PAUL ROBINSON, STRATEGIST

Table of Contents
Futures as a Trading Vehicle ..........................................................................................................3

Contract Specifications ..................................................................................................................4

Margin, Leverage & PnL Calculations .............................................................................................7

Margin and Leverage Example ............................................................................................................... 7

Summary ........................................................................................................................................9

Disclaimer ....................................................................................................................................10

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Futures as a Trading Vehicle
The futures markets offer a great way for traders to express their views on various asset classes. For
example, when trading the S&P 500 you can establish a position in a number of ways – CFDs
(contracts for difference), ETFs (exchange traded funds), options, or futures. Each one of these
instruments have their own set of characteristics and appeal to different types of traders and
investors for different reasons.

The futures market is appealing as it offers significant amounts of liquidity in stock indices,
commodities, currencies, interest rates, and select cryptocurrencies. This is done in a centralized
manner via regulated exchanges, the flexibility to go long or short, extended trading hours, and the
ability to apply leverage. There are a few important aspects to futures that one should understand
before trading these dynamic products, but overall they are relatively straight forward.

We will start by discussing the basics of what you need to know about a contract, then move into the
most important component – margins, leverage, and PnL calculation.

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Contract Speci�ications

On the websites of the various exchanges that offer futures, you will find the contract specifications
(“Contract Specs”) with all the pertinent details you need to know about the contract you are
considering trading. The following are the most important details you should know in order to have a
good grasp on the markets you are trading.

Contract unit tells you how much of the ‘underlying’ the contract represents. You can think of it as a
multiplier as you determine the full notional value of the contract by multiplying the contract unit by
the price of the contract. For example, the contract unit for gold futures is 100 troy ounces, which
means each contract represents 100 troy ounces of gold. If the price of gold is $1,400, then the
notional value of the contract is $140,000 (100 x $1,400).

100 troy ounces x $1,400 per troy ounce = $140,000 notional contract value

Trading hours vary from contract to contract, but most contracts these days trade for the better part
of 24-hours over a 5-day week. However, this does not mean liquidity is good over the course of a
24-hour cycle, so you want to investigate the different contracts as to liquidity patterns. Typically, the
local business hours for the exchange that lists the contract are the most liquid.

Minimum price fluctuation tells you at what increments the contracts change and what it is worth.
For example, WTI crude oil trading on the NYMEX has a minimum price fluctuation of $0.01 per barrel,
which is equal to $10. For every penny crude oil moves your profit and loss on one contract will move
by $10. A $1 move in the price of WTI is equal to $1000 (100 cents x $10 = $1,000).

1 Crude Oil Contract bought @ $50 and sold at $51 equals $1,000 in profit (minus commissions);
this is based on $10 per minimum price movement of $0.01

Product code is the ticker symbol. For example, the e-mini S&P 500 futures contract product code is
“ES”.

Listed contracts tell you what month or quarter the contract represents. Each month is denoted by a
letter and can be found on the exchange’s website. For example, “H” is used for the month of March.
Then of course at the end of the code is the year. Combining the product code and listed contract you
arrive at the specific contract identification. For instance, if you are trading the March 2021 e-mini
S&P 500 contract, the exact ticker symbol will be “ESH21”:

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 ESH21 = ES (Product code for E-mini S&P 500) + H (Month = March) + 21 (Year 2021)

Settlement method tells you whether it is a deliverable (i.e., commodities such as oil) or settles
financially (i.e., stock index futures).

Termination of trading tells you when the contract no longer trades. It is typically the third Friday of
the expiration date, but varies by contract. You can do one of three things here: offset the position by
closing it, roll it over to the next lead month, or go into settlement. As a trader, you do not want to go
into settlement as this will require either physical delivery (i.e., commodities like WTI crude oil) or
cash settlement (i.e., E-mini S&P 500). Rolling a position is typically done days in advance of
expiration as liquidity moves from the lead month to the next available month. For example, index
futures trade on a quarterly basis. If you wanted to carry a position forward as expiration approaches
you would roll by simultaneously closing out a June contract and opening a September contract.

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 E-Mini S&P 500 Futures – Contract Specifications (Chart 1)

Source: CME Group website

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Margin, Leverage & PnL Calculations

Margin and leverage are considerations of risk management, which is arguably the most important
factor to good trading. This is also where maybe the biggest misconceptions lies with respect to
futures – that they are dangerous because of the available leverage and limited margin required to
hold a position. But just because leverage is available doesn’t mean you have to use it, and in fact
responsible trading entails only using minimal amounts of leverage.

Margin is the amount of capital needed to buy or sell one futures contract. You can think of it as a
deposit. It works similarly to margin in other leveraged products, whether it be spot FX (“forex”),
stocks, or CFDs. In futures there are two kinds of margin: initial margin and maintenance margin. The
initial margin is the amount that is required by the exchange to enter into a position, while the
maintenance margin is the minimum amount that is required in your account to continue holding the
futures contract(s). If your account declines below the maintenance level you may get a ‘margin call’
that will require you to add funds to your account to bring the account balance up to the initial margin
level, or you may be forced to liquidate the position.

Typically, the margin rate will range between 3% and 12% of the total notional contract value. This is
where the misconception lies about futures being unusually risky. Let’s work through an example to
better understand how margin and leverage are different, how you should think about it with respect
to your trading account and why leverage is risky if you abuse it.

Margin and Leverage Example

Let’s say you want to be long the S&P 500 so you buy one E-mini S&P 500 futures contract at a price
of 4,100. First, to determine the notional value of the contract you need to take 4,100 and multiply
that by the contract unit size, which for this contract is $50 x 1 S&P 500 index:

4,100 (S&P 500 price) x $50 (contract unit size) = $205,000 (notional contract value)

This formula brings you to the total value of the contract; however, this is not what the broker requires
you to have in your account to place this trade. This is where margin comes into play.

Let’s say on the exchange where this contract trades (in this case the CME), the initial margin is set
at $12,100 while the maintenance margin is $11,000. At an initial margin of $12,100, this represents

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a margin rate of 5.9% of the notional value of the contract (12,100/205,000 = 5.9%), which means on
a leveraged basis if you had only the required $12,100 in your account you would be trading with a
leverage factor of nearly 17:1 (205,000 / 12,100 = 16.94). Indeed this would be a lot of leverage. It
would only take a decline of 22.25 S&P points for your balance to decline below the maintenance level
of $11,000, at which time you would need to deposit more capital up to the initial margin requirement
or be forced to liquidate your position.

The math:

-22.25 points x $50 per point = -$1,112.50 loss; $12,100 initial margin – $1,112.50 loss = $10,987.5,
which is less than the $11,000 maintenance level

Since the $10,987.5 is less than the $11,000 you would need to add $1,112.50 to bring your balance
back to the required initial margin level of $12,100.

It is obviously not ideal to trade at the margin, literally, so you want to make sure that you are
capitalized well beyond the margin requirements to ensure your leverage factor is reasonable. If for
example, you had a cash balance in your account of $50,000, then holding one e-mini S&P 500
contract would be far more reasonable, as your leverage factor would be just a little over 4x. (205k /
50k = 4.1). You would still need the $12,100 to initiate the position, but your leverage would be
significantly lower than the top offering.

The exchanges change margin levels from time to time to reflect material changes in the price of the
underlying market and volatility, but will generally stay steady for periods of time. Your broker,
however, may increase margins if they deem there to be too much risk at the exchange minimum
levels. Also worth noting, is that for some contracts at some brokers they will offer day-trading
margins, which can be below the minimums set by the exchanges. This is only allowable as long as
the position is not held beyond the end of the trading day. Some brokers will offer margins at 25% of
the overnight minimum for the most liquid contracts such as the E-mini U.S. index contracts. Again,
just because the leverage is offered doesn’t mean you should exploit it. Trading with day-trading
margins could mean you are trading upwards to a leverage factor of 80x!

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Summary

If used properly and with the right capitalization, futures offer traders a tremendous way to express
their views on a wide variety of markets with the safety of exchange listed contracts and the liquidity
to enter and exit trades during a large part of the day. And remember, just because small margin
requirements may be required, it doesn’t mean you should use all the available leverage.

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Disclaimer
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High Risk Investment

Trading in financial markets, foreign exchange, indices and commodities on margin carries a high level of risk
and may not be suitable for all investors. The high degree of leverage can work against you as well as for you.
Before deciding to trade in financial markets, foreign exchange, indices and commodities, you should
carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists
that you could sustain losses in excess of your initial investment. You should be aware of all the risks
associated with financial markets, foreign exchange, indices and commodities trading and seek advice from
an independent financial advisor if you have any doubts.

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