Why do people trade in futures?
There are essentially two types of participants in futures markets: hedgers and speculators. Hedgers are looking to gain better control over costs and prices in order to make a reasonable profit in regular business operations. Users or producers of commodities are most likely to be hedgers. Speculators buy or sell commodities or futures contracts in order to profit from favourable price changes.
How do I buy or sell futures?
Your advisor at RBC Dominion Securities – Gary H. Liu – can provide you with advice and trading services that suit all your needs. You are always welcome to call us for any further information.
How does hedging work?
Hedging is a strategy used to reduce the risk of unfavourable price changes in a certain commodity or currency. Let’s use a currency hedging strategy as an example. A Canadian investor with a U.S. investment portfolio is concerned about the impact of a rising Canadian dollar. If the value of the Canadian dollar rises 5% against the U.S. dollar, then the portfolio would be worth 5% less when converted to Canadian dollars. To provide a hedge against this, the investor buys a futures or call options contract on the Canadian dollar. If the Canadian dollar goes up, the investor sells the futures or call option contracts at a profit, offsetting the losses in the U.S. portfolio due to the rising Canadian dollar. If the Canadian dollar goes down, the investor sells the futures of call option contracts at a loss, offsetting the gains on the U.S. portfolio due to the falling Canadian dollar. In either case, the investor has mitigated the impact of Canadian/U.S. currency fluctuations on the U.S. portfolio when expressed in Canadian dollars. While not benefiting from a falling Canadian dollar, the investor is protected if it goes up.
How does speculating work?
A speculator in the futures market is not usually a direct consumer or producer of commodities, nor does one have to be in futures to be a speculator. Let’s say you’ve done some research and you’re of the opinion that the value of the Canadian dollar is going to strengthen against the U.S dollar. You purchase an option or a futures contract to buy the Canadian dollar at the current price. If you are correct in your assumption and the Canadian dollar appreciates in value, you would sell the option or futures contract and pocket the gain. Should the price go down, you would lose the premium that you paid to have the option to buy the Canadian dollar at today’s price. Speculators play an essential role in commodities markets. They improve the ease of transactions by injecting liquidity into the system and increasing the numbers of those willing to buy and sell, and by taking on some of the risk that hedgers are trying to avoid.
Are there other reasons to invest in futures?
For sophisticated investors, investing in commodities is an additional way to diversify a portfolio. Historically commodity futures have a direct negative correlation to stocks – a bull market in stocks is usually met with a bear market in commodities, and vice versa. Last century’s longest commodities bull market began in 1933 – the year of the Great Depression.
What risks are involved in speculating in futures?
Speculating in commodity futures is a high-risk investment strategy that is not suitable for all investors. Before implementing any futures or options strategy, you should always consult with a qualified professional.
Can futures help protect investment portfolios?
Yes. By trading equity index futures, you can benefit when an equity market moves up – or down. For example, if you owned a large stock portfolio with significant exposure to a certain equity index, you could hedge against a potential decline by using equity index futures.