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3 Advantages of Futures Trading That Help Manage Risk

April 6, 2020 by Daniels Trading| Futures 101

Among the many advantages of futures trading is its utility in regard to risk management. Futures give market participants the ability to directly increase or decrease exposure to almost any asset class. This is possible because of three primary futures market characteristics: standardization, liquidity, and volatility. Given these benefits, traders may proactively limit risk by entering and exiting the market efficiently at their leisure.

1. Standardization

One of the key advantages of futures trading is that all trade is standardized. This means that transactions are cleared through a formal exchange, eliminating the risk of counterparty default. In addition, every contract is issued with a distinct quantity and expiration date, thus eliminating any guesswork regarding valuation. If you are buying one lot of 2020 September corn (ZC), then you are purchasing a contract for 5,000 bushels that ceases trade on September 14, 2020.

Participants in other markets do not enjoy this degree of clarity. In the spot and over-the-counter (OTC) markets, transactions can be nondescript, and the risk of counterparty default is real.

For example, assume a corn producer agrees to sell a portion of the upcoming harvest to a credit buyer. If the buyer defaults on the obligation, the producer is left out in the cold. On the buyer side of the equation, issues such as product quality and regional pricing can impact the value of the exchange. Given the customizable nature of OTC and spot transactions, they are often much riskier than exchange-based trade.

2. Liquidity

If you have ever tried to buy or sell an expensive item such as land, a house, or a business, then you can attest to the challenges of market liquidity. Fortunately for active traders, liquidity is among the leading advantages of trading futures.

Markets with robust liquidity have two features that are extremely valuable for reducing financial risk:

  • Pricing efficiency: Liquid markets exhibit a high degree of public interest and participation. As a result, the process of price discovery may be carried out in an efficient manner. The risks of market manipulation and outright fraud are reduced exponentially because the sheer number of participants promotes “fair” pricing.
  • Ease of exit: In any business deal, the ability to get out when things aren’t going well is a critical part of managing risk. Liquid markets afford participants the luxury of quickly closing out open positions when warranted. Illiquid markets do not, thus opening the door to financial catastrophe.

For futures traders, liquidity is scarcely a problem. In fact, the CME’s 2019 average daily traded volume measured 19.2 million contracts. Essentially, no matter which asset class you’re trading, chances are you can exit the market anytime at a reasonable price.
Want to know more about trading CME Futures? Learn more >>>

3. Volatility

It may seem like a counterintuitive point, but pricing volatility can actually help to manage risk. One of the key advantages of futures trading is the flexibility to take long or short positions as needed. Given an appropriate strategy, fluctuations in futures contract pricing can help limit risk exposure in other markets.

To illustrate how futures volatility may be used to manage risk, assume that Tristin owns a freight delivery company based in Topeka, Kansas. Unfortunately, Tristin’s business has been on the downswing because of losses stemming from higher fuel costs. To limit these losses, Tristin decides to buy 10 contracts of 12-month deferred West Texas Intermediate (WTI) crude oil futures. Bullish volatility in the crude oil markets will generate positive income, largely offsetting losses incurred by rising refined fuel prices.

Capitalize on the Many Advantages of Futures Trading

The futures markets offer participants a vast array of risk management applications. To learn more about how futures can help you guard against the unknown, check out Daniels Trading’s online hedge portal today.

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Filed Under: Futures 101

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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