Commodity Market Forecasts How Do I Trade Them? PART 3 Decrease Risk and Increase Staying Power
Producing a high probability trade forecast is not easy. Just as difficult is determining the best trading strategy and vehicles to capitalize on the forecast. Read on to learn some of my favorites trading strategies.
How about futures contracts? Is there a way to reduce our risk when buying futures? The risk problem with futures is they are marked to the market. This means they always have a “delta” of 1.0, meaning they track the cash market closely. With options, as the market moves against you, the delta will shrink and erode more slowly. Plus, you can only lose what you paid for the commodity option.
With a futures contract, it’s more like trading on a razor’s edge. The advantage is the futures contract does not erode in premium like an option. Generally, if a cash market does not move for two months, the future stays flat with little or no loss while the option will surely lose its premium value.
So how do we hedge our futures contract? Here’s how: Let’s say we go long a futures contract. We then buy a put option with a strike price that is near the current futures contract price. If the market went sharply against us, normally the loss could be very large - holding a naked future.
But with the put option hedge, loss is limited to the premium we paid plus the difference between the option strike price and where we put on the futures contract. Bottom line is we can use the option as our synthetic futures contract “stop loss” order. If the maximum we can lose with the put option hedge is $1,000, we know our true risk no matter what happens.
The advantage here is STAYING power. Let's say the futures contract (with no hedge) took a $3000 dip against us, but then rallied to finally make a big profit. We would have probably been stopped out holding the naked futures contract, whereas the option hedge would let us ride through the adversity with a maximum limited loss at any time of $1,000, until option expiration. In addition, we have protection from an overnight market gap surprise. This one benefit alone may be worth the hedge.
Trading futures while using this option hedging technique will take some "insurance premium" profit out of the bottom line, but when you consider the possible risks of holding naked futures overnight, one has to wonder why someone would not always want to make their stop loss order in the form of a hedged long put. (Or for a short future, use a long call hedge)
Just having a market forecast is not enough. Not every “low-risk, high probability” trade works as we expect. Some turn into high-risk, low probability trades. Having a few strategies like this to reduce our risk will shave profits somewhat, but will usually help our equity curves to trend smoother without the chaotic dips.
Account survival is first, but second is a smooth, up-trending account equity curve. It is well worth the small hedging premium we pay. Scaling in and scaling out in both price and time will also help to smooth out this curve.
Having these techniques available to you will give you more confidence to hold through adversity for the bigger moves. It will also reduce your fear of market unknowns.
How about futures contracts? Is there a way to reduce our risk when buying futures? The risk problem with futures is they are marked to the market. This means they always have a “delta” of 1.0, meaning they track the cash market closely. With options, as the market moves against you, the delta will shrink and erode more slowly. Plus, you can only lose what you paid for the commodity option.
With a futures contract, it’s more like trading on a razor’s edge. The advantage is the futures contract does not erode in premium like an option. Generally, if a cash market does not move for two months, the future stays flat with little or no loss while the option will surely lose its premium value.
So how do we hedge our futures contract? Here’s how: Let’s say we go long a futures contract. We then buy a put option with a strike price that is near the current futures contract price. If the market went sharply against us, normally the loss could be very large - holding a naked future.
But with the put option hedge, loss is limited to the premium we paid plus the difference between the option strike price and where we put on the futures contract. Bottom line is we can use the option as our synthetic futures contract “stop loss” order. If the maximum we can lose with the put option hedge is $1,000, we know our true risk no matter what happens.
The advantage here is STAYING power. Let's say the futures contract (with no hedge) took a $3000 dip against us, but then rallied to finally make a big profit. We would have probably been stopped out holding the naked futures contract, whereas the option hedge would let us ride through the adversity with a maximum limited loss at any time of $1,000, until option expiration. In addition, we have protection from an overnight market gap surprise. This one benefit alone may be worth the hedge.
Trading futures while using this option hedging technique will take some "insurance premium" profit out of the bottom line, but when you consider the possible risks of holding naked futures overnight, one has to wonder why someone would not always want to make their stop loss order in the form of a hedged long put. (Or for a short future, use a long call hedge)
Just having a market forecast is not enough. Not every “low-risk, high probability” trade works as we expect. Some turn into high-risk, low probability trades. Having a few strategies like this to reduce our risk will shave profits somewhat, but will usually help our equity curves to trend smoother without the chaotic dips.
Account survival is first, but second is a smooth, up-trending account equity curve. It is well worth the small hedging premium we pay. Scaling in and scaling out in both price and time will also help to smooth out this curve.
Having these techniques available to you will give you more confidence to hold through adversity for the bigger moves. It will also reduce your fear of market unknowns.
Producing a high probability trade forecast is not easy. Just as difficult is determining the best trading strategy and vehicles to capitalize on the forecast. Read on to learn some of my favorites trading strategies.
How about futures contracts? Is there a way to reduce our risk when buying futures? The risk problem with futures is they are marked to the market. This means they always have a “delta” of 1.0, meaning they track the cash market closely. With options, as the market moves against you, the delta will shrink and erode more slowly. Plus, you can only lose what you paid for the commodity option.
With a futures contract, it’s more like trading on a razor’s edge. The advantage is the futures contract does not erode in premium like an option. Generally, if a cash market does not move for two months, the future stays flat with little or no loss while the option will surely lose its premium value.
So how do we hedge our futures contract? Here’s how: Let’s say we go long a futures contract. We then buy a put option with a strike price that is near the current futures contract price. If the market went sharply against us, normally the loss could be very large - holding a naked future.
But with the put option hedge, loss is limited to the premium we paid plus the difference between the option strike price and where we put on the futures contract. Bottom line is we can use the option as our synthetic futures contract “stop loss” order. If the maximum we can lose with the put option hedge is $1,000, we know our true risk no matter what happens.
The advantage here is STAYING power. Let's say the futures contract (with no hedge) took a $3000 dip against us, but then rallied to finally make a big profit. We would have probably been stopped out holding the naked futures contract, whereas the option hedge would let us ride through the adversity with a maximum limited loss at any time of $1,000, until option expiration. In addition, we have protection from an overnight market gap surprise. This one benefit alone may be worth the hedge.
Trading futures while using this option hedging technique will take some "insurance premium" profit out of the bottom line, but when you consider the possible risks of holding naked futures overnight, one has to wonder why someone would not always want to make their stop loss order in the form of a hedged long put. (Or for a short future, use a long call hedge)
Just having a market forecast is not enough. Not every “low-risk, high probability” trade works as we expect. Some turn into high-risk, low probability trades. Having a few strategies like this to reduce our risk will shave profits somewhat, but will usually help our equity curves to trend smoother without the chaotic dips.
Account survival is first, but second is a smooth, up-trending account equity curve. It is well worth the small hedging premium we pay. Scaling in and scaling out in both price and time will also help to smooth out this curve.
Having these techniques available to you will give you more confidence to hold through adversity for the bigger moves. It will also reduce your fear of market unknowns.
How about futures contracts? Is there a way to reduce our risk when buying futures? The risk problem with futures is they are marked to the market. This means they always have a “delta” of 1.0, meaning they track the cash market closely. With options, as the market moves against you, the delta will shrink and erode more slowly. Plus, you can only lose what you paid for the commodity option.
With a futures contract, it’s more like trading on a razor’s edge. The advantage is the futures contract does not erode in premium like an option. Generally, if a cash market does not move for two months, the future stays flat with little or no loss while the option will surely lose its premium value.
So how do we hedge our futures contract? Here’s how: Let’s say we go long a futures contract. We then buy a put option with a strike price that is near the current futures contract price. If the market went sharply against us, normally the loss could be very large - holding a naked future.
But with the put option hedge, loss is limited to the premium we paid plus the difference between the option strike price and where we put on the futures contract. Bottom line is we can use the option as our synthetic futures contract “stop loss” order. If the maximum we can lose with the put option hedge is $1,000, we know our true risk no matter what happens.
The advantage here is STAYING power. Let's say the futures contract (with no hedge) took a $3000 dip against us, but then rallied to finally make a big profit. We would have probably been stopped out holding the naked futures contract, whereas the option hedge would let us ride through the adversity with a maximum limited loss at any time of $1,000, until option expiration. In addition, we have protection from an overnight market gap surprise. This one benefit alone may be worth the hedge.
Trading futures while using this option hedging technique will take some "insurance premium" profit out of the bottom line, but when you consider the possible risks of holding naked futures overnight, one has to wonder why someone would not always want to make their stop loss order in the form of a hedged long put. (Or for a short future, use a long call hedge)
Just having a market forecast is not enough. Not every “low-risk, high probability” trade works as we expect. Some turn into high-risk, low probability trades. Having a few strategies like this to reduce our risk will shave profits somewhat, but will usually help our equity curves to trend smoother without the chaotic dips.
Account survival is first, but second is a smooth, up-trending account equity curve. It is well worth the small hedging premium we pay. Scaling in and scaling out in both price and time will also help to smooth out this curve.
Having these techniques available to you will give you more confidence to hold through adversity for the bigger moves. It will also reduce your fear of market unknowns.
posted by zzzzzzzzzzz at
2:30 AM
<< Home