There are most probably a lot of terminologies we come across in the stock market. Well, if you are a newcomer, you might want a deeper understanding of what you have just heard or read. Reading and speaking the stock market language only comes from knowing every term you come across. So, what are futures? If you have come across it recently, you might want to know what it really means or how it would play a part in your investments and trade.
About Stock Market Futures
Stock market futures are also called market futures or equity index futures and represent for many investors the best stocks to buy. They are future contracts that enable visibility of a specific benchmark index more like the S&P 500. Commodity futures need the delivery of underlying goods like corn, sugar, and more. These market futures contracts are further settled with cash.
Stock Market Futures allow traders in trading towards the direction of equity index and hedge equity positions. They are used as lead indicators for the markets and stocks.
In simpler terms, futures are representatives of agreements and terms to buy or sell a specific quantity of stock, security, or a commodity at fixed prices on a specified date in the future.
Futures exchange a variety of commodities, currencies, and indices, giving traders a broad range of options. Futures contracts are a popular product among day traders because they can be bought and sold at any time the market is open until the fulfilment date. Here’s an overview of futures contracts, including what they are, how they work, and what you’ll need to get started trading them.
How are these Stock Market Futures Used?
To benefit from directional moves, market futures contracts may be traded long or short. There are no uptick rules, allowing traders to short-sell on the inside bid rates rather than waiting for an uptick to be filled. Portfolio investors commonly use them to hedge both long and short bets. The futures will be arbitraged with the underlying index through institutional program selling.
Most times futures and options are presumed to be taken as the same thing, as they are both termed as derivatives.
So, what are these two, and how are they different from each other?
A future is a contract that gives you the right and the duty to purchase or sell an underlying stock (or another asset) at a predetermined price and over a predetermined period of time. Options are a right to purchase or sell equity or index without being obligated to do so. A Call Option allows you to buy something, and a Put Option allows you to sell something.
Options and futures are exchanged in one-month, two-month, and three-month contracts. On the last Thursday of each month, all F&O contracts will expire. Because of the time value, futures sell at a Futures price, which is usually higher than the spot price. For each option, there will be only one Futures price for a stock.
Futures offer you the option of buying equities on margin. However, regardless of whether you are long or short on futures, the risks are limitless on the other hand. When it comes to futures, the buyer will only lose the sum charged as a premium. Options are more amenable to dynamic Options and Futures strategies because they are non-linear.
The Benefits of Investing in Futures:
You might wonder what your advantage of investing in futures would be, so here is a list you can swift through.
1. Futures are Leveraged Investments –
In trade futures, an investor has to usually invest a margin, mostly it is 10% of the contract’s value. This margin is collateral, and the investor has to keep with their broker just in case the market moves the opposite position to what they have taken and may incur losses. But what trading means for investors is that they can expose themselves to a bigger value of stocks. It is also a plus when the market moves in his direction, and his profits can multiply.
2. Future Markets are Liquid –
Future contracts are very liquid because they are traded every day in huge numbers. The consistent presence of buyers and sellers when it comes to futures ensure the market order can be placed very quickly. It also entails that do not fluctuate that drastically for contracts that are near maturity. There will not be a very adverse effect on the prices.
3. Commission and Execution Costs are Low –
The commissions on future trades are the lowest and are charged only when the position is closed. Though it is dependent on the service provided by the broker, the commissions and the execution costs for futures are comparatively low.
4. Speculators Make Fast Money –
Any investor with good judgment can kick the jackpot at share market futures. An investor makes quick money in futures when they have sound judgments and are essentially trading with ten times more exposure than normal stocks. Additionally, the prices in futures contracts tend to move much faster than in the cash markets.
5. Futures are a Great Way of Diversification of Hedging –
Futures are enhanced for managing different types of risks. For instance, companies that are engaged in overseas trade use futures to manage their foreign exchange risk and interest rate risks by locking them in. They lock them in by the anticipation of a drop in rates when they have investments to make. They are also in for locking in prices of oil, crops, metals, and much more. Future contracts help as derivations to increase the efficiency of the underlying market and unforeseen cost fluctuations.
6. The Future Market is More Efficient and Fairer –
Except where someone exchanges to hedge against a price spike and takes delivery of the commodity/stock on expiration, the real stock/commodity being sold is hardly exchanged or shipped. Futures are usually a paper trade for investors who are only interested in making a speculative profit.
7. Short Selling is Much Easier –
Selling a futures contract to gain short exposure on a stock is fully legal and extends to all types of futures contracts. On the opposite, one cannot always short all stocks, and different markets have different rules, some of which ban short-selling entirely.
Futures are a great way for an investor to trade products and grow out to be a chance of making money to hedge current investments. Futures are a great place where you can put your trading skills to the test and still not incur a lot of losses. As the margins on investments do not change drastically like they do in general stocks and funds.