Futures contracts were initially designed as hedging tools or “insurance” for commodity trading such as wheat. As wheat production takes a long time and prices can change for the better or worse during that year, the wheat grows to maturity, the buyer of the wheat can enter into an agreement with the farmer to buy their wheat at harvest at a price agreed right now. Such an agreement ensured that the buyer would always be able to buy wheat exactly at the price he wanted, and the farmer also had assurances that he would be able to sell his wheat at that price, even though prices under the harvest. That is the original purpose of futures contracts.
However, the creation of modern futures markets where similar futures can be freely sold among futures traders as well as the creation of futures contracts on less traditional assets such as stocks and indices, futures trading also became a speculation tool.
Yes, stock futures are a fairly recent innovation that is not yet as popular as stock options. These futures on stocks are called Single Stock Futures. Single stock futures are futures contracts with stocks as their underlying asset. This means that when you take delivery of the futures contract for so long, you will receive the stocks covered by the futures contracts.
The beauty of Single Stock Futures as a speculation tool can be summed up with a single word “leverage”. Gearing means doing more with less, and in this case, controlling the profits of more stocks with less money, which in turn means making more money with less money.
Single Stock Futures allows you to control the underlying stock using only 25% of the cash that would be paid for the stock itself! For example, if AAPL trades at $ 200 and 100 shares cost $ 20,000, you can control the same 100 shares in AAPL using only $ 5000! Good news is that the $ 5000 you “paid” to buy AAPL’s single stock futures will remain your money and would be used to deduct losses in the position or returned to you along with profits if the position is closed profitably! This is known as an initial margin.
Assuming you purchased the above futures contracts and AAPL increased $ 10 the same day, your account will be credited $ 1,000 ($ 10 x 100) the same day! This means that you earned $ 1000 using $ 5000 in just one day through futures trading instead of earning the same $ 1000 by spending $ 20,000 by buying the stock itself. It’s leverage.
Assuming you bought the above futures contracts and AAPL dropped $ 10 the same day. The $ 1000 loss would be deducted from the $ 5000 you originally paid to get the position. See how the $ 5000 is really still your money?
What if the stock fell a mile in a day?
That brings us to the risk of futures trading, margin calls. If AAPL dropped enough to bring your original $ 5000 balance below a limit set by the stock exchange known as the “maintenance margin”, you would receive a message from the broker to fill your account up to the original $ 5000. do not have the cash to do so, your position is immediately closed by the broker. Yes, the stock can go up in your favor and it can go down as well. In fact, you do not lose more money than trading on the stock itself by trading its futures. You lose exactly the same amount as if you had the same amount on the underlying stock. This means that even if you paid a bit to get the position, you need to be prepared with more cash than necessary to survive the temporary withdrawals that inevitably happen in the stock market.
The problem with most beginners, futures traders, is that they are only prepared to win, not lose and usually have little or no cash left on the sidelines to support temporary losses.
In conclusion, trading a stock futures gives you leverage and the opportunity to earn more with less, but you also need to be prepared with more cash than necessary to meet temporary losses. Remember that the gearing cuts both ways. Consult your broker to see if they offer futures stock trading and definitely get a mentor to guide you through your initial trades.