caused by short covering, meaning that there is no sound reason tobelieve that prices are on the rebound. Additionally, livestock priceswere in a weakening trend during this period, so there does notappear to be any impetus for a dramatic turnaround or change inthe price direction.The technician reviews charts in an attempt to perform thiskind of analysis. One of the most important aspects of chart analysis is observation of the trading range, or the space between the topand bottom. In the previous chart, the trading range maintainedapproximately the same distance from top to bottom, even whilethe general price level declined. This was a one- to two-pointspread, not a lot of change. However, it is significant to observethat the consistency of breadth remained unchanged over the fourday period. A technician may interpret this as a sign of continuinglow volatility even in conditions of falling prices.In comparison, not all trading ranges are so reliable in terms ofbreadth, or the distance between high and low prices. For example,
Technical Analysis of Futures
107
Figure 7-2 shows the April contract in natural gas. This pattern isfar more volatile and difficult to predict. Chart watchers face thisdilemma constantly. A very low-volatility chart is easy to predict,but small price movement reduces trading opportunities. And highvolatility charts present greater chances for short-term profits, butthey are more difficult to predict based on trading patterns.In the case of the natural gas contract, three short-term tradingpatterns—all rather strong—are experienced. The first and thirdare uptrends, and the second is a correcting downtrend. Where willit go next? The point difference during this period is not tremendous, but the volatility itself implies some additional likely problemsin the market. This is where the fundamentals and the current newscome into the picture. This price pattern emerged during a periodof high volatility for all energy futures, augmented by rumors ofrecession, unrest in the Middle East, and consumer worries aboutinflation (which were at least partially blamed on rising oil pricesacross the board).FIGURE 7.2. NATURAL GAS—APRIL CONTRACT DAILY CHART
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
108
Reaching the Market
The tops and bottoms of trading ranges are very difficult toidentify in the short-term chart for natural gas, because tradingmoves all over the chart. In situations like this, it makes sense toalso review longer-term charts to view the larger trend, and to helpidentify potential seasonal effects as well, not to mention currentnews headlines and a summary of the economic report.The technical approach is based on the important concept ofsupport and resistance. This is a reference to the lowest and highestprice levels in the current trading range. Support is the lowest priceat which buyers and sellers agree to exchange contracts, and resistance is the highest agreed-upon price. As a general rule, pricestend to remain within established support and resistance borders,and this is significant for three reasons:1. The support and resistance levels define volatility. The nature ofthe trading range defines the very level of volatility. That range,defined in turn by the established support and resistance pricepoints, is expected to hold unless a major change occurs.2. As the trading range narrows or widens, technicians anticipatefuture price changes as well. This all-important trend reveals andanticipates new directions in the near future. Changes in volatility, represented by narrowing and widening ranges, is a furtherindication of pending change.3. Any attempt to break through support or resistance is important,whether it fails or succeeds. If price approaches support twice ormore and then retreats, technicians expect price levels to rise inresponse. The ‘‘failed’’ breakout below support shows sellingweakness, and that implies buying strength. The opposite istrue on the top: If price approaches the resistance level two ormore times but fails to break through, it implies buying weakness, and prices are expected to fall shortly afterwards. Thesefailed attempts are seen in technical patterns like double ortriple tops and bottoms. The head and shoulders pattern is another, with three rises to resistance followed by a price retreat.This is considered a failed breakout pattern at resistance. Areverse head and shoulders shows the same pattern, but atsupport.
Technical Analysis of Futures
109
A successful breakout may imply one of two price trends. Firstis a momentary breakout, in which price levels are expected to filland retreat to previously established trading range levels. Second isa strong price movement resulting in establishing a new tradingrange. The inclusion of gaps in trading price levels helps technicians to interpret breakout patterns and to determine what theymean.
■
Pattern Recognition and InterpretationPrice movement adopts distinct patterns. Technical analysts havenoticed that these patterns often anticipate price weakness orstrength in coming periods. By looking for pattern changes, technical analysts also believe that they can time their trades to take advantage of momentary market aberrations. There is some supportfor this. Remember, markets tend to overreact to news and information. In spite of the long-term price direction, price actionwithin a single day or over a few days tends to be chaotic; andmovement is likely to consist of movement in one direction, offsetby countermovement the other way, an unending series of erraticmovements, corrections, and subsequent movements.The existence of support and resistance as the boundaries ofestablished trading ranges provides a clear and definitive areawhere trading is expected to occur. Sudden price movements evenwithin trading ranges can be significant, especially if those movements approach the boundaries or violate them. And when it comesto pattern recognition, it is significant that a trading range is not somuch an exact price level, but a range of trading breadth.For example, if a particular future is trading between 8 and 11,its breadth is three points. As long as the price remains within thoseranges, the price levels are fairly predictable even if there is a lot ofback-and-forth action. But in other futures contracts, a three-pointrange may exist in a contract that is moving up or down in price.The example shown in Figure 7-1 demonstrated how this works.The breadth remained very constant even as prices fell.The trend within a trading range—unchanged, rising, or falling—is called the price channel. Traders like predictability, so aslong as the support and resistance levels are easily spotted, it is
110
Reaching the Market
comforting to accept the premise that the range itself, or at leastthe point spread in the breadth, is going to remain constant. Channels can take a number of shapes and sizes, sometimes rising andat other times falling. A momentary sideways price movement mayarise as a rest during a longer-term uptrend or downtrend as well.This pattern is also called a rectangle, because it forms that shapewith resistance on the top, support on the bottom, and the sidesconsisting of a start and finish. For example, the propane monthlychart shown in Figure 7-3 establishes an overall upward pricemovement, but with two periods of relatively sideways-movingtrading. This example of support and resistance occurs often aspart of a longer-term price pattern.The channel is simply the price movement within the range,FIGURE 7.3. PROPANE—MONTHLY CHART
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
Technical Analysis of Futures
111
and that may be sideways, upward or downward in direction. Another significant pattern is the triangle. This is a trading patternwhere the breadth of the range narrows or widens. For example,the weekly chart for corn futures demonstrates a triangle patternas shown in Figure 7-4.In two instances on this chart, the pattern widens in anticipation of a strong price movement. This does not mean that the pattern is always going to occur in the same manner, but it is oneindication of expanding breadth, which also translates to expandedbuyer/seller exchange.The patterns and variations on those patterns are among manytools technicians use. As chartists—those who time trades basedon chart patterns—futures traders have to act quickly because themarket may change within a single day. The rapid volume of trading in some commodities makes chart analysis elusive. Looking atvery long-term trends is unreliable as well, given the short-termlife of each specific contract. However, when applied to daily priceFIGURE 7.4. CORN CONTRACT—WEEKLY
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
112
Reaching the Market
movements, the trader who employs chart patterns to assist in thetiming of trades may be able to anticipate developing price movement.
■
Trend Lines and Moving AveragesTraders follow channel patterns seeking information to time buyand sell decisions. In stocks, long-term trends are granted a lot ofcredibility, because companies are permanent and stock trends dotend to follow distinct overall tendencies. For futures, though, theshort-term trend is more likely to be followed. While overall futuresprices are expected to trend in a particular way, the action thatreally matters is what occurs in the past month and what is goingto occur in the next month.An example of a strong uptrend can be seen in the long-termmonthly chart for gold futures, as shown in Figure 7-5.Note that the uptrend occurred over several years, and was verystrong. Toward the end of 2007, the gold price rose even morestrongly. This augments the rate of increase, but should also concern gold futures traders. The likelihood of profit taking becomesstronger when prices jump so quickly, because the tendency is forprice to retreat and fill in, at least in line with the established rateof change.An uptrend in gold often reflects currency weakness. For example, during the same period that gold rose strongly, the U.S. dollarfell. Figure 7-6 shows the monthly dollar futures value.From 1999 to 2001, the dollar actually rose, but since then ithas fallen. After a brief rally in 2005, the decline took over onceagain. Thus, the long-term trend for the U.S. dollar is ever-greaterweakness. Some traders view this as part of an ongoing trend thatis expected to continue, while others expect a dollar rebound in thefuture. The point here, however, is to demonstrate the appearanceof a downtrend over the long term. The fact that the downtrendlasted for so many years demonstrates how some futures trendsdevelop and are sustained. The comparison between gold and currency values further shows how virtually all futures are connectedto one another in some manner. Just as energy prices affect grainvalue (notably corn as a feed source as well as potential energy
Technical Analysis of Futures
113
F I G U R E 7 . 5 . G O L D — M O N T H LY C H A R T
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
source), gold and currency values also tend to move opposite ofone another.The rise or fall in a trend is rarely going to occur in a straightline. If you look at current charts, even for futures that are clearlymidtrend, you will often find a back-and-forth price action. Forexample, prices will rise several points, then retreat, followed byanother rise. This effect, called climbing the stairs, is common inboth directions. Because buyers and sellers are constantly negotiating back and forth, the forces of supply and demand are rarelygoing to occur in one direction for very long, without offsettingmovement in the opposite direction.An aid to understanding trends is the moving average. In manycharts, you find not only the periodic price action represented byvertical lines or boxes; but also one or more lines moving acrossthe chart, representing moving averages.
114
Reaching the Market
FIGURE 7.6. U.S. DOLLAR MONTHLY CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
A simple moving average is calculated by adding together thenumber of periods; and then dividing the total by the number. Eachperiod’s new moving average is calculated in the same way, addingnew data and dropping off old data. Futures analysis often involvesthe combined use of 50-period and 200-period moving averages.With online charting, calculations do not have to be made, becausethey are performed automatically. Each period’s moving average(MA) line represents the latest updated information.A variation of the simple MA is called exponential moving average (EMA). This calculation is more complex, because it grantsmore weight to the latest information. Using EMA is justified because the latest information reflects more updated knowledgeabout the underlying commodity. So the move in the futures pricemay be granted greater weight due to its current importance.The significance of MAs involves comparisons between the av-
Technical Analysis of Futures
115
erages and the level of price. MAs are expected to follow pricemovements, because averages are lagging indicators of price. So ifprice falls beneath the MA, technical analysts believe this signals adownward trend, and the MA is expected to follow. The purpose ofstudying MA is to identify a lag time and anticipate likely priceaction based on how MA stands in comparison to current pricelevels.
■
MACD and RSIMoving average certainly provides a revealing look at price movement and trend. A variation of this useful tool is called MACD,which summarizes the daunting name, Moving Average Convergence Divergence.MACD converts MA into what technicians refer to as a ‘‘momentum oscillator.’’ This is a type of indicator comparing earlierprices to more recent prices, with the purpose of judging how rapidly price is changing.Any two moving averages can be used in MACD, although themost popular are 12-day and 26-day exponential moving averages.The so-called 12/26 MACD is studied by how close or far apartthey are, as a means for determining the longer-term price trend.When the 12-day is higher than the 26-day MA, that is consideredpositive and anticipates that price is going to rise; and of course theopposite pattern implies that price is likely to fall. Taking this beyond the stationary comparison, when the two MAs are movingfarther apart (diverging) or coming closer together (converging)the MACD is even more revealing. There are actually four possibleMACD patterns:1. The shorter-term MA is above the longer-term MA, and the twoare diverging. This indicates strong upward momentum inprice.2. The shorter-term MA is above the longer-term MA, but the twoare converging. This indicates that the rising price trend is becoming weaker.3. The longer-term MA is above the shorter-term MA, and the two
116
Reaching the Market
are diverging. This indicates a strong downward momentum inprice.4. The longer-term MA is above the shorter-term MA, but the twoare converging. This indicates that the falling price trend is becoming weaker.MACD analysis can also involve the use of a signal line otherthan price. A third MA, for example, may add additional insightabout a future contract’s price strength or weakness. However,proximity to delivery date is going to affect MACD analysis as well.Remember, futures traders use a continuous rolling effect, meaningthat current holdings are closed and replaced by later-expiring delivery dates. This also affects the price and may distort the apparentMACD. It may be accurate to observe that MACD for longerspanning trends is more reliable than when it is applied against thecurrent contract. MACD is popular to use for stock price analysis,given the longer-term nature of stocks. However, it is one morepiece of the puzzle in technical analysis of futures.A more reliable measure of price strength or weakness is theRelative Strength Index (RSI) of a futures contract. This indicator,like MACD, is a momentum oscillator because it is designed tomeasure and compare the price momentum in the contract. Sousing RSI, you can determine the speed of price change (momentum), and also derive a single-digit indicator comparing thestrength of price increases with the strength of price decreases.RSI is normally summarized on a futures chart (as well asMACD), to augment the reported price level and trend. The RSIcalculation is a popular momentum oscillator and perhaps moreapplicable to futures contracts than the more oblique MACD. RSIcompares recent price gains to price losses, and then converts thedifference into a single value between zero and 100. The calculation is based on varying time frames, often 14 days. Most analystsconsider a factor of 70 or higher to be the line defining when afutures contract is overbought; and use 30 or below as the pointwhere the contract is undersold. So as a clear bullish (70 or higher)or bearish (30 or lower) signal, RSI is easily tracked and interpreted. As with all indices, it is valuable to track RSI over time. Forexample, if RSI is ranging between 50 and 65 consistently, and
Technical Analysis of Futures
117
then spikes up to 75 for one or two days, that does not mean everything has changed. As long as RSI retreats to the midlevel factor,you can ignore the momentary spike. In comparison, if the RSI isgradually increasing and passes 70, remaining above that level, it ismore likely that the futures contract is overbought at that point.The fact that RSI ranges between zero and 100 implies that themidpoint between overbought and oversold is always 50. However,this can be misleading because short-term aberrations in trends canmove RSI above or below that level frequently without violating themore obvious ‘‘above 70’’ and ‘‘below 30’’ criteria. This is especiallytrue when you remember that all indicators have to also considerthe relatively short-term delivery and the natural rolling out of onecontract and into another.For an example of an overbought futures contract, see theMarch 2008 propane contract summarized in Figure 7-7.FIGURE 7.7. PROPANE—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
118
Reaching the Market
Prices rose strongly throughout the previous year, and then appeared to reach a resistance point between November and December. This would be difficult to interpret by itself. However, RSI haddipped into the midrange during exactly the same period, buttoward the end actually rose above 70, settling at 77.25 by the endof December. Technicians tracking RSI would have noted this increase at the last half of December 2007 and concluded that thecontract was overbought.An example of a futures contract approaching oversold conditions was the March 2008 lumber contract, as shown in Figure7-8.Although the RSI remains above 30, note the trend. If RSI continues to fall as it did between August and December, chances arethe contract would become oversold. RSI remains slightly above 30for most of this period, but toward the end had fallen to 31. AnyFIGURE 7.8. LUMBER—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
Technical Analysis of Futures
119
additional decline would signal that the price had reached bottom,and would level out and rise. In fact, the same contract continuedits decline and by January 10, RSI had fallen dramatically, as shownin Figure 7-9.Note that the price decline continued in the 10 days since theprior chart, but RSI fell to 15.79, a clear sign that the contract wasoversold. Because RSI involves a single point value, determiningthe trend is simple, and the price rise or decline is given greatermeaning, helping traders time their decisions.
■
Volume, Open Interest, Bollinger, Elliott, andStochasticYou will notice that in addition to MACD and RSI, charts containboth open interest and volume. The open interest is the number of
FIGURE 7.9. LUMBER—MARCH CONTRACT (AS OF JANUARY 10, 2008)
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
120
Reaching the Market
currently outstanding and active contracts; and volume, shown atthe bottom of the complete chart, shows the number of trades occurring in each reported period.A ‘‘unit’’ of open interest involves a buyer and a seller, so whenthe two sides come together, they reside on each side of a singlecontract. The trend in open interest is interesting to watch. Naturally, as delivery nears, open interest is expected to decline whentraders roll positions into later contracts. Volume trends may alsoanticipate pending price movement. Referring back to the Marchlumber contract in Figure 7-9, for example, you see that volumespiked at the beginning of December and prices (and RSI) both fellsharply throughout the month of December and into January.Volume is important because it indicates the level of interest inthe contract. The lumber contract is a good example of this. Noticethat volume was quite low until December, and following the spike,volume remained much higher than it had been previously. Eitherbuying or selling activity can lead the level of interest in a futurescontract. In the case of March lumber, sellers were clearly generating interest as both price and RSI fell on heavy volume. That situation is referred to as distribution, meaning that sellers are incontrol. Long positions closing drive the exceptional volume. Forthose with short positions in the contract, the deterioration in pricetranslates to profits. When buyers drive volume, it is called accumulation, meaning that traders view the contract as desirable. Thebuying demand drives up the price.Three final but important technical indicators worth mentioning are Bollinger, Elliott, and Stochastics. Although these soundlike a law firm, they are not. Bollinger Bands are indicators used tocompare futures contract volatility. There are three price bands inthe analysis. The primary band is in the middle and consists of asimple moving average of price. The second (upper) and third(lower) bands are calculated to show how much deviation occursfrom the average price on both upside and downside. When pricesare volatile, Bollinger Bands expand away from the primary trend,and when prices are more stable, the bands contract. As prices getcloser to the upper band, it indicates that the contract is becomingoversold. (It is also productive to study Bollinger Bands in conjunction with RSI to see whether these two indicators confirm the indi-
Technical Analysis of Futures
121
cated significance.) And as the price gets closer to the lower band,it indicates an oversold condition. Bollinger Bands are excellentconfirming indicators.The Elliott Wave is an indicator involving a series of waves inone direction, used to spot long-term trends. This indicator isprobably more applicable to stock price analysis than to futures,but many futures technicians use Elliott Wave studies as a furtherconfirmation of RSI and other indicators.The stochastic is a measurement of oscillation like so manyother technical indicators. Price volatility is a defining predictivevalue in future contracts. A stochastic measurement compares current price to the daily trading range. The idea behind this is thebelief that price tends to follow the established trend; so if an uptrend dominates, price tends to close closer to the upper tradingrange, for example. However, when a trend has been going on forsome time, you may notice a weakening in the stochastic strength.This anticipates a slowing down of the trend and perhaps a reversalin the near future. It is more esoteric than indicators like RSI andthe simple observation of price movement over recent trading periods. Few people would need extra help in understanding the direction of the trend in the March lumber contract, for example.However, a stochastic study could point to a slowing down in thedowntrend itself.You may find any number of technical indicators to help compare and study price action in a futures contract. However, becausefutures are going to exist for only a limited period of time (in comparison to stocks, which do not have delivery deadlines), so manytechnical indicators developed for stock analysis may not be applicable or as informative when applied to futures.The next chapter explains in detail a final method of reachingthe market—trading in options on futures. Options provide an interesting alternative to other methods of trading, and make the entire futures market accessible on a highly leveraged basis.
■
Notes1. Theopolis Waters, ‘‘Pork Futures, Hogs Advance,’’ Dow Jones Newswires,January 8, 2008. (reprinted at FXstreet.com).
C
H
A
P
T
E
R
8
THE LEVERAGEDAPPROACH: OPTIONSON FUTURES
T
he complexity of futures trading is, for most traders, best managedby using indices and ETFs. Direct trading is expensive and involvesmany risks most people do not want to accept. In addition, thefutures contract is an intangible derivative of the underlying commodity or asset. Most futures traders never intend to accept ormake delivery of the actual product, but are only speculating on thechanging price levels.Complicating matters even more, you can buy or sell optionson futures. This is actually a derivative on a derivative, which is acomplex step beyond most people’s interest level. For those whowant to examine the entire range of possible methods for reachingand studying the futures market, options open up some interestingpossibilities, involving leverage of your money, reduced risk exposure, and added hedging possibilities. The ability to trade optionson futures is a relatively new idea. The Chicago Board of Tradefirst introduced it in 1982, when such options were first allowed onTreasury bond futures contracts. Since then, the range of futurescontracts on which options can be written is broad, and today traders are able to find many avenues for futures speculation and hedging with the use of options.122
The Leveraged Approach: Options on Futures
123
You leverage capital buying and selling options, because the option value (called the premium) is a small percentage of the fullfutures contract price. Just as the futures contract is a small portionof the underlying commodity, you reduce your capital even moreby trading in options on those same futures. This is the epitome ofleverage.In most cases, added leverage also means more risk. But withoptions, the risk level really depends on whether you are long orshort on a futures contract. The risk of short options can be considerable if the price takes off in the underlying commodity. Traderswho would want to short the commodity think the price is goingdown. But with options, you can actually bet on the downside witha long position, and at the same time limit your capital exposure.The elegance of option trading is that it allows you to pick a tradingstrategy that is perfectly suited to your own risk tolerance level.The following sections explain the basic attributes and definitions of options trading. For those readers familiar with options onstock or indices, an important distinction has to be made. Withlisted stock options, every option is related to 100 shares of theunderlying stock. However, with futures, the contract value is different for each commodity. So you have to make sure that youknow how many contracts you are involved with before determining whether the current price level of the option is attractive ornot—and whether the risk level is acceptable if and when you selloptions.Options on futures are certainly interesting in the sense thattheir use can open the doors to many variables on trading. Even ifyou limit your trading activity to options on futures-based ETFs orindex funds, options expand your potential market exposure whileproviding many hedging possibilities. Throughout this chapter, theexamples used for option trades and strategies are focused ontrades in futures ETFs and indices. This is the most likely venuefor futures trading most readers are going to use. Thus, it is logicalto also assume that the interest level is going to be focused on option trades for those pooled products. References to an option’s‘‘underlying security’’ can refer to a specific futures contract, but itis more likely that the security will be a fund comprised of futurescontracts. Option examples will be based on the tracking index
124
Reaching the Market
GSCI Commodity Indexed Fund (GSG) and the oil ETF, UnitedStates Oil Fund (USO), as of the close of business on January 11,2008. (Note: Although share values change continuously, the fixedpoint in time for these selections remain valid on a relative basis.Given the price levels and time element of option trading, you canaccurately assess option values based on these examples.)
■
Types of OptionsThe first step in understanding options is to master the terminologyin this specialized market. Most traders not familiar with optionsthink they are complex and high risk. But this is not the case. Themost important feature of the options market is that each trader isable to select a specific risk level, based on what kinds of optionsare used, and whether they are long or short.Options are intangible contractual rights, much like futurescontracts. They have a finite life and their value is based strictly onhow futures contract prices change. There are two kinds of options, calls and puts. A call grants its buyer the right, but not therequirement, to purchase a specified number of futures contracts.This right has to be exercised within a specified time frame (beforeexpiration date), and occurs at a fixed price, called the strike. Ofcourse, if you buy a call, you do not have to buy those futurescontracts. If their value rises, you can sell the call at a profit. Remembering this distinction between the two kinds of options is imperative to developing specific strategies.A put is the opposite of a call. It grants its owner the right, butnot the requirement, to sell a specified number of futures contractsat a fixed price and by a specified date. The long put can be usedas an alternative method for trading on pessimism about price. Asthe futures price declines, the put’s value grows.The choices for sellers are more limited than those for buyers.When you sell options, you give up the choice of whether or not toexercise. So you might be required to deliver called stock or to havestock put to you if and when a buyer exercises your short option.Figure 8-1 summarizes the benefits and contingent obligations ofoption trades.All options are tied to a specific futures contract or range of
125
The Leveraged Approach: Options on FuturesFIGURE 8.1. COMPARISONS BETWEEN CALLS AND PUTS
CALLBUYER
has a right but not a requirement to:buy 100 sharesat a fixed price
SELLER
PUT
sell 100 sharesat a fixed price
could be required to:sell 100 sharesat a fixed price
buy 100 sharesat a fixed price
contracts. The most likely venue for trading in these contracts isgoing to occur in futures-based indices or ETFs, many of whichallow option activity. The option cannot be transferred from onespecified underlying security to another. That underlying security,by definition, is a particular futures contract (referring to one commodity and one delivery date), a group of futures (such as energyor agriculture) or a pooled product (an ETF or index fund).The leveraging aspect of options is what makes them attractive.You can control a number of contracts (or, in the case of ETFs andindices, shares) for each option you buy or sell, and this has a twopart effect many traders find attractive. First, you can use a smallamount of capital to create potential profits in a larger base of thefutures market; second, you can limit risks, because when you golong in options the maximum you can lose is the amount you payto buy the option. In comparison, buying or selling contracts directly or going short in any market can involve considerable risk,which is what frightens away so many would-be futures traders.Options present the perfect solution, assuming you master the terminology and trading rules as a first step.Both calls and puts are defined by a series of terms. The firstterm is the type of option, call or put. Second, all options refer to
126
Reaching the Market
specific underlying securities. Next is the strike price, the fixed andunchanging price at which that option can