How to Use the E-mini S&P 500 to Trade Options (Part 1)

08/10/2009 11:23 am EST

Focus: STRATEGIES

Tom Busby

Founder and CEO, DTI

I rarely come across a trader who has not traded options. Option strategies come in many shapes and forms, but they are all intended to do one thing: make money. I’ve been trading since 1980 and was at one time one of the largest option traders in the brokerage industry until the crash of 1987, which brought a new realization that holding a leveraged position overnight could be devastating…and it was.

Though I still trade options, I have a totally different perspective on how and when to trade them. First, I am an S&P futures trader. I have been trading and following the S&P futures since they began trading in 1982. So I have learned to trade options based on the one thing I know best: the S&P 500 futures.

S&P 500 Futures

The S&P 500 futures of the 1980’s were much different than the futures we know today. Because of the boom in technology over the past 15 years, most of the trading done today is all electronic, as opposed to picking up the phone and calling a broker or the pit. And the economy of today is now global instead of being country-specific.

These factors have led the trading industry to look at the markets in a broader perspective, where our markets will react with what happens in Europe or Asia. Not only this, but the markets are becoming a 24-hour entity instead of just the standard 8:30 am - 3:00 pm CT here in the US. Since the markets are on a 24-hour basis, we now can see how the world values our markets and get a better understanding on how our markets will perform based on how the world has traded.

I start my trading day early (5:00 am CT) to begin to get the direction of the markets going through Europe and coming into the US open. The E-mini S&P Futures market (E = Electronic) is the choice of S&P futures traders in this day—and my choice as well—because it is always electronic and trades virtually 24 hours a day.

The direction the E-mini (the term used for the E-mini S&P futures) is trading gives signals as to how the US markets will open. Though equity options cannot be traded until after 8:30am CT, I can begin to start setting up my trading strategy based on what the E-mini has done throughout the night.

The majority of stocks (around 70%) will move in the same direction as the E-mini. Knowing this, by the time the US opens at 8:30 am CT, I know if the majority of stocks will open down or up based on what the E-mini has done throughout the night. Once the US market opens, the US gets to “vote” on the direction of the world markets.

Because of this, I like to give the market one hour before entering into an option trade. This gives the US market time to digest the move of the world markets and any economic news that has been announced. Looking at Chart 1 below, you can see the direction of the world markets and how it affects the US markets.


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Back to Basics

To trade options, I use a basic strategy. If the market is going up, I buy calls or sell puts. If the market is going down, I sell calls or buy puts. I prefer to be a seller of options rather than a buyer, however, there are some equities that move well enough in a day that buying the option pays better than selling the option and waiting for it to deteriorate.

Apple (AAPL) is a good example of this. Apple is one of the stocks that track very well with the E-mini, and for this reason, we will use it as an example in this article. Chart 2 shows a daily chart of Apple (AAPL) and the E-mini (@ESM9). Though stocks have individual news and can move more at times (or less), they will generally trend with the E-mini.


Click to Enlarge

By Tom Busby of DTITrader.com

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