Recently, I was invited to speak at a trader's meet-up in Los Angeles. It was a fun event and I met a lot of passionate and intelligent active traders. However, out of all the attendees, only about 10% had ever traded futures.
In my experience, this seems to be a common theme among retail traders, which is a shame; There are a number of reasons that equities traders should consider trading futures.
Commission Efficiency
The cost of a stock trade - even at what are considered discount brokers - can get as high as $9.95 per side. For active traders, this commission structure adds up and eats into profits or results in further loss. The E-mini S&P 500 (ES) futures by contrast averages only about $2.50 per contract. These lower transactions costs are especially advantageous to day traders.
[Stay tuned to learn more about Tradovate's game changing plans for the costs of trading futures. Tradovate will be launching soon with a cost structure that puts futures traders' interests first. Sign up here to get more information when we launch.]
24/5 Trading
Overnight risk is something equities traders have to deal with when the exchanges are closed and they are unable to manage their open positions. But the stock index futures market is open almost continuously - with the exception of two brief daily maintenance periods - from Sunday at 5:00 pm CST until Friday afternoon at 4:15, allowing around the clock access. With futures, if a market moving event happens during the week you'll never have to wait 8 hours to react to it.
Liquidity
Volume on the ES averages over 2 million contracts per day, or over $200 billion in total value. That's a lot of liquidity. And one of the benefits of that massive liquidity is a narrow spread - the difference between the bid and ask price - of only 1 tick, or $12.50 per contract. This spread translates to just .012% of the total ES contract value, roughly $105,000, making it one of the tightest spreads in any market.
All-Electronic Markets
The bane of most equities traders are the various players that stand between their orders and the exchanges, but many futures contracts, including the ES, are traded 100% electronically. This means there is no specialist, market maker, locals, or floor brokers involved in the execution of index futures, providing active traders the type of access that cannot be found with stocks.
Leverage
With equities, the maximum leverage you can get is 2x for overnight trades and 4x for day trades. With some futures contracts you can get 20x or more leverage, and even holding overnight can cost you as little as 10% of the total contract value. It must be said that leverage cuts both ways as the potential for loss is just as great as the potential for gain, but to those who know how to use leverage responsibly, trading the futures markets can have has its advantages.
No Pattern Day Trading Rule
If you do more than three equity day trades in a rolling 5-day period, you are considered a pattern day trader and must have at least $25,000 in your account or your trading privileges will be suspended. Futures accounts can be opened with as little as $4,000 and there is no pattern day trading rule, allowing you to day trade as frequently as you wish, using much less capital.
Ease of Shorting
Unlike with stocks, there are no special privileges or requirement when you short futures - you just sell the contract. Shorting equities requires a special account with higher margin use. In addition, many stocks have a limited number of shares available to short or area not shortable at all. And though there is currently no uptick rule for shorting stocks, it can be put in place temporarily, as was done during the 2008 financial crisis, or even permanently, at any time, by regulators. Futures contracts have no uptick rule, nor have they ever.
Tax Advantages
Short-term capital gains on stocks, meaning those you own for less than 12 months, are taxed at your personal income tax rate, which can vary from 10% to 39.6%. But futures are taxed using a 60/40 blended rate. 60% of your gains are taxed at long-term rates and 40% at short-term rates. Depending on your tax bracket, you may pay less taxes on the same amount of profit trading futures than you would trading equities.
Pure Plays
There is no way to effectively trade commodities using equities. Take gold for example. Trading a gold mining stock exposes you risks unrelated to the price of the commodity, and gold ETF's (as well as the ETF's of all commodities) have been shown to poorly reflect the underlying asset's value. Futures contracts are the most efficient and accurate way to trade commodities.
Related Reading
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