Trade Index, Stock, Currency, Commodity, and Financial Futures Online Learn, Network and Improve with My Trading Advisor
FUTURES // LOW BROKERAGE, TRANSPARENT, EXCHANGE TRADED, LIQUID
- What is Futures Trading01
- Key Features of Futures Trading02
- Day Trading & Swing Trading03
- Suitability of Futures Trading04
- Futures Trading Examples05
- Key Benefits of Futures06
- Margin Obligations07
- Risks of Futures Trading08
- Styles of Futures Trading09
- Tools & Resources10
- How to Open an Account11
- Supported Brokers12
1. What is Futures Trading?
A Futures Contract is an agreement traded on a Futures Exchange by which you either buy or sell a specific quantity of a specific product (Underlying Instrument) for settlement on a specified date. Settlement can be via physical delivery or cash settlement. The Underlying Instrument may be, but is not limited to, a security (such as a share), index, commodity, currency or other financial product.
A Futures Option Contract gives the buyer the right, but not the obligation, to acquire an Underlying Instrument at the prescribed Exercise Price in return for payment of a Premium (being the price of the Futures Option Contract). The seller has no right other than the right to the Premium.
The Underlying Instrument may be a Futures Contract, where the seller will be under an obligation to enter into a Futures Contract at the Exercise Price if the Futures Option Contract is validly exercised by the buyer. If the Futures Option Contract is exercised, it results in the establishment of a Futures Contract.
Deliverable Futures Contracts: The seller agrees to deliver to the buyer and the buyer agrees to take delivery of, the quantity of the Underlying Instrument (such as a commodity) at the time the Futures Contract expires.
Cash settled Futures Contracts: Two parties’ make a cash adjustment between themselves at the time the Futures Contract expires according to whether the price of the Underlying Instrument (such as a commodity, financial instrument or index) has risen or fallen since the time the arrangement was made.
Reasons to Trade Futures
2. Key Points of Futures Contracts
Trading Futures Contracts and Futures Option Contracts allows you to ‘leverage’ your positions to take a much greater exposure to the price of the Underlying Instrument than if you were to buy and sell the Underlying Instrument directly. This has the capacity to significantly increase the potential losses or returns. It therefore involves significant risk. Transactions should only be entered into by traders and investors who understand the nature and extent of their rights, obligations and risks.
FUTURES TRANSACTIONS KEY POINTS:
THE DURATION AND STANDARDISED NATURE OF FUTURES CONTRACTS
Futures Contracts may be made for periods of up to several years in the future. One part of the standardisation of Futures Contracts is that the contract’s Expiry Dates follow a predetermined cycle. For example, the SPI 200® Futures Contract traded on the ASX 24, can be made for settlement only in March, June, September or December, and only up to 18 months from the time of the trade.
Futures Contracts are standardised and interchangeable, meaning that they are of a particular class are perfect substitutes for each other. A consequence of contract standardisation is that the price is the only factor that remains to be determined in the marketplace (outside of the contract month and volume). On the ASX 24, Futures Contracts are quoted and traded on an electronic trading platform (SYCOM®), which provides a system of continuous price discovery. This means that the price at which trades take place may continually change throughout a trading session. These features are common through most international Futures Exchanges.
Since all Futures Contracts for a given month in the same market are interchangeable, they can be Closed Out by entering an opposite position in the same contract. The net result is that the trader no longer holds a position in the Futures Contract. Similarly, a client who has sold a given Futures Contract can cancel the position or Close Out by buying the same contract.
THE ROLE OF THE CLEARING HOUSE
Futures Exchanges generally have a Clearing House. Clearing Houses clear and settle Futures Contracts executed on the Futures Exchange. The primary role of the Clearing House is to guarantee the settlement of obligations arising under the Futures Contracts registered with it. This means that when your Futures Broker buys or sells a Futures Contract on your behalf, neither you nor your broker needs to be concerned with the credit worthiness of the other side of the contract. The Clearing House will never deal directly with you, rather the Clearing House will only ever deal with its Clearing Participants – that is your broker (where your broker is a Clearing Participant), or where your broker is not a Clearing Participant, your Futures Broker’s Clearing Participant.
When a Futures Contract is registered with the Clearing House, it is novated. This means that the Futures Contract between the two brokers who made the trade is replaced by one contract between the buying broker (or its Clearing Participant) and the Clearing House as seller and one contract between the selling broker (or its Clearing Participant) and the Clearing House as buyer.
In simple terms, the Clearing House becomes the buyer to the selling broker, and the seller to the buying broker.
You, as the client, are not party to either of those Futures Contracts. Although your Futures Broker may act on your instructions or for your beneﬁt, the rules of the Clearing House provides that any contract arising from an order submitted to the market is regarded as having been entered into by the executing broker as principal. Upon registration of the contract with the Clearing House in the relevant Clearing Participant’s name, that Clearing Participant will incur obligations to the Clearing House as principal, even though the trade was entered into on your instructions.
The Clearing House ensures that it is able to meet its obligation to Clearing Participants by calling a margin to cover any unrealised losses in the market.
YOU CAN TAKE BOTH LONG AND SHORT POSITIONS
CALCULATING PROFITS AND/OR LOSSES
These examples are included for illustrative purposes only, and are not indicative of actual exchange rates or values.
Assume you purchase 1 SPI200® Futures Contract (i.e. you enter into a “long” Futures Contract) where the Underlying Instrument is the ASX200® Index and the level at which you enter into the Futures Contract is 5450. Your later Closed Out the Futures Contract by “selling” (or exiting the “long” Futures Contract) at a higher level of 5475. The resulting gross profit on the transaction would be $625 being sale level (5475) less buy level (5450) x 1 x 25 (the dollar amount per point of the Futures Contract). The net profit is determined after deducting your Futures Brokers commissions (charged on both opening and Closing Out the transaction) and any other charges as set out by your Futures Broker.
Assume you purchase 1 SPI200® Futures Contract (i.e. you enter into a “long” Futures Contract) where the Underlying Instrument is the ASX200® Index and the level at which you enter into the Futures Contract is 5450. You later Closed Out the Futures Contract by “selling” (or exiting the “long” Futures Contract) at a lower level of 5440. The resulting gross loss would be $250 being sale level (5440) less buy level (5450) x 1 x 25 (the dollar amount per point of Futures Contract). The net loss is determined after adding commissions and any other charges.
This example is included for illustrative purposes only, and is not indicative of actual exchange rates or values.
If Trader A was to sell to Trader B at $100 per unit, the Clearing House would become the buyer to A and the seller to Trader B. If Trader B sells to Trader C for $120 per unit, the Clearing House is now novated as the buyer to Trader B and the seller to Trader C. Trader A would therefore have an open sold position and Trader C would have an open bought position. Trader B no longer has a position and has therefore realised a profit of $20 per unit (ignoring for the purposes of this example any transaction fees that may apply).
The Futures Contracts which Trader B held (one to buy and one to sell) have been settled in cash between B and the Clearing House. Trader B simply receives the net profit. Any profit due to Trader B is paid out by the Clearing House in cash, even though the original seller (Trader A) remains in the market.
Your Futures Broker, the Futures Exchange, or the Clearing House also has the ability to amend or cancel a trade as stated in your Futures Brokers Client Services Agreement. This could cause a loss or increased loss to be suffered.
Any unilateral Close Out directive from or by a Clearing House, Futures Exchange or the regulator in accordance with the rules, regulations, customs and usages of the market will be accepted by you and settled based on that Close Out and you will accept any costs involved in the re-establishment of a position if you re-open the position.
VALUATION OF FUTURES CONTRACTS
DELIVERABLE FUTURES CONTRACTS
If you have bought a Deliverable Futures Contract that is still open at the close of trading on the Settlement Date or First Notice Day (whichever comes first), you will be under an obligation to take delivery of, and pay the contract price in full for, the Underlying Instrument described in the Futures Contract.
If you have sold a Deliverable Futures Contract that is still open at the close of trading on the Settlement Date or the First Notice Day (whichever comes first), you will be under an obligation to deliver the Underlying Instrument described in that Futures Contract.
Most online futures brokers do not permit its clients to make or take delivery under a Deliverable Futures Contract. Exceptions to this policy may be granted in certain instances with your Futures Broker in advance.
Your Futures Broker reserves the right, in its absolute discretion, to Close Out any open position you hold in a Deliverable Futures Contract if you have not Closed Out that Futures Contract price to the First Notice Day.
CASH SETTLED FUTURES CONTRACTS
Profits made from trading in shares are treated as income and are typically subject to income tax and depending on the jurisdictions, may also be subject to stamp duty and GST. Investing is typically more tax effective and less fee intensive than trading so carefully consider your options before taking the plunge.
FUTURES OPTIONS KEY POINTS:
Options traded over Futures Contracts are commonly known as Futures Option Contracts. A Futures Option Contract that is a “Call Option” gives the buyer the right, but not the obligation, to buy a Futures Contract at the prescribed Exercise Price in return for payment of a Premium. A Futures Option Contract that is a “Put Option” gives the buyer the right, but not the obligation, to sell a Futures Contract at the prescribed Exercise Price in return for payment of a Premium.
The seller will be under an obligation to sell a Futures Contract (in the case of a Call Option) or to buy a Futures Contract (in the case of a Put Option) at the Exercise Price of the Futures Option Contract if the Futures Option Contract is validly exercised by the buyer. If an Futures Option Contract is exercised, it results in the establishment of a Futures Contract.
STYLES OF FUTURES OPTIONS CONTRACTS
There are two types of option styles; American style options (American Options) and European style options (European Options).
European Options can only be exercised on the Expiry Date and not before. American Options can be exercised at any time up until, and including, the Expiry Date. Futures Option Contracts traded on most Futures Exchanges are American Options. The seller of a Futures Option Contract that is an American Option must be prepared for that Futures Option Contract to be exercised at any time before the Expiry Date.
You should clarify whether the Futures Option Contract you intend to trade is an American Option or a European Option prior to entering into the Transaction, as the operating rules of the Futures Exchange may vary depending on the type of Futures Option Contract you are dealing with.
EXERCISING CALL OR PUT OPTIONS
The diagram below sets out the results from the buyer’s and seller’s viewpoint when the buyer exercises a Call Option or Put Option:
|Bought Call Option||Bought Underlying Contract (at the Exercise Price of the Futures Option Contract)||Sold Call Option||Sold Underlying Contract (at the Exercise Price of the Futures Option Contract)|
|Bought Put Option||Sold Underlying Contract (at the Exercise Price of the Futures Option Contract)||Sold Put Option||Bought Underlying Contract (at the Exercise Price of the Futures Option Contract)|
“IN THE MONEY”, “AT THE MONEY” AND “OUT OF THE MONEY”
A Futures Option Contract is always either “in the money”, “out of the money” or “at the money”.
“IN THE MONEY”
An “in the money” Futures Option Contract is, in relation to a bought Call Option, if the Exercise Price is lower than the current market price of the Underlying Instrument and, in relation to a bought Put Option, if the Exercise Price is above the market price of the Underlying Instrument. An “in the money” option is, in relation to a sold Call Option, if the Exercise Price is higher than the current market price of the Underlying Instrument and, in relation to a sold Put Option, if the Exercise Price is below the market price of the Underlying Instrument.
“AT THE MONEY”
An “at the money” option is, in relation to both Put Options and Call Options, if the Exercise Price is equal to the current market price of the Underlying Instrument.
For the most part, at expiry all “in the money” or “at the money” options are automatically exercised by the Clearing House, however not all Future Exchanges automatically exercise “in the money” or “at the money” options at expiry. Accordingly, you should contact your Options Broker representative before the Expiry Date or the option may lapse worthless.
“OUT OF THE MONEY”
An “out of the money” option is, in relation to a bought Call Option is, if the Exercise Price is higher than the current market price of the Underlying Instrument and, in relation to a bought Put Option, if the Exercise Price is below the market price of the Underlying Instrument. An “out of the money” option is, in relation to a sold Call Option, if the Exercise Price is lower than the current market price of the Underlying Instrument and, in relation to a sold Put Option, if the Exercise Price is above the market price of the Underlying Instrument.
If a Futures Option Contract is “out of the money” at a particular point in time, it does not mean it does not have value. That is, it may still have time value i.e. time until the Expiry Date in which the price of the Underlying Instrument may move in your favour.
HOW IS THE PREMIUM DETERMINED?
The price to be paid or received in relation to a Futures Option Contract is the Premium. It is negotiated between the buyer and seller of the Futures Option Contract via the market, and is payable by the buyer to the seller (through the Clearing House) at the time the Futures Option Contract is entered into. The Premium is the compensation for the seller accepting the risk involved in selling the Futures Option Contract. The full value of the Premium is payable immediately upon executing the Futures Option Contract. This means that there must be sufficient Net Free Equity in your Trading Account before you can commence trading.
Paying the Premium will allow you to keep or hold the Futures Option Contract until its Expiry Date (when it can either be exercised or it will lapse) or to sell it at any given point of time prior to its Expiry Date i.e. Close Out the open Futures Option Contract. The value of an Futures Option Contract will fluctuate during the life of the Futures Option Contract depending on a number of factors, including:
- the price of the Underlying Instrument;
- the nominated Expiry Date and the time remaining to expiry;
- the nominated Exercise Price;
- the volatility of the Underlying Instrument; and
- interest rates, dividends and other distributions paid or payable in respect of the Underlying Instrument and general risks applicable to markets.
3. Day Trading and Swing Trading
In stocks, the lack of leverage and fees can be prohibitive for short term trading styles like Day Trading and Swing Trading. In Futures, due to the high leverage and very lost costs, Day Trading and Swing Trading can be profitable endeavors.
At MyTradingAdvisor we focus more on Swing Trading approaches to the markets though we do cover Systems Trading in detail and that includes systems that may buy and sell in the same day.
4. Suitability of Futures Trading
Index Futures involves buying and selling futures contracts on popular stock market indices including the SPI200 Index in Australia, the S&P500 Index in the USA, the Dax30 in Germany and the FTSE 100 in England and more.
Futures Trading Contracts are available on commodities such as Crude Oil, Natural Gas, Unleaded Petrol, Gold, Silver, Copper, Platinum, Soybeans, Soymeal, Corn, Wheat and so on.
You can also trade futures on financials such as interest rate products like bonds and bank bills. Currency Futures are also very liquid and provide an alternative to Forex covering many of the major Forex crosses.
5. Futures Trading Examples
We have described how Futures Transactions work and the basic points of Futures.
6. Key Benefits of Futures Products
Futures Trading provides a number of benefits which must be weighed against the risks of using them. The benefits of Futures Trading are as follows:
LIMITED COUNTERPARTY RISK
PROFIT POTENTIAL IN BOTH RISING AND FALLING MARKETS:
TRADE FROM ANYWHERE
7. Margin Obligations
Futures Contracts and Futures Option Contracts are subject to margin obligations i.e. you must have sufficient Net Free Equity in your Trading Account for security and margining purposes. You are responsible to meet all margin obligations.
TYPES OF MARGIN
Margins are generally a feature of all exchange-traded derivative products (including Futures Contracts and Futures Option Contracts) and are designed to protect the Clearing House against default. A margin is the amount calculated by the Clearing House as necessary to cover the risk of financial loss on an open exchange traded derivatives contract due to an adverse market movement.
The Clearing House contracts with Clearing Participants. Where a Clearing Participant has an exposure under an open Futures Contract to the Clearing House, the Clearing House will call amounts of money known as margin from the Clearing Participant to cover the risk exposure to the Clearing House. The amount of margin required is determined daily by the Clearing House, following the close of trading each day. In times of extreme volatility an intraday Margin Call may be made by the Clearing House.
There are two components of the Margin Requirements which you may be required to pay in connection with Futures Transactions; Initial Margin and the Variation Margin.
In order to enter into a Futures Contracts or Futures Option Contracts you will be required to pay us the Initial Margin or have an amount of Net Free Equity in your Trading Account that is at least equal to the Initial Margin. The Initial Margin represents collateral for your exposure under a Transaction and is used to cover any potentially adverse fluctuations against your initial position.
The Initial Margin required depends on the Futures Exchange on which the Futures Contracts or Futures Option Contract is traded. The Initial Margin will vary from time to time according to the volatility of the market. This means that an Initial Margin may change after a position has been opened, requiring a further payment (or refund, where applicable).
The buyer of a Futures Option Contract (“long”) is generally not subject to margin obligations as the buyer of an Futures Option Contract is required to pay the full value of the Premium at the time the Futures Option Contract is acquired. However in some instances an Initial Margin may be acceptable as opposed to paying the full premium when initiating a long position.
The seller of the Futures Option Contract (“short”) is entitled to receive a portion of the Premium based on the “mark to market” valuation of the Futures Option Contract (i.e. the seller of an Futures Option Contract does not receive the full value of the Premium upfront). A seller would also be required to pay an Initial Margin to open the position.
The Initial Margin will typically be between 2% and 10% of the face value of the Futures Contract or the Options Contract. However, it is possible for Initial Margins to be above this range. The amount may change at any time and at the discretion of the relevant Clearing House (or the relevant Futures Exchange, in some cases). You should refer to the website of the relevant Futures Exchange to confirm the actual requirement for your proposed Transaction at any particular time.
As the value of your open positions will constantly change due to changing values of the Underlying Instrument, the Margin Requirement (being the minimum Net Free Equity required in your Trading Account) on the open positions will also constantly change. This is referred to as a Variation Margin. The amount of your Margin Requirements (being the Initial Margin and any adverse Variation Margin) at any one time will be displayed on the open positions report made available through your Trading Platform.
Any adverse price movements in the market must be covered by further payments from you (unless you already have sufficient Net Free Equity in your Trading Account). Your Futures Broker will also credit the Variation Margin to your Trading Account when a position moves in your favour.
Your Futures Broker will determine the Variation Margin for a Transaction by reference to changes in the value of the Underlying Instrument. In other words, each contract is effectively “marked to market” on at least a daily basis. “Marked to market” means that an open position is revalued generally in real time or at least on a daily basis to the current market value. The difference between the real time/current day’s valuation compared to the previous real time/day’s valuation respectively is the amount which is debited (in the case of unrealised losses) or credited (in the case of unrealised profits) to your Trading Account. The valuations are calculated using the closing value (at the close of trading on each day) of the Underlying Instrument as determined by the relevant Pricing Source. Intraday “marked to market” revaluations will be based on the last available value of the Underlying Instrument as determined by your Futures Broker in their sole discretion.
Margin Calls are made on a Net Trading Account basis i.e. should you have several open positions with respect to a particular Trading Platform, then Margin Calls are netted across the group of open positions. In other words, the realised and unrealised profits of one Transaction can be used or applied as Initial Margin or Variation Margin for another Transaction.
Your Broker will be notified of a margin call using ‘pop-up’ screens or screen alerts on the Trading Platform or via e-mail and in some cases by phone. Your Futures Broker will typically require you to log into the Trading Platform regularly when you have open positions to ensure you receive notification of any Margin Calls.
Your Futures Broker is under no obligation to contact you in the event of any change to the Margin Requirements or any actual or potential shortfalls in your Trading Account.
FAILING TO MEET A MARGIN CALL
Your Futures Broker will generally apply risk limits (referred to as Default Liquidation Thresholds) to ensure that the percentage of your Trading Account balance which you are using at any one time to satisfy Margin Requirements (Margin Utilisation) does not exceed certain pre-defined levels. If your Margin Utilisation exceeds the Default Liquidation Threshold for your Trading Platform, a Margin Call will generally be applied to your Trading Account. If you do not meet a Margin Call immediately, your Futures Broker may Close Out some or all of your open Transactions without notice to you.
The Default Liquidation Threshold is determined by your Futures Broker. It is implemented for risk management purposes, and may be varied by your Futures Broker at any time.
8. Risks of Trading in Futures
CHANGES IN THE PRICE, VALUE OR LEVEL OF THE UNDERLYING INSTRUMENT
Trading in the Futures Contracts and Futures Option Contracts involves a high degree of risk. It is important that you carefully consider whether trading Futures Contracts and Futures Option Contracts is appropriate for you in light of your investment objectives, financial situation and needs.
If there is an adverse change in the price of the Underlying Instrument, you will be required to immediately transfer additional funds to your Futures Broker in order to maintain your position if you do not have sufficient Net Free Equity in your Trading Account. Those additional funds may be substantial. If you fail to provide those additional funds immediately, your Futures Broker may Close Out some or all of your open positions. You will also be liable for any shortfall in your Trading Account balance following those closures.