Advantages of Trading Futures vs. Stocks (2024)

Futures are derivative contracts that derive value from a financial asset, such as a traditional stock, bond, or stock index, and thus can be used to gain exposure to various financial instruments, including stocks, indexes, currencies, and commodities.

Futures are a common vehicle for hedging and managing risk;If someone is already exposed to or earns profits through speculation, it is primarily due to their desire to hedge risks.

Future contracts, because of the way they are structured and traded, have many inherent advantages over trading stocks.

Key Takeaways

  • Stock investors may have heard the term "futures" or "futures market," but thought to themselves that these esoteric derivatives are not for them.
  • While futures can pose unique risks for investors, there are several benefits to futures over trading straight stocks.
  • These advantages include greater leverage, lower trading costs, and longer trading hours.

8 Advantages of Trading Futures

1. Futures Are Highly Leveraged Investments

To trade futures, an investor has to put in a margin—a fraction of the total amount (typically 10% of the contract value). The margin is essentially collateral that the investor has to keep with their broker or exchange in case the market moves opposite to the position they have taken and they incur losses. This may be more than the margin amount, in which case the investor has to pay more to bring the margin to a maintenance level.

What trading futures essentially means for the investor is that they can expose themself to a much greater value of stocks than they could when buying the original stocks. And thus their profits also multiply if the market moves in his direction (10 times if the margin requirement is 10%).

For example, if the investor wants to invest $10,000 into the S&P 500 index they can either buy 25 shares of the SPDR S&P 500 ETF (SPY) priced at around $400 per share, or 1 E-mini futures contract with a margin requirement of $10,000. If SPY increased to $401, the investor would have made $25. Over that same period, the E-mini contract would have increased from $4000 to $4010 resulting in a $500 gain (1 index point = $50.00).

2. Future Markets Are Very Liquid

Future contracts are traded in huge numbers every day and hence futures are very liquid. The constant presence of buyers and sellers in future markets ensures market orders can be placed quickly. Also, this entails that the prices do not fluctuate drastically, especially for contracts that are near maturity. Thus, a large position may also be cleared out quite easily without any adverse impact on price.

In addition to being liquid, many futures markets trade beyond traditional market hours. Extended trading in stock index futures often runs around the clock.

3. Commissions and Execution Costs Are Low

Commissions on future trades are very low and are charged when the position is closed. The total brokerage or commission is usually as low as 0.5% of the contract value. However, it depends on the level of service provided by the broker. An online trading commission may be as low as $5 per side, whereas full-service brokers may charge $50 per trade.

Note that online brokers are increasingly offering free stock and ETF trading across the board, making the transaction cost proposition for futures a bit less attractive than it had been in the past.

4. Speculators Can Make Fast Money

An investor with good judgment can make quick money in futures because essentially they are trading with 10 times as much exposure as with normal stocks. Also, prices in the future markets tend to move faster than in the cash or spot markets.

A word of caution, however: Just as wins can come quicker, futures also magnify the risk of losing money. That said, it could be minimized by using stop-loss orders. Because futures are highly leveraged, margin calls might come sooner for traders with wrong-way bets, making them potentially a more risky instrument than a stock when markets move fast.

5. Futures Are Great for Diversification or Hedging

Futures are very important vehicles for hedging or managing different kinds of risk. Companies engaged in foreign trade use futures to manage foreign exchange risk, interest rate risk by locking in an interest rate in anticipation of a drop in rates if they have a sizable investment to make, and price risk to lock in prices of commodities such as oil, crops, and metals that serve as inputs. Futures and derivatives help increase the efficiency of the underlying market because they lower unforeseen costs of purchasing an asset outright. For example, it is much cheaper and more efficient to go long in futures than to replicate the index by purchasing every stock.

6. Future Markets Are More Efficient and Fair

It is difficult to trade on inside information in future markets. For example, who can predict for certain the next Federal Reserve policy action?Unlike single stocks that have insiders or corporate managers who can leak information to friends or family to front-run a merger or bankruptcy, futures markets tend to trade market aggregates that do not lend themselves to insider trading. As a result, futures markets can be more efficient and give average investors a fairer shake.

7. Futures Contracts Are Basically Only Paper Investments

The actual stock/commodity being traded is rarely exchanged or delivered, except on the occasion when someone trades to hedge against a price rise and takes delivery of the commodity/stock on expiration. Futures are usually a paper transaction for investors interested solely on speculative profit.This means futures are less cumbersome than holding shares of individual stocks, which need to be kept track of and stored someplace (even if only as an electronic record). Companies need to know who owns their shares in order to pay out dividends and to record shareholder votes. Futures contracts don't need any of that record keeping.

8. Short Selling Is Easier

One can get short exposure on a stock by selling a futures contract, and it is completely legal and applies to all kinds of futures contracts. On the contrary, one cannot always short sell all stocks, as there are different regulations in different markets, some prohibiting short selling of stocks altogether. Short selling stocks requires a margin account with a broker, and to sell short, you must borrow shares from your broker to sell what you don't already own. If a stock is hard to borrow, it can be expensive or even impossible to short-sell those shares.

The Bottom Line

Futures have great advantages that make them appealing to all kinds of investors—speculative or not. However, highly-leveraged positions and large contract sizes make the investor vulnerable to huge losses, even for small movements in the market. Thus, one should strategize and do due diligence before trading futures and understand both their advantages as well as their risks.

Advantages of Trading Futures vs. Stocks (2024)

FAQs

What are the advantages of trading futures vs stocks? ›

Here we will discuss the many key advantages of trading futures vs. stocks including increased leverage, 24-hour trading, unrestricted shorting, tax advantages and trading on a level playing field just to name a few.

What are the pros and cons of futures trading? ›

Future contracts have numerous advantages and disadvantages. The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.

Why do people buy futures instead of stocks? ›

If you trade in the futures market, you have access to more leverage than you do in the stock market. Most brokers will only give you a 50% margin requirement for stocks. For a futures contract, you may be able to get 20-1 leverage, which will magnify your gains but will also magnify your losses.

What is the main benefit of using futures for day trading? ›

One of the key benefits of futures trading is leverage. In other words, one of the major advantages of trading futures is that you can pay a margin and get the same benefit of buying the entire quantity of stock. The other advantages of trading futures include speculation, arbitrage, hedging, etc.

What's the difference between trading futures and stocks? ›

Futures are contracts with expiration dates, while stocks represent ownership in a company. The following chart may help delineate the major differences between them.

What are the advantages of futures vs forwards? ›

Differences Between Futures and Forwards
FuturesForwards
No counterparty risk, since payment is guaranteed by the exchange clearing houseCredit default risk, since it is privately negotiated, and fully dependent on the counterparty for payment
Actively tradedNon-transferrable
RegulatedNot regulated
2 more rows

What are the downsides of futures trading? ›

The Risks of Trading Futures

Basis risk: This is the chance that the price of the futures contract doesn't move the same way as the price of the asset. This means that even if your predictions play out with the prices for the underlying asset, you might not make out as well as expected.

What are the advantages and disadvantages of futures compared to forwards? ›

Futures are marked to market daily, meaning they are settled every day until the contract's expiration date. Forwards involve considerable risks for one of the parties. Futures contracts imply negligible risks for both counterparties. Transaction markings only occur twice: on the purchase and settlement dates.

What are the cons of futures options? ›

Cons
  • Costs: Trading options on futures can involve several types of costs, including commissions, bid-ask spreads, and, for options buyers, the premium.
  • Risk of Illiquidity: Some options on futures may be illiquid, meaning they are not traded frequently.

What are the benefits of futures? ›

Narrator: One use of a futures contract is to allow a business or individual to navigate risk and uncertainty. Prices are always changing, but with a futures contract, people can lock in a fixed price to buy or sell at a future date. Locking in a price lessens the risk of being negatively impacted by price change.

Are futures more profitable? ›

Neither market inherently offers more profitability than the other. However, here are some factors to consider: Trading Capital: Spot trading, especially with high leverage, might require less initial capital than futures trading.

Why are futures banned? ›

The futures and options (F&O) contract of any stock can be put under a ban to prevent heightened speculation activity. Typically, a ban, which is a restriction, is put in place when the total open interest, or OI, of a stock, crosses 95 per cent of the market-wide position limit (MWPL).

Do I need 25k to day trade futures? ›

You can day trade without $25k in accounts with brokers that do not enforce the Pattern Day Trader rule, which typically applies to U.S. stock markets. Consider forex or futures markets, which have different regulations and often lower entry barriers for day trading. Swing trading is another option.

What is the best time of day to trade futures? ›

Futures can be traded almost 24 hours per day. There are short pauses but traders can trade them any time, day or night. The most popular traded hours are 9:00am to 4 pm est.

What is the key purpose of futures? ›

A futures contract allows an investor to speculate on the direction of a security, commodity, or financial instrument, either long or short, using leverage. Futures are also often used to hedge the price movement of the underlying asset to help prevent losses from unfavorable price changes.

What are the cons of futures trading? ›

Following are the risks associated with trading futures contracts:
  • Leverage. One of the chief risks associated with futures trading comes from the inherent feature of leverage. ...
  • Interest Rate Risk. ...
  • Liquidity Risk. ...
  • Settlement and Delivery Risk. ...
  • Operational Risk.

Is trading futures riskier than stocks? ›

That said, generally speaking, futures trading is often considered riskier than stock trading because of the high leverage and volatility involved that can expose traders to significant price moves.

Why futures are safer than options? ›

1. Which one is safer futures or options? Options are generally considered safer than futures because the potential loss in options trading is limited to the premium paid, whereas futures carry higher risk due to potential unlimited losses resulting from leverage and market movements.

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