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On 21 January everything changed for traders. In just one day, a variety of factors combined to send global equity markets into a tailspin. Helen Castell takes heart that big money can be made from the market swings

On a typical day, the FTSE 100 tends to move in a range of around 50 to 100 points. Since the market mayhem of 21 January, daily gyrations have widened out to 200 points and upwards. But good volatility is a pre-requisite for making money. And futures can be one of the best ways of riding the rollercoaster.

‘We’ve certainly seen our futures business increase over the past month, both over the telephone and through our online platform SMART,’ says Mark Greenaway, Head of Private Client Services at Sucden. ‘Volatile markets obviously mean there’s a lot of money to be made there. The flip side of the coin is that if you get it wrong there’s a lot of money to be lost.’

‘When you have volatility – providing it’s not excessive – it’s a fairly conducive environment for people like us to be in,’ agrees Richard Cunningham, Managing Director at City Index Advisory. ‘When it gets very extreme, it becomes difficult to actually manage the positions – to get in and out, but we prefer it to be volatile than not.’

Futures are a good-value strategy, with brokers typically charging £5 to £10 per trade, says Cunningham. One limitation is their set contract sizes (generally £10), but prices are dictated by the market rather than book makers, making them very clear and easy to follow. Futures contracts are also traded through an exchange, giving investors worried about broker balance sheets added peace of mind.

It can be hard for the retail investor to second guess when a market has reached its bottom – especially as profit taking after heavy falls can create an unexpected bounce, notes Robert Gray, head of institutional UK at Saxo Bank. One way to manage this risk is via buy or sell stops, says E*Trade. One of the beauties of using futures is that ‘you can put in your stop and your market limit orders, so you can come in and out of the market at your pre-defined entry and exit points.’

Sadly, not enough investors are in on the trick, says Sandy Jadeja, Chief Market Strategist at ODL Securities. ‘Traditionally, the best way to ride the market is using futures,’ he says. But ‘at the moment a lot of people are missing out on the advantage of using futures to capture the short moves.’

If an investor has a view that the market is likely to fall they could short the FTSE but place a sell stop one point below the previous week’s market low, and a stop just above its high, he advises. Short-term traders could likewise place them at the previous day’s high or low.

‘So without getting caught up emotionally in the market, technically the markets will be able to get the investor in and out using a very simple instrument,’ Jadeja says.

If, for example the difference between the low and high was 100 points, and the minimum futures contract was £10 per tick, this would give them £1,000 risk. ‘If they think they can handle that they should go ahead with that order. If investors had assumed such a position they would easily have been able to capture the downside moves, and the volatility and the suddenness of the moves would have been in their favour.’

Straddles

By using ‘straddles’ – buying a call and a put, both with the same strike price – investors can hedge against big upward or downward moves, and will actually make more money the more volatile the market becomes. As long as the market moves a long way away from the strike price, ‘your call or your put will expire worthless and you won’t exercise it – but the other call or put will be worth quite a lot of money,’ Gray says.

If, for example, the FTSE was trading at 5650, an investor could buy a put and a call, each with a strike set at 5700. ‘If the market disappears down to 5300 your puts are worth an absolute fortune and your calls aren’t worth anything. The only way you would lose money is if the market stayed exactly where it was – your options would gradually lose money over time.’ But with buying options, ‘at least you know how much money you’re going to lose,’ he adds.

‘Options are fantastic – you can make some really good, quick, short-term returns,’ agrees ODL’s Jadeja. However, they’re also much more complex. ‘With futures, the first thing you need to figure out is direction. The second thing you need to figure out is what your entry levels are,’ he explains. ‘With options you need to figure out both which month to trade on, which strike price you’d like to use – and of course which one is offering the most volatility as well. So there are more decision processes required.’

Investing in options requires foresight, City Index’s Cunningham argues. ‘If you had been buying put options on the FTSE in December, when volatility was not that high … you would have made a fortune in January. But now you’ve had the movement, options are quite expensive, so a strategy that tends to try and sell the options premium, even in volatile markets, is actually one that tends to work better. If you were to buy a call and a put right now at say 5800 on the FTSE, you could pay a lot of money on that, and you’d have to have the index move by 300 points plus for one of those options to gain in value enough to offset the cost of the other,’ he says.

For the investor who just got even more confused, managed futures programmes could be a good way to get a futures fix. ‘There’s a big argument for having professionals doing it for you,’ Cunningham says. Retail investors tend not to appreciate just how quickly these markets can move. City Index’s CARMA Managed Futures Account is open to private and professional investors with some experience in derivative-type products such as CFDs, spread bets and futures. With a minimum investment of ?50,000 or sterling equivalent, it can also be accessed through an investor’s Sipp.

In high volatility, City Index’s traders still aim to make clients money, but will tend to trade smaller position sizes, he says. ‘We’re aware these are fairly unprecedented conditions. They will calm down, they will return to normal – but in this environment the safe trade is not to do too much.’

One thing brokers do agree on is that volatility is with us for the medium term – meaning there’s still time to brush up on your futures theory, get that account opened, and start trading.

Just like the aftershocks from a volcano, ‘what tends to happen is you have this explosion of volatility that then gets followed by a period of slightly less volatility,’ says Cunningham. ‘I don’t think we’ll see the kind of daily movements combined that we saw on 21 and 22 January for a while ... [but] volatility will stay strong.’