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In the stock market, one way to invest is by buying or selling stock futures. These contracts are cash-settled and based on a specific stock market index. According to the Bank for International Settlements, the global market for exchange-traded equity index futures was valued at US$130 trillion in 2008.
Index futures
An index future is a cash-settled futures contract based on a particular stock market index. According to the Bank for International Settlements, the global market for exchange-traded equity index futures is valued at US$130 trillion. Index futures have been around for years and are a popular way to hedge stock market risks.
Index futures are traded similarly to stocks but much more efficiently. As their prices are tied to the underlying index, they are less volatile than stocks. The only risks are derived from investors’ speculative positions and the trades’ leverage. Using index futures as a hedging tool can greatly reduce the investor’s overall risk.
Buyers and sellers trade index futures. To invest in them, traders need to determine the price they are willing to pay for a specific index or stock. Once the price is set, the trader enters the futures market to buy or sell. Futures brokers place buy and sell orders on behalf of both buyers and sellers. The futures broker can sell it for a profit or loss if the contract is legally valid.
Single-stock futures
A single-stock future is a contract between two parties for a specific number of stocks from a company. These contracts are traded on a futures exchange. Both parties agree to deliver the stocks at a specified future date in a single-stock future. The contract is usually short-lived, but it can last up to two years.
Single-stock futures can be used to hedge long or partially-long positions. For example, a futures contract in Microsoft allows you to hedge your long position in the stock without actually owning the shares. But you must be comfortable with leveraged trading before implementing this strategy.
Cash-settled contract
Cash-settled stock futures contracts are based on the concept of physical delivery. A person with a short position in underlying security must deliver that asset. Similarly, an investor holding a long position will need to take delivery of the shares. The price of a futures contract is determined by the supply and demand for the underlying asset at the time of the contract.
This settlement option is available in futures and options trading. There are three types of cash-settled futures. The PRA publishes a standardized market price, and the parties settle by exchanging cash.
Long and short positions
Regarding stock futures trading, there are two basic positions: long and short. The former involves buying stock in anticipation of a price increase, while the latter involves selling stock in anticipation of a price decline. Both positions have advantages and disadvantages, and knowledgeable investor knows how to incorporate each into their trading strategy.
The difference between long and short positions in stock futures is the amount of money required for each. For short positions, the investor is required to have a margin account with a brokerage firm. Margin calls are common in this type of trading, and failure to meet them may lead to closing the position. The result is that the investor can incur a large loss or gain based on a small change in the price of the underlying contract.
Risks
Trading in stock futures may be a risky venture for some investors. Although they can provide substantial profits, they can also result in significant losses. As with other investments, futures prices depend on the underlying assets. Traders need to know all the risks associated with these contracts before moving.
A secondary risk is known as industry risk. This risk is inherent to any future position and can be present in any industry. For example, traders trading in oil is exposed to a systemic risk caused by changes in the oil market. Traders of futures in these markets should diversify their portfolios to minimize this risk.
Futures are riskier than options because they are much more sensitive to small changes in the underlying asset. They are also more volatile, which means they can lose money quickly. In addition, futures involve more leverage, which makes them more volatile and prone to large losses.
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