Also known as index equity futures, stock market futures are agreements to purchase or sell a particular amount of a security, commodity, or stock at a set price on a stipulated date in the future.
The legally binding agreement must be fulfilled either through cash settlement or by physical delivery.
Currencies, indexes, and several commodities are traded in futures, giving traders a wide range of investment products. Stock futures have become popular among traders because they can easily be purchased and resold as long as the market is open.
What are stock futures?
When a person buys a stock future, they are not purchasing or disposing a stock contract. Instead, they are getting back into a stock future agreement or contract to purchase or dispose of the stock cert using an agreed price on a particular date.
Unlike conventional stocks buying, the buyer doesn’t own the stock, meaning they are not entitled to dividends. They also cannot attend shareholder meetings.
However, the good thing about stock futures is that you make money whether the prices at the stock market are high or low. This is different from traditional stocks where investors only benefit when prices are high.
There are two major positions on stock futures. The first one is known as long where an investor agrees to purchase a certificate as the expiry date approaches. The second one is a short position where an investor decides to sell when the agreement comes to a close.
If an investor thinks that the price of the stock will go up in the next three months, they will probably consider going long. On the other hand, if they think the price will drop within the coming three months, then they will rather go short.
Let’s see an example of a long position. It is February and an investor enters a futures agreement to purchase 100 shares of Apple stock at a price of $150 per share.
The contract price is $5,000 but if the stock value raises by the beginning of May, they will be able to sell it early and make some profit.
Assuming the price of Apple shares suddenly rises to $52 per share on April 1. If the investor sells the contract for 100 shares, they will make a profit of $200 because the new price will be $5,200.
The same thing applies to short positions. An investor enters into a futures agreement to sell 100 shares of Apple at $50 per share on May 1 for a price of $5,000. On April 1, the price of Apple shares dropped down to $48. The short strategy is to purchase back the contract prior to delivering the stock.
One of the most interesting things about trading futures is that the investor pays part of the price of the futures contract. This is also referred to as buying or purchasing on margin. A margin can be between 10 to 20% of the futures contract price.
How are stock futures calculated?
The fair value of stock futures is usually announced every morning on different business channels. The fair value depends on the cash value of the underlying index.
For instance the formula or method of arriving at the fair value of the S&P 500 futures is determined by taking the current S&P 500 and multiplying it by the interest rate.
How stock futures work
The price of stock futures is ever-changing. This means that investors are always on the lookout for any price changes to ensure that they don’t incur losses. A tick is the smallest price fluctuation that a stock future can make in a day at any given point.
The size of the tick is often determined by the stock futures being traded. For example, E-mini S&P 500 (ES) moves in $0.25 increments whereas cue oil (CL) moves in $0.01 increments (tick size).
Whenever there is a tick movement, it shows that the trader or investor holding the stock future has either gained or lost money.