Futures trading is on the rise and continues to grow in popularity. The trouble for most traders new to futures markets is it can be overly complex and difficult to manage.
Futures markets are more capital-efficient than stocks. However, the contracts have complicated and confusing specifications that discourage many traders.
Thankfully, our guest Pete Mulmat is on a mission to make futures contracts more accessible with small, standardized, and simple futures contracts.
What is a Futures Contract?
Futures contracts are derivative investments traded on specialized exchanges. A futures contract is an agreement to buy or sell a specific quantity of a security at a specific price on a specific date in the future.
Futures contracts are standardized. Each point or tick is a specified amount that derives its value from the underlying security.
Futures markets were created for price discovery and hedging.
For example, when a farmer plants a crop of corn in March, they know they’re going to harvest in October or November.
But, the farmer has no idea what the corn will sell for in October or November. A futures contract can be used to lock in the corn’s price today for a set price in the future.
Standardized contracts are a key benefit of futures. It creates uniformity and transparency. You can buy a contract, and the marketplace guarantees you that the seller will honor their obligation.
There is also an equal playing field. If you are first in line on the bid and Morgan Stanley is behind you trying to buy 1,000 contracts, they have to wait until your order is filled.
So it is truly a level playing field. You're getting wholesale prices, not marked-up products.
Leverage
Futures contracts use leverage. Leverage magnifies positive and negative returns, so it can be dangerous if the price goes against you.
Futures use leverage because you are not buying or selling an asset. You are buying or selling a contract that obligates you in the future. Therefore, futures contracts are treated differently in terms of margin.
Futures contracts are similar to the real estate market; you can get a loan with a small down payment, but you might bite off more than you can chew.
Because of leverage, it may be wiser to make small trades that are easier to manage and won’t blow up your account if the trade goes against you.
Capital Efficiency
Futures are centrally cleared, so they’re very capital efficient.
While futures contracts can be difficult to manage, the capital efficiency of leverage lets you do much more with much less. You can control $50,000 of an asset by posting only $5,000.
Futures are a neutral security, which means you can buy them as easily as you sell them. It's not like selling a stock where borrowing the stock to short can be expensive.
Benefits of Futures for Options Traders
The main benefit for options traders with relatively smaller portfolios is the ability to hedge positions with futures. This helps reduce exposure overnight or over the weekend. That is a unique tool to add to your toolbox.
It is all about effectively maximizing the efficiency of our strategies. That is where capital-efficient, appropriately-sized futures fit into a trader’s existing portfolio.
The Goal of The Small Exchange
Small Exchange’s goal is to standardize contracts, make them smaller, and make them more accessible and manageable for people.
Small Exchange built its products around three tenants: small, standard, and simple.
Small Exchange aims to take your ideas to execution. Each product offers a combination of products, so you don’t have to choose just one.
For example, their precious metals product is a combination of gold, silver, and platinum. Their dollar index product combines seven currency pairs.
Small Exchange removes some of the barriers around futures and makes it easier for people to feel comfortable and confident trading futures.
Learn More About The Small Exchange
thesmallexchange.com has a tremendous amount of educational material.
Small Exchange facilitates business for its customers. Check with your broker. Let them know about your interest in smalls, and have them reach out to the Small Exchange.
And the best part about using Small Exchange is there are no market data fees!
Trader Q&A:
“Lucky: Hey, Kirk. I really appreciate the training you have put together. It's really been very beneficial for my progress over time in options trading. The question I have is: I’m going to go inverted on an iron butterfly. The iron butterfly is centered at 270 for SPY, and has a width of 10 points on either side at 260 and 280. I'm deep-in-the-money on the call side, so I want to go inverted. I was wondering how far to go inverted with my protection on the call side being at 280. I want to roll up my 270 put to 280, which would effectively convert into somewhat of a vertical spread. I’m forcing a lot. I know that, but I'm deep ITM. The current price is 283. We're about a week out from expiration. I want to see what your comments were on this particular deep inversion. Appreciate it. Thank you very much.”