What is a futures and options fund?
A futures and options fund (note 1) generally refers to a fund that seeks to achieve capital appreciation primarily through investment in futures contracts and options.
Futures contracts are exchange-traded derivative instruments and represent commitments to buy or sell a predefined amount of the underlying asset at a predetermined price on a specified future date.
On the other hand, options are contracts that enable the buyers to have the right, but not the obligation, to buy according to a "call" option from, or to sell according to a "put" option to the sellers a predefined amount of the underlying asset at a predetermined price during a specified future period.
There is a wide range of assets underlying futures contracts and options, including commodities (such as agricultural products and precious metals), currencies, interest rates and equity/other indices.
Futures contracts and options are leveraged instruments (i.e. both gains and losses are magnified), so even if a futures and options fund invests primarily in futures contracts and options, it would not commit all of its assets as margins for the futures contracts or premium for the options purchased. Instead, a futures and options fund will need to retain at least 30% of its net asset value (NAV) in the form of deposits or liquid short term debt instruments so as to meet liquidity and margin call requirements (note 2). A futures and options fund may also invest in other over-the-counter derivative instruments on an ancillary basis.
In general, futures and options funds try to make profit by taking long positions in futures contracts / buying call options to capture on rising price trends in the respective asset classes or by taking "short" positions / buying put options to profit on falling price trends in the respective asset classes.
To fulfil its investment objective, futures and options funds usually adopt the investment strategy of trend following and use systematic models to guide their investments under various market conditions and pre-set conditions. Examples of these investment decision indicators can be price movements of underlying assets, trading volume and average holding periods of underlying assets.
What are the key risks involved in futures and options fund?
As noted above, a futures and options fund may use a combination of long and short investment strategies and the risks inherent in a futures and options fund are not typically encountered in traditional funds. Besides, futures and options funds undertake special risks which may lead to substantial or total loss of investment and therefore are not suitable for investors who cannot afford to take on such risks. In view of the risk profile of a futures and options fund, the manager may impose a higher minimum initial subscription amount so as to help investors to better differentiate a futures and options fund from other traditional funds.
In general, the key risk factors associated with futures and options funds include:
Futures contracts/options risk
Basis risk: The prices of futures contracts/options may not always go in line with/be perfectly correlated to the value of the underlying assets in the spot markets. For example, an increase in the spot price of the underlying asset may not cause the NAV of the futures and options fund to rise by the same magnitude. In fact, the NAV of the futures and options fund may not change at all or may even fall.
Volatility risk: With substantial investment in futures contracts and options, the funds’ prices may be subject to the risk of very volatile price movements of futures contracts and options. Futures contracts/options price movements may be caused by other factors such as changes in government policies, supply and demand, changes in interest rates and economic conditions. Futures contracts'/options' prices are highly volatile, and so are prices of the futures and options funds. Furthermore, many futures and options funds may invest in futures contracts/options with underlying asset classes such as commodities and foreign currencies which are generally more volatile. Learn more about the key features and risks of commodities funds.
Besides, some futures exchanges may impose limits on daily futures price movement. In this case, even if a futures and options fund tries to close out its futures position to limit loss, the orders may not be executed due to such limits.
Margin risk & liquidity risk: If the market moves against the futures position, the futures and options funds may be required to pay additional margins, to maintain the trading positions on short notice. The fund may need to liquidate its assets at unfavorable prices in order to meet these margin calls and suffer substantial losses.
Some futures and options funds can only be redeemed at limited intervals (e.g. monthly). If you invest in such a fund, you may not be able to cash in on your investment at your desired price or when you are in need of cash.
Trading of futures contracts and options may carry a high degree of risk. The amount of initial margin/premium for entering into futures contracts/options is small relative to the value of futures contracts/options so that transactions are leveraged. In this way, a small change in contracts prices may result in magnified profit or loss, depending on the extent of leverage employed by the funds. A futures and options fund may or may not be leveraged. Although a futures and options fund may not invest all of its assets in futures contracts/options, where a futures and options fund is leveraged, the fund may lose all of its assets in its entirety due to the leverage effect of futures contracts/options. You should pay attention to the leverage level of a futures and options fund in which you invest, as well as the attendant risks.
The performance of futures and options fund depends mainly on success of its investment strategy, which is generally model-based. However, the use of model does not guarantee positive performance and any unexpected changes in market could hurt the model's performance. Moreover, it is not guaranteed that the model can be fully executed in an accurate and timely fashion.
Performance fee risk
The manager of a futures and options fund may charge a performance fee, which is payable to the manager annually if a pre-determined net appreciation of the fund's NAV is achieved. As the performance fee usually accrues on a daily basis and if payable, is deducted from the fund's net assets value on a daily basis, this gives rise to the risk that an investor redeeming his/her units may still need to bear a performance fee in respect of those units, even though a loss in the investment capital has been suffered by such redeeming investor.
When a futures and options fund invests in options or other derivative instruments that are traded over-the-counter, the fund will be subject to the risk of default of its counterparties in performing any of their obligations. It may result in losses to the fund.
What should investors consider before investing in futures and options funds?
As an investor, you should always understand the nature, investment objective and strategy, key features and risks of a futures and options fund before you invest. You should also understand how fees and charges of the fund are charged and calculated, and consider how they may affect your investment return.
How do I know if a futures fund is suitable for me?
Before buying futures funds, do your due diligence. Find out about the investment strategies, investment risks, fees and charges from the offering document. When in doubt, please seek professional advice.
1 In this document, a futures and options fund refers to one which is authorised by the SFC for public offering in Hong Kong pursuant to 8.4A of the Code on Unit Trusts and Mutual Funds ("UT Code").
2Requirement in 8.4A(b) of the UT Code.