Question 2
Lohit from New Delhi asks:
What in your experience is the best options strategy, all said and done? I traded straddles for many years but have gone back to being naked long or short albeit with smaller bets.
(Editors note: This question appeared in a previous edition of Fast Break "Ask an Expert." Following is an alternate perspective on this topic.)

Dear Lohit,

In my experience, the best options strategy involves the selling or writing of out-of-the-money options. I firmly believe that if you want to make money trading options in the long run, you need to be a net seller of options instead of a buyer of options. When selling options I also think it is very important to sell out-of-the-money options, because you will have a buffer between the current futures price and the options strike price. This will allow you to be wrong about market direction and possibly still win with the trade!!

I think the general public gets taken by the idea of buying options. When you buy options you are paying a fixed price and that is the most you can lose (limited liability). The problem is that all options have expiration dates and most options expire worthless. Time works against you when you buy options. You could buy a call, the market could go up and you could still lose if the market does not move far enough or fast enough. I think that buying options is a sucker's game.

On the other hand selling options gives you the ability to be wrong and still make money. I think if you surveyed professional floor traders they would all say that in the long run the real profit is in selling options. There are real risks, however. If you sell naked options your risk is unlimited (just like futures) so you must be careful. That is why I prefer selling credit spreads when I take option positions. In this strategy you have limited risk, just like when you buy options, but the odds are now in your favor.

Question 3
John from Iowa asks:
Would it be a good time to buy call options on corn and beans for next November or December,and what would be a good strike price for the money?

Dear John,

On Wednesday we hit contract lows in November beans and December corn. Relative to the last few years we are at very low levels in both corn and beans. A lot can happen over the next 8 months that could cause these markets to rally. Bad planting weather, a hot, dry summer or a cold wet one, or a late summer freeze could all cause huge rallies in these unpredictable, weather driven markets.

As stated earlier I am definitely not a fan of buying options, so in general I would rarely recommend spending money for options. However, if that is what you want to do then there are definitely scenarios where you could make a lot of money being long calls in the grains from near the current contract lows. Specifically, if you wanted to buy November soybean calls I would purchase the $7.00 strike price. They are going for approximately 10 cents or $500 each. Last year the contact reached $7.99, which means the $7.00 calls were worth $4,950 intrinsically. As for December corn I would buy the $2.50 calls for 12 cents or $600 each. The high for corn last year was $3.35, which means the $2.50 calls would be worth 85 cents or $4,250 intrinsically.

Question 5
Derrick from Chicago asks:
I have traded options before but not to any great extent. I never have had the "guts" to write. What type of capital do you recommend someone start with when taking a net selling method? Also, how much capital do you think someone should have in trading a net selling method?"

Dear Derrick,

It is understandable that you have never had the guts to write options. As a broker I remember what it was like when I started out back in 1990. At first I bought options for clients and it didn't take me long to realize this was a losing proposition. When I started to sell options, I was unsure of what I was doing and it took me a while to get comfortable with the margin requirements and the risks involved. My best recommendation is that you get a broker who is knowledgeable in this area and that you start slowly.

As for the capital question it is a difficult one to answer. At an absolute minimum I think you need at least $10,000 risk capital to start selling options. You will be limited to some of the lower margin markets and strategies, but at least you can get your feet wet. As for the second part of your question obviously you must work with what you consider "risk capital" when trading these markets. I would suggest working with approximately 25% of your overall investment portfolio or approximately 10% of your net worth. These percentages might be higher or lower depending on the individual.

Question 6
Fred from Chicago asks:
A few years ago the Euro Futures and Options were a huge
place to trade. Since then they have declined. What is a hot market to get in? What spreads or strategies do you like on an Interest Rate based Option? Are Straddles a good trade for a beginner in options? Finally, how much does Volatility influence a decision to make a trade or not?

Dear Fred,

First off let me just say that you couldn't be more wrong with your comment concerning the Euro. Since its inception in 1999, volume and open interest have consistently increased in Euro futures and options, and today it is the most actively traded currency. In fact, the SF and BP are the dying contracts while the Euro is more robust than ever.

There are a lot of hot markets today. Obviously the energy markets have been extremely active and volatile the last few years but I find them very dangerous. Personally I like trading the S&P500 options along with the Euro and interest rates. These markets are fair, active and liquid, which are the three most important factors when deciding what to trade. On a secondary level the precious metals have jumped back to life in the last few years after an extended dull period in the late '90s.

My favorite strategy for trading the interest rates is to sell out of the money credit spreads. A credit spread is a limited risk strategy that involves selling an option and buying another option farther out of the money for protection. I specifically like this strategy in the interest rates because the bonds and notes tend to make sudden moves immediately after the release of economic data (unemployment, non-farm payrolls, CPI, PPI, GDP). An unprotected position can get really hurt after a surprise announcement.

I am not a big fan of straddles for a beginner. A straddle involves selling an at the money put and call and relies on the market NOT to make a big move in order to be profitable. If the market becomes volatile it is very possible for a beginner to become a deer caught in the headlights and this could lead to big losses.

Volatility is just one of the many factors that goes into deciding on a particular trade. It definitely plays a role, but will never be the sole factor in deciding whether or not to make a trade.