US Stock Futures
What are US Stock Futures?
For those who are considering investing to expand their portfolios, US stock futures offers an interesting choice. Stock futures do not work the same way as buying stock in a company. And that difference is important to understand for those who want to take advantage of what US stock futures offers.
What are US Stock Futures?
Stock futures are contracts that obligate the buyer and seller to make the transaction at a pre-determined date with the agreed upon price. Instead of purchasing the stock immediately, the transaction is delayed for weeks or months until the date is reached. At that point, the buyer will pay the seller the price that was agreed to in advance.
The purchase is made regardless of the current price of the stock or commodity. This is the function of stock futures as they allow buyers and sellers the ability to take advantage of pricing depending on their ability to correctly gauge future prices.
In some ways, futures are like derivative products. Because the value is based on the current value of the underlying asset, they can be considered derivatives. And as with many derivatives, they can be leveraged financially.
The futures market has its own market and exchange rates separate from standard stock trading. The market is regulated by the Commodity Futures Trading Commission or CFTC. This is a federal agency created in 1974 to oversee and ensure the integrity of the market. From regulating brokerage firms to stepping in when abusive trade practices are detected or reported, the CFTC is there to step in.
How US Stock Futures Work?
A good example of stock futures can be found in the relationship of the grocer and the farmer. The grocer knows that the crop of the farmer will come in at a set time in the future. Instead of waiting for the crop to mature, the grocer instead pays for the crop today at a set price. It’s quite possible that in the months before the crop is ready, the actual price may shift considerably. However, the grocer has already locked in the price in the contract with the farmer.
The risks and rewards are obvious. If the price of the crop goes up before it is ready to send to the grocer, the grocer saves a considerable amount of money. However, if the price drops then the grocer has lost money as they could’ve paid for the crop at the lower price when it was ready for the market.
US stock futures work on the same principle. You do not purchase the stock itself, but rather you enter a legal agreement that on a date set in the future you will pay the agreed upon amount for that stock. The future itself is identified in part by the month it is due. For example, a October futures is a contract that expires at the end of October.
Predicting the Future with US Stock Futures
Because the prices are locked in advance, the stock market itself is often driven or at least influenced by the futures market. You may see this on the news or with financial information programs that look to the futures market to see what commodities and other items in-demand three to six months from might be now.
For example, a rise in the purchase of oil futures may signal a shift in the oil market. Such a move might be interpreted as an upcoming shortage in the production or delivery of oil. Or, it may relate to outside events that might influence the oil industry. Quite often, the activities of the futures market influences the rest of the markets.
US Stock Futures are Not Futures Options
This can be confusing as there is a difference between US stock futures and futures options. Both are virtually identical except for one aspect. Stock futures are contracts in which both the buyer and seller must go through with the deal at the agreed upon time. Futures options provide the holder of the stock the right, but they are not obligated to exercise the contract.
In other words, stock futures are mandatory in terms of following through with the deal. While futures options are not. Keep in mind that futures options have their own market and exchange rates different from stock futures.
Types of US Stock Futures Available
For those interested in purchasing stock futures, there are several types that are available.
The following is a list of the most common types of US Stock Futures that you may purchase on the market:
- Stock Index Futures: For example, the S&P 500 Index
- Commodities: For example, oil, wheat, or gas
- Precious Metals: For example, gold or silver
- Currency: For example, the US Dollar or Euro
- US Treasury Bonds and More
From this list, you can choose the ones for purchase on the futures market. This provides you flexibility to take advantage of the market at a pre-set date.
Pros & Cons of US Stock Futures
There are definite advantages along with some risks investing in US stock futures. Depending on your ability to predict future trends in the market, you stand to gain considerably from your purchase. Conversely, you may be stuck with paying far more than the current market value.
Advantages of US Stock Futures
To hold the futures contract, you need only make a small deposit. This will ensure that the contract is upheld for its full length. The low deposit means less out of pocket expense and keeping more if you have guessed correctly as to the future price of the item in question.
Companies can protect their investment in the products or raw materials they produce by selling on the futures market. By having a pre-set price, it can help protect such items from being sold at a far lower value. The futures market allows the company to seal in a price regardless of the fluctuations that occur when they are eventually sold.
A savvy or lucky investor can cash in on getting an excellent deal on US stock futures by paying a price that may be far lower than market value in the time that it is purchased. This type of purchase makes it possible to buy low and then sell high when the market price peaks.
Of course, there is considerable risk involved when making purchases on stock futures. Before taking the plunge, it is best to know the downsides.
Disadvantages of US Stock Futures
Just as you can reap considerable rewards from guessing right, so too can you guess wrong and wind up paying far more than the item is worth. This is the chance you take when you try to predict future prices.
Companies that engage in stock futures run the risk of missing out on opportunities because they locked in the price of their product. For example, during the last gas shortage which caused prices to rise considerably, companies that had locked in their prices on the futures market found themselves missing out on considerable profit.
You might say that the risk of purchasing stocks today and on the futures market is for the most part the same. The only difference is that you own the stock now compared to waiting to pay for the stock at a future point.
Cash Settlement of US Stock Futures
One of the most asked questions about US stock futures is what happens if you hold the contract until it expires without making the purchase? The answer is that you may be able to pay a cash settlement that is based on the increase or decrease of the underlying asset. In practical terms, if you have made the agreement and the price turns out to be far different than you predicted, then instead of fulfilling the contract you instead pay a cash settlement.
The settlement will be based on whether the asset has increased or decreased in value. So, you will be paying something, but not as much as if you had fulfilled the contract. However, some futures contracts will mean the physical delivery of the product itself. The investor holding the contract will need to pay for the handling, storage, and insurance of the asset. This is usually for physical products such as food, oil, and the like.
Selecting a Futures Broker
If you are interested in US stock futures, then you will need the services of a broker to help you make the best-informed decisions. The broker provides access to the markets where you can invest in stock futures. You will need to choose a broker that has experience in the field, can relate information on the activity of the stocks, and offers a fair price for their services.
Keep in mind that even the best stock brokers in the futures market cannot make accurate predictions all the time. If they could, they would all be quite rich by now. Instead, the best that they can do is provide the available information and past stock trends that might give insight into which areas to invest. The rest is up to you. Your ability to succeed in US stock futures will depend mostly on your ability to read trends, make the right purchases, and luck.