Most often asked questions and answers
 | Do margin requirements change?
 | Yes. Remember that margin is a reflection of risk. If the volatility in a market
increases, so can the margin. Margins are subject to change without notice and can be
changed after you establish a position. Always check with your broker for the most current
margin requirements. |
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| I'm just starting to paper trade. How many markets should I watch?
| Everyone has their own comfort level in the number of markets they can effectively
watch. The most common mistake that most paper traders make is watching too many markets.
They feel compelled to watch every trade on a market update and can get
completely overwhelmed with the whole process. If you are watching 5 markets and are
having trouble keeping up with your technical or fundamental system of trading, consider
cutting the number back. Try to make your paper trading experience as real as possible.
Select markets that are realistic to trade in. If you never plan to trade with more than
$2000 why paper trade a market with a margin requirement of over $5000? |
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| Does the futures price have to trade through my strike price to make money on an
option?
| No. This is the most common misconception about options. The expression I use to clearly
state the relationship of an option to the futures is "the option will increase in
value at an increasing rate the more it approaches the strike price." Options, just
like futures, have trading ranges throughout the day. If the high of the day is 6 cents
and the low was 3 cents that would illustrate the gain or loss potential in the value of
that option that session. |
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| What is the difference between extrinsic and intrinsic value in options?
| An option has intrinsic value if it would be profitable to exercise the option.
Extrinsic value is just 'time value' and reflects the amount of money that buyers are
willing to pay in hope that an option will be worth exercising at or before expiration.
For example, if Dec Corn futures is selling at 2.16 and a Dec Corn 2.00 call is selling
for 18, then the intrinsic value equals 16 cents (the difference between the strike and
the futures) and the time value of 2 cents (the difference between the total premium and
the intrinsic value). An options time value decreases as it approaches expiration. It will
have no time value at expiration and any remaining value will consist of only intrinsic
value. * |
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| Calls and Puts confuse me, is there any solid definition that is helpful in
understanding them?
| Having a solid understand of futures will help provide a foundation in understanding
options trading. A call is the right but not the obligation to buy the underlying futures
at that strike price. A put is the right but not the obligation to sell the underlying
futures at that strike price. The "right but not the obligation" illustrates
that it is not required for you to exercise your option but you have the right to if you
have incentive to do so. |
|
| How do I know if I should exercise my option?
| You can sell your option or exercise it. You can simply pencil it out to determine which
scenario will profit more. Remember, when you exercise your option you give up the
premium. Let's use a real example using real prices. On Sept 18, you bought a Dec Corn 270
call for 7 ¼. Today, the futures price is at 282 ¾, and the premium is now at 13 ¾ . If
you exercise, you will be long in futures from 270. If the futures market is at 282 ¾ then
your open trade equity would be 12 ¾. Don't forget that you give up the 7 ¼ you paid in
premium making the net profit potential 12 ¾-7 ¼ or 5 ½ cents. If you simply
liquidate your option however, you realize a net gain of 6 ½ (13 ¾ -7 ¼).
You would make
a little more by simply liquidating or (selling your option back) and not exercising. In other words, you have no
incentive to exercise. |
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| What is the difference between volume & open interest?
| Volume is the number of contracts traded (one side of each trade only) for each delivery
month during that trading period. Open interest is the accumulated total of all currently
outstanding contracts. |
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| What is 'marking to the market'?
| At the end of each trading day and all following days that
your position remains open, the contract value is 'marked to the
market.' Your account is either credited or debited
based on that days trading session close. An updated status of your account is available
from your broker on a daily basis based on these figures. |
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| Is it better to trade the fundamentals than the technicals?
| There is no right or wrong answer to this question. The markets are very dynamic and
react to a massive variety of different types of information, both fundamental and
technical. The job of the prudent trader is sorting through what information is important
and what is not (i.e. what the market has "factored in" and what is a
"surprise" to the market). |
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| I'm not understanding how commissions work. What exactly is a
roundturn?
| Commission rates are commonly quoted in roundturns. This means for a full buy and sell
in one contract or option. A $65 roundturn would mean $32.50 in and $32.50 out. Many
brokerages charge all of the commission upfront for options and $0 to liquidate. Yet
other brokerages will charge half in and half out, like futures, with no commission
charge if the option expires. This can work well if you are 'fishing' for out of the money
options that may expire and can prove to be of significant savings in the long run. Also,
spread trades can be charged differently, depending on where you trade. One brokerage may
charge $80 roundturn for a spread trade; others may hit you with the full commission
and offer a small 'rebate.' In addition, your brokerage may provide reduced rates for mini
contracts. Be sure and ask your account representative exactly how their commissions are
charged in futures AND options. |
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Let me just end by saying the markets are very dynamic and that you may experience
success and failure as a trader. Focus on the learning aspect of the markets and develop
a relationship with a reputable and helpful broker that will assist you in your trading
endeavors. In sum, patience, discipline, and education are all important qualities to
cultivate your trading. Good luck.
by Michael Weaver
This publication is strictly the opinion of its writer and is intended solely
for informative purposes and is not to be construed, under any circumstances by
implication or otherwise, as an offer to sell or a solicitation to buy or trade in any
commodities or securities herein named. Information is obtained from sources believed to
be reliable, but is in no way guaranteed. No guarantee of any kind is implied or possible
where projections of futures conditions are attempted.
Futures trading involves risk. In no event should the content of this market
letter be construed as an express or an implied promise, guarantee or implication by or
from Michael Weaver or LIT First Division of First Options of Chicago, Inc. that you
will profit or that losses can or will be limited in any manner whatsoever. No such
promises, guarantees or implications are given. Past results are no indication of futures
performance.
* Reference to Chicago Board of Trade, Agriculture Options
for the Beginner, 1996
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