Distinction Between Futures vs Stocks

Distinction Between Futures vs Stocks

One of the most confusing forms of investment you can get into is called derivatives. When you invest in a derivative like a stock option you are not actually buying the underlying stock. You are not buying anything tangible right now. You are buying an option to buy or sell that stock at a certain price. In other words, you are buying a right, a legal right. If you look at the term derivative, it means, the property interest derives its value on an underlying stock. Stock brokers, brokerage houses and investment forms create a derivative. These are legal fictions that can turn into reality if certain conditions happen. Stocks, on the other hand, involve buying and selling pairs right now as they exist when you buy a stock. You own that stock. You sell a stock you no longer own that stock. It’s very straight forward. It’s very tangible. When you are dealing with futures in the other hand and you really don’t have anything in your hand currently, you are just hoping that a certain condition happens. And then you either can have profit from it or you can lose money based on it. This is the key distinction between the futures and stocks.

Complexity In Tax Reporting

The great thing about trading and stocks is that your tax liability is very straight forward. You only need to figure in the amount of money you paid for the stock and deduct it from the amount of money you got when you sold the stock. If this deduction results in a positive amount, you owe Uncle Sam some money. If these results in a negative figure, Uncle Sam can give you credit in terms of a loss you can carry over to the next stock period very straight forward even if you do a lot of trading. It’s still very easy to look at the time frame when you bought a stock and when you sold a stock and see when you get money or you lose money. This is much more complicated when you are dealing with futures. Remember, futures involve certain pricing actions based on an execution time. There is a strike period when the option takes effect. In many cases, this strike period is a period of time. In other words, it’s not one specific day. It’s a range of dates. The amount of money you make depend on when you execute the option or when you take action. This can be quite complicated and you really need to work with your brokerage company to insure that you don’t paint yourself to a corner regarding tax liabilities. The best case situation is to minimize your tax liabilities while maximizing your tax profits. This is not as always easy to do. Since there is complicated timing issues involve.

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Contract Vs Ownership

As mentioned above, when you buy a future, the only thing you own really, is a right. You have a contract right where you enjoy a benefit when a certain condition happens. Obviously, if the condition is not a present, you don’t get that benefit. Compare this with ownership. You either buy something or you sell something. You either are the owner of a stock or you’re not, very black and white. With stocks, you own the stocks or you don’t. With futures, you basically have a contract right with the company who issued the future so you can get the option to do something at a certain date, or when a certain condition happens.

Margin Requirements

Most stock brokerages allow traders buy stocks on margin. However there's a certain rule to doing this. You can only buy on margin based on the value of your stock. If your stock goes up in value, you r margin account gets bigger. On the other hand, if your stock goes down in value, your margin gets smaller and there is a margin call. When a margin call happens, this can be extremely bad news, because it is either you can sell your stock to cover the margin call, or you have to put in more money into your account so the stocks don’t have to be sold. A lot of stocks crash because of margin calls. Either the investors would cash in gains they have already realized on paper or they have to sell and depressed the price. This is a key distinction between futures and a stock. With futures, you can buy margins to certain extent. This is where it can get dangerous because not only are you buying your rights, but you are not paying money for those rights. This can lead to a very dangerous situation where you are borrowing quite a bit of money to benefit from a future event that might not happen.

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Liquidity Issues

When you buy stocks, chances are, you are dealing with a market maker that has a lot of stocks to lend. This creates a market. you have to remember, when it comes to buy or sell a stock, it doesn’t necessarily mean that somebody has to be there, but the other end of the trade with the stock ready, there has to be a market maker in looking to sell you the stock in a certain price or buy the stock from you at a certain price. With stocks market makers abound. It’s not really an issue. You were always made sure that when it comes to when it’s time for you to buy or sell stocks; you can do so, close to the official price of the stock. This is not always the case with futures. Since with futures you are buying a certain right and depending on the particular underlying stock of that future, you might have to wait or you might have to pay a higher premium to get that right. You have to factor in the potential upside of the trade or else it might not work in the particular situation. Still there are market makers in futures its just the question of premium you have to pay. Since with stocks the market maker is much more establishes so the premiums tend to be small.

If you are looking to invest in stocks or futures, keep in mind that the big distinctions between the futures vs stocks. This distinctions can help you make a lot of money, or can get in the way you making substantial gains. Still there is lot to recommend futures and stocks; you just need to know exactly what you’re getting into. And of course always focus on return of investment.