Back to School on the Futures

Those swashbucklers who do have discretionary investment money and enjoy the thrill of the potential for big profits (and who grasp the real potential for big losses) may want to open a futures trading account. The investor can call a futures brokerage and speak to an introducing broker, or go online to find a firm such as Merrill Lynch, Prudential Securities, Man Financial, Lind-Waldock and dozens of others.

There's the usual paperwork to sign, including risk disclosure documents, and the added step of depositing margin money (usually $5,000 or higher), before you're set to trade futures. But before you reach for your phone, first read on about some of the pitfalls.

Hot Investing, Burned Newbies

With all the talk and business media coverage of commodities, there has been keener interest among individual investors in trading commodity futures. However, before an unwitting investor calls his broker and instructs him to get him in on the long side of corn or soybean futures, it's prudent to first become familiar with the vagaries of trading futures markets.

The lure of trading futures is making huge profits with little money laid down. Where stock traders can operate on margin rates of 50%, commodity futures traders can own commodity contracts with less than 10% of the total value of the futures contract deposited with a broker.

For example: In corn, with around $1,000 in margin money deposited with a futures broker, an investor can own one contract on corn futures that is worth around $20,000. Every 1-cent price move in a bushel of corn amounts to a $50 change in the value of a corn futures contract, which equates to 5,000 bushels.

If the corn futures market at the Chicago Board of Trade rallies 10 cents a bushel during a trading session, then an investor on the long side of one corn futures contract would make a $500 profit. Sounds great so far, right?

Here's the catch. Commodities markets are volatile, much more so than stock markets. While the major U.S. stock indices very rarely make a daily permissible limit price move, commodities futures markets make daily limit price moves much more often. The futures exchanges establish daily permissible trading limits on price moves in futures markets to help control price volatility during very active markets. Just two weeks ago, corn futures opened and closed locked up the daily permissible price move of 20 cents a bushel. That's $1,000 a contract.