What is futures contract leverage?

Futures contract leverage amplifies profit and loss potential by enabling traders to control contract positions larger than their available capital, allowing them to potentially maximize earnings or incur significant losses.

Dec 16, 2024 at 11:27 am

What is Futures Contract Leverage?

Futures contract leverage is a tool that allows traders to multiply their potential profits (and losses) by borrowing capital from the exchange. By using leverage, traders can increase their position size beyond what they would be able to afford with their own capital.

Leverage is expressed as a ratio, such as 10:1 or 20:1. This means that for every $1 of their own capital, the trader can control $10 or $20 worth of futures contracts.

Why use futures contract leverage?

There are several reasons why traders use futures contract leverage:

• To increase potential profits: By using leverage, traders can magnify their potential profits. For example, if a trader has $1,000 of their own capital and uses 10:1 leverage, they can control $10,000 worth of futures contracts. If the price of the underlying asset increases by 1%, the trader will make $100 profit. However, if the price of the underlying asset decreases by 1%, the trader will lose $100.
• To reduce trading costs: Leverage can also be used to reduce trading costs. For example, if a trader is trading a futures contract with a $10 minimum price increment, they would need to have $10,000 of their own capital to trade one contract without leverage. However, with 10:1 leverage, the trader could trade one contract with just $1,000 of their own capital. This would save the trader $9,000 in trading costs.
• To hedge against risk: Leverage can also be used to hedge against risk. If so, a trader can use leverage to reduce their exposure to price fluctuations in the underlying asset. For example, if a trader has a long position in an underlying asset, they can use leverage to create a short position in futures contracts for the same asset. This will reduce the trader's overall exposure to price fluctuations in the underlying asset.

Risks of using futures contract leverage:

There are also several risks associated with using futures contract leverage:

• Increased potential for losses: As mentioned above, leverage can magnify both profits and losses. This means that traders who use leverage should be prepared to lose more money than they originally invested.
• Margin calls: When using leverage, traders are required to maintain a certain amount of margin in their account. If the price of the underlying asset moves against the trader's position, the trader may receive a margin call. This means that they will need to add more money to their account to maintain their position. If the trader fails to meet a margin, call, their position will be liquidated.
• Forced liquidation: In some cases, the exchange may force liquidate the trader's position if the price of the underlying asset moves too far against them. This can happen even if the trader has sufficient margin in their account.