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Archive for the ‘Futures’ Category

Futures are a mystery to most people, even some otherwise savvy investors. Ironically, futures (or their predecessors, “forward contracts”) are some of the oldest financial instruments known to man.

The Purpose of Futures

Futures are man’s attempt to conquer fate. That may be putting things a bit dramatically, but the truth is that man is rarely comfortable with uncertainty, and futures allow people to eliminate, or at least reduce, life’s ambiguities.

For example, when a 19th century farmer sold December corn futures in May, he knew exactly what price he would be getting for delivery of his crop, seven months ahead of time. This is the usefulness of futures.

Commodity Futures

The most common type of futures still stem from commodities. Corn, wheat, oats, soybeans, and sugar, as well as crude oil, natural gas, live cattle, and pork bellies are all examples of commodity futures. A farmer can sell a futures contract in order to lock in his price, and then buy back the same contract at a later date, either for a profit or loss, in order to avoid making delivery.

It is often impractical for a futures trader to either deliver or accept large quantities of corn or cattle, so most times; contracts are “closed out” in this fashion. For people who have an actual interest in the commodities (farmers on the sell side, large users of the commodity on the buy side), this can be seen as a form of insurance.

For people who do not have a real interest in the commodities, this is seen as speculation, or the attempt to profit by predicting price movements of the future contracts.

Financial Futures

In addition to commodities, future contracts for various financial instruments are also actively traded. There are futures for various stock indices, Federal Funds interest rates, and almost everything imaginable. The amazing thing about these futures is how accurate they tend to be.

As explained in the book, The Wisdom of Crowds, the large pool of participants in these markets create an almost supernatural, hive mentality that has an uncanny knack for getting things right. If the futures market anticipates a Federal Funds rate hike, then chances are, there is one in the works.

A Brief History of Futures

Future contracts evolved from “forward contracts.” These were handshake agreements made between 19th century farmers and large buyers of their crops or livestock. For example, a farmer might have agreed in May to deliver 5,000 bushels of grain to a miller in September, at a set price.

This cut down on the stockpiling by stockyards that created price disequilibrium – the stockyards would buy grain cheap when supplies were high, and then sell it for a huge profit later in the year when their supplies began to dwindle. Farmers and large buyers decided to create forward contracts in order to eliminate these middlemen.

Unfortunately, there were problems with forward contracts. For one, buyers and sellers had a hard time finding one another – unlike in the financial markets of today. And more importantly, buyers and sellers could each renege on prior agreements without much consequence.

Future contracts, by contrast, are standardized, which makes finding buyers and sellers much easier. And they are regulated by exchanges, who enforce the contracts, if need be.

The Modern Futures Market

Today, futures are traded in the world’s greatest financial marketplaces. Some of them include the Chicago Board of Trade, the Chicago Mercantile Exchange, ICE Futures, Euronext, the London Metal Exchange, the Tokyo Commodity Exchange, the New York Board of Trade, and the New York Mercantile Exchange (NYMEX).

Today’s most popular commodities include crude oil and natural gas, as well as various metals, such as gold, copper, silver, and platinum.

Can a person with limited funds; say a couple of thousand dollars, trade commodities? In a word, yes.

You don’t need $20,000, or even $5,000, to be a successful commodity trader. The mini-futures contracts were designed to fill the gap that exist between the high roller large accounts and those that only have a couple of thousand dollars to invest.

New traders are told to stay away from mini-futures because there is not enough contracts traded and you can lose all your money. That statement is true, and applies to trading standard commodity contract as well, if you plunge right in without first learning your craft.

Mini futures provide excellent trading opportunities for the small trading accounts.

It does not take a trading genius to make money trading mini commodities, just a little common sense and patience. There is nothing mystical about trading commodities nor are there any great secrets to trading.

Standard and mini futures contract charts look all most identical.

The major difference is the volume of contracts traded is much less that that of a standard futures contract. It should be noted that standard size contract charts can be used to find trades for the Mini Futures market simply because the mini-futures, for all practical purposes, mirror the standard size contracts.

Currently there are four groups of futures contracts that trade the mini contracts.

A Agriculture. Long term trading

1. Wheat

2. Corn

3. Soybeans

B Currencies. Extremely risky

1. Euro FX mini

2. Japanese Yen mini

C Precious metals. Extremely risky

1. NY Gold mini

2. NY Silver mini

D Indexes. Extremely risky

1. Nasdaq 100

2. Russell 2000 emini

3. S&P 500 emini

A new trader should stick to the first category to learn the proper way to trade commodities. There is still a risk in the corn, wheat, and soybean markets but it is reduced a great deal with the mini contracts. The other three categories do have mini contracts. However, they can be extremely volatile and wipe out a trading account in a heart beat.

Trading mini futures contracts can give new traders a chance to gain experience while building confidence and cash in on the fabulous profits being made in the futures markets. It does not take a small fortune to learn how to trade commodities.

Current margin (performance bond) required for a mini wheat contract is $400. One point (Cent) on a mini soybean contract = $10. With proper money management a new trader can slowly build their trading account and at the same time learn the craft of futures trading.

There are fortunes being made by commodity traders (speculators) every year. The best part about being a commodity trader is it does not matter if the markets are going up or down. You can make money even if the economy is in a recession.

Over night fortunes are very rare to non-existent in commodity trading.

However, you must understand perfect trades do not happen every day and it will take some experience to spot them. Mr. Larry Williams, a recognized trading professionals, made the statement “You don’t have to take every trade; just the winning ones.” Patience is one of the key ingredients of successful trading.

It’s tough sitting on your hands and not jumping on every trade but it pays off in the long run.

Always remember. Commodity trading is an extremely risky business. The first rule of a successful commodity trader is Plan Your Trade! Trade Your Plan!

It is often seen that new traders start with Futures and Options instead of futures contracts, while professional traders usually trade in options. New traders start with options because there is less risk and volatility involved.

This article contains some basic and introductory level knowledge about Futures and Options.

What are Futures and Options?

In simple terms F&O can be defined as, forms of exchange- regulated forward trading in which investor enters into transaction today, the settlement of which is scheduled to take place at a future date. The settlement date is called the expiry of the contract.

Futures

A Futures contract is an agreement between the seller and the buyer for the sale and purchase of a particular asset as a specific future date. The price at which the asset would change hands in the future is agreed upon at the time of entering into the contract.

The actual purchase or sale of the underlying involving payment of cash and delivery of the instrument does not take place until the contracted date of delivery. A future contract involves an obligation on both the parties to fulfill the terms of the contract.

Options

An option is a contract that goes a step further and provides the buyer of the option the right without the obligation, to buy or sell put as specified asset at an agreed price on or up to a specified date. For acquiring this right the buyer has to pay a premium to the seller. The seller on the other hand has the obligation to buy or sell that specific asset at the agreed price. The premium is determined taking into account a number of factors, such as current market price of the underlying , the number of days to the expiration the strike price of the option, the volatility of the under lying assets, and the risk less rate of return. Specifications of the options contract like the strike price, the expiration date and regular lot are specified but the exchange.

Options are of two types – Call and Put, explained below.

Some basic terms involved in Futures and Options:

Calls – You would buy a call option if you believe the underlying futures price will move higher. For example, if you expect wheat futures to move up or follow a upward trend, you will want to buy a call option.

Puts – You would buy a put option if you believe the underlying futures price will move lower. For example, if you expect soybean futures to move lower, you will want to buy soybean put option.

Premium – This term is used for the price of an option. This is the price you pay to buy an option. You can think of the pricing of options as a bet. The bigger the long shot, the less expensive they will be. Oppositely, the more sure the bet is, the more expensive it will be.

Contract Months (Time) – Options have an expiration date, which means they only last for a certain period of time. When you buy an option, you cannot hold it forever. For example, a December wheat call expires late November. You will need to close the position before expiration. Generally, the more time you have on an option, the more expensive it will be.

Strike Price – This is the price at which you could buy or sell the underlying futures contract.

Conclusion and Advantages

Options can provide these advantages to your portfolio like: Greater Cost Efficiency, Less Risk, Higher Potential Returns, and more Strategic Alternatives.

With low commission costs and direct access to the options market through the internet provided by the brokerages the average retail investor now has the ability to use the most powerful tool in the investment industry just like the pros do.

So, take the initiative and dedicate some time on learning how to use Futures and Options properly.

Aditya Todawal

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