The number of investors and traders has grown over time with easy access to the financial market. The market provides a plethora of trading/investment options. You can invest in debt instruments, fixed deposits, equities, and other assets through the cash market or by taking a position in them through futures trading. But have you ever thought about how futures are different from other instruments? If not, here is the explanation.
How is Future Trading different from other financial instruments?
Futures are derivatives that allow you to speculate on the price of underlying assets and agree to trade on that price at a later date. But in bonds or stocks, your position relies on their current price on the exchange.
Investing in stocks in the cash market gives you a stake in the company based on your holdings. You can even participate in crucial company decisions if you have considerable shares of that company in your portfolio. However, you are ineligible for this benefit when trading stock futures.
The asset delivery time in the cash market is typically T+2 days. On the other hand, futures contracts will expire after the agreed-upon date.
You must pay the entire current market price upfront if you want to invest in bonds, stocks, or other assets. In contrast, futures only require margin money set by the SEBI and is typically 5% of the underlying asset’s notional value.
5. Lot size
Each underlying asset has a minimum lot size for which you can place a future and options trade. For example, the single contract size for trading Nifty 50 futures is 50 shares. The lot size for specific stocks, such as Infosys, is 300. If the current price of Infosys is Rs 1655, a single future contract would cost around Rs 4,96,500. However, if you invest in stocks directly on the cash market, you can buy a single share.
If you own stocks, and that specific company performs well and makes a sufficient profit, you are entitled to a dividend. It is entirely up to the company whether or not to declare dividends. On the other hand, holders of stock futures contracts are not eligible for this benefit, even if there is a dividend declaration.
7. Holding period
If you invest in stocks, you can hold them for your life. Similarly, the bonds’ maximum holding period is subject to their maturity date.
But in the case of futures, you must place the trade on the expiry date.
Stocks and futures are both high-risk investments. If the market is bearish, the only way to limit your losses in the cash market is to set a stop loss.
However, in future, you can take a reverse position on a similar underlying asset if you believe the price swing will be against you.
Here is a quick overview of the above differences.
|Ownership||You don’t get a stake in the company.||Investing in stock makes gives you partial ownership in the company.|
|Delivery||No delivery||T+2 days|
|Payment||Only margin money is required.||Complete payment|
|Lot size||You cannot purchase a single share.||You can invest in a single share or bond.|
|Dividends||You are not entitled to receive any dividend.||You are eligible for dividends.|
|Holding period||Till expiry period||Lifelong in the case of stocks.|
Futures differ from other financial instruments in terms of risks, holding period, lot size, and payment. Before implementing any trading strategy available on the market, you must first evaluate your financial goals and current portfolio.