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Futures 101 . . . Section 4

Section Four:

People who are new to futures markets are sometimes unclear about the differences between futures and stocks. Although futures and stocks do have some things in common, they are based on quite different premises. Futures are contracts with expiration dates, while stocks represent ownership in a company. The following chart may help delineate the major differences between them.

Futures vs Stocks

Futures
 Stocks
Trading
 Traded at an organized exchange
 Traded at an organized exchange or over-the-counter
Represents A commitment to buy or sell something in the future at an agreed upon price

 Ownership of a corporation
Issued by
 A futures exchange, which writes the terms of each contract and makes it available for trading, but does not specifically issue it

Buyers and sellers create an obligation when they enter into futures contracts

 A corporation
Maximum number that can be issued
 No limit to the number of futures contracts that can be
 Set by corporate charter

There are, however, position limits and position accountability in stock index futures
Investing
 Can be traded in expectation of making a profit, but can be a zero sum game
 Long-term positive expectation of return, but no guarantee of profit
Cash Flows
 In and out flows to traders’ accounts are based on daily marking to market – a debiting or crediting of each futures account based on that day’s changes in the price of the contract(s) held in each account

May receive dividends
Leverage
 Highly leveraged
 May be leveraged if purchased on margin, with a 50 percent margin being the standard (considered a loan from broker with interest required)
Ability to Sell Short
 Yes, as easily as buying long; no uptick in price necessary
 Permitted under special circumstances. A short sale can only be made on an uptick – when the stock price has gone up a tick
Money
 Buyers and sellers deposit a designated performance bond in an account; the amount is a percentage of the current value of the contract

As contract prices change, the accounts are debited or credited accordingly

 Buyer purchases shares

Margin may be paid as a down payment in some cases

Broker may ask for a margin call – a request for additional money from the person buying or selling on margin due to additional price changes in the stock

Monitoring
 Traders must be aware of expiration day and last trading time

 None
Risk
 Depending on price changes, more than the initial investment can be lost
 If the stock is not bought on margin the most that can be lost is the entire investment

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