Using Futures and Options to Take a View of a Market

For years, investors have been diversifying their portfolios among multiple investment vehicles, including cash, stocks in several industries, bonds, mutual funds and perhaps even some real estate, varying their risk in the process. Asset allocation divides assets among major categories in order to create diversification and balance risk. Futures and options add diversification, as well. As with any other piece of a portfolio, investors will use disposable income to take a view of a particular market.

Carol Dannenhauer, director of managed accounts for retail broker Lind-Waldock, Chicago, thinks managed futures can offer investors a new dimension for one simple reason. Theres a relatively low correlation between the performance of futures and stock prices or interest rates, and thats interesting for larger net worth investors who may not have the time or interest in learning how to trade futures themselves, she says. Investors are used to managed money through mutual funds, and managed futures simply offer them another type of diversification in a different asset class.

Managed futures come in various flavors. Some funds monitor 30 different markets worldwide while others concentrate in a particular area like grains, metals or financial products. If a client has a feel for movement in energy products, each of which may move slightly differently, he may pick a fund that comprises a number of those products.

Dannenhauer says its difficult to offer a general rule of thumb regarding what portion of a portfolio should be in futures, and several factors need consideration. A fairly conservative bond and blue-chip stock portfolio could potentially handle a larger portion in managed futures, she offers. But a portfolio with a larger concentration in start-up companies, joint ventures or speculative real estate might more realistically be able to incorporate a smaller portion. We help clients analyze their overall risk tolerance and interests to help them make prudent decisions and find the right managed program.

Though risk avoidance is a critical function of futures, there are individuals who are interested in embracing risk as a way to diversify, says Russell R. Wasendorf, Sr. PFGBEST.com. Just because they embrace risk doesnt mean that they have entirely different principles from those who want to avoid it. In both situations, people must be very well aware of the markets that they are getting into and do a good job of analyzing the fundamentals. Its critically important for both sides to exist.