Buying Stocks 101

Lately, there has been much in the press about futures markets - mainly negative press relating to oil markets. While, the futures markets have to shoulder some blame for the steep escalation of gas prices in 2008, that serves to underscore just how important they are to our capitalistic economy. Futures markets provide the foundation for wholesale prices, and ultimately retail, of just about every commodity regularly sold around the globe. And futures aren’t just about commodities; they involve stocks, bonds, and other mainstream investment vehicles as well.

So what are futures?

Simply, a future is a contract, referred to as a futures contract, and is held similar to a stock or a bond. But where a stock and bond represent equity and debt respectively, a futures contract sets the terms or conditions for delivery of financial instruments or commodities at a specified time in the future.

What is the difference between Options and Futures?

It is easy to confuse futures with options. Both are contracts, and both reference a specific asset being traded. But where a futures contract gives the buyer the obligation to purchase a specific asset, an options contract gives the buyer the option or the right to purchase that asset. Similarly, a futures contract obligates the seller to sell an asset at a specified future date, unless the position has been closed prior to the date of expiration. Another difference between futures and options is the cost of entry. An investor can enter into a futures contract with no cost upfront aside for brokerage commission, whereas an options position requires the payment of a premium. Think of it like this: no cost upfront for futures but you are obligated to buy or sell; a premium payed upfront for options but you have the option to buy or sell. The premium gets you out of the obligation. One other point is that futures are generally sold in larger positions than options.

What are some details about Futures?

Before trading futures, you need to understand some of the fundamentals. Futures contracts expire, meaning they cease to exist unlike buying stocks or bonds, so you are forced to make a decision: sell the contract to someone else and take your profit or loss or take delivery of the product represented by the contract. Also, futures contracts have daily price limits, meaning that they can only go so high or so low in a given day, due to the natural volatility of this type of security. Lastly, most brokers require that any investor trading in futures have a certain amount of money in their brokerage account, usually around $5,000. Again, this is due to the risk of trading futures contracts.

Are there any terms I need to know?

The futures market has it’s own language. Going Long means you believe the price of the underlying asset is going to rise, and therefore are investing in futures contracts on that asset. Being short means you believe that the price of the underlying asset it going to go down, and so you shorting futures contracts on the asset. Speculators are traders who are trying to make money due to the fluctuation of prices, but never intend to take delivery of the asset itself. Hedging is a technique used to manage risk, where you set up a trade that protects you if the market goes either way. Most of these topics require a post all to them selves so it would benefit you to do some additional research before tackling the futures market. Buying stocks and bonds is one thing; buying or selling futures and options is a whole other dimension of investing.

This entry was posted on Sunday, May 24th, 2009 at 3:08 am and is filed under Advanced. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.