By Peter A. McKkay –
Not many individual investors have weathered the risks of the futures markets for as long as Bruce Reale, who started trading contracts on silver and Swiss francs more than 20 years ago.
Futures trading, traditionally the bailiwick of big Wall Street firms, is essentially a bet on the direction that prices of financial instruments or commodities will take. It often involves much greater use of leverage, or borrowed money, than other investments.
That means investors can end up losing much more money than they originally put in, if their bets go the wrong way. And that means many a newcomer to the futures markets has lost his or her shirt before reaching the tenure of Mr. Reale, who says he has a six-figure futures portfolio stretching across several accounts.
Still, with the stock market in the doldrums the past few years, a growing number of individual investors have turned instead to futures. These instruments technically are contracts to buy or sell an underlying asset on a fixed date, but the assets themselves rarely change hands. Rather, the buying and selling of the contracts serves mainly as a way for investors to try to cash in on price movements in the financial and commodity markets.
Increasing opportunities to trade online and a slew of new futures contracts designed for individual investors are among the factors that have encouraged the trend. Mr. Reale, who owns a telecommunications equipment and services dealership in Naples, Fla., has gone from trading via a broker over the phone to entering his own orders online since the late 1990s. He’s also started trading different products, including stock-index contracts.
He much prefers the new way of trading. “When you had to send every order to a trading floor, they took advantage of you, because the people there were the only ones who could see all the information coming in,” Mr. Reale says. “Now, electronic trading has really leveled the playing field” for small investors.
An exact head count of retail futures investors is difficult to come by. But various signs point toward a boom. For example, the amount of money in futures funds — pools of money from individual investors, managed by market professionals — has more than tripled since 2000, reaching a record $131.9 billion at the end of last year, according to Barclay Trading Group, which tracks the performance of these funds. In this year’s first quarter, the total slipped 3.7 percent to $127 billion, but that still represents a 47 percent rise from a year earlier, says Barclay President Sol Waksman, who believes another record is likely by the end of this year.
Here are some trends that are changing the way everyday investors trade futures:
THE RISE OF ELECTRONIC TRADING.
Futures exchanges resisted online trading for many years, viewing it as a threat to the livelihoods of their floor traders. They simply didn’t offer electronic trading of key contracts, or relegated it to times when the trading floors were closed. But that began to change in the late 1990s as all-electronic European futures exchanges like Eurex and Euronext.Liffe emerged, threatening to siphon off business.
Now, major U.S. markets have made a peace of sorts with electronic trading, maintaining both online platforms and traditional trading pits for their major products. And the electronic platforms’ share of volume has grown rapidly. At the Chicago Mercantile Exchange, the most active U.S. futures market, a record 73 percent of volume was electronic in May.
Much of the floor volume at the CME, as at the neighboring Chicago Board of Trade, is in traditional agricultural commodities, not the financial instruments that attract most retail investors, including contracts on stock indexes, currencies and interest rates. However, even agricultural contracts may eventually go online, say some Chicago veterans, and that could spark new interest in commodity futures from individuals.
“Right now, there would be a huge benefit to moving the Board of Trade’s grain contracts online, and I guarantee you there are people trying to figure out a way to do it and get the floor guys to go along,” says trader Ray Cahnman, a former CBOT director. “Volume would just explode.”
THE PROLIFERATION OF RETAIL-FRIENDLY “MINI” CONTRACTS.
The Chicago Mercantile Exchange can lay claim to perhaps the two most significant innovations in the history of U.S. futures markets. In the 1970s, its currency contracts — including the Swiss francs Mr. Reale used to trade — were the first futures linked to financial assets rather than commodities. That paved the way at other exchanges for various financial contracts, which today represent the majority of futures volume.
Then, in the late 1990s, the CME introduced electronically traded “mini” contracts. The smaller contract size — and online access — made it easier for small investors to place bets on such indicators as the Standard & Poor’s 500 and Nasdaq 100 stock indexes.
For example, the asset underlying the CME’s traditional Nasdaq 100 contract, launched in 1996, is $100 times the value of the index. At the index’s recent levels, that equates to about $210,000 for each contract, and an investor must put up about $19,000 to trade it, according to the exchange’s regulations. By contrast, the E-mini Nasdaq 100, launched in mid-1999, is one-fifth that size. So at recent levels each contract covers about $42,000 in asset value and requires an investor to put up less than $4,000 to trade it — well within the reach of many small investors, who have snapped up such offerings. A total of 5.7 million of these Nasdaq mini contracts were traded in May, and the CME reported exchange-wide daily volume records for the first few trading days of June.
The concept has caught on elsewhere, spawning such offerings as mini crude-oil contracts at the New York Mercantile Exchange, and Dow Jones Industrial Average minis at the Chicago Board of Trade, which are a favorite of Mr. Reale’s these days. (To list the contracts, the CBOT pays licensing fees to Dow Jones & Co., which also publishes this newspaper.)
“People have a growing interest to move into more-advanced strategies, and the minis fit that profile well,” says Randy Frederick, derivatives director for the online brokerage platform CyberTrader, a unit of Charles Schwab Corp. “I think there’s still a lot of room for the futures industry to grow in retail, but the minis have definitely been a boon so far.”
COMPETITION IS ON THE RISE.
For decades, futures exchanges shied away from listing contracts comparable to those of their competitors. But that, too, began to change with the emergence of purely online markets. The result, many experts say, has been lower trading costs and more-active, or liquid, markets in which it’s easier to find buyers and sellers at various price levels.
Both the CBOT and Eurex, for example, now list futures on U.S. Treasury securities. Gold futures trade in both New York and Chicago. And both the CME and Euronext.Liffe offer interest-rate futures on Eurodollars, or U.S. currency on deposit in overseas banks.
Stock-index futures mostly remain subject to exclusive licenses with a single exchange. But in 2003, Russell Investment Group broke ranks and now licenses its Russell 1000 and Russell 2000 indexes across four different markets, including E-mini contracts. By some measures, the indexes’ volume growth has been eye-popping. The CME posted January volume of around 19,000 Russell 1000 contracts. The tally was a record at the time, but volume more than tripled to about 65,000 contracts in May. “One has to suspect that a big part of that is because of increased participation by the retail community,” says Kelly Haughton, strategic director of Russell indexes.
Competitive forces may also be leading to an environment in which investors can find futures under the same roof as other investments. For instance, a proposed merger between the New York Stock Exchange and Archipelago Holdings Inc. would create a marketplace for not only stocks but also derivatives — a term that includes both futures and options. (The merger awaits a vote by NYSE members.)
In the brokerage world, the futures firm Fimat Group, a unit of Societe Generale SA, recently announced it would acquire for an undisclosed amount some of PreferredTrade Inc.’s assets, allowing Fimat to execute stock trades.
Futures generally are regulated separately from stocks, with the federal Commodity Futures Trading Commission playing a role similar to that of the Securities and Exchange Commission in the equity market.
The CFTC’s charter was revised by Congress in 2000, in legislation that made it easier to register new exchanges and erased a prohibition on the trading of futures on individual stocks. However, single-stock contracts, unlike stock-index futures, are subject to dual oversight, from the CFTC and the SEC.
Many industry veterans believe that answering to two regulators has hampered the growth of these contracts, and hope Congress will give the CFTC sole responsibility for them when it revisits the commission’s charter later this year.
“Single-stock futures have never had a chance to get off the ground, but they still could if the regulators straighten out their part of the equation,” says Mr. Frederick, of CyberTrader.
Source: Post Gazette
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