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Options on Currency ETF’s

The Options Hunter Blog — Fri, 25 Nov 2011 17:44:05 GMT

It can hardly have escaped notice that after the Global Financial Crisis, one of the unifying themes that have connected the financial markets of the world is the currency markets. Since 2008, currency markets have expressed their disapproval of a credit crisis, they have expressed vehement disapproval of governments, and they have pointed to the profound challenges the global economy has to overcome in order to recover to a healthy balance.

As is often the case, the currency markets are no less exclusive than other financial markets. Currency markets are particularly exclusive as they operate within tiers defined by the capacity of market participants. So dynamic and erratic are currency fluctuations that volume trades with volume; large traders only deal with others of similar size – there simply isn’t time to consider multiple smaller parcels. This volatile market has now become a refuge for the small investor who simply can’t compete in the tiered international currency market.

Exchange Traded Funds (ETFs) are funds that invest in particular assets. Currency ETFs invest in certain currencies. With risk attributed to a particular currency, as the value of the currency fluctuates, so does the value of the fund. For private investors with smaller amounts of risk capital to that of international participants, currency ETFs offer a viable and accessible trading opportunity.

In pure currency trading in international markets, the cost of holding a particular currency is measured by the opportunity loss of holding another currency. In this manner a bullish view in one currency can be expressed by purchasing that currency or alternatively divesting oneself of investment in the currency that is strongly aligned against, such as that of a major trading partner. Due to the fact that currency ETFs offer an isolated investment in one currency, currency ETFs themselves, and options on currency ETF’s can be a useful hedge against an open market currency position.

Currency markets operate on a plethora of variables not the least of which are political, fundamental and technical. Numerous strategies are employed to exploit value in currency markets but given the liquidity, depth and maturity of the market, pure arbitrage is rarely possible due to market efficiency. Still, currencies offer other types of theoretical edge for the astute trader, and interest rate swaps, future and options in various currency denominations can provide value trading opportunities that exploit economic fundamentals, political climates and technical indicators. The currency ETF option market, even more so than that its underlying ETF currency allows flexibility and leverage to the trader that simply desires to capture value in broader currency asset strategies.

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The Options Hunter Blog — Mon, 12 Sep 2011 20:00:46 GMT

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Staying Protected While Trading Options

The Options Hunter Blog — Tue, 14 Jun 2011 20:41:06 GMT

Risk is a subject one can devote a lifetime to inquire about, and options trading will certainly make up part of that study. Concomitant to survival as an option trader, one needs to be au fait with a number of threats that lay waiting to trap the novice or unwary. Given that survival in order to continue trading is every trader’s paramount objective, the containment of addressable threats is only neglected by the foolish.

Basic option theory reveals that risk is limited when buying options, and unlimited when selling them. The fact that volatility is traded and option positions are hedged does not relieve a trader of this simple fact. Selling options is risky in any language.

Due to this fact, amid the numerous trading opportunities that present themselves around the option markets of the world, those that represent the most value will invariably involve the person benefitting from that value to be selling options. This of course may be in the context of an intricate strategy involving many strikes and types of options, or it can simply be in the form of excessive value being sacrificed by a buyer in order to initiate a position.

The unreflective trader will be presented with this opportunity, and quite understandably react with glee. However, after the value is gratefully accepted, the trader must now convert it into profit. Of course, this can be accomplished by managing the trade, closing it out, or by offsetting the trade through transacting other options.

Still, as the greatest value involves selling options, in the event of additional value opportunities entering the market, that trader will be unable to take advantage of it; they are already fat with risk from previously selling options. In the further event of a large move, the trader may well jeopardize the main objective – survival to continue trading.

In order to avoid this sad turn of events, it will be prudent to affect some insurance beforehand. Bearing in mind that insurance, just like options, comes at a price, the most prudent of insurance will come in the purchase of out of the money protection. Ideally this will be merely a few points for each option, and can be executed efficiently as a combined strangle strategy by purchasing an out of the money put and an out of the money call together at a combined price.

Again, this strategy necessarily means paying away some value in order to be protected, but it will remain an asset that the trader can rely on until expiry. In the meantime the trader will be able to concentrate on trading closer to the money strike prices with larger premiums and greater opportunity for profit. The out of the money options that are acquired will quickly erode to be worthless, but their presence in the portfolio will provide a latent value that only the discerning will appreciate. Trading of at the money options will quickly replenish the insurance expense incurred.

At this point, such a trader is free to exploit the real value in option trading that makes its self apparent. They can participate with confidence as they are protected on either side of the market. In many ways option trading is a constant struggle to emulate one very large and cumbersome butterfly.

EFT Options – Why Would You Sell Puts?

The Options Hunter Blog — Mon, 23 May 2011 23:01:00 GMT

Certainly taken with a view to either purchasing the underlying in the foreseeable future, or conversely with a view to the underlying trading in a range tending slightly toward the upside, the practice of selling puts is not as outrageous as it may at first appear.

If indeed the underlying is going to be acquired, if the market falls the options may be exercised and therefore contrive what was envisaged in the first place – ownership of the underlying. However in this situation the price of ownership has reduced somewhat, and the premium received from the sold options will also offset the purchasing expense.

On the upside, the premium will again be retained and serve to compensate against the now higher price to be paid. Alternatively, the underlying need not be purchased at all; the premium may simply be retained as profit.

When the market is expected to trade within a range for some time, the practice of selling puts will prove to be lucrative should this indeed be the case. Time value will erode to the benefit of the seller.

Time value reflecting volatility will be a component in the option price, and so be captured once the transaction is affected. Apart from the fact that markets rise slowly, the fact that they indeed appear to display disturbing momentum when they tumble, is in this scenario used to the advantage of the seller.

Fully aware of the tendency to higher volatility on the downside, equity option markets will invariably adopt a skew that will extend across all strike prices reaching higher volatility as the strike price is lower. This necessarily means that the seller of at-the-money or out-of-the-money puts will receive statistically higher premiums than a normal bell curve of probability will produce. If prices are achieved that are even higher than what the skewed model reveals, then an even greater mathematical advantage accrues in favor of the seller. Considering the historical appreciation that equity markets enjoy by virtue of inflation, enormous theoretical edge is found in the selling of puts.

While synthetic puts are able to be replicated with covered calls at a par ratio, the volatility reflected in the premium received for sold calls is far less attractive, and so a higher annualized return is possible through selling puts. One consideration that may erode this advantage to some extent is the possibility of dividends accruing through underlying ownership of stock in a buy write strategy. Balanced against the interest expense of purchasing stock, dividends may at times make the covered call the more advantageous strategy.

Additional thought ought to be given to the funding costs of sold puts against that of the covered call. Particularly with the increase in policy and regulation by clearers, the cost of holding uncovered positions will increase exponentially.

Intricacies of Option Spread Trading

The Options Hunter Blog — Tue, 10 May 2011 19:42:00 GMT

Spread trading with options may appear fairly straight forward; even rather attractive due to its risk aversion properties however, as often the case with serious investment; not all is as it seems.

Options like any capital asset are valued according to their future returns, or more precisely, the probability of future returns. According to market perception the forces of demand and supply will manipulate the price of an option, regardless of what a mathematical pricing model suggests.

In this event, the concept of a linear benchmark for annualized option volatility is found to be sorely wanting. Similar to other capital investments whose future earnings are diluted by an increased likelihood of lower spending power, option prices will ultimately be at the mercy of market forces who at times may value the likelihood of returns to be quite at odds with linear projections.

Of course the experience of human nature is of invaluable assistance in this scenario. Many markets behave in precisely the same fashion each time they undergo a uniform shift of similar variety. It is in this observation that spread trading can be maximized to exact value. As markets rise, volatility often plummets as assets are often far slower to appreciate in value than depreciate. This observation would dictate a spread that leaves the trader with a short volatility position as the market rises. Conversely, markets fall with gusto and so remaining long volatility in anticipation of a downward shift will leave a portfolio long when the market retraces and volatility rises without exception. In these sorts of environments, traders need to apply the above strategy to spread trading around the money. The greater the distance between the strike prices, the greater a skew will develop in the market to reflect various volatility differences between strikes. Mathematically, the skew is irrational as often the trader will pay a higher volatility for the long leg of the spread than receiving for the short leg. However, in reality the trader will profit as mathematics is merely art, whereas market fluctuations and human responses are life. With option volatility, art does not replicate life.

When strike prices are come closer together in spread trading, the skew necessarily needs to reduce; proximity breeds familiarity with options, and so care must be taken to avoid excessive zeal in applying a skew principle. Particularly as the strike prices in a spread strategy approach the at-the-money strike, care ought to be taken to incorporate the volatility consequences of the strategy along with future market inevitabilities.

Weekly Options - Shamefully Cheap Premiums

The Options Hunter Blog — Wed, 20 Apr 2011 15:59:00 GMT

Weekly options are offering many traders the opportunity to hedge with even more precision. It offers what is typically no more than that of an option with one week to expiry, but if strike prices are thoughtfully available, the concept of weekly options may serve to be more than a mere I week option; it could attract considerable volume from other option markets and even expand net open interest.

Having said this, weekly options by virtue of their brevity, are likely to be the riskiest options available. While premiums are often what newcomers to the option markets find alluring, the slight premium of a weekly option can be elusive.

Again, a weekly option is no different from a 3 month option, a 6 month option, or any other option of longer maturity. Its mechanics are the same, and indistinguishable when entering the last week to expiry. Given this mathematical relationship, arbitrage opportunities may arise if administrative costs will allow.

For the buyer of options, the last week to expiry has traditionally been the best value. Premiums are shamefully cheap, and often the underlying market will move sufficiently to hedge with gusto. Here, the mathematical model indicates considerable vulnerability, for an annualized volatility is the farthest aspect of reality when an option has one week to expire.

With such a short life span, the gamma of an option will experience profound change on many occasions within one trading day. This of itself will reveal that volatility is invariably found to be too low when an option has one week to expire.

When volatility is increased within the model, the Vega (the premium change for a 1% increase in volatility) will be modest. Volatility will need to be increased dramatically to affect a change of any real magnitude. Of course the delta output from the pricing model will also be altered but similarly, will fail to reflect the precision required for hedging numerous times during one trading day.

For these reasons, many traditional grantors of options will seek to be reverse positions to a relatively flat position in the spot contract about to expire, directing their attention to the following delivery period. Buyers may well experience windfalls due to the dual advantage of short expiry and a vulnerability in the pricing mechanism, but sellers are in direct line for disaster unless sufficient premium is received; but for an option precisely at-the-money, this is rarely the case.

Of course the reason for market volatility in the last week of a contracts life is a moot point. Each moment in the market has reason of its own, but occasionally certain events can trigger an unusual abandonment of one contract in the lead up to expiry, with the entire market focusing its attention elsewhere.

When the tick value of a contract is experiencing transition for example, or if margin requirements have escalated overnight, traders will seek to close out positions and trade an alternative contract. With one week to expiry, the spot option is now a veritable ghost town which may provide some trading opportunities as spreads can widen, and premium can increase sufficiently to satisfy a seller’s criteria.

A Weekly Option Trading Strategy

The Options Hunter Blog — Mon, 04 Apr 2011 16:05:00 GMT

If you are trading weekly options it will behoove the novice to buy options prior to selling. Without adopting this practice, the sheer weight of gamma will crush the investments of one and all under the most modest of underlying market movements. Short-dated options are exciting, but only for the wary.

Ideally, one ought to wait until value presents itself in an offer. Here acquiring a long position will buffer against the urge to sell weekly options. Of course some traders invest in options with a view to market direction, in which case capturing time premium is not imperative. Even these types of directional traders will benefit from exploiting the pricing model by purchasing options to reflect their market view, rather than selling them in the alternative. With the latter investment offering limited benefit from a successful prediction of market direction, the shortcoming s of the pricing model and also reason dictate that the value and even the most modest of anticipated returns will result in a far more astute investment. Returns on investment vary considerably in modern commercial climates, and those that are imbued with the risk of the financial markets demand a commensurate return. Anything less is foolhardiness.

Of course even the most diligent and conservative of investors will need to remain keenly aware when trading weekly options. Essentially all capital investment is the trading of future returns and so to succeed in the pursuit of trading weekly options, all the ramifications need to be understood well.

Despite the trader investing in long options positions before selling, one’s position can change dramatically as the underlying instrument changes course, and a position that was once long volatility will all of a sudden become short volatility. Essentially, as the market moves away from the area where a trader is long options, profits will accrue when time value has been captured through the device of a hedge in the underlying instrument. These profits however, also have a delta and gamma (or rate of change of profit and rate of change of change of profit). This being the case, the profits accrued from a long position will begin to be offset at an increasing rate, the further away the underlying market gets from the long strike price, and the closer it gets to the short strike price.

To prevent this unfortunate turn of events, the wise will ensure that a ratio favoring the long side will be employed to their trading of weekly options. When this is the case, a residue of long options is retained at all times, where the trader is free to sell a portion of his long option accumulation, and still take advantage of value that presents itself as premiums escalate with volatility.

Intricacies of Option Spread Trading

The Options Hunter Blog — Thu, 17 Mar 2011 19:25:00 GMT

Spread trading with options may appear fairly straight forward; even rather attractive due to its risk aversion properties however, as often the case with serious investment; not all is as it seems.

The VIX - Wheels within Wheels

The Options Hunter Blog — Fri, 11 Mar 2011 02:42:00 GMT

The art of option trading is made ever so much easier by technology with most traders using a pricing model to generate benchmark prices. Of course these prices rely not only upon a volatility variable, but also particular variables not the least of which are the price of the underlying instrument, interest rates, dividends and days to maturity. The VIX on the other hand seeks to eradicate these additional dependencies by providing an option market that isolates volatility.

When trading ordinary equity option markets or equity index markets, volatility is inherently high but is merely one of the many idiosyncratic influences on investment analysis. Liquidity, open interest and behavioral aspects of the option market will play an equally relevant part in directing a trader’s intuition. Trading the VIX however, appears to relieve the trader of having to factor in contingencies to an option trade that will otherwise need to be addressed in the future. For example, that equity volatility routinely collapses when the underlying market appreciates has always proved to hamper the buying of out-of-the-money call options in a bid to initiate a long volatility position. Similarly, out-of-the-money puts invariably trade at extremely high volatility due to the skew that incorporates the mayhem of a stock market crash. To use these as a method of selling volatility may be mathematically sound however, when the market actually does reach those levels, volatility is redefined to send chills up the spine of the most seasoned trader. In the panic of a major equity collapse it is more a case of survival than calculating volatility. Even more so than the upside counter scenario, the downside volatility contingencies that will be faced will find the most progressive of pricing models most wanting.

Within this framework the VIX provides the perfect antidote. It isolates volatility to be traded alone without the influence of underlying instruments and unique market behavior. As the VIX is an estimate of price movement in the S&P500 of one standard deviation into the 30 day period approaching expressed as an annualized price range. As such the VIX contradicts the premise that an underlying instrument is absent as the VIX itself is the underlying instrument to the options upon it. It is here that volatility is isolated and the trader is free of external influences. Call options on the VIX will be the right but not the obligation to a long position in the VIX i.e. a long position on the volatility of the S&P500. Put options will provide opportunities to implement sold positions in the VIX; the volatility of the S&P500. Regardless of whether S&P500 option volatility moves up or down in response to underlying market movements, the historic volatility in the underlying S&P500 will be determinative of a VIX option position.

The Relevance of Liquidity in Option Markets

The Options Hunter Blog — Fri, 28 Jan 2011 19:40:00 GMT

All markets endure periods of illiquidity, yet for various reasons some are plagued with this phenomena for extended periods of time. When an option market is liquid, the margin or “spread” between the bid and the offer will narrow as the weight of competition assists in price discovery. In circumstances where option markets are illiquid, the absence of competition will necessarily mean that the bid/ask spread will be far wider.

Often the size of the bid/ask spread is a function of risk. It stands to reason that an option price is contingent upon an underlying instrument, and when that underlying markets is volatile, the risk of mispricing is accentuated. In these conditions, both sides of the market will seek to gain for themselves a buffer against mispricing, which in turn will be reflected in a wider bid/ask spread.

It is not only a volatile underlying market that will perpetuate a wider bid/ask spread. Liquidity or lack thereof will also create wider bid/ask spreads than would otherwise persist. In circumstances of illiquidity, the reality is that market participants are compelled to hold positions for a far greater period of time. In some case, option traders will have to maintain that position for months – possibly even until expiry. With this potential consequence in mind, traders in an illiquid market will also seek to exact as much value out of every trade as possible. In order to address the risk of lengthy open positions, and also basis risk of the underlying (which is assumed by the pricing model to travel at a constant volatility), a trader must demand a greater theoretical advantage.

Having executed a trade at the highest premium of advantage possible, the trader of an illiquid option market will then seek to adjust subsequent pricing in order to reflect the bias inherent in the current portfolio. This strategy underlies the premise that trading a portfolio of options is essentially spread trading options against each other. While value is captured by an individual trade, it is only translated into profit when it is realized. Realization of profits will only occur on cash settlement or closing out of an open position. An illiquid market by definition is the nemesis of closing out a position. Consequently, in order to capture the value and avoid erosion of profit, the open position needs to be offset by another open position. The closer the strike prices of the subsequent trade to that of the open position, the greater the utility of the value capturing taking place. Indeed, profit is a result of value being spread across a series of options.

Implementing an Option Spread Strategy

The Options Hunter Blog — Tue, 18 Jan 2011 18:13:00 GMT

When seeking to enter into an option spread, the trader needs to consider a number of factors. An option spread strategy will possess different characteristics at various intervals throughout its life and it is important that these are monitored carefully before execution.

While many cash settlements engage in spreading to reduce premium outlay, the traditional basis of the strategy is in fact to reduce risk. The risk sought to be reduced is not only holistic premium risk, but also the Vega or volatility risk, time decay or theta risk, and of course delta risk. These risks are all related to one another, but individually represent the precise factors that will differentiate one spread strategy at one point in time, from another at a different time.

Most relevant when contemplating a spread is one’s view on volatility. This view needs to be reflected in the choice of strike that is closest-to-the-money. If for example the trader is bullish on volatility, it would be behoove that trader to ensure that the strike price closest to the money is the leg of the spread that is purchased. The closer to the money that an option strike is, the greater exposure that option has to volatility and time decay. Delta risk on the other hand is universally trumped by the option that is most in-the-money., while theta risk or time decay is like volatility, dominated by those options closest to the market; those with the most time value.

Managing each of these contingencies is imperative to making the correct spread trading choice. Due to the superficial similarity between various spread trading strategies, it will be the latent consequences that will serve to haunt the unthinking trader. An addition to the myriad of traps the potential investor may face, once executed the spread trading strategy will not remain static in character; it will change its properties dynamically as the underlying instrument moves in either direction, as the days to expiry approach, and also as volatility fluctuates up and down. Indeed the dramatic changes in store for the spread strategy will become accentuated as premium reduces due to volatility or due to expiry approaching. When premium is high with many months to expiry, or when volatility is high, the Vega risk or risk of volatility risk, and time decay (theta) risk will remain relatively unexceptional if the strikes are nearby. As strike prices get further apart the difference in Vega and theta become more pronounced as they do when volatility is low or expiry approaches.

In many ways, low volatility, expiry approaching and remoteness of strike price have a common thread of differentiation between the strikes of an option spread strategy.

Further Investment Strategies Using Currency ETF Options

The Options Hunter Blog — Mon, 10 Jan 2011 17:23:00 GMT

Historically, the flight to quality theory of economics has found investors hurrying toward the safest investments available in times of uncertainty. In the recent Global Financial Crisis, even though the United States itself was experiencing unprecedented economic slowing, the US dollar has remained a bastion of economic security since World War II, and so became the haven for funds from all over the world. When in fact no economy exists in order to provide refuge for investors, the investment of choice is usually in precious commodities such as gold. Gold has experienced an unprecedented rally since the Global Financial Crisis began to affect the United States so profoundly, and considering it is in limited supply with supply around the world beginning to be threatened, investors have bought the gold market up from the $400 per oz. level to over $1300 per oz.

Again, investors need not be in actual need of a refuge for their funds; gone are the days for such practical necessity. It is merely enough to anticipate a flight to quality and benefit from the consequential capital gain in asset price. When managing such exposure however, it may be prudent from time to time to hedge the position with $US currency. Since gold is denominated in $US, an appreciation in gold is made possible by investors selling $US to purchase gold. When gold appreciates, the $US dollar necessarily depreciates in value against gold. It may not depreciate in value against other currencies but that eventuality will only mean that those other currencies have depreciated much farther against gold than the $US has.

To hedge a long position in gold an investor will only need to purchase $US. These may not appreciate against another currency but an appreciation against gold will offset depreciation in the gold price. While not a perfect hedge (currency trading rarely has one), ETF call options in $US will provide a suitable and quantifiable hedge when purchased against long gold, while a sale of ETF $US puts will provide premium to offset a depreciation of gold.

In addition to gold hedging, US trading partner currencies will necessarily have a risk to the $US depending on whether they are net importers or exporters of domestic product. Japan for example is a net exporter in the manufacturing industry and so investment in the Nikkei will have a have a sound hedge in $US ETF options. Japanese exporters comprising the Nikkei will be paid in $US and will need to convert those into Yen. The risk to Japanese investment therefore is a stronger Yen and a weaker $US. Yen ETF call options will be able to qualify the value of a hedge, as will the purchase of $US ETF puts. The sale of $US ETF calls or Yen ETF puts will raise premium to also offset any appreciation in the Yen when exporters seek to convert profits into local currency. In this manner the successful hedging of international equity investment is facilitated by currency EFT options rather succinctly.

Taking the VIX Apart

The Options Hunter Blog — Wed, 29 Dec 2010 20:37:00 GMT

While the S&P500 has rarely experienced an ordinate move of more than 5% in the last 20 years, the VIX is a device to represent volatility expectations. Expressed as the expected price movement within one standard deviation this encompasses the likely probability of all contingencies but for 32% i.e. within a 68% probability. When combined with the VIX’s performance against the underlying S&P500, the VIX proves to be a perfect hedge in respect of the latter.

For over 20 years the VIX has moved in the opposite direction to the S&P500 88% of the time. When the underlying equity market has suffered a retracement of 3% the VIX has typically risen by 17%. These facts indicate the integrity with which the VIX is able to provide a hedge against the S&P500 equity market.

In purchasing VIX out-of the-money calls or call spreads, or even selling put spreads in the VIX, a hedge of close proximity is to be had. Conversely, selling volatility by purchasing a put or put spread or selling calls or call spreads will achieve similar results. With the historical precedent set by the VIX against the S&P500, an investor can trade these hedges with confidence.

In visiting the mechanics of options types in the VIX, it is immediately noticeable that VIX options appear to mirror the ramifications of their underlying equity market options. Primarily this is due to the VIX option being a reflection of volatility direction not index or equity direction. This leads to a further discovery that the VIX by its very nature has certain limitations on its underlying value. Reflective of the anticipated price movement over the ensuing 30 day period the VIX is unlikely to dwindle at any time to a value of zero. Indeed, historically it indicates that 10% is a veritable floor. At the other end of the spectrum, the VIX has had occasion to visit levels above 45% but as could reasonably be expected, this type of indication lends itself to fantastic and sustained movement in the S&P500 for a 30 day period. Alas a ceiling for the VIX has presented itself over time.

This being the case, the VIX is a volatility indicator but shows that it also has a volatility of its own. Traditionally the VIX volatility has traded considerably higher than underlying S&P500 volatility. Annualized VIX volatility can reach 80% compared to the volatility range of equity and index markets of 10%-25%. Another point of relevance is that VIX volatility that is incorporated into its options is by nature based on volatility of the forward VIX contract which while still much higher than comparative equity and index markets, is always lower than the spot VIX contract. Froward VIX options volatility meanders at approximately 50%. The VIX give traders a unique opportunity to trade options on a market that has well defined floors and ceilings, is not able to erode in value to zero and is imbued with considerable volatility.

The Carry Trade is Alive and Well with Currency ETFs

The Options Hunter Blog — Tue, 21 Dec 2010 20:22:00 GMT

While the Global Financial Crisis of 2008 has witnessed many casualties in the banking centers of the world, the ability of many institutions to trade with each other has eroded, if not for insolvency, for tighter credit controls, policy, and procedure within the financial markets of the world.

The carry trade traditionally has allowed investors to forgo earning interest in one currency for that of an interest bearing deposit in another currency. The motivation to enter into such a transaction stems from the view that the interest earned in another currency would outperform that earned in the domestic currency. Of course the investment does not accrue profits until the position is reversed and the domestic currency is once again held. This feature of the investment adds another dimension in that a capital risk also exists in addition to the interest earned or forgone. Economic, fundamental or technical properties of various nations can provide the basis for currency investment and divestment in a multitude of currencies in order to exploit price differentials, but trading partnerships between the countries of the world necessarily offer a connection between certain currencies and others. These relationships will determine the structure of an investment and the elements it is comprised of. Currency ETF options offer the most flexible and leveraged opportunities to traders wishing to implement carry strategy or synthetic arbitrage strategy between trading partner nations.

If for example Australian interest rates offered an investor 4% returns while holding $A , compared to a 1% return in say the United States while holding $US, selling $US and buying $A would allow investors to execute a carry trade in order to trade the interest rate differential. Of course the capital risk upon conversion at the conclusion of the trade has the potential to offset any profit already made, and so the device of the currency ETF option is the perfect tool to quantify risk and yet not risk a large capital loss on strategies playing the interest rate differential.

Purchasing outright currency ETFs will invariably pay lower than retail interest in that nation’s currency, but the interest will reflect domestic conditions and so can accurately be used to execute the carry trade. Of course the actual fruits of the carry trade – the interest accruing over time need not be sought; a capital gain from the investment will accrue due to market forces if indeed value is perceived to exist in a particular investment. While a multitude of variables come into play to make this determination, it is the preempting of value in an investment that high lights the versatility that currency ETF options offer investors who seek to trade currency differentials. At a fraction of the cost of exchanging hard currency, these derivatives are second to none in terms of currency market leverage.

Wheels within Wheels

The Options Hunter Blog — Fri, 10 Dec 2010 22:54:00 GMT

The Relevance of Liquidity in Option Markets

The Options Hunter Blog — Thu, 25 Nov 2010 01:12:00 GMT

Options on Currency ETF’s

The Options Hunter Blog — Tue, 16 Nov 2010 03:35:00 GMT

The Value of Open Interest

The Options Hunter Blog — Thu, 11 Nov 2010 15:44:00 GMT

Particularly outside equity markets having a finite number of shares available, many traders ignore open interest records. Primarily this is due to the impossibility of differentiating whether the open interest is long or short, and so whatever good that may result from this knowledge is immediately squandered.

Bearing in mind that option contracts have two methods of closing out; a trade offsetting the opening trade, and exercise of the option which will create a position in the underlying instrument. Both will lead to open interest being commensurately reduced.

When an option strike is traded and the open interest reduces, the fact that previous position holders have closed their positions is revealed. When traded to result in an increase in open interest, clearly, positions have been initiated. When no change exists this shows some parity between closing transactions and initiating transactions. If a particular option strike is traded with keen interest to such an extent that the open interest in that option strike suffers a marked increase, the trader will be able to deduce that a large participant or participants are initiating positions. This could be indicative of the direction that underlying market is about to take, or it may merely be a hedge against a position in a remotely connected external market.

Still the rapid increase in open positions while not particularly concerning to the majority of traders, will be borne in mind by the astute in order to take advantage of others favored positions. When the rest of the market has absorbed the counter position to one particular initiating trade, they will be keen to close that position out and redistribute value across other option strikes. Particularly when this creates a large open position record, it necessarily creates a secondary market in the option strike at hand. By virtue of a secondary market depicted by open interest, liquidity in that option strike is now made inherently stronger. This in turn has consequences for the entire option market and every strike price therein. When liquidity abounds the bid/ask spread for that strike price will narrow due to competition within the market place. As attempts to crystallize profits are made, traders will seek to redistribute value and s doing increased competition will arise in adjoining strike prices.

The wary trader will use this information to preempt the existence of latent over supply or over demand of particular strike prices. Indeed, if these anomalies are public knowledge a natural skew will develop in the market quite aside from probability and its mathematical deduction.

Weeky Options

The Options Hunter Blog — Fri, 05 Nov 2010 15:11:00 GMT

The prospect of weekly options is an exciting one, offering many traders the opportunity to hedge with even more precision. It offers what is typically no more than that of an option with one week to expiry, but if strike prices are thoughtfully available, the concept of weekly options may serve to be more than a mere I week option; it could attract considerable volume from other option markets and even expand net open interest.