Why Trade Futures?

There are a number of reasons why one might wish to establish a futures position.

Speculation

Futures are an obvious choice for speculation on a market. If you suspect the prices are on their way up in a bear market, buy futures and sell for a profit once the prices have risen to the speculated-upon point. Profit can also be made in a bull market by speculating that prices are in for a downturn and selling futures, then buying again when prices are low.

Hedging

As with options, one of the advantages to trading futures is called hedging because you build a virtual hedge to protect your assets. If handled correctly, futures trading can reduce the overall risk by protecting your investments from price fluctuations. This is like insurance against the fall in price of some asset that you want to keep. Let's say you own some asset, and you're worried that the price is in for a downturn, but you don't want to actually liquidate your assets. One way of protecting yourself would be to sell futures in the asset which would offset the cost of any loss incurred by a drop in the price of the underlying asset. Of course, in order to successfully implement this strategy you must already have planned for it. Often, an investor's first step when planning to buy some commodity in the cash market is to buy futures first. When the cash market transaction takes place, the futures contract is no longer required for protection and is closed out. By 'closing out' I mean either buying or selling. In a long hedge the investor would offset his current position by selling the futures contract; in a short hedge he would buy it back.

Asset Allocation

Futures trading can also provide a convenient alternative to difficult or time-consuming transactions when making short-term adjustments to your portfolio. Futures can be used to quickly adjust market exposure without changing your physical holdings or liquidating assets needlessly.

Portfolio Diversification

Two important studies have been conducted showing conclusively that futures trading can provide a profound diversification to your portfolio that can in turn yield greater returns. One study was by Goldman Sachs and spanned a 25-year period, the other was conducted by the Chicago Mercantile Exchange. Both studies concluded that portfolios including futures yield higher returns than portfolios relying on stocks and bonds alone.

Finally, futures can be used to supplement your overall returns by providing an alternative means of manipulating your market position. Don't get me wrong, futures aren't for everyone; don't start trading futures just to make yourself feel like a real investor. It's imperative that futures are correctly managed to provide maximum benefit. When you buy a contract, make sure you have a specific plan or goal in mind and give serious thought to whether the premium is worth the expected benefits.

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