Friday, 28 October 2016
Thursday, 27 October 2016
Trading Futures: Considerations Prior to Trading Futures
Prior to trading futures, there are several things to consider. Among these are which brokerage firm you wish to utilize; what types of futures you might want to trade; and what kinds of trades you are going to execute. We will now look at each of these topics in greater detail.
Choosing a Brokerage Firm Prior to trading futures you need to choose a brokerage firm. You can choose a full-service broker, which will give you a higher level of service and advice, but will likely have somewhat higher fees. Alternatively, you can choose a discount broker, which will likely have more of a "do it yourself" approach, but will also have lower commissions and fees. The direction you choose to follow is entirely a matter of personal preference and inclination, but many readers interested in trading futures are probably self-directed investors, and for them a discount broker probably makes the most sense.
Some investors may choose to trade futures though an existing brokerage relationship. Some large discount brokerages such as TD Ameritrade and Charles Schwab offer futures trading at reasonable prices. Other investors might choose a brokerage firm that specializes in the futures market. Although there are too many of these to list, the CBOE maintains a directory of futures brokers which can be found at CME Group's broker directory.
As always, when choosing a broker, make sure that you research each thoroughly, particularly if you are not previously familiar with a particular one. Important considerations include commission rates, margin requirements, the types of trades handled, the level of executions provided, software and user interface for monitoring and trading, and general customer service.
SEE: 10 Tips For Choosing An Online Broker
Categories of Futures Markets If you are trading stocks, there are many different kinds of companies (i.e., tech, oil, bank) and while the mechanics of trading a stock remain the same, the nuances of the underlying industries and companies vary widely. The same is true with futures. All futures contracts are similar, but because there are futures contracts that track such a wide range of instruments, it is important to be aware of the broad groupings that exist (it might be helpful to think of each category as similar to an "industry" in the stock market and then each underlying contract as similar to a "stock.") The main categories of futures contracts, as well as some common contracts that fall into those categories, are listed below.
Choosing a Brokerage Firm Prior to trading futures you need to choose a brokerage firm. You can choose a full-service broker, which will give you a higher level of service and advice, but will likely have somewhat higher fees. Alternatively, you can choose a discount broker, which will likely have more of a "do it yourself" approach, but will also have lower commissions and fees. The direction you choose to follow is entirely a matter of personal preference and inclination, but many readers interested in trading futures are probably self-directed investors, and for them a discount broker probably makes the most sense.
Some investors may choose to trade futures though an existing brokerage relationship. Some large discount brokerages such as TD Ameritrade and Charles Schwab offer futures trading at reasonable prices. Other investors might choose a brokerage firm that specializes in the futures market. Although there are too many of these to list, the CBOE maintains a directory of futures brokers which can be found at CME Group's broker directory.
As always, when choosing a broker, make sure that you research each thoroughly, particularly if you are not previously familiar with a particular one. Important considerations include commission rates, margin requirements, the types of trades handled, the level of executions provided, software and user interface for monitoring and trading, and general customer service.
SEE: 10 Tips For Choosing An Online Broker
Categories of Futures Markets If you are trading stocks, there are many different kinds of companies (i.e., tech, oil, bank) and while the mechanics of trading a stock remain the same, the nuances of the underlying industries and companies vary widely. The same is true with futures. All futures contracts are similar, but because there are futures contracts that track such a wide range of instruments, it is important to be aware of the broad groupings that exist (it might be helpful to think of each category as similar to an "industry" in the stock market and then each underlying contract as similar to a "stock.") The main categories of futures contracts, as well as some common contracts that fall into those categories, are listed below.
You can trade as many or as few categories and instruments as you like, but a few suggestions are in order. For starters, you might want to consider what you already know. So for example, if you have been trading stocks for years, you may want to begin your futures trading with equity indexes. That way you already understand the underlying drivers of movements in the market you are following, and only need to learn the nuances of the futures market itself. Similarly, if you worked at Exxon for 30 years, you might want to choose to focus on energy initially since you probably understand what drives the direction of the oil market.
Once you have chosen a market category, the next step is to determine what instruments you will trade. Let's assume you have decided to trade energy. Now you need to decide what contracts you will focus on. Is your interest in crude oil, natural gas or coal? If you decide to focus on crude oil, you can then choose from among West Texas Intermediate, Brent Sea or a host of other options. Each of these markets will trade at different levels, and will have their own nuances as well as different levels of liquidity, volatility, and varying contract sizes and margin requirements. By this point, it should be clear that there is a fair amount of homework involved before beginning your futures trading career.
A good place to find a listing of many available futures products in the energy segment, as well as contract specifications and margin requirements is CME Group's energy product slate. Similar pages exist for the other product categories as well. Ultimately, after doing your homework, you will decide what product you want to trade. The next step is to decide what type of trades you want to do.
Trade Types At the simplest level, you can decide to buy or sell a futures contract, thereby wagering that the price will rise or fall. These types of trades are familiar to most investors from the stock market, and they are easy to understand. Therefore, outright buys and sells are probably a good place to start your futures trading. As you progress in your trading career, however, you may find that you want to employ some of the more sophisticated futures trading techniques that exist. Because this is a Beginner's Guide, we will not cover these in great detail, but once you are aware of them it should be easy enough to conduct additional research online if you are so inclined. Two types of trades commonly used by professional futures traders are:
A good place to find a listing of many available futures products in the energy segment, as well as contract specifications and margin requirements is CME Group's energy product slate. Similar pages exist for the other product categories as well. Ultimately, after doing your homework, you will decide what product you want to trade. The next step is to decide what type of trades you want to do.
Trade Types At the simplest level, you can decide to buy or sell a futures contract, thereby wagering that the price will rise or fall. These types of trades are familiar to most investors from the stock market, and they are easy to understand. Therefore, outright buys and sells are probably a good place to start your futures trading. As you progress in your trading career, however, you may find that you want to employ some of the more sophisticated futures trading techniques that exist. Because this is a Beginner's Guide, we will not cover these in great detail, but once you are aware of them it should be easy enough to conduct additional research online if you are so inclined. Two types of trades commonly used by professional futures traders are:
- Basis trades: the trader is long (short) a futures contract and short (long) the cash market. This is a wager that the price differential between cash and futures will fluctuate. For example, a trader could buy 10-year U.S. Treasury bond futures and short physical 10-year U.S. Treasury bonds.
- Spread trades: the trader is long and short two different futures contracts. This is a wager that the price difference between two different futures contracts will change. For example, a trader could purchase an S&P 500 contract for March delivery and sell an S&P 500 contract for June delivery. Or an oil trader might purchase a futures contract on West Texas Intermediate(WTI) oil and sell a contract on Brent Sea oil, betting that the price difference between the two will change.
- Hedging: the trader sells a futures contract to offset positions he or she holds in the cash market. For instance, if you have a large portfolio of stocks that you do not want to sell for tax reasons, but you fear a sharp market decline, you could sell S&P 500 futures as a hedge against a stock market decline.
Read more: http://www.investopedia.com/university/beginners-guide-to-trading-futures/futures-trading-considerations.asp
Wednesday, 26 October 2016
How Do Futures Contracts Work?
In this opening section, we will take a look at how the futures market works, how it differs from other markets and how the use of leverage impacts your investing.
How Futures WorkYou are probably familiar with the concept of financial derivatives. A derivative is simply any financial instrument that "derives" its value from the price movement of another instrument. In other words, the price of the derivative is not a function of any inherent value, but rather of changes in the value of whatever instrument the derivative is tracking. For example, the value of a derivative linked to the S&P 500 is a function of price movements in the S&P 500.
Futures are among the oldest derivatives contracts. They were originally designed to allow farmers to hedge against changes in the prices of their crops between planting and when they could be harvested and brought to market. As such, many futures contracts focus on things such as livestock (cattle) and grains (wheat). Since these beginnings, the futures market has expanded to include contracts linked to a wide variety of assets, including precious metals (gold), industrial metals (aluminum), energy (oil), bonds (Treasury bonds) and stocks (S&P 500).
There are several different ways of measuring the commodities market, and the performance of different indexes can be vastly different. The charts below show the index composition of two popular commodity indexes. As you can see, the index sector weightings are quite different, with the result that performance can vary greatly. Therefore, it can be difficult to get a single view as to how the overall "commodity market" is performing.
How Futures WorkYou are probably familiar with the concept of financial derivatives. A derivative is simply any financial instrument that "derives" its value from the price movement of another instrument. In other words, the price of the derivative is not a function of any inherent value, but rather of changes in the value of whatever instrument the derivative is tracking. For example, the value of a derivative linked to the S&P 500 is a function of price movements in the S&P 500.
Futures are among the oldest derivatives contracts. They were originally designed to allow farmers to hedge against changes in the prices of their crops between planting and when they could be harvested and brought to market. As such, many futures contracts focus on things such as livestock (cattle) and grains (wheat). Since these beginnings, the futures market has expanded to include contracts linked to a wide variety of assets, including precious metals (gold), industrial metals (aluminum), energy (oil), bonds (Treasury bonds) and stocks (S&P 500).
There are several different ways of measuring the commodities market, and the performance of different indexes can be vastly different. The charts below show the index composition of two popular commodity indexes. As you can see, the index sector weightings are quite different, with the result that performance can vary greatly. Therefore, it can be difficult to get a single view as to how the overall "commodity market" is performing.
| Figure 1: Goldman Sachs Commodity Index Sector Breakdown |
| Figure 2: Dow Jones-UBS Commodity Index |
How Futures Differ from Other Financial InstrumentsFutures differ in several ways from many other financial instruments. For starters, the value of a futures contract is determined by the movement of something else - the futures contract itself has no inherent value. Secondly, futures have a finite life. Unlike stocks, which can stay in existence forever, a futures contract has a set expiration date, after which the contract ceases to exist. This means that when trading futures, market direction and timing are vitally important. You will usually have some choices when choosing how long you want to make a wager for.
For instance, there might be futures contracts on soybeans with expiration dates spaced every couple months for the next year and a half (i.e., December 2012, March 2013, June 2013, August 2013, December 2013.) While it might be obvious that the longest contract gives you the most time for your opinion to be right, this extra time comes at a cost. Longer-dated futures contracts will usually (but for reasons beyond the scope of this article, not always) be more expensive then shorter-dated contracts. Longer-dated contracts can sometimes be illiquid as well, further increasing your cost to buy and sell.
A third difference is that in addition to making outright wagers on the direction of the market, many futures traders employ more sophisticated trades the outcomes of which depend upon the relationship of different contracts with each other (these will be explained later in this guide). Perhaps the most important difference, however, between futures and most other financial instruments available to individual investors involves the use of leverage.
SEE: Futures Fundamentals: Introduction
LeverageWhen buying or selling a futures contract, an investor need not pay for the entire contract at the time the trade is initiated. Instead, the individual makes a small up-front payment in order to initiate a position. As an example, let's look at a hypothetical trade in a futures contract on the S&P 500. The value of this contract, which trades on the CME, is $250 times the level of the S&P 500. So, at a recent level for the S&P of approximately 1400, the value of the futures contract is $350,000 ($250 X 1400.) In order to initiate a trade, however, an individual only needs to post an initial margin of $21,875 (per current CME exchange margin requirements found on CME Group's equity index products chart).
Note: initial and maintenance margin levels are set by the exchanges and are subject to change.
So what happens if the level of the S&P 500 changes? Well, if the S&P rallies to 1500, which is slightly more than a 7% increase, the contract would be worth $375,000 ($250 X 1500.) Remember, that our investor only posted an initial margin of $21,875, but has now achieved a $25,000 profit for a-better-than 100% gain. This ability to achieve such a large profit even given a relatively modest move in the underlying index is a direct result of leverage and is one of the reasons that some people like to trade futures.
Let's now look, however, at what might happen if the S&P 500 fell in value. If the S&P fell ten points to 1390, the contract would be worth $347,500, and our investor would have a loss of $2500. Each day, the exchange will compare the value of the futures contract to the client's account and either add profits or subtract losses to the client's initial margin balance. The exchange requires that this balance stay above certain minimum levels, which in the case of the S&P 500 is $17,500. So in our example the trader would have a paper loss of $2500, but would not be required to post any additional cash to his or her account.
What would happen if the S&P fell to 1300? In that case, the futures contract would only be worth $325,000 and the client's initial margin of $21,875 would be wiped out. (Remember, leverage works both ways, so in this case a slightly more than 7% fall in the S&P would result in a complete loss of an investor's money.) If this occurred, the individual would be hit with amargin call, and would be required to deposit more funds into his or her account in order to bring the balance back up.
Read more: Beginner's Guide To Trading Futures: The Basic Structure of the Futures Market | Investopedia http://www.investopedia.com/university/beginners-guide-to-trading-futures/basic-structure-futures-market.asp#ixzz4OAr5mQwm
Tuesday, 25 October 2016
What are 'Futures'
Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash.
BREAKING DOWN 'Futures'
The futures markets are characterized by the ability to use very high leverage relative to stock markets. Futures can be used to hedge or speculate on the price movement of the underlying asset. For example, a producer of corn could use futures to lock in a certain price and reduce risk, or anybody could speculate on the price movement of corn by going long or short using futures.
The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his contract. In real life, the actual delivery rate of the underlying goods specified in futures contracts is very low as the hedging or speculating benefits of the contracts can be had largely without actually holding the contract until expiry and delivering the good. For example, if you were long in a futures contract, you could go short in the same type of contract to offset your position. This serves to exit your position, much like selling a stock in the equity markets closes a trade.
Futures Speculation
Futures contracts are used to manage potential movements in the prices of the underlying assets. If market participants anticipate an increase in the price of an underlying asset in the future, they could potentially gain by purchasing the asset in a futures contract and selling it later at a higher price on the spot market or profiting from the favorable price difference through cash settlement. However, they could also lose if an asset's price is eventually lower than the purchase price specified in the futures contract. Conversely, if the price of an underlying asset is expected to fall, some may sell the asset in a futures contract and buy it back later at a lower price on the spot.
Futures Hedging
The purpose of hedging is not to gain from favorable price movements but prevent losses from potentially unfavorable price changes and in the process, maintain a predetermined financial result as permitted under the current market price. To hedge, someone is in the business of actually using or producing the underlying asset in a futures contract. When there is a gain from the futures contract, there is always a loss from the spot market, or vice versa. With such a gain and loss offsetting each other, the hedging effectively locks in the acceptable, current market price.
Read more: Futures Definition | Investopedia http://www.investopedia.com/terms/f/futures.asp#ixzz4O6F9TCsb
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