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Futures FAQ

Q: How does risk affect my returns?
Your returns may change radically at any time because futures and options are subject, by nature, to abrupt changes in price. Commodity prices are volatile because they respond to many unpredictable factors: weather, labor strikes, inflation, foreign exchange rates, government monetary policies, etc. And, in an individual account, because your position in futures and options is leveraged, even a small move against your position may result in a large loss, including the loss of your entire initial margin payment and liability for additional losses. The same risk of loss applies to a commodity pool, but your loss may be limited to the amount of your investment.
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Q: Are there strategies for reducing risk?
In an individual account, there are certain types of orders (such as "stop-loss" orders or "stop limit" orders), which are designed to limit losses to certain amounts. However, these orders may not be effective in limiting losses because market conditions may make it impossible to execute your orders at a reasonable price. Strategies using combinations of positions, such as "spread" and "straddle" positions, may be as risky as taking simple "long" or "short" positions. In a commodity pool, you should ask the pool about any strategies it employs to reduce risk. As always, be extremely wary of claims of guaranteed profit and minimal risk.
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Q: Do options carry less risk than futures?
Not necessarily. If you plan to trade through an individual account and are considering trading options on futures contracts, you should familiarize yourself with the types of options (puts or calls) that you contemplate trading and the risks associated with each. You should calculate the extent to which the value of the options must increase for your position to become profitable, taking into account the premium and all transaction costs. You should also understand that certain market conditions (such as lack of liquidity), market rules, or the pricing relationships between the underlying interest and the option may increase risk.
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Q: Do the risks vary between puts and calls?
The purchaser of an option (known as a "long" call or being "long" a put) can do the following with an option position. The purchaser may "exercise" the option if it is profitable, or allow the option to expire if it is not profitable. The exercise of an option by someone who is "long" results either in a cash settlement or in the purchaser acquiring the underlying interest. If the option is on a futures contract, the purchaser will acquire a futures position with associated liabilities for margin (see the section, Futures, above). If a purchased option expires worthless, you will suffer a total loss of your investment, which will consist of the option premium plus transaction costs. If you are contemplating purchasing "deep-out-of-the-money" options, you should be aware that the chance of such options becoming profitable ordinarily is remote.

Selling, or shorting, an option generally entails considerably greater risk than purchasing options. Although the premium received by the seller is fixed, the seller may sustain a loss well in excess of that amount. The seller will be liable for additional margin to maintain the position if the market moves unfavorably. The seller will also be exposed to the risk that the purchaser will exercise the option, obligating the seller to either settle the option in cash or to acquire and deliver the underlying interest. If the position is "covered" by the seller holding a corresponding position in the underlying interest or a future or another option, the risk of loss may be reduced, but the loss may still exceed the premium received. If the option is not covered, the risk of loss can be unlimited. How do commissions and fees affect my rate of return?

Obviously, fees will reduce your rate of return and should, therefore, be examined carefully. In an individual account, the disclosure statement does specify fees and expenses. However, you are encouraged to consult your broker and be fully aware of the fees you will be charged. A commodity pool is required to provide you with a complete description of fees, commissions, and other expenses. Before allocating any funds to a pool, you should pay particular attention to the "break-even analysis" and other required fee disclosures to determine how fees will affect your potential rate of return.
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Q: Is there a limit on potential losses?
Before participating in a commodity pool, read the disclosure document closely for information on losses. Losses to commodity pool participants are ordinarily (but not always) limited to the amount of your participation. Sometimes in a commodity pool, in order to protect against catastrophic losses, a loss greater than a given percentage will trigger the sale of all open positions and will result in closing the pool account. The disclosure document must clearly state this possible course of action.

In an individual account, the leveraged nature of transactions can result in significant losses or gains, and losses may exceed your initial margin deposit. If so, you are responsible for covering those losses with additional funds.
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Q: How can I evaluate a broker's track record?
If you plan to participate in a commodity pool, information on past performance must be included in the risk disclosure document, which is required to be provided to you by the Commodity Pool Operator. Bear in mind that past performance is not a predictor of future results.

If you authorize a Commodity Trading Advisor to direct trading in your individual account, the Commodity Trading Advisor must provide you with a disclosure document including information on past performance. In reading the disclosure document, note whether the performance results are based on actual trading results of client accounts. The Commodity Trading Advisor must disclose whether information is based on the Advisor's own proprietary (personal) account, or based on hypothetical or simulated results. If the information is based on hypothetical or simulated results, the Commodity Trading Advisor must disclose the inherent limitations of these results. No representation may be made that any account will or is likely to achieve profits or losses similar to those shown.

If you plan to open an individual account, and plan to ask your Futures Commission Merchant, Introducing Broker, or one of their Associated Persons for advice or have the firm or Associated Person trade on your behalf, get as much information as possible about the firm's or the Associated Person's track record on behalf of other clients. While the firm or associated person is not required to provide this information, be wary of any firm or associated person who is not forthcoming or who provides you with incomplete information.
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Q: Can I withdraw my investment at any time?
The funds needed to meet initial margin requirements in an individual account can only be withdrawn after trades are settled and, in some cases, after all open positions are closed. Accruals on futures contracts are paid out daily. Funds held in an individual account above and beyond the required margin or account-opening requirements should be able to be withdrawn. If you participate in a commodity pool, you may or may not be able to withdraw some or all of your money at any given time. Some pools have limitations on when funds can be withdrawn. You may only be able to redeem your funds on a monthly, quarterly, or even annual basis. Restrictions on the withdrawal of money should be evaluated by reading the disclosure document and asking questions before you invest in the pool.
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Q: What information should my broker give me once I open an account?
In the case of an individually managed or personal account, you should receive confirmation by mail of all purchases and sales, and a month-end summary of transactions, showing gains, losses, and a mark-to-market valuation of your open positions and current account value. Your broker should also be willing and able to provide you with this information on a daily basis. In a commodity pool, your pool operator ordinarily should send you a monthly statement of net asset value. However, if commodity pool assets do not exceed $500,000 at the beginning of the pool's fiscal year, reporting will be made quarterly.
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Q: Are my funds protected?
In an individual account, funds that you have deposited with your commodity brokerage firm to trade on commodity exchanges located in the United States are required to be segregated (held separately) from any of the brokerage firm's own funds. The amount segregated will increase or diminish as you make or lose money from your trading. Also, even though your brokerage firm is required to segregate your funds, you may still not be able to recover the full amount of any funds in your account if the brokerage firm becomes insolvent and there are insufficient funds available to cover the obligations to all of its customers. Your account is not insured.

If, in your individual account, you trade on commodity markets located outside of the United States, your brokerage firm will set up a trading account for you, which is in addition to the account set up for your trading on U.S. markets. The funds in your foreign account will be segregated by your brokerage firm only while you maintain an open position on a foreign market, and then only to the extent of any margin required on that position, plus or minus any unrealized gain or loss on that position. You should ask your broker about account protection and should be aware of the limitations imposed on the protection of the funds in your commodity trading accounts.

A Commodity Pool Operator is required to disclose what percentage of the pool's assets will be held in segregation.
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Source: http://www.cftc.gov/opa/brochures/opafutures.htm

WE HAVE PROVIDED THIS INFORMATION AS A SERVICE TO INVESTORS. IT IS NOT A LEGAL INTERPRETATION. NEITHER IS IT AN INTERPRETATION OF OR A STATEMENT ABOUT SEC POLICY. IF YOU HAVE QUESTIONS CONCERNING THE MEANING OR APPLICATION OF A PARTICULAR LAW OR RULE, PLEASE CONSULT WITH AN ATTORNEY WHO SPECIALIZES IN SECURITIES LAW.