Stock futures trading are a way to hedge yourself in stock trading. Put simply, this type of a transaction is defined as the one where you agree to pay a seller a specific price for a specific amount of stock that you buy from him on a particular date in the future.
On the other hand, stock futures trading is an investment option and these can be traded on the markets in a manner similar to ordinary stocks. This type of trading is usually conducted on a margin basis, that is, you only pay a small part of the price of the stock when you enter into a contract.
What Are The Benefits?
This is an important investment avenue, open to investors for hedging their risky stock purchases. They can go short on such future contracts, implying that they sell the stock before they actually own it. They can also go long on such future contracts.
Being margin based, this form of trading allows an investor to buy a large portfolio of stocks with a comparatively smaller down payment as compared to traditional stocks.
Options available to the investor are much more than if you invest in traditional stocks. You can go long and short on the same stock. You can work on a calendar spread, wherein, you enter into a contract to sell the stock futures you have bought a month from now, and again enter into another contract to buy the same stock three months from now.
Disadvantages
Any high return investment avenue, by its very nature, will also be highly risky. The same is true for stock futures trading. Let us compare the scenario of an investment in traditional stocks versus investment in stock futures.
When you buy stocks of a particular company, you will need to pay the current price of that specific stock. If the price of that stock declines, at which point you sell the stock, you will make a loss to the extent of the difference in your purchase and selling price.
In the case of stock futures trading, you undertake margin trading and therefore, buy a much larger portfolio or a larger number of stocks than in the case illustrated earlier. If the price of the stock then declines, you are faced with a situation where you would lose most of your initial investment and will also owe money to your broker. In this case, you are required to make good the loss, and this can put a severe strain on your financial position.
Additionally, in contrast to the situation where you own physical stocks of a company, in stock futures trading, you do not have any rights of stock holders. You are therefore not entitled to any dividend or bonuses, which the company might announce, nor will you have any voting rights.
Stock futures trading are an exciting investment avenue; however, you can easily burn your fingers, so does your research well before you step into this arena.
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