RE: [RT] Commodities, especially live cattle, RealTraders Email List Archive

-----Original Message-----
From: Trey Johnson [mailto:dickjohnson3@xxxxxxxxxxxxxx]
Sent: Friday, November 19, 2004 9:42 AM
To: realtraders@xxxxxxxxxxxxxxx
Subject: RE: [RT] Commodities, especially live cattle

Hello Andrew,

You mean there's another reason that driving is risky? Isn't that why people buy car insurance? Futures trading is most certainly riskier than stocks, theoretically.

NW: Why do you think futures are more risky than stocks? If you equalize the leverage, on average, most commodities are less volatile than the average stock. Have you ever seen a commodity lose 50% of its value in one day or become worthless in a few days? I have seen many stocks do that.

TJ: Yes, if equalize the leverage. But isn't leverage one of the main attraction to futures? If you equalize it away, isn't that defeating the purpose? My point was that leverage increases risk. I haven't seen a commodity like cattle become worthless in a few days, but that doesn't mean that it can't happen. However, I have seen countries default on their bonds and devalue their currencies. Happened quite a bit in the 1990s.

First, futures trading is a zero sum game.

Stocks are also a zero sum game.

TJ: Admittedly, I've struggled with this one and it seems there's no clear cut answer. Is it possible that stock trading is zero sum, but that stock investing is positive sum? I definitely understand how futures is zero sum, in the absence of transaction costs, because for every buyer there is a seller and they off-set each other. There doesn't appear to be any creation of wealth, just wealth transfer. However, with stocks and stock markets in general there at least appears to be actual wealth creation. Would you mind elaborating some more on this?

Secondly, futures have expiration dates. You never have to worry about taking delivery of live cattle when trading stocks.

NW: Only about 1% of all futures are ever used for delivery. This is a red herring argument.

TJ: What's a red herring argument?

Thirdly, it's a mathematical fact that leverage increases risk. If you have an account fully invested at a leverage of 10 to 1, then a 10% move against you in the underlying wipes you out. They same account trading with no leverage would require a 100% move against you to wipe you out. From a probability standpoint, which is more likely to happen, a 10% move or a 100% move? Please correct me if I'm wrong with my math here as certainly wouldn't be the first time. Of course, someone trading the leveraged account would compensate for the increased risk by trading fewer contracts. In stocks, most people don't trade with leverage. If they do, it's by choice. Plus, they must get approval and there are limits to the amount of margin. However, in futures everyone is leveraged. Therefore, futures trading, from a leverage stand point is most certainly more risky than non-leveraged stock trading.

NW: You are wrong. The leverage offered in futures is optional. No one is making you get fully margined. Comparing futures to stocks by using the fully margined futures example is like comparing apples to oranges. If you want to make a fair comparison, use the same amount of margin for each.

Remember, the risk of loss for futures and stocks is substantial.

TJ: When I said 'everyone is leveraged in futures' I didn't mean that everyone is fully leveraged. Right after I said correct me if I'm wrong with the math, I said that someone trading the leveraged account wouldn't trade at full leverage because of the increased risk, meaning the risk associated with the leverage. I meant that everyone is margined which involves an amount of leverage that you can't get in stocks. I guess that not everyone is margined. Can you buy an entire contract for the face value prior to expiration or delivery, as opposed to buying on margin? I've never considered it because it's never been a concern of mine. What would be the purpose?

Thanks,

Trey