Basic Information on Futures Trading
What is Futures trading? How well do you know about futures? If you are not familiar with futures, just follow my 4 weeks articles and you will learn all the following important topics in simple layman language:-
- What is futures?
- Why invest in futures?
- Fundamentals of futures market.
- Profit and loss calculation of futures transactions.
- Players of futures market.
- Opportunity and risk in futures trading.
- How does one get started?
- Correct techniques in Futures trading.
- Using futures as a hedging tool for your investment.
- Spread contract.
What is Futures?
Using laymen language, I will explain the following concepts in futures:-
1) Terminology
2) Product available
3) Contract Specification
4) Underlying market
1) Terminology
This is a quick introduction into “jargon” used in futures. The below table spells out all the important futures’ trading terminology with simple explanation being given.
No | Trading Terminology | Common Terms |
1 | Long | Buy |
2 | Short | Sell |
3 | Margin | Deposit |
4 | Margin Call *will cover in detail in week 3 | Shortage of deposit |
5 | Mark-to-market | A process that require investor to deposit further fund into their trading account if their account dropped below certain value. |
6 | Cash settlement *will cover in detail in week 4 | All contracts upon expiry will be close-out at a cash price without delivery of physical good need to set in. |
7 | Physical delivery *will cover in detail in week 4 | Investors bounce to deliver the underlying commodity upon expiry. |
2) Product Available
Currently, in Malaysia, you will able to trade the below few products under Bursa Malaysia Derivative:-
i) Commodity Derivatives
Crude Palm Oil Futures (FCPO)
USD Crude Palm Oil Futures (FUPO)
Crude Palm Kernel Oil Futures (FPKO)
ii) Equity Derivatives
FTSE Bursa Malaysia KLCI Futures (FKLI)
FTSE Bursa Malaysia KLCI Options (OKLI)
Single Stock Futures (SSFs)
iii) Financial Derivatives
3 Month Kuala Lumpur Interbank Offered Rate Futures (FKB3)
3-Year Malaysian Government Securities Futures (FMG3)
5-Year Malaysian Government Securities Futures (FMG5)
3) Contract Specification
Contract Specification will spell out all the elements of a futures product. This is similar to Sales & Purchase agreement (S & P) which spells out the terms of the agreement, included, the sales price, the total square feet of a house etc.
The same goes for contract specification, it will spell out all the important standardised information of the futures products. Please access to http://www.loveonlinetrading.blogspot.com/p/futures.html for all the contract specification.
4) Underlying market
Futures is a derivative product, thus, it “derives” its value from an underlying asset. The below table defines the individual futures contract’s underlying market.
No | Futures Products | Underlying Products |
1 | Crude Palm Oil Futures (FCPO) | Crude Palm Oil |
2 | USD Crude Palm Oil Futures (FUPO) | Crude Palm Oil |
3 | Crude Palm Kernel Oil Futures (FPKO) | Crude Palm Kernel Oil |
4 | FTSE Bursa Malaysia KLCI Futures (FKLI) | FTSE Bursa Malaysia Kuala Lumpur Composite Index (FBM KLCI) |
5 | FTSE Bursa Malaysia KLCI Options (OKLI) | FTSE Bursa Malaysia Kuala Lumpur Composite Index (FBM KLCI) |
6 | Single Stock Futures (SSFs) | Selected stocks |
7 | 3 Month Kuala Lumpur Interbank Offered Rate Futures (FKB3) | Ringgit Interbank time deposit in the Kuala Lumpur Wholesale Money Market with a three month maturity on a 360-day year |
8 | 3-Year Malaysian Government Securities Futures (FMG3) | 3-year Malaysian Government Securities |
9 | 5-Year Malaysian Government Securities Futures (FMG5) | 5-year Malaysian Government Securities |
Readers should understand the reasons why one should invest in Futures. Remember, defining the objective of trading in Futures is just as important as understanding the concepts of futures trading.
Why invest in Futures?
1) Diversification
Diversifying your investments will reduce investment risk while maintaining your desired return. Futures can be treated as another investment choice for investors, especially in a bear market.
2) Hedging
Hedging is simply protecting your investment rather than profiting from investment. It is somewhat similar to insurance concept. We will cover hedging’s concept in detail on week 4.
3) Higher return
Futures has higher volatility and risk when compare to other financial products like stocks and bonds. Nonetheless, potential return is higher due to its high risk, high return nature.
4) Profiting in a bear market
Futures allows you to initiate a short position if you are of the view that the market will trade downwards and you can close the position by buying back later. This allows investors to profit even in a bear/ downward trading market.
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