Comparing stock trading with futures trading

While investors might think of stocks as the only way to trade, stocks represent only one asset class. One of the advantages of futures is that they allow trading of all asset classes. There are several asset classes beyond stocks or equities that hold numerous trading opportunities for individual traders.

While investors might think of stocks as the only way to trade, stocks represent only one asset class. One of the advantages of futures is that they allow trading of all asset classes. There are several asset classes beyond stocks or equities that hold numerous trading opportunities for individual traders.

Futures traders can trade products such as fixed Income, foreign exchange (FX) and commodity asset classes (energies, metals, grains, livestock). Should stocks not offer trading opportunities, or if a trader is looking to trade a non-correlated asset to diversify your risk, futures can often present trading opportunities.

Futures (as well as options) are classified as derivative instruments. A derivative is a contract that derives its value from the performance of an underlying entity. An underlying entity can be a stock index such as the S&P 500, a commodity such as crude oil or gold or interest rate. S&P 500 futures, Crude Oil futures, and Treasury futures are three examples of widely traded futures or derivative instruments.

Advantages of futures trading

Trading futures is not too much different than trading stocks or ETFs. Futures can even offer advantages not seen with other trading instruments. What are some of these advantages to futures trading?

1. Exceptional liquidity - Many futures contracts offer unsurpassed liquidity, more so in fact, than even the most liquid stocks or ETFs.
2. Small transaction costs - Commissions and fees are very low compared with the costs of stock trading
3. Capital efficiencies - The upfront deposit of “margin” to get into a futures position runs between 3-5 percent of the contract’s value allowing traders to more efficiently use their trading capital.
4. Around the clock trading - Stock traders do have pre-market trading and post-market trading that adds to the trading day. However, futures traders can enter and exit positions around the clock nearly 24 hours a day, 6 days a week.
5. Strategic advantages - There are strategies such as spread trading that simply can’t be done in stocks as easily. For example, to take advantage of the spread between Brent Futures and WTI crude oil futures, you would need to trade futures. This couldn’t be done with stocks.
6. Tax efficiencies - Gains on futures trades (depending on holding period & trader locale) are taxed more favorably that gains on stock trades.
7. Portfolio diversification - the ability to invest in asset classes not correlated to equities

Differences in trading futures and stocks

Now that you can see the many advantages of trading futures, let’s take a closer look at some of the logistical/mechanical differences in trading futures over stocks.

Trading venues and regulation — Stocks are traded on securities exchanges such as the NYSE, Nasdaq or other exchanges whereas futures are traded at futures or derivatives exchanges like CME Group. Stocks/ETFs and securities in general are regulated by the Securities and Exchange Commission (SEC) and futures are regulated by the Commodity futures trading commission (CFTC). This is important because it lends credibility to our markets.

Trading account structure — While stocks are traded out of securities accounts, futures can’t be traded from such accounts and require the opening of a futures account at a Futures Commission Merchant or FCM. Opening a futures account is a straight forward process that includes an account application/agreement, risk disclosure documents and some other pertinent documents that explain the nature of futures. Net worth and income statements may also be required as futures trading is not for everyone!! (that’s a phrase you will hear often in your learning curve)

Research/analysis — Both futures and stocks lend themselves to technical as well as fundamental analysis. Many traders are either fundamental traders, they take into consideration revenues, earnings, etc., or they consider technical analysis and analyze charts and various technical indicators to discern the direction of an investment. The same fundamental and technical indicators used in analyzing stock prices can be used when trading stock index futures. A 200-day moving average in a security is no different than one in futures.

Trading unit…shares vs. contracts and dividends — When you trade in stocks, you buy shares which represent a share in a business. You can hold shares of stock for a few hours or for a few years depending on your outlook for the company and the market. Many companies pay shareholders part of their earnings as dividends. Futures, on the other hand, are legally binding contracts or agreements to buy/sell a certain commodity or financial instrument in a certain quantity by a certain expiration date. For example, the holder of a December 2020 WTI Crude Oil futures contract confers the right to buy (and if desired, to take delivery) of 1,000 barrels of WTI crude oil at expiration. Unlike stocks, futures do not pay dividends.

Margin considerations — Margin is a term common to both stocks and futures, but they have significantly different connotations. When you buy stocks on margin, you put down 50% of the purchase price and borrow the other 50% and pay an interest rate. Margin with stocks requires a margin account as well. With futures, you put a small good faith deposit down (usually 2-6% of the contracts total value) and can meet that deposit with cash or treasury bills. There is no borrowing. Because of these differences, futures accounts are set up to trade futures in a way that doesn’t require a separate “margin account” per se.

Minimum price fluctuations (or tick) — All stocks trade in a minimum increment of a penny ($0.01). Apple Computer stock can move from 221.00 to 221.01…never a smaller increment. It could jump several pennies but never advance or decline by increments of less than $0.01. Each futures contract has its own characteristic minimum fluctuation or “tick”. For Gold futures, the minimum tick is .10. Since each contract confers 100 ounces of gold, that .10 tick represents $10.00 (= 100 oz x $.10/tick)

Investor protection — In the United States securities markets, certain levels of protection or insurance exist for investors. For example, if a stock brokerage firm were to go out of business the Securities Investor Protection Corporation (SIPC) provides for a certain amount of assets in an account to fall under SIPC protection much like FDIC insurance for bank deposits. For futures trading there is no SIPC or SIPC-like insurance. However, futures traders, especially those at CME Group, enjoy some of the highest levels of risk mitigation in the financial world. The clearinghouse continually monitors all FCMs, sets initial, variation and maintenance margins, and has the right to change margins. All profits and losses are debited and credited to investor’s accounts each night. In the very few instances where a futures broker ceased operation, futures accounts were transferred to other FCMs quickly and seamlessly. In the 180-year history of futures trading, there has never been a loss due to the failure of a firm

Ticker Symbols and Quotes — Like stocks, futures contracts have ticker symbols too but given they have discreet and multiple expiration months, they require some additional symbology. For example, the ticker symbol for the E-mini S&P 500 for December 2020 expiration is ESZ0 (ES is ticker symbol for E-mini SP 500. Z 0 is code for the December 2020 contract month). CLZ0 would be the ticker for WTI Crude Oil for December 2020 delivery.

Selling short stocks vs. futures — Selling short is technique that allows an investor to profit from a decline in prices. Selling short reverses, the old maxim from “buy low sell high” to “sell high, buy low”. Both stocks and futures allow this, but the mechanism for doing so is vastly different. With stocks, you must borrow shares, sell them and then subsequently repurchase and replace the borrowed shares (hopefully at a lower price). Stock short sellers are responsible for paying the dividends owed to the holder of the shares. With futures, no such borrowing of “shares” exists. You simply sell futures contracts if you anticipate a price drop and repurchase them at lower prices later. If the price rises, you may be forced to liquidate or offset your position at a loss. And since futures pay no dividends, the seller of a futures contracts need not worry about dividend payments.

Primary differences at a glance

Clearly, there are some mechanical differences between transacting in the two markets. The table below summarize the primary differences between stocks and futures.

Activities

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