Stock futures are a type of contract that gives you the right to buy or sell a specific stock at a predetermined price by a certain date. As such, when trading stock futures you’re not buying shares of the stock directly but rather an agreement to do so at a later date. Because they’re so similar, many investors tend to group futures together—and for good reason. Both types of contracts have their pros and cons, and both have high levels of risk associated with them.
Understanding which one is right for you can be tricky. But by breaking down some key differences and weighing your own personal risk appetite, you can better understand how each works and whether they’re appropriate for your portfolio. Read on for more information about US stock futures
S&P 500 E-MINI FUTURES Live
[wpcode id=”1107167″]NASDAQ 100 E-MINI FUTURES Live
[wpcode id=”1107170″]S&P 500 E-MINI FUTURES Live
[wpcode id=”1107174″]What is a Stock Future?
A stock future is a contract to buy or sell a certain amount of stock at a specific price on a specific date in the future. They’re similar to stock options in that they provide the right, but not the obligation, to buy or sell shares of a given stock at a specific price on a specific date. They’re also used to manage risk and increase returns in the stock market. With futures, you’re buying the contract in hopes that the contract price goes up.
If that happens, you make money on the difference between the contract price and the price at which you can sell it. Futures are often used by large companies or investors who want to hedge risk in the market by locking in an acceptable price for a commodity. There are a few different types of futures, but we’ll focus on stock futures.
Understanding Stock Futures Risk
The risk of loss with a futures contract is high, and you can lose more than your initial investment. To better understand this risk, let’s say that you buy a futures contract to buy 1,000 shares of Microsoft stock at $100 per share at the end of this month. You’ve agreed to buy the shares at whatever price the contract was set at, whether it’s above or below the current market price. Let’s also say that the contract you’ve bought is for the July 2019 contract.
That means you’ll be responsible for buying 1,000 shares of Microsoft stock at $100 per share on July 31—no matter what the current market price is. If the price of Microsoft stock is $50 per share on July 31, you’ll be responsible for buying 1,000 shares at $100 per share. Unfortunately, you can’t just sell your shares to recoup your losses. You’d have to wait until the contract expires before you could sell them.
US Stock Futures Explained
Unlike options, futures have a set expiration date and the underlying asset does not need to be publicly traded. Most futures contracts are for commodities such as corn, gold, crude oil, and silver. However, there are exchange traded stock futures that track an underlying index. These futures are standardized and have predetermined settlement dates and contract amounts of a fixed amount of shares. With these futures, you’re betting on the overall direction of the underlying index by buying a “long” position.
If you think the index will rise, you’ll buy a long position. If you think it will fall, you’ll buy a short position. In either scenario, you’re assuming risk, as these futures have a large amount of risk associated with them. You might be surprised to learn that the most common futures contract is short term. The average length of the most common stock index futures contract is approximately six months, with the shortest being one month and the longest being two years.
Equity Options
These are options on stocks that are listed on an exchange. These options are standardized with set strike prices and expiration dates. While there are many benefits to stock options, they’re not available to all investors. They tend to be more expensive to trade, and they require a brokerage account.
Just like futures, you can buy a call option if you think the stock’s price will rise or a put option if you think the price will fall. However, options have a limited life, so if the price of the stock doesn’t meet your predictions, the option will expire worthless.
Index Options
These are options on an index and are based on the value of the index. For example, an index option contract may be based on the S&P 500 or Dow Jones Industrial Average. These options are standardized with set strike prices and expiration dates. Just like equity options, index options are more expensive to trade and require a brokerage account.
Exchange Traded Funds (ETF)
An ETF is a type of fund that holds assets such as stocks, commodities, or bonds. ETFs can be purchased and sold throughout the day like individual stocks, but they trade like a futures contract.
There are ETFs that track the prices of indexes such as the S&P 500, Dow Jones Industrial Average, Nasdaq, and many others. They provide investors with a low-cost way to invest in the overall direction of the index. While they’re not the same as owning the underlying stocks that make up the index, they do provide a good way to earn a return in a specific market.
Ultra Short Bonds and Ultra Short ETFs
Like stock futures, ultra short bonds and ETFs are contracts that give investors the right to buy or sell a specified amount of bonds or ETFs at a specific price on a specific date in the future. Unlike stock futures, they’re not standardized and are not based on an index. Investors use ultra short bonds and ETFs as a way to reduce their risk in the market.
Conclusion
Despite their name, futures contracts don’t actually have to be “futures”—they can be for commodities, bonds, or ETFs. All futures contracts are standardized, so contracts are interchangeable. All futures have a set expiration date, and very few can be held until they expire. Most of them must be bought and sold before the contract expires. Futures contracts are risky because the price of a futures contract can change several times before the contract expires. And because both the contract price and the market price can move up or down, it’s important to manage your risk when trading futures.
