BEYOND THE CHART · CHAPTER 06
Futures, ETFs & Leveraged Products
The learner can explain what a futures contract is, describe expiration and settlement, understand how futures differ from spot positions, explain ETF structure, describe inverse and leveraged ETFs, recognise the effects of daily resetting and compounding, identify tracking differences, and compare instrument-specific risks. The chapter remains educational and does not recommend any product or trading approach.
A futures contract is a standardised agreement
Define futures.
A futures contract is a standardised agreement to buy or sell a specified asset at a predetermined price on a specified future date. Contracts are traded on exchanges and have standard sizes, expirations and settlement terms. The asset may be a commodity, index, currency or financial instrument.
Long and short futures positions
Compare long and short futures exposure.
A long futures position profits if the contract’s price rises and loses if it falls. A short futures position profits if the price falls and loses if it rises. Because futures are leveraged, gains and losses can be much larger than the initial margin posted.
Futures margin is performance collateral, not a down payment
Explain futures margin.
Futures margin is a performance bond posted to cover potential losses. Unlike stock margin, it is not borrowed money or a partial payment. Initial margin is required to open a position; maintenance margin is required to keep it open. Futures margin allows leveraged exposure but magnifies both gains and losses.
Daily settlement and variation margin
Understand mark-to-market.
Futures accounts are marked to market daily. Gains and losses are settled each day, and variation margin may be required. This daily settlement means account equity changes continuously with the contract price, rather than only at expiration.
Expiry and settlement
Explain futures expiration and settlement.
Each futures contract has an expiration date, after which it settles. Settlement may be physical, where the underlying asset is delivered, or cash, where a final price difference is paid. Traders who do not want settlement must close or roll the position before expiration.
Contango and backwardation affect carry
Introduce term structure risk.
Futures prices for different expiration months may be higher or lower than the spot price. Contango is when later contracts are more expensive; backwardation is when later contracts are cheaper. For positions rolled over time, these differences can create a cost or benefit, particularly in commodity and volatility products.
ETFs are baskets, not single stocks
Explain ETF structure.
An exchange-traded fund, or ETF, is a pooled investment that usually holds a basket of assets, such as stocks or bonds. ETFs trade on exchanges like stocks, with shares created and redeemed by authorised participants. The market price can differ slightly from the net asset value.
ETF market price and net asset value can differ
Understand premiums and discounts.
An ETF has a net asset value, or NAV, based on the value of its holdings, and a market price determined by exchange trading. The two can differ, especially in volatile or illiquid markets. A premium means the market price is above NAV; a discount means below.
Inverse ETFs seek daily opposite returns
Explain inverse ETFs.
An inverse ETF is designed to move opposite to the daily return of its benchmark. It uses derivatives and other instruments to achieve that objective. The inverse relationship is usually reset daily, meaning performance over longer periods can differ significantly from negative one times the benchmark’s longer-term return.
Leveraged ETFs target daily multiples
Explain leveraged ETFs.
A leveraged ETF seeks to deliver a multiple of its benchmark’s daily return, such as 2x or 3x. The multiple applies to the daily return and is reset daily. Over longer periods, compounding can make the result different from the simple multiple of the benchmark’s total return.
Daily resetting and compounding drift
Explain why leveraged and inverse ETFs can diverge over time.
Because leveraged and inverse ETFs reset exposure daily, their performance over weeks or months depends on the sequence of daily returns, not only the total return of the benchmark. In volatile markets, this can produce returns that are worse, or sometimes better, than a simple multiple of the benchmark’s total return.
Instrument-specific risks and theory boundaries
Compare risks across futures, ETFs and leveraged products.
Futures carry leverage, margin, daily settlement and roll risk. ETFs carry premium/discount risk, tracking error, fees and liquidity risk. Leveraged and inverse ETFs carry daily reset risk, compounding drift and the possibility of large losses in volatile markets. This content explains mechanics; it does not recommend any product.