Calling On XJO Options Part 2

Following on from last week’s article on XJO options, let’s have a look at some real trades. The SPI 200 and the XJO have seen a short retracement over the last few days. As we are still technically in an up trend, this retracement now offers a potential bullish trade.

In this case we are going to assume a long call is the strategy we are most comfortable in using. Buying a call will give us the ability to buy at an agreed price that will potentially be attractive in the future if the market continues an up trend. Based on the long trade currently forming, as well as previous forecasts from Tom, Noel and David, a conservative price target of 3600 by the end of July ’04 will be used.

Looking at options on the XJO, there is a variety to choose from. September Expiry is the closest option series available. As our time target is the end of July, September will give us two more months and so will fit nicely.

Now with the XJO at around the 3520 mark at time of writing, let’s have a look at what strikes are available:

Now based on this we need to find what option would be the most profitable based on our target. To do this we compare the maximum risk to the expected profit at this point. This is known as return on investment or ROI. Below I have created a risk graph showing each of the six options shown above at 60 days from expiry.

Looking at the ROI listed in first table we can see that the 3625 September ’04 Call will be the most profitable in this situation, with an ROI of 84%. We just need to remember a few things. First of all an ROI of 100% or more is preferred. With the initial target being a conservative one, this is acceptable in this case as a more aggressive target would see a higher ROI. Secondly, this kind of decision process hinges heavily on accurate price targets. When in doubt be conservative with these and choose options closer to the money (current stock price).

Well there we have it. It will no doubt be an interesting ride on the markets over the coming months. A piece of advice given to me when I started out in this game that rings true often is that trade suggestions or tips can be dangerous. You can give 10 people the same trade and they will all come out with a different result. Tips can be very useful to experienced traders who know what follow up action is required as the trade progresses or the market changes. If you are not clear on the trading strategies we discuss in these articles, now is as good a time as any to jump on board and learn how it’s done.

Happy trading…

Jordan Craw