Trading Futures
To start trading futures, you have to provide a deposit which is known as a margin. This provides collateral to the exchange against the possibility that you don’t meet the contract. Given the size of standard futures contracts, as you will see the next section, there is a lot of money at stake so it is only reasonable that there is a guarantee that you can cover reasonable changes in price. The amount varies, depending on what is being traded and how much it typically fluctuates, but it may be about 10%. On the other hand, if you are spread betting on futures then you can choose your stake, and will not have to find the sort of funds that are needed to enter the true futures market.
The other thing to know about futures is that the price is updated each day, which is called marking to market. However much the value has changed in the day, that amount is reflected in your margin account. If the price has fallen, the money will be taken out of your account. If your account falls below a certain level because of this, then you may get a ‘margin call’ to put more money in, again to make sure that the market is covered against you failing to meet the contract. Basically you’re paying for losses in the contract as you go along.
It’s very important that you answer the margin call straight away, because otherwise the broker is entitled to liquidate any of your holdings you have with him in order to pay it. It could even be an unrelated stockholding, and you can’t hold him responsible for any losses you sustain. Once again, this works differently when you are spread trading, where futures are simply another financial instrument that you can place a bet on.
Of course, marking to market can also work in your favour. If the value of the contract goes up, then your account is credited. So, unlike stocks, you can make a profit without having to sell any of your holding. Although you would have to think carefully before doing it, so that you did not risk being caught out later, you could even take money out of your futures account that had accumulated because of the change in price without having to close any contracts. The money could also be used to secure further futures contracts.
As each futures contract has a date associated with it, called the delivery date or expiration date, you can’t just sit back as you can with a stock investment. You need to have a plan to trade, usually selling the contract, hopefully for a higher price, before the expiration. Some dealers will allow you to roll over the money into another contract with a later date, but you can always expect there to be price adjustments which you must be prepared for and anticipate.
Just one more thing, the exchanges impose a limit on how much the price can vary each day. This is because futures can be very volatile and the exchange needs to keep some order in the markets. If a commodity repeatedly closes ‘limit up’, going as far as allowed each day, then they can change the limits temporary to let the price find a better level, but this doesn’t happen often. When spread trading, the price swing may be artificially limited in this way. However, your contract is usually with the bookmaker who is entitled to select his own prices for the bets. You will find that most bookmakers keep their prices in line in order to avoid the possibility of giving away the chance of arbitrage to betters who have more than one account.
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