Efficient Capital Deployment
Decrease costs and increase potential returns.
Use of futures contracts makes it possible to control positions without tying up the total underlying cost of those positions. Futures contracts are inherently leveraged instruments. Leverage is therefore present without the cost of borrowing.
Futures contracts allow the investor (or manager on behalf of the investor) to control a significantly larger amount of capital than what the deposit at your Futures Clearing Merchant (broker) could cover. Certainly this has some risk, but also some efficiencies. Exchanges and Futures Clearing Merchants (FCMs) have margin requirements for the positions an account has assumed. Margin means “good faith deposit” in the world of futures contracts. It is not a loan. We try to use these characteristics in a way that harnesses the efficiencies available without maxing out margin requirements. This allows us to efficiently manage a systematic and broadly diversified portfolio.
Notional Funding is also possible in some cases. Notional funding means you hire us to trade at a level higher than the cash you actually have on deposit at your Futures Clearing Merchant (FCM). Notional funding is possible because of the inherent leverage in futures contracts. Using notional funding will result in more volatile results and more risk relative to the cash you have on deposit. Clearly potential risks and potential rewards that go along with notional funding is something to consider.
Examples of futures margin:
Lets imagine Corn futures are trading at $4 per bushel with a margin requirement per contract of $750. A corn contract represents 5000 bushels. In this example a corn contract would represent $20,000 at the price of $4 per bushel. Because the margin requirement (margin req can change based on volatility & other factors) is only $750, you could control the 5000 bushels with significantly less than the underlying initial $20,000. Of course, you would not want to do that if your account was only $750 because you need to also be prepared for drawdowns (losses) in any strategy. Risk management is important, but this example illustrates you do not need to dedicate a full $20,000 to manage the position.
In another example, imagine you want to take a position in the Euro Currency. The single contract size is 125,000 Euro. Let’s imagine current margin requirements are $2,500, and current price of one Euro in U.S. Dollars is $1.135. The initial value of the position would then be $141,875. You only need to have the $2,500 margin requirement to control that trade. Once again, we do not max this available leverage out nor do we recommend doing so. However, it should be easy to see the possible efficiencies of the inherent leverage available.
We did not discuss risk management in the examples above, but clearly risk management and position sizing is important. That is another topic. The point here is to explain how it is possible to efficiently control a position without tying up the total underlying cost of the position.
Example of notional funding:
Imagine Ms Smith hires Anderson Creek Trading to manage a notionally funded account with a trading level beginning at $250,000. She only deposits $150,000 at her FCM, but fills out special explicit instructions for Anderson Creek Trading to trade the account with the beginning trading level of $250,000. Ms Smith’s returns will be much more volatile relative to the cash on deposit, but will be the normal returns relative to a fully funded $250k account.
Ms Smith’s motivation for doing this could be any number of things. She might want even more efficient deployment of capital than already possible, and therefore put the remaining balance in an interest bearing account of some sort to earn a bit of a tail wind. She might just want to seek more aggressive returns. Both are reasonable once the investor understands and can accept the risks.
With a notional funding agreement, investors can occasionally dial up or dial down their trading levels and risk with the manager. Notional funding increases risk relative to the cash on deposit, but also increases control and versatility. Most investors new to this space start with a fully funded account, but notional funding is worth considering for experienced investors.
Contact us if you have more questions about these important topics.
THE RISK OF LOSS IN TRADING FUTURES CAN BE SUBSTANTIAL. YOU SHOULD, THEREFORE, CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.