Focus on Futures - Handling Contracts

Last week I wrote briefly about the benefits of futures compared with the popular trading vehicle of options. I have to say upfront that as a directional trader, futures would always be my trading vehicle of choice. Directional trader implies confidence in picking whether the next move is likely to be up or down and trading it. Regardless of how much confidence there may be, the stop loss is the safety net on the occasions the position is wrong.

One of the things that confuses a new trader is knowing exactly what it is they should be trading and charting. When you open up the Software and look in the Symbol Tree under the futures folders, some contracts can have about 20+ listings. You might look at that with new eyes to futures and say, “where do I start?”

As an example, this week I’ll use the Dow Jones futures contract which is traded on the Chicago Board of Trade (CBOT). There have been some very nice profits on the short side over the past couple of weeks, which have been very tradeable. Take it from me. I will visit some of the technical analysis underlying that statement shortly. Let’s just say for now, the chart suggests the Dow is headed for more downward action before an uptrend resumes.

Futures contracts, like any contract, are an agreement and have a set date by which the agreement must be finalised. So therefore contracts come into being, exist for a period of time and then once they expire they cease to exist. So the first point is that we need to keep a chart that is continuous, allowing us to gather some history for a market. We can’t just keep drawing up a new chart for each contract. We need to link them together, building one continuous chart, made up of many linked contracts. In the screenshot below you can see the list for the day-traded contract charts for the Dow.

The Dow contract has expiry months of March, June, September and December. So on the surface of it, we would be rolling over contracts on our continuous chart 4 times per year. This is not always the case for all futures contracts, but for the Dow, it’s straightforward.

In the list you can see specific contracts (e.g. Dec 2004), ‘Gann’ charts (e.g. Mar Gann), ‘Cash’, ‘Spot1’ and ‘SpotV’. This is where the question, where do I start begins to arise.

The first thing is that the ‘Cash’ chart is the actual Dow Jones Industrial Average Index, the underlying physical. In terms of continuous charts, the ‘Gann’, Spot1’ and ‘SpotV’ charts are the choices. The Gann charts link the same contract each year, for example the December 2002 contract, to the December 2003 contract, currently linked to the December 2004 contract. This chart would have long periods of inactivity and then a three-month flurry of activity starting early September each year.

The ‘Spot1’ chart links consecutive contracts as they expire. So currently the Spot 1 chart will contain the data for the December 2004 contract, until the day it expires. Then from that point forward it will use the March 2005 contract, until it expires and so on.

The ‘SpotV’ chart, links consecutive contracts on the basis of which contract has the highest trading volume. This is the chart I tend to start my analysis on. Often the SpotV and the Spot1 only vary slightly around the time to rollover. So at the moment my analysis is done with the SpotV chart and when it is time to take a trade, I use the December contract, it’s that straightforward. I’ll only need to be concerned with rolling over contracts getting closer to the middle of December, for now the choice is simple. Pick the direction well and buy or sell the December contract accordingly to make profits.

The Dow Jones contract has a point value of US$10 per point. So when the Dow is trading at 10,000 one contract is worth about US$100,000. It only takes a margin (deposit) of US$5,000 to control one contract. The delta is basically 1 to 1 and there is no time decay!

Until next week......

Noel Campbell