In the previous article, we talked about the basic specifications embedded in futures contracts and what to consider when trading them. However, it might be interesting to note that futures contracts allow you to apply some creativity to trading – as seen from the following trading strategies available:
Flexibility Of Going Short Easily
Unlike stocks, which have to be borrowed (thereby incurring costs) before you can engage in short selling, shorting futures contracts are as simple as buying them. Since the contracts are simply condition-based agreements, you can quite simply sell a contract outright as long as you put up the minimum required collateral (initial margin).
This also represents an advantage over stocks, in the sense that you are not subject to the inventory that the broker holds. When you short a stock, your borrowing cost or availability is highly subject to market demand and supply conditions, as well as how sophisticated your broker is in terms of managing such borrowing/lending schemes. Confused? Exactly. You can save yourself the headache when shorting by using futures – which are traded on exchanges so this problem is a non-issue.
Going long or short too boring for you? Many traders proclaim themselves to be spread traders, which means they take long and short positions (almost) simultaneously in two or more futures contracts, which means they are trading the relationship between their prices – not the directional move of just an asset itself.
A simple example goes as follows: Given both US Treasury Bonds and the Japanese Yen (JPY) are both traditionally safe haven assets (meaning they go up when there is fear in the market), there should be a theoretical relationship between the two. After you do your research, you find that the spread between the two are at historical extremes, so you sell the spread. However note that the number of contracts to use on each long and short leg need to be determined and are variable over time.
This is a common textbook strategy for trading futures. In this case, you are trading the spread between the near-dated and longer-dated contracts. This typically requires a deeper understanding of the asset you are trading, for you to spot trading opportunities.
You’d need to understand concepts like contango and backwardation (former is when futures curve is sloping up, latter is down), and the reasons why they exist. Different assets exhibit different patterns in futures curves, so it might be wiser to study more in depth before trading calendar spreads.
Read Also: Finance Dummies Series: Hedge Funds
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