PART 1:

A funny thing happened at lunch on Saturday. Joining friends from St. Louis who for many years have traded in real estate, I was asked by their guests the usual, "So, what do you do?" Trying to answer so as not to send them running, I answered softly and slowly, "Well...actually...I trade futures and also do some coaching of traders using principles from psychoanalysis."

“Really?! Futures?! You mean like orange juice?” they asked.

Laughing, I answered “No, futures on stock indexes like the Dow Industrials or the S&P 500.” Figuring they most likely invested, if not traded in stocks, I went on to explain I actually was finishing an article about switching from stocks to futures, but I was grappling with not writing a pure sales pitch for futures because I did indeed find them so much easier than stocks.

“Easier for you,” they quipped with a pronounced incredulity.

Ironically, as my companion then explained his background as a Federal Reserve economist, the conversation immediately turned to their idea of buying Canadian dollars to hedge the operations of a business they own. Later I couldn’t help but wonder who was actually the biggest risk taker. Was it the real-estate flippers, the travel professionals looking to hedge costs with a foray into currency trading or me?

Yes, I fully admit to being a calculated risk taker. Although just the word risk can intimidate people, I emphasize the “calculated” part. I have repeatedly taken what others consider outlandish risks, and yet you will never find me in a casino; the math doesn’t add up because the house always has the advantage. On the other hand, a trader in stocks, futures or any other financial instrument, can constantly control the risk by learning to execute increasingly better entries and exits. Essentially, the quest for better execution on both sides of the trade caused me to switch my focus to the electronic futures markets.

Looking Back

I first heard of S&P 500 futures more than a decade ago when I was taught to watch the spread between futures and the cash index as... a part of judging the stock market on an intraday basis. My first attempt to trade a futures contract, however, came much later and was a logistical disaster. The calculated risk taker had decided to buy the new VIX futures contract as a way of hedging against the risk of terrorism during the political season. At the time, I traded through a proprietary stock-trading firm and through two full-service stockbrokers, so I asked all three for help.

After they repeated, “you want to do what?” I heard, in successive order, “No, we used to do futures but do not anymore,” then “Uh, well, uh, maybe. Let me ask” and third, “Yes, we do that, let’s see how to go about it.”

Days turned into weeks until finally the “maybe” and “yes” turned into “no” and “maybe.” Another week went by when the last “maybe” morphed into “No, we cannot do that because I am not licensed and neither is my manager, and we cannot open an account for you in another part of the firm.”

In retrospect, the black holes found in two centuries-old Wall Street firms should not have surprised me, but it did. Both offered options, hybrid instruments, private placements and other services besides simple stock brokerage. So I naively thought they would both have a futures group and be interested in holding an additional account from me. I vaguely had paid attention to the advertising in trading magazines but the dartboard approach didn’t appeal to me. I wanted to understand execution costs, software and margins. As it turns out, the futures exchanges themselves offer much of this information, but at the time I turned to people I knew. Stymied, I gave up on the trade and turned to plans for the August doldrums.

Something else was going on. My intraday stock trading consisted more and more of the “Spiders” (SPY) and “Diamonds” (DIA) for two reasons. The old method of finding the strongest and weakest stocks of the day had become much harder with the spread of electronic trading and decimalization and the other key – the option of shorting SPYs and DIA on a downtick.

Still, despite ample intraday leverage, making or losing 10 cents in the SPYs for every $1.00 move in the S&P futures translated into lots of shares and too much commission. And then it was time to subtract some money from that 10 cents – a penny per share commission, the misnamed “taking away liquidity charge” to hit the bid or take the offer on ECNs, or the slippage associated with the specialist-based venues – and it rapidly becomes clear that making seven or eight cents versus losing 12 or 13 cents adds up to a very tough game. Compare this to making $50 per point in the E-mini S&P and paying a commission rate of, say, $6 per roundtrip. In other words, it made more sense to earn $44 or lose $56 per contract than to make $70 versus losing $120 per 1,000 SPYs. Hence, in the back of my mind it seemed that I also was developing a plan to move completely to futures trading.

--> Part 2 of Denise's Series

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