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TRADER'S NOTEBOOK


The Ever So Fashionable Mini Contracts

03/10/10 09:23:20 AM PST
by John Devcic

Mini maybe, but its benefits boom!

Many investors are interested in trading futures contracts. However, their efforts can be quickly discouraged by the difficulties in understanding futures. The lack of available quotes and the steep price needed for margin on these contracts can turn you off. While the markets have tried their best to make investing in futures easier by giving you the ability to buy exchange traded funds (ETFs) or invest in hedge funds, neither is the same as directly investing in futures. If you have been interested in adding futures and commodity contracts to your portfolio but not gotten involved for various reasons, this is the time.

Enter the mini contract. The mini contract was designed for the beginning futures and commodities investor but has up to now been left standing in the sidelines because most investors know little about them. So what are these mini contracts? How do they work? This article will answer all those questions that traders unfamiliar with the minis need answered.

WHAT ARE MINIS?
Mini contracts are not new; they have been trading for a long time. From 1868 to 2003, the MidAmerican Commodities Exchange was trading contracts that were a fifth the size of standard commodities contracts. The contracts were smaller, making trading more accessible for inexperienced traders as well as traders without a lot of cash to risk. The MidAm had contracts on corn, wheat, oats, soybeans, live cattle, live hogs, silver, gold, and platinum. In 2003, the MidAm contracts were absorbed into the Chicago Board of Trade and renamed CBOT mini contracts.

The current minis or mini contracts are a smaller version of the original contracts. A mini contract can range anywhere from a third or a fifth in size to as small as a tenth the size of a regular futures or commodity contract. The mini contract will move in step with the original contract from which it is derived.

For example, let's look at the current specifications for a corn contract. The contract size is for 5,000 bushels. The minimum tick is $12.50 per contract. This is the minimum move per trade either up or down. Margin requirements are as follows:

  • Initial margin is $1,350
  • Maintenance margin is $1,000.

A quick review margin is earnest money that must be put down in order to control the contract. It is not, however, to be confused with a down payment. Maintenance margin is simply the minimum amount of money in an account in order to keep the trade open. You may have heard the term margin call, and that means a trader will have to deposit more money into his account in order to return the balance to the maintenance margin level. If a trader does not meet margin call, the open trade will be closed, all proceeds will be kept, and a balance will be owed.

Getting back to our example of corn, both the initial and maintenance margin requirements are steep for new investors just starting out. This is exactly where the mini corn contract comes in very handy. The mini corn contract is only for 1,000 bushels with a tick size of $1.25 per contract. Initial margin is $270 and a maintenance margin of $200. Prices are far more favorable for a new trader.

IS THE MINI RIGHT FOR ME?
A mini contract can be a very good idea if you are looking to get into the futures and commodities market but do not have the experience or, more important, the funds to get started. Many new traders and investors looking to enter the futures market consider trading mini contracts as the first step. You must also remember that while the profits are lower, so is the risk. The biggest problem new traders have with futures and commodity contracts are the risks involved. The likelihood of a trade going from profitable to receiving a margin call can happen quickly.

Mini contracts are becoming more popular every day. Brokerage firms are gaining customers who are interested in trading the mini contracts because they want to trade commodities as well as futures contracts but cannot meet the initial margin levels set for the regular-sized contracts. Many futures brokers who once shied away from new inexperienced futures traders are now embracing them.

KEEP IN MIND

  • The biggest advantage of mini contracts is simply their size or lack thereof. Their small size means that a beginner trader or a trader without a lot of capital will still be able to make profits from these markets without needing to place large margin deposits to get started.
  • Mini contracts are tied to their bigger brothers. Because mini contracts are so closely related to the regular-sized contracts, they will move in the same direction as the original contract. This means that an investor who wants to trade corn, for example, but does not have the funds necessary to buy a regular contract can do so with the mini contract and still profit from the move.
  • You can learn money management strategies. Trading mini contracts will enable you to become familiar with position sizes as well as true money management without having to learn about them first on the regular-sized contracts.
  • Mini contracts are less profitable. The biggest complaint about them is that they will not have the same profits as their bigger brothers. Since they have smaller initial and maintenance margins as well as smaller tick sizes, it translates into smaller losses as well as smaller gains. True, you will not be profiting the same way from a move as you would if you traded the regular contract, but the smaller risk makes up for that.
  • Liquidity. Like all securities that can be traded, it is important to keep an eye on the volume of trades. Some mini contracts will not be as liquid as the regular-sized contracts. Each mini contract is different and you need to look at this before deciding to trade one. Look at the liquidity level over time and compare the mini contract's liquidity level to the level of the regular-sized contract. If there is a large gap in liquidity, you are going to have to trade that mini contract with caution.

GETTING STARTED
In order to begin trading mini contracts, you will need to find a broker. You can look for a new broker who specializes in trading futures, or there is a good chance that your current broker will allow you to trade futures as well. Each broker will set a minimum deposit for opening a futures account so you need to keep an eye on that. You will also need to look at any fees that might be charged on top of what the commission normally would be.

Fees are charged on a per-contract/per-side rate. That means a commission will be charged when you buy the contract as well as sell the contract. Do not expect that just because you are trading the mini contracts, the commission will also be smaller. In many cases, the broker will charge you the same commission rates for mini contracts as they do for the standard contracts. One of the other features you may want to look for in a broker is education. A lot of brokers are adding education to their sites. These links will feature live webinars as well as articles aimed at the inexperienced trader. Many will allow you to open an account and practice trading with a fake account till you are ready to place actual money in the account. This practice account, however, will give you all of the features given to a regular account holder.

If you are planning on starting with a practice account, try to trade the number of contracts you actually will be trading when you finally fund your account. Having a practice account for $50,000 is nice, but it's not a realistic account size for a new trader just learning how to trade the mini contracts. Have a rough idea of how much you will have available to fund your account and stick to trading the number of contracts that will meet that level. It is a very good idea to keep track of commissions.

Many traders are surprised how quickly commissions can eat into a winning trade once you start trading in a real account. While the size might be mini, the benefits of trading mini contracts are far from small. For contract specifications and other details, visit the education section at www.cmegroup.com.

SUGGESTED READING
Devcic, John [2010]. "Choosing The Right Hardware," Technical Analysis of STOCKS & COMMODITIES, Volume 28: March.
_____ [2009]. "Leveraged ETFs," Technical Analysis of STOCKS & COMMODITIES, Volume 27: December.
_____ [2009]. "Get Shorty," Technical Analysis of STOCKS & COMMODITIES, Volume 27: November.



John Devcic

John Devcic is a market historian and freelance writer. He may be reached at drmorgus@gmail.com

E-mail address: drmorgus@gmail.com


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