Leverage

Futures contracts are leveraged instruments. Payment of the margin gives the trader full control of the total contract amount.

As an illustration, consider the Dow Jones contract with the index at 12000. The value of the futures contract is 5 times the index, or $60,000.

If a trader buys $60,000 worth of shares at full price (spread across the Dow Jones component companies), a 1% rise in the index results in a gain of $600 (1% of the capital employed).

In contrast, the day trading margin on the (mini) Dow Jones futures contract is $2,188, meaning a trader need only invest $2,188 to effectively control a $60,000 parcel of shares. Now a rise of 1% in the DJ index, increasing the contract value by $600, represents a return of 27.4% on capital employed.

Leverage is a double edged sword. It enables the trader to make large profits very quickly, but equally allows large losses. For example, a 4% fall in the DJ index gives a $2,400 loss in the DJ futures trade – more than the original capital ($2,188) invested!

By the way, the margins shown above are not fixed in stone. In fact, they are frequently adjusted to reflect current market volatility.

 

 

Comments are closed.