Filling Out the Deposit Slip—Preconditions for the Endplay

So much for negativity. The preconditions for a good endplay trade are remarkably straightforward and easily met, and here they are:

1. Option expiration must be no more than two day sessions away when we write the options, whether using the one-sided approach or the strangle, and the less time remaining, the better for us.

2. The IVs of the nearby options in this market must be high. If the market has natively very high absolute volatility (natural gas, coffee, etc.), we still prefer that the present IV be in the upper half of its 6-month range.If the market has only middling-highish native volatility (cocoa, soybeans, crude oil, etc.), we insist that the IVs be near the top end of their 6-month range.

3. In the strangle approach to endplays, ROC net of costs should be at least 3% of double the initial SPAN margin requirement. In the onesided approach, net ROC should be at least 2% of double initial SPAN requirement.

4. If the market can be strongly affected by overnight weather developments, and one or more such developments are even possible in the next 2–3 days, do not use the endplay strategy at this time in this market. This strategy is completely dependent on our being very confident that there exists a short-term news/event vacuum in our selected market.

5. If there is any supply/demand news pending in a market in the next 2–3 days, or better still 4–5 days, do not use the endplay strategy. The endplay strategy works best when the trade is entered a day or two after a scheduled supply/demand report or other significant information has reached the market, and the news/event vacuum is now present.

6. Don’t be greedy. Attempting to make 8–10% or more, while possible,gives away the structural advantage of the trade. Select the strike(s) of the endplay as far away from the current market as possible, consistent with the goals for ROC.

Condition 1 is part of the definition of the strategy. Don’t adapt it by extending the trade to three or four days, because more time until expiration means more possibility of external events intruding on the trade. Condition 2 is likewise vital, particularly for the strangle approach. If option IVs are low, strangle-style endplays will need to be defended much more often than we’d like, which defeats the purpose of the trade. Sure, we’ll defend if necessary,
but, once again, we do not want to seek out trades that we are more likely to have to defend.

Lower IVs are acceptable in the one-sided approach,as long as you’ve a reasonable measure of confidence that your view of the market’s direction over a day or two isn’t considerably off the mark. Use non-seasonal reasoning here: you don’t need to be right to make a profit,merely not significantly wrong.Conditions 3 is included because a considerable number of traders consider a 2–3% return on a trade to be not worth their while.

Two or three per cent over a year? I agree completely. But, 2 or 3 per cent over 1 or 2 days?How greedy are these traders, anyway? If we were able to find enough trades yielding 2% over 2 days, consecutively throughout a year’s time, we’d be staring at a 1,161% total ROC at the end of the year. Maybe I’m missing something here, but that’s certainly enough for me. Condition 6 applies here, too.

As in other option writing strategies, keep the strikes of the written options as far from the current market price as feasible, the more so given the modest ROC requirement.Condition 4 is somewhat amorphous, but still easily implemented.For example, the natural gas market is notoriously affected by certain weather conditions—an extended nationwide heat wave in the summer,prolonged cold as we saw in the winter of 2000–2001, or the advent of a hurricane near the production areas in the Gulf of Mexico.

If any of these exist,or might come to exist within 48 hours, don’t enter an endplay trade. If they don’t, then go ahead. Condition 5 is really the key to this strategy. In an endplay, the occurrence of new news is either outright evil, in the straddle approach, or halfway risky, in the one-sided approach. The less likely that new information will appear in the marketplace over the 1–2-day term of the trade, the more likely the trade is to succeed.

Markets that have regularly scheduled weekly or monthly releases of supply/demand data are considerably more likely than other markets to be good candidates for endplays. This is why the NYMEX energy markets tend to offer more opportunities to apply this strategy.

For crude oil, heating oil,and gasoline, the major weekly reports and their times of release are wellknown and, even more importantly, well trusted by the market participants.By mid-morning every Wednesday, the market has digested the weekly API and DOE supply/demand figures, and if the current month options expire on that Thursday or Friday, we have the potential for a good endplay trade.

Fun and Games in the Big Apple—When Is the Trade Over?

This brings us to the energy markets, which undoubtedly offer us more opportunities for endplay trades than any other class of market. However, we must be even more alert than usual when attempting an endplay in these markets, because the rules of the New York Mercantile Exchange are a little bit odd regarding option expiration. … Continue reading

Never Take Your Eye Off the, Er, Bull

The various shades of defense are not particularly important of themselves;we apply defense as necessary. What is important is that we keep our eye on the bull. Whether in El Toro Grande or toro poco, one premise of the trade is that the bull market, great or small, will not resume violently. If the premise … Continue reading

Toro Poco—More Frequent, Less Volatile

Another factor that limits the usefulness of El Toro Grande is that opportunities to implement it are rare.We absolutely must witness the occurrence of a runaway bull market before we can use it, and these come along, what,once every 3 or 4 years or so.Recently, we’ve had the 2000–2001 natural gas market, the 1995 grain … Continue reading

El Toro Grande—Runaway Parabolic Markets

In physical futures markets every so often, supply, demand, and market sentiment among the participants become so unbalanced that prices becomebid to amazing levels. Usually, the bull move in such markets begins when the market participants realize the possibility of a supply shortage in future.Developments unfold and supply problems do begin to emerge, prompting users … Continue reading

Suitability—Round Up the Suspects

The inflation of options’ IVs can theoretically occur in any market, from azuki beans to wheat, and probably in stamps, baseball cards, and Ming porcelain,too, but not all markets offer opportunities for Martian ratio-spreads.In some markets, call premiums can become wildly out of line relative to that market, but still not reach the quite high … Continue reading

Setting Up the Advantage—Selecting Strikes

A ratio-spread involves selecting two different call option strikes in the same month of expiration. Selecting the lower strike first is pretty much an art form, and it’s more than a little dicey. In the best of all possible ratiospreads, we’d love to see the market move up to or somewhat above the lower strike … Continue reading

Spreading with an Attitude—The Ratio-Spread

A ratio-spread is a trade in which we purchase a call option and write some number of higher-strike call options against it. In a traditional ratio-spread,we buy an ATM or slightly OOM option, and we write two higher-strike OOM options of the same expiration against it, with the written options typically having too high an … Continue reading

How Can the Market Beat Us? Never Say Never, but . . .

Once we’ve selected a disciplined entry point and begun riding the bear, the only threats to our profitability are human error or a new spike low in the market. Given our preconditions, there is only one generic occurrence that might generate enough selling to produce such a spike. Such occurrences are historically extremely unlikely, and … Continue reading

Profit Each Month-or Walk Out on the Bill

What we really would like to do when we ride the bear is to stay right on his back, to turn a profit for several months in succession while a market puts in an extended bottom. Suppose we’d be required by the lack of liquidity or the complete non-existence of the next month’s options to … Continue reading