Nov. 20, 2006 — The holiday season commences next week for the world of futures. An often-overlooked aspect, and potential benefit, of this period is the reduced liquidity in the options on certain futures markets. Many traders shy away from trading during this light volume time of year, but an educated trader can find some of the best deals on both buying premium and premium collection. Here is a quick synopsis of this abnormal trading time and how best to take advantage of it.
First, let’s talk about the main differences between the Thanksgiving to New Year’s holiday season and the rest of the year. During this vacation period the number of locals (floor traders who represent their own and other private accounts on the floor) diminishes considerably and the number of large lot orders from big trade houses drop drastically. The individual speculators become scattered and the overall average daily volume of most markets drop by as much as 30-50%. The other noticeable element to this holiday period is price volatility. In addition to a drop in the average daily volume, the average daily price range tends to consolidate. This is offset by a few sporadic days, major price spikes due mainly to fundamental news forcing a spike in volume and price action. In a nutshell, you have a six-week stretch with low volume, reduced daily trading ranges and the occasional massive price spike. So what does a trader do to profit from this upcoming shift?
To profit from this analysis one must first accept the obvious – none of this tells you whether crude oil is going to rally 20% or orange juice is going to tumble or if the corn market is going to trade sideways. However, you can look to the option arena to scalp valuable dollars out of markets that will have skewed option prices. Typically, when someone refers to an option skew, he is talking about a bias within the market that over values either the put side or the call side of a market. In this case, I refer to skew more in terms of tilted or ‘off’ fair value pricing within an option chain. Assuming you use the Black-Scholes approach for determining fair value of an option, you can view an option and determine what prices are off from your market assessment. But during the holiday period, all that matters is the bid/ask spread. Let’s use a hypothetical example to illustrate the shift from normal trading to holiday trading:
Normal Market
A February Natural Gas 9.20 call, based on a Black-Scholes pricing model, has a fair value of $2,200. The bid on the floor is 20 contracts at $2,150 and the ask is 10 contracts at $2,300. 50 more contracts are bid at $2,100 and 100 contracts at $2,000. 50 contracts are offered at $2,400 and 200 contracts at $2,500.
Holiday Market
The same call, with the same fair value, is bid two contracts at $2,150 versus five contracts offered at $2,600.
Clearly, the difference here is that lack of volume and market interest has diminished competition for the option strike being analyzed. This leaves the door open for a floating sell offer at $2,550 waiting for a buyer to go to market or pay a premium. These opportunities abound on both the sell side and buy side, but it takes patience and willingness to analyze constantly the option chains and the pricing on the floor.
The next question you should not be asking is how do you know what the bid/offer on the floor was to take advantage of the pricing? A great trader is only an average trader if he doesn’t have great floor traders and an open line of communication. A great broker loses his value without a knowledgeable trade desk and top-notch floor brokers. The bottom line is that markets are going electronic and market depth will soon become transparent, but until then smart traders with the right setup and analysis can find incredible deals during holiday trading.
Top five Holiday Option Markets
Coffee
Natural Gas
Cotton
Canadian Dollar
Sugar
Look for two weeks of dead trade to buy premium and sell premium on days where there is a price spike. Look at this approach like the right way to buy a car. If you show up at the dealership needing a car today, you are going to be taken for a ride. Show up not caring if you walk out of there with a car and you are probably going to get a great deal. I throw a bunch of ‘feelers’ out there and let the market come to me.
James Mound
James Mound Trading Group
(888) 744-8866
info@moundreport.com
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Disclaimer: There is risk of loss in all commodities trading. Please consult a James Mound Trading Group Broker before you trade for the first time. Losses can exceed your account size and/or margin requirements. Commodities trading can be extremely risky and is not for everyone. Some option strategies have unlimited risk. Educate yourself on the risks and rewards of such investing prior to trading. James Mound Trading Group, or anyone associated with JMTG or moundreport.com, do not guarantee profits or pre-determined loss points, and are not held monetarily responsible for the trading losses of others (clients or otherwise). Past results are by no means indicative of potential future returns. Information provided are compiled by sources believed to be reliable. JMTG or its principals assume no responsibility for any errors or omissions as the information may not be complete or events may have been cancelled or rescheduled. Any copy, reprint, broadcast or distribution of this report of any kind is prohibited without the express written consent of James Mound Trading Group LLC.
