Stock Futures Investing: How To Invest Like A Pro?

The stock futures investing offers the investor the option of using small amounts of their own money to control large amounts of products, including futures of oil, gold, currency, and commodity futures. A notable difference between the futures and the equity markets involves the use of term margin.

Even though the contract sizes for currency futures are large, you need not buy or sell a full contract by paying hefty money. Rather, by depositing a margin (a fraction of full contract value), you’ll be able to secure the full contract. Minimum margin requirements vary from broker to broker. But are typically only fractions of the contract’s total value that are not related to the actual price of the contract involved.

What are the Benefits of Stock Futures Investing?

With stock futures investing, you’ll be able to take a long-term view on the underlying stock. Stock futures offer high leverage. And hence you can take large position with less capital. Oftentimes you will have to pay 20% initial margin of the total cost of lots. Stock futures are usually settled in cash. The final settlement price is the closing price of the underlying stock.

You can easily close your position at any time until the expiry of the contract. As an investor you can buy and then sell stock futures or can first sell and then buy stock futures to close your position. If you visit Bloomberg Futures  you’ll find live update of the US stock futures.

What is a Stock Futures Investing?

This is a financial legal contract where you will find an individual stock future consists of the underlying stock. In Stock Future contract you need to enter into an agreement with the interested buyer or sellers to either buy or sell a specified number of underlying stocks. Future price is determined by market demand and supply. The whole process is done through the specified stock exchanges driven by the market lot, expiration date, unit price, tick size and mode of settlement.

The futures contract is a legitimate contract to follow, whether you are selling (short-position), or buying (long-position) futures of specific commodity, stock, index, or currency at a pre-defined date or price. The amount and date of delivery of the contract are specified, though in almost all cases delivery is not taken as contracts are bought and sold for speculative or hedging purposes.

How a Commodity Futures Trades?

The commodity futures are put to use by both the actual user of commodity and by the traders. For instance, as a farmer, you may sow some corn in the month of May, but have no idea at what price the corn will be selling in November. You can then sell or short a corn futures contract for November and lock-in the future selling price today.  

No matter what happens to the underlying corn crop price, you need not worry as long as the long future price remains within the future selling price. You can also buy or long a stock futures contract if you believe that the price of the stock is going to appreciate. Likewise, can sell or short-sell a futures contract if they believe the price of a security is going to decline.

What are the Purposes of Commodity Trading?

Futures trading are the key activity of businesses on the commodity exchange. In fact, the commodity exchanges are organized mainly for futures contracts. The futures contracts are made for two distinct purposes: speculation and hedging. Accordingly, they are either speculative or hedging contracts. Speculative activity is such an important part of the commodity exchanges that commodity exchanges are sometimes referred to as the speculative market.

Are Stock Futures Investing-Speculative or Gambling?

In speculation, you usually peep far into the future out of the window of the present. Speculation tends to estimate the future trend of prices and proceed on that basis keeping in mind the targeted profit margin. You may buy commodities at the current price and selling them at a higher price in future or vice-versa.

You will find it hard to differentiate them. There is a very thin line in-between gambling and speculation. Typically both appear to be the same, but in fact, speculation refers to the taking up of legitimate enterprises on the basis of your analysis of market trends and other factors that have a bearing on prices. But, when you start speculating recklessly and blindly without applying your mind and intelligence, and without possessing the resources necessary to meet your commitments, it degenerates into sheer gambling.

How does a Stock Future priced?

This is theoretically done by adding the current spot price and cost of carrying. Thus a future price is equal to the spot price plus cost of carrying. This is why stock future price often carries premium value. Sometimes stock futures are traded on discounted price. The actual price of future contract is often driven by the demand and supply of the underlying stock.

Here cost of carrying is the interest cost you are to incur for holding a specified number of stocks termed as lot size. Your total cost of possession of one lot is a fraction of what you need to incur when you trade a similar number of stocks in cash market. Your cost of possession of lot is what you need to keep minimal in your trading account known as margin money. The margin money is determined by the stock exchange of any respective country.   

How Technical Knowledge is going to Help You.

If you are trading futures based on technical analysis then you’re aware of how the futures are priced. However, a good working knowledge would help you a lot. The stock futures derive its value from its underlying stock. Usually, when the underlying price of stock falls, the futures price falls and up when the stock price surge. The difference in price between the futures price and the spot price is called the spread. This spread arises when the variables such as interest rates, dividends, time to expiry, etc are operative. In simple term you can easily work out the future price of a stock or index. 

How Do You Calculate the Future Pricing? 

The futures pricing generic formula is =Spot Price * [1+ rf * (x/365)-d] where rf = Risk-free interest rate, d is Dividend and x is number of days to expiry.

The rf’ is what you can earn for the entire year. Now, considering 1 month, 2 month and 3 months of expiration, you can scale it proportionately for time periods other than the 365 days.

From the Indian stock market perspective, I am giving you an example of HDFC Ltd. The current risk-free interest rate (as per RBI data) is 5.283%.The close price of HDFC Spot as on Sep 20, 2019 is 2049 whereas Future Price for Sep 20, 2019 is 2059 with 7 days to expire. Here the Spread is 10 points (2059-2049).

Futures Price of HDFC = 2049 * [1+5.283 %( 7/365)] – 0=2051

It’s assumed dividend as 0 because HDFC is not expected to pay any dividend over the next 7 days. The future price shown above is 2051. This is the ‘Fair value’ of futures, which differs from the actual contract price is called the ‘Market Price’. This difference is come about primarily due to the market costs such as transaction charges, taxes, margins, etc.

How Can You Trade a Stock Futures Contract?

Futures contracts must be traded through futures brokers or stockbrokers who operate both full-service and discount operations. However, popular discount stockbrokers do not handle futures contracts.


Why do traders prefer Stock Futures over Stock Options?

 

Futures are often thought of in the same category as options. While they are both derivatives, in that they derive their value from some base security, there is one very important difference. Option buyer of stock has the right and not the obligation, to buy or sell the underlying stock. While with stock futures, both the buyer and seller have the legally binding obligation to buy/sell the underlying stock. 

Thus, while options limit your loss to the price paid for that option, futures trading could lead to a loss of your entire investment for meeting that obligation. The price of stock futures is affected mainly by the prices of the underlying stock whereas, in case of stock options, the option price is depended on option Greeks or roughly volatility of the underlying stock.

With less volatility or slow movement of the underlying stock, option buyers are the greatest loser due to Theta or time decay as expiration date comes closer. But with stock futures investment, you’ll be going to lose minimally. But when you write (short-sell) an option, it behaves just like futures.

What are the Profits and Losses in Case of a Stock Futures Position?

The profits and losses would depend upon the difference between the price at which the position is opened and the price at which it is closed. Suppose you have a long position of one November Stock “X” Futures @ 530. If you square up your position by selling November Stock “X” futures @ 550, the profit would be 20 per share. In the reverse case, when you square up the position by selling November Stock “X” futures @ 500, the loss would be 30 per share.

What is Future Spread Trading?

Spreads are the contracts for capturing the differential price. The implication of this is that when you buy a November contract and sell October contract, you simply enter into a contract and pay the difference for this transaction. This means you bought a November future contract and sold an October contract and deposit upfront the initial margin.

Similarly, you can reverse the process means selling a November contract and buying a November contract. By doing so you’re entitled to get positive balance in your trading account.  And you instructed your broker that you want to receive the difference amount.


How Do You Utilize the Stock Futures When You Anticipate a Fall in Stock Price that You’re Holding?


The beauty of the stock futures investment is that you can profitably utilize the stock in your holding. For instance,  you hold a sizable quantity of stocks of a company in your DP account and the stock price is undergoing a heavy correction. And you’re in a loss for holding the stocks and don’t want to sell your stocks by accepting a huge loss. In this situation you can sell a future to avoid a loss without having to sell the share. Any loss caused by the fall in the price of the stock is offset by gains made on the stock future position.


How Can You Benefit from an Anticipated Rise or Fall in the Price of a Stock?

As an investor, you can benefit from an anticipated rise in the price of a stock by buying futures. As the price of the futures rises, you will make a profit. You will just need to pay the margin, and your return on stock futures investing will often be higher than on an equivalent stock holding. Likewise you can benefit from an anticipated fall in the stock price by selling stock futures. As the price of the future falls, you will make a profit.


What is Future Pair Trading?

Pair trading strategy requires taking a position based on the relative performance of two stocks. This is often achieved by buying stock futures expected to perform well and selling stock futures predicted to perform badly. The overall gain or loss depends on the relative performance of the two stocks.

The Final Takeaway: All futures contracts are usually made for the purpose of speculation or hedging. It’s a highly specialized market. Big firms, institutional investors and hedge funds are frequently utilizing all sorts of futures for speculative and hedging purposes. As such, even before thinking of putting your money in futures trading, be it stock futures investing, commodity futures, oil futures or currency futures investing, you should educate yourself enough.

Also, you should check how much time and money you have available to invest in a futures contract. It would be wise to formulate a financial road-map that can deliver an edge in next level of futures investing. You can seek financial advice from a reliable financial professional before stock futures investing.

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