Leverage
Leverage, borrowing to increase the return on one's investment, is what attracts speculators to the futures markets. Speculators, being individuals, tend to have less money on hand than a major oil company or investment bank would. But even with only tens of thousands of dollars to spend, instead of tens of billions, speculators have access to margin with which they can exercise some control over a great deal of underlying commodities. Margin requirements are much lower on the futures exchanges than on the stock exchanges. A futures trader need have only one dollar in his long portfolio for every 10 or 20 dollars in his short portfolio, as opposed to the one-to-one required by major stock bourses. This 5 to 10% initial margin requirement is the norm, although it can be raised by the exchange or its regulators, in response to market volatility.

SEE:
Margin Trading

Leverage allows for short-selling, which is also easier in the futures market than in the stock market in terms of procedure. Shorting the futures market involves nothing more than buying a contract. If you believe in July that the price of ethanol is headed lower, first you'd contact your broker to ensure that your margin requirement was met. Next you would sell short a contract at the prevailing rate of 2'542 (which means $2.542/gallon) with the expectation of making an offsetting purchase at a lower price before the contract expires, say in November. If you can cover the contract at a lower rate, then you make a profit.

The above ethanol contract was for 29,000 gallons, that is, a railcar full. It would probably take you somewhere between 15 to 20 years to burn that much fuel. People are by nature risk-averse so, if you did not engage in futures trading for your own consumption and for thrills, then you must have done because you expected to make enough money off the transaction to compensate you for taking on the exposure. That, then, is the true mark of a speculator.

LOOK OUT!
Both hedgers and speculators contribute to market liquidity and price stability. On the long side, a hedger secures a price to protect against higher prices and a speculator secures a price in anticipation of higher prices. On the short side, a hedger secures a price to protect against lower prices and a speculator secures a price in anticipation of lower prices.



General Futures Terminology

Related Articles
  1. Investing

    Trading Gold and Silver Futures Contracts

    If you are a hedger or a speculator, gold and silver futures contracts offer a world of profit-making opportunities.
  2. Investing

    The Art Of Speculation

    Speculators believe that the market overreacts to a host of variables. These variables present an opportunity for capital growth.
  3. Investing

    Leveraged Investment Showdown

    Margin loans, futures and ETF options can all mean better returns, but which one should you pick?
Frequently Asked Questions
  1. Who is eligible for Canada Pension Plan benefits?

    Learn more about the Canada Pension Plan, who contributes to the plan and who can receive standard, disability, early retirement ...
  2. Who are Monsanto's main competitors?

    Learn about Monsanto Company's two main operating divisions and its main competitors within each sector, including The Mosaic ...
  3. What is an assumable mortgage?

    The purchase of a home is a very expensive undertaking and usually requires some form of financing to make the purchase possible. ...
  4. Do I have to complete all exams within a certain period of time to receive the CFA charter?

    According to the CFA Institute, a candidate can take as much time as necessary to complete all three levels of the CFA program.Therefore, ...
Trading Center