When it comes to deciding between stocks and futures, it’s not like you are suddenly between a rock and a hard place. That’s because both investment vehicles have their unique risks and rewards.
Most people are more familiar with investing in stock markets than investing in futures markets. They know the basics of equities, including that when you invest in a company, you’re buying a piece of it, or a “share.” And you can hold those shares outright or through mutual funds.
With futures, you are not investing in a corporate entity. Instead, you’re buying a contract to have exposure to physical assets, ranging from corn or soybeans to coffee or oil. You may also buy futures contracts to cover stocks, bonds, currencies, even the weather. In stocks, you may well hold that share certificate in your hand, or at least see the security represented in your online account.
In futures trading, however, you don’t want to wake up one morning and find a truckload of pork bellies in your driveway. Because with futures, it’s unlikely you want to take physical delivery of the commodity you’re investing in.
Stocks and futures do have some similarities. Whether you’re buying shares or futures contracts, you’re likely working with a broker. Both types of transactions are facilitated through an exchange, such as the New York Stock Exchange for stocks or the Chicago Mercantile Exchange for futures.
For many people, investing in futures is a way to diversify into a much different investment sphere — one that requires using diverse strategies.
When you invest in equities, the number of shares offered by a company is finite, until they decide to sell more on the market. Stocks don’t typically expire while the company is a going concern. So, “buying and holding” is a common strategy for long-term equity investors. But with futures contracts, you agree to buy or sell a commodity at a future date. With futures, it’s not about the buying and holding, rather it’s a technique that involves entering and exiting the market.
When you buy a stock, the money will be withdrawn from your account at the time of purchase. But with futures, your broker will require a certain amount of cash up front, called margin, to cover any potential losses.
If you’re familiar with moving anything heavy, it’s good to have leverage. One of the biggest advantages of investing in futures is that you put down a relatively small deposit to gain leverage over a larger asset.
Here’s how it works. Let’s say you want to invest in the gold market but don’t want to hold the precious metal in your hands. Instead, you may buy a futures contract covering 100 ounces of gold. In our scenario, gold is trading at $1,250 an ounce.
The exchange you are dealing with might have a margin requirement of $4,950. If you do the math, you can see with an original investment of less than $5,000 you have leverage over $125,000 worth of gold. Then the trick is knowing when to exit the contract to make a profit or to avoid losses as the price of gold — the underlying asset — fluctuates.
To sum up, investing in stocks or futures entails different sets of risks and rewards. But as always, investors in either vehicle need to stay informed, including working with a financial advisor to ensure they’re making the right choices.