This is going to be a relatively short lesson, as the underlying theme should be of no surprise – as we have already established the importance of it several time throughout your investment journey here, at Invest In Wall Street.
And in today’s lesson, we will be covering the capital for trading futures (or any other types of financial asset for that matter) to show you how to conserve your money, give you a sense of how much it would be to trade different types of assets, and how you can use the knowledge to help benefit you in the long run.
But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.
Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.
Maximize Capital Efficiency
Sophisticated traders who are ready to trade futures typically do so for a number of reasons.
One reason is that futures can require a small initial cash outlay.
This is because futures are highly leveraged, which means that they require a relatively small amount of capital to control a larger investment.
To explain how this works, we’ll compare the amount of capital required to trade stock versus futures.
Let’s say a trader has $40,000 cash to invest. For one of their investments, they’d like to take a long position representing the S&P 500 index.
One way they could do this is to open an equity position. For this example, we’ll use a fictional basket of stocks that tracks the S&P 500 index, symbol SANDP.
If SANDP is trading at $226 per share, and the trader buys 500 shares the trade will have a notional value of $113,000.
They don’t have enough capital to buy the shares outright – but they can buy them on margin.
Even the standard 30% margin requirement – the trader would need to have $33,900 of capital in their account to place this trade, plus transaction costs.
So they could do it, but it would tie up almost all of their available capital.
Another strategy is to invest in the S&P 500 index using futures. The E-mini S&P 500/ES is a futures contract that represents $50 times the S&P 500.
If the index is trading at $2,262, one’s futures contract has a notional value of $113,100.
However, the margin requirement for futures is very different – as its set by the exchange and is subject to change.
But the last time, it was believed to be $5,225 for one ES contract -this is significantly lower than that of the stock position.
In this example, trading futures provides the same market exposure while freeing up $28,675 of capital that could be used for something else.
Its important to remember that leverage is a trade-off. While it frees up capital, it can increase risk.
Additional education can help you evaluate the risks associated with futures trading.
Managing Capital For Futures Trading
- Futures requires a small initial investment with a high level of leverage – this can be less expensive than buying an equity position or to buy on margin initially – which can use up all of your available capital
- However, the margin requirement for futures is very different – as its set by the exchange and is subject to change
- Its important to remember that leverage is a trade-off. While it frees up capital, it can increase risk
This has been a very short crash course on capital efficiency for futures trading. If you want to trade any asset for that matter, you have three options to trade the underlying asset:
The first and obvious choice would be to outright buy the shares of stock using your own capital, but of course, this may not be cost effective for some traders – promoting them to use the second known method: buying on margin.
Buying on margin simply mean that you have an agreement with your broker, in which your broker “loans” you the amount of shares that you would like to trade – of course, this isn’t free – as you are obligated to buy back the same amount of shares from your broker again – sounds simple right?
The only catch is that if the price movement goes against you, you will be forced to buy back the shares at a price greater than you have received them at – causing you to lose money in the process. When buying on margin, the potential for loss is unlimited, so this is more of an advanced strategy that should be used by professional traders only.
Luckily, all brokers require you to fill out an application first in order to have a margin trading account, so for most, this is not something that you have to worry about.
The last option, which is the underlying theme of today’s lesson, is to buy futures contracts on the underlying that you would like to trade. With a futures contract, you receive the same market exposure for more than half the price than that of stock shares and can use the advantage of leverage and high liquidity to enhance your chances of profiting from a trade with almost no cost to you.
But as always, futures trading, like all derivative day trading, is extremely risky. This should only be used by advanced and sophisticated traders who have years of experience and expertise.
I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.