Iran has threatened to close the Straits of Hormuz in retaliation for the EU embargo of Iranian oil and other sanctions. This would block about 12 percent of world oil production from leaving the Persian Gulf. The US Navy Fifth Fleet patrols the Persian Gulf, Red Sea, Arabian Sea, and the African coast down to Kenya. One of it carriers, the USS John Stennis recently passed through the Straits of Hormuz during Iranian naval exercises in the area. Should Iran choose to follow through with its threat it would sure come head to head with US Naval forces in the area. Part of the reason for Iran’s threat to close the straits is that Saudi Arabia and other Persian Gulf oil producers have indicated that they will ramp up their own production to make up for what the world might lose if Iran production finds no buyers. In this sort of impending crisis options trading allows traders to hedge investment risk. If, for example, a trader buys calls on oil futures he will be expecting them to go up. If Iran comes to its senses, agrees to open its facilities inspection, and forego any attempt to develop nuclear weapons sanctions could be lifted and the price of all would likely fall. By purchasing calls on oil futures instead of buying calls the trader hedges his risk when trading oil after an incident such as the EU embargo of Iranian oil.

If a trader chooses trading options on oil futures instead of buying options he is leveraging his investment capital. The costs of options are commonly much lower than the costs the commodities themselves. If the EU embargo of Iranian oil leads to a substantial rise in oil prices the trader can execute the options contract and profit. He will have done this with substantially less capital than if he had purchased oil directly. This argument applies primarily to oil producers and refiners but also to transportation companies such as airlines who can hedge their fuel price risk by trading options on oil as opposed to buying huge stocks in anticipation of a price rise. Although such times are worrisome they can go good times for trading options as futures prices may rise and fall precipitously in response to actions of or threats by the principals involved.

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Useful Specifics

• Nonfarm payroll rose by 200,000
• The most job gains occurred in transportation, warehousing, retail, manufacturing, health care, and mining.
• Total unemployment stands at 13.1 million
• The unemployment breakdown by major groups is as follows:
  • Adult men: 8%
  • Adult women: 7.9%
  • Teenagers: 23.1%
  • Whites: 7.5%
  • Blacks: 15.8%
  • Hispanics: 11%
  • Asians: 6.8%
• Long term unemployed (>27 weeks): 5.6 million, 42.5 % of total unemployment
• The number of part time workers whose hours have been cut or who are working part time as they are unable to find full time work declined by 371,000 to 8.1 million in December.
• Two and a half million people have worked in the last twelve months or looked for work during that time but have not looked for work in the last four weeks.

So, in what sector do you trade options on the US economic recovery? If you are interested in Forex options trading you need to compare the US economic figures with those of Europe, Great Britain, Japan, or whatever nation whose currency you choose to trade. As Europe sinks deeper into its debt dilemma there could be a steady rise in the dollar versus the Euro. If this turns out to be the case traders could profit by scalping profits on the falling EUR/USD ratio as the dollar climbs and the Euro falls.

Are US stocks the best way to trade options on the US economic recovery? Many thought so last year but the rally fizzled out mid-year. Of course one of the reasons that traders buy options is that they can limit their risk. Even if an options trader expected US stocks to continue to rise, or fall, and was mistaken his losses were limited to the price of the options contracts he purchased. For those who read the markets correctly the leverage offered by purchasing options provided greater return on investment that traders would have earned if they had simply bought and sold or sold and bought stocks. In the case of those who wish to trade options on the US economic recovery with commodities options, traders need to consider what a recovery economy does to various commodities. For example, oil prices rise with a recovery economy while those trading gold options may well see bullion fall.

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The recent EU summit arrived at two useful solutions. One is that going forward Euro Zone economies will be more closely linked, with the end result that it will harder for nations to overspend. The other is that the European Central Bank now has more flexibility and independence in dealing with both insolvent banks and insolvent nations. The bank recently made loans of roughly half a trillion Euros to stabilize the continental banking system. Investors and traders were first relieved that the bank was putting things in order. Then everyone seemed to change their minds and worry that the various banks needed so much money in the first place. Nevertheless, the fact that the EU seems to have a clearer game plan and that they are taking firm action seems to have pleased the markets. The French austerity plan is a good case in point. Now the news that manufacturing is stronger in Germany, the continent’s leading manufacturer, leads traders and investors to believe that a Euro Zone recovery is in the works. It also does not hurt that manufacturing in China came in ahead of forecasts and that the US economy seems to be finally picking up steam.

A Euro Zone recovery will not necessarily mean that all stocks will rise. For example, investors and traders are more interested in German companies as the German economy is stronger and more stable. As evidenced by the rise in stocks and fall in the Euro recently it could well be that a developing Euro Zone recovery might not be linked to a stronger Euro, at least in the short term. This is, of course, one of the reasons why many buy options. Whether it is dealing with volatile foreign currency rates or a chaotic stock market, traders can hedge their investment risk when buying calls or puts on stocks or currencies. Likewise the ability to leverage investment capital gives options traders the opportunity to multiply their gains should a strong Euro Zone recovery emerge.

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The extreme polarization of US politics has tended to make effective governance a remote possibility, just at the time that cool heads and compromise should be the order of the day. If the dollar falls, if interest rates rise, or if stocks plummet trading options on equities or trading options on futures contracts could be lucrative even though the worldwide economy could fall into the second dip of a prolonged recession. Whether one looks to trade puts on oil or profit by buying calls on Caterpillar , predicting how the US and Europe will deal with mounting debt is critical. In a sense much of options trading today is proxy for trading options on US debt.

There are two time frames to consider when trading options on US debt by proxy with stocks, currencies, or interest rates. Over the long term both Europe and the USA need to reduce their debt burdens or do the previously unthinkable, devalue their currencies. If the two greatest economies in the world do not fix their debt issues the Forex world will devalue their currencies for them. Depending on the stock this may be a good or a bad thing. Companies that make things in Europe or the USA would benefit from cheaper currencies as their products would be more attractive in other markets. A perpetually falling dollar would tend to drive up interest rates, which would provide traders with further opportunities. All of this could play out over years. For such longer term issues traders might consider longer term options such as LEAPS. One can trade options on futures contracts that come due ten years hence but the options contract only last a few months. The other time frame is now. There are things going on today that will shape tomorrow. For example, the so called Super Committee was given exceptional powers in order to find a way to save a trillion dollars or so over the next ten years. Their apparent miserable failure is already driving markets and providing opportunities for currency, commodity, interest rate, or stock options trading as proxies for trading options on US debt.

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Hedging risk with options is done to protect investments and cash flow. Thus the company or individual doing this limits himself to the stocks he owns, the currencies he trades, or the commodities that he buys and uses or makes and sells. Beet farmers trade options on beet futures and airlines trade options on aviation fuel of simply crude oil. Companies in the US dealing with companies in Europe may need to trade options on the Euro. This limits the range of equities that these folks trade but, since they are protecting their investments that is the limit of their interest. On the other hand a currency speculator can choose the currency on which he wants to trade options based solely on profit potential. He can buy calls on gold or sell puts on oil simply because he expects to profit from a big price move.

The risk scenario is different for those hedging risk with options versus speculators. A US company buying machine parts from a German company will need to pay in Euros, no matter what the exchange rate. The only risk the company sees is a change of the exchange rate between signing a business contract and payment for receipt of the product. The company already has the cash or credit to make payment and there is typically no leverage involved. On the other hand a currency speculator may sell puts on the Euro versus the Yen if he expects the Euro to recover. He will be making this trade using a margin account and stands to lose the entire margin account or even more if the EU comes not come to happy resolution of the debt dilemma and the Euro falls significantly instead of rising. This same scenario plays out when buying puts on LinkedIn or any other stock. The risk of substantial loss when selling puts and calls is why the business of selling puts is commonly limited to large institutional traders with very deep pockets. Large US multinationals may have even deeper pockets but their business in hedging risk with options is commonly limited to reducing currency risk in international business transactions.

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Starbucks has been a great success story. The stock sold for less than a dollar share twenty years ago and sells for forty-four dollars a share today. However, the company has grown in two waves, separated by a dive in stock price from around thirty-seven dollars a share in late 2006 to roughly eight dollars a share in late 2008. When sales began to lag during a period of continued expansion Howard Schultz resumed control of day to day operations. Hundreds of stores were closed in the US and worldwide. Food menus were changed and the company moved back to a more coffee-based experience, its original and ongoing intent. Along the way trading options on Starbucks has been profitable a number of times as the stock has advances and retreated on its way up, in both waves. How to trade options on Starbucks over the years and now does not really differ from trading other stocks.

Successful options traders watch stock fundamentals. There is a widespread belief that Starbucks cannot keep growing forever without diluting its value. That is certainly what seemed to have happened in 2006 when same store sales in many locations were dismal and the company was putting up store across the world. The bloodletting of then next two years removed hundreds of unprofitable stores and refocused Starbucks strategy. Nevertheless traders watch Starbucks financials every quarter looking for weakness in sales. The company is moving in China in a big way with five hundred stores as of late 2011 and a goal of 1,500 stores by 2015 in a so far successful effort to convert a tea drinking culture to coffee drinkers. A successful options trading strategy for Starbucks will likely include a close look at technical price patterns in order to anticipate changes in market sentiment. As the company continues to grow it is likely that the issue will continue to arise as to whether Starbucks can increase return on investment along the way.

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The end of October market adjustment is consistent with profit taking by those who successfully anticipated the rise in stock prices over the month. Many believe that US fundamentals are improving and that the many US companies sitting on substantial sums of cash will eventually start using that cash for R&D, expansion, or other purposes that will result in job growth and a stronger economy. Those folks will likely use the most recent retreat to buy calls on promising stocks. Those day trading options, on the other hand will likely just follow the shorter term corrections of the market. These folks virtually never buy stocks but rather buy and sell options contracts, essentially scalping profits from the market as it moves up and down. Successful options trading does not come from trading options on rumors . It comes from skillful analysis and execution of trades.

In day trading options traders look at both fundamentals and what other traders are doing. In options trading education traders learn than fundamental analysis for day trading options is really no different than what one does for trading stocks directly. Traders look at the intrinsic value of a stock and at its margin of safety. Then they use technical analysis to track stock prices and options prices. Markets tend to repeat themselves and technical traders believe that by watching a specific price pattern develop that they can predict, solely on this basis, where a stock price or options price will go next. This approach is especially useful when day trading stocks directly and day trading options. The fundamentals of the stock many not have changed from when the market opened until it is ready to close but traders will often have bid a stock price up and down in an effort to profit from further expected movement.

In day trading options, as in other stock options trading , smart traders always use trading stops. This means that when a trader buys calls on a stock at a given price he sets a limit order for the opposite trade on the same stock at a slightly lower price. In this way he avoids losing the value of his contract if new, negative fundamentals emerge. As the price of the stock and the option rises he will steadily increase his stop loss limit order. He will also decide on a reasonable amount of profit to expect and, hopefully, execute at the top of the price curve before a fall, when day trading options.

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One of the problems for Netflix and an issue for those trading Netflix options to consider has to do with the company changing its business model. Netflix essentially drove Blockbuster and many other video stores out of business allowing customers to order movies from home and have them delivered by US mail. There was no more going to the video store only to find out that all of the copies of all of the most recent movies had already been rented out. Prices were competitive and customers were happy. Share price went up astronomically. Then the company decided to offer streaming video to its customers. It talked briefly about splitting into two companies, one that offered movies delivered by mail and the other that offered streaming video but that never happened. Experts in the area generally believe that Netflix is being held captive by the content producers in this instance, paying millions of dollars for the right to broadcast movies that are already available on CD. Raising their charges as well seems to have been the last straw for nearly a million previous customers. How to trade stock options successfully always requires a clear sense of the fundamentals of a company. Market sentiment can take a stock price very high or very low but the price will eventually land where cash flow and corporate assets dictate. Right now Netflix is in a tough place. They were probably overpriced, although foreign markets remain largely untapped. A price correction was probably in the cards anyway, both for the stock price and Netflix options price as well. However, with the company changing its business model investors are not sure just exactly how valuable the company is. If they insist on going with streaming video they may just end up being held captive by and eventually taken over by one the content producers. If they give up the movie by mail business they take away the main asset by which investors valued to company. We are not suggesting either calls or puts on Netflix but suggest that those interested in trading Netflix options study the situation carefully.

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The VIX is weighted measure of options on the S&P 500 index. It measures out of the money calls and puts. The VIX uses a mathematical formula to produce its number. Many traders are just as happy measuring simple past volatility as in using the VIX to predict future options and stock prices. An interesting comparison to VIX related stock gains is one of the Japanese Candlesticks, the Doji. This easy to read set of symbols has been in use for centuries, having had its origin in rice trading in ancient Japan. The Doji candlestick is vanishingly short with long upper and lower shadows. This signal tells us that the equity involved opened and closed at nearly the same price but that it traded substantially higher and lower during the trading period measured. It is considered a measure of market indecision and typically precedes a market turnaround. In this sense it is like the VIX which indicates volatility but not necessarily the direction in which options or stocks will move. A large part of options trading education is, in fact, to learn to use these tools effectively and profitably.

The current issue occupying the options market is the state of European debt crisis. Interestingly only a small percentage of US exports go to Europe and US banks are said to have little exposure to the national debts of the five PIIGS nations (Portugal, Ireland, Italy, Greece, and Spain). Nevertheless the ongoing drama across the Atlantic seems to be impeding an otherwise promising US recovery as companies hold off on investments due to uncertainty about the global financial situation. The stock market has lost ground in big swings and sentiment has become bearish. A number of analysts are making the point that when virtually everyone thinks the market is bad that it is time for the market to turn around. This sentiment is in line with the history of VIX related stocks gains after the VIX hits historic highs. A reasonable way to interpret a really high VIX is that the market has overshot on its way down, due to individual investor and trader panic. Memories of the 2008 crash are fresh and no one wants to get burned again. However, there comes a point when stocks are woefully undervalued and it is time to buy. Those who believe that the market is set to rally can take advantage of options trading leverage and buy calls with the possibility of substantial profits if the market produces VIX related stock gains. As always we are not suggesting trading the S&P 500 or any particular stock or option. Rather we suggest that options traders learn to use and consider all market indicators when trading.

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Some finely made copper products require stock piling before use and uses of petroleum products, such as airlines trade copper and oil options in order to secure a stable, and favorable, price for purchase of these products. An early sign that China was starting to lead the way out of the recession a year or more ago was the report that Chinese electrical appliance device manufacturers were ordering large quantities of high quality copper wire of the type used in high end computerized products. In options trading traders will buy calls on oil and copper futures if they believe that the economy is recovering and puts on oil and copper futures if they believe that the economy is falling. Currently prices are falling and those who purchased puts in copper and oil options trading have profited. The ratio of puts to calls in copper and oil options trading is also useful in predicting the profitability of stocks. ExxonMobil – XOM – the oil company and Freeport-McMoRan Copper & Gold Inc. – FCX – who mine copper and gold are obviously affected by changes in oil or copper demand. Delta Airlines – DAL – and other transportation stocks are affected by high oil prices and a falling economy whereas companies like Hewlett Packard – HPQ – are directly affected by a falling economy.

Copper at its lowest price in nearly ten months and oil futures fell almost three percent in recent trading. Those who believe that we are headed for another dip in the recession may be interested in buying puts in both copper and oil options trading. As the primary issue right now is the Greek debt bailout traders in copper and oil options, and virtually everyone else, are reading about the results of recent German elections in which voters expressed dissatisfaction about the willingness of German Chancellor Angela Merckel to risk German assets in propping up what Germans see as a profligate government in Greece. Factors as wide ranging as US Federal Reserve policy and the pronouncements of both European central banks and Chinese lenders have a bearing on copper and gold options trading both directly through the commodities markets and indirectly through stocks affected by oil or copper prices. Copper and oil options volatility are high these days due to the uncertainty of the markets. However, trading options on these commodities typically helps the investor limit his investment risk as his risk is limited to the price paid for the option in question.

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