Knowing the advantages of futures trading also important when you start learning the futures market. In this article, I will briefly explain some of the advantages of futures market. You can learn about disadvantages here.
- Limit downside risk in stock positions with futures
- Future trading is agnostic to market direction
- Take a consolidated view of markets or sectors
- High Liquidity
- No Time Decay Involved
- Stable Margin Requirements
- High Volatility
Advantages of Trading Futures
First advantage of Trading Futures is
Limit downside risk in stock positions with futures
Futures contracts can be a useful tool for managing risk in investment portfolios. Let us take a hypothetical example, You expect the market to correct by 10-20% due to macro concerns. However, you believe that would be temporary and markets would bounce back. You can hold on to your stocks and sell futures contract against that.
When the market corrects, you just sell the futures and the profits will help you to reduce the cost of holding your cash market stock position. The big advantage of futures contracts is not that they can be used for speculation but that they can be used to hedge your risk.
In the example above, selling futures against a stock position can help to limit downside risk if the market corrects. Futures contracts can also be used to hedge other risks, such as currency risk or interest rate risk. By carefully managing their futures positions, investors can help to protect themselves from losses in volatile markets.
Here is another example:
In the past, if you owned stocks and the market took a turn for the worse, there was very little you could do to protect your investment. However, with the advent of futures contracts, you can now limit your downside risk. For example, let’s say you own stocks in XYZ Corporation. You believe that the market will correct by 10-12% due to macro concerns, but you think this will be a temporary dip.
Rather than selling your stocks and taking a loss, you can sell XYZ Corporation futures contracts against your position. This will help to offset any losses in your stock portfolio. If the market does indeed correct by 10-12%, you can simply buy back the futures contracts at a lower price and lock in your profits. In this way, futures contracts provide a valuable tool for hedging your risk in the stock market.
Futures trading is agnostic to market direction
Future trading is a form of investment that is agnostic to market direction. This means that whether the market is going up or down, you can still make money if you have correctly predicted the price movement of the underlying asset. This makes futures an attractive investment for many people, as it provides the potential for greater profits than other forms of trading.
However, it is important to remember that futures contracts come with a high degree of risk, and you can lose money if you do not correctly predict the price movement of the underlying asset. If you are positive about a stock, you can buy it. That is simple. However, if you are bearish, you can either sell your delivery or you can sell short for intraday. Beyond that, you need to give delivery. That is a big constraint in falling markets. If you are positive, buy futures and if you have a negative view, then just sell futures.
Take a consolidated view of markets or sectors
When it comes to making investment decisions, it’s important to take a consolidated view of markets or sectors. This means taking into account all of the relevant factors that could affect performance – both positive and negative. For example, if you’re thinking about investing in a particular sector, you’ll want to consider things like economic conditions, company performance, sector trends, and so on. By doing your homework and taking all of these factors into account, you’ll be in a much better position to make informed investment decisions.
Advantages of Trading Futures
High liquidity is one of the most important benefits of futures markets. It allows traders to enter and exit the market when they wish to. The liquidity is especially high in case of currencies, indexes, and commonly traded commodities. This allows traders to trade with confidence, knowing that they will be able to buy or sell their position at any time. High liquidity also helps to keep costs down, as there is no need to pay for expensive market makers. As a result, futures markets offer an efficient and cost-effective way to trade a variety of assets.
No Time Decay Involved in Futures market
In options, the value of assets declines over time and severely reduces the profitability for the trader. This is known as time decay. A futures market trader does not have to worry about time decay.
Stable Margin Requirements
Margin requirements for most of the commodities and currencies are well-established in the futures market. Thus, a trader knows how much margin he should put up in a contract.
Usually, a futures market has more volatility than the share market. Though this means more risk, it also means more opportunities and liquidity for investors to make big profits. In a futures market, an investor can make big investments even with a small amount of money.
This is because an investor usually needs to deposit 10% to 15% of the value of the trade as a margin. Thus, the real return in the case of positive trade is quite high due to lower invested capital. The futures contracts relate to weather and commodities. Where it is difficult to have any such insider information relating to weather etc., hence, there could be fewer possibilities of trading futures contracts based on insider information.
In comparison to other investments, the trading charges are less in the futures market. These contracts are good instruments for businesses to lower their risk. And, in turn, helps them to lower their input cost.
You can learn about disadvantages here.