Options Question and Education

[charliebrown]

Re: Options Question and Education

your contributions are limited but i-bonds, through treasury direct? guranteed not to lose principle and you get an inflation adjustment. Maybe a 2% yield with no principle risk? You have to at least leave them in for 1 year before you can withdrawl. I am spreading out my contributions so some money will be available every month.

I would not mind a floating NAV on money markets EXCEPT .... than any mm transaction in a non-retirement account becomes a taxable transaction what a pain in the petuty. I have been watching MINT too waiting for a price pull back but it is not happening. if you divide yield by price volatility, BSV is about the same as MINT. I have a brokerage account at vanguard so they let me trade BSV for free. BSV is 80% treasury, 20% corp. 3 yr duration.

[jpetr48]

Re: Options Question and Education

I am doing this too, although being "smart" I have modified allocations. (Had I had the 25% allocation to stocks this gold hit would not be so painful)
Current targets are 15% bonds, 50% cash, 25% gold, 10% stocks. For bonds I am using BSV because I don't see a lot of appreciatiation in bonds.
If i were to see the yield on the 10 treasury year move to 2.5% or so, I might increase the duration of the bonds.

Like you I am watching HYG, SJNK to look for cracks in the bond market. So far no stress is evident.

An interesting psycological effect occurs currently if 10yr hits 2.75, or short corps hits about 2%. At these points the free cash flow for rolling over old debt for new is over. So far uncle ben has the yield curve well under control.

I am hearing of SEC considering floating NAV on money markets. http://www.bloomberg.com/news/2013-0...-with-irs.html
My cash is also up there near 50-60%.
So i am looking at MINT for parking cash sometime in early June. Its in a seasonal topping pattern now - quick glance.
Any thoughts besides short term treasuries?

[charliebrown]

Re: Options Question and Education

I am doing this too, although being "smart" I have modified allocations. (Had I had the 25% allocation to stocks this gold hit would not be so painful)
Current targets are 15% bonds, 50% cash, 25% gold, 10% stocks. For bonds I am using BSV because I don't see a lot of appreciatiation in bonds.
If i were to see the yield on the 10 treasury year move to 2.5% or so, I might increase the duration of the bonds.

Like you I am watching HYG, SJNK to look for cracks in the bond market. So far no stress is evident.

An interesting psycological effect occurs currently if 10yr hits 2.75, or short corps hits about 2%. At these points the free cash flow for rolling over old debt for new is over. So far uncle ben has the yield curve well under control.

[c1ue]

Re: Options Question and Education

With options - volatility itself is a big factor. This is reduced for very low duration options, but in general volatility (as expressed by VIX) can dramatically change.

Thus while the 'fees' ostensibly are lower than they used to be, the changes in value due to VIX changes is - I suspect - greater than before. This being due to HFT exaggerating the already existing market maker bias.

The last couple of years has seen low volatility, but the changes associated with a EJ/iTulip inflection point would seem to be one which would see the return of 1000 point Dow shifts - i.e. huge VIX.

[bart]

Re: Options Question and Education

This is very helpful. You did a great job of putting the information in easy, bit-sized chunks, too. We total newbies really benefit from that!

Thanks!

My pleasure, glad you found it useful.

[bart]

Re: Options Question and Education

There seem to be a couple of "helpful" educational sites that quote the gold e- mini at 50 ounces. As you've stated, the correct size is 33.2 oz according to my brokerage and most reputable looking sources. But a few sites say 33.3 oz, which makes a lot more sense than 33.2.

The nice part is the "fees and commissions" can be quite reasonable. On my full size contracts for gold, I pay $7.95 per contract each way. Right now the bid ask spread is 1410.60/1410.70. If you buy gold right now and immediately cover you would lose 007% plus the commission each way. I don't bother with limit orders with spreads this small.

That's total friction of .017% - less than 2/100 of one percent. You can't beat that with a stick as far as I am concerned.

Yes, I was imprecise on the mini gold - it's 33.2 oz, not 33 even.

No question on the friction, it's one of the reasons that I'm a futures trader. I can manage my own rollovers from one contract to the next too, and ETFs can get hit significantly.

The commission structure is quite good too, although fees for various market feeds can add up for smaller traders at places like IB. Small accounts or broker assisted accounts can have much higher commissions too. I've seen them well over $35 per round trip trade over the years.

It's sure not all peaches & cream. The risks can be very substantial, like being caught in limit moves going against one's position. It's happened to me more than once, most recently in a wheat trade.

[jpetr48]

Re: Options Question and Education

Unless i was not listening in class, Finster offered up some good advice. As you may know he follows Harry Browne's school of thought of being diversified across bonds, stocks, cash and commodities. It is designed almost alike the PRPFX. Finster once said why short the market when you can go into bonds. So i purchased 2.5% of tlt and 15% of vcalx (vanguard municipal). The vcalx tracks well with both MUB and TLT, only it is not as volatile as TLT plus i need some tax relief living in CA. Now i respect EJs get out of bonds however i do have some eyes on this besides my own.

I dont expect to hold this bond position beyond fall 2013 and then will reposition accordingly. One of the canaries in the mind that i am watching closely for breaking resistance or rising interest rates is an inverse junk bond etf, sjb. once it breaks resistance, alerts go off and that will be my warning sign to consider exit.

[astonas]

Re: Options Question and Education

This may help too:
http://www.nowandfutures.com/futures_trading.html

This is very helpful. You did a great job of putting the information in easy, bit-sized chunks, too. We total newbies really benefit from that!

Thanks!

[astonas]

Re: Options Question and Education

There seem to be a couple of "helpful" educational sites that quote the gold e- mini at 50 ounces. As you've stated, the correct size is 33.2 oz according to my brokerage and most reputable looking sources. But a few sites say 33.3 oz, which makes a lot more sense than 33.2.

The nice part is the "fees and commissions" can be quite reasonable. On my full size contracts for gold, I pay $7.95 per contract each way. Right now the bid ask spread is 1410.60/1410.70. If you buy gold right now and immediately cover you would lose 007% plus the commission each way. I don't bother with limit orders with spreads this small.

That's total friction of .017% - less than 2/100 of one percent. You can't beat that with a stick as far as I am concerned.

Indeed! And thanks to both you and bart for your input. The presence of sites giving wrong information is a bit distressing. It makes me glad that I posted my findings, though, since I was able to get not only corrections, but even more information.

[rogermexico]

Re: Options Question and Education

The full size gold contract is for 100 oz, the mini is for 33 oz. A gold mini contract at $1400 gold has a value of 1400*33, or $46,200. The full size contract has a value of 1400*100, or $140,000.

The full size silver contract is for 5000 oz, the mini is for 1000 oz.

The full size S&P 500 contract is for $250 times the index, the mini is for $50 times it. So if the S&P 500 index is at 1600, the mini contract value is 1600*$50, or $80,000.

Again with the example of an S&P mini futures contract, let's say you have $20,000 in a futures account and sell one contract at 1600, and the S&P 500 goes down to 1550. The contract now has a value of $1550*50 or $77,500, and you close the trade.
You have made $2500 (the $80,000 starting value less the $77,500, and less any fees or commissions).


This may help too:
http://www.nowandfutures.com/futures_trading.html


oops, look like roger covered the same areas a bit before I posted.

There seem to be a couple of "helpful" educational sites that quote the gold e- mini at 50 ounces. As you've stated, the correct size is 33.2 oz according to my brokerage and most reputable looking sources. But a few sites say 33.3 oz, which makes a lot more sense than 33.2.

The nice part is the "fees and commissions" can be quite reasonable. On my full size contracts for gold, I pay $7.95 per contract each way. Right now the bid ask spread is 1410.60/1410.70. If you buy gold right now and immediately cover you would lose 007% plus the commission each way. I don't bother with limit orders with spreads this small.

That's total friction of .017% - less than 2/100 of one percent. You can't beat that with a stick as far as I am concerned.

[bart]

Re: Options Question and Education

The full size gold contract is for 100 oz, the mini is for 33 oz. A gold mini contract at $1400 gold has a value of 1400*33, or $46,200. The full size contract has a value of 1400*100, or $140,000.

The full size silver contract is for 5000 oz, the mini is for 1000 oz.

The full size S&P 500 contract is for $250 times the index, the mini is for $50 times it. So if the S&P 500 index is at 1600, the mini contract value is 1600*$50, or $80,000.

Again with the example of an S&P mini futures contract, let's say you have $20,000 in a futures account and sell one contract at 1600, and the S&P 500 goes down to 1550. The contract now has a value of $1550*50 or $77,500, and you close the trade.
You have made $2500 (the $80,000 starting value less the $77,500, and less any fees or commissions).


This may help too:
http://www.nowandfutures.com/futures_trading.html


oops, look like roger covered the same areas a bit before I posted.

[rogermexico]

Re: Options Question and Education

Thanks again, rogermexico, for your detailed help. I can see several places where I was simply misunderstanding things, including some pretty basic ones. You've cleared them up pretty well, though.



(You also mention in your primer that 1 contract represents an obligation to provide 1000 oz. gold at a given price.)


I'd remembered that you had mentioned a mini-contract in one of your earlier posts, and went hunting around for more info. I thought I'd provide the information here for the benefit of others who might have a similar not-quite-yet-a-millionaire problem. ;-)

There are 44 different E-mini futures contracts, which are designed to have much smaller multipliers, for smaller traders. In the case of both the S&P and gold, the multiplier is 50, instead of the standard 1000.

So, an e-mini contract would allow an investor to speculate on 50 oz. of gold, with an initial margin of $3,376, and a maintenance margin of $2,500. I have no idea about whether these are still a good deal (if the trading friction and contract costs scale well) though I suspect rogermexico could rattle that off.

I'd suspect there's not many choices for those who don't have an account worth even the ~$71k associated with 50 oz. of gold, but it is nice to know you don't have to work in increments of ~$1.4M+. Even if one did have that much free, one might in cases prefer a more incremental speculation strategy.

I hope it was obvious I was using large round numbers and full size contracts for purposes of illustration. E-minis are obviously much more accessible. I think they should be plenty liquid if using them for precious metals and stock indexes.

For much smaller accounts, I think standard short selling is more appropriate than options for calls like "time to short the S and P"....

For Comex gold the contract size is 100 ounces, not 1000. If I ever said 1000 ounces that was a typo. One contract at today's price for gold controls approx. $141,000 worth of gold, not $1.4 M. And at one third the size, the gold e-mini controls about $47,000 worth of gold.

For Comex silver the standard contract size is 5000 ounces, and the e-mini size is 1000 ounces.


For the S and P index, it is $250 times the index value for a standard contract, as I stated in my example. The e- mini has a multiplier of $50, so the position size would be about $80,000 at today's prices. That's indeed a lot of money, but I would guess many itulipers have enough assets that hedging or shorting the whole market with a chunk that size would be appropriate and useful.

Standard contract size for Henry Hub natural gas is 10,000 MBTU which is $40,000 at today's prices. The gas e-mini is 2500 MBTU or about $10,000. Buy the contract 6 to 12 months out and roll forward every 3 months for a simple long NG strategy that avoids severe losses due to front month contango (when it's there). I view this as the best PCO play in terms of risk/ reward right now. Quality coal stocks are a close second at recent prices, esp. BTU which has been beaten down by China fears but which has very sound long term prospects.

Avoid gas etfs if possible esp. ones that robotically roll the front month contracts. There will be infrastructure plays with PCO but you need to find one that offers the intermediate term upside (2-3 years) of gas doing nothing but mean reverting to its normal ratio relative to oil. I am sure they exist but I have not done the work to find them, and there are no management issues with the commodity itself.

Oil does not even need to rise for gas to do very well.

[astonas]

Re: Options Question and Education

Thanks again, rogermexico, for your detailed help. I can see several places where I was simply misunderstanding things, including some pretty basic ones. You've cleared them up pretty well, though.

Let me give an example. You have a brokerage account with 1 M in it. If you have roughly 20,000 in cash in your account (2% of the 1M) then you can go short one S and P contract which is worth just under $400,000. You are now short the S and P with 40% of your 1M account. You pay no margin interest, the trade costs about $10 each way, and if you look at the S and P futures curve, you will see that you can hold this contract for months with little change in the contract price compared to the huge time decay with options. You earn $250 x each dollar the contract drops or lose $250 for each dollar the contract rises in price. If you have one of the near contracts, this is essentially identical to shorting the S and P with no margin interest paid. I challenge anyone to show me an example of how to do this with less costs - less friction. Or how to do it with more liquidity. NOTHING is more liquid and has lower spreads than index futures. NOTHING.

(You also mention in your primer that 1 contract represents an obligation to provide 1000 oz. gold at a given price.)


I'd remembered that you had mentioned a mini-contract in one of your earlier posts, and went hunting around for more info. I thought I'd provide the information here for the benefit of others who might have a similar not-quite-yet-a-millionaire problem. ;-)

There are 44 different E-mini futures contracts, which are designed to have much smaller multipliers, for smaller traders. In the case of both the S&P and gold, the multiplier is 50, instead of the standard 1000.

So, an e-mini contract would allow an investor to speculate on 50 oz. of gold, with an initial margin of $3,376, and a maintenance margin of $2,500. I have no idea about whether these are still a good deal (if the trading friction and contract costs scale well) though I suspect rogermexico could rattle that off.

I'd suspect there's not many choices for those who don't have an account worth even the ~$71k associated with 50 oz. of gold, but it is nice to know you don't have to work in increments of ~$1.4M+. Even if one did have that much free, one might in cases prefer a more incremental speculation strategy.

[rogermexico]

Re: Options Question and Education

I agree with rogermexico for the most part but there is a steep margin cost associated with holding a short futures position - especially when the trade period is open ended (unless you have in mind a time frame to enter and exit this position?).

There is a little bit of expense associated with this alternative but you have more time to be correct; buy a long put synthetic straddle.



To do this you go long the S&P ETF for 100 shares. This gives you your long exposure in the underlying.

At the same time, purchase two at-the-money puts expiring in three months. This sets up your synthetic straddle.

Remember, an option gives you the right but not the obligation to purchase 100 shares of the underlying so we need two puts (equivalent to 200 shares) for this trade. If you wanted to purchase only 50 shares of SPY (for example) then you only need to buy one put.

If the market falls steeply, you make money from the puts which can be sold before there is one month remaining until expiry. Now you are left holding a long position in the S&P and you have no time constraints on the instrument. So hold the position until it rises again and then sell for breakeven or profit.

If the market rises steeply, you sell the long position in the shares and are left holding your puts. In the worst case, the market does not fall during the three month period and you lose the premium paid for those puts. Best case, the market falls steeply and the puts are also deep in-the-money.

If nothing happens after two - two and a half months , liquidate all positions and wait for a better entry.

There is a wide breakeven for this trade but if you expect fireworks similar to the 2008 collapse then I see no problem with taking on that small additional risk. The nice feature of this trade is that your risk is capped but your potential profit is uncapped.

I'll post an example spreadsheet later.

Steep margin cost? I don't follow. See my answer to astonas. Takes 20 K cash to control 400K of S and P 500 index futures.

Futures are dead simple for shorting.

Step one sell contract

Step two buy contract (close position)

Nothing synthetic required.

[rogermexico]

Re: Options Question and Education

Thanks, rogermexico, for this clear advice. I'm sure it was trivial to you, but for some reason I had accumulated exactly the opposite impression, that futures contracts were more risky, with higher friction, and more complexity than options. As a consequence, I have learned (a very small bit) about options, and always assumed that futures were for bigger, smarter, and braver folks than I. It's great to know that might not be true!

So suddenly I'd like to learn more about futures. If I'm remembering right, you posted an extensive primer here once upon a time, which I didn't probe too deeply for the above reasons. Would you happen to remember where that thread was placed, or even what it might have been titled?

Futures for the beginner: http://www.itulip.com/forums/showthr...990#post234990

I was also reading another thread recently, which raised in m mind some specific questions, some of which might be too unusual to have made it into your general writings. (And of course, if you have already covered these concerns in depth in your earlier primer, I'll be happy to read it there rather than making you go through it again for me.)


I was having trouble understanding the MFGlobal collapse. Were the people who lost out on gold hedges there using futures, or options? Is there anything fundamental to either vehicle that makes it preferable in the event of an MFGlobal-type fraud or larger systemic collapse? Are both, for example, equally available for rehypothecation, and subject to the same levels of counterparty risks in extreme market conditions?

How does one assess and value the risk of being forced to settle in cash vs. obtaining physical delivery for futures? For that matter how does one account for any risk that the warehouse paperwork that indicates theoretical ownership may not be honored in practice? How exactly does that work? If I buy gold for future delivery, can I show up at the door of the warehouse one day with my papers, and walk away with a bar of gold in my bag? Does the gold get shipped to me?

I thought you might have asked the same questions last time I posted on this, but perhaps it was someone else. In any case, my general view is that MF global is to futures as the boston marathon is to pressure-cooker-based IEDS. There is nothing inherent in futures as a class that has anything to do with theft. Theft can occur with any fiduciary that is inclined to thieve, whether the fiduciary holds cash, stocks, bonds metals or derivatives like futures or options. Admixing customer assets with house assets and then leveraging them is the issue with MF global, the losses to investors had nothing to do with futures as an asset.

Your other questions imply I might have endorsed futures in some SHTF context. Let me be clear, I don't endorse or not endorse any particular organ of the entire paper and digital financial universe as being any more sound than any other in some unforseeable doomsday scenario.

The issue I see is given that you have a marginable brokerage account and given that you want to make paper profits when some event like a stock market crash is likely. I find futures simpler and less expensive and easier to understand than relatively complicated hedging strategies with options.

Let me give an example. You have a brokerage account with 1 M in it. If you have roughly 20,000 in cash in your account (2% of the 1M) then you can go short one S and P contract which is worth just under $400,000. You are now short the S and P with 40% of your 1M account. You pay no margin interest, the trade costs about $10 each way, and if you look at the S and P futures curve, you will see that you can hold this contract for months with little change in the contract price compared to the huge time decay with options. You earn $250 x each dollar the contract drops or lose $250 for each dollar the contract rises in price. If you have one of the near contracts, this is essentially identical to shorting the S and P with no margin interest paid. I challenge anyone to show me an example of how to do this with less costs - less friction. Or how to do it with more liquidity. NOTHING is more liquid and has lower spreads than index futures. NOTHING.

Did I mention the tax advantages? I think I did. 60/40 long term/short term vs all short term for trades held less than one year.

Is your liability really unlimited? Of course not. Not in the real world outside of theory. If stocks go to zero, then you made 400K If they go up 100% then you lose 400K when you cover your position or at expiration. Your losses are only infinite if you think stocks can go up infinitely and who think they will be too dumb to close their position soon enough. Who thinks this? People who think high schoolers will soon run one minute miles?

By comparison it is true that if you buy an option, you are guaranteed to lose no more than what you paid for the option, but you are also much more likely to lose money than by taking the same directional bet with a futures contract. The mathematics of the options market demand this the same way the mathematics of a casino demand that slots have the worst odds.

No need to know in or out of the money, no black-shoales equation, no giant spreads, no shitty liquidity when you want to close your position, no paying for time premium (talking about index futures here, contango with commodities is a different story - or course there are no options on commodities anyway! - just options on commodity futures)

I actually think the relative ease of finding options-enabled brokerage accounts versus futures enabled ones is the same reason its easy to find slot machines in casinos. Options trading is profitable for brokerage houses the same way slot machines are. And your odds are much better at the high stakes poker table of futures contracts. Think about it!

Don't misunderstand me, I get that futures are usually used for hedging, and settling in cash is usually what people do, with offsetting purchases or sales of physical being conducted locally. But how would it work if the market shifted (say for example, local physical gold became impossible to find) and one decided the best thing to do was to actually collect the good that one had a contract to buy?

I am not sure what gold has to do with anything in the context of shorting the stock market. If you are concerned about the dreaded paper vs physical decoupling, then by all means bury krugs and eagles in a safe place under cover of darkness. OTOH, if you think the financial system framework with its ones and zeros will survive the reset of the IMS the way it survived 2008 ( I do, in case it is not clear from my writings) then use futures to lock in high gold prices by selling at the top as a hedge against your physical. Do you expect to unload 100s of physical coins instantaneously at good prices? Good luck with that.

In short, are futures still the best answer for everyone when TSHTF, with many institutions all over the place looking like MF Global did, or worse?

I am not sure what your concept of SHTF is, but mine is a Janszen scenario posited sovereign debt crisis and high gold prices, not dissolution of the entire framework of the monetary system and fallback to barter and oxen drawn mercedes. Your best bet to have your digital assets safe, be they stocks, cash, commodities futures or whatever, is to have them held in an account managed my someone you trust. That trust should be the same now as in the future. And for my part, I trust my assets in my futures enabled brokerage account more than I do my bank.

I don't see "lots of institutions looking like MF global" in the discount brokerage business. My brokerage is owned by Schwab, which is not an investment bank and has no prop trading desk at all. They can't be using my assets because they don't do thier own trading or underwriting or any investment banking stuff like a leveraged investment bank. Unlike a bank, it does not depend on lending money into existence nor would it be susceptible to a run - as there is no borrow short and lend long bank scam involved. It claims to hold my assets in my account, and I believe they do.

Again, if you think SHTF means the digits all simply disappear, then hold physical PMs. There would be no differentiating between futures contracts, options, ETFs or even stocks if you think that will happen. And if not, then all these various stocks, bonds and derivatives are likely to be equally sound in terms of contract and counterparty risk, IMO.

Thanks in advance for your time, and expertise. I know there's a barrage of questions above, so if you'd rather just skip to the last one, I'd completely understand.

No problem