Trading in Futures
Welcome to the dizzying world of futures trading (commodity trading, commodity futures trading).
A futures contract is an agreement between two parties to transact a physical commodity or financial instrument for future delivery (on a specified date) at a particular price. Futures contracts involve standardised quantities or amounts, and are transferable and exchange-traded. You can have a long position (you agree to buy) or a short position (you agree to sell, possible even if you do not own the commodity or financial instrument). In order to ensure that payment occurs, futures trading incurs margin requirements that must be settled daily.
Futures are a type of derivative (similar to options and CFDs); when you trade futures, you are not actually buying or owning anything (unlike trading stocks and bonds), simply speculating on the future direction of the price of the underlying. The underlying in a futures contract can be a commodity, bond, currency or stock index. Unlike options, futures contracts involve an obligation to buy, so as a futures trader you would have to close out your position at some point before the last trading day for that contract otherwise you would then be obligated to accept delivery – and make full payment – for the commodity.
The underlying in a futures contract can be a:
- Bond or Note, eg the US T-Bond and 10-Year T-Note;
- Commodity, eg coffee, pork bellies, rubber, soybeans and wheat;
- Currency, eg the Euro, Japanese Yen, Swiss Franc and US Dollar;
- Energy, eg WTI crude oil and Brent crude oil;
- Metal, eg gold and silver;
- Stock Index, eg S&P 500 and STI;
Today’s futures markets are meeting places for farmers and manufacturers, exporters and importers, and traders (speculators). The players fall into two categories: hedgers (players who want to protect themselves against adverse price movements) and speculators (players who want to benefit from price movements). Speculators perform the function of providing liquidity and assuming the risk of price fluctuation in exchange for the possibility of earning substantial returns.
Futures are traded at exchanges located all over the world; some of the biggest exchanges in the world are Chicago Board Of Trade (CBOT), CME (Chicago Mercantile Exchange), New York Mercantile Exchange (NYMEX) and SIMEX (Singapore International Monetary Exchange).
There are several advantages to trading futures, but two stand out:
- Leverage – futures involve highly leveraged financial instruments, thus providing much higher returns on risk/investment than trading the underlying.
- Liquidity – the biggest futures markets trade in huge amounts and attract world-wide participation, thus offering traders very low Bid/Ask spreads;
In conclusion, futures markets began as a way for farmers to hedge against unfavourable price movements of their produce, but have since evolved to provide continuous, accurate, well-publicised price information and liquid markets, not just for commodities but also for financial instruments.
As professional futures traders will tell you, futures trading can be risky and complicated (a situation compounded by the use of leverage). There is theory, and there is practice. As in any other business, only a few traders make it in the long run. However, with the proper mindset (trading psychology), money management (trade and portfolio risk management) and method (knowledge) we can give ourselves the very best odds possible in this highly challenging industry.
The E-Mini S&P 500, often shown as E-mini or Emini, is an index futures contract on the S&P 500 Stock Index. It has the prefix ’ES’, is listed on the Chicago Mercantile Exchange (CME, cmegroup.com) and is traded electronically (versus open-outcry pit trading). The contract has a value of US$50 x E-mini S&P 500 futures price.
The E-mini has an older cousin – the standard S&P 500 futures contract – but has quickly overtaken it as the most popular equity-index futures contract in the world. Its daily volume averaged 2.25 million contracts, or about US$143 billion, in 2010.
(Note that E-mini futures contracts can also be found on the Dow, NASDAQ-100 and Russell 2000 stock indices.)
The minimum price movement the S&P 500 E-minis can make is called a Tick (or 0.25 Point). A tick is worth US$12.50 per contract; 4 ticks make a Point so a point is worth US$50 per contract. You can trade as many contracts as you like provided you have the trading capital to do so.
To trade the E-minis you need to open a futures trading account with a futures broker, who will instruct you on how to fund the account. Your broker will tell you how much margin is required to trade the E-minis. Margins are essentially ‘good faith deposits’ that protect the broker in case your trade moves against you. The margin gets returned to you once you close out the trade.
Margins for day trading are usually US$500-$1000 per contract so, for example, a US$10,000 account can trade 10 to 20 contracts.
The E-mini trades 23.25 hours a day, five days a week. Trading hours are Mon-Thurs 5pm – 3:15 pm & 3:30pm – 4:30 pm, US Central Standard Time.