Trading Futures for Less Margin

One of the numerous ways to make trading more accessible for yourself is the ability to trade what is known as a synthetic futures position. It's when you purchase a call and a put in such a manner as to give yourself the ability to have unlimited upside opportunity, but the downside is you also expose yourself to downside risk. But the overall benefit is not having to put up the same hefty margin as if you were trading the futures.

The components required to establish a long synthetic futures contract are the purchase of a call option and the sale of a put option of the exact same price. That call gives you access to unlimited profit potential, but the sold put opens you up to unlimited loss on the downside. This strategy works best when you buy and sell both options at-the-money; you can collect the maximum amount of premium.

Example 1: Synthetic Long Futures Position

You first select a "Strike Price", in this instance it will be 1350. You buy a "call" and you then sell a "put". The net cost to you in premium is only $725. This is a far cry from the futures margin of $22,500. It doesn't even compare to the net premium expense of $725. This is like night and day.

This is a huge difference in price, $21,775 to be exact. But the trade can't be left naked. It has to treated and protected just like a naked position. Either you can use an option as a hard stop or you can create a collar on the position.

Based on this example for $3,000 to $4,000, a slightly out-of-the-money protective put can be purchased at 1345. This would make the maximum loss of the sold put limited to 5 points. This protective measure also has the potential to encourage your FCM or brokerage to minimize their restrictions on your selling options.

So for a total of $4,725 you are trading the value of a full-sized S&P 500 contract, with risk management protection-the same margin price that an Emini S&P contract would cost without any risk management in place.

This contract is still a futures contract, though, so you do end up picking a side, long or short. If the market doesn't move in that direction, you will lose value in your premium. Therefore you must watch the values of the various premiums, and if the market is moving against your position, simply exit the position entirely.

Synthetic Futures Short Position

A short synthetic futures position is simply a mirror of a long synthetic futures position. An at-the-money put is purchased and an at-the-money call is sold. This opens the door for unlimited profits if the market drops in value, but it also allows for unlimited loss if the market moves towards the upside. The actions to protect the synthetic short position are the same as a normal short position. Purchase a call to protect you from upside risk or use a collar. Any other form of risk management can be used, but may also be too complicated to keep track of.

The Brent light sweet crude oil contract is another great commodity to use a synthetic position with. The Brent light sweet crude oil futures contract margin is $12,488 (see table).

Example 2: Synthetic Short Futures Position

In this instance we pick the same strike price again, $138, for both the put and the call. The net premium expense is $930.

There is no comparison in value for your investment. The actual contract is valued at $12,488 and the synthetic is only $930. Another $2,000 (estimate based on the example prices) spent on a protective option position would still only set a speculator back by $2,930. The mini crude oil contract has a margin of $6,244. The amount of capital committed is half of the mini contract and you are still gaining value in your position at the full contract rate.

In these two examples we can see the value of synthetics when it comes to margin requirements, but you still need to be cautious and cover your downside risk.

Noble DraKoln is founder of Speculator Academy, http://www.speculatoracademy.com. After becoming a licensed broker at the age of nineteen, he has gone on to author seven trading books. He is a former editor of Futures Magazine, regular contributor to Forbes, has been a featured guest on numerous financial channels, and is a sought after consultant speaker in the futures, forex, and options world. Needless to say his twenty-one years in the industry have been well spent.

He is also the author of the books Trade Like a Pro, Winning the Trading Game, published by Wiley and Sons, and the author of four book "Small Speculators Series".

His books have been translated into German, Romanian, and is currently being translated into Chinese, Korean, and Spanish.

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