Mastering Futures Options for Beginners - Your Top 5 Plays!

The A to Z guide to futures option trading by nationally recognized futures veterans.
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  • Lectures 32
  • Length 2.5 hours
  • Skill Level Beginner Level
  • Languages English
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About This Course

Published 2/2016 English

Course Description

A Rare Minimum Risk — Unlimited Return Opportunity to Master Futures & Futures Options

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ATTENTION: Updated Thursday, August 25, 2016, 12:35 P.M.

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Ed Seykota is an electrical engineer who trained at the Massachusetts Institute of Technology (M.I.T). But he wanted to work on Wall Street.

He started as a market analyst.

But he was smart in math and programming. He worked out a trend following system that is consistent with all that we know in academic finance that makes sense in futures and futures options.

He astonished the world by producing 250,000% returns for his investors over 16 years between 1972 and 1988. Read the details in the New York Times Bestselling book “Market Wizards” by Jack Schwager.

How to Hedge Your Stock Portfolio Against Major Market Crashes with Index Futures Options!

You are reading this now because you have probably had problems in the past trading futures or futures options. Or perhaps you are interested in the market to hedge your risk in stocks in your 401[K].

Either way everybody knows that futures and futures options are dangerous.

Many investors lose ever dime they put into these markets. Even worse I remember a Coast Guard aviator who lost over one hundred and fifty thousand dollars in these markets on margin call.

He was unable to retire as planned.

The Elements of Good Trading

According to Ed Seykota there are three critical factors to your trading.

  1. Cutting losses.
  2. Cutting losses.
  3. Cutting losses.

He is not joking. Implementing techniques for cutting losses is what the Coast Guard chopper pilot failed to grasp.

Your Three Most Important Rules to Remember …

But like the United States Coast Guard this course is based on a rigid set of safety rules. They are,

  • RULE #1: Cut losses.
  • RULE #2: Ride winners.
  • RULE #3: Test with small bets.

I am Dr. Scott Brown. At the turn of the century I devised a technique to answer the most controversial question ever asked in the futures market.

I wanted to know if the floor was ripping off retail traders with slippage.

This got the attention of the Chicago Board of Trade. They mobilized a team to gather data for my doctoral dissertation in finance at the University of South Carolina.

Professor Tim Koch (Ph.D. Purdue), Eric Powers (Ph.D. M.I.T.), and Glenn Harrison (Ph.D. U.C.L.A.) oversaw my research efforts.

We proved that not only does the floor not steal from the small trader but that most of the times market orders are best for entry. Slippage works to the profit of a trader as often as a loss.

Inside You’ll Discover the Top 5 Futures & Futures Option Strategies …

  • FIRST: The E-Mini Protective Put
  • SECOND: Deep in the money Call
  • THIRD: Deep in the money Put
  • FOURTH: The Bull or Bear Credit Spread
  • FIFTH: The Bull or Bear Debit Spread

Here is what my students have to say about how I can move your training up a notch or three,

  • "I have a lot of respect and admiration for you, your education and your teaching ability." -Charlie White, 1/29/2016

Enroll Now for Life!

Your Education is Protected with a 30 Day No-Questions Asked Money Back Guarantee from Udemy Staff Members as Third Party Fulfilled!

Every second that ticks by is one less opportunity to discover the top 10 futures and futures option strategies.

Enroll now! I am waiting inside to help you progress. -Scott

Dr. Scott Brown

Associate Professor of Finance of the AACSB Accredited Graduate School of Business of the University of Puerto Rico.

P.S. WARNING: Get the only Chicago Board of Trade sponsored training by a Major State University Finance Professor!

P.P.S. Join this unbiased futures and futures option learning community now.

What are the requirements?

  • Common sense is a highly useful non-mandatory pre-requisite for this course.

What am I going to get from this course?

  • Incorporate futures options trading concepts into your portfolio.
  • Analyze all possible payoffs and risks before entering into a position.
  • Trade futures option in your sleep and when you are away from your desk with program trading robots.

What is the target audience?

  • This course is the perfect progression for those traders who are interest in controlled leverage investing.

What you get with this course?

Not for you? No problem.
30 day money back guarantee.

Forever yours.
Lifetime access.

Learn on the go.
Desktop, iOS and Android.

Get rewarded.
Certificate of completion.

Curriculum

Section 1: A Big Welcome to a Fascinating World of Commodity and Financial Futures Options!
02:23

Dr. Brown explains how to get the most from this course. Make sure you dig in and study hard on the content.

Learn everything you can about the markets!

Remember that your are a financial steward first for your family. You are their first defense from poverty.

2 questions

What are the most important ways to get the most from this course?

Section 2: The Basics from Futures Options Theoretical Concepts into Black-Scholes Pricing!
03:39

Futures Markets require risk management. This is particularly critical in light of the fact that leverage is inherent in each trade from contract to option in futures. But futures related ETFs can be used to unwind leverage investing in shares.

This can be done in a Roth or individual 401(k) which is prohibited for futures.

But you can’t trade ETFs if you can’t discern trend and trade the futures. This Udemy course is intended to teach you all of this.

Forward Contracts

A forward contract forces you or the counter party to your trade to deliver the underlying asset at the agreed price at entry on the contracted future deliver date. These are not traded across an organized exchange. Forward contracts are tailored to the sellers and buyer’s needs. Size is not standard, it is custom.

The most widely known forward market is the currency market.

Futures Contracts

A futures contract is the same as a forward contract except that it trades in standardized underlying quantities across standardized exchanges with just one delivery date per month at most. The futures price is a mutually accepted price paid at maturity under the terms of the futures contract.

A long position is created when a trader buys a futures contract or futures option contract.

A short position is created when a trader counter party to the trade sells to the trader who desires to go long. The long trader agrees to accept delivery of the underlying at maturity of the futures contract. The short trader agrees to deliver the underlying.

Profits to Long/Short Traders Profit Diagrams show how you profit long or short a futures contract. I also show you how call option profits fluctuate. It is interesting to note that his slide shows you the three best ways to make money in futures if you can get the trend right.

05:59

Contemporary Futures

Futures markets are traded across four broad categories.

  • Agricultural Commodities
  • Minerals and Metals
  • Currencies
  • Financials

Single stock futures have been around since 2002 but have little trading activity. These futures contracts have been a flop rather than a hoped for innovation by the exchange.

Samples of Futures Contracts

Each of the four categories except currencies can be subdivided further. Agricultural commodities are split between

  • Grains — Corn, Wheat, and Soybeans are the strongest here.
  • Meats — Hogs and Live Cattle are the most interesting.
  • Softs — Cocoa, sugar, orange juice, and coffee are softs.

And minerals and metals can be divided into

  • Energies — Crude oil is an energy.
  • Industrial — An example of an industrial metal is copper while silver is precious.
  • Precious — Gold is the most important contract.

Financials is composed of

  • Index — The SP E-Mini is the only worth watching.
  • Interest — Here, the 15 Year Treasury Bond and Eurodollar contracts dominate.

Foreign currencies include the following

  • Great Britain Pound
  • Dollar Canadian
  • Japanese Yen
  • Euro Currency
  • Australian Dollar
  • New Zealand Dollar

Trading Mechanics

If you watch the hilarious comedy entitled, “Trading Places” with Eddie Murphy and Dan Ackroyd the open outcry, eight sided pit trading in the movie is now a thing of the past. Today the vast majority of futures trading operates over electronic clearing networks (ECN) that match buy and sell orders automatically. There is no human floor broker or local intervention.

The clearinghouse is a Futures Commission Merchant (FCM) that acts as arbitrator between futures buyer and seller by escrow process. The amount forced into escrow is the maintenance margin on the contract.

The FCM ensures that both buyer and seller can count on receiving payment when profitable. The other trader cannot back out of the deal capriciously. This creates more trading by increasing trust in the futures system.

Futures contracts are closed out through reversing trades. Buying into a long position is closed out with a reversing sell order.

Selling into a short position is closed out by a reversing buy order. Nearly all futures positions are closed by reverse order.

Very few are delivered.

Open interest is a count of the total number of contracts that are outstanding on a given day. When one long trader buys a contract from a short selling counter party open interest increases by one.

Open interest is zero when a futures contract begins trading. It peaks over time just before first notice day.

Traders roll positions from old contracts that are soon to expire forward to the new.

If the long trader closes out his or her position where a new buying trader takes over the contract open interest does not change.

The expiration of the contract reduces the open interest. If there is no available counter party the reversing order will result in a decrease of one in open interest.

04:49

Trading with and without Clearinghouse

Panel A of the diagram is a transaction between two traders with no clearinghouse. This is how the Forex market works. Panel B shows the same situation with a clearinghouse.

The clearinghouse rides the fence with a short and long position between two traders. It is fully hedged.

Solvency and Convergence

The margin that traders put up when they enter a contract is forfeit to the FCM. This means that the clearing firm can (and does) take money out of the loser’s account and moves it to the winner every trading day.

This process is known as marking to market. The act of moving the funds is known as daily settlement.

Modern futures brokerages send you a daily account statement reflecting settlement.

The amount you have to put down to buy or sell futures contracts is known as initial margin. This is a lot like the minimum bet to play blackjack in Las Vegas.

On January 12th of 2016 it was $5,060 for the E-Mini futures contract. This tracks the S&P 500 index. That means that you have to have at least this much in your account to initiate a trade.

Maintenance margin is the minimum you must maintain in your account to keep a position open. This was $4,600.

The account cannot drop more than $460 below $5,060 or the trader receives a margin call.

A margin call is an order to place more funds in the account to keep a position open. These come by email in modern futures brokerage.

RULE: Never meet a margin call. If you get one you are wrong and need to get out and regroup!

Luminary economist Paul Samuelson pointed out that the futures price today eventually must converge to the spot price. This forces prices into alignment.

Physical and Cash Futures Settlement

As explained before futures contracts are either written on physical commodities that can be delivered by shovel, tube, refrigerated container, livestock car, etcetera. These futures contracts stipulate physical delivery.

This makes people think that a dump-truck will back up and deposit a pile of corn on their lawn if they are not careful. The reality is that you will have to pay a nuisance fee if you do not close out a long or short futures contract before the delivery date.

This is termed physical settlement.

Financial futures do not have physical assets. These are delivered in cash equivalent value.

This is termed cash settlement.

03:07

Futures Market Regulation

The futures market is regulated by the Commodity Futures Trading Committee (CFTC) overseeing …

  • Futures price change limits.
  • New contracts.
  • Daily trade record maintenance.

Futures trading taxes are paid at year-end on cumulative profits/losses regardless of whether position is closed. But taxes on futures are far less severe than those on Forex.

Sixty percent of your futures gains are treated as long term and taxed as such. The remain 40% is taxed at your highest marginal rate as short term gains.

With Forex 100% of your gains are taxed as short term at your highest marginal rate.

Futures Market Trading Strategies

Speculation is the purchase or sale of a futures or futures option contract with the risk of loss made in the hope of gain. You sell short if you believe the price will fall. You buy long if you believe price will rise.

Hedging is a trade intended to reduce risk from adverse price fluctuations in asset value. Futures contract are common hedging instruments.

  1. Long Hedge Example: A hedge fund must purchase stock in 3 months. The manager buys index futures with 3 month deliveries to protect against possible adverse share price increases.
  2. Short Hedging Example: A pension invests in long-term bonds. The manager is worried that a rise is coming in interest rates and sells 15-year Treasury futures.

Revenue Hedging with Futures Contracts Diagram

The sale of oil produces revenue that is depicted with the rising line. The profit on a futures contract is captured by the down-sloped line. The flat line is the unchanging sum of revenue and futures profits.

03:40

Basis and Hedging

Basis is the price difference between the quotes on a spot and a futures contract. Basis risk comes from erratic differences between the spot and the futures price. Basis risk arbitrage can be done by going long and short in the same futures contract in two different maturities.

Spot-Futures Parity Theorem

You could buy an underlying commodity like gold now and store it for a period of time. You could sell the futures contract at the same time. The total cost of buying and storing gold has to equal the futures price. If not arbitrage drives prices back into line. However, this does not always happen quickly since there are very real barriers to arbitrage.

Spot-Futures Arbitrage Strategy

Notice that these combined strategies conclude that the price for the futures contract has to equal the spot price for the underlying less the cost of carry. Do not take this result lightly. Markets are rarely out of alignment.

01:55

Another Arbitrage Proof of futures-spot Parity

Now I walk you through another arbitrage argument regarding futures-spot parity. Imagine you buy 100 ounces of physical gold. Then the alternative strategy B is that you go long the same quantity in a futures contract. The second step of this alternative is to invest the present value of the futures price in Treasury bills. This example shows that the futures price is the same as the spot price less the cost of carry.

The S&P 500 Monthly Dividend Yield

This chart of the monthly dividend yield of the S&P 500 hundred index remains in a narrow band throughout the year. This reflects the central tendency of dividends of 500 stocks in the aggregate.

January and April are associated with low dividend yields. May has high dividend yields. An S&P futures contract and stocks can be used for index arbitrage to gain on parity violations of stock-index futures contracts.

Gold Futures Prices

This is a chart of three futures contract that differ just in delivery date. You can see that futures prices are also determined by maturity. For a physical commodity such as gold the later deliveries garner higher prices under normal conditions. This is known as contango. Some markets are in backwardation. This is when the futures price is less than the spot price. These are good markets to seek out long entry. The equation shows that futures prices at different maturities should move together. The chart supports this.

02:48

Stock-Index Futures

Stock index futures are a form of financial futures. These are made on domestic and international equities that underlie each contract. Stock index futures have advantages over owning stock outright. Futures offer a way to control stock with lower transaction costs than outright stock purchase.

Plus a futures contract offers a way for investors to access leverage at a lower cost than an option.

Most of a stock’s movement is attributed to the index of which it is an element. Stock index futures allow traders to implement timing and allocation strategies with great ease as compared to transacting in actual stock.

This table of Stock Index Futures shows that the S&P 500 contract has the Standard and Poor’s 500 index as underlying assets. The contract size is $250 times the S&P 500 Index.

This futures contract trades across the Chicago Mercantile Exchange.

This is the most commonly traded contract among the indexes. But the table also lists specifications for the DJIA, NASDAQ 100, Russel 2000, Nikkei 225, FTSE 100, CAC 40, DAX 30, and the Hang Seng. Notice the wide variation in contract size. There are also many exchanges including the Chicago Board of Trade, Intercontinental Exchange, ICE Chicago Mercantile Exchange, London International Financial Futures Exchange (Euronext), Euronext Paris, Eurex, and the Hong Kong Exchange.

Correlations among Indexes are displayed in this table. The lowest correlation is between the NASDAQ and the NYSE at about 86%. This is a very high correlation that tells you that you only need to track one index contract. Some futures traders seek to profit from changes the spread between shorting [long] one index contract such as the NASDAQ while simultaneously buying [selling] the NYSE futures.

01:59

Creating Synthetic Stock Positions and Index Arbitrage

Financial futures such as stock index futures generate the payoffs of the underlying stocks that compose the index the contract is written on. But a futures contract is not a share of stock.

For this reason, futures contracts are considered a way to synthetically create stocks.

This allows for low cost investments in foreign stock markets through German DAX, English LSE, or Japanese NIKKEI futures. This is the primary tool for market timers.

Alternatively, a trader can maintain enough cash in treasury bills and trade the futures contract depending on index trend. A prior lecture explained that buying a futures contract and owning an equivalent amount in Treasury bills is akin to owning the stock.

The Basics of Index Arbitrage

Imagine that the S&P futures price is deemed to be too high as compared to the value of the underlying stocks composing the index. In this case an index arbitraging market timer will short the futures and buy 500 stocks in the S&P.

The idea is to take advantage of short term pricing gap that naturally occurs between the futures and stock.

The two rules of index arbitrage are simple but simultaneous in transaction.

  • Rule 1 — short futures and buy the underlying stocks when the futures price is too high.
  • Rule 2 — buy futures and sell the underlying stocks short when the futures price is below the market price of the index.

Index Arbitrage Program Trading in Practice

The reality is that simultaneity in index arbitrage is insanely hard to do in practice. It is so hard that it requires special programs written by teams of traders holding doctorates in finance and math. Even so many programs must be abandoned because transaction costs get in the way of profits. These programmed trading systems operate through computers in the SuperDot system that assists in rapid trade execution. Another important dimension in index trading is that exchange traded funds (ETFs) are available on indexes. Combining these with equity options allows you to move the leverage of index futures trading into a 401(k) or Roth IRA where it would be otherwise a prohibited transaction.

02:23

Currency and Financial Futures

Foreign currency contracts allowed small retail traders to access the exclusive inter-bank foreign exchange market in 1972. This capital market was more important before the introduction of the retail Forex brokerage. Today Forex clearing firms like FXCM increase in market dominance each year. The currency futures and retail Forex markets allow international banks to more effectively spread foreign exchange (Fx) risk. Fx risk is an unwanted by product of foreign trade for large Fortune 500 exporters and importers. These are most frequently used to hedge or cross-hedge large foreign exchange exposures.

Futures contracts are accessible for all major currencies and some of the most liquid cross-pairs at the main futures exchanges mentioned before such as the Chicago Mercantile Exchange (CME), the LIFFE, and so on. The most common future delivery dates are in March, June, September, and December.

Interest Rate Futures

Major contracts include contracts in the interest rate futures group are the,

  • Eurodollars
  • Treasury bills
  • Treasury notes
  • Treasury bonds

Some foreign interest rate contracts are out there but have poor liquidity. Short sellers of interest rate futures contract profit when interest rates rise. Those traders long lose in the same scenario but win in falling interest rate environments.

The Cross Hedge

Hedging with futures is difficult for many situations because there is no corresponding futures contract. This can sometimes be remedied by a cross-hedge. Here you hedge your cash investment with a futures contract in a different but closely related asset. Imagine that you retire and move all your money to corporate bonds. You are afraid that the FOMC will announce a rate hike next week. You can hedge your corporate bond portfolio by selling a selling Treasury-bond futures. You could also buy a Treasury-bond futures put. But that topic is discussed in detail in another course I teach on futures options.

01:36

The interest Rate Swap

Interest rate swaps are a big part of derivatives market. One corporation agrees to pay a variable and the other a fixed rate of interest. No principal is exchanged just profits or losses on delivery. The swap market is over $400 trillion in size.

Interest Rate Swap Diagram

Imagine a company [B] that is already paying 7.05% on corporate bonds issued in the past. They can pay this to a swap dealer and get paid the London Interbank Offer Rate [LIBOR] in return from another public corporation [B]. The swap dealer earns a spread of 0.1% of the notional principal.

Currency Swaps

Major world currencies are associated with different exchange rate corresponding to sovereign bond issuance. In a currency swap both parties swap the payments of principal and interest payments at a fixed exchange rate. Either corporation can borrow capital at the lowest interest rate swapping payments through the corporate home currency or any other as needed.

This constant activities creates greater precision in interest rate knowledge.

10 questions

The quiz seeks to measure your knowledge of the basics of futures markets.

Section 3: The Only Game in Town - Trading E-Mini Futures and Options to Hedge & Speculate!
04:10

The intent of this section is to explain the distinction between futures and options on indexes from those on single stock. Then you will discover how speculation differs from hedging as well as how options and futures are used as key tools. 

Recent research shows that options can foretell changes in the underlying stock price. You will master hedging portfolios by volatility with serious examples.  Mastery of trading E-mini futures contracts and options entails…

  • Stock Index Options and Futures
  • The Big Idea Behind Derivatives
  • Trading Futures on a Stock Index
  • Trading Options on a Stock Index
Using individual stock options is very time consuming for stock investors with more than 3 stock in their portfolios.  Most investors have many stocks in their portfolio that mimic positions in an index. Others simply own a lot of stocks. Either way these portfolios will rise and fall as the general stock market averages rise and fall.This created a lot of demand for derivative contracts in the form of contracts and options on either ETFs or indexed futures. The Value Line Index has been widely studied by academics. 
The Kansas City Board of Trade created a futures contract on the Value Line Index in 1982.
08:14

A derivative contract comes in three forms with regard to stocks.  Stocks are also known as equities.  
These are (1) the stock option contract, (2) the futures contract, and (3) the futures-option contract. 
Stock investors use single stock call options to extract the highest returns on individual equities. These same investors can hedge positions in indexed mutual funds with ETF options

 The reason these investments are called derivative contracts is because they are based (derived) on something else.  In this case that something else is the underlying S&P 500 index.  

Programmed trading is done by computers that are driven by a algorithm written by an institutional trader.  Buy and sell triggers initiate very large orders that are triggered by pre-planned conditions. 

Very large numbers of underlying shares can be controlled by an E-Mini contract or futures option. 

This table shows you how index futures are quoted in the financial press. You can see that the Mini S&P 500 Index (CME) contract for September delivery fluctuated throughout the day.  Notice that this is by far the most liquid contract based on the massive amount of contracts open (interest).  The December contract trades slightly lower on less open interest.  This quote displays the two front months.  

This table shows you how index futures contracts are priced using a multiplier.  Notice that the Mini S&P contract settled at a specific price.  The point multiplier is 50.  This means that the E-mini futures contract closed the month of September with a value of over fifty thousand dollars.

Notice that the full size contract trades at a value of over two hundred thousand.

05:24

Notice that the full size S&P 500 futures contract also trades at different prices spreads over different months.  The changes are similar for both September and December deliveries. 

This business is the simplest in the world.  When the stock market is rising you buy a futures contract or futures call option.  

  1. Buy when market is rising.  
  2. Sell a futures contract or buy a futures put option when the market falls.  

All futures contracts have …

  • Expiration (Delivery) Cycles
  • Margin Deposit and Maintenance
  • Settlement by Cash
  • Basis Price in Cash
07:49

The months in which a futures contract expires in a single year is called the trading cycle.  

The trading cycle for the E-Mini covers 4 months:

  • March expiration
  • June expiration
  • September expiration
  • December expiration

The 3rd Thursday of each month is the last trading day for the E-Mini. 

Index futures have specific initial and maintenance margins. These amounts are small for hedgers and day traders. That is because both hedging and getting out at the end of the day are less risky than holding the position for long periods of time.  

Here is the idea

If a hedge fund manager already has a large portfolio of stocks equal to the full size contract of about a half of a million dollars.  This is less risky than a dead broke investor without a dime in his or her pocket.  The exchange reduces the margin required in this case. 

Commodities are physical raw inputs for the food and manufacturing industry.  These allow for physical delivery if the trader desires.  

Index futures are cash settled.  The losing trader account is debited while the winner receives an offsetting credit entry in the nightly mark-to-market process.  

04:57

You may have noticed that later dated futures contracts usually trade for a little higher price.  As speculators trade physical commodity futures there are manufacturing firms buying factors from producers in the cash (spot) market. The difference between the futures and the cash price of the underlying asset is termed basis.Research started by associate professor of finance of U.C. Berkeley Victor Neiderhoffer and Zeckhauser first theorized that the futures contract responds faster to market conditions than does the actual underlying index.  This has been supported in recent empirical research. 

It turns out that the E-Mini is the most responsive of all of the futures indexes. For that reason, among others you should focus only on the trading the E-Mini.  

Here is an extremely unlikely example of basis in the E-Mini where the multiplier is 50… Stock index futures price  

• September: 2,020.10  

• December: 2,006.10 

Actual underlying index  

• September: 2020.10  

• December: 2010.00 

Basis          

• September: + 0.10    

• December:  - 3.90 

September trades at a premium over spot.  December trades at a discount to cash.   Basis fluctuates over time.  Premiums are predictive of bullishness and discounts are predictive of bearishness.   This table shows the specifications for each index futures contract.  Again, keep in mind that the E-Mini is the best across all parameters.  

06:23

Speculators are very different than hedgers.  A speculator pays close attention to market trend and does not deal or hold a portfolio in the underlying asset.  
The speculator rides on market moves like a surfer rides a wave.  Stock index futures offer speculators leverage that expands both the risk and the profit potential.  

Stock investors are able to take positions in:

  • Single equities
  • ETF index options
  • Stock index futures
  • Stock option index futures

There are a number of perks to trading stock index futures. 
You can moderate your leverage from as low as owning the stock outright to high amplification of buying and selling power from leverage. Leverage is also called gearing and it allows the investor to control over $100K worth of stock for just $4,950.00 of E-Mini maintenance margin.  That allows each $1 of stock to be controlled with a 25¢ deposit of maintenance margin
The E-Mini futures contract is much more efficient than trading deep-in-the-money calls and puts on an equivalent ETF such as the SPDR (SPY). This also allows you to avoid the systematic risk of the single stock market that offers the highest expected return when combined with deep-in-the-money calls on fast rising single momentum stocks.  

Hedging a defense tactic. An E-Mini futures contract is a near-perfect hedge to an underlying S&P 500 stock index fund. This allows me to sell the E-Mini futures contract when the VIX goes into the 30s and the market tanks. 

The parts of our portfolio that are in index funds will have losses offset by gains in the E-Mini contract. 


06:01

Here is an example of hedging

A family has a $2 million retirement portfolio sitting in an indexed mutual fund such as VFINX or SPY. The stock market breaks the 200-day average as the VIX shoots above 30.  The family member that stewards over the stock portfolio can scale into around 20 contracts short to offset losses on the $2 million retirement portfolio. Stops are trailed as each resistance level forms.  Here is the formula used to calculate the number of contracts needed to hedge the portfolio. 

The reason it is a good idea for E-Mini futures traders to focus on investing in indexed mutual funds is because the beta is 1.  This simplifies the formula in the last slide. Imagine that the E-mini is trading at 2,000.00.  Since the multiplier is 50 this contract is worth $100,000. Hence,
Hedge Position = $2,000,000 ÷ $100,000 = Short 20 E-Mini Contracts.
If the stock market drops by ten-percent, the portfolio will lose $2,000,000 × 10.0% = $20,000 
But the gain on the 10 E-Mini contracts is 10 × 2,000 × 10% = 2000 points × $10 per point = $20,000.  
The loss on the stock portfolio is perfectly covered by the gain on the short E-Mini position. 

There are other interesting hedges that use the E-Mini or full size S&P futures contract. These are used by…

  • Underwriters
  • Specialists (Dealers)
  • Retirement managers (Estate planners)
  • Tax reduction accountants
04:31

Arbitrage is a theoretical idea that a no-risk transaction can be done when the same asset trades at two different prices in the same market across two different exchanges due to pricing errors.  This concept has been heavily criticized due to limits to arbitrage.  Nonetheless institutional investors seek out arbitrage strategies constantly.  

Stock E-Mini index options allow investors to speculate or hedge against sudden market crashes.  These operate in much the same way as call and put options on single stocks.  But these are priced in points per options rather than 100 shares of underlying equity shares.  T
Futures index option buyers pay premium to sellers who create a put or call contract to consummate the transaction.  This new formation of a contract increases open interest by 1.  When the contract is closed out with a reversing order open interest in that contract month drops by 1. 
Equity index options and futures options are settled in cash.  This is different than with single stock options where the writer of the option may be forced to deliver shares to the option buyer. 
This table shows that October calls traded for 61.05 and while puts sold for 6.00.  The cost of the call is 61.05 × $10 = $610.50 in option premium.  This is the maximum loss for the call trader. 
The put trades for 6.00 × $10 = $60.00.  
Don’t write (sell) futures options. A study by Boyer and Vorkink in the Journal of Finance show that writers have negative expected gains (i.e. losses). Buyers have positive expected gains. Deep int he money call buyers have the highest expected gains of all when it comes to single stocks. However, at the money call options in futures offer the best trade off between cost and time to expiration.  

05:08

Imagine that the S&P 500 Index when October contract is expected to expire optimistically at one thousand, one hundred and sixty.  The value is this amount less one thousand and ninety or seventy.  

For the full size contract, the option value is seventy points times one hundred dollars per point or seven thousand dollars.
If the ending price is seventy points above the strike the cost is six thousand, one hundred and fifty dollars which is sixty-one point five times a hundred dollars per point. The profit is seven thousand minus six thousand, one hundred and fifty dollars or eight hundred and fifty dollars. 
This example ignores commissions
This table summarizes the transactions I just described.  An eight hundred and fifty dollar gain occurs under optimistic outcomes.  A total loss of six thousand one hundred and fifty is obtained under pessimistic scenarios. 
This table shows that the loss on the put option is sixty dollars under pessimistic conditions. A gain of six thousand four hundred is created under optimistic outcomes.  

06:02

Tax avoiders, underwriters, dealers and specialist will all discover that futures are more efficient investments and hedge instruments than futures options. 

As I mentioned before investors can lever with stock index futures, stock index ETF options, and options on stock index futures.  Stock index options give the buyer the right to purchase (sell) the index futures contract in the case of a call (put) for a set period of time. 
An option on stock index futures gives the holder the right to purchase the stock index futures contract at a specified price over a given period.
This diagram compares options on stock index futures as compared to stock indexes. 

Time premium is an additional amount that option buyers how to pay to options sellers for longer expiration options. There is also a discount for contango (backwardated) markets where the longer (far-term) dated futures trade below cash. 
Futures options are settled in cash.  If a futures E-Mini call or put buyer exercises his or her option, the writer has to deliver the underlying contract. 

10 questions

Work through each question.  Study over and reflect deeply on questions you miss to strengthen those areas. 

Section 4: Futures Option Insights Commodity Newsletter – For Serious Options Traders!
[NEW] 2016 August 25 Commodity Option Insights: Crude Oil Futures!
02:19
05:11

PREMIUM CONTENT by Dr. Scott Brown, May 3, 2016, 5:39 PM

SAN JUAN, May 3, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Tuesday in live video market update. I am out testing possible bullishness in the crude oil corn.

· Oil, Light Crude (OCLM6) C41.5 for $1,990.  Max Loss = ½ Und I Margin =$1,870.

· Corn (OZCN) C3.85 for $906.25.  Max Loss = ½ Und I Margin =$453.

The trick is to keep your premium cost below 50% of initial margin. Watch new video update. –Doc Brown

06:09

PREMIUM CONTENT by Dr. Scott Brown, April 26, 2016, 2:25 PM

SAN JUAN, April 26, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I am out testing possible bullishness in the crude oil market cash.

· Oil, Light Crude (OCLM6) C41.5 for $1,990.  Max Loss = ½ Und I Margin =$1,870.

· Corn (OZCN) C3.85 for $906.25.  Max Loss = ½ Und I Margin =$453.

Testing a corn and oil call. Watch new video update. –Doc Brown

06:04

PREMIUM CONTENT by Dr. Scott Brown, April 18, 2016, 5:23 PM

SAN JUAN, April 18, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I am out testing possible bullishness in the crude oil market cash.

· Oil, Light Crude (OCLM6) C41.5 for $1,990.  Max Acceptable Loss = ½ Und I Margin =$1,870.

As you can see the cost of the option was just $20 more than half of initial margin of $3,740 ($1,870). This form of money management that relates the positon cost to the initial margin is the most effective especially when combined with stops. 

Study new video update. –Doc Brown

04:26

PREMIUM CONTENT by Dr. Scott Brown, April 10, 2016, 12:47 PM

SAN JUAN, April 10, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Sunday in live video market update. I am out to cash.

· Out to Cash

Study new video update. –Doc Brown

06:04

PREMIUM CONTENT by Dr. Scott Brown, April Fourth, 2016, Eight Twenty-Five PM

SAN JUAN, April 4, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I am off $175 on this position.

·         Long 1 S&P E-Mini 1935 Call (OESJ6) C2040 | Paid ($) = $1,312.50 | V =$3,500 | IMU = $5,225 | Exp. 11 Days

Study new video update. –Doc Brown

03:36

PREMIUM CONTENT by Dr. Scott Brown, March 28, 2016, 12:52:00 EDT

SAN JUAN, March 28, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I will report results on a position basis.

·         Long 1 S&P E-Mini 1935 Call (OESJ6) C2040 | Paid ($) = $1,312.50 | V =$3,500 | IMU = $5,225 | Exp. 25 Days

Study video update. –Doc Brown

06:17

PREMIUM CONTENT by Dr. Scott Brown, March 21, 2016, 11:46:00 EDT

SAN JUAN, March 21, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I will report results on a position basis.

My $2,062.50 call is worth $4,962.50. There are just 10 days left to expiration.

The position must be closed for profit or rolled forward to a later expiration date.

[Current Positions]

  • Long 1 S&P E-Mini 1935 Call (OEWH6) C1935 | Paid ($) = $2,062.50 | V =$3,500 | IMU = $5,225 | Exp. 10 Days

Rolling to …

  • Long 1 S&P E-Mini 1935 Call (OESJ6) C2040 | Paid ($) = $2,062.50 | V =$3,500 | IMU = $5,225 | Exp. 25 Days

Study video update. –Doc Brown

05:23

PREMIUM CONTENT by Dr. Scott Brown, March 14, 2016, 16:40:00 EDT

SAN JUAN, March 14, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I will report results on a position basis.

My $2,062.50 call is worth $3,445. Time decay is accelerating.

I have to take a profit or roll forward sometime soon.

[Current Positions]

  • Long 1 S&P E-Mini 1935 Call (OEWH6) | Paid ($) = $2,062.50 | V =$3,500 | IMU = $5,225 | Exp. 17 Days

Watch video update. –Doc Brown

03:24

PREMIUM CONTENT by Dr. Scott Brown, March 7, 2016, 12:40:00 EDT

SAN JUAN, March 7, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I will report results on a position basis.

I am currently up 69.70% on my first SP E-mini at the money call trade in the account. This is so because I paid $2,062.50 for a call that is now worth $3,500.

[Current Positions]

  • Long 1 S&P E-Mini 1935 Call (OEWH6) | Paid ($) = $2,062.50 | V =$3,500 | PL = $1,437.50 | Exp. 24 Days

Watch video update. –Doc Brown

08:51

PREMIUM CONTENT by Dr. Scott Brown, February 29, 2016, 10:48:00 EDT

SAN JUAN, February 29, 2016 (UDEMY) – Dr. Brown reports commodity option futures trading results for this Monday in live video market update. I will report results on a position basis.

[Current Positions]

  • Long 1 S&P E-Mini 1935 Call (OEWH6) | Paid ($) = $2,062.50 | V =$2,062.50 | PL = $0.00 | Exp. 30 Days

Watch update. –Doc Brown

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Instructor Biography

Dr. Scott Brown, Major State University Finance Professor, Investments Expert

"There is no one like you that I know of who is this transparent, that is what makes your service and education so valuable. Please keep on." -L.B. A Washington State Stock Investor

Dr. Scott Brown and “Intelligent Investing” — helping you get the most out of your hard earned investment capital.

As an investor, I have spent over 35 years reading anecdotal accounts of the greatest investors and traders in history. My net worth has grown dramatically by applying the distilled wisdom of past giants.

I have researched and tested what works in the world’s most challenging capital markets — and I teach you every trick I know in my Udemy courses!

>>>Learn from leading financial experts!

>>> How about discovering how I have tripled family member’s accounts in six years with simple stock picks?

>>> Want to master set and forget limit stop loss tactics for sound sleep?

>>> Does Forexinterest you?

>>>Is your employer sponsored 401(k) plan optimized?

>>>Do you know the fastest rising highest dividend yielding common stock shares in the market today?

>>> High roller? How would you like to know how to dramatically lever your savings with deep-in-the-money call options?

Enrollin my Udemy courses — you can prosper from all of this — plus much, much more now!

(In the last six years we have exploded our net worth and are absolutely debt free, we live a semi-retired Caribbeanlifestyle in atriple gatedupscale planned community from a spacious low maintenance condo looking down on our tropical beach paradise below).

My Curriculum Vitae:

Investment Writing and Speaking:

I am an internationalspeaker oninvestments. In 2010 I gave a series of lectures onboard Brilliance of the Seas as a guest speaker on their Mediterranean cruise. Financial topics are normally forbidden for cruise speakers. But with me they make an exception because of my financial pedigree.

On day 6 the topic I discussed was “Free and Clear: Secrets of Safely Investing in Real Estate!“ The day 7 topic was “Investment Style and Category: How the Stock Market Really Works!” Then on day 8 I spoke about “The 20% Solution: How to Survive and Thrive Financially in any Market!” The final talk on day 11 was “Value Investing for Dummies: When Dumb Money is Smart!

Gina Verteouris is the Cruise Programs Administrator of the Brilliance of the Seas of Royal Caribbean Cruise Lines. Regarding my on-board teachings she writes on June 19th, “You have really gone above and beyond expectations with your lectures and we have received many positive comments from our Guests.”

I sponsored and organized an investing conference at Caesars Palace in Las Vegas in 2011 under my Wallet Doctor brand. This intimate conference was attended by 14 paying attendees.

As such many strides were made in financial education that week. For instance I met a woman who is a retired engineer from the Reno, Nevada area.

She made a fortune on deep in the money calls during the bull markets of the 90s.

This humble and retired engineer inspired me to look more seriously at deep in the money calls with far expiration. She also gave me an important clue regarding trading volume.

Her call option and volume insights have been confirmed in the Journal of Finance.

In 2012 I gave a workshop at the FreedomFest Global Financial Summit on stock investing at the Atlantis Bahamas Resort. I was also a panelist on a discussion of capital markets.

My course “How to Build a Million Dollar Portfolio from Scratch" at the Oxford Club is an international bestseller. In 2014 I co-authored “Tax Advantaged Wealth” with leading IRS expert Jack Cohen, CPA. This was the crown jewel of the Oxford Club Wealth Survival Summit.

I have been a regular speaker at the Investment U Conferences.

In 2012 I gave a workshop entitled “How to Increase Oxford Club Newsletter Returns by 10 Fold!” The conference was held at the Grand Del Mar Resort in San Diego, California. This resort destination is rated #1 on TripAdvisor.

In 2013 I spoke at the Oxford Club’s Investment U Conference in San Diego California. The talk was entitled “The Best Buy Signal in 103 Years!” Later in the summer I spoke at the Oxford Club Private Wealth Conference at the Ojai Valley Inn.

This was at the same time that Jimmy Kimmel married Molly McNearney in the posh California celebrity resort. It was fun to watch some of the celebrities who lingered.

I also operate a live weekly investment mentorship subscription service under the Bullet-Proof brand every Monday night by GoToWebinar.

Academic Research:

I am an associate professor of finance of the AACSB Accredited Graduate School of Business at the University of Puerto Rico. My research appears in some of the most prestigious academic journals in the field of investments including the Journal of Financial Research and Financial Management. This work is highly regarded on both Main Street and Wall Street. My research on investment newsletter returns was considered so important to investors that it was featured in the CFA Digest.

The Certified Financial Analyst (CFA)is the most prestigious practitioner credential in investments on Wall Street.

Prestigious finance professor Bill Christie of the Owen School of Business of Vanderbilt University and then editor of Financial Management felt that our study was valuable to financial society. We showed that the average investment newsletter is not worth the cost of subscription.

I am the lead researcher on the Puerto Rico Act 20 and 22 job impact study. This was signed between DDEC secretary Alberto Bacó and Chancellor Severino of the University of Puerto Rico.

(See Brown, S., Cao-Alvira, J. & Powers, E. (2013). Do Investment Newsletters Move Markets? Financial Management, Vol. XXXXII, (2), 315-338. And see Brown, S., Powers, E., & Koch, T. (2009). Slippage and the Choice of Market or Limit orders in Futures Trading. Journal of Financial Research, Vol. XXXII (3), 305-309)

Graduate Degrees:

I hold a Ph.D. in Finance from the AACSB Accredited Darla Moore School of Business of the University of South Carolina. My dissertation on futures market slippage was sponsored by The Chicago Board of Trade. Eric Powers, Tim Koch, and Glenn Harrison composed my dissertation committee. Professor Powers holds his Ph.D. in finance from the Sloan School of Business at the Massachusetts Institute of Technology [MIT]. Eric is a leading researcher in corporate finance and is a thought leader in spin offs and carve outs.

Dr. Harrison is the C.V. Starr economics professor at the J. Mack Robinson School of Business at Georgia State University.

He holds his doctorate in economics from the University of California at Los Angeles. Glenn is a thought leader in experimental economics and is the director of the Center for the Economic Analysis of Risk.

Tim Koch is a professor of banking. Dr. Koch holds his Ph.D. in finance from Purdue University and is a major influence in the industry.

My dissertation proved that under normal conditions traders and investors are better off entering on market while protectingwith stop limit orders. The subsequent article was published in the prestigious Journal of Financial Research now domiciled at Texas Tech University — a leading research institution.

I earned a masters in international financial management from the Thunderbird American Graduate School of International Business. Thunderbird consistently ranks as the #1 international business school in the U.S. News & World Report, and BloombergBusinessWeek.

Academic Conferences:

I spoke at the 2010 annual conference of the International Association of Business and Economics (IABE) conference in Las Vegas, Nevada. The research presented facts regarding price changes as orders flow increases in the stock market by advisory services.

I spoke at the 2010 Financial Management Association [FMA] annual conference in New York on investment newsletters. The paper was later published in the prestigious journal “Financial Management.”

I presented an important study named “Do Investment Newsletters Move Markets?” at the XLVI Annual Meeting of the Consejo Latinoamericano de Escuelas de Administración (CLADEA) in 2011 in San Juan, Puerto Rico. The year before that I presented my futures slippage research at a major renewable energy conference in Ubatuba, Brazil.

I spoke at the Clute International Conferences in 2011 in Las Vegas, Nevada. The research dealt with the price impact of newsletter recommendations in the stock market.

I presented a working paper entitled “The Life Cycle of Make-whole Call Provisions” at the 2013 Annual Meeting of the Southern Finance Association in Fajardo, Puerto Rico in session B.2 Debt Issues chaired by Professor LeRoy D. Brooks of John Carroll University. Luis Garcia-Feijoo of Florida Atlantic University was the discussant. I chaired the session entitled “Credit And Default Risk: Origins And Resolution.” Then I was the discussant for research entitled "NPL Resolution: Bank-Level Evidence From A Low Income Country" by finance professor Lucy Chernykh of Clemson University and Abu S Amin of Sacred Heart University and Mahmood Osman Imam of the University of Dhaka in Bangladesh.

That same year I presented the same study to the Annual Meeting of the Financial Management Association in Chicago, Illinois. I did so in session 183 – Topics in Mergers and Acquisitions chaired by James Conover of the University of North Texas with Teresa Conover as discussant. I chaired session 075 – Financial Crisis: Bank Debt Issuance and Fund Allocation. Then I was the discussant for TARP Funds Distribution: Evidence from Bank Internal Capital Markets by Elisabeta Pana of Illinois Wesleyan University and Tarun Mukherjee of the University of New Orleans.

Academic Service:

I am a member of the MBA Curriculum Review Committee, the MBA Admissions Committee, The Doctoral Finance Admissions Committee, the Graduate School Personnel Committee, and the Doctoral Program Committee of the School of Business of the University of Puerto Rico.

Financial Journalism:

I am the editor of Momentum Investor Magazine. I co-founded the magazine with publisher Daniel Hall, J.D. We have published three issues so far. Momentum Investor Magazine allows me to interview very important people in the finance industry. I interview sub director Suarez of the DDEC responsible for the assignment of Puerto Rico act 20 and 22 licenses for corporate and portfolio tax reduction in the third edition. Then I interview renowned value investor Mohnish Prabia in the upcoming fourth edition — to be made available via Udemy. Valuable stock market information will be taught throughout.

Charity:

In October of 2010 I arranged for the donation to The Graduate School of Business of the University of Puerto Rico of $67,248 worth of financial software to the department that has been used in different courses. This was graciously awarded by Gecko Software.

I have guided thousands of investors to superior returns. I very much look forward to mentoring you as to managing your investments to your optima! –Scott

Dr. Scott Brown, Associate Professor of Finance of the AACSB Accredited Graduate School of Business of the University of Puerto Rico.

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