Fundamentals of Futures trading (Continued)
v) What is margin call? How to calculate margin call?
Margin call is simply being defined as:-
Cash Balance < Initial Margin Required
When a margin call is triggered, the broker will usually inform the investor to fulfill the margin shortfall within a timeframe (usually 1 day). If the investor does not satisfy the margin call within the timeframe, the broker has the right to close his position and the investor will still be held responsible for whatever over losses incurred (if any).
Example below will show how to calculate a margin call for FKLI future contract:-
If Margin Rate = RM3000 for 1 FKLI contract; Investor’s Cash Balance = RM3000
Investor long 1 contract of FKLI @ 1500.
Market dropped to 1490 by day end
(1490-1500) x RM50 = RM500 (loss)
Thus, there is a margin call of RM500 by day end and investor needs to bank in the difference of RM500.
vi) Settlement
Futures will expire at the end of each contract month and the unclosed contract will need to be settled. There are two types of settlement:-
a) Cash settlement; and
b) Physical delivery.
As defined last week, cash settlement means that all contracts upon expiry will be settled at cash price without delivery of physical goods. Meanwhile investor who opts for physical delivery will need to take the delivery or deliver the physical goods upon the contract expiry date.
Opportunity & Risk in Futures Trading
Opportunity
1) Profiting from a bear market
Futures allow 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.
2) Leverage
With a small amount of initial outlay, investors can earn higher return. For example, the margin required by Bursa to initiate a FKLI contract is only RM5000 while the full value of the FKLI is RM75,000 (1500 x RM50) assuming current FKLI’s index is at 1500.
3) Higher volatility
Higher volatility means higher probability than profit expectations can be met within a shorter time period.
4) Higher liquidity
The two most traded products (FKLI & FCPO) are fairly liquid. Higher liquidity provides the means to exit the market at a reasonable price.
Risk
1) Leverage
An investor may suffer huge percentage of losses in relation to the initial outlay committed, especially in a very volatile market. This is because futures is a leveraged product which could magnify both profit as well as losses.
2) Higher volatility
Higher volatility could affect your cut-loss point faster as futures tend to reach your cut loss point easily.
Players of Futures
There are three types of Futures users:-
1) Speculator
Speculators have the pure view of buying futures when the market is bullish and selling futures if the market is expected to be bearish. For example, speculators buy FKLI when they expect FKLI to rise and sell FKLI when FKLI is expected to fall.
2) Arbitrageur
When ‘similar’ products have huge anomalies or price differences between them, arbitrageurs will trade to gain profits from the disparity to arbitrage between the two markets.
3) Hedger
Hedger uses futures to reduce their price risk. For example, equity fund managers with a portfolio of stocks can short the FKLI to protect against decline in portfolio value in a falling stock market. (I will cover more on this topic next week.)
How Does One Get Started?
Simple, just walk in or call any of the licensed broking firm to open a futures trading account. In Malaysia, there are near to 20 broking houses available for you to choose from, the criteria to select a proper broking house is as follows (as a reference):-
i) The commission rate being charged;
ii) Trading platform provided;
iii) Services provided;
iv) Margin facility.
Correct Technique in Futures Trading
Trading in Futures market is different from trading in stock market simply because:-
1) Stock does not have expiry date whereas futures contract will expire at the end of the contract month. You will need to take note of the month end expiry to avoid your trading strategy being interrupted.
2) Futures have mark-to-market requirement where you may need to top up the differences to fulfill the margin required based on the market condition. Failure to fulfill the margin required will cause your position being liquidated and this may affect your trading strategy as well.
3) As futures has higher volatility compared to stocks, you must always have your stop loss level being set whenever you initiate any position and you must have a clear trading strategy (whether is long term or short term trading).
4) Futures traders have shorter trading period as majority of traders are speculators. Speculators on average only hold on to a position from days to week.
No comments:
Post a Comment