The DeCarley Perspective Trading Newsletter
"Free" sugar trade with an option spread
This text was sent to DeCarley brokerage clients on May 14th 2015.
There is substantial risk of loss in trading futures and options.
Past performance is not indicative of future results
On the commodity radar:
* Sugar is relatively cheap, and the seasonal low is looming (monday to be exact). Let's try the upside with an option spread.
"Free" trade in sugar
Our normal "go to" strategies won't really work in sugar given the fact that there isn't a contract month between July and October, there are some liquidity issues in the serial option months, and the options tend to be priced unfavorably for what we are trying to accomplish (low cost/high probability trade). So let's try something a little different...we can create an option spread in which there is no out of pocket expense to execute the trade. However, keep in mind that although the trade is "free", it does require a small margin requirement (less than $1,000) and does come with downside risk.
Specifically, we can purchase the October 1325 call for about 73 ticks, sell the 1425 call for about 37 ticks, and then sell the 1225 put for about 39. The net result should be an even money spread, or maybe even a small credit.
In a nutshell, the primary option in this spread is the long 1325 call; thus it is a bullish position. The other legs of the spread are simply a way to pay for the 1325 call. In other words, instead of paying 73 ticks for the 1325 call, we are selling a call and a put to enter the position using the market's money. The opportunity cost of doing so is accepting theoretically unlimited risk if the market drops below 1225, and giving up the profit potential above 1425.
The max profit of roughly $1,100 on this trade occurs if sugar is above 1425 at expiration. As long as the market is above 1225 at expiration the trade will either break even, or turn a profit. The only way this trade loses at expiration is if the price of sugar is below 1225 at expiration.
In light of the upcoming seasonal tilt, the weaker dollar, and relatively low pricing, we believe the odds of the market being above 1225, and even 1425 125 days from now are favorable.
**Past performance is not indicative of future results (seasonal data tells us what has happened in the past, not necessarily what will happen in the future).
**There is unlimited risk in selling options!