Investing in stock futures is an excellent method to hedge your investments so that market fluctuations don't lead to major financial losses. You won't be immune to market ups and downs, but you will be shielded to some extent. That said, investing in stock futures is risky business. Take the time to learn all about it with our very informative quiz.
Stock futures work like this: Two parties enter into a contract to buy or sell a specified amount of stock for a specified price on a specified future date in an attempt to shield themselves from wild fluctuations in the stock market.
When you invest in traditional stocks, you only make money when the price of your stock goes up. In the case of stock market futures, you can make money even when the market goes down.
Dividends are paid to stockholders on a fixed schedule and stockholders are entitled to attend stockholder's meetings. When you invest in stock futures, you are not a stockholder.
The two positions on stock futures mirror each other. The long position agrees to buy the stock when the contract expires, whereas the short position agrees to sell the stock when the contract expires.
If the value of your investment falls below the agreed upon maintenance level, your stockbroker may issue a margin call, requiring you to pay him extra money in order to bring the value of your futures contract back up to the maintenance level.
To protect yourself against market downturns, you can take opposite positions on the same investment in stock futures.
With a calendar spread you can go both short and long on the same stock future with two different delivery dates. In one example, you might agree to sell 100 shares after a month and in the other, you agree to buy 100 shares after six months, thereby making money on both short-term losses and long-term gains.
When you go short and long on two different futures in related markets, you count on one stock future's loss being the other's gain.
If you buy futures contracts in competing companies like Microsoft and Apple, you hope that one stock future will outperform the other, but not in such a way that they cancel each other out.
Starting out with the same amount of money, you can buy many more futures contracts than actual stock shares. This ability to buy stock futures by leveraging -- also called buying on margin -- is what makes them such a popular investment.
When you buy traditional stocks on margin, you are basically borrowing money from your stockbroker and using the stocks themselves as collateral for the loan.
Investing in stock futures can be very risky business. If something goes wrong, you can end up not only losing your initial investment, but owing more money, as well.
Between 1982 and 2000, the trading of single stock futures was banned in the United States. The Commodity Futures Modernization Act of 2000 reintroduced such trading to the commodities marketplace.
Single stock futures are traded on the OneChicago exchange. Individual investors are called day traders and they use online brokerage services to trade stock futures
To reduce your investment risk, you might prefer to invest in a commodity pool -- a large group of investors who pool their money to buy stock futures. A major advantage is that a commodity pool is managed by an expert team of brokers.