Pros and cons of futures trading for stock speculation

Futures contracts were originally designed as hedging tools or “insurance” for trading commodities like wheat. Since the production of wheat takes a long time and prices can change for better or worse during that year, such wheat takes time to grow to maturity, the buyer of the wheat can make an agreement with the farmer to buy his wheat on the spot. of the crop at a price agreed upon at this time. Such an arrangement ensured that the buyer would always be able to buy that 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 plummeted during harvest. That is the original purpose of futures contracts.

However, with the creation of modern futures markets where 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 became a tool of speculation.

Yes, stock futures are a fairly recent innovation that have not yet been as popular as stock options. These stock futures are known as individual stock futures. Individual stock futures are futures contracts with stocks as their underlying asset. This means that when you take delivery of the futures contract as long as you receive the shares that are covered by the futures contracts.

The beauty of individual stock futures as a speculation tool can be summed up in one word: “leverage.” Leverage means doing more with less, and in this case, it means controlling the earnings of more stocks with less money, which in turn means making more money with less money.

Individual stock futures allow you to control the underlying stock using only 25% of the cash that would be paid for the stock itself! For example, if AAPL is trading at $200 and 100 shares cost $20,000, you could control those same 100 shares of AAPL using only $5,000! The good news is that the $5,000 you “paid” to buy individual AAPL stock futures is still your money and will be used to deduct any losses on the position or returned to you along with the profits if the position is closed profitably. . This is known as initial margin.

Now, assuming you bought the above futures contracts and AAPL went up $10 on the same day, your account would be credited with $1,000 ($10 x 100) on the same day! This means that you made $1000 using $5000 in just one day through futures trading instead of making the same $1000 using $20,000 buying the stock. That is leverage.

Now assuming you bought the above futures contracts and AAPL was down $10 on the same day. The $1,000 loss would be deducted from the $5,000 he initially paid to fill the position. See how that $5,000 is still really your money?

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

That brings us to the risk of futures trading, margin calls. If AAPL falls enough to bring your initial balance of $5000 below a limit set by the exchange known as “maintenance margin”, you will receive a notice from the broker to top up your account again up to that initial $5000. If you don’t have the cash to do that, the broker will close your position immediately. Yes, the stock can go up in your favor and it can also go down. In fact, you are not losing any more money than trading the stock itself by trading its futures. You will lose exactly the same amount of money as if you had the same number of underlying shares. This means that even though you paid little to fill the position, you should be prepared with more cash than necessary to survive those temporary reversals that inevitably occur in the stock market.

The problem with most beginner futures traders is that they are set up only to win, not lose, and typically have little or no cash left on the sidelines to withstand temporary losses.

In conclusion, trading individual stock futures gives you leverage and the ability to earn more with less, but you also need to be prepared with more cash than necessary to cover temporary losses. Remember, leverage works both ways. Check with your broker to see if they offer individual stock futures trading and definitely get a mentor to guide you through your initial trades.