Buy Stock Futures Online Easily
Most transactions in the financial market are settled immediately, futures do the opposite. These are not novel financial instruments in the market, on the contrary, they are even more ancient than, say, the Forex market. The question then remains, why invest in stock futures rather than the stocks themselves? Is there a difference between the two, and if so, which one is better? Here at BuyStocksEasy, our goal is to educate our visitors on the best ways to invest their money, and this is definitely something every investor should consider. By the end of this piece, you should be an expert in stock futures so as to choose if you want to be an investor.
What are stock market futures?
In order to understand stock futures, we need to understand what futures are, to begin with. The term futures actually refers to a futures contract. From the name, you should already tell that there are two parts involved – future and contract. The first part about the future is what sets this financial instrument apart from most others because the two parties involved agree to settle the deal at a predetermined time in the future. The second part seals the deal through a contract, which is legally binding to ensure that the parties both hold up their ends of the deal.
A futures contract can be created for any financial asset that is available, whether commodities, currencies, indices and even individual stocks. In fact, the first futures contracts were created mainly for agricultural commodities. Farmers wanted to ensure that their crops would be bought at a particular price and not be subject to shifting prices due to supply and demand. To achieve their desired price, they would strike a deal with buyers to deliver a particular amount of crop at a specific time and predetermined price. With time, futures contracts were extended to other products and creating the robust futures market we have today.
All futures contracts are traded through an exchange just like you would shares or ETFs. Some of the top futures exchanges are:
- Chicago Board Options Exchange (CBOE)
- Chicago Board of Trade (CBOT)
- Chicago Mercantile Exchange (CME)
You may have noticed that most of the above-listed exchanges are based in Chicago, and that is because it’s the location of the first futures exchange, the CME. Also just like the stock market, each exchange has different offerings of futures. In fact, futures exchanges can be somewhat specialized in specific assets. For example, the CME Group that includes CME and CBOT exchanges deals mainly futures on agricultural products, currencies, indices and 2 metals – gold and silver. This means that if you want to buy, say, copper futures, you will only find these at the London Metals Exchange or New York Mercantile Exchange (NYMEX), where you will also find oil futures. Therefore, if you want to trade in futures, you have to identify where the particular futures contract you want is being traded.
Now that you know what futures are, it’s not too difficult to understand stock futures. However, more often than not, futures are created for stock indices rather than individual stocks.
What is involved in a futures contract?
To enter into a futures contract, two conditions have to be agreed upon – the initial margin and the specifics of the product. An initial margin amount has to be put up to protect both parties from reneging, otherwise many traders would simply walk away. The margin can range anywhere between 2% to 20% of the value of the underlying asset. The actual number will be decided upon depending on the volatility of the product in the open market. When volatility is high, margin increases to protect the parties involved. Therefore, something like currency futures for the sterling pound has a higher margin because the currency is very volatile as a result of the Brexit negotiations.
The other part of the futures contract is where the specifics of the deal are spelled out. This used to be especially important in those early days when they were most commonly used for agricultural products. To satisfy both parties, the first expiration date and time must be agreed upon. This represents the exact time when the contract matures and delivery is expected. If you look at any of the futures contracts available from The Best Trading Brokers, you will notice that they are all tagged by a month, for example, Cotton #2 Jul ’19. This shows you the expiration date of the contract.
Then the price must be determined, which is the price at which the parties will settle the contract. Once the contract is made, this will be the price of the security regardless of the market prices at that time. One party is bound to lose money, but then again that is the whole point of financial markets – a zero-sum game.
Finally, the state of the product needs to be indicated clearly. This is most relevant for commodities and not so much for indices, currencies or stocks. Imagine a futures contract involving gold; that contract must indicate the exact weight of gold to be bought and its quality. This protects the buyer from low quality products while ensuring the seller does not slack off. Lastly, the method of delivery must also be specified whether in cash or physically.
How does a stock futures contract work?
For you to really understand how a stock futures contract could work, it’s worth looking at an example that you might find yourself in. At BuyStocksEasy, we constantly analyze various stocks and you can pick one yourself and use our calculators to estimate future price. One of the hottest picks is Amazon with lots of upside potential, so let’s go with that. Imagine you want to buy futures for Amazon stock, but not at the moment because the stock is in a downturn. For the past month, prices have decreased by almost 10% as you can see from any of the brokers listed by The Best Trading Brokers. About a month ago, the share price was around $1,960 and this is now down to the $1,800 region.
Maybe you think prices will keep dropping for a few weeks to $1,700 before going up again above $2,000 and don’t want the drawdown of waiting. So you decide to set up a stock futures contract. Your contract dictates that you will buy 100 shares of Amazon in August at $2,000, costing you $200,000 in total. Due to volatility in the US securities market, the broker demands a 10% margin, and you put down $20,000.
Your broker will have to sell the shares to you at this price on the expiration date regardless of the market price at that time. If your hunch was right and Amazon shares are trading at, say, $2,200, you will have saved yourself $200 per share. On the other hand, if prices continue to drop or don’t rise above $2,000, then you will be holding overpriced shares.
These futures contracts are mainly used by investment banks and hedge funds to protect their funds from drawdown, but a speculator can also use it to make money. In the above example, the trader who gets the shares at $2,000 is able to sell them at a market price of $2,200 and make $200 per share or $20,000 in total. Moreover, futures contracts can be traded at an exchange. One doesn’t have to keep holding on to the contract until expiration but can sell the contract itself and transfer the responsibility of delivering the product to another person.
How to buy futures online
There is obviously an advantage in buying stock futures as we have seen in the above example, but how do you go about it. The first clue comes from the operation of futures contracts – they are traded through an exchange. Whenever something is traded through an exchange, a broker has to be involved because exchanges couldn’t handle all the individual traders.
If you need tips to find a broker, The Best Trading Brokers has got you covered. Choosing a futures broker is hard because there are many fraudulent brokers out there, which is why you need such a service to weed out the bad apples. Cases of scams perpetrated by fraudulent brokers have been on the rise due to the proliferation of online trading. It used to be that investors had to walk into a broker’s office, and at least that eliminated some fraudsters who were too afraid to show their faces. But now they can hide behind computer screens and do the same thing; worldwide.
Thanks to The Best Trading Brokers, we can now confidently recommend the best brokers to use if you want to trade stock futures. These names will seem familiar, and that is because many of these brokers have proven themselves to be well-rounded and effective in their service provision. Some of them are:
- Interactive brokers – these are among the best futures brokers because they have the lowest commissions as per the quality of their services. Many brokers may claim even lower commissions, but what good is cheap and crappy service that will only cost you more than you gain
- TD Ameritrade – trading with this broker will cost you a bit more, but The Best Trading Brokers recommends them for their other features such as educational and research material as well as trading apps for mobile and desktop devices
- Charles Schwab – this broker attempts to balance between the previous two brokers by offering excellent services at a low cost. They have managed to succeed in doing this, and they are our top pick
Just because The Best Trading Brokers helped you identify the best broker should not tempt you to rush ahead. There are still some more things you need to know about trading stock futures, mainly the costs involved. You will notice that brokers don’t impose a minimum required deposit for you to start trading, but you must have enough to cover the margin. The margin will vary from day to day as the price of the stock fluctuates and your account balance should be able to withstand these variations. Consider the example of Amazon stock mentioned earlier valued currently at about $1,800 and need a 10% margin – $180. Now imagine that the value of Amazon stock shot up to $2,500; the required margin would now be $250. That may not seem like much, but it’s a huge increase when trading hundreds or even thousands of shares. Therefore, you must ensure that you have the necessary capital to weather drastic changes in market price over a long period of time.
When deciding on the amount of capital needed, you have to consider risk management principles – do not risk more than 1% of your capital. Imagine that one tick in Amazon share price is $1 and you place your stop loss 10 ticks away from the current market price. That means that the total amount you’re risking is $10, and given the 1% rule, you ought to have at least $1,000 capital in your trading account. It’s possible to raise the risk level to 2% to lower the amount of capital you need to trade. This is a bit riskier, of course, but may be necessary sometimes. Just remember not to push the risk parameters too far or you might lose a lot more than you could ever make. That is how you end up receiving margin calls and perhaps even, God forbid, a stop out.
When trading stock futures, also take into account the liquidity of the market you intend to trade. Assets with a lot of liquidity are more heavily traded day to day and thus have a low margin requirement, unlike less traded ones. For instance, Amazon stock will have a lower margin compared to penny stocks. The less liquid penny stocks will have a higher margin requirement and thus require you have more capital. Besides, trading these low liquidity stock futures is not exciting for day trading because there are little volatility and price fluctuations. That being said, all you need is good information that you can find right here at BuyStocksEasy. Whatever company you have in mind, just search for it and find out more about its financial performance. We will also keep you up to date with the latest news announcements so that you can trade effectively. Through any of the brokers recommended by The Best Trading Brokers, you will be able to have great access to the stock futures market.