Options, Not Outrights, In Seasonal Trades
Trade Crude Now
by John L. Momsen
Don't brush aside a straightforward futures trade just because you think it's too risky. Try combining seasonals with options -- you might be pleasantly surprised.
A simple option spread combined with a seasonal trade can not only increase the potential for a profit but also improve the risk/reward ratio of your trade. It can also open up the possibility of participating in trades you might have otherwise considered too high-risk for your trading account.
In the February 2000 STOCKS & COMMODITIES, I described a simple method of transforming a good seasonal trade into a great seasonal trade using a three-channel breakout method. You can also use various options strategies in place of straight futures positions. In fact, when the risk/reward ratio of one of my 41 seasonal trades is not to my liking, options may be preferable.
A QUICK REFRESHER
First, let me quickly remind you how my system works. For each of my 41 seasonal trades, all of which have rock-solid fundamentals, I overlay a simple three-channel breakout system. The first channel length is for the entry stop (only active during certain times of the year), the second for the protective stop, and the third for the trailing profit stop. The length of each channel varies with the individual trade.
For my crude oil #2 trade, the entry channel is five trading days (active from August 3 through September 1), the protective stop is three trading days, and the trailing profit stop is eight trading days (the exit day is September 27 on close). The seasonal chart for this trade can be seen in Figure 1. By using a simple channel breakout system, the actual market movement will signal when and where you should enter and exit a trade. (See sidebar "Crude oil seasonal trade #2" on page 56 for the TradeStation code.) Figure 2 displays the profitable results of this specific trade over the years.
Figure 1: Seasonal chart. For the crude oil #2 trade, the entry channel is five trading days, the protective stop is three, and the trailing profit stop is eight trading days.
THE DETAILS
It was the evening of August 30, 1999. A few days earlier, I had been stopped out of my first crude oil trade for a small profit of $260. The entry time window was still active and prices had risen close to the recent highs. It was very possible the market would activate another entry signal at $22.07.
I was ready to go with the new trade, but there was one problem. The three-day protective stop price channel low was at $20.59, making the potential risk for the trade $1.48/bbl. This risk was too high.
The graph of profitable trades in Figure 2 shows that the majority of winning trades had been under the $1,000 mark. I would be risking $1,480 to gain less than $1,000. The risk/reward ratio was out of kilter. Given that my research had shown I had a 73% probability of a winning trade, I'd be willing to take no less than a 1:1 ratio.
Figure 2: PROFITABLE Trade results. Here's how the profitable trade seen in Figure 1 fared over the years.
...Continued in the August 2001 issue of Technical Analysis of
STOCKS & COMMODITIES
John Momsen, who has been an active private trader for the last 27 years, can be reached at mumps@cyberg8t.com.
Excerpted from an article originally published in the August 2001 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2001, Technical Analysis, Inc.
Return to August 2001 Contents