thinkmoney2012fall dl

•random musings for traders at TD AmeritradeFall 2012

thinkMoney/17

10/FOURTRADINGMYTHS…BUSTED18/TRADINGGIANTS WITHANY VOL

24/A NEW LOOK AT LEAPS

FUTURES OPTIONS SPECIAL:

34/YOUR BURNINGQUESTIONSANSWERED

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Market volatility, volume, and system availability may delay account access and trade executions.

The risk of loss in trading securities, options, futures, and forex can be substantial. Clients must consider all relevant risk factors, including their own personal fi nancial situation, before trading.

Options, futures, and/or forex trading privileges subject to TD Ameritrade review and approval. Not all account owners will qualify.

Access to real-time market data is conditioned on acceptance of the exchange agreements. Professional access differs and subscription fees may apply.

Third-party research and tools are obtained from companies not affi liated with TD Ameritrade, and are provided for informational purposes only. While the information is deemed reliable, TD Ameritrade does not guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with respect to the results to be obtained from its use. Please consult other sources of information and consider your individual fi nancial position and goals before making an independent investment decision. Past performance does not guarantee future results.

Commissions, service, and exception fees still apply.

TD Ameritrade, Inc., member FINRA/SIPC/NFA. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2012 TD Ameritrade IP Company, Inc. All rights reserved. Used with permission.

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thinkMoney/17

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04•Contents•Photograph byFredrik Brodén

•tdameritrade.com


http://tdameritrade.com

Four TradingMyths—Busted If you're having trouble followingthe advice of those who camebefore you, maybe you're listeningto the wrong advice. Are the oldrules still valid or just myths?

p. 10


Learn more at www.CBOE.com/VIXJoin the conversation on Twitter with dollar-sign tag $VIX

Execute risk management, diversification and volatility strategies with a wide range of VIX® options and futures.

Options and futures on the CBOE Volatility Index®

Options and futures on the volatility of ETFs, including Brazil, Emerging Markets, Gold and Oil

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies are available by calling 1-888-OPTIONS or at www.theocc.com. You should be aware that trading futures involves the risk of loss, including the possibility of loss greater than your initial investment. Futures and options on CBOE’s volatility indexes have several unique features that distinguish them from most equity and index options, and investors are strongly encouraged to closely read and understand the ODD and the VIX options FAQ at http://www.cboe.com/micro/vix/vixoptionfaq.aspx and other informational material before investing. CBOE®, Chicago Board Options Exchange®, CBOE Volatility Index® and VIX® are registered trademarks and Execute SuccessTM is a trademark of Chicago Board Options Exchange, Incorporated (CBOE). S&P500® is a trademark of Standard & Poor’s Financial Services, LLC and has been licensed for use by CBOE and CBOE Futures Exchange, LLC. Copyright © 2012 CBOE. All rights reserved.

Overseas volatility has you bearish right from the bell.

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http://www.theocc.com

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thinkMoney/17

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07•Contents•Cover photograph byFredrik Brodén

•tdameritrade.com

Miscellaneous

Features

10/ Four Trading Myths—BustedBromides aren’t helpful when your investmentstomach is queasy with financial uncertainty.And neither is trite advice. We break down fourclassic trading adages-turned myth to examinetheir relevance, and perhaps their accuracy.

18/ Vol for One, and One for VolTrading stocks over $100 can be tricky. Evenwhen volatility is low, plain-vanilla calls andputs can still be too rich. And high volatility?Forget about it…Or should you? With so manyoption spreads at your fingertips, there’s a fewthat just might suit your needs, regardless ofprice and volatility.

24/LEAPS, Longs, and Dodging VolWhat do you get when you cross a stock with anoption? How about a long-term option. WithLEAPS, time is on your side and capital risk canbe low. And if you’ve never traded them, theycould be worth a look.

08/A Quick Howdy

15/Love Notes

16/News + ViewsThe problem withshort-selling, tradingplatform pearls fromThe Suit, and a fewhidden tricks onthinkorswim.

32/Vol WatchHow do you confirmwhat volatility is reallysaying? With volatility,of course.

29/Ask the Trader GuyOur resident guru pon-ders the strategy ofscalping options, beta-weighting, and how tobalance trading with aneedy spouse around.

Columns

42/The TokenGlossary

34/Futures Options SpecialFAMILIAR GROUND…SORT OFYes, you can have a derivative on a derivative.But don’t let that scare you. Options on futuresmay be easier to understand than you think.And if you’re not familiar with them, you couldbe missing the point. PLUS: STRATEGY FOCUSHow to trade futures options on thinkorswim FUTURES OPTIONS Q&A

TD Ameritrade Contact Info You Could UseClient Services Representative: 800-669-3900New Accounts: 800-454-9272

•thinkorswim Support: [email protected] Feedback:[email protected] Support:[email protected] paperMoney Support:[email protected] all other inquiries:tdameritrade.com/contact

•General Mailing AddressPO Box 229Omaha, NE 68103

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Follow TD Ameritrade

31/Fearless TechnicianHow do you knowwhen a consolidatingmarket is about totrend? Consider usingthis little indicator tohelp you decide.

To view past issues ofthinkMoney archives fromyour mobile device, justscan this code with yourQR reader.

cont.

22/Gear HeadServing a double fea-ture of trading treats,we break downthinkorswim’s newCovered Call Rolloverand how to use thenew Option’s Statisticsfeature.

40/Coach’s CornerA string of lossesstinks, but there’shope for getting backin the game.



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08•A Quick Howdy•tdameritrade.com

thinkMoney®

EDITORIAL DIRECTORKevin Lund

EDITORThomas Preston

TECHNICAL EDITORAlex Mendoza

ART DIRECTORTom Brown

ASSISTANT EDITOREileen Sutton

DESIGNERJennifer Roberts

•

CONTRIBUTING WRITERSNicole SherrodAlex Mendoza John BrodemusJB Mackenzie Pat Mulally John Carter

CHIEF PHOTOGRAPHERFredrik Brodén

CONTRIBUTING ILLUSTRATORJoe Morse

•PUBLISHERT3 PublishingEmail: [email protected]

ADVERTISING [email protected]

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• Adages. Everybodyknows at least one. Youknow—A bird in thehand…A stitch intime…that sort of thing. Wetend to rely on such triteadvice to give perspectiveto those we teach—particu-larly when we can’t comeup with our own way ofsaying things. Some adagesare good. Some are bad.Some are just pure myth,and need to be revisited.

For this issue’s coverfeature on page 10, wethought we’d have a littlefun and come up with thefour of the most well-

known adages-turned-myths that need debunk-ing—or at least revisiting.Some of them are so deeplyengrained in the collectivetrading psyche, we univer-sally accept them as truths.But it really depends onwhat you’re trading, andhow you’re trading it.

As for what you’re trad-ing, if your vehicle ofchoice has been equityoptions thus far, and youwant to spread your wingsa little, be sure to read theunofficial part two of ourspecial focus on futures. Inthis issue, we’ll focus ontrading options on futures.We’ll spew the nuts, bolts,and practical application ofit all, packed into six tight

pages. You decideif they’re the rightfit. If needed,there’s even astep-by-step onhow to open afutures accountat TD Ameritradeon page 32.

If you’rethirsty for newstrategies andvolatility has you

befuddled, check out “Volfor One, and One for Vol”on page 18. There’s anoptions strategy made forevery conceivable volatilitybackdrop. We’ll start withthree.

Hard to believe, but it’spossible that everythingwe’ve jammed in these 44pages may not be enoughto quench your thirst forgood trading content. If it’snot, head over to ourmonthly online trading andinvesting newsletter, TheTicker Tape Monthly at tick-ertapemonthly.com. Parttrader, part investor con-tent, there’s a longer-termslant to Ticker that mightsatiate you at last. If it does-n't, you could always killsome time coming up withnew adages.

Happy trading,TD Ameritrade

True Lies?

edit.

We GoofedIn the last issue ofthinkMoney (Summer2012), we mistakenly credited the wrongauthor for our “GearHead" column. Propercredit should have beengive to Greg Edwards.Thanks Greg, and sorryabout that.

Got Feedback? Great. Write to us [email protected]. You'll feel better.




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• The information presented in this publication does notconsider your personal investment objectives or financialsituation; therefore, this publication does not make per-sonalized recommendations. This information shouldnot be construed as an offer to sell or a solicitation to buyany security. The investment strategies or the securitiesmay not be suitable for you. We believe the informationprovided is reliable; however, TD Ameritrade, Inc., andits affiliated companies do not guarantee its accuracy,timeliness or completeness. Any and all opinionsexpressed in this publication are subject to change with-out notice. • Options transactions involve complex tax considera-tions that should be carefully reviewed prior to enteringinto any transaction.

• The risk of loss in trading securities, options, futuresand forex can be substantial. Clients must consider allrelevant risk factors, including their own personal finan-cial situations, before trading. Options involve risk andare not suitable for all investors. See the Options Disclo-sure Document: Characteristics and Risks of Standard-ized Options. A copy accompanies this magazine if youhave not previously received one. Additional copies canbe obtained at tdameritrade.com or by contacting us. • Trading foreign exchange on margin carries a high levelof risk, as well as its own unique risk factors. Before con-sidering trading this product, please read the Forex RiskDisclosure, available at http://www.nfa.futures.org/NFA-investor-information/publication-library/forex.pdf. • A forex dealer can be compensated via commissionand/or spread on forex trades. TD Ameritrade is subse-quently compensated by the forex dealer.• Futures and forex accounts are not protected by theSecurities Investor Protection Corporation (SIPC).

thinkorswim, Division of TD Ameritrade, Inc., memberFINRA/SIPC/NFA

TD Ameritrade, Inc. Member SIPC FINRA NFA

© 2012 TD Ameritrade IP Company, Inc. Product and company names mentioned herein may be trademarks and/or registered trademarks of theirrespective companies.

thinkMoney/17

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09•Disclaimers•tdameritrade.com

• Neither Investools® norits educational sub-sidiaries nor any of theirrespective officers, person-nel, representatives,agents or independentcontractors are, in suchcapacities, licensed finan-cial advisors, registeredinvestment advisors orregistered broker/dealers.Neither Investools norsuch educational sub-sidiaries provide invest-ment or financial adviceor make investment rec-ommendations, nor arethey in the business oftransacting trades, nor do

they direct client futuresaccounts nor give futurestrading advice tailored toany particula r client’s sit-uation. Nothing containedin this communicationconstitutes a solicitation,recommendation, promo-tion, endorsement or offerby Investools or others described herein, of any particular security,transaction, or invest-ment. Investools Inc. and TD Ameritrade, Inc.are separate but affiliatedcompanies that are notresponsible for eachother’s services or policies.

important

info

Transaction costs (com-missions and other fees)are important factorsand should be consid-ered when evaluatingany options trade. Forsimplicity, the examplesin these articles do notinclude transaction

costs. At TD Ameritrade,the standard commissionfor online equity ordersis $9.99, online optionorders are $9.99 + $0.75per contract. Ordersplaced by other meanswill have higher transac-tion costs. Options exer-cises and assignmentswill incur a $19.99 com-mission.

3




http://www.nfa.futures.org//NFA-investor-information/publication-library/forex.pdf

http://www.nfa.futures.org//NFA-investor-information/publication-library/forex.pdf

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11•Busting Myths•tdameritrade.com

WORDS BY THOMAS PRESTON PHOTOGRAPH BY FREDRIK BRODÉN

BROMIDES AREN’T HELPFUL WHEN YOUR INVESTMENT STOMACH IS QUEASYWITH FINANCIAL UNCERTAINTY. AND NEITHER IS TRITE ADVICE. REPLACEBOTH WITH LOGICAL APPROACHES TO MANAGING YOUR TRADES.



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12•Busting Myths•Photograph by Fredrik Brodén

•tdameritrade.com

M Y T H N O. 1 — CUT YOUR LOSSES SHORT,AND LET YOUR WINNERS RUN. What it means. One of the oldest ones in the book.The idea is that your long-term trading success is deter-mined by large winners. If you can just keep the losseson your losing trades small, the large profits from thewinners will offset them, and you’ll be profitable overtime. You’ll hear stories from investors about how theybought some high-flying stock at a much lower price,or bought some out-of-the-money calls for pennies thatturned into dollars. They will likely attribute that to for-going taking a small profit, and being patient enough towait for the big score. You will likely not hear themutter the word “luck.”

Why it’s busted. This isn’t necessarily bad advice, butit doesn’t tell the whole story. Every option trade, forexample, starts as a loser, simply because of thebid/ask spread. And you could also get whipsawed outof every type of trade on an intraday swing, if your onlycriteria is to exit on “small losses” alone.

Further, trades with huge profits don’t happen veryoften, and this rule doesn’t give any guidance aboutwhen to take profits to make sure they don’t turn intolosers. For example, how much should you let a win-ning trade “run”? The longer you hold a profitableposition, there is a growing likelihood that the stockcould reverse itself and turn that winning trade into ascratch, or even a loser. That’s why this adage seems tobe more about luck than strategy.

Make it smarter. Let’s flip this one on its head. Insteadof focusing on trying to get big wins, you may want toconsider trades with smaller profits, and with fewer,smaller, losing trades. In other words, keep both yourpotential profits and losses small, using strategies withinherently higher probabilities of success, and lower,defined risk. That doesn’t mean you should be trying toscalp stock, and run up huge commissions. For exam-ple, option-credit spread strategies can have higher

probabilities of profit, and havedefined risk where the maxi-mum loss is limited, such asvertical spreads and iron condors.They can be the foun-dation of building a portfoliowhere profits are built upslowly, over time.

M Y T H N O. 2 — ALWAYSUSE STOP ORDERS What it means. The “flashcrash” of 2010. The financialmeltdown of 2008. The collapseof the “irrational exuberance”in 2000. And the granddaddy ofthem all—Black Monday, 1987.These events are etched into

our financial subconscious, and woe to any trader whoblithely buys stocks ignorant of history. Stop orders (orstop-loss orders) are activated when the price of a stockdrops to a certain level, and routes a market order toclose a position to limit the loss. The objective is tokeep a small or moderate loss from turning into a mon-ster that can wipe a trader out—particularly if he or sheis trading on margin.

Why it’s busted. Stop orders seem to make sense, butthe big question is, where to place them? A stop pricethat’s too close to the current price can keep lossessmall. But a long position can be stopped out as a los-ing trade before the stock rallies, and the positionpotentially becomes profitable, simply because of thestock’s random up-and-down swings. A stop that’s toofar away means the potential loss is much greater.Either way, a stop order doesn’t do much to protect youif a stock “gaps” lower—dropping to a much lowerprice on the open of trading (or possibly during theday)—that results in stop orders being filled at pricesmuch lower than the stop price. And if you’re using astop-limit order, fuggedaboudit. Your stop might gettriggered, but it the stock is volatile enough, you maynever get executed.

Make it smarter. Using stops is a rudimentary way tomanage risk on a stock you’ve bought. But a smarterway to think about it is that risk management starts atorder entry. The maximum loss on a stock position isthe difference in the price you pay for the stock (pluscommissions and fees), and $0. On a $20 stock, that’s$20 max loss per share, or $2,000 for 100 shares. Butyou don’t really know your potential loss with a stoporder. Rather, use strategies where the max loss isknown when you enter the order, and is within yourrisk parameters. For example, certain option-spreadstrategies have their max potential risk defined toeither the debit paid, or the difference between thelong-and-short strike prices, minus the credit received.A bullish spread with a maximum possible loss of, say,$60, would lose no more than $60 plus commissionsand fees, even if a crash takes the price of the stock to$0. No stop needed.

If you’ve traded long enough, you’veprobably heard an old trading adagebeing spewed from an authority on the markets or trading. Whileheeding sound advice is a good thing,not all advice is equal. When adagesturn to myths, it’s time to bust ‘em.Here’s four of the biggest.



M Y T H N O. 3 — DIVERSIFY YOUR PORTFO-LIO WITH STOCK, BONDS, AND CASH.What it means. Who knows which stock, sector orproduct will go up in the future? Instead of pickingone, spread your investment dollars around to a vari-ety of stock, bonds, funds, and leave some cash inreserve. This is diversification, and it can mean yourportfolio won’t see such large swings in profit or loss,and will hopefully benefit from the component assetsrising over time.

Why it’s busted. It’s true you don’t want to take everypenny you have and buy some stock, or option, orbond, and hope it goes up. But, with an efficient mar-ket, you can't really predict which way a stock or bondwill go next. Diversification doesn’t change that. Andtraditional diversification doesn’t factor in the relativerisk between assets like bonds and stocks.

Make it smarter. Diversify, but diversify across time,strategy, and markets. Spreading your trades out overtime, and using strategies like certain defined-risk,higher-probability option spreads, such as verticals,and those found on page 18, that let you take advan-tage of changing volatility and rates of time decay.

Also, if you use strategies that require smaller amountsof capital than buying stocks or bonds, you can havesmaller amounts at risk across even more stocks,indices, or sectors, creating even more diversification.Consider using tools like the beta-weighting tools on thethinkorswim tradingplatform to help assesspossible total risk of allyour positions.

M Y T H N O. 4 —VOLATILITY IS BAD, BAD, BAD!What it means. Stockscan move up anddown, and volatilitymeans how far theycan move up anddown. And with mostpeople buying stocks,bigger moves to thedownside are scary,and a reason to avoidinvesting in stocks dur-ing volatile times.

Why it’s busted. Guesswhat? Volatility worksboth ways. A stock thathas a 20% move up, isjust as volatile as astock that has a 20%move down. Those bigwinners some traderschase are only possiblein volatile markets.Plus, volatility changesall the time. It moves upwhen there’s a lot offear in the market, andit moves down whenthere’s more compla-cency. And compla-cency often sets in aftera big rally. So, whenyou decide volatility islow enough to start investing in stocks again, volatilitycan spike up with a big sell off.

Make it smarter. High volatility that means largerpotential moves in the stock price, also means poten-tially higher option premiums. And that can meanlarger credits for strategies, like covered calls (see page22, this issue) and certain option spreads. Those largercredits can also mean larger potential profits. Justbecause the credits are higher doesn’t mean you waituntil volatility is high to load your portfolio up withshort-option strategies. Be aware that larger potentialprofit usally means larger potential loss as well. Keepyour position size small, so that even if the worst casehappens, whether volatility is high or low, the loss ismanageable.

The information contained inthis article is not intended tobe investment advice and isfor illustrative purposes only.Multiple option strategiessuch as those discussed inthis article can entail sub-stantial transaction costs,including multiple commis-sions, which may impact anypotential return. These areadvanced option strategiesthat often involve greater andmore complex risk, than basicoptions trades. (See page 9,#3 for more details.) Be sureto understand all risksinvolved with each strategy,including commission costs,before attempting to placeany trade. Be aware thatassignment on short optionstrategies discussed in thisarticle could lead tounwanted long or short posi-tions on the underlying secu-rity. Clients must consider allrelevant risk factors, includ-ing their own personal finan-cial situations, before trading.All options involve risk andare not suitable for allinvestors. Supporting docu-mentation for any claims,comparisons, statistics, orother technical data will besupplied upon request

Important Information

SEE GLOSSARYPAGE 42

Course CorrectionYesterday's advice maychange tomorrow. Listen in on active conversationtoday, by experiencedtraders. Tune into SwimLessons daily between10:30 a.m. - 1:30 p.m. CT.Just fire up your thinkorswim platform andclick Support/Chat buttontop left. Select ChatRooms > Swim Lessonsand you're there.


Go beyond tweeting and tagging. Choose your app from the leader in mobile trading.*

* Mobile leadership claim based on analysis of publicly available competitor data concerning number of mobile users and daily average revenue trade levels.

** TD Ameritrade and tastytrade, Inc. are separate, unaffiliated companies. TD Ameritrade is not responsible for any third-party content or opinions presented.

The paperMoney® software application is for educational purposes only. Successful virtual trading during a one-time period does not guarantee successful investing of actual funds during a later time period—market conditions change constantly.


The risk of loss in trading securities, options, futures, and forex can be substantial. Clients must consider all relevant risk factors, including their own personal financial situation, before trading. Options, futures, and/or forex trading privileges subject to TD Ameritrade review and approval. Not all account owners will qualify. Futures and forex accounts are not protected by the Securities Investor Protection Corporation (SIPC).

TD Ameritrade does not make recommendations or determine the suitability of any security, strategy, or course of action for you through the use of TD Ameritrade’s trading tools. Any investment decision you make in your self-directed account is solely your responsibility. Please consult other sources of information and consider your individual financial position and goals before making an independent investment decision.

Third-party research and tools are obtained from companies not affiliated with TD Ameritrade, and are provided for informational purposes only. While the information is deemed reliable, TD Ameritrade does not guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with respect to the results to be obtained from its use. Please consult other sources of information and consider your individual financial position and goals before making an independent investment decision. Past performance does not guarantee future results.

Access to real-time market data is conditioned on acceptance of the exchange agreements. Professional access differs and subscription fees may apply. For details, see our Professional Rates and Fees listing.


TD Ameritrade Mobile Straightforward access to your account essentials.

▪ Easy mobile monitoring and trading

▪ Enhanced third-party research from industry leaders

▪ Scan a bar code to get a stock quote, then add it to your watch list or place a trade instantly with Snapstock™

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▪ Trade equities, multi-leg options, futures, and forex from anywhere

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▪ Practice new trading strategies without risking a dime with paperMoney®

▪ Live, streaming video from CNBC U.S., CNBC Europe, CNBC Asia, and tastytrade® **

You can tweet about your cornflakes. Or you can eat the market for breakfast.

Choose your app at tdameritrade.com/mobileapp.

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thinkMoney/17

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15•Love Notes•Hyperbole and Trading PearlsFrom …You•Photograph byFredrik Brodén

Got a quip, a poem or a pearl you’d like to share? Send your best prose [email protected].

• Exasperation...er, I meanexpiration Friday...No, wait. Igot that right the first time…Danielle

• You’re better off putting themoney into dating, drinks, andclothes than in markets if youdon’t understand them.Stefan

• Please get all the factsstraight first so that they maybe distorted correctly later.Ben

• I told my wife if she walksout that door, I don’t haveenough money to change thelocks…due to bad trading.Trey

• Who needs astrology whenyou have Gann charts?Hector

• Keeping my eyes open for“I'm in a coma, not dead”cross.Danny

• If you look back at a 10%gain as a loss, you will neverbe right.Trevor

• Damn, [thinkorswim] chatwon't let me exclude myself.Luke

• The FWIW chart…Is it a cupand handle? A rounded bot-tom? A double bottom? A gapfill failure? A Fib stop andreverse? It could be anythingyou want. Welcome to tradingafter the fact of course. Or elsehow could one take precogni-tion credits…or 20/20 hindsight…or...well...you get thepicture. Oh boy.Phil

• I may have been up sick allnight, but at least I didn’t missany action in the markets thismorning.Renee

• All I need is a 600,000 pointmove on my one contract toafford a $30 mil home. Rick

• October: This is one of thepeculiarly dangerous months tospeculate in stocks. The othersare July, January, September,April, November, May, March,June, December, August andFebruary. Mark Twain

lttrs.

•Important InformationThe comments above areexcerpts of e-mails submit-ted by TD Ameritradeclients as their views and may not reflect those of TD Ameritrade, Inc.Testimonials may not berepresentative of the experi-ence of other clients and is no guarantee of futureperformance or success.

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•

A little Q&A withNicole Sherrod, Managing Director,Trader Group at TD Ameritrade

Ask The

Suit

Q: What’s the best new featurein thinkorswim everyone shouldcheck out?A: One feature I’d urge all youchartists out there to check out isthe new custom time frame feature.Now, you can create your ownaggregation period with either tickor time. The days of being forced topaint one-minute bars are over! I’dalso urge you to check out thethinkorswim Learning Center attlc.thinkorswim.com to find outeven more about how to create yourown masterpiece with thinkorswimCharts.

Q: What’s the best way to sendideas for enhancements to yourtrading platforms?A: We love user feedback and takeit very seriously. In fact, our prod-uct-development team reviewseach and every request that ourvalued users submit. If you havean idea that you believe will helpyou or other traders make bettertrading decisions, we want to hearfrom you. You can send your ideasfor Trade Architect, thinkorswim, or Mobile Trader via the followingaddress: [email protected].

Q: I use both thinkorswim andTrade Architect. I think TradeArchitect needs more workthan thinkorswim—yet newreleases seem to be made morefrequently on thinkorswim.Why?A: For the last six months, we’vebeen working on a redesign ofTrade Architect, and we’re finallyin the home stretch. This newupgrade will make the platformfaster and more nimble. It willalso address a lot of user feedbackthat will result in a more intuitivetrading experience. This projectwas a major undertaking, andshould launch before the nextissue of thinkMoney hits yourmailbox. The new version ofTrade Architect will also providethe foundation that we need tobegin introducing more frequentupgrades. That means you willsee a similar cadence of evolutionfor both thinkorswim and TradeArchitect.

thinkMoney/17

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16•News+Views•A hodgepodge of stuff we thought youshould know.

•Photograph byFredrik Brodén

•tdameritrade.com

nws. The risk of loss on ashort sale is poten-tially unlimitedsince there is nolimit to the priceincrease of a secu-rity. There is noguarantee the bro-kerage firm can con-tinue to maintain ashort position for anunlimited timeperiod. Your positionmay be closed out bythe firm withoutregard to your profitor loss.


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During the 2008financial crisis, therewas much discus-sion about how“naked” shortsales—short sales ofstock where theshares weren’t bor-rowed—were exac-erbating the sell-offin stocks. You mayeven rememberback in 2006, theCEO of Overstockcomplaining that thepoor performance ofthe company’s stockwas due to nakedshort selling. Youdon’t hear muchabout short sellinglately. Has anythingchanged?

Short selling is astrategy that bets onthe price of a stockgoing down. Itmeans selling stockyou don’t own, inhopes you can buy itback for a lowerprice in the future.Traditionally, bro-kers and clearingfirms require you to“borrow” the stockbefore you short it,so it can be “deliv-

ered” to the buyer.Through the clear-ing process, the bor-rowed shares aredelivered withinthree days. If theshares aren’t deliv-ered, a “failure todeliver” occurs.

Because of exten-sions for the deliv-ery period, it’spossible that multi-ple short sellers areallowed to borrowthe same shares ofstock. If that hap-pens enough, therecan be more sharesshort than are in the“float,” or sharesavailable for publictrading. In 2008, theSEC clamped down,and prohibited

naked short sellingafter concerns thatthe failures of BearsStearns and LehmanBrothers had beeneffected in part bynaked short selling.Since then, therehave been somelarge penaltiesassessed to firmsallowing the prac-tice.

Now, part of thereason short sellersgot attention a fewyears ago was themoney they weremaking. In 2007 and2008, the sharp sell-offs in the marketgave short sellersopportunities. But arally for the pastcouple of years hasmade it tougher forshort sellers. And,they’re not makingheadlines any more.

Also, naked shortselling was more ofan institutionalproblem. Retail bro-kers and clearingfirms weren’t over-riding their shortstock rules.

While we canagree that prohibi-tions against nakedshort selling maymake for soundtrading and clearingpractices, have theyreduced marketvolatility? Tough tosay. The global mar-kets are so large andliquid, that theimpact of a gang ofnaked short sellers islikely muted—par-ticularly if theirbanks aren’t lettingthem play that gameanymore.

Is shortselling still a“problem”?

Words by Thomas PrestonIllustration by Brian Cairns

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18•Volatility Trades•tdameritrade.com

TRADING A GIANT—A STOCK OVER $100—CAN BE TRICKYUNDER ANY VOLATILITY BACKDROP. BUT WITH THE RIGHTSTRATEGY, ANY VOL WILL DO.WORDS BY ADAM WARNER PHOTOGRAPH BY FREDRIK BRODÉN

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•Volatility Trades•Photograph byFredrik Brodén

•tdameritrade.com

THE ONE CONSTANT IN THE WORLD OF OPTIONS isthat nothing’s constant. And so goes volatility. Butvolatility, unlike a stock, doesn’t typically move upwithout looking back. That’s because it’s “mean revert-ing,” which in geek-speak means it tends to rise and fallaround an average level. Trying to figure out why astock’s implied volatility is high or low, won’t do you asmuch good as simply determining the optimal strategyto take advantage of the volatility hand you’re dealt—particularly on high-priced stocks.

Generally speaking, there are three volatility envi-ronments you'll need to consider: low, mixed, and high.Here’s a few trend-trade strategies designed to meeteach of these.

1— LOW VOL —BACKSPREADS Is the stock you’re looking at $20 or $200? If the latter,then a simple long-option strategy may be too pricey,

despite low implied volatility. An at-the-money option on the $20 stock might be$2, but on a $200 stock, it could be $20.So what if you think the stock is poisedfor a nice drop in price, and you want totrade that downside? Perhaps a putbackspread might come in handy.

A backspread is comprised of at leastone near-money, or out-of-the money(OTM) options series, and a greaterquantity of long position, in a furtherOTM option series of the same class andexpiration cycle. You want to try to putthem on for a small credit.

What’s the attraction? In addition tolikely being less capital-intensive than their long-optioncounterparts, backspreads give you a two-pronged bet.They generally let you establish a credit in your favor,while getting you poised to take advantage of a rise involatility. Putting them on for a credit may just provideyou with a small profit, if the entire trade expires worth-less. Second, you also have more long puts than shorton a put backspread, and more long calls than short ona call backspread, so you could profit if the underlyingmoves sharply beyond your strike prices.

What’s the downside? You lose in general if theunderlying stock hovers near the long strike, and youlose big if you do nothing, and the stock closes right atyour long strike.

Suppose stock XYZ is trading at $225. XYZ has ral-lied considerably over the past six months. You suspectthe uptrend is tired, and the stock may drift over thecourse of the next two months, or possibly even crashhard. To put on a bearish put backspread, you’d sell,say, two August 220 puts in XYZ, for $11.50 (for a totalcredit of $2,300). Against that, you could theoreticallybuy four August $200 puts, for $5.00 each (for a totaldebit of $2,000). The margin you would need to put upis the difference between the short and long strikes (inthis case, net-net, you take in a credit of $300.

An upward move in the stock is pretty straightfor-ward. Your profit maxes out at the $300 you took in as acredit (less commissions and fees).

A downward move in the stock is trickier. If XYZcrashes, you could potentially cash in—again, thanks toowning the extra put. The lower it goes, the better.

Looking at a profit curve of the backspread in Figure 1, notice the change in the difference betweenthe date of entry (red dash line), and trade expiration.As time passes, the potential loss increases, as timedecay sets in the long options, with the greatest loss atthe long-put strike.

However, the backspread’s best performance comesif XYZ collapses immediately. That’s because of the twoadditional long puts, which should benefit if XYZdeclines—even if XYZ declines towards our long strikeof $200.

If XYZ doesn’t move quickly enough, however, youmay not be so lucky. Though you typically don't wantto hold a backspread until expiration, your worst-casescenario occurs if XYZ closes exactly at $200 on Augustexpiration. The $220 puts you sold at $11.50 each expireat $20, which produces a loss of $1,750. What’s more,the 200-strike puts you bought $5 each go worthless.That’s another $2,000 down the drain. Since you tookin a $300 credit at the onset of the trade, your total losswould be $3,450 (plus commissions and fees) in thisscenario ($300 - $1,750 - $2,000). Ouch.

2— MIXED VOL —LONG VERTICAL When volatility is at heightened levels, but not tooextreme, a long vertical spread is a defined-risk strategydesigned to profit from a directional move, while alsohedging volatility. It typically requires only a smallinvestment—you simply need to cover the debit youincur.

With a long-call vertical, you’re making a bullish betby purchasing a call, and selling a higher-strike call ofthe same class and expiration, in equal amounts.(SeeFigure 2) With a long-put vertical, you’re making abearish bet by purchasing a put and selling a lower-strike put of the same class and expiration, in equalamounts as well.

Vega—the rate at which an option changes whenvolatility changes—is the culprit for taking money awayfrom you, when volatility collapses in a long position.However, in a long vertical, the reason your negativevega is hedged somewhat, is because the volatility yousell in the short option, negates some of the volatility

SEE GLOSSARYPAGE 42

FIGURE 1: The Backspread In low-vol environments, particularly onhigh-priced stocks, the backspread offers an alternative to expensive callsand puts.

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BACKSPREAD

Profit

Loss

Stock Price

BREAKEVEN



you’re buying in the long option. Itdoesn’t hedge all of it, but it helps.And you could still potentially ben-efit from a rise in volatility. Moreimportantly, the long-vertical couldposition you to profit from theunderlying stock move.

Suppose you’re mildly bullishon hypothetical stock FAHN, butnot interested in a big bet onoption volatility. You could theo-retically buy a call-vertical spreadby purchasing 2 FAHN August 230calls for, say, $9.00 (=$1,800),and selling 2 FAHN August 240calls for $6.00 (=$1,200), for atotal outlay of $300 (plus commis-sions and fees). This is also yourmax risk. And your max reward is$7.00 per spread (less commis-sions and fees).

What’s next? If you do nothing,and FAHN settles anywhere below$230, the spread goes out worth-less, and you lose the entire $300.However, on the upside, if FAHNexpires above $240, the spread isworth $10 ($240-$230). Since youpaid $3.00 for it, you make the dif-ference of $7.00 x 2, or $1400. Yay.

If FAHN closes anywhere in themiddle of the strikes, you win orlose the difference between theintrinsic value of the spread, andthe $3.00 debit you paid. So youbreak even at $233, and max outon profit potential at $240.

3— HIGH VOL —SHORT VERTICALSuppose you’re still bullish, ormildly bullish, on FAHN, butvolatility is too high to purchase along vertical spread. Therisk/reward just isn’t there. Insteadof buying a call vertical, you sell anout-of-the-money put vertical

spread. (Figure 3) Painting broad strokes, astock can go up, down, or stay put. Withstock, or long calls, or long vertical spreads,you lose in two of those three scenarios. Buta short out-of-the-money put vertical canmake money if the market goes up, stays thesame, or even drops a bit—just as long as thestock is above the short strike at expiration.

What does it look like? Using our FAHNexample, suppose you short the August 220puts at $11.50, and purchase the Aug. 210puts at $9.50, for a credit of $2.00 each, or$200 per spread (less commissions andfees).

If FAHN expires anywhere above $220,you keep the $200 (less commissions andfees). If it closes below $210, your maximumloss is the difference between the strikes, lessthe $2.00, for a net loss of $8.00 per spread,or $800. If it closes in between, you loseintrinsic value, less the $2.00. For example, ifFAHN finishes at 215, you lose $5.00 perspread, less the $2.00 your received, for atotal of $3.00 per spread, or $300.

In the case of a short vertical, you’recounting on volatility collapsing, whichhelps your trade. The sooner the volatilitypremium is pulled out of the options, thesooner you profit. On the other hand,should volatility increase, this would hurtyour trade. You only profit if you can buythe spread back cheaper than you sold it for,or it expires worthless.

Obviously, short verticals are similar tolong verticals. However, they’re a modestbet against volatility. It’s a great alternativeto its unhedged cousin, the short-naked put.But with a short vertical, you have a built-instop at your long strike, should the stock goawry.

HIGH-PRICED STOCKS don’t have to beintimidating, and neither does their volatil-ity. These are just three of the many optionspreads designed to mitigate your volatilityrisk and attempt to capitalize on the prevail-ing trend—without breaking the bank.

Volatility LessonsBefuddled about volatility?You're not alone. Start fromthe beginning by readingthe Volatility Focus in issue#12 of the thinkMoneyarchives.

Just go to dameritrade.com/thinkmoney and click thecover of issue #12.

FIGURE 2: Long Call Vertical One benefit to a long vertical spread isyou're buying and selling volatility, which essentially negates it.

FIGURE 3: Short Out-of-the-Money Put Vertical High volatility is akiller of long option strategies. That's why short verticals are designed toprofit from a drop in volatility.

Options involve risks andare not suitable for allinvestors. The informationcontained in this article isnot intended to be invest-ment advice and is forillustrative purposes only.The spread strategies dis-cussed above and othermultiple-leg option strate-gies can entail substantialtransaction costs, includ-ing multiple commissions,which may impact anypotential return. These areadvanced option strategiesthat often involve greaterrisk, and more complexrisk, than basic optionstrades. Clients must con-sider all relevant risk fac-tors, including their ownpersonal financial situa-tions before trading. Trans-action costs (commissionsand other fees) are impor-tant factors and should beconsidered when evaluat-ing any options trade. Forsimplicity, the examplesabove did not includetransaction costs. At TD Ameritrade, the stan-dard commission foronline equity orders is$9.99, online option ordersare $9.99 + $0.75 per con-tract. Orders placed byother means will havehigher transaction costs.Options exercises andassignments will incur a$19.99 commission.


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LONG CALL VERTICAL

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Stock Price

BREAKEVEN

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SHORT OUT-OF-THE-MONEY PUT VERTICAL

Stock Price

BREAKEVEN

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LongStrike

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http://tdameritrade.com/thinkmoney

AS A CHILD, I REMEMBER GOING TO THElibrary with mom and watching her combthrough “Value Line” binders that were big-ger than my booster seat. This was how sheresearched her stocks.Thanks, technology,for making our lives easier today, and well,less archaic.

But there are still some trading activi-ties today that continue to be prehistoric.Take, for instance, the action of rolling for-ward on a covered call. What’s that? Sayyou’re long stock, and you sold short-term, out-of-the-money call optionsagainst your position to generate incre-mental income, and to drive down yourposition’s cost basis by the amount ofcash you received. This is the plain-vanillacovered call. To “rollover,” you buy toclose your near-term option, and sell toopen a slightly further-term option at thesame strike price, while leaving the longstock position alone. If you keep rollingthe short option from one expiration toanother (month to month), you couldpotentially create a consistent monthlyflow of income, as long as your stockdoesn’t get called away with an assign-ment* and of course, transaction costsdon’t cut into your profits.

CARPE COVERED CALL ROLLERBut why go through the hassle of initiatingthe roll each month? And what if onemonth you forget, and miss the opportu-nity? Introducing the “covered call roller.”

This new user-friendly feature recentlyintroduced on the thinkorswim tradingplatform, is designed to completely auto-mate the process of rolling forward. Youcan now program virtually every consider-ation you would normally make in rollingforward, so you can completely defineyour parameters for future actions. What’smore, the capability also has robust notifi-cations so you are kept abreast of anyautomated adjustments made to yourposition for the life of your trade.

Let’s start with the overall sentimenton the position. If I’m short-term deltaneutral on the position—meaning thedelta of all legs in the position net out tozero—I would want to roll forward intothe same, or similar, strike. But if I’m morebullish, I would want to roll out and up toa higher strike in an attempt to capture a

profit in the stock, should it move higher.You can program this easily with the Mar-ket Sentiment slider.

The same holds true for other customcapabilities. If you’d like to get the most outof these features, the best place to turn isthe thinkorswim Learning Center attlc.thinkorswim.com. When the CoveredCall Roller launches around November,you’ll find a video of the same name tohelp you better understand this excitingnew feature.

thinkMoney/17

•

22•Gear Head•Our favorite gadgets you may not have heard of

•Tool #1 Words by Nicole SherrodManaging Director, Trader Group at TD Ameritrade

•Tool #2 Words by Editorial Staff

gear

FIGURE 1: Automate Your Rolls . The Covered CallRoller in thinkorswim allows you to customize your monthlyrolls with so many levers, you'll start to wonder what to dowith all your new free time. For illustrative purposes only.

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A Little ExtraRedOption1.com is a greatway to learn more aboutcovered calls, and they havean advisory of covered-calltrade ideas. Paid sub-scribers are notified eachtime Red Option recom-mends a new covered calltrade, makes an adjust-ment, or closes a position.Then, once you find theright idea, you can auto-mate your strategy with thenew Covered Call Roller.(launching in November,2012).

TOOL #2

thinkorswim’sOptions Statistics•

Digging deep into the market mood forclues to what might be next

STOCK TRADERS, HERE’S A NEWS FLASH:You don’t actually have to trade options topotentially benefit from them.

Take implied volatility—the volatilityof the price of a security that is “implied”by the price of the options. When it’shigh, that’s generally a reflection of nerv-ousness in a stock. As traders start puttingon more hedges, put activity mightincrease, taking volatility in the optionswith it. When volatility goes up, optionpremiums tend to get inflated.

This information can benefit both thestock and options trader. As a stock trader,

TM17_GearHead_RD5.qxd:pages.layout 2012-09-17 12:12 AM

http://RedOption.com


1RED Option Advisors, Inc. and TD Ameritrade, Inc. are separate but affiliated firms.Advisory services are provided exclusively by RED Option Advisors, Inc. and brokerageservices are provided exclusively by TD Ameritrade, Inc.

*Covered call strategies can limit the upside potential of the underlying stock position,as the stock would likely be called away in the event of substantial stock price increase.(Short options can be assigned at any time up to expiration regardless of the in-the-moneyamount.) Please note that a monthly covered call rollover strategy will entail transactioncosts (commissions and other fees) for each rollover transaction executed which mayimpact any potential return. Commissions and fees are important factors and should beconsidered when evaluating any options trade or strategy.

Information and analysis available in the Option Statistics tool cannot predict per-formance, and past performance is no guarantee of future results. The information con-tained in this article is not intended to be investment advice and is for educationalpurposes only. Be sure to understand all risks involved with each strategy, includingtransaction costs, before attempting to place any trade. Be aware that assignment onshort option strategies discussed in this article could lead to unwanted long or short posi-tions on the underlying security. Clients must consider all relevant risk factors, includingtheir own personal financial situation before trading. Options involve risk and are notsuitable for all investors. Supporting documentation for any claims, comparisons, statis-tics, or other technical data, will be supplied upon request. Market volatility, volume, andsystem availability may delay account access and trade executions.


SEE GLOSSARYPAGE 42

market “nervousness” is hard to gaugefrom charts alone. And, for the optiontrader, when option premiums are expen-sive, it’s typically better to be implement-ing sell strategies, such as covered calls,rather than buying them. Higher premi-ums can erode quickly, making it difficultfor long strategies to profit.

But what’s “expensive” or “cheap”anyway? After all, volatility is relative.Just because a tech company has highervolatility than a paint company, doesn’tmean its options are more expensive. TheOptions Statistics tool in the Trade page ofthe thinkorswim platform provides addi-tional information that might be useful inhelping you decide whether you want totrade tech or paint.

As you plan your next trade, take alook at a few items from Options Statisticsthat might help you make sense of things.

CURRENT IV PERCENTILE:Most of the occurrences of implied volatil-ity over the past 52 weeks have occurredabove this number. This is key for factor-ing whether options are “cheap” or“expensive.” In the case of Figure 2, cur-rent volatility sits at the bottom 18% of allother instances of volatility in the past 52weeks—pretty cheap. This might be acandidate for a position that’s net long vol(i.e., buy option strategies such as longvertical spreads). If it were on the highend—say, over 60%—you might want tobe net short volatility (i.e., sell optionstrategies, such as short vertical spreads).

The area in the middle column of thetool under “Trade Analysis” takes it a littlefurther, to help you determine if tradersare actually buying or selling options.

TRADED AT THE BID:Looks at how many traders are likely sell-ing options, which likely indicates theyare getting out of positions, or establish-ing short positions.

TRADED AT THE ASK:Looks at how many traders are likely buy-ing options, which indicates they are likelyentering positions or covering shorts.

DELTA BETWEEN:Traded at BID and Traded at ASK providesgreat info, but the challenge is, you can’ttell if the trades were previously openedpositions closed at the end of the day, orthey’re establishing new positions today.“Delta between” might provide clues. Thedelta of at-the-money options is typically.50. So, if a majority of options are tradingin the money again, the question is, arethey getting in or out? Typically (and thisis anecdotal), seasoned traders will hedgewith puts. If there are a lot of calls trading

in the money, this could be a bullish sig-nal, since it would be unusual for tradersto buy in-the-money calls as a hedge.

There’s always a nugget or two ofinformation traders can pull from theoptions market. But, just as important asmaking the effort to dig a little, is under-standing what you’re looking at when youfind it. Options Statistics goes a littlebeyond your standard volatility readings,and hopefully offers some clues as towhat to do next. This goes for you too,stock trader.

FIGURE 1: Data is King . Take heed, stock traders. The Options Statistics tool in thinkor-swim contains a bunch of information about the general mood of the market, and collectively,what other traders are thinking. For illustrative purposes only.

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24•LEAPS•tdameritrade.com

TM17_Leaps_RD5.qxd:pages.layout 2012-09-17 12:18 AM


THERE’S NO ARGUING that options are time-sensi-tive instruments. They decay, which is one of the reasonsmany new traders shy away from them. And long-terminvestors—well, forget it. Most often, buying an option with alimited life span is like racing against the clock—the stock’sgotta move before time runs out. And even that doesn’t guar-antee a profit.

So what do you need? More time. And that’s what LEAPSoptions are all about. LEAPS—Long-Term Equity AnticipationSecurities—are options that have expiration dates rangingfrom nine months to nearly three years. But these long-termcontracts come with their own set of questions. How do theydiffer from standard options? And what strategies can a traderemploy to take advantage of these differences? >>

WHAT DO YOU GET WHENYOU CROSS A STOCK

WITH AN OPTION? HOWABOUT A LONG-TERM

OPTION. WITH LEAPS, TIMEIS ON YOUR SIDE AND

CAPITAL RISK IS LOW. ANDIF YOU’VE NEVER TRADED

THEM, THEY COULD BEWORTH A LOOK.

WORDS BY ALEX MENDOZA PHOTOGRAPHS BY FREDRIK BRODÉN


BABY LEAPSFirst and foremost, LEAPS are as close to buying astock as you can get—without actually buying a stock.It’s not an asset like a stock, but it does qualify as asecurity as the name suggests.

But even if you don’t intend to hold them for thelong term (many traders don’t), LEAPS may be usefulin your portfolio, depending on your investing objec-tives. For example, you might want to have fair expo-sure to a certain sector, without tying up too muchcapital, or borrowing on margin. LEAPS can also runabout 20% of the price of the underlying stock. So, ifyou only have a few thousand bucks to spare—a mod-est sum if many of the stocks you’re looking at mightbe trading over, say $100—this might help you achievesome diversification and invest in options on a few dif-ferent equities.

That said, you could implement a LEAPS-basedstrategy on individual stocks, or broad-based indices, oryou could find a happy medium and build a sector-spe-cific portfolio. And to boot, depending on the strategyyou implement, if you hold a LEAPS option for at least12 months, it could qualify for long-term tax treatment.But that’s a question for your accountant, of course.

A DIFFERENT KIND OF GREEKTo understand the differences between LEAPS and stan-dard options, we have to delve into the world of optiongreeks. You may already be familiar with option greeksas they pertain to standard options. (See the glossary,page 42, if you need to brush up on greeks.). However,the option greeks that pertain to LEAPS options tend tohave some significant differences. As a result, you maywant to structure your LEAPS trades in considerably dif-ferent fashion from your standard option trades. Toillustrate, take a look at the following table:

The table compares two at-the-money option con-tracts. One option has a week left until expiration. Theother has two years left. More specifically, XYZ stock istrading for $550 per share, and the table compares theone-week 550-strike call, with the two-year LEAPS 550-strike call. Even though the options share the samestrike, the similarities stop there. Let’s break down thedifference between each greek.

DELTANotice that the delta of the LEAPS is significantlyhigher than that of the weekly option, even thoughboth are at the money. You might expect delta to beabout .50. However, in the real world, options arepriced based on something called the “forward price ofthe stock.” Rather than pricing the options based on a

stock price of $550, they are priced off $550, plus anyinterest on that amount, until option expiration. For theLEAPS call, the additional interest is enough, so thateven though you are trading the 550-strike call, it’sbeing priced off a value significantly higher than $550.Because the stock price being used is higher than thestrike price, the option is technically in the money, andhence, it correctly reflects the higher delta.

GAMMAThe longer an option has until it expires, the smallerthe gamma becomes. While the reasons can get com-plicated, think of it this way: gamma is a measure ofhow much the delta changes based on a small move inthe stock. Since longer-term options are big-ticketitems, a small move in the stock is likely to have a neg-ligible effect, as compared to what it would do with ashorter-term option.

THETAIf gamma is fairly negligible in longer-term options, itfollows that theta is also negligible. Why? Not only istheta the effect of time decay on the price of an option,but it’s also referred to as “the price of gamma.” So, ifyou own LEAPS, you probably won’t have to worrymuch about time decay until you start getting closer toits expiration day. That’s what differentiates LEAPSfrom standard options, and is the reason they may beviable, alternative investment for certain traders tohold for months, even years, at a time.

VEGAIf there’s one wet blanket to throw on the virtues ofLEAPS, it’s vega. The effect of volatility swings on anoption’s premium is a killer. In fact the farther out intime you go, the greater your vega. Take weeklyoptions. The difference between a LEAPS option and anextremely short term option like a Weekly, is almosttenfold. In a nutshell, if the implied volatility levelchanges by so much as one percentage point, you couldbe looking at some fairly significant P&L swings. This isclearly something you need to address in order to suc-cessfully incorporate LEAPS into your trading arsenal.

RHORho is typically the “forgotten” greek. In fact, you canget pretty far in an options education curriculum andnever hear anyone mention rho. The reason is twofold.First, the change in the option value based on a one-per-centage point change in interest rates is typically a smallnumber. Second, interest rates don’t commonly changeby a full percentage point during the life of an option.

This all changes with LEAPS. Because of the lengthyperiod until expiration, changes in interest rates matter.Think of it like a bank loan. If you’re going to borrowmoney for the next 30 days, then the difference betweenan interest rate of 4%, as compared to one of 5%, is

thinkMoney/17

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26•LEAPS•tdameritrade.com

Speak GreekNeed to brush up on youroption greeks? See theToken Glossary on page 42, or go to the new Learning Center attlc.thinkorswim.com andtype in "greeks" in thesearch box. You'll be gladyou did.

Exp. Delta Gamma Theta Vega Rho Opt . Price

1 Week

2 Years

.50

.60

.03

.002

-.51

-.08

.28

2.68

.05

3.57

$6.00

$97.00




fairly negligible. However, in terms of a 30-year mort-gage, the difference in interest between a 4% rate, and a5% rate, is substantial. Well, that’s a little primer onhow rho gets factored into options.

COVERED CALL REVISITEDOkay, so given what you now know about LEAPS,here’s an example of how LEAPS could be used in atrading strategy, like selling covered calls, and how thegreeks can impact your decisions.

By now, you’ve heard of the covered call—youknow, where you buy a stock in increments of 100shares, and sell a call against it that’s slightly out of themoney. While it’s a common stock-trading strategy tohelp lower the cost of a stock, or provide cash flow froma stagnant stock, it can also benefit the LEAPS buyer inunique ways.

With a LEAPS “covered call,” Instead of purchasingstock, you could purchase an at-the-money LEAPSoption and sell a slightly out-of-the-money, short-termcall. Though the LEAPS option isn’t an asset like astock, you’re “covered” because the strike of theLEAPS option is lower than the short-term option, andthe expiration is farther out in time. Should you be

assigned on the higher, short strike, you'd be short 100shares of stock, but you're covered (hedged) by thelong LEAPS option.

Trading the LEAPS covered call this way has a two-fold effect: were you to do this month after month, youcould 1) offset the extrinsic value (time value) of theLEAPS option; and 2) you could reduce the overall pos-itive vega of the position.

On the other hand, if the stock is at, or closer to, arecent high, it may revert and give back some of itsgains. You could still lose the entire premium of theLEAPS, should this happen. However, remember thatwhen the market falls, volatility typically rises. And arise in overall volatility can have a large, positiveimpact on your large-vega trade.

And while we’re currently in a world where interestrates have relatively little room to drop, a sudden spikein interest rates could provide an additional jolt to yourLEAPS call option. So, who knows, you may find thatrho could possibly become an unexpected friend.

LEAPS aren’t a replacement for stock, but they canprovide a few of the same benefits, without the ero-sive nature of short-term options. Don’t get us wrong.They’re still an option. So yes, you can just the same

lose all your invest-ment, as you can forshort-term options.However, for traderswith smaller accounts,who want to trade afew different securi-ties without fear ofrapid decay, LEAPSmight make sense. Or,for traders who simplywant exposure to sec-tors in which they’renot comfortable tyingup a lot of capital,LEAPS are a low-capi-tal alternative. Heck,the CBOE recentlylisted five-year optionson the SPX, known as“Super LEAPS.”That’s an eternity tosome traders. But, ifyou want longer-termexposure to the“broad market,” with-out tying up precioustrading capital, or youwant to try a longer-term trading strategy,like the covered callalternative, there’s noshortage of ideas.


Asset allocation and diversi-fication do not eliminate therisk of experiencing invest-ment losses. Options involverisks and are not suitable forall investors. Supporting doc-umentation for any claims,comparisons, statistics orother technical data will besupplied upon request. Theinformation contained inthis article is not intended tobe investment advice and isfor illustrative purposes only.The LEAPS “coveredcall”/spread strategydescribed above and othermultiple-leg option strategiescan entail substantial trans-action costs, including multi-ple commissions, which mayimpact any potential return.These are advanced optionstrategies which often involvegreater risk, and more com-plex risk, than basic optionstrades. Clients must considerall relevant risk factors,including their own personalfinancial situations beforetrading. Investors should also consider contacting atax advisor regarding the taxtreatment applicable to multiple-leg and LEAPStransactions.


CME GROUP FUTURES EDUCATION

Opportunities in Upand Down marketsWhether you are looking to go long in the gold market or short the S&P 500, futures allow traders to access markets when and where they want, responding to changing conditions regardless of market direction. In addition, futures trading combines fast execution and accurate reporting to trade effectively in volatile economic times. Diversify the products you trade. Express your true market opinion using contracts covering all major asset classes. When you include leverage, hedging opportunities, and tax benefits, it’s easy to see why sophisticated traders utilize futures contracts to maximize profit potential and help reduce risk associated with trading.

Explore more at cmegroup.com/resources

Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures. CME Group is a trademark of CME Group Inc. The Globe logo, CME, Chicago Mercantile Exchange, E-mini and Globex are trademarks of Chicago Mercantile Exchange Inc. CBOT and Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange and ClearPort are trademarks of New York Mercantile Exchange Inc. COMEX is a trademark of Commodity Exchange Inc. S&P 500 is a trademark of The McGraw-Hill Companies, Inc., and has been licensed for use by Chicago Mercantile Exchange Inc. Copyright © 2012 CME Group. All rights reserved.

AGRICULTURE | ENERGY | EQUITIES | FX | INTEREST RATES | METALS | WEATHER

TM17_HeyTrader_RD3.qxd:pages.layout 2012-09-17 12:15 AM

http://cmegroup.com/resources

Q: I see a numberlabeled “beta” onthe trading plat-form. What is it?

A: Beta describeshow much a stockwould change if anindex changes 1%—typically the S&P500. For example, ifa stock had a beta of1.25, and the S&P500 moved up 1%,theoretically thestock would moveup 1.25%.

Beta works thesame way if the S&P500 moves down.Beta is calculated bya statistical regres-sion between thepercent changes inthe stock, and thepercent changes inthe S&P 500, oversome previous num-ber of days. On thethinkorswim trading

platform the beta iscalculated for moststocks using fiveyears of monthlydata. So, beta isn’tfixed, and it canchange if you usedifferent timeframes in the calcu-lation, or if the stockand the S&P 500move in differentways in the future.

Q: What do youthink about scalp-ing options as ashort-term strat-egy?

A: Some people likethe idea of buyingoptions with theidea of selling themquickly—hopefullyfor a profit. This isbecause of thedefined risk natureof long options, andtheir typically lowercapital require-ments than, say,long, or short stock,or even futures.That sounds greatexcept for threethings: bid/askspreads, fees, andcommissions.

Let’s say you werethinking aboutscalping an at-the-money option with abid/ask spread of.10. If you boughtthe option at the askprice, then sold it onthe bid price, that’s$10 you’re losing,because of thebid/ask.

Compare that to a.01 or .02 bid/askspread for activelytraded stocks, whichtranslates into $1 or$2 of slippage. Also,to get the same mar-ket exposure as 100shares of stock,you’d probably haveto buy two of thoseat the moneyoptions. That meansnot only twice theslippage, but twicethe fees and com-missions, as well.Plus, commissionsfor options are typi-cally a much higherpercentage of theinvested amountthan for stock.While option strate-gies can make sensein different situa-tions, they are notoften used for short-term scalps.

Q: I’ve been play-ing with some ofthe option pricingtools on the tradingplatform. Whatinterest rate dothey use?

A: Most pricingmodels use a short-term, risk-free rateby default, like the

Fed Funds rate, forexample, or a three-month T-bill rate.But if you want tosee how ratechanges can impactoption prices, inputsomething like thebroker call rate.That’s more realis-tic, because it’scloser to the rateyou’d pay to borrowmoney if youbought stock onmargin. The interestrate in an option-pricing model deter-mines the carrycosts of a stock posi-tion, to create anarbitrage-free theo-retical valuebetween the stockand the call and put,at a particular strikeand expiration.

Q: Now that myhusband and I areboth retired, andour kids are out ofthe house, hewants to watch thesunrise with me.But I’m busy trad-ing forex at thathour. How can I tellhim that Mamaneeds to trade?

A: Tell him that toolittle sleep causesheartburn, and thatthe early-bird spe-cials don’t start untilafter the close, any-way. If that doesn’twork, lock him inthe bathroom.

thinkMoney/17

•

29•Ask the Trader Guy•Saving traders, one question at a time.

•Photograph by Fredrik Brodén

trdr.

The information con-tained in this articleis not intended to beinvestment adviceand is for illustrativepurposes only. Besure to understandall risks involvedwith each strategy,including commis-sion costs, beforeattempting to placeany trade. Clientsmust consider all rel-evant risk factors,including their ownpersonal financialsituations, beforetrading. Optionsinvolve risk and arenot suitable for allinvestors. Supportingdocumentation forany claims, compar-isons, statistics, orother technical datawill be suppliedupon request.


TM17_HeyTrader_RD3.qxd:pages.layout 2012-09-17 12:15 AM

Trade with your ear to the pit.Access FREE futures and forex resources, including

streaming data, live audio from the futures pit,

and advanced technical studies from seasoned

traders like John Carter and John Person.



Trading futures and forex involves speculation, and the risk of loss can be substantial.

Forex investments are subject to counter-party risk, as there is no central clearing organization for these transactions.

TD Ameritrade does not charge platform, maintenance, or inactivity fees. Commissions, service fees, and exception fees still apply. Please review our commission schedule and rates and fees schedule for details.

Futures and forex accounts are not protected by the Securities Investor Protection Corporation (SIPC).

Futures and/or forex trading privileges subject to TD Ameritrade review and approval. Not all account owners will qualify.

TD Ameritrade pays John Carter and John Person for research material regarding investments and securities that they may distribute to their own customers. John Carter and John Person are not representatives of TD Ameritrade.


Find out more at tdameritrade.com/futuresforex

TDA 1375 D 03/12

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ocdeartiremadtta

xreofstureuf/m

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xreofstureuf/m

TM17_FearlessTech_RD5.qxd:pages.layout 2012-09-17 12:09 AM

http://tdameritrade.com/futuresforex

• It’s the eternal question. You’ve got asetup that you like, on an index that you fol-low. Now...do you go directional, or do yousell some option premium?

The first question I typically ask myselfabout a pending trade goes like this. Is thismarket consolidating or trending? If it’s con-solidating, then I look at selling some pre-mium. If it’s trending, and the market hasjust pulled back to support, then I could doeither—such as buying a .70 delta call foran in-the-money directional trade, or sell anat-the-money put vertical spread. Bothtrades make sense.

But what if a market is about to makethe “switch”? The switch? Yes, the switch.

The switch takes place during thosemoments when a market transitions fromconsolidating, into a full-on trending mar-ket. Although it’s easy to identify in hind-sight, I look at tools that can help detectwhen a switch might be near.

Connect The DotsFigure 1 shows a chart of the NDX withthe TTM Squeeze indicator on the bottom.The red dots along the horizontal axis atPoint 1 show a market that is “squeezing”out the last bit of consolidation from aperiod of sideways price action; and isnow building up energy to “make theshift” to a trending market.

The first green dot at Point #2 suggests“the squeeze is on,” and this market isready to move.

In this case, with the histogram abovezero, a bullish o ption strategy might makesense. So, do you go directional, or sellsome premium?

At these moments, I prefer to leg into abullish-call vertical spread, which essen-tially turns into a “poor man’s covered call.”

Initially, I will buy in-the-money calls. Iprefer a delta of at least .70, in order to getprice movement in the option that closelymimics the underlying.

And then I wait...and wait... for themomentum on this trade to end. And thattakes place at point #3 on the chart, whenthe momentum on the histogram changescolor, indicating that the trending priceaction is coming to an end.

This is where I typically like to sell someat-the-money calls close to expiration tocomplete the vertical spread.

A best-case scenario at this point is amarket that goes back into a choppy consol-idating phase. Under these circumstances,our long in-the-money calls hold mostlyintrinsic value, and suffers minimal pre-mium decay. Our short call, on the otherhand, starts losing premium at a quick clip.

IN SUM, THE TTM SQUEEZE INDICATORrepresents a unique moment in the life ofthe underlying asset. The key here is toidentify that critical moment, and utilizedelta in the options, to maximize the poten-tial of the situation.

John Carter is a recognized authority on technical analysis but is not a representative of TD Ameritrade.

thinkMoney/17

•

31•Fearless Technician•Chart candy for traders

•Words by John F. Carter

FIGURE 1: Squeeze Me. Markets typically break out of consolidations. The TTM Squeezeindicator (lower histogram) attempts to alert you when it may happen. Chart from thinkorswim. For illustrative purposes only.

To access the TTMSqueeze indicator, log into the thinkorswim trad-ing platform, and selectthe Charts tab. In the upperright of any chart followclick path to Studies>Quick Study> John Carter’s Studies

The information, opinions and analysis contained in this article are the author’s alone. TD Ameritrade does not endorse the material, and did not participate in the development ofthe material. Technical analysis cannot predict performance, and past performance is noguarantee of future results. Options trading involves significant risks and is not suitable forall investors. Clients must consider all relevant risk factors, including their own personalfinancial situations before trading options. Creating spreads or legging into spreads optionpositions can entail substantial transaction costs, including multiple commissions, whichmay impact any potential return. These are advanced option strategies and can involvegreater risk, and more complex risk, than basic options trades.


•

Is a market switch near? Use this littleindicator to help you decide.

Get Your Squeeze On

tech

SEE GLOSSARYPAGE 42

21

3

TM17_FearlessTech_RD5.qxd:pages.layout 2012-09-17 12:09 AM

• I bet you thought the trading world hadalready invented a volatility index foreverything. But guess what: the CBOE hasone more up its sleeve—the volatility ofvolatility!

That’s right, CBOE VIX Volatility Index(VVIX) is the volatility of options on theCBOE VIX itself—hence, the volatilityof…well, volatility. Confusing? Perhaps.Useful? Sure.

WHEN TWO VOLS COLLIDEYou would expect VIX and VVIX to tell asomewhat similar story. A spike in “fear”typically leads to a lift in VIX—pretty muchby definition—as put activity increases dur-ing market shocks. And if VIX is spiking, itseems likely traders will pay up for optionson VIX, which would in turn spike VVIX.

In fact, it’s almost self-defining. VIXhas a “positive skew,” which means thehigher the strike price of a VIX option, thehigher that option’s implied volatility.Thus, even if nothing changes (volatility-wise) on the VIX options, a higher VIXwill beget a higher VVIX, because the cal-culation will now apply greater weight tothe higher-volatility, higher strikes in VIX.

Look at the top chart of VVIX in Figure1 since its inception in March 2012.

Then look at the bottom chart of VIXitself over the same stretch in March.

Notice a couple of interesting diver-gences? VIX basically started out thisthree-month stretch at its local lows. Dur-ing the same period, VVIX meandered,then tanked in late April, a pretty largeunder-the-radar reduction of fear whichVIX missed. That boded poorly for themarket.

Conversely, VVIX hit its local highs inlate May, about a week and half beforeVIX itself hit its local highs. So in thatinstance, we saw a “fear” bubble in VVIXfirst. That boded well for the market.

HOMEGROWN VVIXNow, before you start viewing VVIX as a“leading indicator,” remember this is a nar-row timeframe. And, divergences don’talways give such clear signals in hindsight.

Even though VVIX only started tradingin March 2012, we can proxy it quite easilyon the thinkorswim trading platform, andgo back much further. Simply pull up aVIX chart and add the Implied Volatility

indicator fromStudies. Theimplied volatilityfield actually usesthe VIX methodol-ogy to calculate avolatility index onany underlyingstock. So by apply-ing it to VIX, we’veessentially createdour own VVIX.

Now, do a side-by-side, 2011-2012comparison of VIXand our replicatedVVIX. Both peakedon August 8th,2011, with VIX hit-ting 48, and VVIXat 144. VIX dipped,then surged in earlyOctober, rising ashigh as 45.5, before

embarking on a long fade that bottomedin March 2012 in the low teens. VVIX,however, didn’t come anywhere close tothe August highs—only hitting 105 inearly October. Rather, it diverged, and sug-gested relative complacency under thesurface, which in this instance, presaged afive-month market rally.

So no, VVIX won’t become a Magic 8-ball anytime soon. But it’s nice to have anadditional volatility indicator to help sup-port, or negate, your opinions on the over-all volatility backdrop itself.

thinkMoney/17

•

32•Vol Watch•Viewing the marketsthrough the eyesof volatility

•Words by Adam Warner

vol

When VolMeets Vol•

How do you confirm whatvolatility is really saying? With volatility, of course.

The views in the section above are those of theauthor, but are not necessarily those of TD Ameritrade, Inc. and are not intended to bespecific investment advice. Clients must con-sider all relevant risk factors, including theirown personal financial situation before trad-ing. Be sure to understand all risks involvedwith each strategy, including commission costs,before attempting to place any trade.


FIGURE 1: When Two Vols Collide . If you see divergences between the VIX VolatilityIndex (VVIX-top) and VIX itself (bottom), the market could be telling you something. Pastperformance does not guarantee future results or success.

TM17_VolWatch_RD3.qxd:pages.layout 2012-09-17 12:53 AM

THE MARKET MOVES FAST. STAY AHEAD OF THE CURRENT. Swim Lessons gives you tips and techniques for using the thinkorswim platform.

SWIM LESSONS IS A FREE AND DAILY WEBCAST THAT WILL SHOW YOU:

How, when, and why to use thinkorswim

Tools to implement your strategies in any market

The possible impact of current events on your portfolio

Log on to thinkorswim to get Swim Lessons every weekday from 10:30 a.m. to 1:30 p.m. CT.Support/Chat > Chat Rooms > Swim Lessons


In order to demonstrate the functionality of the platform, we need to use actual symbols. However, use of actual symbols should not be inferred to be a recommendation to trade specific securities.


TM17_VolWatch_RD3.qxd:pages.layout 2012-09-17 12:53 AM

thinkMoney/17

•

34•Special Focus:Futures Options•tdameritrade.com

WORDS BY THOMAS PRESTON PHOTOGRAPH BY FREDRIK BRODÉN

TM17_SpecialFocusFuturesOptions_RD3.qxd:pages.layout 2012-09-17 12:47 AM


Familiar Ground…

Sort of

Options on Futures:

YES, YOU CAN HAVE A DERIVATIVE ON A DERIVATIVE.BUT DON’T LET THAT SCAREYOU. OPTIONS ON FUTURESCERTAINLY AREN’T FOREVERYONE, BUT THEY MAY BEEASIER TO UNDERSTANDTHAN YOU THINK.


HERE WE ARE. 2012.Options. Futures. Options onfutures. Derivatives on deriva-tives...exponential permuta-tions and combinations that

threaten to strike fear into our hearts...and stuff thatsounds eerily like what nearly killed the economy backin 2008. Wasn’t it derivatives on derivatives that has sofar cost JP Morgan a few billion?

Rest assured, the products themselves don’t kill you.It’s generally how they’re used. To wit: options on futuresare pretty similar to the options you use to sell coveredcalls against your long stock. And they’re the only way toestablish positions with lower risk and lower capitalrequirements in certain markets—like physical com-modities that don’t have another product, such as anindex or fund that tracks them. If you get to know howfutures options work, you can use them to expand youruniverse of trading opportunities. Don’t let the wordsscare you off. Read on and decide for yourself if you’reready to incorporate futures options into your portfolio.

NOT YOUR FATHER’S OPTIONBuying an option gives you the right to buy (in the caseof a call), or sell (in the case of a put), an underlyingsecurity at the strike price of the option. That should bepretty familiar to most people who’ve traded an optionon a stock. That’s how a future option works, too. If youbuy a call option on corn futures, that gives you theright to buy a corn future at the strike price of the call.But a few nuances make futures options a little unlikestock options. And these nuances don’t necessarilymake it harder to trade them, but you should be familiarwith the twists and turns before you start tradingoptions on futures.

1— WHAT YOU GET. This is the simplest. What does afuture option deliver when you exercise it, or it’sassigned?

A future option delivers one futures contract. So,let’s use options on the E-mini S&P 500 future as anexample. If you exercise a call option on the E-mini S&P500 future, you’ll be long one E-mini S&P 500 future. Ifyou exercise a put option on the E-mini S&P 500 future,you’ll be short one E-mini S&P 500 future. If you exer-cise a call option on soybean futures, you’ll be long onesoybean future. You won’t have 5,000 bushels of soy-beans in your driveway. That’s why the price of thefuture option is driven by the price of the future that itdelivers on exercise, not the “spot” price, like the SPXS&P 500 cash index, or a bushel of soybeans.

But unlike a stock option that always delivers 100shares of the same stock, a future option delivers thefuture that expires at the same time, or later.

Futures have expiration dates. So you can’t have anoption that delivers a future that’s already expired. Forexample, an October expiration option on the E-miniS&P500 future delivers a December E-mini future. Sodoes a November and December expiration option. Buta January expiration option on the E-mini S&P 500 deliv-ers a March E-mini future. This is important becausefutures prices on the same index or commodity can have

different prices in different expirations, and can movewith either greater or lower volatility than a future in adifferent expiration. In grains, for example, planting isdone in the spring and harvesting in the fall. Futures thatexpire in March through September are termed “old”crop, because they would deliver grain harvested theprevious fall. Futures expiring in November and Decem-ber deliver grain that’s just been harvested. Old crop vs.new crop futures can have different price changes.Options on futures will change in price according to thechanges in the future that the options deliver.

2— POINT VALUE AND TICK SIZE. A standard equityoption has a point value of $100, and changes in either.01 or .05 increments, with each .01 increment worth$1.00. That is, if a call on a stock goes from 2.50 to 3.50,its value has increased $100. After a 3:2 stock split, theoptions have a point value of $150, but that’s about ascomplicated as they get. The point value of futuresoptions isn’t standardized. For example, one point in anE-mini S&P 500 future option is worth $50, and the min-imum increment is .25, which is worth $12.50. Onepoint in a bond future option is worth $1,000, and theminimum increment is 1/64th, which is worth $15.625.And one point in a corn future option is worth $50, justlike the E-mini S&P option, but the minimum incrementis 1/8th or .125, worth $6.25.

Before you trade them, get familiar with the pointvalue of the future option you like (which you can get atthe website of the Chicago Mercantile Exchange atwww.cme.com). Risk management starts at order entry,and the dollars you put at risk on a trade depend on theoptions’ point values. Also, you can calculate theamount of slippage, or the difference in dollar value,between an option’s bid and ask prices. A bid/askspread of .50 in an E-mini S&P 500 option is worth $25.But a bid/ask spread of four ticks on a bond option isworth $62.50.

3— EXPIRATION. Stock options almost always expireon the Saturday after the third Friday of the month. Asa stock option trader, that’s handy for planning vaca-tions. But, futures options don’t always give you thatfreedom. The E-mini S&P 500 future options expire atthe same date as the equity options. They weredesigned as a hedge for equity, and to make equityoption portfolios easier.

But bond future options have some funky expira-tions. They expire on the last Friday that precedes thelast business day of the month preceding the optionmonth by at least two business days. Huh? Septemberbond future options expire in August. December bondfuture options expire in November. Crude oil-futuresoptions expire three days before the end of trading ofthe corresponding future, which expires in the monthbefore the future expiration month, to accommodatedelivery of crude oil. Double huh, right? Make it easy onyourself and look on the left-hand side of the Trade pageof TD Ameritrade’s thinkorswim platform, for the num-ber of days until the last trading day of the options. It’sthe number in parentheses after the expiration month.This will help you not get surprised by expiration

thinkMoney/17

•

36•Special Focus:Futures Options•Photograph byFredrik Brodén

•tdameritrade.com

fut.

Need to open a futuresaccount?The process is completed inthree easy steps:

1 You need to have Level 3options approval prior to filling out the futures appli-cation. To apply for Level 3options, log in to the TD Ameritrade website,click on My Profile and clickEdit Option Trading. Com-plete and submit theUpgrade form.

2 After receiving yourapproval, log back in. UnderMy Profile, click on Upgradeyour futures account forfutures and forex. Completethe “Upgrade Agreementfor Futures and Forex.”

3 Once your account hasbeen upgraded, (which maytake about a day or two) goback under My Profile andclick the Futures Apply button. Fill out the onlinefutures application andyou’re on your way to trad-ing futures.

Contact us [email protected],or call 866-839-1100.



http://www.cme.com


BACK TO THE FUTURE(S)That’s pretty much it for the differences. Now let’s dipinto some of the most actively traded futures. Futures,future options, and index options work together in theS&P 500. You have the SPX, SPX options, E-mini S&P500 futures, and E-Mini options, all based on the S&P500, right? Well, sorta.

S&P 500 index (SPX). The SPX is the index based onthe composite value of the 500 stocks in the S&P 500.You can’t buy or sell the SPX itself. But it can drive thevalue of the E-mini S&P 500 futures, based on an arbi-trage relationship between the interest cost and divi-dends on the 500 stocks, and the expiration of thefuture. So, SPX moves up, and E-mini S&P 500 futuresmove up. But sometimes the E-mini S&P 500 futuresmove up quicker, or more, than the SPX. (For more onfutures trading, see our Futures Special Focus inthinkMoney, Summer 2012, page 34.)

You also have SPX options, which are cash-settledoptions that deliver the cash difference between thestrike price and the SPX. You’d think SPX options arepriced off of the SPX, but you’d be wrong. Why? SPXoption traders can’t trade the S&P 500 stocks any easier

than you can. So they typically use E-mini S&P 500futures as their hedge. When the hedge moves, theoptions move. SPX option market makers factor the costof carry and dividends out of the E-mini S&P 500 future,and use that to come up with the prices of the SPXoptions. Fun, no?

E-mini S&P 500 futures. SPX options aren’t the onlyones to use E-mini S&P 500 futures to price themselves.

Options on the E-mini S&P 500 futuredo, too. The differ-ence between E-miniand SPX options isthat the E-mini S&P500 futures optionsdeliver the future,not cash. They don’tneed to factor in thecost of carry and div-idends of the SPX.So, both SPX optionsand E-mini S&P 500futures options arevalued off the E-miniS&P 500 future.

Don’t confuseSPX options with E-mini S&P 500futures options. AnS&P 500 futureoption is an Ameri-can-style option,meaning a longoption can be exer-cised at any timebetween the time it’spurchased throughexpiration, and itsfutures settled. Thismeans if you exer-cise a long S&P 500futures call, you’lltake delivery of oneS&P 500 future. SPXoptions are cash-set-tled, and European-style. Importantly,one point in the E-

mini S&P 500 future option is worth $50. But one pointin an SPX option is worth $100.

PICKING FAVORITESSo, which is better—SPX options, or E-mini S&P 500futures options? It’s not a question of the best product.But, how best to use the product.

Let’s look at the pros and cons of using them as away to potentially enhance a $100,000 stock portfolio’sreturns. Selling an out-of-the-money call vertical is astrategy that could be used in this way. With the SPX at1362, a short 1390/1400 call vertical with 28 days toexpiration is worth about $3.10. If we sell 10 of them, the

Past performance of a securitydoes not guarantee future resultsor success. The information con-tained in this article is notintended to be investment adviceand is for educational purposesonly. Clients must consider allrelevant risk factors, includingtheir own personal financial sit-uation before trading. The risk ofloss in trading futures andoptions on futures can be sub-stantial. Clients must considerall relevant risk factors, includ-ing their own personal financialsituations before trading. Sup-porting documentation for anyclaims, comparisons, statistics,or other technical data, will besupplied upon request. Multiple-leg option strategies such asthose discussed in this articlecan entail substantial transac-tion costs, including multiplecommissions, which may impactany potential return. Be sure tounderstand all risks involvedwith each strategy, includingcommission costs, beforeattempting to place any trade. Beaware that assignment on shortoption strategies discussed inthis article could lead tounwanted long or short positionson the underlying security.Options involve risk and are notsuitable for all investors.


DON'T LETTHE WORDSSCARE YOUOFF. FUTURESOPTIONS ARE PRETTYSIMILAR TOTHE OPTIONSYOU USE TOSELL COVEREDCALLS GAINSTYOUR LONGSTOCK.


thinkMoney/17

•

38•Special Focus:Futures Options•tdameritrade.com

maximum potential risk is $6,900, if theSPX is above 1400 at expiration. Thepotential enhancement to the portfoliowould be $3,100, if the SPX is below 1390.(Breakeven on the SPX is $1393.10.) SPXoptions have the widest bid/ask differen-tial, meaning slippage is potentiallyhigher. But you can execute the SPX verti-cal, and the execution price would be$2.90, making the maximum potential risk$7,100, and the potential return $2,900.(Break even on the SPX is $1392.90.)

Finally, with the E-mini S&P 500 futureat 1,362, the 1390/1400 call spread with28 days to expiration is worth $3.25. To getan equivalent amount of risk and rewardto the SPX verticals, we’d have to sell 20 ofthe E-mini future option spreads with amaximum potential loss of $6,750, if theE-mini S&P 500 future is above 1400,and a potential enhancement of$3,250, if the future is below 1390 atexpiration. (Breakeven on the E-minifuture is $1393.25.) Factoring in slip-

page of one tick, or .25,the net price of the spreadmight be $3.00, which wouldgive it a maximum potentialloss of $7,000, and an

enhancement of $3,000. (Breakeven onthe E-mini future is $1393.00.) With E-mini S&P future options, commissionscould be two times higher than with SPXoptions. But that could be offset by lowerslippage. In this case, whether you useSPX options or E-mini S&P 500 optionsdepends on the size of your portfolio, aswell as your ability to work your orders inbetween the bid/ask to get better pricing.

NOW THAT YOU’VE LEARNED SOMEof the basics about futures options, con-sider testing them out in paperMoney,found on the thinkorswim trading plat-form. Or if you are ready to incorporatethem into your portfolio, you can applyfor a futures account to trade them along-side your stocks and stock options.

• Got the option tradingblues when equity mar-kets close at 4pm ETeach day? What if you

could trade 24 hours per day? You can—inthe futures options market. Yup, 24 hoursa day, 5.5 days a week, you can trade E-mini S&P and E-mini Nasdaq, as well ascrude oil, gold, corn, the euro currency,and many more. Just be sure to check thetrading hours at tdameritrade.com. Theyall have their own trading hours, whichcan differ. (Click path tdameritrade.com> Trade >futures.)

Now, if you come from the equityoption world, the notion of trading aderivative of a derivative might make youa little uneasy. But don’t worry. Tradingoptions on futures isn’t that different thantrading equity options. The same basicconcepts—option greeks, time value,strike price, and most of the strategies youcan do with equity options—also apply to

futures options. And if you’re alreadyusing the thinkorswim trading platformfor your equity options trading, you’reprobably familiar with how to place tradeson futures options. You just follow thesame three steps:

1— Select your underlying futures prod-uct. Choose a product like the E-mini S&P(/ES) under the main Trade tab. This willdisplay the active month under theFUTURES section.

2— Expand the OPTION CHAIN section.By expanding this section, you can viewthe strike prices by month. In addition,you have access to the same great optionstools you use when trading equity options.For example, you can increase the numberof strikes you can view per contract, and,view different spread order types (i.e. Sin-gle, Vertical, etc), or customize your lay-out to show things like implied volatility,option greeks, volume, and open interest.

3—Confirm and send your order. Takeone last moment to review your order toinsure the contract, strike price and quan-tity are what you wanted. If so, simplyclick the Confirm and Send button. If not,

How to…Trade options onfutures in thinkorswim

FIGURE 1: Futures Options trading on thinkorswim is pretty much like trading equity options. Youcan place a trade in about three steps (read the article), but bear in mind, you have to have a futuresaccount (see sidebar, page 36). For illustrative purposes only.

fut.

•

If you’re already trading equity options, you’re half way there

SEE GLOSSARYPAGE 42

3

2

1





Q: Do I need afutures account totrade futureoptions, or can Iuse my stockaccount?

A: You need totrade futuresoptions in a futuresaccount. While youcan see the futuresand future optionpositions side byside with yourstocks, options andmutual funds onthe thinkorswimtrading platform,there are really twoaccounts on theback end—anequity account forthe stocks, stockoptions and mutualfunds, and a futuresaccount for thefutures and futuresoptions.

Q: Can I tradefutures options inan IRA?

A: Currently, youcannot tradeoptions on futuresin an IRA on eitherthinkorswim ortdameritrade.com.

Q: How are mar-gin requirementsdetermined forfutures options?

A: The marginrequirement onfutures option posi-tions are calculatedby a process knownas SPAN (StandardPortfolio Analysisof Risk) SPAN cal-culates the loss ofyour future optionspositions in a vari-ety of scenariosincluding possiblechanges in theunderlying futuresprice, and changesin volatility over aone-day period.The margin for thefuture option posi-tion is the maxi-mum loss identifiedby SPAN across thatrisk array.

Q: Can I beassigned on afutures optionbefore expiration?

A: Yes, if theoption has Ameri-can style exerciseprocedure. Mostfutures optionstraded in the US areAmerican style,which means ifyou’re long anoption, you canexercise it and takedelivery of thefuture, or if you’reshort an option,you might have totake delivery of thefuture before expi-ration. Becausefutures don’t paydividends likestocks do, the deci-sion whether or notto exercise a longfuture optiondepends on theamount of interestyou would earn byeither being long afuture at a lowerprice or short afuture at a higherprice by either exer-cising a long call orput.

Q: Are profits andlosses on futuresoptions credited tomy account in thesame way futuresare?

A: No. Whilefutures optionshave settlementprices each day that

can be used to cal-culate profits andlosses, the dollarvalue of the profitand loss isn’t cred-ited or debited fromthe trading accountas it would with afutures position.The profit or loss isrecognized whenthe future optionposition is closed.

Q: Can I worklimit orders inbetween thebid/ask spread?

A: Absolutely. Youcan enter limitorders in betweenthe publishedbid/ask spread aslong as the limitprice is in a trad-able increment. Forexample, if an E-mini option (/ES)were quoted 8.00bid and 8.50 ask,you could enter alimit order to buyor sell at 8.25.

Q+A:FUTURES TRADING

you can either delete the order or adjustthe order in the Order Entry window.

A nice perk of using the thinkorswimplatform is that you can trade multipleasset classes from the same platform,with the same look or feel, using thesame log in. But before you jump off thestarting block, take advantage of the edu-cation available to you to be aware of allthe important nuances. Knowing thingslike the correct trading hours of theunderlying futures product, as well aseach of their respective price increments,could make a huge difference in yourprofit/loss if you’re not paying attention.

Now, if you have a burning questionabout how to trade options on futures,you can always reach out to our futuresTrade Desk. Click on the Support/Chatbutton in the trading platform to contacta futures Trade Desk representative viaLive Support, or just enter one of theChat Rooms. If you’d rather speak to ahuman (gasp), call us at (866) 839-1100and we’ll answer your question live.

You can learn more about options onfutures by going to the CME’s OptionEducation center located at(http://www.cmegroup.com/educa-tion/options.html). In addition, TD Ameritrade’s education affiliate,Investools, offers a variety of educationalseminars to help educate you aboutoptions trading.

If at any time you have any questionsabout the account opening process,please contact us [email protected] or call us at 866-839-1100.

Investools® does not provide financial adviceand is not in the businessof transacting trades.Investools, Inc., and TD Ameritrade, Inc., areseparate but affiliatedcompanies that are notresponsible for each other’sservices or policies. For details, please see disclaimer, page 9.


RESTASSURED, THE FUTURESOPTIONSPRODUCTSTHEMSELVESDON’T KILLYOU. IT’S GENERALLYHOW THEY’REUSED.


http://www.cmegroup.com/education/options.html

http://www.cmegroup.com/education/options.html




• I thought I was dancing until somebodystepped on my face…

At some point in your trading career, youmay experience the jolt of a fairly largedrawdown in your equity curve—eitherthrough a string of losses, or one big one.Either way, this is every trader’s cross tobear. So how you cope with the situationmay not only define the depth of the loss,but also your ability to recover.

GET OVER ITAs a trader, drawdowns are a fact of life.Just as the market moves up and down, sogoes your trading account. Feelings of regretfrom a large loss can beget further errors injudgment, such as rationalizing why youshould continue to hold losing positions.Research by the Econometric Society showsthat the second $100 loss is easier to takethan the first. And the third is easier thanthe second—until, at some point, the tradebecomes a “buy and hold” investmentregardless of your original strategy.

SHINE YOUR DANCING SHOESAvoiding drawdowns is impossible. How-ever, the negative effects both financiallyand psychologically can be mitigated. How?

1/ Visualize. Have a vision of what you’retrying to accomplish over the next one-to-five years. Then define a plan for what youneed your trading account to do on aweekly and monthly basis to make thathappen. Having a long-term goal, and thenmanaging positions in alignment with thosegoals, will keep you less myopic and morefocused on the prize.

2/ Size your positions smartly. Too muchsize and a sudden, adverse event, can bedevastating. Too little size, and a favorablemarket barely moves the needle. Figure outthe position size and risk that works foryour profit/loss, and stick with that.

3/ Get out. There’s no shame in sheddingyour losers. Don’t let ego, hopes, or fearsparalyze you. As the old saying goes, “Selldown to the sleeping level.”

4/ Get back in(when you’reready). After a largedrawdown, youmay be afraid to getback on the dancefloor. That’s fine.Perhaps you papertrade using some-thing like paper-Money* on thethinkorswim trad-ing platform untilyou’re ready to putreal dollars back towork. When youput on a smallerportion of the posi-tions than you nor-mally would. Thefirst goal isn’t to get

back what you lost. And, trade the amountof positions typical for you, but keep thesize small until you build confidence.

DRAWDOWNS HAPPEN. BUT SO DOprofits. Accepting that things change is cru-cial. So after a drawdown, move on. I like tosay I’ve given up all hope of having a betterpast. So, remember the lessons from thepast, look to what you can do now, andbuild towards your future.

thinkMoney/17

•

40•Coach’s Corner•Pulling pearls from your favorite trading instructors.

•Words by Pat MulallyInvestools Instructor

*Funny MoneyGetting back in the game iseasier said than done whencommitting real trading dollars. With paperMoney,you can work on buildingyour confidence back with a fake money/real marketexperience. Just pull up the log-in screen on thinkorswim, and selectpaperMoney before signing in.

Dealing withDrawdowns•

A string of losses stinks, but there’s hope for getting back in the game

Past performance of a security does not guarantee future results or success. The informationcontained in this article is not intended to be investment advice and is for educational purposesonly. Clients must consider all relevant risk factors, including their own personal financial situ-ation before trading. Supporting documentation for any claims, comparisons, statistics, orother technical data, will be supplied upon request. Investools® does not provide financialadvice and is not in the business of transacting trades. Investools, Inc., and TD Ameritrade,Inc., are separate but affiliated companies that are not responsible for each other's services orpolicies. For details, please see disclaimer, page 9. PaperMoney is for educational purposes only.Successful virtual trading during one time period does not guarantee successful investing ofactual funds during a later time period as market conditions change continuously.


crn.

TM17_CoachesCorner_RD3.qxd:pages.layout 2012-09-17 11:58 PM

Screen stocks, identify trends, and get the vital stats you need with our advanced Stock Screener —now available on Trade Architect.

Learn more and view a demo at tdameritrade.com/ta.

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TM17_CoachesCorner_RD3.qxd:pages.layout 2012-09-17 11:58 PM

http://tdameritrade.com/ta

In the money• An option whosepremium contains“real” value, i.e. notjust time value. Forcalls, it’s the strikethat is lower than theprice of the underly-ing equity. For puts,it’s the strike that ishigher.

At the money• An option whosestrike is “at” the priceof the underlyingequity. Like out-of-the-money options,the premium of an asabove option is all“time” value.

Out of themoney• An option whosepremium is not onlyall “time” value, butwhose strike is awayfrom the underlyingequity. For calls, it’sthe strike that ishigher than theunderlying. For puts,it’s the strike that’slower.

Scalp Stock• A trading strategyseeking to profit fromincremental moves in a stock.

Delta• A measure of an

option’s sensitivity toa $1 change in the

underlying asset. Allelse being equal, an

option with a 50 delta(also written as .50)for example, would

gain or lose $50 per $1move up in the under-lying. Long calls andshort puts have posi-

tive (+) deltas,meaning they gain asthe underlying gains

in value. Long putsand short calls havenegative (–) deltas,

meaning they gain asthe underlying loses

in value.

Theta• A measure of an option’s sensitivity tothe passing of time by one calendarday. Positive theta refers to option posi-tions that gain in value as time passes.Whereas, negative theta refers to posi-tions that decay as time passes.

Selling a naked put• A STRATEGY DESIGNED TO PROFITFROM SHORTING AN UNHEDGEDPUT TO COLLECT A PREMIUM. IF YOUBELIEVE THAT A STOCK WON’TDROP VERY MUCH AND HAVE ABULLISH BIAS ON IT, YOU MIGHTCONSIDER A SHORT PUT. THE MAXLOSS IS THE STRIKE PRICE MINUSTHE PREMIUM PLUS TRANSACTIONCOSTS. THE PROBLEM: YOU HAVENO HEDGE. HENCE, YOU’RE“NAKED”—MEANING, YOU’REEXPOSED, WITHOUT A SAFETY NET.

SHORTING• To short is to sell an asset, such as an option or stock that youdon’t own in order to collect a premium. The idea being that ifyou believe the price of the asset will decline, you can buy back

(or “cover”) your short at a lower price later. Your potential profitwould be the difference between the higher price you shorted at

and the lower price you covered.

Vertical Spread• A defined-risk, directional spread strategy,composed of a long and a short option of thesame type (i.e. calls or puts). Long verticalsare purchased for a debit, while short verti-cals are sold for a credit at the onset of thetrade. Long call and short-put verticals are

bullish, whereas long put and short-call verti-cals are bearish. The risk of a long vertical is

typically limited to the debit of the trade,while the risk in the short vertical is typically

limited to the difference between the shortand long strikes, less the credit.

found on pages:

12, 23 & 31

2013 & 23

found on page:

found on page:

31

found on pages:

found on pages:

23, 26 & 31

Iron Condor• A defined-risk, short spread strategy,constructed of a short put vertical and ashort call vertical. You assume theunderlying will stay within a certainrange (between the strikes of the shortoptions). The goal: As time passesand/or volatility drops, the trade can bebought back for less than the credittaken in or expire worthless, resulting ina profit. The risk is typically limited tothe difference between the strikes,minus the total credit received.

found on page:

12

found on pages:

23 & 31found on pages:

thinkMoney/17

•

42•The Token Glossary•Terms you might stumble across in this issue.•tdameritrade.com

12found on pages:

Rho• A measure of an option’s sensitivity to a1% change in interest rates.This numberbecomes more significant the farther out intime an option expires.

found on page:

26

20found on pages:

VEGA•A measure of an option’s price sensitiv-ity to a one-percentage-point change inits implied volatility.

gls

26found on pages:

26

TM17_Glossary_RD3.qxd:pages.layout 2012-09-17 12:13 AM


The thinkorswim trading platform received 5 stars overall in the 2011 Stockbrokers.com Forex Broker Review (sharing the highest score with one other broker), as well as 5 stars in the categories of “platforms and tools” (sharing the highest score with one other broker), “investment offerings” (sharing the highest score with three other brokers), and “customer support” (sharing the highest score with one other broker). thinkorswim was evaluated among a total of 16 forex brokers and trading platforms reviewed.



Trading futures and forex involves speculation, and the risk of loss can be substantial.

Forex investments are subject to counter-party risk, as there is no central clearing organization for these transactions.

TD Ameritrade and Stockbrokers.com are separate, unaffiliated entities and are not responsible for each other’s products and services.

TD Ameritrade does not charge platform, maintenance, or inactivity fees. Commissions, service fees, and exception fees still apply. Please review our commission schedule and rates and fees schedule for details.

Futures and forex accounts are not protected by the Securities Investor Protection Corporation (SIPC).

Futures and/or forex trading privileges subject to TD Ameritrade review and approval. Not all account owners will qualify.


Find out more at tdameritrade.com/futuresforex

Trade with your finger on the market.Explore futures and forex trading with thinkorswim

®, our award-winning, feature-packed trading

platform. Use Monkey Bars, Pairs Trading, and the Active Trader Ladder to help make your

strategy even stronger. Access all your trading, data, and idea-generation tools in one slick,

customizable window. Or take your trading on the go with TD Ameritrade Mobile Trader.

Both platforms are free to download. And they’ll change the way you trade.

TDA 1377 D 03/12

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TM17_Glossary_RD3.qxd:pages.layout 2012-09-17 12:13 AM

http://Stockbrokers.com

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Market volatility, volume and system availability may delay account access and trade executions.

TD Ameritrade and Apple, Inc. are separate, unaffi liated companies and are not responsible for one another’s services and policies.


Mobile trading that kicks app.Find out more at tdameritrade.com/ipad.

For illustrative purposes only. Not a recommendation.

PRSRT STDUS PostagePaidTD Ameritrade

The risk of loss in trading securities, options, futures, and forex can be substantial. Clients must consider all relevant risk factors, including their own personal financial situations, before trading. Options involverisk and are not suitable for all investors. See the Options DisclosureDocument: Characteristics and Risks of Standardized Options. A copyaccompanies this magazine if you have not previously received one.Additional copies can be obtained at tdameritrade.com or by contactingus. Trading foreign exchange on margin carries a high level of risk, as well as its own unique risk factors. Please read the followingrisk disclosure before considering trading this product: Forex Risk Disclosure (www.nfa.futures.org/NFA-investor-information/publication-library/forex.pdf). A forex dealer can be compensated via commission and/or spread on forex trades. TD Ameritrade, Inc.,member FINRA/SIPC/NFA.TD Ameritrade is a trademark jointly ownedby TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank.© 2012 TD Ameritrade IP Company, Inc. All rights reserved. Used with permission.

thinkMoney from TD AMERITRADE1005 North Ameritrade PlaceBellevue, NE 68005

TDA 2012 BR 10/12

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http://www.nfa.futures.org/NFA-investor-information/publication-library/forex.pdf

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http://www.nfa.futures.org/NFA-investor-information/publication-library/forex.pdf

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Documents

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