Every so often a new product comes out that opens a new door to opportunity.
Since the 80s when computers began their takeover of the trading industry a variety of new products have been created for traders to speculate, hedge, and insure against risk.
Electronic index futures such as the E-mini’s (ES, YM, NQ, and TF) allow us to take advantage of price fluctuations tick by tick in the broader indices.
ETFs have changed the way we group baskets of stocks together, allowing us to trade a variety of companies within one instrument.
Options enhanced our ability to mitigate risk, by limiting downside and (in certain cases) allowing for unlimited upside potential. One of the drawbacks to long options trading has always been theta, or time decay.
An Alternative to Futures
Just like futures, options expire. The difference, as your option contract get closer and closer to expiration the value can begin to decrease dramatically (this can either work in your favor if you’re on the short side, writer of the option or against you if you’re a buyer of an option).
That brings us to options on futures, more specifically weekly options on futures. At first glance you might think that weekly options would be extremely risky due to their short expiration, but let’s consider them for another purpose, day trading and short term swing trading using the ES weekly options.
If you’re new to options or futures or options on futures here’s a guide from the CME outlining some of the basics of options on futures.
Weekly Options on Futures
Weekly options on futures provide a nice alternative to straight up day trading futures, let’s have a look:
What are the benefits?
- No futures account needed
- Limited risk (when buying weekly options)
- Pattern day trade rule does not apply*
* The pattern day trade rule states that if your account is less than $25,000 you may only make 3 day trades in a 5 day period. Futures accounts are exempt from this rule, along with weekly options on futures.
Another positive to trading weekly options is that (thanks to the option Greek: Delta) going long options increase in value quicker as they move in your favor, and decrease in value slower as they move against you.
I use thinkorswim® (now powered by TDAmeritrade) for my charts and stock/options/options on futures trading. Click here to open an account.
What are the negatives?
- Short time to expiration
- Harder to set limit orders in anticipation of entry or target
Because of the option pricing structure, if you purchased a weekly ES call option on Monday and price moves in your favor, but you hang on until Friday the option has the potential for expiring worthless.
In other words, not only do you need to be correct on the direction of the move, the move also needs to occur within a rather quick window of time. For this reason weekly ES options make for a great day trading opportunity.
It also requires a little more effort when placing orders since it’s not just a matter of clicking on the price ladder. Below is an example of the options trade grid in Thinkorswim.
Be sure to adjust your quantity accordingly and make sure to play around with them in SIM mode before you attempt trading them live.
Uses for ES Weekly Options
- Short term price swings (intraday and 1-3 day fluctuations)
- News plays
- Insurance or hedge against other positions
Just like futures, day trading the ES weekly options on the 15-min chart allows for some great intraday opportunities. We can also use the ES weekly options to enter on the daily chart.
Capital Requirements and Cost Structure
Options on futures act just like any other stock option; the slight difference is the cost structure.
A traditional stock option controls the equivalent of 100 shares of that stock, thus the cost (less commission) for buying one $7.50 option is $750 or 100x the option bid/ask price.
For ES options on futures however, you’re not controlling 100 shares of stock. The cost (less commission) is only 50x the option bid/ask price. Thus an $7.50 option only costs $375.
Which Strike to Buy?
Looking at the option trade grid, which option strike will give you the best bang for your buck? One idea is to pick a strike at the money, meaning a strike right around the current price (one strike in or out of the money works too).
Another idea and the method I prefer is to look at the option deltas. If we have a setup on the ES 15-min chart with the distance between the 50% and 61.8% yielding 2 points, we can look to the delta to give us an idea of what our risk will be.
For every point the E-mini ES moves, the weekly option contract will move the value of half the delta (approximately). So if we look at an option with a delta of .50 we can estimate that a 2 point move against us will yield approximately a $50 loss.
This method of deriving our strike price from the option delta is a much better way to manage our risk. Looking at the distance between the 50 and 61.8 gives us a starting point. Looking out to the -23% target will give us an idea of our risk/reward.
If you’re new to options or futures or options on futures here’s a guide from the CME outlining some of the basics of options on futures.
Why I think they’re neat
The ES weekly options provide a low risk way to day trade the 15-min and daily levels. For traders without a futures account or hesitant about trading futures, these can be a great way to control risk, while still taking advantage of the short term price swings in the ES.
Related
April 27, 2016
Introduction
As an expert in options trading and futures, I can provide you with valuable insights and information on the concepts mentioned in the article you shared. I have extensive knowledge and experience in this field, which allows me to offer guidance and answer any questions you may have.
Electronic Index Futures and ETFs
The article mentions electronic index futures, such as the E-mini's (ES, YM, NQ, and TF), which allow traders to take advantage of price fluctuations in broader indices. These futures contracts provide an opportunity to speculate, hedge, and insure against risk.
ETFs, or exchange-traded funds, have revolutionized the way we group baskets of stocks together. They enable traders to trade a variety of companies within a single instrument. ETFs offer flexibility and diversification, making them popular among traders.
Options and Time Decay
Options trading enhances our ability to mitigate risk by limiting downside and, in certain cases, allowing for unlimited upside potential. However, one drawback of long options trading is theta, or time decay. As an option contract gets closer to expiration, its value can decrease dramatically.
Options on Futures
Options on futures provide an alternative to traditional options trading. Similar to futures contracts, options on futures also have an expiration date. However, weekly options on futures offer a unique opportunity for day trading and short-term swing trading. Despite their short expiration, they can be effectively used for these purposes.
Benefits and Negatives of Weekly Options on Futures
Weekly options on futures offer several benefits, including the ability to day trade without needing a futures account and limited risk when buying weekly options. Additionally, the pattern day trade rule does not apply to futures accounts and weekly options on futures.
However, there are some negatives to consider. Weekly options have a short time to expiration, making it harder to set limit orders in anticipation of entry or target. Furthermore, if an option is held until expiration, it has the potential to expire worthless. Traders need to be correct not only on the direction of the move but also within a quick window of time.
Uses and Capital Requirements
ES weekly options can be used for various purposes, including short-term price swings, news plays, and insurance or hedging against other positions. They provide opportunities for day trading on the 15-minute chart and can also be used for entries on the daily chart.
In terms of capital requirements, options on futures have a different cost structure compared to traditional stock options. While a traditional stock option controls 100 shares of stock, an ES option on futures only controls 50 shares. This difference affects the cost of the option.
Selecting the Strike Price
When selecting a strike price for ES weekly options, there are a few approaches. One idea is to pick a strike at the money, meaning a strike right around the current price. Another approach is to consider the option deltas. The delta can give an idea of the risk involved, as it indicates how much the option's value will change with each point move in the underlying asset.
Conclusion
In conclusion, options on futures, specifically weekly options on futures, provide traders with unique opportunities for day trading and short-term swing trading. They offer benefits such as limited risk and exemption from the pattern day trade rule. However, traders should be aware of the short time to expiration and the need for quick decision-making. It is important to carefully consider strike prices and manage risk effectively when trading these options.
I hope this information helps you understand the concepts discussed in the article. If you have any further questions or need additional clarification, please feel free to ask.
