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CME OPTIONS ON NIKKEI 225 FUTURES – ENHANCING THE STOCK INDEX RISK MANAGEMENT REPERTOIRE

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JOHN NYHOFF

Nikkei 225 futures, and in particular CME’s Nikkei 225 futures, have experienced significant growth during 2013, motivated by optimism for the Japanese economic outlook. To help equity market participants take advantage of this changing Japanese economic landscape CME Group will introduce both quarterly and serial options on Yen Denominated Nikkei Stock Average futures on CME Globex beginning at 5PM on January 12, 2014 for trade date January 13, 2014.

CME Group

CME Group

“Abenomics” has been the recent catalyst for increased activity in Japanese cash equity market and Japanese equity derivative market activity. Abenomics refers to the economic policies implemented in Japan under the direction of Prime Minister Shinzo Abe. The three pronged approach of Abenomics includes – monetary stimulus; fiscal stimulus; and, structural reforms. The intent of Abenomics is to jumpstart Japanese economic growth, which has been quite lackluster since the late 1980s.

It is an understatement to indicate that the Japanese equity market has reacted very favorably to Abenomics. The Nikkei 225 index, Japan’s premier equity market index, rallied more than 50% from December 28 2012 through the closing level posted on May 22, 2013. Subsequently, the Nikkei 225 declined more than 20% from late May 2013 through mid-June 2013, before recovering substantively. As of November 8, 2013, the Nikkei 225 index has appreciated slightly more than 35.5%. This price pattern is illustrated in the Nikkei 225 Index chart below:

nikkei225

nikkei225

An alternative way of viewing the recent heightened Japanese equity market price volatility is through the lens of Nikkei 225 Index 20-day historical volatility (20-day HV). During late 2012, the range for Nikkei 225 20-day HV lingered in the 12% to 16% range. The strong early 2013 Japanese equity market rally propelled 20-day HV into the 20% to 30% range. Historical volatility exploded along with the Nikkei 225’s strong price declines in late May/early June 2013, peaking near 52%, before reverting back towards the recent 20% level. The historical volatility pattern is shown in the Nikkei 225 Index 20-day Historical Volatility chart below:

nikkei225

nikkei225

A significant increase in Nikkei 225 futures trading activity has coincided with the recovery in the Japanese equity market and the increase in realized volatility. Trading volume in CME’s Yen Denominated Nikkei 225 futures has increased more than 100% to nearly 47,000 contracts per day during the first ten months of 2013, while Nikkei 225 futures volume at the Osaka Securities Exchange has increased more than 77% during the same time period.

This substantial Nikkei 225 futures volume trend has created demand for options on Nikkei 225 futures, a contract that CME has introduced which can be cleared at CME. Japanese equity market participants have been seeking an alternative method of gaining exposure to the equity market price shifts. The introduction of CME options on Nikkei 225 futures gives traders an enhanced set of tools by which they can establish market exposures than can’t be accomplished with futures contracts alone.

The potential options on futures strategies that may be used include, but are not limited to: limited risk price directional positions associated with long option exposure and/or debit vertical spread exposure; long or short volatility trading positions via traditional straddle or strangle positions; income enhancement positions via covered option writing programs;, time value capture related positions via butterfly, condor or horizontal spreads; as well as dynamic portfolio reweighting programs via strangle writing strategies.

CME will introduce options on Yen Denominated Nikkei Stock Average futures on CME Globex beginning at 5PM on January 12, 2014 for trade date January 13, 2014.

CME options on Yen Denominated Nikkei futures will be listed on 2 quarterly cycle months (March/June/September/December) and 2 serial months (January/February/April/May/July/August/ October/November) listed at any time. The cycle month options will feature American-style exercise, whereas the serial month options will feature European-style exercise.

Serial month options will be automatically exercised into CME Yen Denominated Nikkei futures based on a fixing price determined by trading activity in the mini Nikkei futures at the Osaka Securities Exchange (OSE) during the last thirty seconds of cash equity market trading on the serial option expiration day. Contrarian instructions are not permitted for serial options on CME’s Yen Denominated Nikkei Stock Average futures.

Quarterly CME Yen Denominated Nikkei Stock Average futures will settle to a Special Opening Quotation (SOQ) of the Nikkei 225 index on the second Friday of the expiration month. In-the-money options on CME’s Yen Denominated Nikkei Stock Average futures are automatically exercised on expiration day into the underlying futures contract, which is then marked to market against the Nikkei 225 Stock Average SOQ.

Futures and options trading is not suitable for all investors, and involves the risk of loss. Futures and options are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.

Any research views expressed are those of the individual author and do not necessarily represent the views of the CME Group or its affiliates.

All examples are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.

All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT, NYMEX and KCBT rules. Current rules should be consulted in all cases concerning contract specifications.

JOHN NYHOFF

JOHN NYHOFF

About the Author:
JOHN NYHOFF
Executive Director, Financial Research and Product Development
John Nyhoff serves as Executive Director, Financial Research and Product Development of CME Group. He is responsible for developing interest rate and credit-related products. Previously, Nyhoff served as Director, Research and Product Development of CME since March 2006.

Before joining CME, Nyhoff most recently served as Executive Vice President and Co-Chief Operating Officer for Tokyo-Mitsubishi Futures, Inc., the futures subsidiary of Japan’s largest bank.  He worked for Tokyo-Mitsubishi since 1988, holding a variety of roles responsible for strategic planning, economic analysis, marketing and electronic trading including Senior Vice President, Trading & Research and Vice President & Chief Economist.  He also worked as an Options Specialist for SECTREND, a futures commission merchant that became part of Tokyo-Mitsubishi.  Nyhoff also served as Vice President for Refco, Inc. where he was responsible for recruiting new customers to derivatives trading.  He began his career as Senior Financial Economist for The Chicago Board of Trade.

Nyhoff earned a bachelor’s degree in economics from DePaul University, a master’s degree in economics from Northern Illinois University and a master’s degree in financial economics from Simon Graduate School of Business at the University of Rochester.  He has worked as a business statistics instructor at Northern Illinois University and has co-authored a number of publications, including Trading Options on Futures: Markets, Methods, Strategies & Tactics (John Wiley & Sons, 1988) and Trading Financial Futures: Markets, Methods, Strategies & Tactics (John Wiley & Sons, 1988).

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How has the online trading landscape changed in 2020?

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How has the online trading landscape changed in 2020? 1

By Dáire Ferguson, CEO, AvaTrade 

This year has been all about change following the outbreak of coronavirus and the subsequent global economic downturn which has impacted nearly every aspect of personal and business life. The online trading world has been no exception to this change as volatility in the financial markets has soared.

Although the global markets have been on a rollercoaster for some time with various geopolitical tensions, the market swings that we have witnessed since March have undoubtedly been unlike anything seen before. While these are indeed challenging times, for the online trading community, the increased volatility has proven tempting for those looking to profit handsomely.

However, with the opportunity to make greater profits also comes the possibility to make a loss, so how has 2020 changed the online trading landscape and how can retail investors stay safe?

Lockdown boost

Interest rates offered by banks and other traditional forms of consumer investments have been uninspiring for some time, but with the current economic frailty, the Bank of England cut interest rates to an all-time low. This has left many people in search of more exciting and rewarding ways to grow their savings which is indeed something online trading can provide.

When the pandemic hit earlier this year, it was widely reported that user numbers for online trading rocketed due to disappointing savings rates but also because the enforced lockdown gave more people the time to learn a new skill and educate themselves on online trading.

Dáire Ferguson

Dáire Ferguson

A volatile market certainly offers great scope for profit and new sources of revenue for those that are savvy enough to put their convictions to the test. However, where people stand the chance to profit greatly from market volatility, there is also the possibility to make a loss, particularly for those that are new to online trading or who are still developing their understanding of the market.

The sharp rise in online trading over lockdown paired with this year’s unpredictable global economy has led to some financial losses, but with a number of risk management tools now available this does not necessarily have to be the case.

Protect your assets

Although not yet widely available across the retail market, risk management tools are slowly becoming more prevalent and being offered by online traders as an extra layer of security for those seeking to trade in riskier climates.

There are a range of options available for traders, but amongst the common tools are “take profit” orders in conjunction with “stop loss” orders. A take profit order is a type of limit order that specifies the exact price for traders to close out an open position for a profit, and if the price of the security does not reach the limit price, the take profit order will not be fulfilled. A stop loss order can limit the trader’s loss on a security position by buying or selling a stock when it reaches a certain price.

Take profit and stop loss orders are good for mitigating risk, but for those that are new to the game or who would prefer extra support, there are even some risk management tools, such as AvaProtect, that provide total protection against loss for a defined period. This means that if the market moves in the wrong direction than originally anticipated, traders can recoup their losses, minus the cost of taking out the protection.

Not a day has gone by this year without the news prompting a change in the financial markets. Until a cure for the coronavirus is discovered, we are unlikely to return to ‘normal’ and the global markets will continue to remain highly volatile. In addition, later this year we will witness one of the most critical US presidential elections in history and the UK’s transition period for Brexit will come to an end. The outcome of these events may well trigger further volatility.

Of course, this may also encourage more people to dip their toes into online trading for a chance to profit. As more people take an interest and sign up to online trading platforms, providers will certainly look to increase or improve the risk management tools on offer to try and keep new users on board, and this could spell a new era for the online trading world.

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Trading Strategies

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Trading Strategies 2

By Paddy Osborn, Academic Dean, London Academy of Trading

Whether you’re negotiating a business deal, playing a sport or trading financial markets, it’s vital that you have a plan. Top golfers will have a strategy to get around the course in the fewest number of shots possible, and without this plan, their score will undoubtedly be worse. It’s the same with trading. You can’t just open a trading account and trade off hunches and hopes. You need to create a structured and robust plan of attack. This will not only improve your profitability, but will also significantly reduce your stress levels during the decision-making process.

In my opinion, there are four stages to any trading strategy.

S – Set-up

T – Trigger

E – Execution

M – Management

Good trading performance STEMs from a structured trading process, so you should have one or more specific rules for each stage of this process.

Before executing any trades, you need to decide on your criteria for making your trading decisions. Should you base your trades off fundamental analysis, or maybe political news or macroeconomic data? If so, then you need to understand these subjects and how markets react to specific news events.

Alternatively, of course, there’s technical analysis, whereby you base your decisions off charts and previous price action, but again, you need a set of specific rules to enable you to trade with a consistent strategy. Many traders combine both fundamental and technical analysis to initiate their positions, which, I believe, has merit.

Set-up

What needs to happen for you to say “Ah, this looks interesting! Here’s a potential trade.”? It may be a news event, a major macro data announcement (such as interest rates, employment data or inflation), or a chart level breakout. The key ingredient throughout is to fix specific and measurable rules (not rough guidelines that can be over-ridden on a whim with an emotional decision). For me, I may take a view on the potential direction of an asset (i.e. whether to be long or short) through fundamental analysis, but the actual execution of the trade is always technical, based off a very specific set of rules.

To take a simple example, let’s assume an asset has been trending higher, but has stopped at a certain price, let’s say 150. The chart is telling us that, although buyers are in long-term control, sellers are dominant at 150, willing to sell each time the price touches this level. However, the uptrend may still be in place, since each time the price pulls back from the 150 level, the selling is weaker and the price makes a higher short-term low. This clearly suggests that upward pressure remains, and there’s potential to profit from the uptrend if the price breaks higher.

Trigger

Once you’ve found a potential new trade set-up, the next step is to decide when to pull the trigger on the trade. However, there are two steps to this process… finger on trigger, then pull the trigger to execute.

Paddy Osborn

Paddy Osborn

Continuing the example above, the trigger would be to buy if the price breaks above the resistance level at 150. This would indicate that the sellers at 150 have been exhausted, and the buyers have re-established control of the uptrend.  Also, it is often the case that after pause in a trend such as this, the pent-up buying returns and the price surges higher. So the trigger for this trade is a breakout above 150.

Execution

We have a finger on the trigger, but now we need to decide when to squeeze it. What if the price touches 150.10 for 10 seconds only? Has our resistance level broken sufficiently to execute the trade? I’d say not, so you need to set rules to define exactly how far the price needs to break above 150 – or for how long it needs to stay above 150 – for you to execute the trade. You’re basically looking for sufficient evidence that the uptrend is continuing. Of course, the higher the price goes (or the longer it stays above 150), the more confident you can be that the breakout is valid, but the higher price you will need to pay. There’s no perfect solution to this decision, and it depends on many things, such as the amount of other supporting evidence that you have, your levels of aggression, and so on. The critical point here is to fix a set of specific rules and stick to those rules every time.

Management

Good trade management can save a bad trade, while poor trade management can turn an excellent trade entry into a loser. I could talk for days about in-trade management, since there are many different methods you can use, but the essential ingredient for every trade is a stop loss. This is an order to exit your position for a loss if the market doesn’t perform as expected. By setting a stop loss, you can fix your maximum risk on a trade, which is essential to preserving your capital and managing your overall risk limits. Some traders set their stop loss and target levels and let the trade run to its conclusion, while others manage their trades more actively, trailing stop losses, taking interim profits, or even adding to winning positions. No matter how you decide to manage each trade, it must be the same every time, following a structured and robust process.

Review

The final step in the process is to review every trade to see if you can learn anything, particularly from your losing trades. Are you sticking to your trading rules? Could you have done better? Should you have done the trade in the first place? Only by doing these reviews will you discover any patterns of errors in your trading, and hence be able to put them right. In this way, it’s possible to monitor the success of your strategy. If your trades are random and emotional, with lots of manual intervention, then there’s no fixed process for you to review. You also need to be honest with yourself, and face up to your bad decisions in order to learn from them.

In this way, using a structured and robust trading strategy, you’ll be able to develop your trading skills – and your profits – without the stress of a more random approach.

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Economic recovery likely to prove a ‘stuttering’ affair

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Economic recovery likely to prove a ‘stuttering’ affair 3

By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.

As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.

Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.

We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.

Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.

Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.

China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.

Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund.  As is almost always the case, a messy compromise will probably end up being hammered out.

An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.

Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.

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