futures trading guide

OSK GUIDE TO

TRADING FUTURES.

Introduction to Trading Futures.

1

Welcome to the exciting world of Futures. This booklet serves as an

introductory guide for those wishing to start trading futures

contracts.

What are Futures Contracts?

A futures contract is an agreement between buyer and seller of an

underlying commodity / financial instrument / asset at a price set

today for delivery in the future. They are standardised contracts

traded on Exchanges around the world. Example:

The History of the Futures market

Forward contracts, a predecessor of futures trading, originated as

early as ancient Greece, where merchants traded contracts for olive

produce.

In Japan, during the 17th Century, there existed the Dojima Rice

Market in Osaka which was probably the earliest version of the

modern day organised futures exchanges.

The 19th century saw standardised grain futures contracts being

traded on the Chicago Board Of Trade (CBOT).

Currently, futures contracts are traded on more than 80 Exchanges

all around the world with diverse contracts such as indices, interest

rates, energy and metals, besides the traditional agricultural

commodities.

Who are the players?

Participants in the futures market can be chiefly divided into two

groups depending on the rationale behind trading the market.

The first group comprises Hedgers; these are mainly corporations,

businesses or individuals who enter the futures markets to remove

or hedge their price risk.

These are people normally holding the underlying commodity or

asset. For example, producers of crude palm oil or gold; asset

managers who hold equity portfolios; and banks with loan portfolios.

Their main rationale in using the futures market is to reduce or

eliminate price risk.

The second group comprises Speculators; these are institutions or

individuals whose main rationale is to profit from movements in the

prices of futures contracts. They are largely bank proprietary or

treasury desks, hedge funds, arbitrageurs and individual traders.

Speculators assume the risk that Hedgers seek to offset, with a view

to profit from it.

Underlying Commodity/Asset

Futures Contract Exchange

Crude Palm Oil Crude Palm Oil Futures

Bursa Malaysia Derivatives (BMD)

Gold Gold Futures Chicago Mercantile Exchange (CME)

Hang Seng Index Hang Seng Index Futures

Hong Kong Exchange (HKeX)

2

Structure of the Futures Market. Different bodies or participants make up the structure of a futures

market and this usually comprises the following:

The Exchange

The Clearing House

Regulators

Brokers

The Clearing House

The Clearing House plays the critical role as the counterparties to all

buyers and sellers in a futures market. The Clearing House, in

effect, acts to guarantee the performance of all futures contracts in

the market.

In order to do that, buyers and sellers of futures contracts are

required to put up sufficient deposits, called margin, to back the

position that they have in the market.

Regulators

The role of the regulating authority is to supervise the Exchange,

the Clearing House as well as the Brokers. The Regulator also has

investigative as well as enforcement powers to ensure compliance to

the Rules and governing laws in order to maintain fair and orderly

markets.

In most jurisdictions it is the role of the Regulator to conduct

licensing for the intermediaries in the market as well. Ultimately, the

role of the Regulator is to ensure investor’s interests are protected.

In Malaysia, the regulating body for the futures market is the

Securities Commission of Malaysia.

Brokers

Brokers act as intermediaries to provide their clients, who may be

both hedgers and speculators, access to the Exchange to buy or sell

futures contracts. Brokers charge brokerage commissions for the

execution services as well as other services which may include

advice, voice or online trading platforms, market research or

analysis.

In most countries, brokers and their representatives are required to

be licensed before they can offer their services to clients. In

Malaysia, all Futures brokers and representatives are required to

pass licensing examinations and obtain a license to deal with clients.

The Exchange

The Exchange aims to provide an efficient, transparent and orderly

trading environment where futures contracts are bought and sold.

The Exchange creates

and designs the

standardised futures

contracts and offers

them to the market

for trading.

3

The futures market has many distinct advantages for investors and

traders. Here are the main advantages of trading futures:

Leverage

Leverage enables an investor to hold a larger sized investment using

a smaller capital outlay.

This is an inherent feature of the futures market as brokers and the

clearing house require the investor to put up a margin deposit which

is always much less than the notional value of the futures contract.

For example, in order to trade one contract of Bursa Malaysia FTSE

Kuala Lumpur Index Futures (FKLI) contract, one would need to put

a margin deposit of, say, RM4,000.

The notional value of a FKLI contract is valued at RM50 multiplied

by the Kuala Lumpur Index. If an investor bought one FKLI contract

at 1,600, he would, in notional terms, have bought RM50 x 1,600,

or RM80,000 worth of Kuala Lumpur Index Stocks.

Essentially with a deposit of RM4,000 he now holds RM80,000 worth

of stock. He is said to have employed RM80,000 / 4,000 or 20x

leverage for his position.

If the Kuala Lumpur Index rises by 10%, the investor would stand

to gain RM8,000 or 200% on his initial deposit. The 20x leverage

enables him to realise a 200% gain rather than just 10% if he had

put up RM80,000 to buy the same stocks. That is the power of

leverage.

Liquidity

Liquidity is how actively a particular futures contract is trading in

terms of volume and frequency. The more liquid the futures

contract is, the more buyers and sellers are in the market to

transact.

It is very important to trade liquid contracts too, as they enable the

investor to easily enter and exit the market.

A very liquid futures contract also allows an investor to trade larger

positions knowing that he can choose to exit the market at any

time.

Why trade the Futures Market?

4

The global futures market offer a multitude of different contracts all

going through bear or bull cycles with abundance of trading

opportunities.

Low Transaction Costs

Futures contracts are relatively cheaper to trade than the underlying

commodity of financial instruments.

Diversification to Alternative Investment

Adding alternative investments into your portfolio can help to reduce

your portfolio volatility as well as enhance your portfolio returns.

Studies have shown that investments into alternative investment

products especially ones that are non-correlated to traditional bond

and equity markets tend to give that effect.

Futures, especially commodity futures, are pure alternative

instruments that can help you achieve this diversification.

Why trade the Futures market? Volatility

The more volatile a particular futures contract, the greater the

possibility for profitable trading opportunities. The futures market has

strong price moves and this volatility create many opportunities for

investors to profit.

Trade Bull and Bear markets

The futures market allows an investor to take a bullish view of the

market as well a bearish position. Unlike, say a pure equity investor,

who can only profit from a rising stock market, a futures investor can

make money when stocks are rising as well as falling.

5

How it works?

These daily profit and loss movements in margins are referred to as

variation margin.

Margin Calls

Margin calls occur when the variation margin losses reduce the

trading account balance to the point that they are below the margin

required by the Clearing House.

In this case, the broker will inform the client of the margin call. The

client can then choose to add more funds into the account, reduce

his position or liquidate the position entirely.

Example of Margin Calculations:

Say a client bought a position of 10 contracts in CME Gold Futures

Contract. If the initial margin of Gold Futures is US$10,000, the

client has to have a minimum of US$100,000 for his 10 contracts.

Assuming if gold prices dropped on the same day and the client’s

loss was US$25,000, his account balance would be reduced to

US$75,000.

Opening a Trading Account

In order to start trading futures you need to open a futures trading

account with a broker. You are normally required to sign a Risk

Disclosure Statement to declare that you are aware of the potential loss

in trading futures.

The trading account documents will set out the terms and conditions for

trading including brokerage commission charges and well as other

services provided.

Initial Margin

After the trading account is approved, you would be required to put up

an initial margin deposit into your trading account in order to be able to

start trading. The minimum initial margin is usually determined by your

broker.

The initial margin deposited will determine how many futures contracts

you can trade. Margins per contract are determined by the Clearing

House but may differ depending on your broker. The Clearing House

normally determines margins according to the risk and volatility of a

particular futures contract.

Variation Margin

Daily movements in the pricing of futures contracts create profits or

losses for a position in that futures contract. At the end of the trading

day, all profits and losses against a settlement or closing price are

credited or debited respectively into the account of the client who has a

position in the futures contract. This process is called marked to

market.

6

How it works?

Examples of contract sizes:

Gold Futures (COMEX/CME) - 100 oz

Crude Palm Oil (BMD) - 25 metric tons

Hang Seng Index - HK$50 x Hang Seng Index

Contract Months – Specify the months available for trading.

Normally you would choose an active contract month to trade to

take advantage of the liquidity. You would normally not trade the

Spot Month of a physically deliverable contract unless you are

commercially involved in buying or selling the physical underlying.

Minimum Price Fluctuation – Defines the minimum price

movement of the contract in terms of index point, dollar per oz,

Ringgit per etc.

Delivery Method – Specifies how the contract is settled during

the expiry of the particular month. If it is a physically delivered

contract, buyers will need to take delivery of the underlying asset

or commodity. Otherwise, most futures contracts are cash settled

Trading Hours – Defines when the contract opens and closes for

daily trading.

Last Trading Day – Defines the last day and time where all

trading of a particular futures contract ceases.

Since the client is required to have at least US$100,000 in his account,

the broker will request for additional deposits to be made until that is

achieved. This request for additional funds is called a margin call which,

in this case, is US$25,000, as illustrated in the table below:

Table 1: Margin call tabulation

Contract Specifications

Contract specifications are important for the investor to understand as

it spells out the how, what, where and when of trading a particular

futures contract. Here are the essential features of a futures contract

that need to be understood:

Contract Size – This states the size in weight, dollar value, quantity or

in the case of indices, the contract multiplier for the Index.

At start of day

Margin requirement per contract US$10,000

Margin requirement for 10 lots US$100,000

Initial Margin in clients account US$100,000

At end of day (EOD)

Variation Margin Loss EOD US$25,000

Balance in clients account EOD US$75,000

Margin call on clients account US$25,000

7

What Futures to trade?

The notional value of an index futures contract is calculated by

multiplying the contract multiplier with the current value/pricing of

the index. For example, if the E Mini Dow Jones Futures Index

Futures of a particular month is trading at 12,000 and the contract

multiplier is US$5 per index point, then the notional value equals

US$60,000.

Example:

Individual Equities

Individual Equity Futures are contracts based on the individual stock

or securities and are commonly called Single Stock Futures (SSF).

For example, Genting SSF or Air Asia SSF are SSF contracts traded

on Bursa Malaysia Derivatives Exchange.

Over 12 billion futures contracts are traded annually in over 80

Exchanges around the world. The futures market offers an array of

diversified products, be it stock indices, agricultural commodities,

metals or energy products. This opens the door to new and exciting

investment choices for you.

Futures contracts can be widely divided into the following categories:-

Equity Indices

Individual Equities

Interest Rates

Agricultural Commodities

Non Precious Metals

Precious Metals

Energy

Equity Indices

Futures on equity indices are one of the most popular futures contracts

traded around the globe. These contracts are usually based on popular

or benchmark stock market indices for example Dow Jones & Nasdaq

Indices of US, Nikkei 225 index of Japan or Hang Seng Index of Hong

Kong.

Equity Index Futures are designed to reference the movements of the

underlying Indices. So a Dow Jones Index Futures contract has its

underlying in the Dow Jones Industrial Average (DJIA), an index of the

top 30 large capitalisation blue chip stocks traded on the New York

Stock Exchange.

Equity Index

Futures Contract

Contract

Multiplier

Value /

Price of

Index

Notional

Value

Hang Seng Index HK$50 19,000 HK$950,000

Nikkei 225 Yen 500 9,000 Yen4.5 mil

Bursa Malaysia

KL Index RM50 1,600 RM80,000

E Mini Dow Jones US$5 12,000 US$60,000

8


For example, one contract of CBOT 10 Year Treasury Note Futures

is based on face value at maturity of US$100,000 whereas the CME

Eurodollar Futures is based on a principal value of US$1million

worth of Eurodollar Time Deposit of 3 month maturity.

Agricultural Commodities

The notional value of a SSF contract is usually derived by multiplying

the stock price with the contract multiplier. For example, Air Asia has a

multiplier of 1000. If Air Asia is now trading at RM3.60 then the

notional value of the Air Asia SSF is RM3600.

Example:

Interest Rates

Interest rate futures are another active contract mainly traded by banks

and financial institutions that are exposed to global interest rates and

money supply dynamics.

One of the most actively traded interest rate futures contracts in the

world are the CME Eurodollar Futures as well as the CBOT 10 Year

Treasury Note Futures.

Interest rate futures usually have their contract sized fixed to specific

face values of the underlying debt instrument or fixed dollar values.

Single Stocks

Futures Contract

Contract

Multiplier

(Shares)

Value/

Price of

Stock

Notional

Value

Genting 1000 RM8.80 RM8,800

Air Asia 1000 RM3.60 RM3,600

Agricultural commodities futures

comprise a major group of

futures contracts actively traded

globally. Traditionally, most

futures markets had its

beginnings from physical

agricultural commodities

Some of the most actively

traded agricultural commodities

futures in the world are cotton,

sugar, rubber, soyabean oil and

corn. The most actively traded

futures contract on Bursa

Malaysia Derivatives is the

Crude Palm Oil futures contract

since Malaysia is a major

producer of Crude Palm Oil.

9


Agricultural commodities are a great alternative investment since

they are not well correlated to equity or bond markets. Agricultural

commodity prices tend to be volatile due to the susceptibility of

crops to weather uncertainty as well as global demand trends.

Agricultural commodities futures contract sizes are usually specified

by standard weight or volume per contract.

Example:

Non Precious Metals

Non precious metal futures are mainly contracts on metals mined

mainly for industrial usage. They have surged in interest to

speculators and traders due to large price movements in 2005-2007.

The main non precious metal contracts traded around the world are

copper, zinc and aluminium. Much like agricultural commodities

futures, non precious metals futures contracts are quoted in weight.

Commodity Futures Contract0 Contract Size

Rubber (TOCOM) 5,000 kg

Corn (CBOT) 5,000 bushels

Soybean Oil (CBOT) 60,000 lbs

Crude Palm Oil (BMD) 25 metric tonnes

Precious Metals

Precious metals like gold

and silver caught the

attention of traders after

a long and major bull

market since early 2000

and have remained one

of the most actively

traded futures contracts

in the world.

Many Futures Exchanges

around the world offer

Gold Futures but the

main Futures contract

for gold and silver is

traded on COMEX in the

US where it sets the

benchmark for global

gold and silver prices.


The London Metal Exchange (LME) is also a major Exchange for

trading the metal.

Gold and silver futures contracts are quoted in weight per contract

as in the example below:

Energy

Energy Futures is an active and vibrant market due to the

importance of energy products to the world economy. The energy

markets today play a major role in global economic and political

developments.

Both hedgers and speculators participate in the energy futures

markets due to the volatile nature of energy prices which are

extremely sensitive to geopolitical changes in the global economy.

10

Metal Futures Contract Contract Size

Gold (COMEX) 100 troy oz

Silver (COMEX) 5,000 troy oz

Copper Futures (COMEX) 25,000 lbs

The most followed energy futures contract globally is the Crude Oil

futures contract traded on two major Exchanges, NYMEX and ICE.

The WTI Light Sweet Crude Oil and Futures Brent Crude Oil are

traded on NYMEX in the US and ICE in Europe respectively.

Other popular energy futures are Natural Gas, Gasoline and Heating

Oil. Here are some contract sizes for the main energy futures

contracts:

Energy Futures Contract Contract Size

WTI Light Sweet Crude (NYMEX) 1,000 barrels

Brent Crude (ICE Europe) 1,000 barrels

RBOB Gasoline (NYMEX) 42,000 gallons

Natural Gas (NYMEX) 10,000 mmBtu

Basic Futures trading strategy.

Conversely, if his forecast was incorrect, the trader will make a loss

instead. From the same example below, if he had bought a

September Gold Futures Contract in June at $1,580 and

subsequently closed out at $1,550 in August, he would make a loss

of $3,000.

Example: Going LONG on Gold Futures Contract – Loss if price drops

Selling Hang Seng Index Futures to profit from an expected

drop in equity prices

If a trader forecasts that Asian equity prices are going to drop in the

near future, he could profit from this by SELLING (Go SHORT) the

Mini Hang Seng Index Futures.

If his forecast is correct, he can profit by BUYING back the Mini

Hang Seng Index Futures later.

Buying gold to profit from expected rise in gold prices

If a trader believes the price of gold is going to increase in the near

future, he could profit by BUYING (Go LONG) a Gold Futures

Contract.

If his forecast is correct and prices rise, he can then SELL it later at a

higher price and make a profit.

Assume that in June, the trader bought one September Month COMEX

Gold Futures Contract at $1,580 per oz.

He pays a margin of approximately $10,000 to the broker to hold one

gold futures contract.

If his forecast is correct and by August, the September Gold Futures

rises to $1,650, he can then sell the gold futures contract for a profit of

$7,000 on the trade. The table below illustrates the example.

Example: Going LONG on Gold Futures Contract – Profit if price rises

Price per oz

US$

Value of Contract

US$ (100 oz)

June Buy 1 Sep Gold

Futures Contract 1,580 158,000

August Sell 1 Sep Gold


Profit 70 7,000

Price per oz

US$

Value of Contract

US$ (100 oz)

June Buy 1 Sep Gold


August Sell 1 Sep Gold


Profit -30 -3,000

11

12

Basic Futures trading strategy.

Example: Going SHORT on Mini HSI Futures Contract – Loss if index

rises

Assume the trader went SHORT one June Month Mini HSI Futures in

April at 20,000 points. He pays the broker say, HKD13,000, as margin

to hold one contract of Mini HSI Futures.

Margin requirements for going SHORT are the same as initiating a

LONG futures contract.

Example: Going SHORT on Mini HSI Futures Contract – Profit if index

drops

If in the month of May, the June Mini HSI Futures contract drops to

19,000, the trader would make a profit of HKD10,000 if he BUYS back

the futures contract at 19,000.

However, if the trader’s forecast is incorrect then he would make a loss.

Assuming the Mini HSI Futures rises to 21,000, the trader would have

made a loss of HKD10,000.

Index

Level

Value of Contract

(Index x HKD 10)

April Sell 1 June Mini HSI


May Buy 1 June Mini HSI


Profit 1,000 10,000

Index

Level

Value of Contract

(Index x HKD 10)

April Sell 1 June Mini HSI


May Buy 1 June Mini HSI


Loss -1,000 -10,000

13

How to place an order with your broker?

Stop orders are usually used as a stop loss order to limit losses to a

position. For example, an investor with a long position in Crude

Palm Oil Futures at 2500 may put the sell stop order at 2450. When

the price of 2450 is traded, this will trigger a Sell Market Order. It

can, however, also be used as a way to enter a new position if a

certain target price is reached.

Stop limit orders - A stop limit order lists two prices and is an

attempt to gain more control over the price at which your stop is

filled. The first part of the order is written like a stop order. The

second part of the order specifies a limit price. This indicates that

once your stop is triggered, you do not wish to be filled beyond the

limit price.

Stop limit orders can be used similarly as stop loss order or as an

entry into a new position. However, do note that if used as a stop

loss order, it may not be filled within the specified limit and your

position will not be stopped out. An investor with a long Crude Palm

Oil Futures contract at 2500 who places a Sell Stop Order at 2450

with a limit of 2430 would result in a Sell Limit Order of 2430 if 2450

is traded. However note that if prices gap below 2430, his Sell Limit

Order may not be filled if the market continues to move lower.

Good Until Canceled Order (GTC) – A GTC order is used in

conjunction with a Limit or Stop order. Orders will remain valid and

worked until the client cancels order, or if it is filled, or if the

contract expires.

Types of orders

Here are some common order types you are likely to use:

Market orders – This is an order to buy or sell which is executed at

the best possible price obtainable immediately.

Limit orders – This is an order to buy or sell at a designated price.

Limit orders to BUY are placed below the market while limit orders to

SELL are placed above the market.

Since the market may never get high enough or low enough to trigger a

limit order, a trader may miss the market if he uses a limit order.

Stop orders - A buy stop order is placed above the market and a sell

stop order is placed below the market. Once the stop price is touched,

the order is treated like a market order and will be filled at the best

possible price.

In futures trading, there are many

different types of orders that can

be placed with your broker

depending on what you intend to

do.

There are orders for initiating an

entry into the market; orders to

exit a current position as well as

contingency orders to limit losses

after you have a position in the

futures market.

14

Getting started.

Knowing what to trade

Getting to know what you are trading is an important step when starting

out to trade futures. Read as much as possible or get advice from

professionals in the business. There are many resources on futures trading

that you can use. You should be able to find ample resources online that

are free, which provide a great deal of information.

With the correct knowledge, you now need to decide on a trading plan,

what to trade and what trading style is suitable for your investment

requirements.

Know how much funds to risk

It is advisable to have an idea of how much funds you will allocate for your

futures trading account. This is determined by how much risk capital you

are willing to fork out. Futures trading entails some risk and one is well

advised to only trade with risk capital you can afford.

Work with your broker / dealer

When you first start out in trading futures, it is important to communicate

with your dealer / broker to determine your trading needs and as well as

what sort of requirements you will need for support such as research,

trading ideas, news updates and trading platforms.

15

Why trade Futures with us?

OSK Investment Bank Berhad (OSKIB) is a regional investment bank

with presence in Malaysia, Singapore, Indonesia, Thailand,

Cambodia, Hong Kong and China.

OSKIB is proud to be one of Malaysia’s top futures broker providing

access to futures trading in Malaysia as well as in major futures

markets around the world. Whether you are trading equity indices

like the Hang Seng Index or the e-Mini Dow; commodities like Gold,

Crude Oil or Crude Palm Oil, we provide fast and convenient access

to these markets.

Our online trading platform allows you to trade global futures

contracts on your laptops wherever you are connected to the

internet. With real time quotes and charts, you would be able to

plan your investments even more effectively.

OSKIB has an experienced team of Futures Broker Representatives

and Dual Licensed Holders who can cater to your diverse needs

based on your suitability to certain futures products.

They are trained professionally and have a good understanding of

the markets. Their experience and knowledge can certainly help

improve your trading performance.

In order to serve your needs for trading futures in different time

zones, we also have a night desk dedicated to support your queries

and trading needs.

To find out more, visit us at www.osk188.com

http://www.osk188.com/






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