluctuation.001/gallon=$4.20

CMEGroupULSDHeatingOilcontractsize=42,000gallonsContactMonths-AllMinimumFluctuation.001/gallon=$4.20

GrainsCMEGroupCorn,SoybeansandWheatcontractsize=5,000bushelsContractMonths-March,May,July,September,December,SerialandWeeklyMinimumFluctuation¼cent=$12.50

MeatsCME Group Feeder Cattle contract size = 50,000 pounds Contract Months-January,March,April,May,August,September,OctoberandDecemberMinimumFluctuation.025c/lb=$12.50

CMEGroupLiveCattlecontractsize=40,000poundsContractMonths-February,April,June,August,October,DecemberandSerialMinimumFluctuation.025c/lb=$10

CMEGroupLeanHogcontractsize=40,000poundsContract Months-February, April, May, June, July, August, October andDecemberMinimumFluctuation.025c/lb=$10

MetalsCMEGroupCoppercontractsize=25,000poundsContractMonths-AllMinimumFluctuation.05c/lb=$12.50

CMEGroupGoldcontractsize=100ouncesContractMonths-February,April,June,August,October,DecemberandSerial

MinimumFluctuation.10=$10

CMEGroupSilvercontractsize=5,000ouncesContractMonths-February,March,May,July,September,DecemberandSerialMinimumFluctuation.005=$25

ExoticsICECocoacontractsize=10metrictonsContractMonths-March,May,July,September,DecemberandSerialMinimumFluctuation$1permetricton=$10

ICECoffeeCcontractsize=37,500poundsContractMonths-March,May,July,September,DecemberandSerialMinimumFluctuation.05c/lb=$18.75

ICECotton#2contractsize=50,000poundsContractMonths-March,May,July,October,DecemberandSerialMinimumFluctuation.01c/lb=$5

ICESugar#11Worldcontractsize=112,000poundsContractMonths-March,May, July, October and SerialMinimum Fluctuation.01c/lb=$11.20

ICEOrangeJuiceFCOJ-Acontractsize=15,000pounds

ContractMonths-January,March,May,July,September,NovemberandSerialMinimumFluctuation.05c/lb=$7.50

Futures andoptions investments carry significant risk of loss andarenotsuitable for some investors. Past performance is not indicative of futureresults. This information can be considered a solicitation to enter into aderivatives trade. Use only risk capital when investing in high riskinvestmentslikefuturesandoptions.

Thecontentwithinthisbookisforinformationalpurposesonly. No guarantees are being made to its accuracy or completeness.Contractspecificationschangefromtimetotime.Contacttheexchangestofinduptodateinformation.

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