Pros and cons of futures trading for stock speculation

Futures contracts were originally designed as hedging or “insurance” instruments for trading commodities such as wheat. Because wheat production takes a long time and prices can change for better or worse in that year, that wheat must grow to maturity, the wheat buyer can enter into an agreement with the farmer to buy his wheat at harvest at the agreed price. now. Such an agreement meant that the buyer could always buy those wheat at exactly the price he wanted, and the farmer was also assured that he would be able to sell his wheat at that price, even if the price fell to harvest time. This is the original purpose of futures contracts.

However, with the creation of modern futures markets in which similar futures contracts can be freely traded between futures traders, as well as the creation of futures contracts on less traditional assets such as stocks and indices, futures trading has also become , a tool of speculation.

Yes, stock futures are a fairly recent innovation that has not yet been as popular as stock options. These equity futures contracts are known as single shares. Single-share futures contracts are futures contracts with shares as an underlying asset. This means that when you take delivery of the long-term futures contract, you receive the shares that are covered by the futures contracts.

The beauty of futures with single shares as a tool of speculation can be summed up in one word “Leverage”. Leverage means doing more with less, and in this case, it means controlling the profit on more shares with less money, which in turn means making more money with less money.

Single-stock futures allow you to control the underlying stock using only 25% of the cash you would have 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 of AAPL using only $ 5,000! The good news is that the $ 5,000 you “paid” to buy AAPL’s individual futures shares remains your money and would be used to deduct losses from the position or will be returned to you along with the profits if the position is closed. profitable! This is known as the initial margin.

Now, assuming you bought the above futures contracts and AAPL increased by $ 10 on the same day, your account will be credited with $ 1,000 ($ 10 x 100) on the same day! This means that you have earned $ 1000 using $ 5,000 in one day by futures trading instead of earning the same $ 1000 using $ 20,000 by buying the shares themselves. This is leverage.

Now, assuming you bought the futures contracts above and that AAPL fell $ 10 the same day. The $ 1,000 loss would be deducted from the $ 5,000 you initially paid to take up the position. Do you see how $ 5,000 really is your money?

Now, what if the stock dropped a mile in a day?

This brings us to the risk of futures transactions, margin calls. If AAPL has dropped enough to reduce the initial balance of $ 5,000 below a limit set by the stock exchange known as the “maintenance margin”, you will receive a notification from the broker to replenish your account back to the initial $ 5,000. If you do not have the money to do so, your position will be closed immediately by the broker. Yes, the stock may increase in your favor and may also decrease. In fact, you don’t lose more money than trading the stock itself by trading futures contracts. You will lose exactly the same amount of money as if you owned the same amount of underlying shares. This means that even though you have paid little to occupy your position, you need to be prepared with more money than is necessary to survive those temporary withdrawals that inevitably happen in the stock market.

The problem with most futures traders for beginners is that they are only prepared to win, not lose, and usually have little or no money left over to support temporary losses.

In conclusion, long-term trading of single shares gives you leverage and the ability to earn more with less, but you should be prepared with more money than is needed to deal with temporary losses. Remember, the lever reduces in both directions. Consult your broker to see if he offers single-share futures trading and definitely get a mentor to guide you through the initial transactions.

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