Futures markets have been described as continuous auction markets
and as clearing houses for the latest information about supply
and demand. They are the meeting places of buyers and sellers
of an ever-expanding list of commodities that today includes
agricultural products, metals, petroleum, financial instruments,
foreign currencies and stock indexes. Trading has also been
initiated in options on futures contracts, enabling option
buyers to participate
in futures markets with known risks.
Notwithstanding the rapid growth and diversification of futures
markets, their primary purpose remains the same as it has been
for nearly a century and a half, to provide an efficient and effective
mechanism for the management of price risks. By buying or selling
futures contracts--contracts that establish a price level now for
items to be delivered later--individuals and businesses seek to
achieve what amounts to insurance against adverse price changes.
This is called hedging.
Volume has increased from 14 million futures contracts traded
in 1970 to 179 million futures and options on futures contracts
traded in 1985.
Other futures market participants are speculative investors who
accept the risks that hedgers wish to avoid. Most speculators have
no intention of making or taking delivery of the commodity but,
rather, seek to profit from a change in the price. That is, they
buy when they anticipate rising prices and sell when they anticipate
declining prices. The interaction of hedgers and speculators helps
to provide active, liquid and competitive markets. Speculative
participation in futures trading has become increasingly attractive
with the availability of alternative methods of participation.
Whereas many futures traders continue to prefer to make their own
trading decisions--such as what to buy and sell and when to buy
and sell--others choose to utilize the services of a professional
trading advisor, or to avoid day-to-day trading responsibilities
by establishing a fully managed trading account or participating
in a commodity pool which is similar in concept to a mutual fund.
For those individuals who fully understand and can afford the
risks which are involved, the allocation of some portion of their
capital to futures trading can provide a means of achieving greater
diversification and a potentially higher overall rate of return
on their investments. There are also a number of ways in which
futures can be used in combination with stocks, bonds and other
investments.
Speculation in futures contracts, however, is clearly not appropriate
for everyone. Just as it is possible to realize substantial profits
in a short period of time, it is also possible to incur substantial
losses in a short period of time. The possibility of large profits
or losses in relation to the initial commitment of capital stems
principally from the fact that futures trading is a highly leveraged
form of speculation. Only a relatively small amount of money is
required to control assets having a much greater value. As we will
discuss and illustrate, the leverage of futures trading can work
for you when prices move in the direction you anticipate or against
you when prices move in the opposite direction.
It is not the purpose of this brochure to suggest that you should--or
should not--participate in futures trading. That is a decision
you should make only after consultation with your broker or financial
advisor and in light of your own financial situation and objectives.
Intended to help provide you with the kinds of information you
should first obtain--and the questions you should seek answers
to--in regard to any investment you are considering:
* Information about the investment itself and the risks involved
* How readily your investment or position can be liquidated when
such action is necessary or desired
* Who the other market participants are
* Alternate methods of participation
* How prices are arrived at
* The costs of trading
* How gains and losses are realized
* What forms of regulation and protection exist
* The experience, integrity and track record of your broker or
advisor
* The financial stability of the firm with which you are dealing
In sum, the information you need to be an informed investor.
Past performance is not necessarily indicative of future results.
The risk of loss exists in futures and options trading.
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Introduction