Futures Markets: How to Take Advantage of the Selloff

To take advantage of increased volatility in the futures markets Thursday, sell puts on the June SP500 and euro currency futures contracts.
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CHICAGO (TheStreet) -- In early Thursday morning trading action, we are seeing many of the futures markets sharply lower. Some jitters on corporate earnings and renewed fears about the state of Greece's economy and sovereign debt issues appear to be taking their toll on markets this morning. Add to that the continued uncertainty over the fate of Goldman Sachs and the financial reform bill, and you have a recipe for risk aversion. And from what I am seeing, it looks as if investors are doing just that -- shedding risk. When markets see sharp selling such as this, volatility goes up-and therefore option prices typically go up as well. Here are two ways to try to take advantage of the increased volatility this morning:

Sell puts on the June SP500 futures contract.

For investors who feel we are seeing a minor correction, and that the market will resume its uptrend, this is one way to take advantage of the sell-off. Look to sell the May 1100 put option for a premium of 5 points or better. In dollar terms this is equal to $1250. With commissions and fees not exceeding $50 per contract, this would net the investor $1200. This option has 29 days until expiration and expires on May 21. This is a marginable position that carries with it unlimited and substantial risk.

The investor can lose money if forced to liquidate the position due to a margin call or adverse market movement. The investor may also choose to close the position with losses any time prior to expiration without a margin call. An investor must determine his or her own tolerance for risk on a position. The break-even on this position at expiration is 1095.20 on the June futures contract. Below the break-even price, the investor will lose $250 per every point on the June SP futures contract.

The position can potentially profit in two ways. First, if there is a decrease in volatility, the option prices may deflate in which case the option seller may potentially profit. Secondly, if the investor holds the option until expiration and the June SP500 futures contract is above 1100 the investor can earn the maximum profit of $1200. (The premium collected minus commissions and fees.) The investor can also close the position with a possible profit at any time prior to expiration. Selling of options is not suitable for all investors. The risk of loss is substantial. An investor can lose more than the original investment.

Sell puts on the June euro currency futures contract.

I recommend selling the June 127 put for a premium of 45 points or better. In dollars this equals $562.50. With commissions and fees not to exceed $50 per contract, the investor would net a credit of $512.50. This option has 43 days until expiration. The expiration date is June 4. This is a marginable position that carries with it unlimited and substantial risk. The investor can lose money if forced to liquidate the position due to a margin call or adverse market movement. The investor may also choose to close the position with losses at any time prior to expiration without a margin call.

The investor must determine his or her own tolerance for risk on a position. The break-even on this position at expiration is 125.59 on the June euro currency futures contract. For every point below the break-even price, the investor will lose $12.50 per point. This position may potentially profit in two ways. First, if there is a decrease in volatility, the option seller may possibly profit if option prices deflate. Secondly, if the investor holds the option until expiration and the June euro currency futures contract is above the strike price of 126 the investor will earn the maximum profit of $512.50 (The premium collected minus commissions and fees.) The investor can also close the position with a possible profit at any time prior to expiration. Selling of options is not suitable for all investors. The risk of loss is substantial. An investor can lose more than the original investment.

-- Written by Matt Zeman in Chicago

Matt Zeman is a principal with Lasalle Futures Group and chief market strategist for Time Means Money.Com.