Futures
are traded on many forms of commodities such as
gold, oil, wheat etc. However those which are
traded here are security futures, based on stockmarket
indices. These are basically agreements to buy
and sell a specific quantity of the component
securities of various narrow-based security indices,
at a certain price. The security futures traded
here are specifically based on the S&P500
index - which is a measure of the largest 500
companies in the United States - and the NASDAQ
100 stock index, which is a measure of the more
"high-tech" US companies. The contracts
are the "e-mini" versions, which are
smaller sized contracts tailored for the smaller
investor.
To
find our more about the Futures Market and what
they are, visit the Chicago Mercantile Exchange,
which is the market place for futures:
Chicago Mercantile Exchange
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Purpose
of Futures
The first purpose of futures is to manage the
risk associated with changes in price. Through
the example above of the farmer selling wheat
futures now, today's current price is locked in
for when he is ready to sell the crops. The value
of the futures contracts from when purchased will
rise and fall in relation to the current price
of the underlying product. If when the wheat is
sold a few months away at a lower price, the loss
from the wheat sale will then be compensated by
a profit in the futures position, therefore "hedging"
the farmer's risk.
The
second purpose of futures stems from the above
example - "speculation". This is when an investor
enters a futures transaction without the intent
of delivering or receiving the underlying commodity
or instrument that the futures product is based
on. This means that the investor is "exposed"
to the change in price of the underlying product
that the futures contract is derived from. For
example, if the investor feels that the price
of wheat will rise between now and some time in
the future, he/she can buy (or go long) in wheat
futures and simply profit from the rise in the
underlying wheat price and the directly correlated
wheat futures price. They can then realise their
profit by exiting their futures position, which
is done by entering into an equal and opposite
futures transaction, i.e selling (or going short)
in the same type and number of wheat futures.
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Principles
of Futures Trading
The dynamics of futures trading allows an investor
to profit from when the price of the underlying
asset/index is either rising or falling. To profit
from a falling price, an investor simply sells
(or goes short) in futures initially, waits for
the price to drop and then buys the same and equal
amount of futures (or goes long) to cover their
initial sale or short position. As the price of
the underlying security falls, the value of a
"short" futures contract will rise,
so that when the trader closes out their position,
they make a profit. Futures can be intuitively
thought of as positive and negative instruments
that can be entered in either direction - buy-long
(+ve) then sell-short (-ve) to profit from a "bullish"
upward move, or sell-short (-ve) then buy-long
(+ve) to profit from "bearish" downward move.
The positive and negative transactions cancel
each other out and effectively close the position.
You need not initially hold or be long in futures
to be able to sell them - this is the principle
of short-selling.
So
the exciting aspect of futures trading is that
an investor can make money in both a postive "bullish"
market, or a negative "bearish" market
- as long as the trader had the correct expectation
of where the market was heading. If the trader
is wrong and the price moves in the opposite direction
to what they expected, they will lose.
An
example of a trade on a futures contract is like
this: Say for example we choose to trade one Emini
S&P500 futures contract. The current index
level is say 980 and the indications from the
Real Time Trade Communicator are showing a strong
"long" move i.e. the market is bullish
and the index is expected to rise. We go to our
Futures trading platform and "buy" one
Emini S&P500 futures contract for an initial
margin of US$720 - so we are now effectively sitting
on an underlying contract that is worth US$49,000
(980 x $50 - as $50 is the value of each point
of the index). We aim for a move of say 3.0 points,
i.e. we will wait until the index reaches 983,
and then we will close our position. The market
moves up as expected and reaches the 983 level,
where a preset "limit-order" sells a
futures contract and closes our position. Now
each point move in the Emini S&P500 futures
contract is worth $50, so the three point move
grossed $150 profit. We then subtract the commission
cost of the trade, which is $19.04 for the round-turn
and we have made a net profit of US$130.96. This
is the profit per contract, so if we entered into
three positions, which would require US$2,160
of margin equity, then we would have made a net
profit of US$392.88. To intuitively understand
the return, the underlying contract was initially
"bought" for US$49,000, and was then
"sold" for a value of US$49,150 (983
x $50) so the difference is the profit.
An
example of a "short" trade is: The Real
Time Trade Communicator is showing indications
of a bearish trend, or a strong sell signal indicating
that the market may trend down in the next while.
We go to the Futures trading platform and "sell"
short one S&P500 futures contract at the 980
level, which requires an initial margin of US$720.
The market trends down as expected to 977, where
the platform "buys" one S&P500 futures
contract, through a "limit-order" that
we the trader have preset. Again the profit is
from a 3 point move, 3 x $50, less the $19.04
round-turn fee, to give a net profit of $130.96
per contract. I.e. we "sold" the underlying
contract for $49,000 (980 x $50) and closed the
position through "buying" it back for
a lower underlying cost of $48,850 (977 x $50)
all for an initial margin requirement of $720.
Overall the trade made a return of 18.2% on the
invested initial margin equity i.e. the US$720
is now worth US$850.96. Without the use of leverage,
the actual return on the underlying security was
merely 0.267%! ($130.96 / $49,000). So the effect
of leverage can be seen from this, however it
can also reduce your capital significantly if
the trade loses. The aim is to make more profitable
trades than loss trades.
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Margins
The margin deposit required to trade a futures
contract is not a down payment on a purchase of
equity, as many perceive margins to be in the
stock markets. Rather, the margin is a performance
bond, or good faith deposit, to ensure against
trading losses. The margin requirement allows
traders to hold a position much larger than the
account value, as it is only a small percentage
of the underlying contract value.
Firstly
the Initial Margin is the amount of equity
that must be held in your account and set aside
as a "performance bond" to enter into
a trade on a contract. For traders via eTradernet's
associates, this is approx 1.5% of the underlying
contract value and is effectively 20% of the standard
margins available to most other futures traders.
Therefore this only represents a very small portion
of the actual underlying contract itself. The
main point to note is that because the margin
deposit required to open a security futures position
is a fraction of the nominal value of the contracts'
being purchased or sold, security futures contracts
are highly leveraged. This means that buying (or
selling) a security futures contract provides
the same dollar and cents profit and loss outcomes
as owning (or shorting) the underlying security.
However, as a percentage of the margin deposit,
the potential immediate exposure to profit or
loss is much higher with a security futures contract
than with the underlying security.
The
Maintenance Margin is that amount of
equity required to be set aside for the traded
contract in order to maintain the position you
hold. Should a futures trade enter into a loss
situation and the amount of equity in your trading
account is no longer sufficient to cover the required
maintenance margin, you will receive a Margin
Call. This is when a trader is required to
deposit further funds into their trading account
in order to keep the position they currently have.
If this is not done, the position can be liquidated
and the net funds are then returned to the trading
account. The trader can be liable for any resulting
shortfall.
With
the system offered by eTradernet and the associated
entities, only intra-day trades are taken with
the use of strict stop-loss techniques. On a practical
basis, this means the initial margin to enter
a futures position will be all that is required
to undertake the trade. If a trader were to not
enter a stop-loss and therefore not cap their
potential loss, or the stop-loss failed to liquidate
their position, then the trader may be called
upon to deposit further funds into their trading
account.
The
Initial Margins available to our customers are
generally preferable to those available to a standard
futures trader because of the day-trading nature
of the system. This allows an investor to heavily
leverage their account for maximum capital utilisation.
While offering maximum capital utilisation and
potential growth, this does however introduce
further risk.
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Intra-day
Trading
The type of trading that is undertaken here is
purely "intra-day" trading. That means
that no "open" positions are held outside
the normal trading day, which is based on the
US markets in New York. Positions taken in the
futures market under the principles of a "day-trader"
are only held for a matter of minutes. Because
of the highly leveraged or geared positions that
traders can hold, a few minutes is a long enough
time to potentially make a reasonable return.
The main point is that the margins given to traders
under this system are done so on the understanding
that no "open" positions are carried
into the US night time - i.e. outside of the opening
hours of the US Stockmarket.
The
small initial margins as detailed are no longer
appropriate if an investor wants to hold a position
overnight under the GLOBEX system (the name given
to the Electronic Exchange System which futures
are traded through the Chicago Mercantile Exchange).
The market becomes much less liquid outside the
New York trading day making it potentially difficult
to exit a position. That means that an investor
may be exposed to larger price change before they
can exit the position, without the normal benefits
of standard "stop-loss" and "limit"
orders. A small day-trade margin is then no longer
enough to cover a potential move.
A
"normal" trading day for the S&P500
for example, may see a move of up to 20 points
fluctuation during that day. This is enough movement
to allow an investor to make a good return, considering
a one point move on the "e-mini S&P500"
is worth $50 per contract held.
If
a trader does take an open position outside the
normal trading hours, their position will be automatically
liquidated for a possible loss if there is insufficient
"night-time" margin in their account
to cover the trade.
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What
Every Futures Trader Should Know
The US Futures Market is a very popular market
for speculation, due to its well-known attributes
of size, reasonable-liquidity, and tendency for
securities and indices to move in strong trends.
An enticing aspect of trading futures is the high
degree of leverage available. This system allows
positions to be leveraged up to approx 65:1 i.e.
$1 of capital invested, effectively gives you
$65 of underlying capital to trade with. Without
proper risk management, this high degree of leverage
can lead to enormous swings between profits and
losses. Knowing that even seasoned traders suffer
losses, speculation in the futures market should
only be conducted with risk capital funds that
if lost will not significantly affect one's personal
financial well-being.
The minimum required to open a purely "day-trading"
Futures Trading account, available to our customers
is US$5,000. This allows enough capital to cover
day-trade margins and make a reasonable return
on capital.
The
US futures market opens at 9.30am New York Time
(EST) (or 11.30pm AET / 1.30am NZT) and closes
at 4.15pm EST (or 6.15am AET / 8.15am NZT). No
positions can be taken outside these hours and
each trader must be fully closed or "flat"
with no pending market orders.
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