Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
WHAT SHOULD WE BE LOOKING FOR?
The new year is the time in which many traders rethink their strategy and circumstances. What are some pointers on what we should be looking for in a futures and options broker?
First, let me disclose that I have been a registered commodity broker for what will be six years in March 2010, so there is likely some bias to my opinion. Nonetheless, I have witnessed all aspects of the trading and brokerage business and believe I have some helpful comments to make in regards to this topic.
Despite the fact that I make my living through commission, I acknowledge that transaction costs are baggage to trading results. All else being equal, the more that you pay in commission the less profit, or the more loss you will see in your bottom line. That said, for many traders, all else is not equal. I can sum up my overall premise in one rejoinder: “If you think that paying commission is expensive, try getting what you pay for.”
Choosing a brokerage firm and a service level can be as important to determining profit and loss as market timing and strategy. Ideally, traders are looking for the best possible service based on their needs with the most reasonable price tag. If you are a trader experienced in trading futures and options, need little or no peripheral guidance or services, and are well capitalized, feel free to shop around for the lowest rates. There is no reason for you to pay for services you won’t be using.
On the other hand, those who are less experienced are better off being honest with themselves by choosing a brokerage firm capable of shortening the learning curve at a fair commission rate. Commission is an investment rather than an expense if paid to the right broker and under the right circumstances.
Conversely, value diminishes as commission rates increase beyond a certain point. For instance, don’t expect magical guidance and education from a broker charging $100 per round turn (yes, there are still some out there). In fact, many firms that charge excessive commissions don’t expect you to trade again. Their goal is to generate as much in transaction fees as possible the first time around.
On the other end of the spectrum, if you are paying a firm $0.99 per side to clear your trades, you are going to get exactly what you are paying for — next to nothing. If you choose this type of service level, you had better be self-sufficient and well-funded.
There are a few key points that traders should consider when choosing a brokerage firm:
- Accessibility of knowledge Unless you are a professional requiring absolutely no secondary assistance, you should be trading with a firm that has a knowledgeable brokerage staff — in other words, a licensed and experienced brokerage staff who can answer your questions, provide market guidance, and/or execute your orders in a timely and efficient manner. There are firms that offer quality service at competitive rates; access to knowledge doesn’t have to be overly pricey. Remember, misjudgments or market mistakes can be far more expensive than a few incremental dollars in commission.
- Margin handling Firms that charge deep-discount commissions make less revenue per trade executed by their clients but in return they expect absolute margin obedience and cannot afford to manage risk exposure with anything but a heavy hand. For instance, many firms charge incredibly low commission rates and offer daytrading margins in the e-mini S&P near $500 per contract. However, what many don’t realize is that the firm will allow you to put the trade on with an account size of $550, but once it dips below the $500 threshold, it is likely that risk management will force-liquidate open positions.
- Similarly, many of the firms that specialize in low commissions fail to have the ability to monitor and react to drawdowns in short option trading accounts. I have spoken to clients of discount trading firms who experienced force-liquidated short options without notice and prior to a margin call being triggered or without the account being in any immediate danger of going negative, losing more funds than on deposit.
- Premature or unnecessary liquidation of positions might cause hundreds or thousands of dollars in damage to a trading account. In some cases, for just a dollar or two more in commission, the firm will make an effort to work with you to alleviate margin issues rather than tinker with your trades without your consent. Keep in mind that brokerage firms have every right to force-liquidate accounts that are undermargined, especially if the account is at risk of losing more than is on deposit; however, extra coddling in this area can go a long way.
- Access to products Many firms operating as a broker/dealer that handle both equity and futures products have limited access to the futures and option markets. Simply, you might not be able to trade all products with such a firm. Typically, these firms only have access to the electronic versions of a contract and not open outcry.
If you are a trader who would like to participate in an option spread strategy, it is important that your brokerage firm have the means to execute trades in an open outcry environment. In addition, there are times in which event risk is high, causing market makers in the electronic options on futures to run for the sidelines. During times like this, the online bids and asks can be wide, and having access to execute through an alternative method can make a large difference in your ability to navigate the markets. It might be far more expensive to pay the consequences for a lack of access to proper execution than paying incrementally more in commission to a brokerage with the ability to trade in all venues. Remember, there is substantial risk in trading options and futures. It is not suitable for everyone.