From the February 01, 2010 issue of Futures Magazine • Subscribe!

Small contracts, big opportunities

CME Group also offers mini-sized contracts on corn, wheat and soybeans, E-minis on light sweet crude and heating oil and E-minis on gold and silver. Last year, CME Group rolled out its E-micro forex contracts, which are one-tenth the size of its standard forex futures, on EUR/USD, USD/JPY, GBP/USD, USD/CAD, AUD/USD and USD/CHF (see “Micro mania” ).

NYSE Liffe US’s mini gold contract is 33.2 ounces, compared to their full size contract of 100 ounces, and the mini silver contract is 1,000 ounces, which is 1/5 the size of the standard 5,000 ounce contract. NYSE’s metals contracts are the former CBOT metals complex. NYSE also offers MSCI mini contracts.

“Our mini contracts are physically deliverable. It has become more and more important for people who are participating in the precious metals markets not [only] to have something that’s tracking the price of gold or silver but [also to have] the ability to take delivery of it if they want to,” says Jennifer Ropiak, vice president of precious metals business development at NYSE. In the mini gold contract, the client that is long receives a warehouse depository receipt. If the client is long three gold warehouse depository receipts, they can submit them to the exchange and receive a vault receipt, which can be used to take gold out of a vault. The same is true for the mini silver contract, but in series of five.

BINARY BOOST

The North American Derivatives Exchange (Nadex) specializes in even smaller sized contracts than the larger exchanges. Nadex offers binary options (see “Binary bonanza,” page 52) and spec contracts. Binaries are all the same size, with a contract value of $100. Your price may be anywhere from $4-$96.

Spec contracts have variable sizes. The contract size can be $100-$500, depending on the underlying value. With Nadex contracts, due to their smaller size, the amount of money you put up initially is much smaller than the amount you would put up for E-minis. Binaries do not offer the flexibility of margining. You need to fund your account at 100% of the risk you take. “With a Nadex contract, what they have to put up is between $4 and $96. If you’re buying futures, you have unlimited risk and unlimited reward. One of the ways to protect yourself is [through] the type of contracts we offer, which are capped,” says Yossi Beinart, president and CEO of Nadex.

Getting started in smaller contracts requires knowing how much money you want to put up and understanding how the markets work. Volume and liquidity also are important factors to research. Binaries offer a good training ground for new traders and help them avoid the pitfalls of being over leveraged.

GOT LIQUIDITY?

While smaller contracts can give traders access to markets they would not have if they could only trade the larger contracts, it is important to make sure there is enough liquidity. “Volume is the key thing I would caution people about. If there’s not liquidity, you should stay away from it. There are some mini contracts that are not as liquid and it may not benefit you to trade them because of the lack of volume,” Cholly says.

That can lead to what traders call “Hotel California” trades: that is, trades you can get in any time, but you can never leave. The ability to exit trades without giving up slippage is extremely important. Liquidity often is measured by volume and open interest, but you also should understand how a mini contract tends to act in highly volatile markets. If the volume tends to congregate in the larger contract during high stress markets, you need to know that. This is particularly important for short-term and day traders who are attempting to take smaller chunks out of the market on each trade.

Ropiak agrees that the number one thing that investors need to be aware of is liquidity. “The more liquid a contract is, the more chances you have of getting executed at the price you want and rolling it forward at a reasonable price,” she says.

As with any trading, practice helps. “There’s no education like real trading. When I open a demo account, I always make money. When I open a real account, I don’t always make money,” Beinart says, adding that you should stick to markets that have transparent pricing so you understand how they work, regardless of the size of the contract. “Do your homework. For retail investors that’s important because they’re new to this,” he says.

All smaller contracts, though different, have similar benefits; namely, risk control, flexibility and diversification opportunities. In today’s volatile market conditions, risk control is a major factor. A mini crude contract, for example, allows you to play a volatile market, Cholly says. “With the geopolitics, it’s always a wild card what’s going to happen there,” he says, so trading smaller can be better in this case. “Some markets are going to be more liquid than others. E-mini S&Ps are my favorite mini market and crude is very good. The metals are usually pretty good. It does limit the risk. It has less reward also, but it allows you to average in a little easier,” he says.

Flexibility is key as well. Smaller contracts allow you to get exposure to a certain market without committing too much capital. “Smaller contracts are appealing to the individual retail or active trader. If you want exposure to the price of gold you can buy a futures contract. You only have to put up approximately 4.5% of the value of the contract. Only if you want to take delivery of the gold do you have to put up the whole value of the contract. Mini gold futures allow individuals to be more flexible with their cash,” Ropiak says.

Smaller contracts mean less money locked down into one particular contract, allowing for more portfolio diversification. With smaller contracts, “you [can] spread your ideas among multiple markets and multiple contracts, and put less money at risk in each one. It’s a question of how much money you’re willing to risk. It’s [about] how you can best optimize the use of your resources,” Beinart says. He adds that for a beginning trader, smaller contracts allow for learning opportunities. “The best way to teach yourself how to trade is to trade with smaller contracts. If you want to invest $5,000, buy 10 $500 contracts. If you have $10,000 [to trade with], you can kill it all by making two wrong decisions. If you go with smaller contracts, you can make small mistakes, understand and tune your models and learn more. That’s my number one reason to go smaller. Try it out before you commit yourself.”

And this is not just talk. Some of the most successful futures traders, Richard Dennis perhaps being the most famous, started their careers at the old Mid-America Exchange. The Mid-Am offered smaller sized contracts in agricultural, livestock, metals and financial futures markets long before there was an E-mini. These traders learned their craft trading multiple smaller sized contracts and went on to great success.

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