What is the Odd Future Market? Why would anyone trade it?
Wikipedia says that a Odd Future Market is a financial market where futures contracts can be traded. A Futures Contract is an legally binding agreement that allows you to purchase specified amounts of financial instruments or commodities at a specific price and delivery at a certain time in the Odd Future.
It is important that you emphasize the word Contract. The most important difference between Odd Future Markets and Stock Markets is that Futures Markets trade contracts, not stock shares. You are not purchasing and selling shares (or pieces) of a company. Futures contracts are agreements between investors to trade a certain quantity of a commodity, financial instrument, or other commodity. They can be used for, for example, to trade gallons of gasoline or tons of wheat.
It’s easy to understand how commodities work. For example, an airline may agree to buy 100,000 gallons fuel at current market prices, but will not take delivery until later in the future.
Southwest Airlines was able to make money even though fuel prices were $140/barrel, while other airlines didn’t have any. They had previously negotiated Futures Contracts years ago with several oil companies, but waited until 2007-2008 for delivery. They will be purchasing Futures Contracts in 2011/2012, when oil prices are lower.
You may think that is all fine and dandy, but it’s not using a trading system that has trading strategies. It’s negotiating.
There is always some risk associated with Odd Future Contracts. Odd Future Contracts can be leveraged against the asset’s value.
Southwest took on risk. They paid more if the price of crude oil fell below what they paid. They also reduced their risk by believing that oil prices would rise above their contract price. Leverage was profitable in their case.
Take a look at the oil companies. They believed that crude oil prices would fall below their contract price with Southwest, so they reduced the risk. They took on risk when the oil price rose above the contract, which resulted in them losing any additional revenue. Their leverage wasn’t as high as it could have been in this instance.
This is where you can stop and say that you are not Southwest Airlines. I am an individual day trader. I don’t wish to purchase 100,000 gallons crude oil. What is the best way to trade Futures?
Chicago Mercantile Exchange, (CME), which trades the majority of Futures contracts, recognized that individual investors wanted to trade Odd Future like large institutions. Individual traders also wanted to increase their risk. Small investors won’t risk millions of dollars buying gallons worth of gas or wheat. CME created an investment environment to encourage individual investors to trade Odd Future.
As a small investor, there are many exchanges that you can use for trading. You can also invest in tech stocks with NASDAQ and large-cap stocks on the NYSE. CME created a Futures exchange to attract investors.
First, the CME has created Odd Future specifically for individual investors. They can be traded electronically by using the e in Odd Future. Your trades will be sent to the CME via a trading platform that you can access from your desktop. Mini means that the contract you trade is smaller than the one that larger institutions trade.
The S&P500 is the most popular CME Odd Future. This contract is based on the S&P500 Index, which represents the top 500 stocks on the NYSE. The S&P500 Index is price-weighted. This means that some stocks have more importance or weight than others. The index’s value can be moved higher or lower by larger companies.
You believed that futures trading was only for commodities such as corn, wheat, and rice.
Think about it for a second. Imagine being able to trade all 500 top stocks simultaneously. This would increase risk. You would still have 498 stocks to trade if one or two stocks failed that afternoon. There is no need to choose one stock. There’s no reason to spend hours researching stocks. Why? Because you trade all of them. It would be expensive to trade 500 stocks simultaneously. Selling and buying S&P500 Odd Future Contracts at a fraction the price is like trading all 500 stocks simultaneously.
How did the CME convince a day trader that he could trade Odd Future? Take a look at the benefits of trading Odd Future Contracts. It’s easy to see why professional day traders have given up other exchanges.
1) The S&P500 Odd Future is extremely liquid. This means that it has lots volume and lots of action. You can quickly enter and exit, sometimes in just 1 second. This contract traded an average of 7,000 contracts per day when it was first introduced in 1997. It is not unusual to see 3-4 Million contracts per day.
2) It is a completely electronic environment. CME does NOT have Market Makers that could refuse to fill your trades like the NYSE. CME’s book is FIFO. This makes trading on CME an equal playing field for all investors regardless of whether you trade 1 or 100 contracts.
3) Commission for Odd Future based on a Round Trip rather than in-and-out.
4) There is only one tick on the CME that distinguishes between the Bid price (the highest price a buyer will pay) and the Ask price. This is the lowest price a seller will sell a contract at. The minimum price movement is called a tick. S&P500 trades at 25 cent increments. One tick = 25 cents. 4 ticks equals 1 point. The pay out is slightly different. If you gain one tick in your trade, the reward will be $12.50. 4 ticks equal $50. A 1 tick – Ask / Bid difference without Market Makers is comparable to trading NYSE securities, where the difference between Ask and Bid can be substantial, especially if the Market Maker quotes the spread difference.
Trading Odd Future is a way to only watch one chart every day. If you could only watch one chart, wouldn’t that make you a great trader? Stock traders often watch several stocks simultaneously, flipping through charts to avoid missing price action.
6) There is not much research you need to do each evening. You can trade all the “500 stocks” simultaneously. It doesn’t matter if you are researching one stock or another, or worrying about quarterly reporting, pre-announcements, whisper figures, accounting minefields, or how to handle quarterly reporting.
Option traders must know how to trade four conditions to ensure consistent trading success: strike price, volatility and time decay. Option traders can be right, but lose their trades because they did not have enough time to make a profit. Futures traders only care about two conditions: an advancing or declining market. Futures traders don’t have to worry about time decay.
future rapper traders are able to trade at favorable margin rates. For just $400 per contract, you can trade one S&P500 E-mini contract using margin. You would need at least 100 shares to trade stocks. The average stock costs $25 per share, which is $2500 to get in. This is a big difference. A day trade is a transaction that was opened and closed on the same trading day as it. Any trader who executes more than 4 trades in a 5-day period is referred to as a “pattern day trader”. You must have at least $25,000 in your brokerage account to become a NYSE day trader. If you are caught day trading, your account will be frozen for 90-days. Day trading Futures does not have such restrictions. A brokerage account requires far less capital. You can open a brokerage account with as little as $2,500, according to most Odd Future brokers. This allows small investors to trade in the Odd Future market.
9) You can trade futures “long” and be a day trader. This means that you expect the contracts to rise. You can also trade futures short, but expect the contracts to fall. Stocks less than $5 are not allowed to be short-sold. Short selling Futures Contracts is not subject to any restrictions. Why? These are not stock shares, but contracts. Day traders want to maximize the volatility of the Market. Half of your trading will be lost if you can’t shorten. You might have to wait for the Market to swing back up before you can enter a trade. If the Market is down 200 point, it could be a long wait.
10) If you trade with an IRA/401k account, exiting a trade doesn’t mean you have to wait for it to settle before you can use the same money to trade again. The same money you used to exit your Futures trade is still available for you to use in another trade within seconds. Stock trading can be slow. You may have to wait up to 3 days for your money settle before you can trade again.
11) Futures trading is a derivative of commodities. Therefore, the rules that were originally designed for commodities are also applicable to e-mini Futures. The 60/40 split in taxes is 60% for long-term trades (15% tax bracket), and 40% for short-term trades (28% tax bracket). This is similar to stocks: if you hold a stock for less than one year, it’s a short-term trade. To qualify for long-term capital gains, you must keep the stock for at least one year. Futures breaks down your trading by the 60/40 rule. This applies even if you trade for less than 2 minutes. Your Futures broker will send you a 1099B at the end of each year. This is a 1-liner that shows the net amount of all your trading and not the trades. Say you made $50,000. That’s all. The 1099-b will only show $50,000. You can now claim $30,000 for long-term capital gains and $20,000 for short term (60/40 split). It is much easier to file your taxes. Your broker will give you the net trade entry. Only one entry is allowed on your tax return. You must enter each trade if you trade stocks. It can take hours to enter transactions if you trade stocks daily. Futures trading is quick and easy.
12) Futures are traded almost every day, around the clock, 24-hours a day. Saturday is the only day that Futures cannot be traded. Many stocks are unable to trade after hours and, if they do, it’s very light trading. Trades are made all around the globe for the S&P500 E-mini. The e-mini is traded heavily depending on the time of the day. The Japanese trade the Odd Future at 2:00 AM EST. The e-mini is traded by the Europeans at 4:00 AM EST. E-mini trading is a great option for those suffering from insomnia.
13) Unlike stocks, which trade on multiple exchanges with different Bid/Ask rates and exchange prices, e-mini futures only has one price and that is on CME. This means that for e-mini Futures contracts there is only one price.
14) You get filled if you are in a trade. You get filled if you are involved in a trade where the e-mini prices exceed your offer. For smaller Forex traders, this can cause problems. A trade may be open and you are waiting for an offer to buy. Your price is what the Forex contract will go to and it doesn’t guarantee that you get filled. You should also read the fine print in your Forex Brokers contract. They don’t guarantee fills. CME Clearing House acts in the role of a guarantor for each member of its clearing network, ensuring trade integrity.
15) Futures contracts are not worthless if they expire on Fridays during the contract month. You can transfer your money to the new contract unlike Options, which expire worthless.