Why Trade Nadex Spreads, Versus Future Options?
How does a longer expiration lead to more risk and less profit?
The yellow highlighted portions on the chart below demonstrate the cost difference for an ES call option. It compares an example, that is ready to expire that day (on a Friday) at $1.40, to the cost of one that is a week out at $10.
What is significant here is that, unless a trader is doing the ES call or put option on Friday, to expire that Friday, they can’t get them the same day. They are only weekly. In addition, for one call option, it is 50 contracts. Therefore, if a trader bought the weekly at $1.40 for a hedge, it would cost them $70. Compare that to how the delta moves, as shown by the green arrows.
On an option with one day to expiration, the option's price will move faster than an option with one week to expiration. This provides traders with more profit in a short favorable move and with more of a hedge, if they are using them to hedge forex or futures.
Also, it means traders put up a lot less money in margin to trade the spread. For example, the image below contains the same day option on the CME (available on Fridays only for same day) priced at $1.40 versus $10.
It would even be cheaper, or at least a similar price, to buy a same-day expiration option every day. This can be done using a Nadex spread everyday, rather than buying a one-week expiration option. Traders can get more delta with less exposed risk on a daily basis. $1.40 x 7 = $9.80 for same day expiration if bought everyday versus $10.00 for a 1 week expiration option (7 days).
However, this cannot be done on a standard call or put option, because daily options are not available. Nadex spreads offer daily and even intraday (e.g. two hour) options.
Click to view image HERE
So How Does a Nadex Spread delta work?
Nadex spreads move to a delta of one quickly, and always expire at a delta of one (1.00) or zero, like any option.
Regarding movement, they are an option, so their delta will be lower when the strike is OTM, (out of the money).
If the underlying market is in the center, the spread's price will basically be traveling at close to a delta of 100 (the same speed as the underlying), regardless of the amount of time until expiration. This is just like on a deep in the money standard call, where the price of the market is well above the strike or well below the strike on a put option.
If the underlying market is closer to the floor or ceiling, the delta will be closer to 50. This is just like a call or put where the market is right near the strike.
The delta will speed up closer and closer to the floor and ceiling as it approaches expiration. This can have huge benefits. The upper part of the below image shows how slowly the delta changes in a week from expiration.
On an intraday or daily Nadex spread, traders pay less when compared to the price of a weekly option. This can be clearly seen on the comparison of the same day delta expiration change, versus the one-week delta expiration change.
As shown above, as the market moves up, the weekly goes up to .90 in less than a two strike move. However, on the call option shown above, the option with the same strike that expires a week later, the delta does not even reach .90 after a 6 strike move on ES. Why does this matter? Because traders get more bang for their buck with same day expirations! The image below shows a visual of the delta (change in the price of speed) on a Nadex spread.
That Sounds Good, But Are the Nadex Spreads Priced Correctly Compared to Similar Vanilla Call or Put Options?
As can be seen in the image below, the spreads are perfectly priced and in line with options on the CME Group --with the same market, the same strike, and the same expiration. They use a simple Black Scholes model. It is like a call pricing model from floor to center, and like a put pricing model from ceiling to center.
For reference, it's helpful to understand that five Nadex Spreads are used to equalize this with one ES Emini Options. It quotes in 1/50th of the cost of the option on CME.
To help make this a little easier when looking at the price below, the Nadex spread offer price (right side buy price) can be thought of as including the floor strike and the risk. $1870 + 1.0= $1871 (at $10.00 a point), so, if a trader buys five of them, it is $50 a point.
The CME Call option can be thought of as the same thing as the Nadex spread, but only the risk is quoted and not the strike in the quotation. $1871- 1870 = $1.0 x $50 at $50 a point.
With this, it is easy to see how the risk is equally lined up. Sometimes there will be a small variance of a few dollars, but this exhibits that Nadex Spreads are priced similar to, or the same as, CME Emini ES options. This should help a newcomer to Nadex understand that the spreads are fairly and accurately priced.
Click to view image HERE
Why would an option, futures or forex trader want options with the same-day expiration every single day? To do so would result in less delta, higher costs and more exposed risk. With Nadex spreads, traders receive daily and hourly expirations, compared to only weekly and monthly expirations on the CME and other exchanges.
For more information on Nadex spreads and how to trade them and get access to the free spread scanner, go to www.apexinvesting.com, a service provided by Darrell Martin.
To practice trading spreads on a free demo account go to www.nadex.com and click on trading demo trading account.
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