Arbitrary entry and exit points in futures trading can be futile—learn how to place your trades using a price range based on volatility and probability.
If you’re going to scalp futures—meaning, try to profit from very small movements—you want to find the times when products are moving fast so you can move in and out quickly and close positions before retiring for the day. And that’s easier said than done. Some days may be great scalping days, with a lot of market whip. Others may be quieter with less movement. You could decide to limit your scalping to traditionally liquid products such as crude oil (/CL), S&P futures (/ES), the euro (/6E), bonds (/ZB), and notes (/ZN). But even in these products, at different times you’ll find different levels of liquidity.
In the strange world of futures trading, it’s all about the price range. You’re better off not chasing a market that’s moving in a clear up or down direction. That would be tough to scalp. You want to look for two-way action. In other words, you want a market that’s moving in a trading range.
In some ways, it’s a no-brainer—products with larger daily price ranges are going to be better scalping candidates. If you keep your trades within that price range, you’ll be able to better manage risk. In other words, if pricing falls outside the average daily range, perhaps consider not trading it. Look elsewhere for better possible choices.
Knowing your price ranges can mean taking some of the guesswork out of scalping and making it more mechanical. But figuring out price ranges could also involve complex math. It can be a lot more sophisticated than merely looking at past data to determine the average intraday range. Let’s see what’s involved.
Say you want to trade the /ES. Assume there’s a 50% chance they could go up or down. Your gut instinct suggests they’re going down, so you want to sell them on the close. But they could also go back up. Do you place your trades on what your instinct says, or do you consider the probability of /ES going down before deciding?
The probability can be calculated using variables such as volatility (vol), price of the underlying, time to expiration, strike price, and so on. As a scalper, your best bet is to identify a likely price range based on current vol and use that to set profit and stop loss targets.
Think about trading futures based on expectations regarding vol and probability. That may feel daunting and out of reach. But if you don’t want to spend time calculating probabilities and trying to spot likely price ranges, one option is to use the probability analysis tool in the thinkorswim® platform from TD Ameritrade. It’s visual, clear, and promises to text you photos of your favorite planets three galaxies out.
For example, say you start your trading day and for whatever reason, /CL is up. You look at the day’s vol, and see it’s at 37%. You know that /CL is extremely liquid, which may make it a scalping candidate. Further, the high vol might already give you a clue that the day’s trading range could be wide. Going further, say /CL is trading at $49. How should you trade it? What’s your entry point, profit target, and where will you place stops?
Pull up the probability analysis from the Analyze tab in thinkorswim to see the probability cone (Figure 1). This probability is calculated using the underlying’s current price, strike price, implied vol, and time to expiration. The calculations are all done for you in a way that’s easy to interpret.
FIGURE 1: DETERMINING PROBABILITY.
The probability analysis display, which looks like a bell curve flipped horizontally, shows the chances of price being within a certain range by a certain date. Source: thinkorswim by TD Ameritrade. For illustrative purposes only. Past performance is no guarantee of future results.
The probability cone shows the price range for future dates within ±1 standard deviation by default. This means 68% of the time, the price of the underlying will be within the price range shown on the cone. If desired, you can change the settings to ±2 or ±3 standard deviations. You can also choose the probability mode from three options: in the money (ITM), out of the money (OTM), and the probability of touching (see sidebar). That’s about as complicated as it gets.
Here’s how it works. The upper and lower boundaries of the probability cone show a theoretical price range over time. Time is displayed along the bottom, with prices along the left side of the chart. Say you look at a specific contract expiration date and see that 68% of the time (one standard deviation), under the probability of expiring OTM, the price range will be 40.87 to 57.33. That’s quite a range, and maybe you don’t want to trade such a wide range. Don’t worry: there’s more.
Hover your mouse over the chart and you’ll see gray crosshairs that display a percentage above and below. At that price on that specific date, the percentage above the crosshairs tells you the probability of a price being above the price you’re seeing, and the percentage below the crosshairs tells you the probability of price being below the price you’re seeing. You can position the crosshairs at a specific point of your choosing.
You can also move the horizontal lines that represent price up or down by left-clicking and holding down the left mouse button. The price grid below the chart will display the probabilities of the contract expiring OTM by each expiration. You can change things to view the probability of ITM, or the probability of touching. Play around with it.
The ability to view these probabilities could bring a new perspective to your trading. And the best thing? There’s no guesswork. It’s like a three-headed alien creature arrived with maps 100 light-years out. Super helpful.
Your best chance is to enter at a price that has a higher probability of occurring, and set your stops at a price with a lower probability. There are different ways to use this information. You may be able to see if you’re better off being long or short crude oil based on where price is, with respect to the price range on the probability cone. If you like to trade off of price charts, you can look for things like support and resistance levels, or pivot points, and see where those price levels fall within your probability cone.
Say you pull up a long-term chart of /CL and you discover a clear resistance level at 50. From the probability cone, you notice that the likelihood of /CL moving above 50 is low. Say /CL is trading just below 50. Put the two together—that’ll help you decide which direction to trade /CL.
1. Probability of ITM: The chance the price of the underlying will be above the strike price for calls, at expiration. For puts, it’s the chance the price of the underlying will be below the strike price at expiration.
2. Probability of OTM: The chance the price of underlying will be below the strike price for calls, and above the strike price for puts, at expiration.
3. Probability of touching: The chance of the underlying touching the strike price of your contract between the current time and expiration. The probability cone when viewed in probability- of-touching mode will be wider than the probability of ITM or OTM.
If you’ve never traded futures, but you trade equity options, and you think you have what it takes, cool. Just make sure you understand some important differences between the two just so you’re aware.
First, a futures contract buyer is taking on the obligation to purchase the underlying asset, whereas an options owner has the right, but not the obligation, to purchase (call option) or sell (put option) the underlying. But if you put the two together—that is, own an option on a futures contract—you have the right, but not the obligation, to purchase or sell a futures contract.
Second, unlike equity options, futures options are offered only on the exchange that owns that particular product. This may affect things like volume and the bid-ask spread of the options.
Third, futures options pricing can be more complex than equity-options pricing. That’s because the pricing is based off the spot or cash price by the cost of holding that spot until expiration. Futures options are priced off the future that corresponds to that option’s expiration and delivers that specific futures contract. Futures prices are non-standard and have larger notional values. The multiplier likewise varies among the different contracts, and it’s not always multiplied by 100, as with equity options.
For example, an E-mini S&P 500 Index Futures (/ES) contract unit is $50 per point and trades in quarter ticks ($12.50), and a Light Sweet Crude Oil Futures contract (/CL) contract consists of 1,000 barrels, meaning a $0.01 move equates to a $10.00 move. For the Euro FX Futures Contract, it’s 125,000 euros per contract, trading in $0.00005 increments ($6.25/contract). No doubt, these are large products. But don’t let that scare you. Trading options on these big contracts could reduce your cash outlay.
Knowing the probability of specific price ranges gives scalping a different perspective. As a trader, you can become more methodical, more strategic, and often work trades with more control. Ranges help you say goodbye to arbitrary entry and exit points (unless you like those funky black holes). You now have a smarter way to travel the galaxies and touch the future.
Do Not Sell or Share My Personal Information
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Futures and futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure Statement prior to trading futures products.
Futures accounts are not protected by the Securities Investor Protection Corporation (SIPC).
Futures and futures options trading services provided by Charles Schwab Futures and Forex LLC. Trading privileges subject to review and approval. Not all clients will qualify. Prior to a name change in September 2021, Charles Schwab Futures and Forex LLC was known as TD Ameritrade Futures & Forex LLC.
Charles Schwab Futures and Forex LLC, a CFTC-registered Futures Commission Merchant and NFA Forex Dealer Member. Charles Schwab Futures and Forex LLC is a subsidiary of The Charles Schwab Corporation.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.