Futures For You

INSIDE THE FUTURES WORLD

Want to learn how the futures markets really work? Dan O'Neil, a principal at online futures and forex broker Xpresstrade (www.xpresstrade.com), responds to your questions about today's futures markets.

To submit a question, post your question to our website at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
Dan O'Neil

EXECUTION VS. CONFIRMATION

Though the futures industry continues to move toward more electronic trading, many important commodity futures continue to trade in the traditional, open-outcry pits. A few examples of hot commodities trading primarily - or even exclusively - in the old-fashioned pits include gold, crude oil, silver, copper, coffee, and sugar.

Happily, technology has helped improve the routing of orders to and from the trading pits; in fact, a good number of orders can be sent directly to electronic devices operated by floor brokers standing in the middle of the action. But the inescapable fact is that human beings ultimately are executing the orders. And during periods of heavy volume or extreme volatility, these folks can quickly become overwhelmed. Whereas you might have a confirmed fill in a second or less when trading a fully electronic product like the emini S&P, the process may take considerably longer in an open-outcry market. As a trader, you have to be aware of this and set your expectations accordingly.

Any good brokerage firm understands that few things in life are more agonizing for a trader than to wait for what seems like an eternity for a fill confirmation. This is just as frustrating for us as it is for you. We understand the importance of speed, we're pushing as hard as we can for your fills, and we know that quicker confirmations make you more likely to trade more. I'm even aware of at least one futures broker that's developed an automated system to continuously scan customer orders and market data. When it identifies any order in an open-outcry market that should have been executed, it mercilessly pesters the trading floors until a confirmed fill has been received.

So why can't this problem of slow fills in open-outcry markets be solved once and for all?

The main reason is that this is a problem at the exchange level. Until the exchanges do away with pit-style trading, this will be a challenge with which every futures broker will have to struggle. The situation is exacerbated by the fact that in most cases, floor brokers don't work for us - they're independent contractors who handle orders from a number of brokerage companies - and in many pits, the truth of the matter is that there isn't a particularly wide selection of floor brokers from whom to choose. Even if we spot a floor broker who appears to be consistently slow in reporting fills, we often have few alternatives.

There's a bit of good news, however - which most traders don't seem to realize - and this is the distinction that's drawn between order execution and fill reporting. Even during the busiest market conditions, there's typically little delay in getting your order to the trading pit and executing it in a timely manner. Floor brokers standing in the trading pits give their immediate attention to filling orders, and fills are reported as time allows. This is a crucial point worth repeating: Your orders in open-outcry pits are almost always executed in a very timely manner, even if the fill reports might occasionally be delayed.

TAX ABCs FOR FUTURES TRADERS

Though April 15 hasn't yet arrived, it's never too early to start thinking about taxes. Because everyone's personal financial situation is different, and because the tax implications of futures trading can be complicated, it's important to consult your accountant or tax advisor. But here's a primer so you'll at least be aware of the main issues.

The universe of trading instruments is growing every day, providing traders with many new opportunities for profits. From a tax perspective, the US Internal Revenue Code classifies all these instruments into two main tax categories: securities or commodities. Products classified as commodities have tax benefits that securities do not have.

Commodities, or "regulated futures contracts" (RFCS), are traded on commodities exchanges, and as the "regulated" label suggests, these RFCS are regulated by a licensed exchange and the US Commodity Futures Trading Commission.

Exchange traded futures products, including "currency RFCS" are considered to be Section 1256 contracts in the Internal Revenue Code. Business traders and all investors report RFC Section 1256 contracts as capital gains and losses on Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles). This allows them to split the gains and losses 60/40 on Schedule D: 60% long-term, 40% short-term.

One of the most common questions we see is this: Are futures trades executed on foreign exchanges also taxed at 60/40 for US citizens, or does the 60/40 blend apply only to futures contracts traded at US exchanges?

There's a reasonable basis in fact and law to conclude that futures traded on certain foreign contract markets with either a CFTC Rule 30.10 exemption or No Action Letter are entitled to classification as Section 1256 contracts (for example, regulated futures contracts) with the result that "60/40" tax treatment is appropriate.

Originally published in the April 2006 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 2006, Technical Analysis, Inc.

Return to April 2006 Contents