Author Topic: Index Futures Leverage  (Read 5972 times)

Zach

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Index Futures Leverage
« on: February 01, 2014, 11:59:09 PM »
I was wondering if anyone can explain to me how index futures can be used to leverage your investment?

core

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Re: Index Futures Leverage
« Reply #1 on: February 02, 2014, 08:18:14 AM »
I'm not sure I understand what you're asking.  The leverage comes from the fact that you're only required to put up a small portion of the contract value.  It's not all that different from buying stock on margin.  Except there's no interest and they mark to market your positions each night and settle out the profit/loss from that day.

Rob L

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Re: Index Futures Leverage
« Reply #2 on: February 02, 2014, 11:44:02 AM »
Yeah, the margin requirements for stocks and stock index futures are vastly different. It's the Chicago way.

For stocks you have to put up $1 margin for every $2 of the stock purchase price so your leverage is 2:1.
You'll get a margin call to put up more money if the stock drops about 50%.
Assuming a long side trade with stocks a 50% drop wipes out your investment and your gains are multiplied by 2.

For stock index futures (say the mini-spx) you only have to put up $1 initial margin for every $20 of the index futures contract price so your leverage is 20:1.
Index futures are marked to market every night. You'll get that margin call any night when your margin value is below the "maintenance margin" value. That's about 5% below the initial margin value. Note in fast moving markets it is possible to get margin (or even multiple margin calls) calls during the day.
Assuming a long side trade with futures a 5% drop wipes out your investment and your gains are multiplied by 20.

Zach

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Re: Index Futures Leverage
« Reply #3 on: February 02, 2014, 11:38:53 PM »
Thanks for the info Rob and Core!

I'm curious how an investor can possibly sustain trading with potential margin calls that are ever-so-slightly below the cost of the security. You would only be able to have a small portion of your intended portfolio in futures at once, with the possibility of a margin call....Does that question make sense? Or is that basically the intention?


Rob L

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Re: Index Futures Leverage
« Reply #4 on: February 03, 2014, 12:20:43 AM »
You can have as much cash as you want in your account; the numbers I provided are the minimums. You won't get a margin call unless your cash falls below the minimum. The more cash in your account the less leverage you're actually using. Leverage is a two edged sword as they say.

But even a 5% move in the S&P index is a pretty big move. With the Dow at about 15,700 that would equate to a move of 785 Dow points. We've seen days (even minutes) with moves that large but it's unusual. With the S&P at 1780 that's about 89 S&P points. I think equity futures when used by individuals are most often for the purpose of short term trading. The markets are extremely deep and liquid and are widely used for hedging other positions (such as by index options market makers) and for arbitrage with stocks themselves. The arbitrage purpose is where all that "program trading" stuff got started years ago.

Index futures are not for the faint of heart. Trading index futures and options are among the most highly competitive endeavors in existence.

core

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Re: Index Futures Leverage
« Reply #5 on: February 03, 2014, 12:35:28 AM »
It's kind of funny to me to hear the words "portfolio" and "investment" when talking about futures.  Some may disagree perhaps.  But just ignore the percentage that you have to put up because it might as well be zero because it's so low; pretend it's free.  All you are doing is agreeing to lose (or make) $x.xx per point that it moves.  Those are the dollars that matter.  Percentage of portfolio doesn't really have meaning here, to me.

As for the intention, well that's just the thing:  You have to have an intention first,, because these are tools, a means to an end, obviously not things you just buy and hope they increase in value over time.  This intention is either a hedge or a wager (disregarding spreads for simplicity).  The futures price and underlying will converge as time approaches expiration so if the futures price was above the underlying when you bought it then your "investment" is losing money every day that you hold it.  And conversely if the futures price was lower then you may make a modest amount just from the passage of time as they converge.  That underlying better do what you wanted it to.

I don't know.  These things are not instruments that you just buy because the underlying "seems like a good thing to invest in".  And I think I'm hearing a little of that here.  It's just two guys betting against each other; it's not an investment.  It's fine (maybe even desirable) to be on the losing side of the bet when it was a hedge, or you're offsetting another position that went south (or could go south after hours, like an option), locking in a price if you're a farmer, etc.  But not for random investing without a pretty specific goal in mind, a specific thought about what the underlying's going to do (and when) or at least about what people think it's going to do.  Market expectations are already built into the price; no free lunch on Wall St.

Bohb Daishi

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Re: Index Futures Leverage
« Reply #6 on: February 03, 2014, 02:28:30 AM »
Yeah, the margin requirements for stocks and stock index futures are vastly different. It's the Chicago way.

I work for a trading firm at the CBOT, so this is right up my alley. Granted, we don't trade S&P futures, but we keep a close eye on them since they are closely correlated to the 10yr futures (which we do trade).

The E-Mini S&P future is $50 x the index of the S&P, so with the current price of the Mar14 contract at 1774.5, the value of a single contract is about $88,725. The margin you have to put up is $4,725 per contract, so like Rob L said, it's about a 20:1.

However, futures margin doesn't work the same way as stocks. Yes, the $4,725 is the minimum amount of collateral you need to put up the position. But this is not money that you are allowed to risk. If that is all the cash you have in your account and the market goes against you even a single tick, your position can (and eventually will) be automatically liquidated by the your broker/exchange. You need to have a lot more cash in hand to keep yourself from getting a margin call.

Like Core said - you don't "invest" in futures contracts; you trade them. They are solely meant to hedge a position or to bet that the underlying will move in the direction you want to. For example, if you think interest rates will rise, then you should short the 10-yr contract. Likewise, if you have a large bond position and you want to be protected against the risk that rates will go up, you should short the contract. But other than that, the contract does not produce any income, it doesn't have dividends, nor does it have any other real economic value.

If you are investing for the long-term, you are much better off just holding an ETF. I would honestly recommend to avoid futures unless 1) you know exactly what you are doing, 2) you are a multi-millionaire with a wide range of investments that need hedging, 3) you are someone (such as a farmer) who deals with the underlying, or 4) you have insider information that would benefit from that 20:1 leverage.
« Last Edit: February 03, 2014, 02:31:30 AM by Bohb Daishi »
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dontvote

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Re: Index Futures Leverage
« Reply #7 on: February 03, 2014, 02:23:58 PM »
Some people invest in S&P futures to avail themselves of the cheap financing embedded in the instrument.  E.g. I have calculated that my best portfolio (on some efficient market frontier) is 70% bonds, 30% stocks. The return of this portfolio sucks so I borrow money (by buying stocks via futures and I free up 28% of my portfolio) to further buy stocks/bonds.
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