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Option Trading in Practice – Week 1

17 May 2018,

Dear readers and traders, here is the first part of our practical series on gas option trading. This week you will enjoy our reports a bit more than usual, because we have to catch up with time slip. So, I have decided that today I will describe you trading in the first week of May, and right after I will describe what happened in the second week of May. By the next week, from Thursday you will be able to download all the reports (directly generated from the broker) after logging in to the client section here on the Quastic, reports will include my comment. I will inform you about new trades (with your agreement of course) by e-mail.

  1. Trade description

On May 1st, we entered to our first gas trade. It was a short position on natural gas realized through the option position BOIL 18’May 27.0 CALL. We have shorted 9 call options on our account with EUR 80,000, representing an exposure of about USD 48,000 (9 * 27 * 100 * 2) in dollars for natural gas. (9pcs * strike price * multiplier * 2x leverage for ETF BOIL). In the first trade, we have used about half of the account.

On one option, we have collected $ 116. This option expires in a less than a month. Once the option expires, our earnings within three weeks will be approximately $ 1045, which would correspond to an estimated 1% revenue per month. This roughly corresponds to our target for this account. The size of the position is certainly not conservative. Our expected return for the full year is 12% -15% pa, to which we also need to adjust the size of the positions. On the other hand, this exposure is not extreme.

Our fee for opened position is US $ 1.73, which represents $ 0.19 fee for one option. Thanks to the smart cost minimization system, we can trade at a discount of approximately $ 0.50 per option against standard of Interactive Brokers fees. We will talk about this system more in one of our next educative parts of this series. If we would trade with expensive brokers with a cost of $ 5 per option, we would pay roughly $ 43 more.

2. Reasons for trade

The reason we opened this position has many levels. We follow several levels at the same time.

(a) strategic,

b) technical-tactical,

c) fundamental.

First of all, the strategic level reflects that it is a leveraged ETF with a contango that is targeted for a long-term decline (see my series about ineffective ETFs). Therefore, we want to go generally short and use a short call option to create a short exposure.

Second, technical-tactical level, tells us that natural gas today is neither oversold nor overbought. If natural gas would be overbought, we would have chosen strikes rather bellow the spot price to make our short more aggressive. Conversely, if the gas would be oversold, we would rather kept ourselves out of the market or have selected strikes well above the spot price. However, the current state of gas in the neutral band offers the opportunity to place the strike slightly above the spot price (which creates a defensive pillow) and still go for an interesting bonus in% p.a. expression.

The third level we want to talk about is a fundamental one. Here we are not able to describe all the fundamental factors we are following in one article. These include weather factors, LNG exports, gas and coal competitiveness, gas extraction costs, etc.

Today, I will show one of the fundamental factors, for example, the year-on-year growth rate of natural gas production. This suggests that there is a significant increase in production. If we carefully analyze all the data, we find that the structural demand for gas (adjusted for weather conditions) is growing at a much lower rate. This suggests that there is pressure to build up reserves for the future, and hence the potential pressure for a fall in natural gas prices. That’s one of the reasons why we started trading with short positions.

 

Obr.1: Meziroční změna produkce zemního plynu

Figure 1: Year-on-year change in natural gas production

 

3. Account report

Since the new section for sharing weekly reports is now being prepared on Quastic, let me now show you a few basic data directly from the report generated (1-4 May).

Account Overview - základní přehled klíčových charakteristik účtu

Figure 2: Account Overview – A basic overview of key account characteristics

 

Risk measures - analýza rizik a základní ukazatele

Figure 3: Risk measures and basic indicators

 

Obr.4: Trade Summary - obchody realizované za sledované obdo

Figure 4: Trade Summary – Trades over the given period

 

 

A detailed pdf report will be available during the next week after logging in to your client section on Quastic, as I mentioned, I will inform you about new trades as well as you will have a weekly summary sent via e-mail. So, if you are interested in this information, please enter your e-mail address in the box below.

 

Option report

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02-2018-05-11-account-overview

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