Using options to hedge a futures scalping strategy?

Hello Option Gurus,
I'm a wannabe trader, with an initial account of 5K. I'm currently using a simulator from the kind folks at CMS-forex.com in order to get a feel for the currency markets. I traded ag commodities back in the 80's. but haven't traded since. I'd like to pursue a day trading, scalping strategy one of the e-mini S&P500 or Naz, or the e-mini euro (haven't decided which yet). I expect to trade just one of these instruments while I get back into the trading swing.

When I was trading ag commodities, president Carter announced a russian grain embargo. I wan't in grains at the time. But it was really amazing to watch the boards go limit down for days in a row.

Scalping on the e-minis seems to offer the perfect combination of liquity, margin, and volatility - but how to manage the risk? Events do happen.

I'm wondering if you have any ideas for a creative use of somewhat out of the money options, preferably purchased at a time of lower volatility, that will allow me to concentrate on my scalping, and know that my downside is covered. I'd like to limit my downside to $500.00 before the option is in the money.

Because I'll be scalping up one minute and down the next, I'll need to buy both put and call options. I guess I just see this as the cost of "insurance" I've got to pay because my account is so small. I am hoping that during a time of higher volatility I will be able to sell further out of the money otpions, but I'm not sure any futures broker will let me do that with a 5K account size (even if I own the closer to the money option).

The trick is that as the market moves, I may need to adjust my hedging band, and I'm not clear about how to deal with the fact that the volatility will be going up and down, that I may to trade for a different strike price at a time when volatility is high..

Your comments are invited.
Thanks,
JO

JumpOff said:

I'd like to limit my downside to $500.00 before the option is in the money.

Click to expand...

I forgot to say that I'll be trading just one contract at a time.

JO

What about commissions? Could be expensive.

You're after the impossible, maximum upside risk with very limited downside risk.

In this game you're basically paid more for the more risk you take. So if you try to eliminate downside risk you're going to also eliminate possible income. You cannot have it both ways.

And even if you did find a way to do it (on paper), in reality all your profit would disappear in trading costs.

Good luck anyway in whatever you do.

oatman said:

What about commissions? Could be expensive.

Click to expand...

Hi Oatman,
I'm not familiar with the options game. Never bought or sold them before. I would have thought the premium would be 95+% of the cost. I was hoping I could keep the same 2 option contracts unless/until the price moves dramaticly.

You cannot have it both ways.

Click to expand...

Anley, I expect some losses. What I am after is a little time to react. Knowing that my total loss is limited might allow me to make decisions without panicking. If the market locks limit against me, I won't be able to close the underlying contract, but I would know my total loss, - and perhaps have an opportunity to sell a further away option when premiums are higher - and that would cover most of the cost of the option premium I paid when the volatility was lower.

If I don't take pre-emptive steps to manage the risk and event occurs, then wouldn't I be forced to buy an option when the option prices are highest? Are you saying that it is not possible to use one option as a worst case stop loss for many little scalping trades?

At this point, I'm not looking for a high profit strategy. I see it as tuition. I'm buying a safe sandbox to play in, so that I can concentrate on learning the scalping technique. When I was trading ag commodities, I never heard of anybody scalping from a remote location - the data feeds were delayed by about 120 seconds, and the commission structure just didn't make sense. The modern electronic platform makes this all different. At this point I don't even know if I will be able to be a succesful scalper - but after practicing sucessfully on a simulator, I've got to trade live money to find out. I'm after some kind of method that lets me live to trade another day if the market goes wild..

As my account size builds, if I stay with single contracts, I can handle more risk per contract, use futher out of the money options - or just drop the need for them all together.
Maybe make the big bucks they pay you all.....

Thanks,
JO

JumpOff….

Short term trading is a risky business full stop. I know many who do it. If I am honest I would have to suggest that your risk is not from sudden news events as you have suggested. The risk is your trading style (ie very short term). One imagines that you will be trading via a direct access broker ? If you are spreadbetting then most will allow you g/teed stops on certain instruments.

The nature of short term scalping means that you will be highly leveraged. If you did want stops to limit your loss to $500 then you’d be dealing with options only 10 points out of the money. These would not be cheap. You would in fact have to trade in and out of your options positions on a daily basis because the hedge which you bought on Monday has a high likelihood of being of little use on the Tuesday as the market will have moved.

I can not remember the last time the S&P’s locked limit up or down. It is indeed a very rare occasion.

I’d have to suggest that it is impossible to protect your scalping activity with options. You are just not going to generate enough profits to afford to be able to do it.

The best way to scalp is to establish the trend and go with it. I do scalp from time to time. The best way I have found is to use the daily chart to establish the short term trend and then use the 5 min chart to establish good risk / reward entry points near support and resistance. A good working knowledge of some chart patterns is also useful. I personally look out for patterns which don’t occur. In other words, I take positions when I think that the market reacting in the opposite manner would produce a weird or rare pattern. I can work quite well but it is not a mechanical method, it is purely down to experience and the watching of E-mini 5 min charts for many years.

Hope this helps,
Steve.

Yes, good points SS.

Many people think that 'day-trading' is the best way to go forward because of 'less risk' etc (especially overnight risk). But as you rightly point out Steve, day-trading is actually a very very risky strategy to do, in fact it's most probably THE most risky trading strategy around today.

Also as you say when was the last time the stockmarkets went limnit down (or even nearly limit down), 2-3 years ago. That's approaching 1000 days of option time decay which is very very expensive.

Jump Off. If you want to give yourself a chance forget about options and forget about trying to limit your downside. If the downside is really what's worrying you then trading is not for you. Sorry if I'm sounding harsh here, it's nothing personal buddy...

Undercapitalization Sucks

Instead of trading e-Minis at the CME, take a look at Tradesports.com. They have some micro-eMini contracts on the S&P, Dow Jones & NASDAQ. I believe they're 1/10th the size of the eMini. You could trade those with less worry about being on the wrong side of a 500 point move.

Thirteen said:

try scalping naked options instead

Click to expand...

Thanks everyone for your strong opinions. This T2W forum is a wonderful dash of cold fresh air. I will look into scalping options. That gives me a limited downside, and since I won't generally be holding the position for more than a day (sometimes not more than a few minutes) I shouldn't suffer enough time decay to worry about.

Can any of you recommend a good platform and broker for this kind of strategy? I'll want to do simulated trading before opening an account. Keep in mind that my account size puts me in the "no go" zone with most brokers for selling options (even when they are covered by one closer in the money).

Thanks,
JO

JO....

I can't see you being able to scalp options with that limited account balance. It says you are America based. I dont see what other choice you have ? In the UK there are a number of spreadbetting companies / cfd providers which do offer some options but 1) you cant access them by law from the States, and 2) You'll find the spreads too big for scalping even if you could use them.

You seem to be looking for 'something for nothing'. Where there is reward there is risk. The S&P500 Emini futures market is about the most liquid you'll find. You'll rarely get slippage on a stop placed on that market. You'd be better off forgeting about a 'one off' event which causes a tank and just concern yourself with placing a sensible stop on any trade you might enter. One assumes, if you are scalping, you'd be flat over night and at weekends and only trade during real market hours. If this is so then there is little need to worry about this insurance.

Steve.

Jump

Forget about scalping options it's impossible for someone new to the game. In the options markets you're pretty much trading with the best the world has to offer and they're also 10 times worse than sharks.

Basically you'll find it impossible to buy the bid (until it goes offered) and vice-versa with the offer. So in effect you'll end up paying offers and selling bids which is the opposite to scalping. Also with a minimum bid-offer of 5 points that's a hell of a spread to pay away (US options not UK ones).

As SS states you're after something for nothing. You therefore have to ask yourself the question, do I want to accept risk or not? If you don't then forget about trading because every trader in the world has to accept risk and also every trader in the world would like to accept risk with virtually no downside or at least a very limited downside should a 10 sigma event happen. But at the end of the day it's impossible.

Anyway the odds are with you. Say a 10 sigman event happens then the only time you can be hurt is if you're long. But if you're flat then no pain but if you're short then xmas has come early.

Again not trying to have a go at you but you must realise these things before you put real money on the line.

stevespray said:

You seem to be looking for 'something for nothing'. Where there is reward there is risk. The S&P500 Emini futures market is about the most liquid you'll find. You'll rarely get slippage on a stop placed on that market. You'd be better off forgeting about a 'one off' event which causes a tank and just concern yourself with placing a sensible stop on any trade you might enter. One assumes, if you are scalping, you'd be flat over night and at weekends and only trade during real market hours. If this is so then there is little need to worry about this insurance.
Steve.

Click to expand...

Something for nothing? Well actually, I am a pretty hard worker, but I can be crazy lazy during rare moments when no one is lookin'! LOL I'm not opposed to taking a freebie if the opportunity presents itself. The best melons in my garden this year were the ones that came up by themselves. All I did was keep the lawnmower away and in return I got 8 luscious melons that were bigger and sweeter than the all the ones in my "normal" patch that I tended, fertilized, mulched, etc... Ah Well, I'm not expecting to be so fortunate with trading.

I also come from and long and distinguished line of worriers. I'd like to know that my risk/reward ratios are in line. And I'm not talking about the per trade entry position thing. I'm talking about that fact that if I work hard and have a smattering of talent, I might be able to make a living at this after a couple of years of experience and building up my account size. In the mean time I have to weigh that *potential* against the current "unlimited risk" that comes with trading futures. When I open a real account, I'll have to sign papers that say I'll meet those margin calls.

Is it really 'wanting something for nothing' to expect to pay the premium for the insurance I want? As I said before - I see it in the same way I think about tuition. Novice acrobats don't work without a net while they are learning the moves, and I don't want to either. I expect to pay for the net. And I don't expect this training period to be profitable - I'm shooting for break even at best.

Yes - I plan to be flat overnight and weekends, that's an obvious way to manage some of the risk. I don't want to trade with a firm that says they can guarantee stops - it's a lie - they are liars... No broker in the world can guarantee your stop if a dirty bomb goes off in Manhattan. And the last time I checked, we don't really know where all of our own nuclear material is, let alone all that stuff that belonged to the former soviet union. It seems to me that we live in a world where "one off " events are becoming more common.

Anyway, you all have given me a lot to think about and I am considering all opinions this thread has inspired. When I think about the likelihood of a starting a successful career by buying/scalping options I have to sit back and digest it all. LOL
Thanks,
JO

JO.....

When I said 'something for nothing' I wasnt refuring to your personal work habits. That would have been very rude of me indeed. What I was meaning was that you were trying to extract something from the market whilst taking no risk. In other words, you would offer nothing by way of underwriting risk whilst at the same time you were looking to profit from market movements.

If you would care to look on the spreadbetting threads you will see that I have a thread there called 'Lets make some money spreadbetting'. In that thread I outline a particular way that I use to earn some money each month. You would have to decide if my strategies where to risky for you. There are a number of ways to protect against a sharp downside move. In this country (the UK) we have a number of companies which offer financial instruments which track the major indecies. These companies will g/tee stops for a small premium. This presents a cheap way of protecting yourself against 'an event' such as the type you fear. (To acheive this you would buy their parallel instrument and place a g/teed stop whilst selling the underlying in equal proportion, if something nasty did happen you parallel position would stop out leaving you net short to hedge your options put exposure).

Steve.

anley said:

Anyway the odds are with you. Say a 10 sigman event happens then the only time you can be hurt is if you're long. But if you're flat then no pain but if you're short then xmas has come early.

Click to expand...

Anley, - You are an oracle! Why wasn't I thinking of this before? Of course a 10 sigma event won't be to the upside! (Well maybe if you were shorting gold ...) So I can take that business of buying call options while I am shorting off my list of things to do during the "sandbox phase." I think you just cut my tuition in half. :idea:

T2W in the best site ....
JO

stevespray said:

If you would care to look on the spreadbetting threads you will see that I have a thread there called 'Lets make some money spreadbetting'. In that thread I outline a particular way that I use to earn some money each month.

Click to expand...

Thanks Steve, I'll look there now, and get back to you.
JO

Hey Steve,
I looked over that "let's make some money" thread. I can see how it works for you. I understand that the seller of option premium is usually the winner. (With direct access you can jump in and hedge with a futures contract if need be).

Doesn't seem like a good plan for me though. No broker is going to allow me to sell 4 uncovered options w/ a 5K account, even if I was crazy enough to try!

Cheers,
JO