The stock market is the most common investment for millions despite dozens of other options to make a profit or to balance a diversified portfolio.
Futures are a type of derivative and comprise a contract based on the value of an underlying asset.
That might be a traditional stock or an index, bond, currency, or any other asset or commodity the buyer takes a position on at a date in the future.
Table of contents
Traders purchase futures and lock in a transaction at a predetermined price, volume, and date. However, there are several ways to extend, roll over or close out a futures position. In addition, traders use derivatives to speculate or hedge.
Investors often favour futures to manage risk and may adopt futures trading strategies alongside stock investments or use futures as a standalone element of a speculative trading style.
How Futures Compare To Stocks
Every investment carries risk, and futures are no different. However, they are worth exploring and have several advantages over solely trading stocks.
Derivatives contracts allow investors to use knowledge, market assessments and indicators to take positions based on how prices and asset values may change, so they are best suited to traders with a specific skill or experience area.
However, traders can use derivatives to speculate, using leverage to expand the size of a position and potentially profit from market movements with low trading costs, high liquidity, and broader availability.
Futures are often highly leveraged, with investors putting down a margin as a deposit, generally at around ten per cent of the total contract value. Brokers and trading platforms take the margin as a down payment and keep this as collateral against potential losses.
The caveat is that leverage is a form of borrowing to amplify a position, so although it can maximise profits, it can also exaggerate losses.
In futures trading, investors will want to take a position on a larger value when they are confident that the stock, asset, or commodity will move in their favour. They will typically be able to purchase a far smaller number of shares for the same amount deposited as margin capital to trade a futures contract, so entry barriers are somewhat lower.
For example, a trader might wish to purchase 25 shares in a listed company at a value of £400 per share, which would require capital of £10,000. If the shares appreciate by just £1 per share, they will make a return of £25.
Investing in a futures contract betting on share prices appreciating would require a lower initial margin. Still, they could invest the full £10,000 available using broker or trading platform leverage to multiply their position.
The same share price appreciation could result in profits 20 times higher, using the same speculative investment on the same stocks but using futures rather than an outright share investment.
Futures contract liquidity
Futures are no small part of the trading landscape, with vast volumes of contracts traded daily, creating high liquidity.
Buyers and sellers are continually active in futures markets as investment speculators, active commercial buyers and those hedging other portfolio risks. Corporations commonly use futures to lock in pricing on raw materials, commodities, or forex to ensure a guaranteed contractual rate to pay for costs linked with core business operations.
Because the pressure on the market is significant, orders are placed and confirmed quickly, ensuring that futures contract prices remain reasonably stable, particularly for contracts close to expiry when no dramatic fluctuations are expected.
Traders can exit a position equally fast if they wish to or place stop-loss orders as another layer of protection to mitigate the impacts of a big loss on a heavily leveraged position.
Most futures linked to stock indices trade around the clock, so there are fewer limitations on trading availability or market hours.
Costs of futures trading
Brokers and trading platforms charge commissions to execute futures as with all trades.
Still, rates are comparatively meagre, typically around 0.5 per cent of the contract’s value. However, that can vary depending on the services required.
Traders may pay as little as £5 for a futures contract executed online but could pay a higher cost of roughly £50 for a futures trade where a broker manages most of the transaction details.
Some investment brokers have begun increasing transaction costs for futures to offset free trading on other markets and products so that fees may be slightly higher now than in the past.
Investment pay-out periods
Futures can have almost any expiry date, from a specific time just a few minutes into the future or a date some months ahead. Investors use futures to speculate, and because trading has around ten times the exposure of traditional stock, they can realise a gain very quickly.
The futures markets move rapidly and can appreciate far more swiftly than spot or cash markets.
However, as with any day trading or scalping investment strategy, the ability to make quick profits equally means the possibility of making losses in just as short a period.
Although futures do not necessarily have to be highly leveraged, they often are, so investors rely on stop-loss orders to minimise the exposure to substantial losses. Margin calls are also more likely for traders who invest in futures but make a bad call because leverage could mean they exceed their account trading capacity quickly.
The efficiency of futures trading markets
Insider trading is not a big factor in futures trades because of the vast number of available assets, stocks, and commodities to choose, while each contract is based on the investor’s insights and expectations.
For example, a futures contract based on exchange rates a year in advance or on global wholesale soybean prices is subjective and difficult to manipulate or influence.
Stocks are subject to potential insider trading because senior figures or corporate managers inside a publicly traded enterprise could – possibly – share information about proposed restructures, mergers, or financial difficulties.
Futures are based on market aggregates and the underlying value of the linked asset, so they are more efficient and essentially a fairer investment vehicle.
Diversifying With Futures Trading
Investors commonly use futures to hedge risks or diversify their portfolios and ensure an even balance or a spread of positions that cancel out the exposure associated with one asset or another.
Businesses use futures to manage their exchange rate risk, locking in purchase rates for currencies they require to fulfil transactions or complete contracts. They also use interest rate risk futures to hedge against rate drops.
Futures contracts can secure commodity prices at a pre-agreed rate, such as metals futures and agricultural futures, which may increase market efficiencies by reducing the unknown costs of buying an asset at current rates without knowing what the future market value may be.
It is often more straightforward and lower price to go long on a futures contract associated with a market index than to attempt to purchase every listed stock within that index, for example.
The actual futures contract does not carry value. Rather, the contract derives value from the asset it is linked to – hence being a type of derivative. In most cases, no actual commodity or stock is delivered or exchanged, except where the futures contract relates to a commercial investor hedging against future price rises.
In this situation, the buyer proceeds until the futures contract expires and takes delivery at the agreed price point.
Most trades are cash settled, where investors engage in paper transactions to speculate – futures are simpler to monitor and store in comparison to individual stock certifications.
Further, the investor does not have to disclose their position to any company or producer associated with the underlying asset. Traditional stockholders must be identifiable to receive dividends and participate in voting processes, whereas a futures contract is at arm’s length and can be anonymous.
Trading Futures v Stocks FAQ
Futures do not carry any inherent risk that surpasses any other investment, such as forex, bonds, or equity stocks. The futures pricing is directly linked to the underlying asset, although leveraging a futures position could exacerbate potential losses.
The primary advantage of futures is that traders can speculate on future prices of commodities, assets or stocks and earn profits with a small initial margin. The downside is that leveraged futures can also create losses larger than the margin if the price movements are unfavourable.
Futures contracts have a fixed expiry date, and the buyer and seller are obligated to fulfil their side of the contract. However, most investors will exit the trade beforehand or roll over the futures contract.
There are several ways to close out a futures position, such as selling the contract or buying an offset contract.
Futures and options are both derivatives with pros and cons. Futures have greater leverage and more liquidity but are also more complex.
Related Articles, Guides and Insights
Below is a list of some related articles, guides and insights that you may find of interest.
Questions or Comments?
We love to get feedback from our readers. So, after reading this article, if you have any questions or want to make comments, send us a message on this site or our social media.
Don’t forget that you can also request the guides sent directly to your email inbox.