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Gitanshu,
Thank you for your further explanation. I would like to add that in all of
our trading (futures and equities) we trade with no stops, so we really let
it all hang out, so to speak. Since you're not using much if any leverage
trading stocks this doesn't make much difference. With futures, it can get
a little nasty.
With S&P futures trading, our maximum available leverage is 16:1 based upon
the minimum initial margin required by our broker. Keeping a substantial
portion of our capital in government bonds (which can be used as margin, by
the way), and working with our 33% investment factor, our actual leverage is
5.3:1. We originally traded at an 8:1 ratio, but that appears to be
excessive, when applied to our numbers.
When comparing this to stock trading, the leverage is greater, but so is the
risk as you so succinctly put it.
Guy
Paranoia...you only have to be right once to make it all worthwhile!
-----Original Message-----
From: owner-metastock@xxxxxxxxxxxxx [mailto:owner-metastock@xxxxxxxxxxxxx]On
Behalf Of Gitanshu Buch
Sent: Monday, July 10, 2000 9:24 PM
To: metastock@xxxxxxxxxxxxx
Subject: RE: Risk of ruin, amount per trade formula?
Mark, here's a clarification - the difference in stocks and futures margin
is this:
The leverage in stocks is 2:1 if you use 100% of the margin that your broker
will give you.
The leverage in futures is 100:1 or 80:1 etc, depending on which market one
trades.
The "1" in each case is upfront capital to get into the trade.
So let us say you have $10,000 in your account.
- you could buy 100 shares of Goldman at $100, and pay for all of it with
the cash in your account (ie you would be left with zero cash and an asset
currently worth $10,000).
- if you buy 100 shares of Goldman at $100, you could put up $5,000 to
control $10,000 worth of asset - the point of your maximum leverage in the
margin account that your broker allows you to operate.
- if you buy 1 at the money call on Goldman, you put up $500 as the call's
premium, but still control ownership rights to $10,000 worth of asset. On
judgment day, you choose between exercising your right or giving it up (as
in booking a profit on whatever that right is at that judgment time).
- if you buy 1 future on Goldman, you put up $10 but control the same
$10,000 worth of asset.
In each case, the % move in Goldman will be a function of how many % it
moves from $100 per share it is today.
The impact is as follows, say Goldman rises 4%
- Long stock, no margin: Profit of $400. Return on investment of $10,000 =
4%
- Long stock, all margin: Profit of $400, Return on investment of $5,000 =
8%
- Long call: Profit of $200, Return on investment of $500 = 40%
- Long future: Profit of $400, Return on investment of $10 = 4000%.
The greater the leverage, the more telescopic your ROI. Hence the temptation
is to max out the account with the max leverage possible. In other words,
you can only really control $10,000 worth of Goldman, but you buy 1,000
contracts to take future delivery for which you pay $10 today (and use up
all your $10,000 today, but tell yourself that you will liquidate all of it
before expiration day).
When Guy refers to x% of account exposed to his E-mini trades, he means he's
got $10 chips to the extent of x% of his account - but that x% of his
account actually controls assets worth 5 or 6 times what 100% of his account
can pay for.
Of course, he could make x = 100% of his account - just as you could buy
$10,000 worth of $10 futures.
But these telescopes work 2 ways: In your favor and against you.
If Goldman falls 4%:
- Long stock, no margin: Loss = $400, ROI = -4%
- Long stock, on margin: ROI = -8%
- Long call, worthless: ROI = -100%
- Long future, ROI = -4000%.
He - and most futures traders who hang around long enough - choose to use x
= 20% to 35% with the rest in t-bills - SINCE they don't want to take a
chance that if they're wrong and they can't square off the trade, they won't
end up selling the house, car, diamonds etc to pay for the -4000%.
Now:
THis is not the same concept as your understanding:
>So if I understand this correctly, translated to stocks if one risks a
>maximum of 3% on each trade (using a hard stop) and trades 11 trades at a
>time then the maximum exposure it 33%. Is this comparable?
When you risk 3% on a stock trade, you stop yourself out if Goldman trades
$97.
But apply the above equations if you were
- using margin
- using calls
- using futures.
And what price level would you stop yourself out at in each instrument?
Thus, on a single trade the max exposure is reached very fast if it is a
directional trades using futures.
Thus, the amount of % in the underlying moving against you balances against
how much $10 worth of futures you've levered. If it is one contract, you can
pay the entire $400 and you're left with $9,590 to come back and play the
next day. If it is 1,000 contracts....
Gitanshu
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