Stock futures is a combination of two words, stock and futures. Both have their own complete existence. However, a combination of both of these adds some extra meaning. So, let’s find it out in this article.
WHAT ARE STOCK FUTURES?
Stock futures refers to the financial contracts in which, the underlying asset is an individual stock. Stock futures contract is an agreement, between two individuals or organisations, to buy or sell a fixed quantity of associated stock on a future date. The price of trading is also specified in the contract. Several standardised specifications, such as market lot size, expiry day, currency involved and method settlement, are also mentioned in the contract.
An investor can square up his/her position anytime till the expiry. The contracts can be either, first bought and then sold or first sold then bought. The duration of a contract’s expiry is different for different stocks. And also the size of a lot of different stocks is different.
HOW ARE STOCK FUTURES PRICED?
The theoretical price of a stock futures contract is total of current spot price and cost of carry.
Stock Futures Price = Spot Price + Cost of Carry
Spot price refers to the price at which the underlying stock trades at the time of performing a trade. Cost of carry is the cost incurred due to the investment. These costs mainly include financial costs such as interest cost on bonds, interest on loans used to purchase the security and other such.
However, the actual price of contracts depends upon the demand and supply of the associated stock. Generally, the futures price is more than the spot price of the stock.
For example spot price of Mindtree = 900
Interest Rate = 8% p.a.
Futures price of 1 month contract of Mindtree = 900 + (900*0.8*30/365)
= 900 + 59.17
DIFFERENCE BETWEEN STOCK FUTURES AND STOCK OPTIONS:
- In stock options, the buyer has the right to buy or sell them. However the time of buying and selling depends upon the investor. But in case of stock futures, the buyer has to sell and the seller has to buy the underlying stock within a fixed period of time, on which they both have agreed upon. They both are legally bounded, to do so.
- Risk return is symmetric in case of stock futures, but it is asymmetric in case of stock options. The risk involved in stock options is much more than stock futures. And also the return generated by stock options is more than stock futures. Stock options have the capability of doubling your money and also halving your money within the span of one month. But, stock futures lack this capability in general cases.
- The price of stock futures mainly depends on the price of underlying stock. But in case of stock options, the price depends on the volatility and price of underlying stock.
BENEFITS OF STOCK FUTURES:
- They offer high leverage. This implies that a trader with very less capital can take large positions. If the high leverage offered is used properly then, they can render very good results.
- As they are traded in large quantity every trading day, therefore they offer good liquidity. The constant pressure of buyers and sellers brings immediate fluctuations in price, but not drastic fluctuations.
- The commission paid on trading stock futures is very less. The commission or total brokerage is as low as 0.5% of the contract value.
- They cannot be easily manipulated.
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