Stock futures are best described by taking the term quite literally — binding contracts to buy or sell a particular stock at a predetermined price and on a set date. They can offer stability to both buyers and sellers by guaranteeing a price and a sale and can offer a way to generate profit if used to correctly speculate on the direction of the market.
How do stock futures work?
Let’s use an example, shall we? Buying a stock future means that you lock in an agreed price on a stock and an agreed date that you’ll purchase that stock.
So let’s say you buy stock futures in Tesla (NASDAQ: TSLA). You decide that you want to purchase 100 shares of Tesla stock and the price is $1,000 per share. You also decide that you want to purchase these stocks in exactly three months’ time. You can enter into a Tesla futures contract which locks in both that price and that date.
Your futures contract has a price of $100,000 when you enter it. But if the price of Tesla stock goes up to $1050 before the three months ends, you’ve now made a profit of $5,000 on the contract. This can be used in many ways.
Why do people buy stock futures?
One of the main reasons people do this is to protect themselves against market volatility. By guaranteeing the future price, investors can “hedge their bets” against unfavorable price movements.
People also use stock futures to generate profit by speculating on the direction of the market. If an investor believes the price of a stock is going to rise significantly, they can use stock futures to guarantee a lower price. In the above example using Tesla, the owner of the futures contract could sell the contract before the three months had expired to collect the profit made on the stock.
One of the biggest attractions to buying stock futures is the fact that often you don’t have to pay the full amount upfront. Stock futures are often sold on margin. This means that you can secure the contract for a deposit of usually 10-20%. This allows investors to take much larger positions than they typically could if they were to buy the stock outright. This can be dangerous though as while the profits can be amplified, so too can your losses.
Stock Futures v.s. Stock Options
Stock futures and stock options are two terms that can often get confused. There’s one key difference between the two to look out for. Both allow you to buy stocks in the future at a set price and on a set date. However, stock futures are a binding contract that obligates you to follow through with the purchase. On the date specified, you have to buy the stock at the agreed price.
Stock options, on the other hand, give you the right to buy the agreed stock at the set price and date but do not obligate you to buy them. Options allow you to let the contract run out with no purchase made.
Should I Buy Stock Futures?
Buying stock futures can be very profitable, but they contain an immensely high level of risk. The ability to buy on margin can enable you to end up in debt larger than your initial financial investment. This is impossible when buying stocks outright, the most you can lose this way is what you put in.
Here at MyWallSt we truly believe in the value of buying and holding stocks you believe in over the long term. Futures can undoubtedly seem interesting and exciting, but when it comes to return on investment, buying and holding stocks offers the safest way to earn money.
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Financial Writer at MyWallSt
Pádraig’s favorite stock is Nike. Growing up as a sports fanatic, seeing Nike collaborate with athletes like Jordan, Lebron, and Ronaldo inspired him and cemented the brand in his mind. Now, despite having failed miserably in his attempts to earn a fabled Nike sponsorship, he still believes in the innovation and creativity behind Nike and is convinced they will only grow stronger as the world's leading sports brand.