Introduction of Futures (2 of 4)

For week 1, please click here.

Fundamentals of Futures trading

Last week, we learnt about the basics of futures trading and the future products. This week, we will look into the details of futures trading. Under BMD, the two most popular and traded products are Crude Palm Oil Futures (FCPO) & FTSE Bursa Malaysia KLCI Futures (FKLI). I will explain how to trade future contracts in the following simple examples.

i)                    Trading Hours

The below table shows trading hours of all future products:-

No	Market State	FKLI, OKLI, SSF	FKB3, FMG3, FMG5, FMGA	FCPO, FUPO	FPKO
1	Pre-Open	08:15:00	08:30:00	10:00:00	10:00:00
2	No Cancel	08:44:30	08:59:30	10:29:30	12:29:30
3	Trading	08:45:00	09:00:00	10:30:00	10:30:00
4	Intraday Pause	12:45:00	12:30:00	12:30:00	12:30:00
5	Intraday Pre-Open	14:00:00	14:00:00	14:30:00	14:30:00
6	No Cancel	14:29:30	14:29:00	14:59:30	14:59:30
7	Trading	14:30:00	14:30:00	15:00:00	15:00:00
8	End Day Close	17:15:00	17:00:00	18:00:00	18:05:00
9	Surveillance	17:30:00	17:15:00	18:15:00	18:15:00

ii)                  Long or Short a Futures Contract?

One can establish a position in futures trading by either:-

a)      Buy contract/ long contract; or

b)      Sell contract/ short contract

It is generally difficult for readers to imagine how futures contract can be sold before you own it, especially for those readers who are more familiar with the stock market. One can either buy/ long or sell/short future contract depending on his expectation of the market direction.

If you are bearish on the market and expect market to fall, you can short futures contract, ie OWN a “sell contract”. When the market falls, you can then buy futures contract to close your short position.

If you are bullish on the market, you can long futures contract, ie OWN a “buy contract” and close the position by shorting futures contract when market trades higher. In simple words, you “long” when you expect market to rise and “short” when you believe market will fall. Every long position must be closed with a short position and vice versa.

The following examples demonstrate how futures can be traded:-

Example 1:

Overnight Dow Jones dropped more than 400 points, investor believes that local market will follow in tandem, thus he initiated a short position of FKLI during the opening hour. At the later part of the day, investor can close the position by buying back the FKLI when the FKLI falls.

Example 2:

Investor believes that the upcoming budget announcement will be positive for the capital market, therefore investor can initiate a long position for the FKLI and close the position by selling a futures contract when the market trades higher.

iii)                Profit & loss calculation

These examples show how to calculate the profit or loss of a transaction made in FKLI:-

1st of August 2012: Short 1 contract of FKLI @ 1500

Assuming the short position above is not closed until 3rd August 2012 when the FKLI dropped to 1450, investor then Long 1 contract of FKLI @ 1450

Profit/ Loss Calculation:

1500 - 1450 = 50 points

As per the contract specification stated, each point equals to RM50,

Thus, 50 points x RM50 = RM2500 (Profit)

However, on 3rd of August, the FKLI surged to 1540 and investor closed the position by buying 1 contract of FKLI @ 1540. So, will the investor profits or loss?

Profit/ Loss Calculation:

(1500-1540) x RM50 = RM2000 (Loss)

These examples show how to calculate the profit or loss of a transaction made in FCPO:-

1^st of August 2012: Investor believes that Malaysian Ringgit will strengthen and will cause FCPO to trade lower, thus, he initiated a short position at 3050 level.

Assume that he does not close the position until 3^rd August 2012 when the FCPO fell to 3000 level, investor then long 1 contract of FCPO at 3000.

Profit/ Loss Calculation:

3050 – 3000 = 50

As per the contract specification, each tick equals to RM1 and each contract consists of 25 metric tonnes (MT), thus, the profit/ loss calculation:-

50 x RM1 x 25 MT = RM1250 (Profit)

iv)                Margin

Margin is required by the Bursa Malaysia Derivatives (BMD) to minimise default risk from investor. The margin rate required by Bursa is normally within 3% – 10% of the futures contract value. For example, if you bought one FKLI contract, the margin required by Bursa for each contract is RM5000, thus, you will need to bank in RM5000 before you can long or short 1 contract of FKLI.

Margin rate will fluctuate as it is subjected to Bursa’s decision in tandem with the market volatility. Higher volatility could result in higher margin and vice versa. Broking houses can request higher margin rate from their clients compared to Bursa’s requirement but cannot impose margin rate lower than Bursa’s requirement.