Understanding Your Risk & Other Aspects Of Trading
What is a risk disclosure document?
Because trading in commodities and options is appropriate only for certain individual investors and businesses, the Commodity Futures Trading Commission (CFTC) requires that you are provided with a disclosure document that describes the risks involved. The document provides you with an opportunity to carefully consider whether futures and options are appropriate for you in light of your experience, objectives, financial resources, and other circumstances. We must receive a signed and dated acknowledgment from you that you have received a disclosure document before Insignia Futures & Options can accept any funds from you. These disclosure documents are provided to your in our new account application.
How does risk affect my returns?
Your returns may change radically at any time because futures and options are subject, by nature, to abrupt changes in price. Commodity prices are volatile because they respond to many unpredictable factors: weather, labor strikes, inflation, foreign exchange rates, government monetary policies, etc. And, because your position is leveraged, even a small move against your may result in a large loss, including the loss of your entire initial margin payment and liability for additional losses. We invite you to contact an Insignia Futures & Options representative to fully discuss your trading objectives and to learn if trading commodity futures & options is right for you.
Are there strategies for reducing risk?
In an individual account, there are certain types of orders (such as "stop-loss" orders or "stop limit" orders), which are designed to limit losses to certain amounts. However, these orders may not be effective in limiting losses because market conditions may make it impossible to execute your orders at a reasonable price. Strategies using combinations of positions, such as "spread" and "straddle" positions, may be as risky as taking simple "long" or "short" positions. Through our Broker-Assisted or Full-Service account plans, you will have the opportunity to discuss your risk objectives with a futures broker to aid you in determining and meeting your trading needs.
Do options carry less risk than futures?
Not necessarily. If you are considering investing in futures options, you should familiarize yourself with the types of options (puts or calls) and the risks associated with each. You should calculate the extent to which the value of the options must increase for your position to become profitable, taking into account the premium and all transaction costs. You should also understand that certain market conditions (such as lack of liquidity), market rules, or the pricing relationships between the underlying commodity and the option may increase risk.
Do the risks vary between puts and calls?
The purchaser of an option (known as a "long" call or being "long" a put) can do the following with an option position. The purchaser may "exercise" the option if it is profitable, or allow the option to expire if it is not profitable. If the option is on a futures contract, the purchaser will acquire a futures position with associated liabilities for margin if the option expires "In The Money". If a purchased option expires worthless, you will incur a total loss of your investment, which will consist of the option premium plus transaction costs.
Selling, or shorting, an option generally entails considerably greater risk than purchasing options. Although the premium received by the seller is fixed, the seller may sustain a loss well in excess of that amount. The seller will be liable for additional margin to maintain the position if the market moves unfavorably. The seller will also be exposed to the risk that the purchaser will exercise the option, obligating the seller to either settle the option in cash or to acquire and deliver the underlying interest. If the position is "covered" by the seller holding a corresponding position in the underlying interest or a future or another option, the risk of loss may be reduced, but the loss may still exceed the premium received. If the option is not covered, the risk of loss can be unlimited.
A "Before-You-Trade" Checklist
Before you begin to trade commodities, have you...
- Clearly identified your financial goals, including the amount of risk and loss you can sustain?
- Determined how much assistance, if any, you need from a commodities futures broker in making trading decisions?
- Checked the registration status and disciplinary history of the broker you've selected with the National Futures Association?
If you have answered "Yes" to the three questions above, then you are ready start. Click Here to begin the simple process of opening your new futures trading account.
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