Futures are legal derivative contracts to buy and sell an underlying asset at a predetermined time and price in the future. The asset can either be a commodity or a financial instrument like currency. At the same time, stocks are securities representing ownership of a fraction of a corporation or company. When you purchase stocks, you own a piece of the company. Both futures and stocks are similar in that they may offer returns on your investments and are a way to build wealth. However, there are fundamental differences between the two.
Stocks involve equal security. Investing in stocks buys you a piece of the company which means you can profit by selling when the stock price goes up. With futures, you don’t own part of the company. Instead, you are signing a contract that stipulates that you will pay an agreed price for the underlying asset in the contract at a particular time in the future. You are, in effect, placing a bet that the asset will cost a specific price by the expiration date of the contract.
Another difference is that when you buy futures, your broker requires a certain amount of money upfront (this is called a ‘margin,’ and it is usually 10% of the contract value) to cover up potential losses. This means that you don’t need to make an outright purchase of anything; you are simply entering the buy-side of the agreement. However, your broker will require you to pay a certain sum of money for a margin account. The minimum margin differs for every commodity. As a trader on the buy-side of a futures contract, if the asset (commodity) ‘s value falls, your contract loses value. Your broker also reserves the right to liquidate your position if your unrealized losses exceed the minimum margin (margin call).
On the other hand, with stocks, you don’t have to concern yourself with margin calls as you are making an outright purchase from the beginning of your investment. You need to have enough money in your account to pay for the stocks and your broker’s commission.
Future contracts are made on a short-term basis with a maturity of less than a year, while stock investments are made for a longer term.
Futures and stocks are facilitated through exchanges such as; the Chicago Mercantile Exchange (commodity exchange) or the New York Stock Exchange (stock exchange) for futures and stocks, respectively. The commodity exchange brings people who are willing to take a risk for the chance to make a profit for taking the said risk, while the stock exchange connects investors with businesses that need capital and facilitates the transfer of property rights.
However, futures and stocks do share some similarities, like the ability to diversify investments in an array of industries and sectors. Both also generate wealth through cash flows and dividends. In addition, futures and stocks are both liquid securities meaning their assets can be quickly converted into cash without losing value.
One advantage futures have over stocks is that it gives you leverage since you are putting down a small deposit to gain a more significant asset. For example, let’s say you invest in 100 gallons of oil selling at $100 per gallon with a margin requirement of $800. Your $800 of original investment gives you leverage over $10000 worth of oil. However, it is essential to know when to exit the contract to avoid losses as the oil price fluctuates.
And that’s about it on this article about futures vs. stocks. Investing in futures or stocks, especially for an amateur investor, requires a proper understanding of their different risks and rewards. Before you decide to invest in any or both, it is best to consult with a broker or financial advisor who understands your goals and timelines. You can also do your research on how the stock market works. Stock latest is a great place to start. Hopefully, this article has shed some light on the differences between futures and stocks.