Advantages of Futures Over Conventional Stock
Well, many traders invest their funds in futures stocks. Speculators such as swing traders, day traders, hedgers, and position traders generally opt for futures stock trading. They mainly use futures as an instrument to hedge price shifts in underlying securities. These traders’ final goal is to mitigate the losses incurred from potentially adverse price shifts rather than harvest massive gains. The other major benefit of trading stocks through futures is that you can short-sell stocks without actually owning them, and you can further carry forward your trading position. Moreover, we cannot ignore that futures positions are leveraged, which means you can own relatively expensive and renowned stocks by spending little.
It must be clear from the points mentioned above that futures stock trading is advantageous for traders. But What does this futures stock trading actually mean? And How can you start futures stock trading? This article deals with all of these queries.
Introduction to Futures Stock Trading
When you decide to sell or purchase futures stock, you are not simply selling or purchasing a stock certificate. It means that you are signing a stock futures agreement. It refers to a contract in which an individual agrees to sell or buy the stock certificate on a specific date at a certain price. It is slightly different from conventional stock trading. Here, you do not own the stock, are not invited to the shareholders meeting, and are not entitled to dividends. In conventional stock trading, you earn profit only when the price of your trade or stock surges. However, with futures stock trading, you can harvest profits even when the market price declines.
How is the Price of Futures Stock Determined?
When we talk about determining a futures stock’s theoretical value, we simply mean calculating the price by summing up the cost of carrying and the current spot price. However, in the practical world, the futures stock contract’s real price depends on the underlying stock’s supply and demand. Usually, the spot prices of underlying stocks are lower than the futures prices.
Futures price = cost of carrying + spot price
Here, the cost of carrying is the interest cost of the same trading position in the cash market.
How do Stock Futures Work?
There are two trading positions in stock futures: short and long positions. The long position means that you agree to purchase the stock when the future agreement expires. The short position is the one where you agree to sell the stock when the futures contract expires. If you feel that the stock price you own will surge in the following three months, you can go long today on your trading position. If you feel that the stock price will decline in the following three months, you can go short today on your trading position.
Do you know what is more interesting about selling and purchasing futures agreements? Here, you need to pay just a percentage or portion of the contract’s entire price with futures stocks. It is known as purchasing on margin. The margin can be anywhere between 10 and 20 percent of the total price of the agreement. You get leverage or margin from the financial service provider.
However, while purchasing on margin, you should keep this particular point in mind that the stock brokerage firm could claim a margin call. They do this when your total investment’s value goes below a predetermined level, also known as the maintenance level. A margin call is simply an additional amount you need to pay to your financial service provider to upgrade the futures agreement’s value to meet the maintenance level.
What is the Difference between Futures and Options Stock Trading?
In options stock trading, the buyer of options has the sole right and is not obliged to sell or purchase the underlying stock on the expiry date. Whereas in the case of futures stock trading, both the seller and purchaser are obliged to sell or purchase the underlying stock at the time of expiration. The risk-return profile is asymmetric in the case of single stock options. In contrast, stock futures payoff is symmetric. Moreover, stock options’ prices are influenced by the underlying stock’s price and the underlying stock’s volatility. But, in the case of stock futures, the underlying stock price is the only factor affecting stocks’ prices.
How do Stock Futures Get Settled?
Stock futures are settled either through physical delivery of the underlying stock on the contract’s expiration date or through cash settlement, where the contract’s value is determined based on the market value of the stock on the date of expiration. Most stock futures are cash-settled, meaning no physical delivery of the stock occurs, and traders receive or pay cash based on the contract’s profit or loss at expiration.
Understanding Pairing Stocks
This trading technique refers to holding a trading position based on the comparative performance of two stocks. It is fulfilled by purchasing futures on those stocks that are anticipated to perform well and selling futures on those stocks that are expected to perform poorly. The net loss of profit lies in the comparative performance of two stocks.
How do I Start Futures Stock Trading?
To start futures stock trading, you need to open an online trading account with the broker. The steps for opening an account are provided below. You just need to spend your five valuable minutes starting to trade in the stock market.
- Visit the official website of the broker. Kindly check the URL of the website to stay away from online trading frauds.
- Get yourself registered by signing up. The information needed for this includes name, last name, country, email ID, and phone number for verification.
- Once you enter the OTP verification number, you will be redirected to the documentation session. Here, you upload the required documents, including address proof, identity proof, bank details, and financial statements not older than three months. It is a piece of advice to keep these documents ready beforehand.
- Choose the stock for which you wish to trade and deposit the amount for it.
- Once the formalities, as mentioned, are fulfilled, you can start trading.
The Bottom Line
The main benefit of futures stock trading is that you can take advantage of market-price shifts from either side. High margin allows you to hold larger positions by paying a percentage of the total amount. But if the condition turns against your expectations, it can lead to huge losses. So, analysts always suggest that those traders who have a high-risk appetite should go with futures and options trading. But that too after building a strong trading foundation.