Advantages of Trading Futures vs. Stocks

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Advantages of Trading Futures vs. Stocks

Futures contracts are derivative contracts that draw their value from a financial asset, such as a typical stock, bond, or stock index, and may therefore be used to obtain exposure to a variety of financial instruments, such as stocks, indexes, currencies, and commodities.

Futures are a frequent vehicle for risk management and hedging. If someone is already exposed to or gains from speculation, it is largely due to a desire to hedge risks.

Future contracts offer numerous inherent benefits versus trading equities because to the way they are constructed and exchanged.

Key Takeaways

  • Stock investors may have heard the terms “futures” or “futures market,” but they may have dismissed these arcane derivatives as unsuitable for them.
  • While futures might provide distinct dangers for investors, there are numerous advantages to trading futures over stocks.
  • These benefits include more leverage, cheaper trading expenses, and extended trading hours.

8 Advantages of Trading Futures

1. Futures Are Highly Leveraged Investments

To trade futures, an investor must deposit a margin, which is a percentage of the whole amount (usually 10% of the contract value). The margin is simply collateral that the investor must hold with their broker or exchange in the event that the market goes against their position and they suffer losses. This may be more than the margin amount, in which case the investor must pay extra to maintain the margin.

Trading futures simply implies that the investor may expose himself to a lot higher value of stocks than they could when purchasing the actual socks. As a result, their earnings quadruple if the market swings in their favor (10 times if the margin requirement is 10%).

For example, if an investor wishes to invest $10,000 in the S&P 500 index, they may purchase either 25 shares of the SPDR S&P 500 ETF (SPY) at roughly $400 per share or 1 E-mini futures contract with a $10,000 margin requirement. The investor would have profited $25 if SPY rose to $401. The E-mini contract would have climbed from $4000 to $4010 within the same time period, resulting in a $500 gain (1 index point = $50.00).

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2. Future Markets Are Very Liquid

Future contracts are exchanged in massive quantities every day, making futures very liquid. Because buyers and sellers are always present in futures markets, market orders may be placed fast. This also means that prices do not change much, particularly for contracts nearing maturity. As a result, a huge position may be simply cleaned out without affecting the price.

Many futures markets, in addition to being liquid, trade beyond typical market hours. Extended trading in stock index futures often takes place around the clock.

3. Commissions and Execution Costs Are Low

Future trade commissions are relatively minimal and are levied when the position is closed. Typically, the entire brokerage or fee is as little as 0.5% of the contract amount. However, it is dependent on the broker’s degree of service. A fee for internet trading may be as little as $5 per side, although full-service brokers might charge up to $50 each deal.

It is worth noting that online brokers are progressively providing free stock and ETF trading across the board, making the transaction cost argument for futures less appealing than it was before.

4. Speculators Can Make Fast Money

A competent investor with excellent judgment may earn rapid money in futures since they are trading with ten times the exposure of typical equities. Furthermore, prices in futures markets tend to change quicker than those in cash or spot markets.

A word of warning, however: While futures might increase the likelihood of winning, they also increase the likelihood of losing money. However, it may be reduced by utilizing stop-loss orders. Because futures are highly leveraged, margin calls may arrive sooner for traders with wrong-way bets, possibly making them a riskier asset than a stock when markets move quickly.

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5. Futures Are Great for Diversification or Hedging

Futures are vital tools for hedging or managing various types of risk. Companies that engage in foreign trade use futures to manage foreign exchange risk, interest rate risk by locking in an interest rate in anticipation of a drop in rates if they have a large investment to make, and price risk by locking in prices of commodities that serve as inputs such as oil, crops, and metals. Futures and derivatives contribute to the underlying market’s efficiency by lowering the unanticipated expenses of acquiring an item outright. For example, going long in S&P 500 futures is more cheaper and more efficient than acquiring every company in the index.

6. Future Markets Are More Efficient and Fair

Trading on inside knowledge in futures markets is tricky. For example, who can forecast the next Federal Reserve policy decision with certainty? Unlike single equities, which contain insiders or company management who might leak information to friends or family in order to pre-empt a merger or bankruptcy, futures markets trade market aggregates, which do not lend themselves to insider trading. As a consequence, futures markets may become more efficient and provide a more even playing field for typical investors.

7. Futures Contracts Are Basically Only Paper Investments

Except when trading to hedge against a price increase and taking delivery of the commodity/stock on expiry, the actual stock/commodity being traded is seldom exchanged or delivered. Futures are often a paper transaction for investors seeking just speculative profit. This implies that futures are less troublesome than having individual stock shares, which must be tracked and held somewhere (even if only as an electronic record).Companies must understand who owns their stock in order to pay dividends and record shareholder votes. Futures contracts do not need any of this documentation.

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8. Short Selling Is Easier

Selling a futures contract to obtain short exposure on a stock is totally legal and applies to all types of futures contracts. On the contrary, one cannot always short sell all stocks since various markets have different restrictions, with some outright outlawing short selling of equities. Short selling stocks necessitates a margin account with a broker, and in order to sell short, you must borrow shares from your broker. Short-selling a stock that is difficult to borrow might be costly or perhaps impossible.

The Bottom Line

Futures offer several features that make them attractive to speculative and non-speculative investors alike. However, overly leveraged positions and big contract sizes expose the investor to massive losses even for minor market changes. Thus, before trading futures, one should strategy and do due research, as well as grasp both their benefits and hazards.

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