March 19, 2013

FTSE Futures and Trading Example

FTSE futures are a way of speculating on the FTSE 100 index. This index is made up of the 100 most capitalized company’s on the London Stock Exchange. The FTSE 100 companies make up approximately 80% of all the market capitalization on the London Stock Exchange.

Historically the index has been volatile reaching a high of 6950 in 1999. This high has not been touched since.

(2017 Edit) Since writing this article, the FTSE 100 is now trading at all time highs, with the cash index reaching a peak of 7338 on the 13th January 2017).

Companies are removed and added to the index a few times per year, based on market cap, which is the current share price of the company multiplied by the number of shares in issue. If they are not in the top 100, they are removed and replaced. The Top 10 companies share prices on the index are:

  • Royal Dutch Shell
  • BP
  • HSBC
  • GlaxoSmithKline
  • Vodafone Group
  • Barclays plc
  • Lloyds
  • AstraZeneca
  • Anglo American

High Risk, High Gain

ftse futuresThe FTSE does have the tenancy to move down very sharply in the event of unexpected fundamental events. For example as you can see from the chart below, the index dropped massively during the 9/11 tragedy. This can make FTSE trading high risk.

FTSE 100 futures are priced at a rate of 10x the value of the FTSE 100. For example if the FTSE is currently priced at 6000 points, the nominal value of a contract will be £60,000. The initial margin requirement of this contract is currently £3000. The maintenance margin is also £3,000. This would mean each index point movement would be worth £10 on any open contract.

Let’s take a look at a speculative example:

Let’s say that the FTSE 100 is currently priced at 6,000 points and Bob wishes to speculate a rise to 6,200, but due to the financing costs being included in the pricing, he does not wish to hold the position more than two months.

Bob buys a contract with a two month expiration date. On expiry, if the FTSE moves to his 6,200 target, Bob would be £2,000 in profit, as each index point is worth £10.

However, if the FTSE moves down 200 index points on expiry, Bob will lose £2000.

Hedging example:

Let’s say that Joe has £120,000 in unit trust investments and the performance of these historically, has been highly correlated to the FTSE 100 index. In the event of a major economic disaster where stock markets are collapsing worldwide (for example the 9/11 crisis), Fred could short sell the FTSE contract to hedge his risk, if he felt the collapse would continue.

Let’s say Joe decides to short sell at 6,000 points.

If Joe is correct and the FTSE continues to crash down to 5,000 points, his futures contract would be in £20,000 in profit. This profit should offset some, if not all the losses to his unit trust investments. This would be an effective hedge.

Joe has the option to close the contract whenever he feels is the best time.

However, if Joe is wrong and the FTSE moves up to 7,000 points, his futures contract will be £20,000 down. If he closes the contract or it expires he will have to pay this £20,000. However, his unit trust investments would probably be up by around the same amount. So he would essentially be in a “net zero” position.

The FTSE futures do not provide 100% guaranteed protection as most unit trust funds are not 100% correlated to the FTSE 100. However, there are tracker funds that do attempt to do this.

Max Hansson

Max Hansson is a guest author to the site. Writing about risk, chart strategies and money management. Max is an active day trader of forex, mainly EUR/USD and GBP/USD.