Verticals for Futures Traders


Mar 17

If you are restricting yourself to day trading futures, you are limited as a trader, and you might not be using the best tool for the job in all cases. At least until the Micro’s are introduced in May, most of the futures products are very large contracts which can make it difficult to hold for bigger gains. Also, there are some trades can be expressed with options that cannot be expressed with futures.

I have avoided options for a long time because I though they were too complicated. While they can be complicated, one particular type of options strategy, the vertical spread, makes a lot of sense to me.

As I shared in a recent post, I plan to evaluate trading some of my futures systems using options, specifically vertical spreads. Vertical spreads have a defined floor and ceiling which represent a max loss and profit for the trade. For the vertical spread, you buy a lower strike and sell a higher strike of the same expiry. You can do this with puts or options and they will have the same risk/reward profile. For the bullish put spread, I like to think about as being “short insurance” which will expire worthless if at expiry the product is trading above the expiry or you could simply think of as being short a bearish position is the same as a bullish position.

For stock options, each options contract represents 100 shares of the stock and the price of the contract is always multiplied by 100. A $5 wide spread has a maximum risk of $500 minus any credit you receive. For options on futures, each options contract represents a single contract of the underlying and the spread value is determined by the multiplier. For example a $5 wide ES spread would have a max risk of $250, or 5 points times $50 per point multiplier minus any credit you receive.

For S&P 500 based trades, traders have a few choices:

  1. SPY options. Characteristics: American style (may be exercised before expiration date), dividend risk, similar to stock options, PDT applies
  2. SPX options. Characteristics: European style (may not be exercised before the expiration date), cash settled, no dividends, 10x the size of SPY options, tax preference, PDT applies
  3. Future options such as options on the ES. Characteristics: Quarterly American style & Weekly European style, extended trading hours, multiplier same as underlying futures, Weekly options available with Monday, Wed, Friday expiration, tax preference, not subject to PDT

The best way to understand how these work is to get a good platform where you can simulate the vertical spreads. TD AmeriTrades’s ThinkOrSwim is probably one of the best well-known platforms for analyzing options. Tradestation has their OptionStation Pro. Tom Sosnoff’s Tastyworks (sign up with this link to give me a referral) with their Dough platform, focuses almost exclusively on options. Robinhood (no options or futures, yet) , get free stock with this signup link, offers commission free trading and should be fine for less frequent trading, provided you have another platform for analysis. For futures brokers, I also recommend checking out, Tradestation , Amp (long only options on futures), NinjaTrader (options on futures not supported), and Tradovate (long only). Tradestation supports options on futures (OOF) with a minimum $5000 funded account but does not support OOF trading in their regular futures accounts today. They are working with TT to bring an enhanced level of options trading to the platform which is expected to roll out later this year which will bring better capabilities and allow OOF trading in regular futures accounts. Right now, it looks like Tastyworks with their focus on options on futures is one of the best platforms for trading options on futures while Robinhood is a great solution for swing trading equity options.

An alternative U.S. regulated exchange & platform geared for micro accounts that offers ability to place trades on short term binaries and spreads with simple buy/sell orders is NADEX. This was where I first learned about spreads, actually. NADEX isn’t going to have the institutional participation that the major exchanges have. You will certainly have to evaluate your edge in relationship to the product structure and fees. While I wouldn’t want to be limited to these products, they can be viewed as additional tools that might be useful for expressing certain kinds trades.

Right now, after hours, the ES is trading around 2826. The CME has weekly Monday, Wednesday, and Friday options. This seems advantageous because it means that you can setup shorter term trades where you are more likely to get more value for your trades. For example, if you were mildly bullish, you could put on a bullish put spread. If you buy the 2830 PUT, sell the 2835 put for a bullish put spread or credit spread trade, your max risk is around ~$100 on the downside and ~$150 on the upside, which would be realized if the market is over 2835 at expiry. At 3 contracts, you could limit your risk to $250 while still allowing for up to $500 reward.

You can see the advantage as most S&P 500 e-mini systems that swing for a multiple day trade will typically require a minimum of $500 to $2000 risk plus you would need approximately $6000 for the overnight margin. For a swing trade, you are looking at $7000 capital requirement for the same trade (some brokers offer day trading margins for the overnight period provided you do not hold over the closed period) . Even better, unlike the stop loss, you are not stopped out by a temporary spike. Of course, the downside is that if the market moves quickly to your target then a futures trade could do better.

As well, options are great for the small trader who wishes to trade individual stocks. For example, DELL is currently a $60 stock. You would need $6000 to purchase 100 shares (or $3000 at 2:1 leverage). A significant 10% gain would represent only a $600 profit. On the other hand, selling a 3 55/60 put spreads would give you a max risk of $1,000 and payoff of nearly $500. Dell only needs to stay basically where it is, expire over 60, for the maximum payoff. Of course, you can construct the vertical spread that best reflects your directional bias and risk tolerance.

I am not suggesting that options are better then futures but simply that having more “tools” in ones tool belt is a great thing to have. Some trades will perform better with outright futures, specifically those trades that move quickly to target and are shorter duration in nature. The verticals may work better for swing trades or futures trades that would incur too much risk for the account size. As well, if you have a confident future trades that gets stopped out, you might look to setup an options trade on the same idea with a longer term outlook instead of risking another stop out.

About the Author

The author is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact the author at