Mathematics of Futures Trading
Small Movements in the Market Can Create Big Changes in Your Account
Here’s an example of how leverage works in futures markets. In anticipation of rising stock prices, you buy one June S&P 500 E-mini stock index futures contract at a time when the June index is trading at 1400. Your initial margin requirement is $4,000. Since the value of the futures contract is 50 times the index each one point change in the index represents a $50 gain or loss.
Here’s an example of how leverage works in futures markets. In anticipation of rising stock prices, you buy one June S&P 500 E-mini stock index futures contract at a time when the June index is trading at 1400. Your initial margin requirement is $4,000. Since the value of the futures contract is 50 times the index each one point change in the index represents a $50 gain or loss.
Because of the power of leverage, an increase in the index from 1400 to 1420 would produce a $1,000 profit (20 X $50) and a decrease from 1400 to 1380 would be a $1,000 loss on your $4,000 margin deposit. In other words, a 2 percent change in the stock index can result in a 25 percent gain or loss in your margin account.
If you cannot afford the risk, or even if you are uncomfortable with the risk, futures trading may not be appropriate for you.
Margin Calls
Before trading in futures contracts, be sure you understand the brokerage firm’s Margin Agreement and know how and when the firm expects you to meet margin calls. Some firms may require only that you mail a personal check. Others may insist you wire transfer funds from your bank or provide same-day or next-day delivery of a certified or cashier’s check. If you do not meet your margin calls in the prescribed time and from, the firm can protect itself by liquidating your open positions at the available market price (possibly resulting in a loss for which you would be liable).
Remember, because of leverage, the gain or loss may be greater than your initial margin deposit.
An Example of Going Long
If you expect the price of a particular commodity or item to increase over a given period of time, you can seek to profit by buying futures contracts (going long). If you are correct and the prices increase, you can sell your futures contract for a higher price. The difference between the price you paid for the contract and the price you received when you sold it is your profit (minus account commissions and other transactions costs). Of course, if the price declines rather than increases, the sale of your futures contract will result in a loss.
Dozens of different strategies and variations of strategies are employed by futures trading in pursuit of speculative profits. This tutorial will describe just a few basic strategies.
An Example of Going Long
If you expect the price of a particular commodity or item to increase over a given period of time, you can seek to profit by buying futures contracts (going long). If you are correct and the prices increase, you can sell your futures contract for a higher price. The difference between the price you paid for the contract and the price you received when you sold it is your profit (minus account commissions and other transactions costs). Of course, if the price declines rather than increases, the sale of your futures contract will result in a loss.
By April, the July soybean futures price has risen to $6.40, and you decide to take your profit by selling. Since each contract is for 5,000 bushels, your 40 cents a bushel profit would be 5,000 bushels x 40 cents or $2,000 less transaction costs.
An Example of Going Long
If you do not meet your margin calls in the prescribed time and from, the firm can protect itself by liquidating your open positions at the available market price (possibly resulting in a loss for which you would be liable).
By April, the July soybean futures price has risen to $6.40, and you decide to take your profit by selling. Since each contract is for 5,000 bushels, your 40 cents a bushel profit would be 5,000 bushels x 40 cents or $2,000 less transaction costs.
Even if you should decide to participate in futures trading in a way that doesn’t involve making day-to-day trading decisions (such as a managed account or commodity pool), you should still understand the dollars and cents of how futures trading gains and losses are realized. Of course, if you intend to trade your own account, such an understanding is essential.
Dozens of different strategies and variations of strategies are employed by futures trading in pursuit of speculative profits. This tutorial will describe just a few basic strategies.
Small Movements in the Market Can Create Big Changes in Your Account
Here’s an example of how leverage works in futures markets. In anticipation of rising stock prices, you buy one June S&P 500 E-mini stock index futures contract at a time when the June index is trading at 1400. Your initial margin requirement is $4,000. Since the value of the futures contract is 50 times the index each one point change in the index represents a $50 gain or loss.
It is essential for anyone considering trading in futures contracts to clearly understand the concept of leverage. In addition, you must also be able to calculate the amount of gain or loss that will result from any given change in the price of the futures contract you are trading.
Because of the power of leverage, an increase in the index from 1400 to 1420 would produce a $1,000 profit (20 X $50) and a decrease from 1400 to 1380 would be a $1,000 loss on your $4,000 margin deposit. In other words, a 2 percent change in the stock index can result in a 25 percent gain or loss in your margin account.
If you cannot afford the risk, or even if you are uncomfortable with the risk, futures trading may not be appropriate for you.
Margin Calls
If you expect the price of a particular commodity or item to increase over a given period of time, you can seek to profit by buying futures contracts (going long). If you are correct and the prices increase, you can sell your futures contract for a higher price. The difference between the price you paid for the contract and the price you received when you sold it is your profit (minus account commissions and other transactions costs). Of course, if the price declines rather than increases, the sale of your futures contract will result in a loss.
Let’s use the example of a margin call. Let’s assume that the initial margin needed to buy or sell a particular futures contract is $2,000 and the maintenance margin requirement is $1,500. If losses on open positions reduce the funds remaining in your trading account to $1,400, you will receive a margin call for the $600 needed to restore your account to $2,000.
Going Long
If you expect the price of a particular commodity or item to increase over a given period of time, you can seek to profit by buying futures contracts (going long). If you are correct and the prices increase, you can sell your futures contract for a higher price. The difference between the price you paid for the contract and the price you received when you sold it is your profit (minus account commissions and other transactions costs). Of course, if the price declines rather than increases, the sale of your futures contract will result in a loss.
Dozens of different strategies and variations of strategies are employed by futures trading in pursuit of speculative profits. This tutorial will describe just a few basic strategies.
An Example of Going Long
Remember that you deposited only $1,000 initial margin for this transaction, so your broker would then call you for additional funds to cover the loss. If you had not sold the contract and left the position open in your account, your broker would ask you to deposit more margin funds into your account to cover the projected losses marked to the settlement price.
Margin Calls
Before trading in futures contracts, be sure you understand the brokerage firm’s Margin Agreement and know how and when the firm expects you to meet margin calls. Some firms may require only that you mail a personal check. Others may insist you wire transfer funds from your bank or provide same-day or next-day delivery of a certified or cashier’s check.Let’s look at an example of a margin call. Let’s assume that the initial margin needed to buy or sell a particular futures contract is $2,000 and the maintenance margin requirement is $1,500. If losses on open positions reduce the funds remaining in your trading account to $1,400, you will receive a margin call for the $600 needed to restore your account to $2,000.
Remember that you deposited only $1,000 initial margin for this transaction, so your broker would then call you for additional funds to cover the loss. If you had not sold the contract and left the position open in your account, your broker would ask you to deposit more margin funds into your account to cover the projected losses marked to the settlement price.
By April, the July soybean futures price has risen to $6.40, and you decide to take your profit by selling. Since each contract is for 5,000 bushels, your 40 cents a bushel profit would be 5,000 bushels x 40 cents or $2,000 less transaction costs.
Even if you should decide to participate in futures trading in a way that doesn’t involve making day-to-day trading decisions (such as a managed account or commodity pool), you should still understand the dollars and cents of how futures trading gains and losses are realized. Of course, if you intend to trade your own account, such an understanding is essential.
Remember that you deposited only $1,000 initial margin for this transaction, so your broker would then call you for additional funds to cover the loss. If you had not sold the contract and left the position open in your account, your broker would ask you to deposit more margin funds into your account to cover the projected losses marked to the settlement price.
Axioem Olayinkas is an author with special knowledge about options trades He can also help you be a better investor.
