This article is meant to be a practical guide to get you started and should give you enough information to build on to make further research.
Introduction
Trading futures on exchanges means you will have to be aware of price limits, position limits and clearinghouses.
Price limits = the max. daily price increase/decrease that the exchange allows. Price will be frozen but no trading. The idea behind is to limit price volatility. Not all exchange have price limits. Limits can be adjusted as a consequence of price volatility. One more thing, these limits do not guarantee you the ability to close a position within the range of the limit.
Currency and interest futures are traded on the IMM - International Monetary Market.
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Futures Months
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Other terminolgy you might relate to is when describing markets as being in Contango or in Backwardation (sometimes also Backwardization).
- A Normal market is a Contago market = cash price lower than futures price.
- An Inverted market or Backwardation market = cash price higher than futures price.
Why a Normal market? because the difference between cash and futures is the result of the carrying charges (insurrance, storage, etc..) and the underlying change in value.
An Inverted market points towards a tight market supply.
Commodities
- Agricultural commodities: wheat, corn, oats, soybeans, cocoa, sugar, coffee
- Livestock: live cattle, feeder cattle, hogs, pork belies
- Energy: crude oil, heating oil, natural gas
- Precious metals: gold, silver, copper, platanium
Contract size: 5000 bushels
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The contract value is thus 5000 x price per unit. So if corn is quoted at 210.40 cents that translates into $2.1040 x 5000 bushels = $10'520
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The contract value is thus contract size x price per unit. So if sugar is quoted at 124.80 that translates into $1.2480 x 112'000 = $139'776
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The contract value is thus contract size x price per unit. So if Live cattle is quoted at $58.50 that translates into $0.5850 x 40'000 = $23'400
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The contract value is thus contract size x price per unit. So if Crude Oil is quoted at $55.20 that translates into $55.20 x 1'000 = $55'200
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The contract value is thus contract size x price per unit. So if Gold is quoted at $1350 that translates into $1350 x 100 = $135'000
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Financial Futures
- debt securities
- equity securities
- foreign currencies
Note: if you trader through futures, know that stock index futures are settled in cash at the close of business on the (contract) specified final settlement date.
Equitiy Indices
Product
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E-Mini
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Nasdaq
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Dow Jones
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Nikkei 225
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Symbol
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/ES
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/NQ
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/YM
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/NKD
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1 point $ value
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$50
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$20
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$5
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$500
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min. tick
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$0.25
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$0.25
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$1
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$5
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- T-Bills are traded on the CBOT - contract size is $1'000'000
- Treasury Bonds, Treasury Notes and GNMAs - contract size $100'000
- Eurodollar - contract size $1'000'000
To put trading volumes numbers into perspective:
- Euro FX Futures: 500-700k contracts traded per day
- Euro FX Options: 20k-30k contracts traded per day
- Crude Oil Futures: in the 1.2- 1.5 million contracts traded per day
- Crude Oil Options: 250k-300k contracts per day
- Gold Futures: 270k-320k contracts per day
- Gold Options: 60k-100k contracts per day
- Eurodollar Futures: 7.4-7.7 million contracts traded per day
- Eurodollar Options: 1.4-1.7 million contracts traded per day
From the CME (pdf): Understanding Eurodollar Futures
From Quandl: CME Eurodollar Futures (ED)
Options on Futures
Futures Options vs Equity Options
- Options on Stocks -> stocks underlying
- Options in Futures -> futures underling
You will have to familiarize yourself with expiration cycles: some futures expire to cash other expire to the underlying futures contract.
What happens at the set exercise with Options on futures?
- If you are a call buyer you will be assigned a long future
- If you are a call seller you will be assigned a short future
- If you are a put buyer you will be assigned a short future
- If you are a put seller you will be assigned a long future
Everything else you know about options applies of course to options on futures like the premium (determined by intrinsic value, time value, volatility, interest rates)
As with all options the risk profiles differs significantly depending if you buy or write an option i.e. an option buyer loss is limited to option premium; an option seller can generate income by cashing the premium but is exposed to potentially unlimited limited risk.
Options on Futures can be great vehicles, however one aspect you want to consider / keep an eye on when dealing with Options on Futures is liquidity. The liquidity profile between Options on Futures vs the underlying can differ substantially. Observe and study.
Synthetic Long Put -> Equivalent = Short futures / long call
Synthetic Long Call -> Equivalent = Long futures / long put
Synthetic Long Future -> Equivalent = Long Call & Short Put (same strike & exp. date)
Synthetic Short Future -> Equivalent = Long Put and Short Call (same strike & exp. date)
- Vanilla: just buying puts or buying calls
- Spreads: a basic spread position is a long and short position (call or put) on the same underlying
- Straddles: a position with an equal number of puts and calls
There are plenty of options' strategies articles out there going into much furter detail. For now remember the following:
- Spreads: Bull spreads make money form a rise in the underlying; Bear spread from a decline in the underlying. Spreads enable limitation of risk. Risk is capped, so ismax. profit potential. A speculator will put on a spread if he has a directional bias. Spreads are not expected to be exercised.
- Long straddle: speculator expects a big move but unsure of the direction. Risk is limited to the paid up premiums
- Short straddle: speculator expects future price to remain neutral; makes money from the premium received. Risk unlimited
Other Spread strategies include: Bull Spread, Bear Spread, Calendar Spread, Vertical Spread, Vertical Bull/Bear Call/Bear Spread, Diagonal Spread and Butterfly Spread.
Futures Margin
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- Clearing margins are deposits your Futures Commission Merchants makes the clearinghouse in order to ensure performance of their clients' positions. Initial margin is set by the clearinghouses. Variation margin can result from market fluctuations and is due within one hour.
- Customer margins are what your FCM requires you to deposit with the firm to buy or sell contracts.
(*) Settlement refers to the Clearinghouse's marking to market calculations i.e. adjusting futures accounts for daily gains and losses