,at least when used in a  1:l ratio with the underlying. If you wanted
less.  The 
the  cost  would  be  much 
8  For  the  options-enabled  reader.  I’m  assuming  an  at-the-money  purchase  of  ei-ther  the  put  or  call.9  Most likely ration,  and  many  would  sell istics  such  as lo  Actually  .38  less  than  the  outright  had  it  not  been  stopped  out.II  Assuming a delta of .5, the rough estimate would be .19 = .38 x .5. This wouldonly be  precisely correct if the underlying were right at the strike price whenbought.  Traders  who  wanted  closer-to-dollar-for-dollar  coverage  (i.e.,  delta  closerto  1)  would  use  an  in-the-money  put.
last  until  expi-took  on  winning  character-
the  trade trades.
the  MinFE  exceeding 
trade  probably  won’t 
the  option  when 
.3  for  reversal 
Using  an  away-from-the-money  put  is  a  neat  way  to  get  a  delta  that  will  get  the
218
Shifting  the  Odds:  Using  Options
Skipping  Stops,  Using  Options
219
roughly the same price movement from the options as the underly-ing, you’d adjust the number of options and/or the strike price.
More  sophisticated  approaches  than  using  an  at-the-money  op-tion  are  possible.12   For  the  short-term  speculative  trader  worriedabout the 3 to 5 days after entry, however, it may be enough to lookat the known cost of the insurance (maximum  .38  on the downside,probably much less), the loss level the trader is trying to manage to(e.g.,  .30),   and  the  hoped-for  short-term  gain  in  the  next  10  to  20trading days (e.g., 1.20). If the underlying moves against the trader,the loss is likely to be .19  or at worst .38  if he or she just keeps hold-ing the option, looking for a more  opportune  exit. This is cheap.
That  the  net  cost  of  using  the  option  in  a  losing  situation  mightnot  be  the  entire  premium,  and  that  the  cost  might  even  be  lessthan the stop is good news on the downside, but what happens onthe upside?
Winners
Things are more complicated on the upside. If the trade moves hisor her way and the trader is long the call; he or she must return tothe  complexity  mentioned  above:  the  option  will  not  move  upwardas  fast  as  the  underlying  would.  Initially,  it  might  move  only  half  asfast.  As  the  trade  advanced  and  the  option  got  deeper  into  themoney, it might start  moving  70%,   80%,   or  90%  as  fast  as  the  un-derlying.  If  the  trader  were  to  hold  it  deeply  into  the  money  untilexpiration,  the  net  profit  on  buying  the  call  would  approximate  the
trading cost of the option into the range of the anmunt  we want  to spend on losscontrol. If the ATM option has delta of  S, we’ll be down  5W when the underly-ing  hits  our  stop  level.  If  that’s  too  expensive,  an  OOTM  option  might  have  adelta of  .3. If 50% is really cheap compared to MAE stop, an ITM option mighthave a delta of .8.I2  Using  a  deep  in-  or  out-of-the-money  option  with  its  different  delta  to  matchthe  exposure  you  like  would  be  one  example.  A  ratio  of  long  and  short  optionsmight cover a specific price range. Knowing the area of price excursion from entrythat must be protected gives the options trader  sane specificity in constructing anoptions  position.
value  of  the  underlying  long  less  the  cost  of  the  option.  Becausewinning reversals out of ranges (as an example) run from 15 to 65days, this would be common.
In the near term, the “long the underlying, purchase a put” strat-egy  has  one  advantage  over  the  “purchase  a  call”  strategy:  on  thenear-term  upside,  it  participates  1:l  with  the  rise  of  the  underlying(less  the  cost  of  the  insuring  put)  while  the  purchased  call  equiva-lent  will  have  a  51  participation,  roughly  speaking,  with  the  rise  ofthe  underlying.
One effect works to the trader’s advantage: the sooner the tradercan  unload  the  position  (when  the  trading  signal  for  the  underlyingflashes exit by hitting the stop), the more premium he or she can re-cover  selling  the  option.  Another  effect  works  against  the  trader:the  further  into  the  money  the  option  goes  (and  the  more  time  thatnecessarily  takes),  the  less  premium  he  or  she  can  recover  sellingthe option. The short time frame of the Crude reversal trade worksfor  the  trader;  success-involving  more  time-works  against  theoption position. Net of both effects, the trader will undoubtedly re-cover  some  premium  in  selling  the  position,  reducing  the  cost  ofhis original insurance. Table 10.3 shows an example (without com-missions) if the trader went long at 17.00.
On  the  upside,  the  outright  is  always  ahead  of  the  purchasedcall  strategy  by  some  portion  of  the  premium.  Eventually,  the  pre-
TABLE 10.3 COMPARING  AN  OUTRIGHT  TO  AN  OPTION
Priceofcrude17.0017.5018.0018.5019.00
Daysi n t oTrade05101520
V?dWof  LongCrude  at17.00II
so1.001.502.00
Value ofLong  CallBoughtat.3838.74”1.121.582.04
Profit ofLong  CallBoughtat .380
.74-.38=.361.12s.38=.741.58-.38=1.20x04-.38=1.66
Advantage  ofUnderlying
Long 
“5.   LongCallo-o=0so-   36  = .I41  - .74  =  261 s  - 1.20 = 302-1.66=.34
I3  .74  = .50 intrinsic value (17.50  - 17.00) +  24 premium. These values are exam-PlW.
220
Shifting  the  Odds:  Using  Options
Skipping  Stops,  Using  Options
221
mium would wear away until the outright’s advantage over the op-tion  would  be  .38,   the  original  cost.  The  purchased  call  cushionsyou on the downside and, on the upside, incurs a greater premiumcost  as  the  trade  wears  on  while  participating  in  the  gain  moreslowly  than  the  underlying.
Had you bought Crude and purchased a put for protection thenseen  Crude  advance  like  this,  you’d  have,  without  commissions,something close to the values shown in Table 10.4. In other words,you suffer the erosion of the premium in a way very similar to thatof  just  holding  the  call,  reinforcing  the  equivalence  of  a  purchasedcall with the “buy Crude and buy a put” approach.
If  your  knowledge  of  Crude’s  behavior  indicates  that  a  trade  islikely  to  be  a  winner,  you  could  take  off  the  put  protection  earlieror  convert  the  call.  For  example,  range-reversal  trades  lasting  tendays  are  rarely  losers.  Reversals  with  a  MinFE  greater than  .1  aresometimes but rarely losers, These are chances to increase profit bydropping  your  insurance  coverage  even  though  you  were  coveredduring the hazardous five or ten days after entry.
Bottom  Line
The  second-to-the-bottom  line  is  that  the  cost  to  the  trader  ofshort-term  usage  of  the  option  in  a  favorable  trade  is  likely  to  be
TABLE  10.4 COMPARING  AN  OUTRIGHT  TOOUTRIGHT  PLUS  OPTION
PriceofCrude
17.001 7 . 5 01 8 . 0 01 8 . 5 01 9 . 0 0
Daysi n t oTrade
051 0152 0
Value  ofLongCrude  at17.00
Value  ofLong  PutBoughtat :38
Profit  ofLong  PutBoughtat .38
Advantage  ofUnderlyingLong  vs. LongUnderlyingand  Lone  Put
II
0
501 .oo1 . 5 02 . 0 0
.3823.10401
II.23-.38  = -.15.,  - .38  = -.28
.5-(.5-.lS)=-.I5, - (1  - ,281 = -.28J-.38=-.34 15(1.5-.341=-.34.Ol  -.38=-.372-(2-.37)=  -37
low+rtainly  not  the  entire  premium-if  the  trade  is  a  loser.  ACrude trader who knows that the time horizon to use the option isfive  to  ten  days  has  a  tremendous  advantage:  if  the  trade  fail%  thecost of protection is likely to be less than the MAE stop (but nevermore than the cost of the option), but if the trade is a winner, he orshe  doesn’t  necessarily  pay  the  entire  cost  of  the  premium  (andnever  more  than  the  premium).
The  bottom  line  is  that  an  option  will  cost  the  trader  somethingbut it may be comparable to the cost of a stop. Comparing the op-tion to a two in three chance (or whatever your loss/win ratio is) ofhitting the stop is, in the case of a Crude reversal trade, just about adraw:
2/3  chance of MAE hit at  .31  @  .20
versus
{an expected option loss of  .19  (on a loser)and a .3  lesser profit (on a winner)]
which works out to:
{2/3  *  .19   +  l/3   *  .3   =  ,221
These  numbers  are  too  rough  to  take  as  other  than  an  indicatorfor judgment, The trader who doesn’t want the stop picked or is ina  very  confused  market  can  use  an  option  instead  without  fearingexorbitant cost. In the 1 l-year test period, the limited evidence sug-gests  he  or  she  would  be  just  as  well  off  using  an  option  as  whenusing a stop and, in a fast market, might be better off.
Each  market  will  differ,  and  because  volatility  of  the  marketschanges, the pricing of the options changes, which affects the com-parison with the  use of a stop. If the option is very expensive, usethe stop. If volatility is low and the option is cheap, use the option.
222
Shifting  the  Odds:  Using  Options
The  Evidence
What  we  learned  in  earlier  chapters  about  how  Crude  behaveswhen we trade a certain way is useful. Because we know the dura-tion of our trades, we know options are likely to cost less than theyseem to cost and may be competitive with stops. Because we knowthe trading rules’ success rate, we can estimate whether options aremore  likely  to  be  useful  than  stops.  Most  important,  because  weknow where our stop/reversal point is, we can objectively compareoptions  versus  outrights.
TRADING
The examples in this chapter show an approach to using options onCrude  reversal  trades.  The  conclusion  might  be  completely  differ-ent  for  a  different  tradable,  a  different  interest-rate  environment,  adifferent  implied  volatility  in  Crude,  or  a  different  MAE  stop.  Al-though  much  can  be  automated  to  speed  up  analysis,  there  is  nogeneral  rule.  Options  fade  in  and  out  of  your  tactical  tool  bag,  re-quiring  your  art  and  judgment  in  employing  them.  As  it  happens,in Crude range-reversal trades, you have the flexibility to use eitherthe  stop  or  the  option,  the  only  difference  being  that  in  using  theoption  you  will  certainly  pay  for  the  insurance,  whereas  with  thestop you may avoid paying any insurance.
Options  do  increase  the  analytical  workload  on  the  campaigner,particularly  if  more  exotic  combinations  than  described  here  areused.  Traders  not  set  up  to  handle  this  complexity  might  find  itjustifiable to skip options on that basis alone.
Regarding  the  profit  impact  of  using  options  on  Crude  reversaltrades,  there  are  no  additional  profits  from  using  them.  In  cam-paigning  with  Crude,  they  might  be  viable  on,  say,  trend  trades  oradd-on trades or trend reversals, but not on range-reversal trades.This  chapter  has  shown  only  the  idea  of  using  options  and  hasgiven an example of testing them on one of the tactics of campaigntrading: reversals out of range. An active campaigner will check outwhether  options  should  be  used  for  every  tactic  he  or  she  employs.
11 wConclusion  to
Campaign  Trading
Whether  in  a  trending  mode  or  a  ranging  mode,  the  Crude  marketbehaves  characteristically  when  viewed  through  the  simple  tradingrules  used  here.  As  an  example  of  campaigning,  Crude  showedmany of the behaviors a veteran campaigner would exploit.
It  turned  out  you  could  trade  Crude  as  a  trending  market,  butyou  could  also  add  additional  trades  to  the  trending  mode  eitherfrom  the  short-term  average  or  the  long-term  average.  You  couldalso reverse out of trending trades profitably.
When  the  market  shifted  to  ranging  mode,  there  was  a  muchsmaller set of trades into the range, but there weren’t enough tradesto  add  on  to  range  trades.  You  could  reverse  out  of  the  range,though, and that turned out to be a very profitable exercise.
Examining  minimum  favorable  excursion  clearly  identified  win-ning  trades  when  reversing  out  of  range,  but  there  were  too  fewcases  in  that  mode  where  this  technique  proved  useful.  Applied  toother  modes  such  as  add-on  trades  from  the  short-term  average,MinFE  might  be  of  more  use.  Although  no  general  rules  wereshown, graphs of price excursion for winning and losing trades bothshowed  characteristic  behaviors,  running  in  channels  that  could  beinformative  to  a  trader  using  judgment  in  managing  trades.
223
224 Conclusion  to  Campaign  Trading
Old  Hands  225
Crude  also  has  a  strong  options  market  that  gives  the  cam-paigner  some  flexibility  in  managing  a  position,  though  in  the  sin-gle  example  in  Chapter  10,  the  trader  could  have  used  either  op-tions  or  stops  equivalently.  Each  situation  would  need  to  beexamined  independently  in  the  future.
SEEING  THE  MARKEl
Leaving aside Crude as a campaign vehicle, the most important les-son is to transform market behavior so that it’s measured from thepoint of entry of an explicit set of rules. Only then can you see themarket in your terms.
Next,  measure  and  chart  the  price  excursion  from  that  point  ofentry to see if there is a distinct difference between the behavior ofwinning trades and losing trades. As Crude showed, you’d like theworst  adverse  excursion  of  winning  trades  to  be  sharply  differentfrom  that  of  losing  trades,  Similarly,  you’d  like  the  least  favorableexcursion  of  winning  trades  to  be  sharply  different  from  that  oflosing trades. This is information you can use.
You  use  it  in  the  case  of  adverse  excursion  by  identifying  losersquickly  with  an  experience-based  stop  that  cuts  losers  before  theydo  great  damage  but  without  unnecessarily  cutting  off  winners.  Inthe  case  of  favorable  excursion,  you  identify  winners  early  on  soyou  can  move  up  stops  and  minimize  losses  without  cutting  offwinners.
CAMPAIGN TACTICS
Every possible campaign tactic hasn’t been covered. Option writingto  exploit  the  directional  information  stops  give  you  was  too  com-plicated  to  include.  Betting  strategies’  weren’t  either;  only  add-ontrades  had  nearly  enough  trades  to  attempt  this.  Countertradinginto the trend was left to the reader.
’  Principally,  martingales,  a  sequence  of  ~varying   bet  sizes  designed to  endprofitably.
Still,  the  basics  are  all  present  in  New  York  Light  Crude:  trendand  ranging,  add-ons  and  reverses.  A  trader  who  doesn’t  want  tobe  restricted  to  just  one  strategy  can  have  two  here:  trending  orranging. A trader who wants a variety of tactics to exploit can havethree:  the  fundamental  trade  (trend  or  into  the  range),  the  add-ontrade, and the reversal trade.
The  result  should  be  an  active  campaigner  steadily  building
strength  with  limited  losses.
Even  with  just  one  trading  vehicle,  it’s  possible  to  have  severaltrades going at once, and add-on trades alone could keep the traderglued  to  the  trading  desk.  Include  several  tradables-or  hun-dreds-and  there  is  ample  opportunity  for  diversification  of  trad-ing tactics, as well as diversification of trading vehicles.
OLD  HANDS
The  tactics  tested  in  this  book  are  common  among  experiencedtraders,  who  learned  them  from  experience.  The  price  excursiontechnique simply puts a picture to the price behavior and gives us-able  information  to  execute  old  trading  maxims,  with  some  rationalapproach.
I realize this material does not provide one simple rule for all sit-uations-the  retail  trader’s  dream.  Constructing  and  analyzing  dis-tributions is a lot of work; it’s as messy as reality. Still, I hope oth-ers  will  expand  this  introduction  and  develop  more  useful  ways  tocapture  the  behavior  of  their  trading  market  and  use  it  for  profit.This  approach  is  the  only  consistent  framework  I  know  withinwhich  a  campaign  of  trading-trading  in  all  market  modes--canbe  undertaken,  Whatever  the  market’s  mode,  whatever  the  tacticyou  employ,  excursion  analysis  shows  you  where  to  get  the  edgeon  the  market  so  you  can  win  with  minimal  losses,  Only  with  thiscapability  can  you  trade  more  or  less  continuously,  constantlybuilding  strength  rather  than  waiting  for  congenial  market  con-ditions.
Within  this  framework,  diversification  of  trading  vehicles  makespractical sense, and not just from some hopeful lack of correlation.In  this  framework,  with  all  vehicles  working  most  of  the  time,  not
226 Conclusion  to  Campaign  Trading
only  may  losses  on  one  vehicle  offset  gains  on  another,  but  morelikely, steady gains in all vehicles will amplify each other,
A  campaign  turns  a  trading  vehicle  from  a  sporadic  contributor
to your strength to something more reliable.
Indeed,  without  analyzing  price  excursion  from  entry,  the  wholenotion  of  campaigning  as  I’ve  described  it  is  not  viable.  Excursionanalysis  unites  all  the  disparate  tactics  and  strategy,  all  the  brieftrades  with  the  long  engagements,  in  a  simple  nuts-and-boltsmethod  to  control  losses  so  that  the  action  of  the  market  can  takeour bank accounts where we want them to go.
Appendix:Trading  Charts
To  prepare  data  for  this  analysis  and  the  resultant  trading,  I  firstdetermined (see Chapter 4) that the two months prior to expirationwere the months to follow when trading the New York Light Crudecontracts (That is, we trade the June contract in April). Then I as-sembled  sequences  of  those  months  for  all  11  contract  years.  Onthe last day of the month, I used the spread between the expiring’contract  (e.g.,  September)  and  the  contract  to  be  picked  up  (e.g.,October) to adjust the new contract’s values so that the change be-tween the days (September 30 and October 1) was the same as inthe  expiring  contract.  Figures  A.l-A.13  also  show  the  12-day  and58-day  simple moving averages used in the exemplary trading.
In  actually  trading  this  information,  you  work  backward,  adjust-ing  the  old  data  to  synchronize  with  the  current  contract.  This  al-lows you to trade off today’s quotes with no adjustments.
The  resulting  continuous  contracts  look  different  from  the  ac-tual  historical  contracts,  and  I  include  them  here  so  that  the  readercan  make  a  quick  visual  search  for  anything  he  or  she  would  con-sider  anomalous
’  The  contract  doesn’t  expire  until  the  month  before  the  nominal  month.  For  ex-ample,  the  November  contract  stops  trading  in  October,  and  for  analysis  and  ac-tual  trading,  we’d  trade  the  November  contract  in  September.
227
228 Aooendix:  Tradine  Charts
Data for this work were generously supplied on a very timely ba-sis  by  both  CSI  and  Dial  Data,  to  whom  I  give  many  thanks.Anomalies  you  may  find,  if  any,  are  most  likely  the  result  of  mymachinations  rather  than  data  errors.
The  data  were  extracted  from  the  vendors’  download  files,  ma-nipulated  in  Microsoft  Excel  for  the  Macintosh  into  continuousdata  series,  transferred  to  DOS  ASCII  files  and  uploaded  intoMetaStock  for  Windows2   using  Equis’s   downloader  utility.  Al-though  I  have  mistakenly  been  quoted  as  favoring  these  vendorsabove  all  others,  in  fact,  many  other  vendors  could  have  handledthese tasks, and my choices here were ones of convenience and fa-miliarity  rather  than  capability.
There’s usually someone who would like the actual numbers. They
are  available  until  April  1999.  Contact  me  at  Nail56@AOL,COM.
2  MetaStock   for  Windows,  of  which  I  used  a  very  early  version,  had  a  minor  bugin that the price scale needed to be reset manually to show the correct values. I be-lieve  I  caught  all  those  instances,  but  if  not,  that  may  explain  values  extremely  atvariance  to  the  reader’s  experience.
229
T
31.030.530.029.529.028.528.027.527.026.5
Z /25.024.5
FIGURE  A.2  1985.
:
ec
II966   IFeb  IMarch   lApril
I
N2
FIGURE  A.3  1986.
20.5
19.0
21.5
21.0
23.5
22.5
23.0
22.0
20.0419.5
17.0
18.5
16.0
16.5
15.5
18.0
17.5
FlCUREA.4   1987.
-E
1987
11988
1 
Feb 
(March 
/April  
l~ay 
IJune
I~~~II~~~,'II,,'II,,,'I.,,
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Ew
FIGURE  A.5  1988.
-
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:
:8
:
: 
:
:
27
2E
2t
24
23
22
21
za
19
1s
17
16
15
14
13
-
40
FIGURE  A.6  1989.
E
FIGURE  A.7  1990.
FIGURE  A.8  1991.
FIGURE  A.9  1992.
i
: 29.c
7
7
28.5
28.0
: 
j
FIGURE A.10 1993.
!i
FIGURE A.11 1994.
FIGURE  A.12  WEEKLY.
:‘I1
184
I1985
II986
I I 9 8 7
I1968
1 1 9 8 9
1 1 9 9 0
11991
11992
11993
11994
11995
jl9
!z
FIGURE  A.13  MONTHLY.
Index
AAdd-on  trades,  107
intraday   trades,  109,  111position-building, 110, 130
Averages,  20
BBins,  50
CCampaign
definition, 2example,  4,  15goal, 133,203tactics,  224vehicle,  102
Capital required, 13, 50Chande, Tushar,  185Consistency,  28Continuous  contracts,  70Cycles,  I,  156
DDaily ranges 74
EEhlers,  John,  8Excursion,  43analysis,  225
FFourier  transforms,  7,  34,  156
GGotthelf,  Edward,  185
HHorizon.  See  Time  horizonHurst, J. M., 7
LLosses,  12,42,63
243
Index  245
Trade horizon. See Time horizonTrading  capital.  See  Capital
required
Trading  experience,  24,61,66
Trading  ranges  See  Range  tradingTrading  rules,  46,  141,  178,224Trending  definitions,  30,  36,  173Trend  trading,  27,74,  133
244  Index
MMAE. See Maximum Adverse
Excursion
MAE  Stop.  See  StopsMarket  behaviors,  143,  166,
198%202,224
Market  memory,  5Market  mode,  13,  137,  153,
225
Maximum  Adverse  Excursion,
24,224definition, 44example,  46
MaxFE. See Maximum
Favorable  ExcursionMaximum Entropy SpectrumAnalysis,  1, 34,  156
Maximum  Favorable  Excursion,
188
MESA.  See  Maximum  Entropy
Spectrum  Analysis
MinFE.   See Minimum Favorable
Excursion
Minimum  Favorable  Excursion,
185,224vs. MaxFE,  191
Moving  averages.  See  Averages
NNew  York  Light  Crude,  71
behaviors,  142,  166,  177,  182,
196,198
0Option&   41