How do futures and stocks relate to each other in the stock market?

 Hello, I'm a dreamy pig who always wants to grow and share information! Today we're going to learn about futures in the stock market, their relationship with stocks, and their impact. It's not uncommon to see articles in the news about how futures prices have risen and how the stock price is expected to change accordingly, but what is the relationship and why should we care about futures prices?

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1. Stocks and Futures (Futures), two terms that can be confusing

 1.1 What is a stock (STCOK)?

   Stocks are securities that represent partial ownership in a company. They give you the opportunity to invest in a company and profit from it, and you can expect the stock price to rise as the company grows.

• Examples: Samsung Electronics Stock, Amorepacific Stock, Tesla Stock, Apple Stock

 1.2 What are Futures?

   Futures are contracts to buy or sell an asset at a specific price on a specific date in the future. Stock futures are futures contracts with a stock as the underlying asset, and investors buy or sell futures based on their expectations of how the stock price will change. A similar example is when a kimchi making company contracts in advance with a private company or a large paddy field owner for a large amount of cabbage and gets it at a contracted price regardless of whether the price of cabbage skyrockets or falls.

• Examples: COSPI 200 Futures, Stock Futures, Gold Futures, Oil Futures

 

2. An interesting relationship: the interaction between futures and stocks

2.1 Futures Price Determinants

Futures prices are determined by the following factors

• Spot Stock Price: Futures prices generally parallel spot stock prices.
• Interest Rates: Interest rate changes can affect the price of futures.
• Supply and demand: Investors' demand to buy and sell futures affects the price of futures.
• Other factors: A variety of factors can affect the price of futures, including market sentiment, economic conditions, news, and more.
• For example, if we think that we're going to need more and more semiconductors, AI chipsets, and so on, and the demand increases, the futures prices will fluctuate accordingly, right?

2.2 Advantages and disadvantages of trading futures

Pros:

• Hedging: It can be used as a hedging strategy to reduce the risk of losses. If you think that the stock you own will fall in the future, you can buy a futures contract at a higher price than the price it will fall at, and avoid losses afterwards, right?
• Monetization: Provides monetization opportunities through predictions of stock price movements.
• The Leverage Effect: A small amount of capital can go a long way. Futures in particular can be leveraged anywhere from 10x to 100x, depending on the instrument. However, leverage can be a double-edged sword.!!!!

Cons:

• High volatility: Futures are more volatile than stocks, making them more risky.
• Complexity: Futures trading is more complex than stock trading and requires specialized knowledge.
• Margin trading: Futures trading is based on margin trading, which means that you need to replenish additional funds in case of losses. To give you an example, you don't need to pay the full $50,000 to trade a $50,000 trade, just a few hundred dollars, but you need to have margin in your account, and if you don't have enough margin, you'll be forced to make a margin call and get liquidated against your will.
• To make it a little easier, let's say you buy a stock futures contract for  100,000 with 10x leverage. In this case, the investor would only pay a margin of  10,000 and borrow  90,000 to trade. If the investor is unable to come up with additional funds, the broker can sell the investor's holdings to cover the loss. In this case, the investor risks losing not only the original $1, but also their holdings. If the price of the stock drops by  10%, the investor's loss would be $1. However, because of the leverage effect, the investor's loss is applied to their margin of 10,000 won, wiping out their margin. At this point, the investor will have to pay an additional 10,000 won.

3. Impact on the stock market

3.1 Increased price volatility

   Futures trading can increase stock market volatility. Investors' activity in buying and selling futures affects stock price movements, which can become more volatile, especially as the expiration date approaches. When futures prices rise, investors tend to anticipate higher stock prices and increase their purchases, causing the stock price to rise.

3.2 Increase market liquidity

   Futures trading can improve the  liquidityof the stock market. Futures trading allows investors to utilize a variety of investment strategies, which contributes to market activity.

3.3 Increase Information Efficiency

     Futures prices can increase the information efficiency of the stock market because they reflect information about future stock prices. Investors can use futures prices to predict the future direction of stock prices and formulate investment strategies. As mentioned earlier, they can also use the information to hedge their risk by setting the futures price before a stock price decline.

 

4. Utilize investment strategies

4.1 Hedging strategies

    You can use a hedging strategy that leverages futures to reduce the risk of loss. For example, an investor holding a portfolio of stocks can reduce their downside risk by selling stock futures.

4.2 Monetization strategies

    You can use futures to employ a strategy that makes money based on your expectations of stock price movements. For example, an investor who expects a stock price to rise can profit by buying stock futures.

4.3 Leveraged strategies

    Futures trading takes advantage of the leverage effect, which allows you to make a large investment with a small amount of capital. However, the leverage effect also increases the risk of loss, so be careful - for example, you can invest 100 million won with 10 million won. And watch out for margin calls!

5. Notes

    Trading futures is more complex and risky than trading stocks, so it's important for investors to gain sufficient understanding and experience before starting to trade futures. Here are some things to keep in mind when trading futures.

• Sufficient learning: You should learn enough about the basic principles and features of futures trading.
• Risk management: Futures trading has a high risk of loss and requires thorough risk management.
• Set your investment goals: You should clearly set your investment goals and develop a strategy to achieve them.
• Refer to expert opinion: We recommend that you consult with an expert when necessary to make investment decisions.

7. additional information

• https://www.fss.or.kr/
• https://www.moef.go.kr/sisa/dictionary/detail?idx=2844

Financial Conduct Authority website

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8. closing remarks

• Trading futures is more complex and risky than trading stocks, so it's important to learn and gain experience before investing. A good way to do this is by using a demo trade.
• Futures trading utilizes the leverage effect, which allows you to make a large investment with a small amount of capital. However, the leverage effect also increases the risk of loss, so you need to be careful. It's not uncommon to see videos on YouTube of people making a lot of money trading futures and then getting margin calls.
• You need to be clear about your investment goals and have a strategy in place to achieve them.
• I don't trade futures, but I do watch futures price trends. I'm only interested in them to the extent that I use them to gauge the direction of stocks.