The UK stock market is one of the most important globally, and its futures markets are used by a variety of participants to trade and hedge risk. In this article, we’ll look at what stock and stock market index futures are, how they work, and some of the key benefits they offer investors.
What are stock futures?
Stock futures trading allows investors to buy or sell a specified number of shares of a single stock at a predetermined price on a specified date. They’re typically used by investors who view where the underlying stock price will be at the time of expiration but don’t want to take on the risk of holding the stock itself.
What are stock market index futures?
Stock market index futures are similar to stock futures, but instead of being based on an individual stock, they’re based on a basket of stocks. The most popular index futures in the UK are based on the FTSE 100 Index, which comprises the hundred largest companies listed on the London Stock Exchange.
Index futures offer many advantages over stock futures
Firstly, they provide exposure to a broader range of stocks in a single contract. It can be helpful for investors who want to hedge their portfolios or take a view of the market’s overall direction.
Secondly, because index futures are based on a basket of stocks, they tend to be less volatile than individual stock futures, making them ideal for investors who want to participate without taking too much risk.
Thirdly, index futures are more cost-effective for trading the market than buying individual stocks. You only have to pay a single commission to buy or sell an index future, whereas you would need to pay commissions on each stock in the underlying index.
Fourthly, index futures offer greater flexibility in a trading strategy. For example, investors can take a long or short position in the market and use leverage to magnify their returns.
Lastly, index futures are traded on exchanges, which provide a regulated and transparent environment for trading as market performance can be easily seen and analysed.
What are the benefits of trading stock futures?
Stock futures offer many advantages for investors.
Firstly, they allow you to take a view of the direction of the underlying stock without having to take on the risk of owning the stock itself.
They also provide a way to hedge your portfolio against downside risk.
Additionally, stock futures offer greater flexibility in a trading strategy. For example, you can take a long or short position in the market, and you can also use leverage to magnify your returns.
Finally, stock futures are traded on exchanges, which provide a regulated and transparent environment for trading.
What are the risks of trading stock futures?
Stock futures are high-risk investments and not suitable for all investors. Before trading stock futures, you should carefully consider your investment objectives, experience level, and risk tolerance. You should also be aware that the price of a stock future may differ from the actual price of the underlying stock, and you could lose money if the stock price falls below the strike price of the futures contract.
In addition, stock futures are subject to margin requirements, which means you’ll need to have a certain amount of money deposited in your account to trade them. If the value of your account falls below the margin requirements, you may be forced to sell your position at a loss.
Moreover, stock futures are a leveraged product, which means that a small move in the underlying stock can significantly impact your account value. It can work in your favour if the stock price moves in the direction you anticipated, and it can also lead to losses if the stock price moves against you.
Lastly, stock futures are subject to market risk, which is the risk that the overall stock market will decline. This risk can’t be diversified away through an index or sector-based ETFs.
