If you are wondering what the Stock Market Futures are, keep reading the guide carefully. Here, you will understand what futures and futures contracts are.
Also, you’ll learn how to do futures trading in the stock market. But for this, you must have some basic knowledge of the stock market and its workings.
In short, the stock market refers to various exchanges where shares of companies are bought and sold. The famous U.S. stock exchanges include the Nasdaq and New York Stock Exchange.
For further assistance, move ahead and read the next section.
What are futures?
Futures are consequent financial contracts that allow parties to buy and sell assets. These assets are purchased and sold at a fixed future date and price. Despite the current market price, the buyer must accept, and the seller must sell the primary asset at a fixed price.
In the year 2000, stocks and indices were introduced in the market. Since then, futures have been known in the reserves. These stocks become popular among retail investors. It is typically used in various markets like currency, commodities, agriculture, and minerals. This includes wheat, soyabeans, natural gas, cotton, wheat, etc.
In the next section, you will learn what is a future contract and how does it work? But, before that, you must understand the fact of derivatives. It is a contract based on the derived value of a fundamental asset. Underlying assets include financial instruments and physical commodities. Further, futures can be used for bordering or trading reasons.
Pros of futures
- To protect against adverse price movements, companies can block the price of raw materials.
- To reflect the direction of the cost of a fundamental asset, investors can use futures contracts.
- Futures contracts may only need a deposit of a fraction of the amount contracted with a broker.
Cons of futures
- Investing in a futures contract hedged to miss out on favorable price movements.
- Since futures use leverage, investors risk losing more than the initial margin amount.
- Margin can be a double-edged sword; it means that gains are inflated, but so are losses.
Definition of a future contract
The future contract, also called futures, allows traders to buy or sell a specific commodity at a fixed price on a set date. These contracts have set prices and expiration dates that are known in advance. However, futures are generally identified by their expiration month. This you will understand by the given an example. Assume you are working in a baked goods company and want to buy large amounts of wheat periodically.
In a month, you will need 100 pounds. However, wheat prices are unstable, and to protect yourself, you enter into this type of contract to purchase wheat. Thus, you buy 100 pounds of grain by paying $2,000 a pound. Hence, wheat prices rise to $2,500 pound in a month. At the same time, you can buy it for $2,000 and save $50,000.
The reason behind this is the type of contact you use. Further, you would have lost 50,000 if wheat prices fell to $1,500. This is a common form of hedging and is used by governments as well as by small and large organizations. For instance, a country that drifts large amounts of petroleum wills bracken against price rises by oil futures.
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Futures contracts aren’t confined. In the futures market, speculators to are eager participants. They can gather the benefits of movements of asset prices. This they can do without purchasing the fundamental asset through futures trading.
You don’t have to take the risk of large quantities of the commodity if you want to make money by chancing on wheat futures. Hence, you don’t have to spend much until you have a deal in the underlying asset.
If you want to trade large quantities, future contracts will help you. This is because you only need to deposit an initial margin with the broker for trading. In general, margins in commodities are low; due to this, traders can deal in massive amounts. However, this is called leverage and can also be called a double-edged sword.
Moreover, because of the large numbers involved, the opportunities for profits are enormous. Thus, if you don’t receive it, losses can be determined. However, if you make losses, you will get margin calls from brokers to fulfil the minimum requirement. If you don’t meet it, the broker will sell the essential asset at a meager cost to recover the amount. Due to this, you might encounter more losses.
Thus, you need to understand what futures are before involving in them. Especially, commodity markets are risky because price movements are volatile and unreliable. Generally, the commodities markets are controlled by prominent institutional players.
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Trading in the stock market futures
You can trade futures contracts on the stock exchange, like other assets. In the US stock market, derivatives arrived over the past years. Since then, it has become common among investors.
However, you can get these contracts for securities and indices like the S&P 500 or Dow Jones. The price of stock futures depends on the demand and supply of assets. Below are the features of a future contract in stocks:
These types of contracts are for one, two, and three months.
You can balance your position before the expiry of the contract.
In shares, futures contracts are not sold as a single share but in market lots. For instance, on individual stocks, the value of these should be at least five dollars at any exchange for the first time. You may know that market lots differ from store to stock.
All futures and options contracts expire on the last Thursday of the month. In such case, a three-month contract will become one for two months, and a two-month contract turns into a single month.
For benefits, there is an appreciable range. If the initial margin is 20% and you want to invest $50 in the future, you must pay only $5. Thus, you can get the risk to a significant position with little capital. Doing this increases the chances of making profits. Remember that your bets will also be high.
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What Happens if You Hold a Futures Contract Until Expiration?
The people who hold futures contracts until expiration will determine their position in cash. A trader will pay or receive some money depending on whether the prime asset increases or decreases. The price is considered during the investment holding period.
Sometimes, futures contracts will require natural release. In such a case, the investor held the contract upon expiration as it takes delivery of the primary asset. Further, they are responsible for the goods and covering costs for physical storage, insurance, and material handling.
After concluding the above information, we found that stock market futures are the best way to surround future prices. Also, they are essential for bluffers. This is because they can trade in large volumes without investing significant capital. However, write in the sections below to clear any issues regarding this topic.