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The Greenrush Capital Report (GCR) is a weekly commodity market newsletter, combined with intra-day trading alerts. GCR is put out by Greenrush Capital Management, a diverse brokerage firm geared towards investors who are looking to start a long-term relationship with a full-service broker. The GCR is available on a subscription basis, but is complimentary to all our clients, whether you are self-directed, managed, broker-assisted, or full-service. Each report and alert consists of live trade recommendations for the global futures and options markets. We use futures, futures spreads and various option strategies, to help you to diversify your trading account by timeframe, technique, and market sector. Sign up today for this exclusive offer.

Markets are moving targets -- they are living, breathing organisms whose behavior is greatly affected by the emotion and psychology of those who trade them. While each individual market may be different than the next, they all share one thing in common: much like your spouse, they will act irrational and extreme one week, and then passive and inactive the next. 

All markets have the tendency to drift and oscillate within a trading range for days, weeks, and months on end. This can be a fantastic situation for option sellers, who watch the premium purchased by option buyers dwindle into dust. On the other hand, markets will have periods where they act wilder than Britney Spears at a Vegas buffet. Trend-less markets with low statistical volatility (SV) can provide awesome setups for massive breakouts, while nut-bar jerky markets with high SV can provide equally marvelous approaches to play for a reversion to the norm. 

The most straightforward way to trade volatility skews (under the appropriate conditions) is to buy straddles in low volatility situations and, conversely, sell strangles in high volatility situations. While the risk/reward profile is different for each strategy, each distinct environment can be quite lucrative for the savvy option trader, just so long as you keep in mind a few rules of thumb.

Very briefly: A long straddle is the simultaneous purchase of an equal number of puts and calls, with the same strike price and expiration dates. Buying straddles offers us unlimited profit potential and a defined downside risk. On the contrary, a short strangle is an option strategy in which an out-of-the-money call and an out-of-the-money put of the same month are sold. Selling strangles offers us limited profit potential and theoretical unlimited risk. Both strategies are not directionally biased when it comes to price; when we buy a straddle, we don’t care which way the market moves, we just want it to move quickly and violently. When we sell a strangle, we don’t care which way the market moves, we just want it to calm down.

One reason I like buying straddles and selling strangles is based simply on the notion that volatility, unlike price, is cyclical and persistent. A market’s volatility is merely how much prices change over a given period of time. Volatility tends to run in cycles, increasing and peaking out, then decreasing until it bottoms out, and round and round we go. Essentially what we bet on when we buy straddles is that we know, with some mathematical certainty, that periods of extremely low volatility tend to be followed by periods of more normal or average volatility. When we sell strangles we assume that periods of high volatility tend to be followed by periods of more normal or average volatility.

The most important thing for you to know is that you Buy low volatility options & sell high volatility options -- that should be your option trading mantra. 

Let’s keep it simple, and look at a long straddle and short strangle that offer what I think as a high probability for success, in both the short term and the long term.

MARCH 2009 SUGAR STRADDLE (SBH9)

Option Straddle: Buy a SBH9 11 cent call & an 11 cent put to open a long straddle for 195 pts or better ($2,184 / straddle)
Expiration Date: 2/17/2009 (459 days)
Desired Risk: Risk is limited to premium paid. We would look to exit the trade if the straddle price falls below 150 pts (a loss of $504 / straddle)  
Target: Look to exit the straddle if it moves above 300 pts (a gain of $1,176 / straddle)
Why: Sugar had an amazing run higher from March 2004 to March 2006, almost quadrupling in price in that short time frame. Equally impressive was the dump that followed -- prices have fallen by more than 50% over the last 18 months. Since the lows from mid-June, sugar option volatility has been dead in the water. The chart below of the straddle exhibits quite clearly how volatility has been falling in the market. As we approach critical support levels on the underlying charts, we are anticipating that things will start to pick up again in the sugar market soon. Remember -- with this position we don’t care if prices explode higher or crash lower -- all we want to see is a big move.

If you cannot view the Sugar chart, go here.

DECEMBER 2007 LEAN HOG STRANGLE (LHZ7)

Option Strangle: Sell a LHZ7 50 put and a LHZ7 56 call to open a strangle write, collecting 180 pts or better ($720 / strangle)
Expiration Date: 12/14/2008 (28 days)
Desired Risk: Theoretically unlimited risk. We would look to exit the trade if the strangle price exceeds 320 pts (a loss of $560 / strangle)  
Target: Look to collect the full premium ($720 / strangle), if the market expires between 50 and 56.  
Why: Hog prices have collapsed over the last few months, with record large supplies of slaughter ready hogs available to processors. Volatility has exploded over the last few weeks as this deeply oversold market has started to perk up. We think this market should chop around over the next few weeks as we figure out which way to go, and with option IV at 2 year highs, a strangle write could be the way to go. Eroding time value is our agenda here. 

If you cannot view the Lean Hog chart, go here.

Conclusion

I think the reason why most people lose so terribly when they buy options is because they don’t take the time to decide which options are the right ones to buy, or even if an option-buying strategy is appropriate in the first place. Forget calling the direction of the market correctly, because that’s not the purpose of the article -- I’m more concerned here with using the appropriate line of attack.

Look, any and every trade has the possibility of being a winner. The key to successful trading is putting probability on your side. When I trade, I’m not trying to hit home runs. In keeping with the baseball analogy, I’m looking to make contact with the ball and advance the runners. If you try to crush the ball out of the park, you may achieve that goal, but more often than not, you’ll end up falling face first in the dirt. 

There are times when a trader needs to be on the defensive -- you need to realize that trading is not ALWAYS about making money. Much of the time it’s about NOT losing it! Minimizing drawdowns and using strict money management are what will keep you in the game for the long term. When I put on a trade, I remove my ego from the equation, and I use vehicles that provide me with the best opportunity to pull more money out of the trade than I put in.
 
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DISCLAIMER -- THE RISK OF LOSS IN TRADING COMMODITIES CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. PAST PEFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. FUTURES & FUTURES OPTIONS TRADING IS COMPLEX AND CAN EXPOSE YOU TO UNLIMITED RISK. NONE OF THE TRADES DISCUSSED TAKE INTO ACCOUNT FEES, COMMISSIONS, OR SLIPPAGE, ALL OF WHICH CAN NEGATIVELY IMPACT YOUR TRADING RESULTS. ALL TRADE CONSIDERATIONS LISTED BELOW ARE MERELY IDEAS THAT ARE SUBJECT TO CHANGE BASED ON MARKET FACTORS. CONSIDERATIONS MAY HAVE NOT YET BEEN AND MAY NEVER BE EXECUTED BY GREENRUSH CAPITAL MANAGEMENT, LLC. INFORMATION PROVIDED IS COMPILED BY SOURCES BELIEVED TO BE RELIABLE. GREENRUSH CAPITAL OR ITS PRINCIPALS ASSUME NO RESPONSIBILITY FOR ANY ERRORS OR OMISSIONS AS THE INFORMATION MAY NOT BE COMPLETE OR EVENTS MAY HAVE BEEN CANCELLED OR RESCHEDULED. ANY COPY, REPRINT, BROADCAST OR DISTRIBUTION OF THIS REPORT OF ANY KIND IS PROHIBITED WITHOUT THE EXPRESS WRITTEN CONSENT OF GREENRUSH CAPITAL MANAGEMENT, LLC.

Drew Klein is President of Greenrush Capital Management LLC, an introducing brokerage and CTA based just outside of Los Angeles, California. Drew has been a member of the National Futures Association in good standing since 2001 and has worked for some of the largest options firms on the West Coast. Drew has been quoted in the Dow Jones print media and recently was a presenter at the Wealth Expo in New York City.

Greenrush specializes in managed accounts and full-service retail brokerage for the more sophisticated client. The firm also offers an aggressive commission schedule to self-directed traders. Drew is a member of the Sigma Chi Fraternity, an organization whose trader hall-of-fame includes the legendary Larry Williams and Ed Seykota.

The Greenrush Capital Report (GCR) is a weekly commodity market newsletter, combined with intra-day trading alerts. GCR is put out by Greenrush Capital Management, a diverse brokerage firm geared towards investors who are looking to start a long-term relationship with a full-service broker. The GCR is available on a subscription basis, but is complimentary to all our clients, whether you are self-directed, managed, broker-assisted, or full-service. Each report and alert consists of live trade recommendations for the global futures and options markets. We use futures, futures spreads and various option strategies, to help you to diversify your trading account by timeframe, technique, and market sector. Sign up today for this exclusive offer.