Futures Trading: Futures Contracts

In futures trading Price is determined by supply and demand among traders competing to buy (bid)  and sell (offer) orders on the exchange of that particular Futures contract

Nowadays, and be very careful with this, the underlying asset to a futures contract may not be traditional “commodities” at all – that is, for financial futures, the underlying asset or item can be Financial indexes (Dow jones, Dax, S&P 500, Eurostoxx 50) currencies ( EUR/USD, the Japanese yen, etc,) securities (apple, google, etc), interest rates (ten year Bonds, federal funds, etc)

Nowadays, these underlying assets are the most liquids and tradable instruments around the world, Financial indexes are the MOST LIQUID futures contracts, therefore they are the “safest” in terms of order executions and number of participants, by liquidity I mean, the number of contracts traded daily, the volume or amount to give it a name. Still some commodities like Corn, Oil, Natural Gas, gold, are pretty High in Liquidity like financial indexes and interest rates.

Cocoa on the other hand or Lumber may not be the case for short term traders

Future contracts are:

  • Exchange-traded, meaning that they are traded at an exchange, every party against every party, the exchange makes the settlements at the end of the day and trading is done.
  • Standardized assets. You buy or sell something that has a particular set of specifications (quantity, quality, delivery date, etc)

We could either open trades using the futures market or we could do it using spread betting. Let’s say Tom Trader decides to open a down bet on the FTSE which is presently trading at 5544 and being quoted at 5543.5 to Sell and 5544.5 to Buy (spread of 1 point). Tom Trader sells at 5543.5 at £100 a point. By the end of the day the FTSE has fallen to 5323.5.

Since Tom sold at 5534 for £100 a point he has made 220 points or £22,000. No taxes would have to be paid on the winnings nor would stamp duty be charged on the contract.

Or we could do the same trade using a futures contract. Again Tom would have made £22,000 but he would be liable for CGT of 18% (this, assuming that Tom Trader has already exhausted his tax free allowance for the year) but no stamp duty as Tom bought a futures contract. So £22,000 -18% = £18,040

Thus Tom would have been £3,960 better off doing the above trade on Spread Betting v Futures.

Of course here we are missing the fact that it is not individual trades that count but your net profit over a period of time and transaction costs do add up over time. For this example, for the sake of simplicity we have also left out the fact that to deal in futures we have to buy/sell in contracts which are for fixed amounts.

I tend to deal in futures directly for intraday trading since transactions costs are minimal and the margins are low for holding intraday positions. However for trading long term periods (1 day+), spread betting makes sense, you get extra leverage, the spreads are competitive particularly for the more commonly traded markets, and of course it’s tax free. Spreadbets also have the edge on longer trades since transaction costs are proportionally not so important – wins and losses are bigger – and of course because my futures trading account does not have sufficient monies in it to trade too much overnight because of the overnight margin requirements.

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