37 lines
2.8 KiB
Plaintext
37 lines
2.8 KiB
Plaintext
Chapter 34: Futures and Futures Options 655
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However, the point is that the businessman is able to substantially reduce the cur
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rency risk, since in six months there could be a large change in the relationship
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between the U.S. dollar and the Swiss franc. While his hedge might not eliminate
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every bit of the risk, it will certainly get rid of a very large portion of it.
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SPECULATING
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While the hedgers provide the economic function of futures, speculators provide the
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liquidity. The attraction for speculators is leverage. One is able to trade futures with
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very little margin. Thus, large percentages of profits and losses are possible.
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Example: A futures contract on cotton is for 50,000 pounds of cotton. Assume the
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March cotton future is trading at 60 (that is, 60 cents per pound). Thus, one is con
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trolling $30,000 worth of cotton by owning this contract ($0.60 per pound x 50,000
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pounds). However, assume the exchange minimum margin is $1,500. That is, one has
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to initially have only $1,500 to trade this contract. This means that one can trade cot
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ton on 5% margin ($1,500/$30,000 = 5%).
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What is the profit or risk potential here? A one-cent move in cotton, from 60 to
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61, would generate a profit of $500. One can always determine what a one-cent move
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is worth as long as he knows the contract size. For cotton, the size is 50,000 pounds,
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so a one-cent move is 0.01 x 50,000 = $500.
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Consequently, if cotton were to fall three cents, from 60 to 57, this speculator
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would lose 3 x $500, or $1,500 - his entire initial investment. Alternatively, a 3-cent
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move to the upside would generate a profit of $1,500, a 100% profit.
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This example clearly demonstrates the large risks and rewards facing a specula
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tor in futures contracts. Certain brokerage firms may require the speculator to place
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more initial margin than the exchange minimum. Usually, the most active customers
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who have a sufficient net worth are allowed to trade at the exchange minimum mar
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gins; other customers may have to put up two or three times as much initial margin
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in order to trade. This still allows for a lot of leverage, but not as much as the specu
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lator has who is trading with exchange minimum margins. Initial margin require
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ments can be in the form of cash or Treasury bills. Obviously, if one uses Treasury
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bills to satisfy his initial margin requirements, he can be earning interest on that
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money while it serves as collateral for his initial margin requirements. If he uses cash
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for the initial requirement, he will not earn interest. (Note: Some large customers do
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earn credit on the cash used for margin requirements in their futures accounts, but
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most customers do not.)
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A speculator will also be required to keep his account current daily through the
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use of maintenance mar~is account is marked to market daily, so unrealized |