They hope to take advantage of swings in commodity prices.
If you deposit the required initial margin of $4,125, you can see why a speculator would go long when prices are expected to rise.
A 100 troy ounce gold contract has a market value of $128,740.
You make money if gold goes up.
The June 2021 con tract's price is 1313.1 one month after you bought it.
You will make a profit of $1,313.10 - $1,287.40 if you liquidate the contract.
A total profit of $2,570 on the long gold contract position with an investment of $4,125 equates to a return on invested capital of 62.3%.
The price of gold could have fallen by $25.70 per ounce.
$2,570 is the loss on the position on a 100 ounce contract.
You would have lost a bit of your original investment: $4,125 - $2,570.
A drop in price is what a short seller is after.
You can sell the gold contract at 1287.4 and buy it back a month later at 1261.7.
The purchase price is the same as the selling price.
The selling price is more than the purchase price.
You might follow the more conservative tactic of spreading instead of speculating on the price behavior of a futures contract.
Spreading with put and call options is similar to combining two or more different contracts into aposi tion that offers the potential for a modest amount of profit but restricts your exposure to loss.
Unlike options, there is no limit to the amount of loss that can occur with a futures contract.
You set up a spread by buying and selling contracts.
Although one side of the transaction will lead to a loss, you hope that the profit earned from the other side will more than offset the loss and that the net result will be at least a modest amount of profit.
The spread will limit losses if you're wrong.
An example of how a spread might work.
You can either buy contract A at 533.50 or short sell contract B at 575.50.
Sometime later, you close out your position in contract A by selling it at 542, and then purchase a contract at 579 to cover your short position in B.
You lost 3.50 points on the contract you shorted because you made a profit on the long position.
The net effect is a profit of 5 points.
If you were dealing in cents per pound, those 5 points would mean a profit of $250 on a 5,000-pound contract.
Any type of investment situation can be set up with commodity spreads.
Most of them require specialized skills.
One of the reasons is oil.
The price of oil fell by almost 70% in six months and it isn't always possible to insulate a company from sending stock prices of oil-related businesses into commodity price risk.
Since then, the economy has created many millionaires through the rebounded, so has the oil futures price, again surpass years, but they have also brought about financial ruin.
The chart below shows the drop in crude oil of oil's volatility, which was blamed on prices from 2007 to 2015.
In 2007, and 2008, crude oil oil futures speculation and a flood of worldwide futures prices were reaching all-time highs.
An explosion in oil oil-related businesses into bankruptcy was caused by the drop in prices.
Cal Dive International, which filed for bankruptcy in 2008, had an average daily trading volume of 15 times world production.
Define the five essential parts of a commodities contract.
Define each of the following.
There are several approaches to investing in commodities.
Commodity futures are an extension of financial futures.
They were created for the same reason as commodities futures, they are traded in the same market, their prices behave like commodities, and they have similar investment merits.
Financial futures are unique because of their underlying assets.
Let's see how investors use financial futures.
Financial futures are the most popular type of futures contract.
The level of trading in financial futures is much higher than traditional commodities.
Hedgers and institutional investors use financial futures to manage their portfolios.
Individual investors can use financial futures to speculate on interest rates and the stock market.
Financial futures can be used to speculate in foreign currency markets.
The financial futures market was created in response to the economic turmoil of the 1970s.
Multinational firms were having problems with the dollar on the world market.
Corporate treasurers, financial institutions, and money managers had difficulties with interest rates.
The parties needed a way to protect themselves from the fluctuations in the dollar and interest rates.
The market for financial futures was born.
Hedging gave the economic rationale for the market, but speculators were quick to join in.
Foreign currencies, debt securities, and interest exchange called Onechicago are the basic types of financial futures.
20% of ssFs are conducted in major market currencies such as regular stock trades, while 50% are used for trading in this market.
The interest version of a stock can be used to support both rate-based securities and speculative investment strategies.
The interest rate futures were very popular, and their press release 7/1/2015 states that popularity continues to grow.
Most of the major U.S. stock indexes are used for today's trading.
Stock index futures contracts can be traded on a number of stock exchanges.
Stock index futures are similar to stock index options and allow investors to participate in the general movements of the stock market.
They derive their value from the price of the assets underlying them.
The general performance of the stock market is reflected in stock index futures.
The value of an S&P 500 futures contract should go up when the market for large-cap stocks goes up.
Stock index futures can be used by investors to buy or sell the market and participate in broad market moves.
Commodity contracts are similar to financial futures contracts.
They control large sums of the underlying financial instrument and are issued with a variety of delivery months.
The lives of financial futures contracts are usually less than a year for most stock index and currency futures.
The Canadian dollars futures quotation is very similar to the com modity futures quotation.
Currency futures quotations give the last, prior settle, open, high, and low prices, as well as contract trading volume.
The owner of a currency futures contract holds a claim on 100,000 Canadian dollars.
The underlying currency amounts can be found in currency futures contracts.
The holders of interest rate futures have a claim on the debt.
Bond quotations are expressed as a percentage of the par value, and the same is true for interest rate futures quotations.
The contract value is $100,000 because 149'21 is 149 + 21/32.
The seller of a stock index futures contract doesn't have to deliver the underlying stocks at the end of the contract.
Cash is the ultimate delivery.
The quotations for financial futures contracts include the daily last, prior settle, open, high, and low prices, as well as the change in price from the previous day's closing price to the current day's last price and the current day's volume.
The euro futures contracts are shown in the top panel while the U.S. contracts are shown in the middle panel.
The bottom panel shows the E-mini DOW futures, while the top panel shows the Treasury bond futures.
Consider the December 2015 E-mini NASDAQ 100 stock index futures contract.
The amount of cash underlying an E-mini NASDAQ 100 futures contract is large, but the initial margin amount for a single contract is less than $4000.
The price of each type of financial futures contract is quoted differently.
The underlying foreign currency is quoted in U.S. dollars or cents per unit.
For example, the value of a September 2013 Japanese yen contract with a settlement price of 0.012774 is calculated as $12,500,000.
Interest rate futures contracts are priced as a percentage of the par value of the underlying debt instrument, except for the quotes on Treasury bills and other short-term securities.
This contract is worth more than the $100,000 par value of the underlying security because of this rate.
The pricing conventions for the variety of other interest rate futures contracts can be found in their contract specifications or included with their quotations.
The S&P 500 Stock Index contract has a settlement price.
The initial margin requirement is less than 5% of the total contract value.
The value of an interest rate futures contract is related to the debt instrument that underlies it.
When interest rates go up, the value of an interest rate futures contract goes down.
When the price of a financial futures contract increases, the investor who is long makes money.
The short seller makes money when the price goes down.
The only source of return to speculators is price behavior.
Financial futures contracts don't have a claim on the interest income of the underlying issues.
Huge profits are possible with financial futures because of the large size of the contracts.
If the price of Swiss Francs goes up by just $0.02 against the U.S. dollar, the investor is ahead $2,500.
A 6-point drop in the index means a loss of $20 for an E-mini futures investor.
When related to the relatively small initial margin deposit required to make transactions in the financial futures markets, such price activity can mean very high rates of return--or very high risk of a total wipeout.
Financial futures can be used for hedging, spreading, and speculating.
Multinational companies that are active in international trade might use currency or Euromarket futures.
Corporate money managers and financial institutions use interest rate futures for hedging.
To lock in the best monetary exchange or interest rate is the same goal in either case.
Individual investors and portfolio managers often hedge with stock index futures to protect their security holdings.
Financial futures can be used to spread money.
The tactic of buying and selling combinations of two or more contracts is popular with investors.
Financial futures are used for speculation.
The use of financial futures by speculators and hedgers will be the focus of this article.
We will look at speculating in currency and interest rate futures.
We will look at how inves tors can use futures to hedge their investments.
Financial futures are of interest to speculators because of their large size.
In the middle of 2015, euro currency contracts were worth $139,262.50 or 125,000 euros and 10-year Treasury note contracts were going for 125'26 or $100,000.
Big price swings can be produced by small movements in the underlying asset with contracts of this size.
Currency and interest rate futures can be used for speculative purposes.
If you expect the euro to appreciate against the dollar, you could buy euro currency futures, which will go up in value.
If you anticipate a rise in interest rates, you should sell interest rate futures since they should go down in value.
Profitability of financial futures can be measured using return on invested capital, because margin is used and financial futures have the same source of return as commodities.
Suppose you think that the Swiss Franc is going to appreciate in value.
You decide to buy three December contracts at a price of just under $1.00 a Franc.
The total underlying value of the three contracts is $364,800.
To acquire this position, you would have to deposit $16,200, which is less than the initial margin requirement.
The value of the three contracts will go up if Swiss Francs go up from 0.9728 to 0.9965.
M16_SMAR3988_13_GE_C15.indd made a profit of $8,887.
A 54.9% rate of return is achieved using Equation 15.1 for return on invested capital.
A small change in the other direction would wipe out this investment.
The high returns are not without risk.
Let's assume that you are anticipating a rise in long-term rates.
The June 2016 T-bond contracts are trading at 141% of par, so you decided to short sell them.
The two contracts have a value of $294,000.
You only need $7,560 to make the investment.
It is assumed that interest rates move up.
The price on Treasury bond contracts dropped as a result.
T-bond contracts make a profit if they cover the short position.
You originally sold the two contracts for $294,000 and then bought them back for $100,000.
The difference between what you pay for a security and what you sell it for is profit.
This return is due to the enormous risk of loss you assumed.
Stock index futures are used by most investors.
Predicting the future course of the stock market is the key to success.
It is important to get a handle on the future direction of the market via technical analysis or some other technique if you are buying the market with stock index futures.
If you have a feel for the market's direction, you can use stock index futures trading or hedging.
If you feel that the market is going to go up, you should buy stock index futures.
Sell stock index futures and make money if your analysis shows a drop in equity values.
Assume that you think the market is cheap and that a move up is imminent.
You would need to deposit a margin of $25,300 to execute this transaction.
If the market does rise so that the S&P 500 Index moves to, say, 2176.6 by the end of the futures contract, you will make a profit of 2,176.6.
Your return on invested capital would be 74% if you invested $25,300.
The investment will be a total loss if the market drops by 75 points.
Stock index futures are used for hedging.
They help investors protect their stock holdings in a declining market.
This tactic does allow investors to obtain protection against a decline in market value without disturbing their equity holdings.
Assume that you have 2,000 shares of stock in a dozen companies and the market value of your portfolio is $235,000.
You can sell all of your shares if you think the market is going to go down.
Short selling stock index futures can be used to protect your stock portfolio.
Since they would be out for the third Friday in a row, you should match the current value of your portfolio.
The stock index futures contracts require an initial margin deposit of only $4,290 per contract, or a total of December.
If the value of index options, and stock index your futures contract to drop to, you will make a profit of $7,605 from futures all expire more or less this short sale.
The futures contract value fell at the same time.
The total profit on these days is $7,605.
If you ignore the equities markets, you can add this profit to the portfolio by purchasing volatile shares of stock at their new lower prices, because speculators and traders may additional shares of stock at their new lower prices.
The result will be a new need to buy or sell large portfolio position that will approximate the one that existed prior to the decline of stock or index in the market.
The stock prices on how far the portfolio dropped in value were calculated.
The positions will closely match if the average price goes down, creating bargains or windfalls of $5 per share.
This does not make money.
The amount of protection provided by this type of short hedge depends on how sensitive the stock portfolio is to movements in the market.
The spread of the expirations of types of stocks in the portfolio is an important consideration in the structuring of options so that they occur throughout the day, instead of a stock index short hedge.
A key to success with this kind of hedging is to make sure that the futures contract closely matches the options and futures contracts of the s&P 500 index.
If the portfolio is made up mostly of large-cap stocks, use the individual stock options and the s&P 100 index options expire at S&P 500 Stock Index futures contract as the hedging vehicle.
If the portfolio holds mostly tech stocks, consider the contract.
Pick a hedging vehicle that reflects the types of securities you want to protect.
If you keep that caveat in mind, hedging with stock index futures can be a low-cost yet effective way of protecting against a decline in the stock market.
As with stock index futures, interest rate futures can be used to hedge bond portfolios.
Foreign securities can be used as a way to protect against foreign exchange risk.
Let's look at an interest rate hedge.
A big jump in interest rates could cause a sharp decline in the value of your portfolio, so it's not something you would want to see.
Assume you have $300,000 worth of bonds with an average maturity of 18 years.
Short selling three U.S. Treasury bond futures contracts can be used to hedge your bond portfolio.
You will protect the portfolio against loss if rates head up.
The amount of protection depends on how well the T-bond futures contracts match the price behavior of your bond portfolio.
There is a downside.
If market interest rates go down rather than up, you will miss out on potential profits as long as the short hedge position remains in place.
The portfolio's profits will be offset by losses from futures contracts.
This will happen with any type of portfolio that is tied to an offsetting short hedge.
You essentially lock in a position when you create the short hedge.
When the market goes up, you don't make anything because you don't lose anything when the market falls.
The profits you make from one position are offset by the losses from the other.
Let's see how futures contracts can be used to hedge foreign exchange risk.
Let's assume you just bought $200,000 of British government one-year notes.
If the value of the dollar rises relative to the pound, this investment is subject to a loss.
If you wanted the higher yield offered by the British note, you could set up a currency hedge.
1 U.S. dollar will buy 0.606 of a British pound at the current exchange rate.
This means that the pound is worth about $1.65
You would have to sell two contracts to protect your $200,000 investment if currency contracts on British pounds were trading at around $1.65 a pound.
If they're being quoted at 1.65, each contract is worth $103,125.
If the dollar's value increases relative to the pound, then 1 U.S. dollar will buy 0.65 pound.
The British pound futures contract would be quoted at around 1.54 under such conditions.
Each futures contract has a value of 62,500 at this price.
Each contract would be worth less than it was a year ago.
Because the contract was sold short, you will make a profit of $6,875 per contract, for a total profit of $13,750 on the two contracts.
The loss you will incur on the British note investment will be offset by the profit.
The money was worth about PS121,000 when you sent $200,000 overseas to buy the British notes.
The 121,000 pounds bought 186,500 U.S. dollars when you brought them back a year later.
You are out $13,500 on your original investment.
If it weren't for the currency hedge, you would be out the full $13,500, and the return on this investment would be a lot lower.
The net effect was that you were able to enjoy the added yield of the British note without having to worry about currency exchange rates.
Financial futures can be an important part of your portfolio if you understand them well.
Financial futures have huge potential for profit and for loss.
The September 2015 S&P 500 futures contract traded at a low of 1963.50 on January 1, 2015, and a high of 2130.00 on June 1, 2015.
The range of 158.5 points translated into a potential profit or loss of $250 for a single contract, and all from an initial margin investment of only $25,300.
Diversification is a means of reducing the impact of price volatility.
Financial futures can provide generous returns if properly used.
The evolution began with listed stock options and financial futures spread.
The ultimate leverage vehicle was options on futures contracts.
They give the holders the right to buy or sell a single standard ized futures contract for a specific period of time at a specified strike price.
Commodities and financial futures have such options.
Clicking on the options icon will allow you to access the futures options quotations.
For the most part, these puts and calls cover the same amount of assets as the underlying futures contracts, for example, 112,000 pounds of sugar, 100 troy ounces of gold, 62,500 British pounds, or $100,000 in Treasury bonds.
Commodities and financial futures have the same amount of price volatility.
The strike prices, expiration dates, and quotation system of futures options are the same as those of other options.
Depending on the strike price on the option and the market value of the underlying futures contract, these options can be out-of-the-money.
The difference between the strike price and the market price of the underlying futures contract is what determines the value of futures options.
They can be used like any other option, for speculating or hedging, in options-writing programs, or for spreading.
The biggest difference between a futures option and a futures contract is that the option limits the loss exposure to the price of the option.
The cost of the put or call option is the most you can lose.
There is no limit to the amount of loss you can incur with the futures contract.