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Futures
What Is Futures Trading?
| 1 | A futures contract is a financial instrument that is derived from an underlying product. |
| 2 | Underlying products (instruments) can be either stock indices, currencies, interest rates, agricultural products, commodities, metals or energy products. |
| 3 | It is a standardised, legally binding agreement between two parties - a buyer and a seller - to buy or sell a specific quantity and quality of a commodity at a specified price at a future date. |
| 4 | Futures are traded in exchanges and can either be traded via open outcry or through an electronic trading system. |
| 5 | Common uses for futures trading include hedging against price uncertainty and speculation for profit earning. |
| 6 | A money deposit (initial margin) allows you to control a position many times larger than the size of the deposit. |
| 7 | Most futures are generally settled on a cash basis, there is usually no physical delivery of the underlying product. |
Trading futures on a margin basis allows you to capitalise on the principle of leverage. Small fluctuation in the price of a futures contract will result in a relatively large movement in the overall value of your position (which can be either favourable or unfavourable).
Price Quotes
| 1 | Futures can be traded via open outcry or through an electronic trading system. |
| 2 | In futures trading, trades are done against the best bid or best offer. |
| 3 |
For example, A bid/offer quote for STI : 1,600 / 1,602 You can either buy the ask price (1,602) or sell at the bid price (1,600). Alternatively, you can better the bid or offer at the price 1,601. |
Initial Margin
Initial margin is simply a money deposit
that is required to support an open position. The amount of initial margin
required is determined by the volatility of the futures contract and
may be adjusted from time to time by the exchange.
Roll-over Of Open Positions
If you have an open long
futures position, and are planning to retain the exposure in the underlying
asset past the expiry date of your futures contract, you can engage in
a spread trade. A spread trade is the buying of one item and the selling
of a related item simultaneously.
Advantages of Futures Trading
Futures trading offers
an investor the following benefits:
| 1 | A hedging tool against price uncertainty in the underlying asset. |
| 2 | Minimal margin deposit required (relative to total contract value). |
| 3 | Flexibility of buying or selling first (short-selling). |
| 4 | Lower brokerage fees compared to the securities market. |
| 5 | Risk diversification when purchasing an equity futures contract. |
Example Of Trading Futures
In a scenario where you
are bullish on the Singapore stock market and wish to profit from it,
instead of spending time picking a stock, you may want to consider buying
a STI futures contract to profit from a rise in the STI if the rally
materialises.
Day 1
Ledger balance = SGD 5,000
Buy 1 STI futures contract at 1,600
Contract value = 1,600xSGD 10x1 contract = SGD 16,000
Initial margin = SGD 1,000
Settlement price = 1,630
Daily marked-to-market = (1,630-1,600)xSGD 10x1 contract
Profit / Loss = SGD 300
Margin account balance at end of Day 1 = SGD 300+SGD 1,000 = SGD 1,300
Day 2
Sell 1 STI futures contract at 1,650.
Profit from squaring off position = (1,650-1,630)xSGD10x1 contract = SGD
200
Total net profit = SGD 300+SGD 200=SGD 500
In this example, your bullish outlook was accurate and the futures price did increase from 1,600 to 1,650. Hence, you would have gained SGD 500.
Conversely, you would have incurred a loss if the STI futures contract falls and you sold it at 1,580.
Loss from squaring off position = (1,630-1,580)xSGD 10x1 contract = -SGD
500
Total net loss = SGD 500 – SGD 300 = SGD 200
In this example, your outlook was wrong and the futures price decreased from 1,600 to 1,580. Hence, you have lost SGD 200.
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