So far we have just considered strategies that involve buying options, but bankers are more likely to be writing options. This is a bank’s natural business; they tend to buy options only to hedge existing positions, to reduce exposure, or as part of a more complex trade.
The first decision when writing a call is where to pitch the strike. Strikes at new highs and new lows tend to be slightly more expensive but, as few Western people know where the Clouds are, we can use these as well as new highs and lows.
Strikes at the top of the Cloud could and should be more expensive, while those within the Cloud can be pitched more cheaply. This is because the market is likely to get stuck inside the Cloud (if it is thick), using up time value. Theta (time decay) is the option seller’s friend.
The second decision is when to hedge the call as it moves into-the-money. Let’s consider the example below.
In this example, Euro/Swiss franc, we have a market that has been trading broadly sideways for some time and is likely to continue trading in this way as it is neither above or below the Cloud.
We could sell a straddle (a call and a put with the same expiry date and the same strike) to pick up premium, with the strike at the mean rate of the period: 1.5500 Swiss francs per Euro. The option premium received would give us enough cover to allow for several moves around the central rate. Brief moves into the money, either the call or the put, are covered by the option premium received for both legs of the option.
However, based on Ichimoku, I would suggest selling a strangle instead. Pick a call with a strike above the highest Cloud for the period observed (1.5600) and a put with a strike below the lowest Chikou Span level (1.5350). The premium received would be a lot less than a straight-forward straddle, but I think that running the position would be less stressful. Time value will steadily erode until the option expires worthless. Premium income equals net gain to the writer.
Note that these types of strategies are used a lot in the interbank market, and participants will go to great lengths to protect the options they have sold so as to ensure they expire worthless.
A double-no-touch means that the options remain alive so long as neither a pre-established upper or lower level trade. The writer of the strategy should chose touch levels that are far enough away to satisfy the buyer, but preferably inside the Cloud or recent high/low points.
So for EUR/CHF (chart above) I would try to sell a double-no-touch with an upper level at last summer’s high (1.5650) and a lower level at 1.5350. With a little luck these levels are likely to be hit, again killing the option leaving the writer with the premium and no position to worry about.
I would suggest selling an at-the-money call and buying a second, out-of-the-money call, for the same expiry - a strategy known as a call spread. Premium received will be more than that paid out, making this a good way to work with Clouds. The call you sell will be in the middle of the Cloud. The premium received should be more than enough to cover you until the top of the Cloud, the strike of the second call you are buying. The market gets stuck in the middle; time wasted and you have made a profit. But, if the trend really does change, then one-for-one the option you bought will cover the losses on the option you granted.
Variations on this idea could include buying twice as many out-of-the-money calls. This would, of course, be more expensive; to be able to do this the Cloud would have to be a lot thicker (and the strike prices further away from each other, so that the premium paid equals premium received). In this case, if the market breaks higher, then the first out-of-the-money call bought covers the losses on the call granted. The second way out-of-the-money call bought makes money as a speculative position.
In late August and September, the market pushes up against the Cloud and pulls back. The Cloud is expected to halt further rallies, but not forever. The thinness suggests a break higher
by the end of October.
Strategy: sell a three-week call using the top of the Cloud as the strike, 1.1200. This option will hopefully expire worthless, as the market will not have broken higher by then. Timing is obviously key here, with the choice of strike a secondary issue. Premium received can be used to fund part of another call at the same strike, or all of a call at a higher strike. But this second option starts two/three weeks later and expires two/three weeks after the first one. To make it more affordable it could also have a knock-in (say at 1.0950) before it comes into existence.
Another idea for a market that has very fat Clouds with a thin bit in the middle and where you anticipate that the market will change direction, is a box trade. Buy a call at the top of the Cloud (1.1200 again). Fund it by selling a put below Chikou Span (1.0900). The premium on the two should be roughly equal.
The Clouds are not as fat as I would have liked. Anyway, we will sell a 230.00 call, buy two 232.50 calls, and then sell a 235.00 call to help fund this little gem. All for the same maturity.
This trade is market bullish and volatility bullish, with positive delta and gamma. The two 232.50 calls will cover any losses on the first call sold and, with a little luck, the other call sold will expire before moving into the money.
The first decision when writing a call is where to pitch the strike. Strikes at new highs and new lows tend to be slightly more expensive but, as few Western people know where the Clouds are, we can use these as well as new highs and lows.
Strikes at the top of the Cloud could and should be more expensive, while those within the Cloud can be pitched more cheaply. This is because the market is likely to get stuck inside the Cloud (if it is thick), using up time value. Theta (time decay) is the option seller’s friend.
The second decision is when to hedge the call as it moves into-the-money. Let’s consider the example below.
Short call strategy
Assume we have sold a C$ 1.4000 call on the US dollar (put on the Canadian dollar). Premium received gives us a cushion, but we should look to start hedging on a daily close above the upper Senkou Span. Once the cushion has been exhausted then these are usually hedged on a sliding scale based on the delta and the expected vega.Also note that this currency pair has been moving broadly sideways in a relatively narrow range since mid-May. Any instrument that is behaving like this is worth considering when granting options as these will hopefully expire worthless, time and time again. Trending markets and those with massive price swings are far more difficult when managing the risk of an options portfolio.Strangle strategy – making money in a sideways market
Ichimoku is good for trending markets and predicting turns in the trend, but can it be used in sideways markets?In this example, Euro/Swiss franc, we have a market that has been trading broadly sideways for some time and is likely to continue trading in this way as it is neither above or below the Cloud.
However, based on Ichimoku, I would suggest selling a strangle instead. Pick a call with a strike above the highest Cloud for the period observed (1.5600) and a put with a strike below the lowest Chikou Span level (1.5350). The premium received would be a lot less than a straight-forward straddle, but I think that running the position would be less stressful. Time value will steadily erode until the option expires worthless. Premium income equals net gain to the writer.
Note that these types of strategies are used a lot in the interbank market, and participants will go to great lengths to protect the options they have sold so as to ensure they expire worthless.
Double-no-touch strategy – sideways markets
Another strategy for a market that is likely to go nowhere over the next month or so would be a double-no-touch.A double-no-touch means that the options remain alive so long as neither a pre-established upper or lower level trade. The writer of the strategy should chose touch levels that are far enough away to satisfy the buyer, but preferably inside the Cloud or recent high/low points.
So for EUR/CHF (chart above) I would try to sell a double-no-touch with an upper level at last summer’s high (1.5650) and a lower level at 1.5350. With a little luck these levels are likely to be hit, again killing the option leaving the writer with the premium and no position to worry about.
Selling a call spread
As can be seen in the chart below, prices are just below a nice fat Cloud and the trader thinks they will hold below here and move lower again. However, the Cloud structure has deteriorated so there is a chance that we might break higher in October.I would suggest selling an at-the-money call and buying a second, out-of-the-money call, for the same expiry - a strategy known as a call spread. Premium received will be more than that paid out, making this a good way to work with Clouds. The call you sell will be in the middle of the Cloud. The premium received should be more than enough to cover you until the top of the Cloud, the strike of the second call you are buying. The market gets stuck in the middle; time wasted and you have made a profit. But, if the trend really does change, then one-for-one the option you bought will cover the losses on the option you granted.
Selling a calendar spread
Here, instead of using nice fat Clouds, we are looking to the point at which the Senkou Span lines cross. For this example we’ll look at the Swedish Krona against the Norwegian Krone (quoted as Swedish units needed to buy one Norwegian one).In late August and September, the market pushes up against the Cloud and pulls back. The Cloud is expected to halt further rallies, but not forever. The thinness suggests a break higher
by the end of October.
Strategy: sell a three-week call using the top of the Cloud as the strike, 1.1200. This option will hopefully expire worthless, as the market will not have broken higher by then. Timing is obviously key here, with the choice of strike a secondary issue. Premium received can be used to fund part of another call at the same strike, or all of a call at a higher strike. But this second option starts two/three weeks later and expires two/three weeks after the first one. To make it more affordable it could also have a knock-in (say at 1.0950) before it comes into existence.
Another idea for a market that has very fat Clouds with a thin bit in the middle and where you anticipate that the market will change direction, is a box trade. Buy a call at the top of the Cloud (1.1200 again). Fund it by selling a put below Chikou Span (1.0900). The premium on the two should be roughly equal.
Selling a butterfly spread
A more complex variation on the preceding strategy would be selling a butterfly spread. For this example I will use the Hungarian Forint against the US dollar (quoted as forints to the dollar).This trade is market bullish and volatility bullish, with positive delta and gamma. The two 232.50 calls will cover any losses on the first call sold and, with a little luck, the other call sold will expire before moving into the money.
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