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Stock Futures – The Basics

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There are two basic positions on stock futures: long and short. The long position anticipates an increase in the price of a stock, while the short anticipates an increase in the price. If you believe that the value of your stock is going to decrease in a month from what it is now, you should go long on the position. You may even call this a “biased position”. Your objective is to take advantage of a falling market if the price moves in your favor.

The 100 shares represents the total number of shares that exist out of which one can purchase futures contract. You should only buy a futures contract if the market has reached the point where it is expected the market will drop by or more than the current sale price of 100 shares. If the market continues its rise, you should sell off all of your shares before the futures contract matures. The sale of all of your stocks must be done by the day of the first anniversary (in the case of a stock) or the day of the last anniversary (in the case of a bond). You should do your calculations and determine if you are at risk for selling if the market rises by this much.

There are two types of stock futures contracts, you can buy: cash futures and equity futures. A cash futures contract gives you the right to buy or sell a certain amount of stock at a fixed price when the contract matures. The price you pay is equal to the present price plus the amount of the discount you are getting from the discount that is offered to you. In other words, the present price is determined when you buy the stock. Equity futures gives you the right to own a certain amount of stock or equity.

How do you know when to buy? Sellers indicate their price with a market order. Buyers usually use a third party to make this decision for them. Either way, there are standard rules for determining the prices for a futures contract.

The primary rule is that buyers order the amount they wish to buy or sell, not the quantity they actually own. They call this minimum order amount. When the stock price falls below this amount, the order is dropped. When the price goes above this amount, the order is raised. No buyer is allowed to place a market order for a stock that has fallen below this order level.

There are three distinct periods during which a futures contract is traded. Short-term trading occurs during the day and is done using a debit account and non-cash options. These include put and call options. Mid-day trading occurs during the mid-day and is done with cash and credit account. Both of these periods are popular because of their ease of execution and low costs.

Investors must understand that an important feature of all orders is flexibility. The price can change without warning at any time. This makes hedging a very appealing strategy for investors who seek safety in the face of stock price fluctuations. In other words, hedge your position with an order that is counter-trend and will reverse once the stock or futures contract becomes oversold or overbought. This type of position can be used to protect your downside risk while still generating a modest annual return.

Finally, when an investor is purchasing stock as a long position, the best time to purchase is when the price is low. Once the option expires, the risk to loss is zero. If you buy when the option is valued at its strike price, you lose only a percentage point of profit. Therefore, it pays to buy as early as possible.

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