Some investors are always on the lookout for daredevil investments. If you want a big roller-coaster ride in your portfolio every day, you can't beat futures for the excitement factor.
But excitement doesn't make something a good investment. Sure, investing in futures can be quite lucrative when you're right. But if you don't know what you're doing and act like a bigwig professional trader without knowing just how big the risks involved are, you can easily find yourself way over your head -- and potentially facing losses way higher than your original investment.
Back to the future
It wasn't so long ago that small investors couldn't have dreamed about having access to trading futures contracts. In the past, most discount brokers only let you trade stocks. Your main alternative was buying mutual funds, typically in an account directly with the mutual fund company in question.
Now, though, things have changed a lot. Discount brokers let their customers invest in lots of things other than stocks. You can buy individual bond issues for particular companies. Mutual fund supermarkets let you have a host of funds from different fund companies all under the same brokerage-account umbrella. And even more exotic investments like options, currency trading, and futures contracts are available to the rank-and-file investor. Several brokers, including Interactive Brokers (Nasdaq: IBKR ) , E*TRADE Financial (Nasdaq: ETFC ) , and optionsXpress, offer futures trading directly. TD Ameritrade (Nasdaq: AMTD ) offers futures through its recent acquisition of thinkorswim, while Charles Schwab maintains a relationship with futures broker Lind Waldock.
So what's the deal?
Futures have gotten popular because of the rising importance of commodities as an asset class. The primary appeal of futures contracts is the leverage that they give investors. For instance, if you want to buy 100 ounces of gold, it'll cost you more than $130,000. But to buy a futures contract that controls 100 ounces of gold, you have to put up less than $6,000 to meet margin requirements.
The availability of leverage can greatly magnify your profits. Again using gold as an example, if the price of gold rises $60 an ounce, then that translates to a gain of between 4% and 5% if you invest in bullion. But with a 100-ounce futures contract, that move would more than double your money on the amount you initially deposited.
That benefit, though, is also the danger of futures trading. The same way that a small move up can make you huge profits, a small move down can completely wipe you out. Reversing the illustration above, all it would take is a move in gold back to $1,250 or so to completely exhaust your initial margin. If you wanted to keep your futures contract, you'd have to put up more money as a maintenance margin or else face having your broker liquidate your contract involuntarily.
The safer alternative
The other downside of futures trading is that you're up against professionals whose specific job it is to know everything there is to know about a given commodity. And while investors who buy stocks often face the same gap in expertise, the limited time frame that futures contracts offer prevent you from taking a long-term perspective with your investment.
If you want to add commodities to your portfolio but never want to face a margin call, you have a number of choices. Exchange-traded funds exist for pretty much any commodity you would want, from SPDR Gold Trust (NYSE: GLD ) for those looking specifically at gold, to the broader iShares S&P GSCI Commodity-Indexed Trust (NYSE: GSG ) , which includes energy, agriculture, livestock, and base and precious metals exposure.
Alternatively, you can simply buy companies that produce the commodities in question. Many see silver-streamer Silver Wheaton (NYSE: SLW ) , for instance, as a way to benefit from higher silver prices that offers potentially larger profits than simply buying silver bullion. Share prices of natural gas giant Chesapeake Energy (NYSE: CHK ) tends to rise and fall fairly closely along with gas prices.
Protect your future
Just because your broker offers a product doesn't mean you should take advantage of it. Futures are a fascinating market, but trading futures isn't something to do as a hobby.
There are still cheap stocks out there. Matt Koppenheffer has found five stocks with single-digit multiples.