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 |
OPTION PLAY
What are some ways that traders use commodity options?
There's no question that commodity options are becoming increasingly popular. Traders see them not only as a great way to speculate on market direction, but also as important tools to manage risk, diversify portfolios, and enhance current income. But there are definite factors to keep in mind when deciding how to incorporate them in your overall portfolio.
For those with a high risk tolerance, commodity options provide a great way to speculate on the markets and an opportunity to use relatively moderate sums of money to control fairly sizable positions. For a fraction of what it would cost to buy large quantities of an actual commodity like gold, crude oil, or Treasury bonds, investors can buy calls giving them the right, but not the obligation, to buy futures contracts as a specific price (the strike price). Of course, the leverage afforded by options is a double-edged sword of sorts; the risk of loss is also greater.
A more conservative strategy involves using options to help protect assets against adverse price fluctuations -- like buying an insurance policy. A futures trader who's concerned about falling prices may elect to protect his long futures position by hedging with a put option. If the futures price declines, the put option will gain in value, helping to offset some of the futures losses. If, on the other hand, futures prices climb, the put option may expire worthless and the profits on the successful futures trade will be reduced by the amount paid for the option.
Another popular and relatively conservative options strategy is covered call writing, which many traders employ to generate additional trading profits. This strategy involves establishing a long position in a market that the trader believes will rally, simultaneously selling an out-of-the-money call option. Options on more volatile commodities tend to be more expensive, so they generate more income when the investor sells the covered calls. More conservative investors tend to choose less volatile commodities, decreasing the likelihood they will have to sell the call option.
Many investors are no doubt employing one or more of these strategies in trading the S&P market, as volume in the Chicago Mercantile Exchange's (CME) emini option contract saw a 94% increase over the previous year through November 2006. In addition, although trading in options was for many years mostly confined to the traditional trading pits at the exchanges -- even while futures trading continued to migrate to an increasingly electronic milieu -- electronic option volume at the CME again provides a good representative snapshot of the sea change at hand. In November 2006, electronic option volume averaged 129,000 contracts per day for the month, up 88% from the same period a year ago, and represented a record 13% of total CME options volume.
It all adds up to more investors seeking out new ways to enhance their futures trading experience and further diversify their portfolios -- the commodity options market is definitely one to watch.
T FORMATION
Is there any way to earn interest on the excess cash in my futures brokerage account?
This is a common dilemma for many traders who want to park their excess cash into some kind of interest-bearing account, or for those looking to keep enough funds on hand to cover any margin calls. Nobody likes to think of money sitting by idly when it might be earning interest elsewhere in a savings or money market account. Because money market funds are technically security products, however, futures brokers are not permitted to offer them to clients.
To solve this problem, many futures brokers are able to offer US Treasury bills as an alternative, providing safety and convenience. In many cases, up to 95% of the face value of any T-bills held in an account may be used toward satisfying a margin requirement. If an investor held a $100,000 Treasury bill in his account, $95,000 could be used for margin purposes. The 5% difference exists because T-bills are issued at a discount to face value and do not appreciate to the full value until maturity.
Many futures brokers purchase T-bills every Monday on the government auction to make available for clients at a nominal fee. The smallest available T-bill size is $10,000, increasing in $10,000 increments. Most brokers will automatically roll maturing T-bills in its clients' accounts into a new issue for a small fee, or liquidate them prior to maturity for a fee.
In most cases, a broker will require that the client maintain positive
equity in his or her account at all times. If adverse market action results
in a deficit and you fail to deposit additional funds immediately, part
or all of the T-bill in your account may be sold to generate cash. Due
to the bank fees associated with selling T-bills prior to maturity, most
brokers will recommend that you monitor your equity closely and not allow
it to fall below zero. An investor whose equity is close to falling below
$0 should consider depositing additional funds in order to keep fees to
a minimum.
Originally published in the February 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
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