Futures and stocks are two of the most widely available financial products to ordinary investors. Each of these investments may provide a return on your investment, but for very different reasons. Both include substantial hazards, although futures are often seen as riskier than stocks. Many investors gravitate toward one or the other, and they may be stock investors, futures hedgers, or market speculators. Should you invest in futures or stocks? To shed light on the subject, we compare the risks and rewards of investing in futures vs. stocks.
Investing in Futures, or futures contracts, and stock are two entirely different types of investments. Stock is an example of equity security. When you purchase a stock, you are a part-owner of a business. If the stock’s price increases above what you paid for it and you sell it, you earn a profit by capitalizing on the increase. You can lose money, but only up to the value of your stock investment plus transaction expenses.
When you invest in futures, you are essentially signing a contract rather than purchasing a piece of a company. The contract specifies that you will pay a specified price for the underlying item at a specified future date. In effect, you are betting that the underlying asset will cost a specific price on a specific day, the futures contract’s expiration date. A commodity or a currency may be used as the underlying asset, and however, it could also refer to a financial asset such as a stock or bond. Futures are typically short-term investments with a one-year or less maturity.
Futures, like stocks, are exchanged on an established exchange, and a futures exchange establishes the contract’s terms and makes it tradeable.
The most significant and noticeable risk associated with entering into a futures contract is that trades can go against you. For instance, suppose you purchase 10,000 gallons of gasoline on a futures contract for delivery in three months for $2 per gallon. If the price of gasoline increases to $2.25 per gallon by the futures contract’s expiration date, you, the buyer, profit. You paid only $2 per gallon. However, suppose the price of fuel lowers to $1.75 per gallon. You must continue to pay $2 per gallon to meet your contract obligations. As a result, you save $0.25 a gallon. Not only have you lost your initial investment of $2 per gallon, but you’ve also lost an extra $0.25 per gallon due to the depreciation in the price of gasoline relative to the price you agreed to pay.
Another risk associated with futures trading is the demand for margin. When you purchase a futures contract, you are often not required to pay the entire amount at the time of purchase. Alternatively, you can use your brokerage account to pay a portion of the contract’s value and borrow the remainder from your broker. Because futures contracts are marked to market, you may need to make periodic deposits to your margin account to meet your margin needs. A performance bond is a term that refers to your deposit. If you lose money on a futures contract, you will also lose the margin money. Additionally, you can sell futures short without requiring a market rise.
Even while the futures market is more liquid and arguably more efficient than the stock market, possibly the most significant risk associated with futures investing is the possibility of losing far more than your initial investment.
When you purchase a stock, you are truly purchasing a small piece of a corporation, even if all you receive is a paper certificate. Investing in stocks necessitates extensive research, which is only achievable if you have above-average financial and stock market understanding.
Stock vs. Futures
To determine whether to trade only stocks or futures, one must first comprehend the similarities and distinctions between the two. Among the similarities is the opportunity to diversify your investments; both stocks and futures markets can provide exposure to various businesses and sectors. Additionally, both classes of securities are liquid. You may typically buy and sell stocks at any time, providing you with convenient and rapid access to your money. Additionally, the futures market is exceptionally liquid, with futures contracts exchanged continuously.
Additionally, both stocks and futures can be used to generate cash. Numerous stocks produce current revenue via dividends. Futures contracts generate cash flow daily as they are marked to market, but that cash flow can be either positive or negative.
However, there is a significant difference between stock and futures, aside from the significantly more considerable risk associated with futures. Cost is one such distinction. Investing in stocks does not entail the significant transaction costs associated with futures trading. Additionally, their temporal horizons are markedly different. Typically, stock investments are made for the long term, in part due to the tax implications. Capital gains on short-term investments are taxed at a greater rate than capital gains on long-term investments. Futures contracts are short-term investments with a maturity of less than one year.
To summarize, here are the key difference between stocks and futures:
|Represents||A part of a company||A contract to buy or sell at a predetermined date and price|
|Issued by||A company||An exchange|
|Timeframe||Typically (not always) long term||Typically short term|
|Value at Risk||Traders can lose more than the initial investment||Max that can be lost is the initial investment (if the stock goes to zero)|
Consider all of these criteria when deciding whether to invest in futures or stocks (or both). Despite some of the advantages of futures trading, it is not a game for inexperienced or tiny investors. You’ll need a firm grasp of the futures market and the assistance of financial pros. However, investing is a personal decision that ultimately boils down to your risk tolerance, time horizon, and investment objectives.