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Technical Analysis

Futures: The Easy Way To Go Long... Or Short

by Patrick Oberhaensli, on Nov 4, 2019 3:18:00 PM

Introduction

In this three part article series, we will present a detailed examination of futures and Contracts For Difference (CFDs). We begin in part one of the series with the definition and overview of the main characteristics of the futures which are Exchange Traded Derivatives (ETDs), followed by the analysis of several key aspects around futures, including their uses.

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What are futures?

Futures are a derivative allowing one to simply gain close-to-identical exposure to the underlying market, for example an equity index, without having to own it when willing to go long or to sell it short. Futures, as any derivative, derives its price from one or more underlying instrument(s) and has an expiration; its liquidity being typically much higher in the nearer expirations. A future has therefore no optionality and that’s important when looking at its sensitivities. What is essential to understand when using futures is that: first, “paper work” needs to be done in order to start trading futures and second there is a margin process, that is, a small(er) amount of money is needed in order to enter (the initial margin) and maintain (the maintenance margin) a futures position. There are particularly high margins for special products such as bitcoin futures. In other words, futures allow to leverage and, depending on the underlying, even to leverage a lot but that does not need to be the main purpose as for commodity futures in the context of commodity index exposure. Let’s have now a detailed look at the main characteristics of futures.


The Main Characteristics of Futures

The table below shows the main characteristics of futures independently from where they are listed & traded.

Characteristic

Description

Format

Standardized instruments

Trading

Futures are traded on the exchange. Therefore, they are Exchange Traded Derivatives (ETDs) and not Over-The-Counter (OTC).

Sectors

Specific sectors include: equity indices, (credit risk “free”) interest rates with short- & (very) long-term maturity, Foreign Exchange (FX) & commodities.

Retailization

This occurs only in particular cases (for example, the S&P 500 micro contract from the Chicago Mercantile Exchange, please see below).

Clearing

Via clearing house (a Central Counterparty). The credit risk is typically from the investor's perspective considered to be extremely low.

Liquidity

Liquidity is often very high but it depends on the types of futures. For example, bitcoin futures which are new to the market, have a small(er) liquidity.

Direct transaction costs

Transaction costs are typically very low depending on the broker and the volume traded. The exchange itself fees should be considered as well.

Risk control of the investor positions (by the exchange)

Via a standardized margining process, the initial margin depends on the underlying instrument (volatility, as an example). It should be noted that margin requirements can typically quickly change.

Passive investment

As there is an expiration, there is a need for rolling the position in order to remain exposed (long or short)

At expiration

Either there is a physical delivery (in the case of oil or gold) or a financial settlement takes place (for equity indices)

Particular trading possibilities

Examining a  case from the Chicago Mercantile Exchange (CME): The Trade At Cash Open (TACO) allows the user to trade before the opening of the underlying cash market as if it had been traded at the opening, taking into consideration the spread between the two markets.

Taxation

Taxation will vary with domicile and citizenship and the use of the futures. It needs to be individually examined. But there could be advantages associated with the use of futures special treatments (comparative versus other instruments from the cash market).

Sensitivities

The Delta (change in the futures value for a change in its underlying instrument) is in most cases in absolute very close to 1.

A short position in a future has a negative Delta. There is no Vega as the futures have no sensitivity to volatility.

Other constraints

The exchange, as well as the broker, can apply other constraints that should be analyzed by the individual investor beforehand.

Position combinations

Futures can be combined in an effort to run specific exposures: For example, via a calendar spread. In this case, a long and a short position in two futures that differ only by their expirations is taken. Combinations can very well have a position impact on margins.

 

The derivative exchange publishes “contract specifications”, providing investors with the following information:

  • What the particular futures represents
  • The specific trading conditions
  • Trading possibilities/constraints
  • How the futures are risk-controlled (before traded)

This information should also be made available through the broker trading platform.

In our next article, we will discuss in detail the key questions related to the use of futures beginning with the rolling matter.

To be continued with the Part two of the CFDs and Futures series: Rolling of the futures matter and concrete futures strategies…


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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
Topic:Trading SignalsAsset AllocationActive TradingInvestment StrategyAnalysis and StrategyFuturesCFDs
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