If you have an urge to trade for big profits, the futures markets are the place for fast-moving action and a chance to score big gains — or wipe out your trading account. Leverage is the grease that makes big profits on small investments possible: It allows you to control tens if not hundreds of thousands of dollars worth of a commodity with a deposit of a few thousand bucks. The futures markets set a different level of leverage for different types of commodities and financial products.
Size of Contracts
Each futures contract is set for a certain amount of the underlying commodity or instrument, and the value of the contract is based on the price of the commodity. Some examples: A corn futures contract is for 5,000 bushels of corn; if corn is at $7 per bushel, one futures contract is worth $35,000. A crude oil contract for 1,000 barrels would be worth $90,000 at $90 per barrel. The popular e-mini S&P; 500 futures contract is valued at 50 times the S&P; 500 stock index value. If the S&P; 500 sits at 1,400, the e-mini futures contract is worth $70,000. E-mini futures are smaller than standard-size contracts, which only trade electronically and are popular with individual traders.
Margin Deposit Requirements
To trade a futures contract, your commodity futures broker will require you to put up a margin deposit. The commodity exchanges set the margin amounts for each type of contract. This is the money you must have to control the value of a specific futures contract. At the time of publication, the margin requirements for the standard corn, crude oil and the e-mini S&P; 500 contracts were $2,700, $5,610 and $3,850, respectively. The commodity exchanges adjust margin requirements as the value of futures contracts rise and fall.
Calculate the leverage of a futures contract by dividing the value of the contract by the margin requirement. If a crude oil contract is worth $90,000, the $5,610 deposit required to trade one contract results in 16 times leverage. For corn and the e-mini S&P; contracts at the current values, the leverage levels are 13 times and 18 times the margin amount. Futures with low levels of volatility, such as Treasury bills, can have much higher leverage. At the extreme, a $1 million 13-week Treasury bill future can be traded with a $405 margin deposit, providing 2,500 times leverage.
Effects of Leverage
Since it is unlikely that you will actually pay $90,000 for 1,000 barrels of oil or $1 million for a Treasury bill, the way to look at futures leverage is to examine the monetary effect on the value of your trading account. If the price of a barrel of oil changes by $1.00, you will have a $1,000 profit or loss. Ten cents on oil is worth $100. On that high-leverage Treasury bill, a 1/100 of a percent change in interest rates is worth $25. Treasury bill rates might move only a few hundredths over the course of a week.
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