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  Futures-trading-guide

  
  
  

  Introduction

  For nearly a century and a half, futures markets have fulfilled an important economic function: providing an efficient and effective mechanism for the management of price risks.
  Beginning with agricultural futures contracts traded on the Chicago Board of Trade in 1865, the U.S. futures markets now list an everexpanding number of instruments, including metals, energy, financial instruments, foreign currencies, stock indexes, prediction markets and event futures. Additionally, the industry introduced trading in options on futures contracts in 1982.

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  How the Markets are Regulated

  The U.S. futures industry has experienced unprecedented growth in trading volume over the past several years, reflecting the high level of trust and confidence that customers have in the marketplace. This confidence is due in part to a strong, effective regulatory structure that safeguards market integrity and protects investors. This regulatory structure has three main components.
  The Commodity Futures Trading Commission (CFTC). In 1974 Congress established the CFTC, a federal regulatory agency with jurisdiction over futures trading. The enforcement powers of the CFTC are similar to those of other major federal regulatory agencies, including the power to seek criminal prosecution by the Department of Justice where circumstances warrant such action.
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  Conducting Business with a Registered Firm

  Membership in NFA is mandatory, assuring that everyone conducting business with the public on the U.S. futures exchanges - more than 4,000 firms and 55,000 associates - must adhere to the same high standards of professional conduct. You can quickly verify whether a particular firm or person is currently registered with the CFTC and is an NFA Member through NFA’s Background Affiliation Status Information Center (BASIC), found on NFA’s Web site (www.nfa.futures.org).
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  Introduction to Futures Trading

  Futures Contracts
  A futures contract is a legally binding agreement to buy or sell a commodity or financial instrument at a later date. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. The only variable is price.
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  How Prices are Quoted

  Futures prices are usually quoted the same way prices are quoted in the underlying cash market.
  That is, in dollars, cents, and sometimes fractions of a cent, per bushel, pound or ounce; also in dollars, cents and increments of a cent for foreign currencies; and in points and percentages of a point for financial instruments. Cash settled index contract prices are quoted in terms of an index number, usually stated to two decimal points. Be certain you understand the price quotation system for the particular futures contract you are considering.
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  The Market Participants

  Should you at some time decide to trade in futures contracts, either for speculation or in connection with a risk management strategy, your orders to buy or sell will be communicated from the brokerage office you use to the appropriate trading pit or electronic trading platform for execution.If you are a buyer, your order will seek a seller at the lowest available price. If you are a seller, your order will seek a buyer at the highest available price. Market fluctuation is a process of finding fair prices for both buyers and sellers. In either case, the person who takes the opposite side of your trade may be or may represent someone who is a commercial hedger or perhaps someone who is a public speculator. Or, quite possibly, the other party may be an independent trader. In becoming acquainted with futures markets, you should have at least a general understanding of who these various market participants are, what they are doing and why.
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  The Process of Price Discovery

  Futures prices increase and decrease largely because of the myriad factors that influence buyers’and sellers’ judgments about what a particular product will be worth at a given time in the future (anywhere from less than a month to more than two years).
  As new supply and demand developments occur and as new and more current information becomes available, these judgments are reassessed, and the price of a particular futures contract may be bid upward or downward. The process of reassessment (price discovery) is continuous.
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  Daily Close
  At the end of a day’s trading, the exchange’s clearing organization matches each clearing firm’s purchases made that day with corresponding sales and tallies each clearing firm’s gains or losses based on that session’s price changes - a massive undertaking considering that several million futures contracts are bought and sold on an average day. Each firm, in turn, calculates the gains and losses for each of its customers having futures contracts.
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  The Arithmetic of Futures Trading

  Leverage
  To say that gains and losses in futures trading are the result of price changes is an accurate explanation but by no means a complete explanation. Perhaps more so than in any other form of speculation or investment, gains and losses in futures trading are highly leveraged. An understanding of leverage - and of how it can work to your advantage or disadvantage - is crucial to an understanding of futures trading.
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  Basic Trading Strategies

  Even if you should decide to participate in futures trading in a way that doesn’t involve having to make day-to-day trading decisions (such as a managed account or commodity pool), it is nonetheless useful to understand the dollars and cents of how futures trading gains and losses are realized. If you intend to trade your own account, such an understanding is essential.
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  How to Participate in Futures Trading

  Now that you have an overview of what futures markets are,why they exist and how they work, the next step is to consider various ways in which you may be able to participate in futures trading. There are a number of alternatives and the only best alternative - if you decide to participate at all - is whichever one is best for you. In addition to describing several possibilities, the pages that follow suggest questions you should ask and information you should obtain before making a decision

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  Trade Your Own Account
  This involves opening your individual trading account and - with or without the recommendations of the brokerage firm - making your own trading decisions. You will also be responsible for assuring that adequate funds are on deposit with the brokerage firm for margin purposes, or that such funds are promptly provided as needed.

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  Have Someone Manage Your Account
  A managed account is also your individual account. The major difference is that you give someone else - an account manager - written power of attorney to make and execute decisions about what and when to trade. He or she will have discretionary authority to buy or sell for your account or will contact you for approval to make trades he or she suggests. You, of course, remain fully responsible for any losses which may be incurred and, as necessary, for meeting margin calls, including making up any deficiencies that exceed your margin deposits.
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  Use a Commodity Trading Advisor
  As the term implies, a Commodity Trading Advisor (CTA) is an individual (or firm) that, for a fee, provides advice on commodity trading, including specific trading recommendations such as when to establish a particular long or short position and when to liquidate that position. Generally, to help you choose trading strategies that match your trading objectives, advisors offer analysis and judgments as to the prospective rewards and risks of the trades they suggest. Trading recommendations may be communicated by phone, electronically via the Internet or through the mail. Some provide a frequently updated hot-line or Web site you can access for current information and trading advice.
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  Participate in a Commodity Pool

  Another alternative method of participating in futures trading is through a commodity pool, which is similar in concept to a common stock mutual fund. It is the only method of participation in which you will not have your own individual trading account. Instead,your money will be combined with that of other pool participants and, in effect, traded as a single account.You share in the profits or losses of the pool in proportion to your investment in the pool. One potential advantage is greater diversification of risks than you might obtain if you were to establish your own trading account. Another is that your risk of loss is generally limited to your investment in the pool, because most pools are formed as limited partnerships. And you won’t be subject to margin calls.

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  Establishing an Account

  At the time you apply to establish a futures trading account, you can expect to be asked for certain information beyond simply your name, address and phone number. The requested information will generally include (but not necessarily be limited to) your income, net worth, what previous investment or futures trading experience you have had, and any other information needed in order to advise you of the risks involved in trading futures contracts. You will also be required to provide proof of identity to comply with federal law.
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  Introduction to Options on Futures
  Although futures contracts have been traded on U.S. exchanges since 1865, options on futures contracts were not introduced until 1982. There are two styles of options—American and European. For the purposes of this discussion, we will focus on American-style options.
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  The Arithmetic of Option

  Premiums
  An option premium is the price paid by the buyer of the option and received by the seller of the option. At the time you purchase a particular option, its premium cost may be $1,000. A month or so later, the same option may be worth only $800 or $700 or $600. Or it could be worth $1,200 or $1,300 or $1,400.
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  Understanding Options Transaction Fees

  Before you decide to buy and/or sell (write) options, you should understand the other costs involved in the transaction - commissions and fees.
  Commission is the amount of money, per option purchased or sold, that is paid to the brokerage firm for its services, including the execution of the order on the trading floor of the exchange. The commission charge increases the cost of purchasing an option and reduces the sum of money received from selling an option. In both cases, the premium and the commission should be stated separately.
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  After You Buy an Option

  At any time prior to the expiration of an option, you can:
  • Offset the option;
  • Continue to hold the option; or
  • Exercise the option.

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  Who Sells (Writes) Options and Why
  Up to now, we have discussed only the buying of options. But it stands to reason that when someone buys an option, someone else sells it. In any given transaction, the seller may be someone who previously bought an option and is now liquidating it. Or the seller may be an individual who is participating in the type of investment activity known as options writing.
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  If a Dispute Should Arise

  All but a small percentage of transactions involving regulated futures and options on futures contracts take place without problems or misunderstandings. However, in any business in which millions of contracts are traded each day, occasional disagreements are inevitable. Obviously, the best way to resolve a disagreement is through direct discussions by the parties involved. Failing this, however, participants in futures markets have several alternatives (unless some particular method has been agreed to in advance).

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© 2010 Laxmi Gold Investment Pvt. Ltd.
Chipledhunga, Pokhara. All Rights are reserved.

Disclaimer: No guarantee of any kind is implied or possible where projections of future conditions are attempted. Futures trading involve risk. In no event should the content of this be construed as an express or implied promise, guarantee or implication by or from Laxmi Gold Investments, that you will profit or that losses can or will be limited in any manner whatsoever. No such promises, guarantees or implications are given. Past results are no indication of future performance.

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