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Futures Are Less Volatile Than Stocks

Futures Are Less Volatile Than Stocks

Most people are convinced that futures are more volatile than stocks; however, the facts belie this notion. Random comparisons over a 5-year, 10-year, 15-year, and 17-year period readily reveal that the percentage changes in the Russell 2000® Index and the Value Line® Index are greater by far than the changes in the Dow Jones-AIG Commodity® Index. The following table illustrates the point:

Price Volatility *
DOW Jones AIG Commodity® Index†
Russel 2000® Index†
Value Line® Index†
12/90
100.00
132.20
241.52
12/95
129.91
315.97
569.91
12/00
184.92
483.53
1124.77
12/05
307.65
673.22
1916.74
12/07
360.13
765.64
2248.66
Change
260.13
633.44
2007.14
% Change
360.13%
579.15%
931.05%
* Data from www.djindexes, http://finance.yahoo.com, http://www.kcbt.com
† The Russel 2000® and Value Line® Index are indexes of stock market activity, while the DOW Jones-AIG Commodity® Index measures activity in the futures markets

Between December 1990 and December 2007, the Russell 2000® Index rose 579.15% and the Value Line® Index rose 931.05%, while the The stock market
was 2 to 7 times more
volatile than the
commodities market.
Dow Jones-AIG Commodity® Index rose only 360.13%. That is, the stock market was 2 to 7 times more volatile than the commodities market.

So why do many people believe futures are more volatile than securities? Because of the leverage employed in the futures markets. Securities require a margin deposit of 50%, while futures contracts typically require only a 5–10% margin deposit. In addition, the 50% of the securities transaction not paid by the customer is paid by the broker with interest charged to the customer on the borrowed funds. In the futures markets, the margin is an earnest money deposit, with no funds borrowed from the broker. In other words, the customer is liable for the entire contract value.

Because of the lower margin requirements for futures, there is greater leverage in the futures markets than in the securities markets. In short, the lower margin/higher leverage multiplies the effect of the existing price volatility. For example, $1,000 of futures margin could purchase a contract worth $15,000. If the value of the contract rises to $15,500, that’s a 3.33% rise in the contract value, but it’s a 50% increase in margin. A small change in the value of the total contract translates into a large percentage gain on the margin deposited.

In conclusion, futures prices are actually less volatile than securities prices; however, the leverage stemming from lower margin requirements magnifies what volatility there is. Convinced?

© 2007 CreativeBusinesses.com, Inc.


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