How to Trade Stock Futures
Stock futures are similar to other futures contracts, like commodities, except the underlying security is a single stock. Stock futures were prohibited in 1932 to help stabilize Depression-era markets but were reintroduced as of November 2002. When you trade stock futures, you purchase a contract to buy (or sell) shares of stock at a fixed price by a predetermined expiration date. Unlike stock options, you are obligated to carry out the transaction. Stock futures can be traded on margin, while stock options cannot.
Other People Are Reading
Instructions
-
-
1
Learn the mechanics of how to trade stock futures. Stock futures are traded as standardized contracts of 100 shares. They are issued for a specified time period and expire on the third Friday of their final month. At that point they must be settled. This means you must buy (or sell) the actual shares unless you have an offsetting option contract (see Step 5). The attraction of stock futures lies in the fact that they can be traded on margin, allowing investors to leverage trades and increase potential profits.
-
2
Open a margin account with a brokerage firm. Trading accounts with margin privileges are similar to regular (cash) brokerage accounts, except that you are allowed to borrow money or stock from the broker. Because you buy a futures contract instead of the stock, there are no interest charges. However, this is considered a margin transaction because your potential liability is greater than the money you put up as a margin requirement. A margin account typically requires a $2,000 minimum balance, although for day traders this may be as high as $25,000.
-
-
3
Place an order to for a call (buy) or put (sell) futures contract with your broker. SEC regulations require a 20 percent margin. For example, if you purchase a contract for a stock selling at $25 a share, you must put up $5 a share or $500. If the stock goes up by $5 a share you make $500---a 100 percent profit, instead of the 20 percent you would make by buying the stock itself.
-
4
Keep up with daily fluctuations in the market price of the stock. The risk when you trade stock futures is as great as the potential profit. If the stock falls in price (or rises for a put futures contract) your investment decreases quickly and you will get a margin call. For example (using the example from step 3), if the stock falls from $25 to $23 a share, your margin falls to $3 a share, or 13 percent of the share price. You must then add more funds or the broker has to close out the account. Since small changes in price have such a large effect, you need to monitor the stock on a daily basis, if not more often.
-
5
Close out the transaction when you are ready. Very few stock futures contracts are actually exercised (that is, the underlying shares purchased and delivered). Instead, trades are normally settled by purchasing a second futures contract of the opposite type (a put if you are holding a call and vice versa). The two contracts simply cancel each other out at expiration.
-
1
Tips & Warnings
You can use put futures contracts to protect gains from regular stock purchases. If you have stock that has risen in price, a put contract bought at that price will gain as much in value as the stock loses if it declines (and the reverse if the stock continues to rise). Hedging stock investments this way is often done to hold stocks long enough to qualify for capital gains tax rates.
