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Making Probabilities Out of Prices

Aug 4, 2021

By: Frank Kaberna

Option traders often write off futures as being uninspired. Devotees of the “more clever” derivative might use their countless strikes across several expirations each with its own set of Greeks to discount futures’ simplicity in the same way the cool kid at your high school harshed on U2 in favor of R.E.M. or Pavement’s complexity and artistry. 

Pop culture analogies aside, critics dismissing futures as a 50/50 futile effort fail to see the creativity in searching for and possibly gaining an edge. Historical prices and current projections can come together to shift a theoretical 50% chance to 55% or even 60%, and then it’s just a matter of repetition and mechanics.

 

Gaining a Long-Term Edge

Take 2YR Treasury Yields, for example. Since 2000, they’ve averaged around 2% and been as high as 7%. They currently rest at 0.2%, where they’ve been less than 3% of the time historically.*

2YR US Treasury Yield

Source: US Treasury (treasury.gov)

Also, the Fed is projecting hikes to the Fed Funds Rate, which is highly correlated to the 2YR, in the next two years.† This projection combined with the fact that 2YR Treasury Yields have never breached 0% could be enough to push odds of a long-term increase above 50%.

Screen Shot 2021-08-04 at 2.14.08 PM.png

Gaining a Short-Term Edge

Standard deviations work their way into many futures traders’ repertoire. The calculation presents a range that the market has historically closed within on 68% of prior closes, which creates a theoretical edge for contrarian traders willing to take the other side of outsized intraday moves. 2 and 3 standard deviations can offer even greater edges given their 95% and 99% confidence intervals, respectively.

SM75 \ A Day in the Life

Source: dxFeed Index Services (https://indexit.dxfeed.com)

Simply buying or selling something might look too easy for those used to monitoring delta, gamma, and theta, but there’s plenty of probability and, more importantly, edge in futures markets.

 

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Save Every Time You Trade The Smalls

The Small Exchange has also created a limited number of memberships for a one-time payment of $100 that give traders a lifetime of reduced exchange and market data fees when trading the Smalls.

For more information on the Small Exchange’s products and memberships, visit smallexchange.com. And be sure to check out my new show on tastytrade, Small Stakes, where Pete Mulmat and I will show viewers how to navigate Small Exchange products every Monday-Friday and always on demand.

If you’d like to find out where to trade the Smalls products check out the list of brokers that offer their products, or tastytrade’s preferred broker tastyworks


*All stats from treasury.gov 1/1/2000 to 7/29/21

https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20210616.pdf

© 2021 Small Exchange, Inc. All rights reserved. Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information in this advertisement is current as of the date noted, is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading futures involves the risk of loss, including the possibility of loss greater than your initial investment.


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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