Trading Futures vs. Stocks: What's the Difference? (2024)

If an investor buys shares of stock, they're purchasing partial ownership of a company, with the exact portion depending on the company's total number of stock shares issued. For example, an investor who buys 1,000 shares of a company that has 1 million shares outstanding owns 0.1% of the company.

Owning shares of stock confers voting rights on some company affairs and the right to attend the company's annual shareholder meeting. Your shares represent ownership of the company's assets and a right to benefit from its future earnings (typically reported on a per-share basis). Some companies may also pay investors a quarterly or annual dividend, which is a proportion of the company's profits distributed to shareholders.

A futures contract is a legally binding agreement to buy or sell a standardized asset on a specific date or during a specific month. Futures contracts are "standardized," or effectively interchangeable, and spell out certain contract specifications, including:

• The quality and quantity of a commodity
• Unit pricing of the asset and minimum price fluctuation (tick size)
• Date and geographic location for physical "delivery" of the underlying asset (Actual delivery rarely happens because most contracts are liquidated before the delivery date. Schwab doesn't allow delivery at all.)

Some of the most widely traded futures contracts are based on major commodities, such as crude oil, corn, gold, and soybeans; others are based on stock indexes, such as the S&P 500^®, or on interest rates—10-year Treasuries, for example. It's also important to note that futures trading involves substantial risk and is not appropriate for all investors.

Major stock exchanges, such as Nasdaq^® and NYSE, provide a central forum for buyers and sellers to gather. With futures, U.S. trading occurs through exchanges like the Chicago-based CME Group (formerly, the Chicago Mercantile Exchange), the ICE (Intercontinental Exchange), and Cboe (Chicago Board Options Exchange).With both futures and stocks, nearly all trading is done electronically.

Many exchanges operate clearinghouses, which serve as backstops or "counterparties" for every trade.

To place a buy or sell order in stocks or futures, an investor would most likely open an account with a broker (many futures brokers are known as futures commission merchants). With both stocks and futures, there are different types of orders investors should understand.

This is an important distinction. An investor could, in theory, hold shares of a company forever as long as the company remains publicly traded. However, there are a number of reasons this may not happen—for example, if the company is acquired or if it converts into a private entity.

A futures contract, in contrast, has a fixed life. A crude oil June 2023 futures contract, for example, expires on a certain date based on the contract specifications. As a contract nears its expiration, many futures traders close or "roll" their positions into a later month because many firms don't allow physical delivery and will close the position prior to expiration.

In the equity market, buying on margin means borrowing money—using leverage from a broker to purchase stock. Margin is effectively a loan from the brokerage firm. Margin trading allows investors to buy more stock than they normally could, often with the aim of magnifying gains (although margin will also magnify losses).

Under the Federal Reserve's Regulation T, or "Reg T," investors with margin accounts can usually borrow up to 50% of the purchase price of eligible securities (also known as "initial margin," some brokerages require a deposit greater than 50% of the purchase price).

Margin works differently in the futures market because it is not a loan.

When trading futures, a trader puts down a good-faith deposit called the initial margin requirement, which ensures each party (buyer and seller) can meet the obligations of the futures contract. Initial margin requirements vary by product and market volatility and are typically a small percentage of the notional value of the contract—often 3% to 12%.

The futures market offers exposure to some of the world's most important commodities and can be a tool to help diversify or hedge a portfolio or speculate on the underlying commodity.

An investor could use futures as an approximate hedge. For example, an investor might observe some correlation between stock and oil prices. Taking a short position on futures might provide profits if oil prices fall, while maintaining long-term bullish positions in oil stocks. There are various ways to use the way short contracts are sold based on size and correlation of stock position to create an approximate hedge. However, it’s important to note that an attempted hedge does not guarantee profits or guarantee a specific limit to losses. Instead, an attempt to use futures as an approximate hedge to a stock position could potentially result in losses.

A futures or stock position can also quickly turn against you, however, and heavy leverage could make matters worse.

Because margin magnifies both profits and losses, it's possible to lose more than the initial amount used to purchase the stock. If prices move against a futures trader's position, it can produce a margin call, which means more funds must be immediately added to the trader's account. If the trader doesn't supply sufficient money in time, the futures position may be liquidated.

Margin calls can also happen in stock trading, so it's important to understand the basics of margin.