Futures contracts were originally designed as hedging or “insurance” tools for trading commodities such as wheat. Since wheat production takes a long time and prices can change for better or worse during that year, that wheat takes time to grow to maturity, the buyer of the wheat can make an agreement with the farmer to buy his wheat right away. of the harvest at a price price agreed 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 the 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 like stocks and indices, futures trading also became in a speculation tool.
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. Single 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.
Single 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 AAPL shares using only $5000! The good news is that the $5000 you “paid” to buy the AAPL single stock futures is still your money and would be used to deduct any losses on the position or returned to you along with the profits if the position is closed illegally! profitable! 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 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 dropped a mile in one day?
That brings us to the risk of futures trading, margin calls. If AAPL drops enough to bring your initial $5,000 balance below a limit set by the exchange known as the “maintenance margin,” you’ll receive a notice from the broker to top up your account back up to that initial $5,000. 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 is necessary to survive the temporary setbacks 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 margin to withstand temporary losses.
In conclusion, trading single stock futures gives you leverage and the ability to earn more with less, but you also need to be prepared with more cash than is 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.