Futures: The easy way to go long or… short (Part 2)
by Patrick Oberhaensli, on Nov 11, 2019 8:00:00 AM
Rolling The Futures Position
As futures have an expiry, the position to either long or short the market must be rolled. This would mean, in the case of a long future, that the investor must sell the current future and buy either the nearest one or another one that is more distant in the futures curve.
This rolling process leads to a gain or a loss depending on the situation. For example, when positioned long and the futures curve is in contango, we find that the further away the futures, the higher their price will be, resulting in a loss. That loss is simple arbitrage relative to financial products meaning no alpha is generated. This is not the case per se for commodities exhibiting convenience yield (the advantage of owning the commodity, which is individual and varies with time).
Examining Uses Of Futures
There are multiple uses for futures, from hedging to asset management. The following are classic and less classic examples:
In asset management, as an asset class by itself: the most direct application, in the context of futures, are managed futures. Managed futures – the strategy behind them are called Commodity Trading Advisors or CTAs in the USA – are simply approaches implemented with futures (essentially or exclusively).
The largest part of the managed futures market is made of (medium-term) trend followers which are systematically managed and diversified. The diversification taking place is generally among the equity-, fixed-income-, commodities- and foreign exchange futures markets. Futures are used in a directional manner for both up-trends (via long-positions) and down-trends (via short positions).
In portfolio management for hedging or to gain temporary long exposure: for hedging purposes, one needs to first distinguish the difference between short hedgers who short futures (for example to reduce their exposure to equities) and the long hedgers who go long futures in order to hedge.
The latter is the case for commodity consumers who want to set their buying price (budget them) in the future. It is the beta that quantifies the relationship between the underlying and the future prices – up to a certain point - and allows to "precisely" calculate the number of futures needed to achieve the net exposure desired.
Another varying parameter to take into consideration is that the beta is not a constant unless one is dealing with the same underlying as the futures' one. In this context, one speaks of a cross-hedge where underlying and futures correlate, but not perfectly.
Exposure Management: Managed Futures and Beyond
An important question for the investor who's willing to develop his/her own futures strategy: what is the typical measure of leverage and what level is reasonable?
Managed futures use the margin/equity ratio. In fact, it is the initial margin/portfolio investment made by the investor with the gains and losses which have occurred. The initial margin is the cash the investor needs to bring at the moment the future position is entered (and it of course it doesn't matter if it is a long or short position: it is the same amount).
The margin/equity is on average a figure around 5 to 10% depending particularly on the risk the investor is willing to take. Managed futures commonly size their position according to how convinced they are that the position is correct but also take account of the volatility of the market. And therefore, contrary to what many think, the lowest level of margin/equity is typically reached at the moment of very high market volatility.
An Extension That Also Considers Retailization
We have seen the rise of the recent phenomenon of the retailization in the futures markets and it could be just the beginning. In this case, retailization would be seen as a growth factor. Let's illustrate the retailization possibility with what has been a great success of the Chicago Mercantile Exchange or the CME - a very large derivatives exchange with an extensive product palette. In this example, we examine the S&P 500 micro contract launched on the 6th of May 2019, with currently quite large volumes.
The approximate daily “move” in USD for the so-called “Micro E-mini S&P 500 futures contract” was during the last weeks: 250’000 (contracts) * 5 (the multiplier) * 2’965 (a recent price) = 3.706 bn USD which compares to the classic E-mini S&P500 contract with : 1’800’000 (contracts) * 50 (the multiplier) * 2’965 (a recent price) = 0.2669 trillion or 266.85 bn USD.
In other words, the retailization process allowed smaller portfolios to use futures efficiently or to hedge more precisely. And it happened in parallel with the futurization of the markets, meaning the transfer of activity from the Over-The-Counter or OTC markets to the derivatives exchanges.
Futures are multi-faceted instruments that are actually useful for most types of investors because the exchanges are typically large, if not very large, and diversified. At least at some point in time, futures are likely to add value to the investor's portfolio. Futures are likely to gain further in importance as the current futurization (transaction volumes moving from Over-The-Counter to Exchange Traded Derivatives due to the legal context) continue to progress further.
Read the third part to this article series, What About CFDs?.
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Written by: EVOLIDS FINANCE LLC, Disclaimer:
- This content is not intended to be a solicitation nor an offer
- The preparation of the information provided herein is done with a high level of care. Nevertheless, errors are possible