Why Trade Futures Contract
Why Trade Futures Contract ? Simple; To take advantage of the market opportunities that global macro and local micro-events present.
- Issues in the Middle East? Trade Oil futures
- The economy is volatile? Trade Gold futures
- Brexit rocks the UK? Trade the British Pound
Whatever is going on with the world economy, you can take advantage of a futures market that is correlated with that part of the world. You can also do so in a capital-efficient manner since futures traders don’t have to put up the entire amount of capital to “buy” or “sell” a futures contract. Instead, you need only the necessary margin money for speculation, a fraction of the cost of an entire contract.
Since the futures markets provide very high leverage for speculators, it is up to the individual trader to decide the amount of capital he or she wants to place in the account. Remember, the greater the leverage, the greater the risk.
Leverage
Futures have lower margin requirements than stocks. A regular, non-margined stock account requires the trader to deposit 100% of the value of the security he trades. A stock margin account requires an initial deposit of at least 50% of the current value of the security.
The remaining value is considered a loan, and the trader incurs interest charges for the borrowed funds. Futures generally require margin of between 5% to 15% of the full contract value. Futures margin requirements are set by the exchange they are traded on and are based on the volatility of the market. Profit and loss, however, is calculated on the full contract value.
Example
Let’s suppose the cost of a single contract is 20,000 PKR. But to trade that contract, you may only be required 1,000 PKR, a mere 5% of the contract’s total value.
If the market moves against you and your position begins taking on an unrealized loss, you can lose more than your initial 1,000 PKR, putting you in an under-margined position. So, be careful when using leverage.
Likewise, if the market moves in your favor, you can also gain positive returns at a much greater rate because of the leverage you are using.
Diversification
Futures allow investors to diversify the holdings in their investment portfolios, which can reduce portfolio risk and improve long-term returns. This is substantiated by academic research, “the combined portfolios of stocks (or stocks and bonds) after including judicious investments…. in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.”
Additionally, a study published by the Chicago Mercantile Exchange revealed that “portfolios with as much as 20% of assets in managed futures yielded up to 50% more than a portfolio of stocks and bonds alone.”
Opportunities
Futures give investors the opportunity to participate in a wide variety of markets, many of which have low correlation to equities and each other. With stocks, the predominant way to trade is to buy stocks, or to sell stocks you have already purchased. It is relatively difficult to short a stock.
You have to borrow stock for sale in the market, but not all stocks are available to borrow. Borrowing stocks for short selling also incurs costs. You have to pay a stock loan fee to borrow, and have to keep margin money in your account for the position.
On the other hand, to short a futures contract, you need only find someone to sell. You don’t need to own it to sell it. In fact, to avoid having to deliver on futures contract, you would buy back your contract before expiration, thus eliminating your obligation to deliver.
In futures, you can also short sell on a down tick, there are no restrictions on which markets can be sold short, and the margin treatment is the same for both long and short positions. The futures markets are also electronic and global in nature. In many cases, this allows for trading opportunities nearly 24 hours a day.
Regulations
As a trader, you can feel assured that operating in this market environment, one which entails greater risk, is overseen by federal regulatory agencies such as SECP and PMEX.
Due to the high level of regulation, many institutions feel comfortable placing funds in clearing firms, and their high volume of trading creates the liquidity for the speculators, both large and small, to trade and speculate in the futures market.
