Introduction to Options Trading Strategies

The private client division of R.J.OBrien & Associates

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Table of Contents
Introduction....................................................................................................................................3 Getting Started.............................................................................................................................4 Bull Call Spread............................................................................................................................5 Bear Put Spread............................................................................................................................6 Long Straddle...............................................................................................................................7 Short Straddle..............................................................................................................................8 Long Strangle...............................................................................................................................9 Short Strangle.............................................................................................................................10 Calendar Call Spread.................................................................................................................11 Ratio Call Spread.........................................................................................................................12 Ratio Put Spread........................................................................................................................13 Strategies at a Glance................................................................................................................14 Quiz Yourself..........................................................................................................................15-17 About the Author........................................................................................................................18 Additional Free Resources........................................................................................................19

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Introduction
Thank you for your interest in the RJO Futures Introduction to Options Trading Strategies.
Many traders turn to options for their leveraging power, limited risk, and potential for higher returns. They can also be a versatile alternative, providing the ability to take advantage of price movements in commodities, foreign currencies, stocks and interest rates. This guide is meant to complement the RJO Futures Introduction to Options Trading Guide, by taking you to the next step in understanding options trading: Determining which options strategy might be best for you. It provides definitions, charts and examples to help you get started. Although options can offer an opportunity to diversify your portfolio, options traders are still exposed to risk and trading options is not suitable for all investors. You should work with an RJO Futures Sr. Trading Advisor to determine if options trading is right for you. The guide was written by RJO Futures Sr. Trading Advisor Donna Heidkamp, applying her 12-plus years of industry knowledge and experience. As you study the content, we encourage you to contact Donna or any RJO Futures Sr. Trading Advisors or Trading Consultants with questions or comments. Its our goal to help you understand how to apply the information within. Regards, RJO Futures Sr. Trading Advisors

Phone: 800-441-1616 or 312-373-5478 Email: info@rjofutures.com

IMPORTANT INFORMATION ABOUT TRADING FUTURES The risk of loss in trading commodity futures and options can be substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate for you. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.

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Getting Started
The RJO Futures Introduction to Options Trading Strategies guide focuses on specific types of common option strategies to help you further understand real uses of options and your potential risk and reward in the market. Although this guide does not include all possible strategies, the most common strategies are included. The purpose of this guide is to offer a bridge between the RJO Futures Introduction to Options Trading Guide and actually trading options in the market.

How Much Time Do You Have to Monitor the Markets?

For traders with limited time to evaluate the markets, limited risk option strategies may be just what you are looking for. Many limited risk option strategies allow you to participate in the market without watching and evaluating the markets as closely as if you were trading straight futures. However, you should always be aware of the underlying market, and analyze possible trend changes to help you time entry and exit levels for your strategy. If you have limited time to analyze the markets, you may want to work with RJO Futures Senior Trading Advisors to help you monitor the market. Communication is the key to a successful full service trading relationship, and they can be reached at 1-800-441-1616 or through www.rjofutures.com.

Reading the Graphs

The included graphs provide examples of various option strategies that you may find helpful. Please note that the strategies are not current market recommendations. They were simply compiled to give you a visual aid to various option strategies. The underlying price, the market volatility, interest rates, and time value (days until expiration, or DTE) all contribute to the value of the option strategy. In the accompanying graphs, the red line depicts that value of the option strategy today. The green line illustrates the value of the option strategy at expiration. As time value decays, the red line and green line gradually convergeassuming the volatility and interest rates stay the same until expiration. The X-axis is the underlying price of the contract. The Y-axis is the potential reward/risk for each strategy in price units.

Margins on Unlimited Risk Strategies

Another factor to consider when trading options includes possible SPAN margin requirements (standardized portfolio analysis of risk) set by the exchange. Limited risk strategies typically do not have additional margin requirements from the exchange. However, unlimited risk strategies do. The SPAN margins can change daily as market conditions change and the underlying price fluctuates. Therefore, if you are trading an unlimited risk option strategy, you should always maintain plenty of margin excess in the account to avoid the risk of becoming overleveraged. If you have a question regarding the SPAN margins and you are a current customer, I recommend that you contact your RJO Futures representative to request a hypothetical SPAN calculation.

Risks of Trading Options

It is also important to note that the risks of trading option strategies are often underestimated, because it is very difficult to calculate the exact time frame and size of a market move. Traders often refuse to cash in prior to expiration, and wind up losing their investment.

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Bull Call Spread

Bullish Limited Risk Strategy
The bull call spread allows you to capture potential profit in a market, with limited risk to the net premium paid + commission and fees. You would be purchasing (pay the premium) a lower strike call and writing (collect the premium) a higher strike call simultaneously. The lower strike call will always be worth more than a higher strike call, because the odds of the lower strike being in the money and having value at expiration is higher. Net Premium in $ value = 9 * $50/tick = $475 Days to Expiration: 43 Net Premium = 152 - 56 = 94 cents (9 cents in laymans terms) 10 (1 cent) in the Corn = $50 EXAMPLE: Long 1 December Corn 450 Call for 152 Short 1 December Corn 500 Call for 56

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Bear Put Spread

Bearish Limited Risk Strategy
The bear put spread allows you to capture potential profit in a market with limited risk to the net premium paid + commission and fees. You would be purchasing (pay the premium) a higher strike put, and writing (collect the premium) a lower strike put simultaneously. The higher strike put will always be worth more than a lower strike put, because the odds of the higher strike being in the money and having value at expiration is higher. Days to Expiration: 43 Net Premium = 194 - 60 = 134 cents (13 1/2 cents in laymans terms) 10 (1 cent) in the Corn = $50 Net Premium in $ value = 13 1/2 * $50/tick = $675 EXAMPLE: Long 1 December Corn 400 Put for 194 Short 1 December Corn 350 Put for 60

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Long Straddle
No Directional Bias Strategy with Limited Risk
A long straddle buys a call and put with the same strike simultaneously. This scenario is ideal for tightly consolidated markets with low volatility and the likelihood of breaking one direction or anotherand are perceived to have increasing volatility. The risk is limited to the premium paid for both the call and the put. The maximum market risk is recognized at expiration, if the market closes at the strike price. Profit potential above = 8600 + 2166 = 10766 Profit potential below = 8600 2166 = 6434 Days to Expiration: 131 1 tick in the crude oil = $10 Premium Paid in $ value = 1214 + 952 = 2166 * $10/tick = $21,660 EXAMPLE: Long 1 March Crude Oil 8600 Call for 1214 Long 1 March Crude Oil 8600 Put for 952

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Short Straddle
No Directional Bias Strategy with Unlimited Risk
A short straddle sells a call and put with the same strike simultaneously. This scenario is ideal for markets with high volatility that are likely to trade in a longer-term range and expected to decrease in volatility. The risk is unlimited if the market moves above or below the strike price + or - the premium collected. In this scenario, you are always at risk on either the call or the putdepending on which direction the underlying market is going. In this example, you would be at risk of loss if the market rallied above 10766 or below 6434 at expiration. Risk of loss above = 8600 + 2166 = 10766 Risk of loss below = 8600 2166 = 6434 Days to Expiration: 131 1 tick in the crude oil = $10 Premium Collected in $ value = 1214 + 952 = 2166 * $10/tick = $21,660 EXAMPLE: Short 1 March Crude Oil 8600 Call for 1214 Short 1 March Crude Oil 8600 Put for 952

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Long Strangle
No Directional Bias Strategy with Limited Risk
A long strangle buys a call and put with the different strike prices simultaneously. This scenario is ideal for markets that are currently trading at lower volatility levels in a range, but are expected to break out of the range and to increase in volatility. The risk is limited to the premium paid for both the call and the put. Maximum risk is recognized if the market closes at or between the two strike prices at expiration. Potential profit at expiration above = 970.0 + 65.3 = 1035.3 Potential profit at expiration below = 850.0 65.3 Days to Expiration: 47 1 tick (10) in the gold = $10 Premium Paid in $ value = 28.3 + 37.0 = (65.3*100) = $6530 EXAMPLE: Long 1 December 2008 Gold 970.00 Call for 28.3 Long 1 December 2008 Gold 850.00 Put for 37.0

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Short Strangle
No Directional Bias Strategy with Unlimited Risk
A short strangle sells a call and put with the different strike prices simultaneously. This scenario is ideal for markets with high volatility that are likely to trade in a longer-term range and expected to decrease in volatility. The risk is unlimited if the market moves above or below the strike price + or - the total premium collected. In this scenario, you are always at risk on either the call or the putdepending on which direction the underlying market is going. In this example, you would be at risk of loss if the market rallied above 1242.0 or below 658.0 at expiration. Maximum profit potential exists if the market closes between the strikes at expiration. Risk of loss at expiration above = 1050.0 + 192.0 = 1242.0 Risk of loss at expiration below = 850.0 192.0 = 658.0 Days to Expiration: 411 1 tick (.10) in the gold = $10 Premium Collected in $ value = 89.5 + 102.5 = (192.0/.10) * $10/tick = $19,200 EXAMPLE: Short 1 December 2009 Gold 1050.00 Call at 89.5 Short 1 December 2009 Gold 850.00 Put at 102.5

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Calendar Call Spread

Bullish Strategy with Limited Risk
In this strategy, the calendar call spread is buying an option with more time value, and selling a near-term option to help pay for the longer-term option. In this example, I used the same strike priceswhich can also be referred to as a horizontal spread. However, you can choose to use this strategy using different strike prices. The chart below displays the reward/risk of the spread at the near-term option expiration. This is a limited risk strategy, because the option leg with more time value (the long leg) should retain some extrinsic and time value. At expiration of the spread, the maximum profit potential would be the value of the long option minus the Days to Expiration of the December option leg: 39 1 tick = $10 Premium Paid in $ value = 1314 772 = 642 * $10/ tick = $6,420 EXAMPLE: Sell 1 December 08 Crude Oil 8400 Call at 772 Buy 1 March 09 Crude Oil 8400 Call for 1314 net premium paid for the spread. It is also important to note that a near-term squeeze for a commodity could negatively impact the spread relationship as well, which could reduce profitability and create additional risk.

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Ratio Call Spread

Bullish Strategy with Unlimited Risk
A ratio call spread buys a call and sells multiple higher strike calls than what was purchased. This type of strategy is ideal if you believe that the bias is for a higher move, with a ceiling at the higher strike price. It is also important to note that the time value to expiration and volatility can have a negative effect on the spread, which is often underestimated. Therefore, you should always have plenty of excess capital to withstand market movements. EXAMPLE: Buy 1 December 08 Crude Oil 8500 Call for 644 Sell 2 December 08 Crude Oil 10000 Calls at 222 10000 (higher strike) 8500 (lower strike) 200 (premium paid) = 1300 + 10000 = 11300. Unlimited risk of loss exists at expiration on a close above 11300. In this example, we are using a 1 X 2 ratio call spread. Maximum profit potential exists at expiration if the underlying is trading at the higher strike price or 10000 in this example. For a 1 X 2 ratio spread, unlimited risk exists at expiration if the market moves above the higher strike price by more than the difference in strikes less the premium paid. Days to Expiration: 39 1 tick = $10 Premium paid in $ value = 644 (222 * 2) = 200 * $10/tick = $2,000

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Ratio Put Spread

Bearish Strategy with Unlimited Risk
A ratio put spread buys a put and sells multiple lower strike puts than what was purchased. This type of strategy is ideal if you believe that the bias is for a lower move, with a floor at the lower strike price. It is also important to note that the time value to expiration and volatility can have a negative effect on the spread prior to expiration, which is commonly underestimated. Therefore, you should always have plenty of excess capital to withstand market movements. EXAMPLE: Buy 1 December 08 Crude Oil 8000 Put for 348 Sell 2 December 08 Crude Oil 6800 Puts at 135 8000 (higher strike) 6800 (lower strike) - 78 (premium paid) = -1122 + 6800 = 5678 Risk of loss exists in this example at expiration if the market is trading below 5678. In this example, we are using a 1 X 2 ratio put spread. Maximum profit potential exists at expiration if the underlying is trading at the lower strike price or 6800 in this example. For a 1 X 2 ratio spread, unlimited risk exists at expiration if the market moves below the lower strike price by more than the difference in strikes less the premium paid. Days to Expiration: 39 1 tick = $10 Premium paid in $ value = 348 (135 *2) = 78 * $10/ tick = $780

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Strategies at a Glance
Bullish Strategy with Limited Risk
In trading options, money can be made whether the market moves up, down, sideways or not at all. But in order to choose your options strategy, you will need to decide which direction you think the market is moving in. This quick at-a-glance guide can assist you in deciding which strategy to usewhether you are bullish, bearish, or neutral the market.

Option Strategy Bull Call Spread

Market Expectation Buy = Bullish Sell = Neutral/bearish Buy = Bearish Sell = Neutral/bullish Anticipating increase in volatility Limited trading range Anticipating increase in volatility Limited trading range Neutral/Bullish Bullish

Risk Buy = Premium paid Sell = Difference between strike prices premium received Buy = Premium Paid Sell = Difference between strike prices premium received Premium paid Unlimited outside of strikes + premium received Premium paid Unlimited outside of strikes + premium received Premium paid for your call premium received for the short call Risk is unlimited if market falls below the sum of the profit and the higher strike price Risk is unlimited if market rises above the difference between the lower strike price and the profit

Reward Buy = Difference between strike prices premium paid Sell = Premium received Buy = Difference between strike prices premium paid Sell = Premium received Unlimited outside of strikes + premium paid Premium received Unlimited outside of strikes + premium paid Premium paid Premium received for selling the call Upside maximum profit is limited by difference in strike premium paid Upside maximum profit is limited by difference in strike premium paid

Bear Put Spread

Long Straddle Short Straddle Long Strangle Short Strangle Calendar Call Spread Ratio Call Spread

Ratio Put Spread

Bearish

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Quiz Yourself: Are You Ready to Advance to the Next Step or Do You Need to Review?
1. Which of these entails selling a call and put with the same strike simultaneously?
a. b. c. d. e. Bull call spread Bear put spread Long straddle Short straddle None of the above

2.

Which of these entails buying a call and put with different strike prices simultaneously?
a. b. c. d. e. Bull call spread Bear put spread Long straddle Short straddle

None of the above

3.

Which of these entails purchasing a lower strike call and writing a higher strike call simultaneously?
a. b. c. d. e. Bull call spread Bear put spread Long straddle Short straddle None of the above

4.

A long straddle entails buying a call and put with the same strike simultaneously.
a. b. True False

5.

A calendar call spread buys an option with more time value, and sells a nearterm option to help pay for the longer-term option.
a. b. True False

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6.

Which of these entails buying a call and put simultaneously?

a. b. c. d. e. Long strangle Short strangle Ratio call spread Ratio put spread

None of the above

7.

Which of these entails buying a call and selling multiple higher strike calls than what was purchased?
a. b. c. d. e. Long strangle Short strangle Ratio call spread Ratio put spread None of the above

8.

A short strangle sells a call and put with different strike prices simultaneously.
a. b. True False

9.

A ratio put spread is considered bullish.

a. b. True False

10. Which of these entails buying a put and selling multiple lower strike puts than what was purchased?
a. b. c. d. e. Long strangle Short strangle Ratio call spread Ratio put spread None of the above

Answers and Scoring on following page.

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Answers
1 (d), 2 (e), 3 (a), 4 (a), 5 (a), 6 (a), 7 (c), 8 (a), 9 (b), 10 (d) Each correct answer equals 1 point.

My score:__________

Scoring (out of 10 possible points)

8-10 = You Understand These Options Strategies Contact an RJO Futures representative at 800-441-1616 now, and learn how you can turn your new knowledge into possible trading opportunities. We can help. You May Want to Revisit the Material Youve learned a fair amount about options strategies. But we recommend you revisit the material to fully grasp the concepts. Once you have it down, you may be ready to apply what youve learned to your trading. Definitely Revisit the Material, and Take the Quiz Again No worries. You simply need to reread the material and/or contact an RJO Futures Trading Consultant at 800-441-1616 for assistance. Well be happy to walk you through any parts of this guide to help you to better understand the content. And we offer many other resources to help you along the way.

6-7

1-5

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About the Author

Donna Heidkamp
Donna is a Senior Trading Advisor with RJO Futures in Chicago, Illinois. Donna graduated from Texas Tech University with a bachelors degree in Agricultural Economics, and completed the Chicago Mercantile Exchange Agricultural Broker Training Program, which enabled her to work with experienced floor traders and develop a strong understanding of the intricacies of trading in the futures markets. Since completing the training program in 1995, she has continued to gain a well-rounded knowledge of the industry by working as an order clerk, trading desk manager, and broker for RJO Futures and now focuses her efforts on helping clients meet their trading goals. Donna also completed a masters degree in financial markets and trading from the Illinois Institute of Technology in May of 1999 to better serve her customers in an ever-evolving and dynamic industry. Donna is a regularly featured commentator on CNBC TV and Bloomberg.

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Additional Free Resources

RJO Futures eView E-newsletter
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RJO Futures Basics of Money Management

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RJO Futures Intro to Technical Analysis

Written by RJOFutures own trading strategists, it provides the information you need to apply this technique to your futures trading. Request your free guide here: https://www.rjofutures.com/ offers/20070411_techguide/index.php

RJO Futures 10 Dos and 10 Donts of Trading Futures

This enlightening guide will help newer futures traders with some of the basic principles that professional traders inherently live by. Request your free guide here: http://rjofutures.com/ offers/10dosanddonts/index.php

Open a Trading Account Today

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IMPORTANT INFORMATION ABOUT TRADING FUTURES The risk of loss in trading commodity futures and options can be substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate for you. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.

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