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

FUTURES ON BASE METALS

I've been trading gold and silver for years, but lately my attention's been drawn to the nonferrous metals. I've read that metals like aluminum, zinc, and nickel have been moving higher. How can I trade these products?

While gold, silver, and other precious metals grab all the headlines, industrial metals like copper, aluminum, lead, tin, nickel, and zinc have been racking up big gains, too. Strong growth and unexpected demand shocks from China and other emerging economies, combined with supply disruptions and delays in bringing new production online, are driving metal prices higher. Anytime a market or sector is trending higher, you can be sure that opportunistic traders will sit up and take notice.

The New York Mercantile Exchange's COMEX division remains the leader in trading futures on precious metals. But if you're interested in the nonferrous metals, the preeminent marketplace is the London Metal Exchange (LME). The LME's origins can be traced as far back as the opening of the Royal Exchange in 1571. This is where metal traders first began to meet. However, it was in 1877 that the London Metal Market and Exchange was formed as a result of Britain's industrial revolution.

Only a few online futures brokers offer access to the LME and its lineup of futures on industrial metals. That's because the LME has a few important quirks that make it different from almost every other major futures exchange. For starters, the LME is most famous for its open-outcry trading between "ring-dealing" members, which takes place on the market floor. The LME uses a "ring," with the traders sitting at fixed points around the circle. Trading takes place throughout the day, with each LME contract traded in specific five-minute periods. This isn't the continuous, ongoing trading action that you're probably accustomed to.

Also unusual is the LME's expiration calendar. Unlike other commodity markets, which are usually based on monthly contract expirations, LME metal futures contracts run on a daily basis for a period of three months. This means that there are daily contract expirations. After the three-month date, the daily prompts for forward trading are reduced to weekly and then monthly contracts out to 15, 27, or 63 months forward. Many retail futures traders will find this kind of expiration cycle to be unique, if not downright confusing.

For traders who can get past the LME's idiosyncrasies, however, the exchange's nonferrous metals can be exciting. Markets like copper, nickel, zinc, and aluminum may be worth a look. The trading whizzes at Credit Suisse First Boston seem to think so - they issued a report earlier in 2006, claiming, "Despite the strong moves in metals already, the market is likely to be further surprised with potential prices spikes ... [and] long-term commodity assumptions need to be revised up significantly." Take a look, and see what you think.

GROWTH IN COMMODITY OPTIONS

I'm an experienced equity options trader, and I'm interested in trading options on commodities, including gold, crude oil, and soybeans. How will be my background as a stock options trader help me make the leap to options on futures?

Great question, because with so many commodities in the midst of powerful bull markets -- while the stock market has been comparatively unexciting -- many active traders are turning to our markets in search of opportunities. There are some important distinctions between securities and futures, but you'll be pleased to know that, by and large, virtually all the fundamental principles of options are the same, whether you're trading options on Google or gold.

Trading in options on futures has expanded and in more recent years, volume growth has accelerated. Institutional and retail traders alike are increasingly embracing futures options as tools to add leverage, manage risk, diversify portfolios, and enhance current income. Traders are increasingly recognizing the flexibility and control that options afford them, too. For just about any time horizon, market outlook, and risk/reward appetite, there's a suitable options trading strategy.

What kinds of commodity options can you trade? Most futures contracts are optionable; generally, if there's a futures contract on a commodity or financial instrument in which you're interested, options will be available, too. There's options activity in metals, energies, grains, livestock, currencies, stock indexes, interest rates, and tropical softs, like coffee, sugar, and cocoa.

Most options on commodity and financial futures still trade in traditional open-outcry pits, but it's likely you're going to see more electronic trading to come. A few options on futures are already electronic, such as CME's options on emini Standard & Poor's 500 futures and CBOT's options on 100-oz. gold futures. The move toward electronic trading will improve speed, transparency, accuracy, and efficiency -- which in turn will bring additional market participation, more liquidity, and tighter pricing. The prospects for options on futures look bright.

If you're migrating to commodity options trading from stock options trading, you should find that most of your skills are transferable. You'll have to get up to speed on the futures markets, but all of your options knowledge will still apply.

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

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