Trading futures

Whether you buy or sell a futures contract, you have to deposit an initial margin.

At the end of each trading day, your position is "marked to market", or valued according to the contract's market value at the end of the day. If the contract price moves against your view so the initial margin deposit falls below the maintenance margin level, your brokerage will normally issue a margin call. This means you will have to deposit additional money to restore the initial margin level. If you don't do this, your brokerage may liquidate your position at market. You will have to bear any loss arising from the forced liquidation.

Initial and maintenance margin levels are normally set by the exchange on which the futures contracts are traded. However, a brokerage may ask for a higher margin level, especially in volatile markets. Make sure you know the margin levels before you trade.

Most Hong Kong exchange-traded futures operate under a market-making system. Registered traders supply market liquidity by providing continuous quotes or entering quotes onto the trading system upon request. Note that their quotes might not match existing orders.

Transaction costs vary for futures traded on different exchanges. For futures trading on the HKEx, transaction costs include a brokerage commission (usually at a flat rate, chargeable each time a futures contract is bought and sold), an exchange fee, SFC levy ($1 per contract per side) and investor compensation levy ($0.50 per contract per side).

Suppose you have bought a commodity futures contract for directional trading and the price of the underlying commodity goes against your view, you can close your position to limit your loss. To close, you reverse an original position by taking an equal but opposite trade on the "same" contract. Normally by default, your brokerage should, on your behalf, give instructions to the exchange or the clearing house to net off your position. As a result, you will not have any outstanding position on the futures contracts.

But when there are difficulties in closing out a position, for example if there is "limit up" or "limit down" in a particular delivery month or if a market is closed for holiday, you may "lock" a position to offset the price risk associated with an open position.

An effective lock normally involves the taking of an equal but opposite trade on a "similar" contract (e.g. a contract with a different expiry date, or one traded on another exchange but linked to the same underlying assets) to your original position. If you hold a long position in a red bean contract for delivery in December 2002, to lock the position you may short a red bean contract for delivery in March 2003. This is different from "closing" a position, as you will hold a "long" and a "short" position in different futures contracts simultaneously. Depending on the policy of the brokerage you are using, you may have to put up margin deposits for each "long" and "short" position you maintain, although you may save on margin on subsequent contracts.

If you want to close out a position and are prepared to take the loss, if any, and if you are able to enter into an equal but opposite trade in the same contract, you should consider doing it. If you attempt to "lock" the position using the same contract and keep the long and short positions in the same futures contract simultaneously, the two open positions would need to be closed out subsequently and additional commission may be incurred.

While the flat commission charged in trading commodity futures may amount to only a small percentage of the underlying asset value, in most cases it might constitute a sizeable percentage of the margin deposit.

Take an example of a flat commission fee at $350 for a Japanese red bean futures contract with an underlying value of $50,000 and which requires a margin deposit of $7,000. When you buy and then close the position by selling a futures contract, the "round trip" commission (for both the buy and sell transactions) payable will be $700. The commission paid is 1.4% of the underlying value of the contract, which is 10% of the margin deposit. Although you can open and close positions as often as you wish, commission costs can be very high if you trade frequently.

• Contract note: After a futures trade has been executed, your brokerage must provide you with a contract note by the end of the second business day after the dealing day (i.e. T+2). This note should contain all transaction details, including the deal date, the settlement date, the name and the number of the contracts traded, the contracted price, whether the contract is for the opening or closing of a position and transaction costs.
• Daily statement: Your brokerage must also provide you with a daily statement by the end of the second business day after you open or close a position (i.e. T+2). The daily statement will set out details of all account movements during the statement date and the outstanding balance, each position closed during the date, including the price at which it is closed, the realised profit/loss, a list of all open positions and the respective floating profits and losses, the net equity, the minimum margin requirement for all open positions as well as the amount of margin excess/shortfall.
  Brokerages may combine a contract note and a daily statement into one consolidated statement. Make sure all relevant information for the two documents are there!
• Monthly statement: You will also receive monthly statements from your brokerage. The only time a brokerage does not have to issue you a monthly statement is if there have been no transactions, there is a zero cash balance and no open positions in your account. The statement will provide you with details of the outstanding balance and net equity, all movements in the account during the statement period, money deposits and withdrawals, a list of open positions and their respective market price, the minimum margin requirement for all open positions, plus the amount of margin excess/shortfall. With the monthly statement, you can review the positions in your account better. It is therefore unwise to ignore this document!

"Black market futures" refers to dealings in Hang Seng Index futures contracts which are not conducted through the Hong Kong Futures Exchange (HKFE). It is an offence to carry out any black market futures business in Hong Kong, and the offender is liable to prosecution.

In order to attract investors' participation, companies conducting black futures business usually solicit clients by charging a low margin deposit or simply waiving the deposit all together. Some unscrupulous operators may also use company names similar to those of licensed dealers so as to confuse the public and deceive investors. As black futures dealings are not conducted through the HKFE, in case of any default or collapse of a company operating the black futures dealings, the interests of the investors will not be protected by the Investor Compensation Fund. Notwithstanding the fact that investors may profit from trading in black futures, they may not be able to claim for any compensation when the relevant companies default in payment.

Moreover, companies of black futures dealings which are incorporated outside Hong Kong, the operations of such offshore companies are not within the jurisdiction of the SFC even if the products they deal in are related to the local financial market in Hong Kong. Neither does the SFC have any statutory power to take action against them.

Therefore, should investors trade in black futures, not only are they exposed to extremely high risks, they are also not protected under the existing legislation. In order to protect themselves, investors dealing in Hang Seng Index futures on the HKFE should trade through intermediaries licensed or registered for conducting Regulated Activity 2: Dealings in futures contracts. Investors should also verify the registration status of the relevant intermediaries with the regulators to avoid falling in the trap of the unscrupulous operators in exchange for just petty gains.

You may visit the HKEx website which contains useful information about margin requirements, registered traders and transaction costs on its futures products:

Margin Table

List of Market Makers or Liquidity Providers in Futures Exchange Products and Stock Options

Trading Fee and Commission Table